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Annual
^Report
V j 2002
Board of Governors of the Federal Reserve System
This publication is available from the Board of Governors of the Federal Reserve System,
Publications Fulfillment, Mail Stop 127, Washington, DC 20551. It is also available on the
Board's web site, at www.federalreserve.gov.
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., April 2003
THE SPEAKER OF
THE HOUSE OF REPRESENTATIVES
Pursuant to the requirements of section 10 of the Federal Reserve Act,
I am pleased to submit the eighty-ninth annual report of the Board of Governors
of the Federal Reserve System.
This report covers operations of the Board during calendar year 2002.
Sincerely,
Contents
Monetary Policy and Economic Developments
3 MONETARY POLICY AND THE ECONOMIC OUTLOOK
4 Monetary Policy, Financial Markets, and the Economy over 2002 and Early 2003
8 Economic Projections for 2003
11
12
14
20
21
23
25
27
34
ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2002 AND EARLY 2003
The Household Sector
The Business Sector
The Government Sector
The External Sector
The Labor Market
Prices
U.S. Financial Markets
International Developments
41 MONETARY POLICY REPORT OF JULY 2002
41 Monetary Policy and the Economic Outlook
45 Economic and Financial Developments in 2002
Federal Reserve Operations
69
69
CONSUMER AND COMMUNITY AFFAIRS
Supervision for Compliance with Consumer Protection and
Community Reinvestment Laws
79 Implementation of Statutes Designed to Inform and Protect Consumers
82 Consumer Complaints
84 Advice from the Consumer Advisory Council
86 Promotion of Community Development in Historically Underserved Markets
93
94
95
105
114
115
115
121
123
BANKING SUPERVISION AND REGULATION
Scope of Responsibilities for Supervision and Regulation
Supervision for Safety and Soundness
Supervisory Policy
Supervisory Information Technology
Staff Development
Regulation of the U.S. Banking Structure
Enforcement of Other Laws and Regulations
Federal Reserve Membership
125
125
126
131
131
134
134
134
135
136
136
136
138
FEDERAL RESERVE BANKS
Major Initiatives
Developments in Federal Reserve Priced Services
Developments in Currency and Coin
Developments in Fiscal Agency and Government Depository Services
Electronic Access
Information Technology
Examinations of the Federal Reserve Banks
Income and Expenses
Holdings of Securities and Loans
Volume of Operations
Federal Reserve Bank Premises
Pro Forma Financial Statements for Federal Reserve Priced Services
143 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE
AND RESULTS ACT
143 Strategic and Performance Plans and Performance Report
143 Mission
143 Goals and Objectives
144 Interagency Coordination
147 FEDERAL LEGISLATIVE DEVELOPMENTS
Records
151 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS
151 Regulation A (Extensions of Credit by Federal Reserve Banks) and
Regulation D (Reserve Requirements of Depository Institutions)
151 Regulation C (Home Mortgage Disclosure)
153 Regulation D
154 Regulation H (Membership of State Banking Institutions
in the Federal Reserve System)
154 Regulation H and Regulation Y (Bank Holding Companies
and Change in Bank Control)
155 Regulation K (International Banking Operations)
155 Regulation W (Transactions between Member Banks and Their Affiliates)
156 Policy Statements and Other Actions
157 Discount Rates in 2002
161 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS
161 Authorization for Domestic Open Market Operations
163 Guidelines for the Conduct of System Open Market Operations
in Federal Agency Issues
163 Domestic Policy Directive
163 Authorization for Foreign Currency Operations
165 Foreign Currency Directive
165 Procedural Instructions with Respect to Foreign Currency Operations
166 Meeting Held on January 29-30, 2002
180 Meeting Held on March 19, 2002
189 Meeting Held on May 7, 2002
197 Meeting Held on June 25-26, 2002
205 Meeting Held on August 13, 2002
213 Meeting Held on September 24, 2002
220 Meeting Held on November 6, 2002
229 Meeting Held on December 10, 2002
237 LITIGATION
237 Litigation under the Gramm-Leach-Bliley Act
237 Other Actions
Federal Reserve System Organization
241
BOARD OF GOVERNORS
244 FEDERAL OPEN MARKET COMMITTEE
245
ADVISORY COUNCILS TO THE BOARD OF GOVERNORS
245
246
247
Federal Advisory Council
Consumer Advisory Council
Thrift Institutions Advisory Council
248 FEDERAL RESERVE BANKS AND BRANCHES
248 Officers of the Banks and Branches
249 Conference of Chairmen
249 Conference of Presidents
250 Conference of First Vice Presidents
250 Directors of the Banks and Branches
267
HISTORICAL RECORDS: MEMBERS OF THE BOARD OF GOVERNORS,
1913-2002
Statistical Tables
272
276
280
281
282
286
290
291
292
293
294
295
296
302
1. Statement of Condition of the Federal Reserve Banks, by Bank,
December 31, 2002 and 2001
2. Federal Reserve Open Market Transactions, 2002
3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities,
December 31, 2000-02
4. Number and Annual Salaries of Officers and Employees of the Federal Reserve
Banks, December 31, 2002
5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002
6. Income and Expenses of the Federal Reserve Banks, 1914-2002
7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve
Banks and Branches, December 31, 2002
8. Operations in Principal Departments of the Federal Reserve Banks, 1999-2002
9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions,
December 31, 2002
10. Reserve Requirements of Depository Institutions, December 31, 2002
11. Initial Margin Requirements under Regulations T, U, and X
12. Principal Assets and Liabilities and Number of Insured Commercial Banks
in the United States, by Class of Bank, June 30, 2002 and 2001
13. Reserves of Depository Institutions, Federal Reserve Bank Credit,
and Related Items, Year-End 1918-2002 and Month-End 2002
14. Banking Offices and Banks Affiliated with Bank Holding Companies
in the United States, December 31, 2001 and 2002
Federal Reserve System Audits
305 AUDITS OF THE FEDERAL RESERVE SYSTEM
307 BOARD OF GOVERNORS FINANCIAL STATEMENTS
317 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS
328 OFFICE OF INSPECTOR GENERAL ACTIVITIES
329 GENERAL ACCOUNTING OFFICE REVIEWS
331
MAPS OF THE FEDERAL RESERVE SYSTEM
335
INDEX
Monetary Policy and
Economic Developments
Monetary Policy and the Economic Outlook
The economy of the United States has
suffered a series of blows in the past few
years, including the fall in equity market
values that began in 2000, cutbacks in
capital spending in 2001, the horrific
terrorist attacks of September 11, the
emergence of disturbing evidence of
corporate malfeasance, and an escalation of geopolitical risks. Despite
these adversities, the nation's economy
emerged from its downturn in 2001 to
post moderate economic growth last
year. The recovery was supported by
accommodative monetary and fiscal
policies and undergirded by unusually
rapid productivity growth that boosted
household incomes and held down business costs. The productivity performance was also associated with a rapid
expansion of the economy's potential,
and economic slack increased over the
year despite the growth in aggregate
demand.
After turning up in late 2001, activity
began to strengthen more noticeably
early last year. Sharp inventory cutbacks
in 2001 had brought stocks into better
alignment with gradually rising final
sales, and firms began to increase production in the first quarter of 2002 to
curtail further inventory runoffs. Moreover, businesses slowed their contraction of investment spending and began
to increase outlays for some types of
capital equipment. Household spending
on both personal consumption items and
NOTE. The discussion here and in the next
section ("Economic and Financial Developments
in 2002 and Early 2003") consists of the text,
tables, and selected charts from the Monetary Policy Report submitted to the Congress on February 11, 2003, pursuant to section 2B of the Federal
Reserve Act.
housing remained solid and was supported by another installment of tax
reductions, widespread price discounting, and low mortgage interest rates.
By midyear, the cutbacks in employment came to an end, and private payrolls started to edge higher.
Although economic performance
appeared to be gradually improving, the
tentative nature of this improvement
warranted the continuation of a highly
accommodative stance of monetary policy. Accordingly, the Federal Open Market Committee (FOMC) held the federal
funds rate at P/4 percent through the
first part of the year. In March, however,
the FOMC shifted from an assessment
that the risks over the foreseeable future
to its goals of maximum sustainable
growth and price stability were tilted
toward economic weakness to an assessment that the risks were balanced.
Around midyear, the economy began
to struggle again. Concerns about corporate governance came to weigh
heavily on investors' confidence, and
geopolitical tensions, especially the
situation in Iraq, elevated uncertainties
about the future economic climate.
Equity prices fell during the summer,
liquidity eroded in corporate debt markets, and risk spreads widened. Businesses once again became hesitant to
spend and to hire, and both manufacturing output and private payrolls began
to decline. State and local governments
struggled to cope with deteriorating
fiscal positions, and the economies
of some of our major trading partners
remained weak. Although the already
accommodative stance of monetary policy and strong upward trend of productivity were providing important support
89th Annual Report, 2002
to spending, the Committee perceived a
risk that the near-term weakening could
become entrenched. In August, the
FOMC adjusted its weighting of risks
toward economic weakness, and in
November, it reduced the targeted
federal funds rate 50 basis points, to
\lA percent. The policy easing allowed
the Committee to return to an assessment that the risks to its goals were
balanced. With inflation expectations
well contained, this additional monetary
stimulus seemed to offer worthwhile
insurance against the threat of persistent
economic weakness and substantial
declines in inflation from already low
levels.
On net, the economy remained sluggish at the end of 2002 and early this
year. The household sector continued
to be a solid source of demand. Motor
vehicle sales surged at year-end on the
tide of another round of aggressive discounting by the manufacturers, other
consumer outlays trended higher, and
activity in housing markets remained
exceptionally strong. Concerns about
corporate governance appeared to
recede somewhat late last year, in part
because no new revelations of major
wrongdoing had emerged. However, the
ongoing situation in Iraq, civil strife in
Venezuela that has curtailed oil production, and tensions on the Korean peninsula have sustained investors' uncertainty about economic prospects and
have pushed prices higher on world oil
markets. Faced with this uncertainty,
businesses have been cautious in spending and changed payrolls little, on net,
over December and January.
Mindful of the especially high degree
of uncertainty attending the economic
outlook in the current geopolitical
environment, the members of the
FOMC believe the most likely outcome
to be that fundamentals will support
a strengthening of economic growth.
Business caution is anticipated to give
way over the course of the year to
clearer signs of improving sales. Inventories are lean relative to sales at
present, and restocking is likely to provide an additional impetus to production
in the period ahead. The rapid expansion
of productivity, the waning effects of
earlier declines in household wealth, and
the highly accommodative stance of
monetary policy should also continue to
boost activity. Although state and local
governments face budgetary problems,
their restraint is likely to offset only a
part of the stimulus from past and prospective fiscal policy actions at the federal level. In addition, the strengthening
economies of our major trading partners
along with the improving competitiveness of U.S. products ought to support
demand for our exports. Taken together,
these factors are expected to lead to
a faster pace of economic expansion,
while inflation pressures are anticipated
to remain well contained.
Monetary Policy, Financial
Markets, and the Economy
over 2002 and Early 2003
As economic growth picked up during
the early months of 2002, the FOMC
maintained its target for the federal
funds rate at 13A percent. A sharply
reduced pace of inventory liquidation
accounted for a significant portion of
the step-up in real GDP growth, but
other indicators also suggested that
the economy was gaining momentum.
Reductions in business outlays on equipment and software had moderated significantly after dropping precipitously
in 2001, and consumer spending was
well maintained by sizable gains in real
disposable personal income. Residential
construction activity was spurred by
low home mortgage interest rates. The
improvement in economic conditions
Monetary Policy and the Economic Outlook
5
Selected Interest Rates
mm
Percent
Ten-year Treasury
V
—
;;;
6
Two-year Treasury
Discount rate
(primary credit) —
Intended federal funds rate V>'^ V v
/\
3'
y*\,
Discount rate
(adjustment credit)
4/1S5/J5
0 / 2 7 S/21 9 / i 7 10/2 i i / 6 12/1 i 1 / 3 0
200!
5/7
6/26 8/13 9/24
2002
; 1/6 12/1.0
1/29
2003
NOTE. The data are daily and extend through
February 5, 2003. The dates on the horizontal axis are
those of scheduled FOMC meetings and of any
intermeeting policy actions. On January 9, 2003, the
Federal Reserve changed the main credit program
offered at the discount window by terminating the
adjustment credit program and beginning the primary
credit program.
sparked a rally in equity markets late in
the first quarter and pushed up yields
on longer-term Treasury instruments
and investment-grade corporate bonds;
yields on speculative-grade bonds
declined in reaction to brighter economic prospects and the perceived
reduction in credit risk. Meanwhile,
surging energy prices exerted upward
pressure on overall inflation, but stillappreciable slack in resource utilization
and a strong upward trend in privatesector productivity were holding down
core price inflation.
At both its March and May meetings,
the FOMC noted that the apparent vigor
of the economy was importantly attributable to a slowdown in the pace of
inventory liquidation and that considerable uncertainty surrounded the
outlook for final sales over the next
several quarters. The Committee was
especially concerned about prospects
for a rebound in business fixed investment, which it viewed as key to ensuring sustainable economic expansion.
Although the decline in investment
spending during the first quarter of
2002 was the smallest in a year,
gloomy business sentiment and large
margins of excess capacity in numerous industries were likely to hamper
capital expenditures. According to
anecdotal reports, many firms were
unwilling to expand capacity until they
saw more conclusive evidence of growing sales and profits. At the same time,
however, the FOMC noted that, with
the federal funds rate unusually low
on an inflation-adjusted basis and
considerable fiscal stimulus in train,
macroeconomic policies would provide strong support to further economic
expansion. Against this backdrop, the
Committee at the March 19 meeting
judged the accommodative stance of
monetary policy to be appropriate and
announced that it considered the risks
to achieving its long-run objectives
as being balanced over the foreseeable
future, judgments it retained at its meeting in early May.
89th Annual Report, 2002
The information reviewed at the
June 25-26 FOMC meeting confirmed
that the economy was expanding but at
a slower pace than earlier in the year.
As expected, the degree of impetus
to economic activity from decelerating
inventory liquidation had moderated.
Residential investment and consumer
spending also had slowed appreciably
after surging earlier in the year. The
most recent data on orders and shipments suggested a small upturn in
business spending on equipment and
software, but the improvement in capital spending appeared to be limited,
unevenly distributed across industries,
and not yet firmly indicative of sustained advance. Industrial production
continued to increase, and the unemployment rate declined somewhat.
In financial markets, investors and
lenders had apparently become more
risk averse in reaction to the mixed
tone of economic data releases, growing geopolitical tensions, further warnings about terrorist attacks, and additional revelations of dubious corporate
accounting practices. In concert, these
developments pushed down yields on
longer-term Treasury securities, while
interest rates on lower-quality corporate
bonds rose notably, and equity prices
dropped sharply. Although the economy
continued to expand and the prospects
for accelerating aggregate demand
remained favorable, downbeat business
sentiment and skittish financial markets
rendered the timing and extent of the
expected strengthening of the expansion
subject to considerable uncertainty. In
these circumstances, the FOMC left the
federal funds rate unchanged to keep
monetary policy very accommodative
and once again assessed the risks to the
outlook as being balanced.
By the time of the August 13 FOMC
meeting, it had become apparent that
economic activity had lost some of its
earlier momentum. Turbulence in financial markets appeared to be holding back
the pace of the economic expansion.
Market participants focused their attention on the lack of convincing evidence
that the recovery was gaining traction
and the possibility that more news of
corporate misdeeds would surface in the
run-up to the Securities and Exchange
Commission's August 14 deadline for
the certification of financial statements
by corporate executives. Although the
cumulative losses in financial wealth
since 2000 were restraining expenditures by households, very low mortgage
interest rates were helping to sustain
robust demand for housing. Moreover,
the financial resources made available
by a rapid pace of mortgage refinancing
activity, in combination with attractive
incentives offered by auto manufacturers, supported other consumer spending.
The Committee continued to judge the
prevailing degree of monetary accommodation as appropriate to foster a solid
expansion that would bring the economy to fuller resource utilization. At the
same time, the Committee recognized
the considerable risks to that outlook
and the potential adverse consequences
for economic prospects from possible
additional deterioration of financial conditions. The members noted, however,
that a further easing of monetary policy,
if it came to be viewed as appropriate,
could be accomplished in a timely manner. In light of these considerations, the
FOMC opted to retain a target rate of
PA percent for the federal funds rate,
but it viewed the risks to the economy as
having shifted from balanced to being
tilted toward economic weakness.
When the FOMC met on September 24, data indicated that economic
growth had picked up in the third quarter, on average, buoyed in part by a
surge in motor vehicle production. The
uneventful passing of the mid-August
Monetary Policy and the Economic Outlook
deadline for recertification of corporate
financial statements briefly alleviated
investors' skittishness in debt and equity
markets. However, the most timely
information suggested that some softening in economic activity had occurred
late in the summer. Those economic
reports, along with a darker outlook for
corporate profits and escalating fears of
a possible war against Iraq, led market
participants to revise down their expectations for the economy. Equity prices
and yields on both longer-term Treasury
and private securities moved sharply
lower in early autumn. In the Committee's view, heightened geopolitical tensions constituted a significant additional
source of uncertainty clouding the economic outlook. Still, fundamentals suggested reasonable prospects for continued expansion. Accordingly, the FOMC
left the federal funds rate unchanged at
the close of the September meeting but
also reiterated its view that the risks to
the outlook were weighted toward economic weakness.
The information reviewed at the
November 6 meeting indicated a more
persistent spell of below-par economic
performance than the FOMC had anticipated earlier. With home mortgage rates
at very low levels, residential construction activity remained high. But
consumer spending had decelerated
noticeably since midsummer under the
combined weight of stagnant employment and declining household wealth
resulting from further decreases in
equity prices. Worries about the potential for war against Iraq, as well as
persistent concerns about the course of
economic activity and corporate earnings, were apparently engendering a
high degree of risk aversion among business executives that was constraining
capital spending and hiring. Despite a
weakening in the exchange value of the
dollar, sluggish economic growth among
major trading partners spelled difficulties for U.S. exports, and a rebound in
foreign output seemed more likely to
follow than to lead a rebound at home.
Moreover, economic slack that was
larger and more persistent than previously anticipated ran the risk of reducing core inflation appreciably further
from already low levels. Given these
considerations, the Committee lowered
its target for the federal funds rate
Vi percentage point, to \lA percent. The
relatively aggressive adjustment in the
stance of monetary policy was deemed
to offset the potential for greater economic weakness, and the Committee
accordingly announced that it judged
risks to the outlook as balanced with
respect to its long-run goals of price
stability and sustainable economic
growth.
When the FOMC met on December 10, overall conditions in financial
markets had calmed considerably. Indicators of production and spending, however, remained mixed. The manufacturing sector registered large job losses in
the autumn, and industrial production
continued its slide, which had begun
around midyear. A more vigorous
rebound in business fixed investment
was not evident, and indeed the recent
data on orders and shipments and anecdotal reports from business contacts
generally signaled continued softness in
capital spending. Very low home mortgage interest rates were supporting residential construction activity, but consumption expenditures were sluggish.
On balance, the Committee's view was
that in the absence of major shocks
to consumer and business confidence,
a gradual strengthening of the economic
expansion was likely over the coming quarters, especially given the very
accommodative stance of monetary policy and probable further fiscal stimulus.
The FOMC left the federal funds rate
8
89th Annual Report, 2002
unchanged and indicated that it continued to view the risks to the outlook as
balanced over the foreseeable future.
By the time of the FOMC meeting on
January 28-29, 2003, it had become
apparent that the economy had grown
only slowly in the fourth quarter of last
year, but little evidence of cumulating
weakness appeared in the most recent
data, and final demand had held up reasonably well. The escalation of global
tensions weighed heavily on business
and investor sentiment. Firms apparently were remaining very cautious in
their hiring and capital spending, and
equity prices had declined on balance
since the December meeting. But yield
spreads on corporate debt—especially
for riskier credits—narrowed further,
and longer-term Treasury yields
declined slightly. Although the fundamentals still pointed to favorable prospects for economic growth beyond the
near term, geopolitical developments
were making it especially difficult to
gauge the underlying strength of the
economy, and uncertainties about the
economic outlook remained substantial.
Against this background, the Committee
decided to leave the federal funds rate
unchanged and stated that it continued
to judge the risks to the outlook as
balanced.
Economic Projections for 2003
An unusual degree of uncertainty
attends the economic outlook at present,
in large measure, but not exclusively,
because of potential geopolitical developments. But Federal Reserve policymakers believe the most probable outcome for this year to be a pickup in the
pace of economic expansion. The central tendency of the real GDP forecasts
made by the members of the Board
of Governors and the Federal Reserve
Bank presidents is 3lA percent to
3V2 percent, measured as the change
between the final quarter of 2002 and
the final quarter of this year. The full
range of these forecasts is 3 percent to
33/4 percent. Of course, neither the central tendency nor the range is intended
to convey the uncertainties surrounding
the individual forecasts of the members.
The civilian unemployment rate is
expected to end the year in the 53A percent to 6 percent range.
Apart from the geopolitical and other
uncertainties, the forces affecting
demand this year appear, on balance,
conducive to a strengthening of the
economic expansion. Monetary policy
remains highly accommodative, and
federal fiscal policy is and likely will
be stimulative. However, spending by
many state and local governments will
continue to be restrained by considerable budget difficulties. Activity abroad
is expected to improve this year, even if
at a less robust pace than in the United
States; such growth together with the
improving competitiveness of U.S. products should generate stronger demand
for our exports. Furthermore, robust
gains in productivity, though unlikely to
be as large as in 2002, ought to continue
to promote both household and business
spending. Household purchasing power
should be supported as well by a retreat
in the price of imported energy products
that is suggested by the oil futures market. And the adverse effects on household spending from past declines in
equity wealth probably will begin to
wane.
A reduction of businesses' hesitancy
to expand investment and hiring is
critical to the durability of the expansion, and such a reduction should occur
gradually if geopolitical risks ease and
profitability improves. Inventories are
relatively lean, and some restocking
ought to help boost production this year,
albeit to a much smaller extent than did
Monetary Policy and the Economic Outlook
9
Economic Projections for 2003
Percent
Indicator
MEMO:
Federal Reserve Governors
and Reserve Bank presidents
2002 actual
Range
Change, fourth quarter to fourth quarter^
Nominal GDP
Real GDP
PCE chain-type price index
Average level, fourth quarter
Civilian unemployment rate
Central
tendency
4.1
2.8
W2SV2
3-33/4
43/4-5
3!/*-3V£
1.9
VA-VA
VA-V/2
5.9
53/4-6
53/4-6
1. Change from average for fourth quarter of previous
year to average for fourth quarter of year indicated.
last year's cessation of sharp inventory
liquidations. In addition, the continued
growth of final sales, the tax law provision for partial expensing of equipment
purchases, replacement demand, and a
more hospitable financial environment
should induce many firms to increase
their capital spending. The growth of
investment likely will be tempered,
however, by the persistence of excess
capital in some areas, notably the telecommunications sector, and reductions
in business spending on many types of
new structures may continue this year.
Federal Reserve policymakers believe
that consumer prices will increase less
this year than in 2002, especially if
energy prices partly reverse last year's
sharp rise. In addition, resource utilization likely will remain sufficiently slack
to exert further downward pressure
on underlying inflation. The central tendency of FOMC members' projections
for increases in the chain-type price
index for personal consumption expenditures (PCE) is IV4 percent to IV2 percent this year, lower than the actual
increase of about 2 percent in 2002. •
11
Economic and Financial Developments
in 2002 and Early 2003
In 2002, the United States economy
extended the upturn in activity that
began in late 2001. Real GDP increased
23/4 percent over the four quarters of last
year, according to the advance estimate
from the Commerce Department. However, the pace of activity was uneven
over the course of the year, as concerns
about emerging economic and political
developments at times weighed heavily on an economy already adjusting to
a succession of shocks from previous
years.
Economic
conditions
improved
through the first part of the year. Household spending on both personal consumption items and housing remained
solid, businesses curtailed their inventory liquidation and began to increase
their outlays for some types of capital equipment, and private employment
started to edge higher. But the forward
momentum diminished noticeably later
in the year when concerns about corporate governance put a damper on finanChange in Real GDP
Percent, annual rate
lllkJi
L__
1996
L
J
J.. •
1998
2000
I
— 4
i_J
2002
NOTE. Here and in subsequent charts, except as noted,
annual changes are measured from Q4 to Q4, and
change for a half-year is measured between its final
quarter and the final quarter of the preceding period.
cial markets and geopolitical developments boosted oil prices and added
to the uncertainty already faced by
businesses about the economic outlook.
In the summer, equity prices fell, risk
spreads widened, and liquidity eroded in
corporate debt markets. Businesses' caution was reflected in their reluctance to
substantially boost investment, restock
inventories, or add to payrolls. Responding to these developments, as well
as some weakening in demand from
abroad, manufacturers trimmed production during the fall. Employment at private businesses declined again, and the
unemployment rate rose to 6 percent in
December. However, despite the modest
pace of last year's overall recovery,
output per hour in the nonfarm business sector grew 33A percent over the
year—an extraordinary increase even by
the standards of the past half decade or
so.
Signals on the trajectory of the economy as we enter 2003 remain mixed.
Some of the factors that had noticeably
restrained the growth of real GDP in the
fourth quarter of last year—most especially a sharp decline in motor vehicle
production—are not on track to be
repeated. Moreover, employment leveled off on average in December and
January, and readings on industrial production have had a somewhat firmer
tone of late. Nevertheless, the few data
in hand suggest that the economy has
not yet broken out of the pattern of
subpar performance experienced over
the past year.
Consumer price inflation moved up a
bit last year, reflecting sharply higher
12
89th Annual Report, 2002
Change in PCE Chain-Type Price Index
Percent, annual rate
• Total
H Excluding food and energy
1996
1998
2000
NOTE. The data are for
expenditures (PCE).
personal
.-,
2002
consumption
energy prices. Excluding the prices of
food and energy items, the price index
for personal consumption expenditures
increased 13A percent, about lA percentage point less than in 2001; this
deceleration most likely resulted from
continued slack in labor and product
markets, robust gains in productivity,
and somewhat lower expectations of
future inflation.
The Household Sector
Consumer Spending
Consumer spending grew at a moderate
pace last year and, on the whole, continued to be an important source of support
for overall demand. Personal consumption expenditures rose 2lA percent in
real terms, near the 23A percent increase
in 2001 and down from the more than
4 percent average growth over the
preceding several years. Sales of new
motor vehicles fell only a little from
the extremely high levels of late 2001;
outlays were especially strong during
the summer and late in the year, when
manufacturers were offering aggressive
price and financing incentives. Growth
of spending on other durable goods
was well maintained last year as well,
although the gains were smaller than is
often seen early in an economic recovery; in contrast to the situation in many
previous cycles, spending on durable
goods did not decline sharply during
the recession and so had less cause to
rebound as the recovery got under way.
Apart from outlays on durable goods,
spending for most categories of consumer goods and services increased at a
moderate rate last year.
That moderate rate of aggregate consumption growth was the product of
various crosscurrents. On the positive
side, real disposable personal income
rose nearly 6 percent last year, the
fastest increase in many years. Strong
productivity growth partially offset
the effects of stagnant employment in
restricting the growth of household
income, and the phase-in of additional
tax reductions from the Economic
Growth and Tax Relief Reconciliation
Act of 2001 boosted household purchasing power appreciably. In addition, high
levels of mortgage refinancing allowed
homeowners to reduce their monthly
payments, pay down more costly consumer credit, and, in many cases, extract
equity that could be used to support
other spending. On the negative side,
household wealth again moved lower
last year, as continued reductions in
equity values outweighed further appreciation of house prices. By the end of
Change in Real Income and Consumption
Percent, annual rate
I Disposable personal income
1 Personal consumption
n
jj
expenditures
—
•III••I
J
1996
J
1998
2000
J_
2002
6
Economic and Financial Developments in 2002 and Early 2003
the third quarter, according to the Federal Reserve's flow-of-funds accounts,
the ratio of household net worth to disposable income had reversed nearly all
of its run-up since the mid-1990s.
Consumer confidence, which had
declined during most of 2001 and especially after the September 11 attacks,
picked up in the first half of last year,
according to both the Michigan Survey
Research Center (SRC) and Conference
Board surveys. However, confidence
retreated over the summer along with
the drop in equity prices, and by early
this year, consumer confidence again
stood close to the levels of late 2001.
These levels of consumer confidence,
though at the bottom of readings of the
past several years, are nevertheless
above levels normally associated with
recession.
The personal saving rate, which has
trended notably lower since the early
1980s, moved above 4 percent by late
last year after having averaged 2lA percent in 2001. The saving rate has been
buffeted during the past two years by
surges in income induced by tax cuts
and by spikes in spending associated
with variations in motor vehicle incentives. But, on balance, the extent of
the increase in the saving rate has
been roughly consistent with a gradual
response of consumption to the reduction in the ratio of household wealth to
disposable income.
Residential Investment
Real expenditures on residential investment increased 6 percent in 2002—the
largest gain in several years. Demand
for housing was influenced by the same
factors affecting household spending
more generally, but it was especially
supported by low interest rates on mortgages. Rates on thirty-year fixed-rate
mortgages, which stood at around 7 per
13
cent in the first months of the year, fell
to around 6 percent by the autumn and
dipped below that level early this year—
the lowest in thirty-five years. Not surprisingly, attitudes toward homebuying,
as measured by the Michigan SRC,
remained quite favorable.
Starts of new single-family homes
were at 1.36 million units last year,
7 percent above the already solid pace
for 2001. Sales of both new and existing
homes were brisk as well. Home prices
continued to rise but at a slower rate
than in 2001, at least according to some
measures. The repeat-sales price index
for existing homes rose 5Vi percent over
the four quarters ended in 2002:Q3, a
slowing from the S3A percent increase
over the comparable year-earlier period.
The constant-quality price index for new
homes rose 4V2 percent last year, but
this increase was close to the average
pace over the past few years. At the
same time, measures of house prices
that do not control for the mix of homes
sold rose considerably more last year
than in 2001, a difference indicating that
a larger share of transactions were in
relatively expensive homes.
In the multifamily sector, starts averaged a solid 345,000 units last year,
an amount in line with that of the preceding several years. However, the pace
of building slowed a little in the fall.
Apartment vacancy rates moved notably
higher last year and rent and property
values declined; these changes suggest
that the strong demand for single-family
homes may be eroding demand for
apartment space.
Household Finance
Households continued to borrow at a
rapid pace last year; the 9Vi percent
increase in their debt outstanding was
the largest since 1989. Low mortgage
interest rates helped spur both very
14
89th Annual Report, 2002
strong home purchases and refinancing of existing loans, which together
increased home mortgage debt 11V^ percent. Refinancing activity was especially
elevated in the fourth quarter, when
fixed mortgage interest rates dipped
to around 6 percent. Torrid refinancing
activity helps explain last year's slowdown of consumer credit, which is
household borrowing not secured by real
estate: A significant number of households reportedly extracted some of the
equity from their homes at the time of
refinancing and used the proceeds to
repay other debt as well as to finance
home improvements and other expenditures. According to banks that participated in the Federal Reserve's Senior
Loan Officer Opinion Survey on Bank
Lending Practices in October, the frequency and size of cash-out refinancings were substantially greater than had
been reported in the January 2002 survey. Although automakers' financing
incentives and attractive cash rebates
stimulated a substantial amount of consumer borrowing, the growth rate of
consumer credit in 2002, at AlA percent,
was more than 2Vi percentage points
below the pace in 2001.
Even though households took on a
large amount of mortgage debt last year,
extraordinarily low mortgage rates kept
the servicing requirement for that debt
(measured as a share of homeowners'
disposable income) well below its previous peak levels. Moreover, reflecting large gains in residential real estate
values, equity in homes has continued
to increase despite sizable debt-financed
extractions. The combined influence
of low interest rates and the sizable
gain in disposable personal income also
kept the total servicing costs faced by
households—which in addition to home
mortgage payments include costs of
other financial obligations such as rental
payments of tenants, consumer install
ment credit, and auto leases—relative to
their incomes below previous peaks.
Against this backdrop, broad measures
of household credit quality deteriorated
very little last year, and signs of financial stress were confined mainly to the
subprime segment of the market. Delinquency rates on home mortgages inched
up, while those on auto loans at finance
companies were flat. Delinquency rates
on credit cards bundled into securitized
asset pools remained close to those of
recent experience.
The Business Sector
Overall business fixed investment
moved lower last year, although the
decline was not nearly so precipitous as
in 2001. Outlays for equipment and software edged up, but spending on structures fell sharply. Financing conditions
worsened over the summer, with equity
prices declining, initial public offerings
(IPOs) drying up, credit market spreads
widening, and banks tightening up
somewhat on credit standards in the
wake of increased reports of corporate
malfeasance. In addition, geopolitical
concerns increased firms' already
heightened uncertainty about the economic outlook. These factors contributed to an apparent deterioration in business confidence, and businesses still
have not felt any great urgency to boost
investment appreciably. For similar reasons, although firms slowed their rate of
inventory liquidation last year, they have
yet to undertake a sustained restocking.
Fixed Investment
After dropping sharply in 2001, real
spending on equipment and software
rose 3 percent last year. Spending on
high-technology equipment, one of the
hardest-hit sectors in 2001, showed
signs of uneven improvement. The
Economic and Financial Developments in 2002 and Early 2003
Change in Real Business Fixed Investment
Percent, annual rate
• Structures
£ Equipment and software
i i j i •
n
[H High-tech equipment
and software
• Other equipment
™
—
0
— 20
— 40
— 20
1996 1997 1998 1999 2000 2001 2002
NOTE-:. High-tech equipment consists of computers
and peripheral equipment and communications
equipment.
clearest rebound was in computing
equipment, for which spending rose
25 percent in real terms; this gain fell
short of the increases posted in the late
1990s but far more than reversed the
previous year's decline. Software investment also turned positive, rising 6 percent after declining about 3 percent in
2001. By contrast, real outlays for communications equipment were reported
to be up only slightly in 2002 after
plummeting 30 percent in 2001.
Business spending on aircraft fell
sharply last year. Airlines were hit especially hard by the economic downturn
and by the reduction in air travel after
the September 11 attacks; although
expenditures for new aircraft held up
through the end of 2001 because of
the very long lags involved in producing
planes, shipments of planes slowed
greatly thereafter. Meanwhile, business
outlays on motor vehicles edged up last
year. Demand for autos and light trucks
15
by rental companies weakened sharply
along with the drop in air traffic that
occurred after September 11 but recovered gradually over the course of last
year. Purchases of medium and heavy
trucks fell off overall, despite the fact
that demand for heavy (class 8) trucks
was boosted by spending in advance of
the implementation of more-stringent
environmental regulations.
Investment in equipment other than
high-tech and transportation goods
moved modestly higher through most
of last year, as real outlays for industrial machinery and a wide range of
other equipment gradually strengthened
through the summer. Although spending
edged lower again in the fourth quarter,
investment in non-high-tech, nontransportation equipment increased 3Vz percent for the year as a whole.
Spending on equipment and software
was supported last year by low interest rates, which helped hold down the
cost of capital, as did the tax provision enacted in March 2002 that allows
partial expensing of new equipment
and software purchased before September 11, 2004. Moreover, modest
increases in final sales together with
replacement demand no doubt spurred
many firms to make new capital outlays.
Nevertheless, some sectors, most notably telecommunications, probably still
had excess holdings of some forms
of capital. Concerns about corporate
malfeasance, which had become more
intense over the spring and summer,
weighed heavily on financial markets
and raised the cost of capital through
reduced share prices and higher yields
on the bonds of lower-rated firms. In
addition, uncertainty about the geopolitical situation, including the possible
consequences for oil prices of an outbreak of war with Iraq, likely made
many firms reluctant to commit themselves to new expenditures. In all, busi-
16
89th Annual Report, 2002
nesses have been, and appear to remain,
quite cautious about undertaking new
capital spending projects.
Real business spending for nonresidential structures declined sharply for
a second year in 2002. Outlays for
the construction of office buildings
and industrial buildings were especially
weak. Vacancy rates for such buildings
increased throughout the year, and property values and rents moved lower. Construction of new hotels and motels also
fell considerably, reflecting the weakness in the travel industry. By contrast,
spending on other commercial buildings, such as those for retail, wholesale,
and warehouse space, moved only a
little lower last year.
A number of factors likely account
for investment in structures having been
much weaker than investment in equipment. Structures depreciate very slowly,
so businesses can defer new outlays
without incurring much additional
deterioration of their capital stock. And
unlike investment in equipment, spending on structures is not eligible for partial expensing. According to some analysts, concerns about additional acts of
terrorism (and, until late in the year, the
lack of insurance to cover such events)
may also have had a damping effect on
some types of construction, particularly
large "trophy" projects.
Inventory Investment
The sharp inventory runoffs that characterized the economic downturn, together
with gradually rising final sales, implied
that, by early last year, stocks were
in much better alignment with sales than
had been the case during 2001. Accordingly, businesses lessened the pace of
inventory liquidation early in the year
and by summer had turned to some
modest restocking. However, firms
appeared to have exerted tight control
over production and inventories; with
prospects for the strength of the recovery having diminished in the second
half of the year, businesses quickly cut
production, and inventories only edged
up in the fourth quarter, according to
incomplete and preliminary data. In all,
total inventories were about unchanged
last year compared with a liquidation
of more than $60 billion in 2001, and
this turnaround contributed 1 percentage point to the growth of real GDP
over the year. At year-end, inventory-tosales ratios in most sectors stood near
the low end of their recent ranges.
In the motor vehicle industry, last
year's very strong sales were matched
by high levels of production, and the
stock of inventories, especially for light
trucks, appeared at times to be higher
than the industry's desired levels. Nevertheless, the surge in sales late in the
year helped to pare stocks, and dealers
ended the year with inventories of light
vehicles at a comfortable level.
Corporate Profits and
Business Finance
The profitability of the U.S. nonfinancial corporate sector improved from its
lows of 2001 but relative to sector output remained at the low end of the
range experienced over the past thirty
years. Economic profits of nonfinancial corporations—that is, book profits adjusted for inventory valuations
and capital consumption allowances—
rebounded in late 2001 and were little
changed through the third quarter of last
year. The sluggish expansion of aggregate demand and the lack of pricing
power associated with intense competitive pressures were the main factors that
held down profits in 2002. Also playing
a role, especially in the manufacturing
sector, were costs arising from underfunded defined-benefit pension plans.
Economic and Financial Developments in 2002 and Early 2003
17
Reflecting the pause in economic
growth, earnings reports for the fourth
quarter indicate that profits may have
dropped some late in the year.
A dearth of expenditures on fixed
capital and moribund merger and acquisition activity were the chief culprits
behind the sluggish pace of nonfinancial corporate borrowing last year. Also
important was the propensity of some
firms to draw on liquid assets—which
began the year at high levels—rather
than to seek external financing. Consequently, debt of the nonfinancial corporate sector expanded only \Vi percent,
a rate slower than the already subdued
pace in 2001. The composition of business borrowing was dominated last
year, as it was in 2001, by longer-term
sources of funds. Robust demand for
higher-quality corporate debt on the part
of investors, combined with the desire
of firms to lock in low interest rates,
prompted investment-grade corporations
to issue a large volume of bonds during the first half of 2002. With funding
needs limited, investment-grade issuers continued to use the proceeds to
strengthen their balance sheets by refinancing higher-coupon bonds and by
paying down short-term obligations
such as bank loans and commercial
paper. Buoyed by declining yields, gross
issuance of below-investment-grade
bonds for the most part also held up well
during the first half, although this segment of the market was hit hard after
revelations of corporate malfeasance, as
investors shunned some of the riskiest
issues; issuance was especially weak in
the beleaguered telecom and energy sectors, which continue to be saddled with
overcapacity and excessive leverage.
Despite falling share prices, seasoned
equity offerings were also well maintained over the first half of the year, in
part because of the decision of some
firms—especially in the telecom and
energy sectors—to reduce leverage.
IPOs, by contrast, were sparse. The
evaporation of cash-financed mergers
and acquisitions and desire by firms to
conserve cash kept equity retirements at
their slowest pace since 1994.
Over the summer, investors grew
more reluctant to buy corporate bonds
because of concerns about the reliability of financial statements, deteriorating credit quality, and historically low
recovery rates on defaulted speculativegrade debt. Macroeconomic data suggesting that the economic recovery was
Major Components of Net Business
Financing
Spreads of Corporate Bond Yields over
the Ten-Year Treasury Yield
Billions of dollars
Commercial paper
U Bonds
H Bank loans Sum of major
components
JPnMi
s
III__
Percentage points
— 800
— 600
High yield
— 400
— 200
—
0
— 200
2000
2001
2002
NOTE. Seasonally adjusted annual rate for nonfarm
nonfinancial corporate business. The data for the sum of
major components are quarterly. The data for 2002:Q4
are estimated.
2001
2002
2003
NOTE. The data are daily and extend through
February 5, 2003. The spreads compare the yields on the
Merrill Lynch AA, BBB, and 175 indexes with the yield
on the ten-year off-the-run Treasury note.
18
89th Annual Report, 2002
losing momentum and widespread company warnings about near-term profits pushed yields on speculative-grade
debt sharply higher. Risk spreads on
investment-grade bonds also widened
appreciably in the third quarter, as yields
in that segment of the corporate bond
market declined less than those on Treasury securities of comparable maturity. Investors' aversion to risk was also
heightened by mounting tensions with
Iraq; by early autumn, risk spreads on
junk-rated bonds reached their highest levels in more than a decade. Gross
bond issuance both by investmentgrade and below-investment-grade firms
fell off markedly, and the amount of
redemptions was large. By the third
quarter, net issuance of bonds by nonfinancial corporations had turned negative for the first time since the early
1950s. Trading conditions in the corporate bond market deteriorated during this
period, as bid-asked spreads reportedly
widened in all sectors. With share prices
dropping and stock market volatility
increasing, issuance of seasoned equity
nearly stalled in the summer and early
autumn. IPOs were virtually nonexistent
amid widely publicized investigations
into the IPO allocation process at large
investment banks.
A smattering of more upbeat news
about the economy in mid-autumn and
the absence of major revelations of corporate wrongdoing sparked a rally in
equity prices and rekindled investors'
appetite for corporate debt. Over the
remainder of the year and during early
2003, risk spreads narrowed considerably on investment-grade corporate
bonds—especially for the lowest rated
of these issues—and even more on
speculative-grade bonds, although they
remained high by historical standards.
In the meantime, liquidity in the corporate bond market generally improved.
A brightening of investor sentiment
caused a rebound in gross bond issuance, with firms continuing to use bond
proceeds to refinance long-term debt
and to pay down short-term debt. Rising
stock prices and reduced volatility also
allowed seasoned equity issuance to
regain some ground in the fourth quarter. The improved tone in corporate debt
markets carried over into early 2003.
Gross corporate bond issuance continued at a moderate pace, and despite the
drop in stock prices in the latter half
of January, seasoned equity issuance has
been reasonably well maintained. IPO
activity and venture capital financing,
however, remained depressed.
The heavy pace of bond issuance,
sagging capital expenditures, and diminished merger and acquisition activity allowed firms to pay down large
amounts of both business loans at banks
and commercial paper last year. The
runoff in business loans that started
in early 2001 intensified in the first half
of 2002. At the same time, commercial
paper issuers that were perceived as having questionable accounting practices
encountered significant investor resistance, and most of these issuers discontinued their programs. Bond rating agencies stepped up the pressure on firms to
substitute longer-term debt for shorterterm debt and thereby reduce rollover
risk. In addition, banks raised the total
cost of issuing commercial paper by
tightening underwriting standards and
boosting fees and spreads on the associated backup lines of credit—especially
for lower-rated issuers. In doing so,
respondents to the April Senior Loan
Officer Opinion Survey on Bank Lending Practices cited heightened concerns
about the deterioration of issuers' credit
quality and a higher probability of lines
being drawn. Many commercial paper
issuers either turned to longer-term
financing or dropped out of the credit
markets altogether, and the volume
Economic and Financial Developments in 2002 and Early 2003
of nonfinancial commercial paper outstanding shrank about one-fourth during
the first six months of the year after
having dropped one-third in 2001.
The volatility that gripped equity and
bond markets around midyear, however, did not spill over to the commercial paper market. Quality spreads in the
commercial paper market were largely
unaffected, in part because many of the
riskiest issuers had already exited the
market, while others had strengthened
their cash positions and significantly
reduced rollover risk earlier in the year.
Indeed, because of difficulties in the corporate bond market, some nonfinancial
firms turned temporarily to the commercial paper market to obtain financing,
and the volume of outstanding paper
rose in July after a lengthy period of
declines. Over the remainder of the year,
business loans at banks and commercial paper outstanding contracted rapidly, as inventory investment remained
negligible, and firms continued to take
advantage of relatively low longer-term
interest rates by issuing bonds.
A decline in market interest rates and
improved profitability helped reduce the
ratio of net interest payments to cash
Default Rate on Outstanding Bonds
19
flow in the nonfinancial corporate sector
last year. Even so, many firms struggled
to service their debt, and corporate
credit quality deteriorated markedly. The
trailing average default rate on corporate bonds, looking back over the preceding twelve months, was already elevated and climbing when WorldCom's
$26 billion default in July propelled
the average rate to a record level. The
amount of nonfinancial corporate debt
downgraded by Moody's Investors Service last year was more than fourteen
times the amount upgraded. At less than
25 percent, the average recovery rate in
2002 on all defaulted bonds—as measured by the price of bonds at default—
was at the low end of recovery rates
over the past decade. Delinquency rates
on business loans at commercial banks
rose noticeably before stabilizing in the
second half of the year, and charge-off
rates remained quite high throughout
2002.
After expanding rapidly in 2001,
commercial mortgage debt grew much
more slowly during the first quarter of
last year, as business spending on nonresidential structures fell. Despite the
continued contraction in outlays on nonresidential structures, commercial mortRatings Changes of Nonfinancial
Corporations
Upgrades
1992 1994 1996 1998 2000 2002
NOTE. The default rate is monthly and extends
through December 2002. The rate for a given month is
the face value of bonds that defaulted in the twelve
months ending in that month divided by the face value
of all bonds outstanding at the end of the calendar
quarter immediately preceding the twelve-month period.
1996
1998
2000
NOTE. Data are at an annual rate. Debt upgrades
(downgrades) are expressed as a percentage of par value
of all bonds outstanding.
SOURCE. Moody's Investors Service.
20
89th Annual Report, 2002
gage debt accelerated over the remainder of the year, apparently because of
refinancing to extract a significant portion of equity from existing properties.
The issuance of commercial-mortgagebacked securities (CMBS), a key source
of commercial real estate financing in
recent years, was well maintained in
2002. Even as office vacancy rates rose,
the quality of commercial real estate
credit remained stable last year. Commercial banks firmed standards on commercial real estate loans in 2002, on net,
and delinquency rates on commercial
real estate loans at banks stayed at historically low levels. Delinquency rates
on CMBS leveled off after increasing
appreciably in late 2001, and forwardlooking indicators also do not suggest
elevated concerns about prospective
defaults: Yield spreads on CMBS over
swap rates remained in the fairly narrow
range that has prevailed over the past
several years.
The Government Sector
Federal Government
Despite modest economic growth, the
federal budget position deteriorated
sharply in 2002. After running a unified
budget surplus of $127 billion in fiscal
2001, the federal government posted a
deficit of $158 billion in fiscal 2002—
and that deficit would have been
$23 billion larger if not for the shifting
of some corporate tax payments from
fiscal 2001 to fiscal 2002. After adjustment for that tax shifting, receipts
declined 9 percent in fiscal 2002: A
$50 billion drop in corporate payments
stemmed largely from tax provisions
enacted in the 2002 stimulus bill (especially the partial-expensing provision on
investment), and a decline in individual
tax payments of $136 billion was largely
attributable to a drop in capital gains
realizations and to lower tax rates that
were enacted in the 2001 tax bill.
Meanwhile, federal outlays increased
nearly 8 percent in fiscal 2002 and
11 percent excluding a decline in net
interest expenses. Spending increased
notably in many categories, including
defense, homeland security, Medicaid,
and income security (which includes
the temporary extended unemployment
compensation program). Federal government consumption and investment—
the part of spending that is counted in
GDP—rose more than 7 percent in real
terms in 2002. (Government spending
on items such as interest payments
and transfers are not counted in GDP
because they do not constitute a direct
purchase of final production.)
The turn to deficit in the unified budget means that the federal government,
which had been contributing to national
saving since 1997, began to reduce
national saving last year. The reversal
more than offset an increase in saving
by households and businesses, and gross
national saving declined to 15 percent of
GDP by the third quarter of last year—
the lowest national saving rate since the
1940s.
After it reentered the credit markets
as a significant borrower of net new
funds in the second half of 2001, the
Treasury continued to tap markets in
volume last year. Federal net borrowing
was especially brisk over the first half
of the year. With federal debt rapidly
approaching its statutory borrowing
limit, the Secretary of the Treasury
declared a debt ceiling emergency on
May 16 and identified about $80 billion
worth of accounting measures that could
be used to create financing room within
the existing $5.95 trillion limit. The Secretary's announcement and subsequent
employment of one of these devices—in
which Treasury securities held in government trust funds were temporarily
Economic and Financial Developments in 2002 and Early 2003
Federal Government Debt Held
by the Public
Percent of nominal GDP
r
1
!!
1962
II
1972
t!
1982
1992
\
— 45
V^—
35
—
25
II 1
2002
NOTE. Through 2001, the data lor debt are year-end
figures and the corresponding value for GDP is for Q4
at an annual rate; the final observation is for 2002:Q3.
Excludes securities held as investments of federal government accounts.
replaced by Treasury IOUs not subject
to the debt ceiling—had little effect
on Treasury yields, as market participants were apparently confident that
the ceiling would be raised in time to
avoid default. And indeed, the Congress
approved legislation raising the statutory borrowing limit to $6.4 trillion on
June 27. With its credit needs remaining
substantial, the Treasury continued to
borrow heavily over the second half of
2002. The increase in the Treasury's net
borrowing last year caused the ratio of
publicly held debt to nominal GDP to
rise for the first time since 1993.
21
ing to the capital markets, many states
will be forced to boost revenues and
hold the line on spending.
Real expenditures for consumption
and gross investment by state and local
governments rose less than 2 percent
in 2002—the smallest increase in ten
years. The slowdown in spending
growth was widespread across expenditure categories and included notably
smaller increases in outlays for construction. Employment in the state and
local sector continued to rise in 2002,
but at a slower rate than in recent years.
Debt of the state and local government sector expanded last year at the
fastest pace since 1987. Governments
used the proceeds to finance capital
spending and to refund existing debt
in advance. Net issuance of short-term
municipal bonds was also well maintained, as California and some other
states facing fiscal difficulties turned to
shorter-term borrowing while fashioning more permanent solutions to their
budget problems. Worsening budget
situations contributed to some deterioration in municipal credit quality last
year. Credit-rating downgrades outpaced
upgrades by a significant margin, and
the yield spread of BBB-rated over
insured AAA-rated municipal bonds
rose significantly over the second half
of 2002.
State and Local Governments
State and local governments have continued to struggle in response to sluggish growth of receipts. In the current
fiscal year (which ends June 30 for most
states), most state governments are
reported to be facing significant shortfalls. Although a variety of strategies
may be available for the purpose of
technically complying with balancedbudget requirements, including tapping
nearly $20 billion in combined rainyday and general fund balances and turn
The External Sector
The U.S. current account deficit widened again in 2002 after a brief respite
during the cyclical slowdown in 2001.
Two-thirds of the expansion of the deficit last year was attributable to a decline
in the balance on goods and services,
although net investment income also fell
sharply as receipts from abroad declined
more than payments to foreign investors in the United States. The broad
exchange value of the dollar peaked
22
89th Annual Report, 2002
around February 2002 after appreciating
about 13 percent in real terms from
January 2000; in early February 2003 it
was down about 5 percent from the February 2002 level.
Trade and the Current Account
Both exports and imports rebounded in
2002 as the cyclical downturn of the
previous year was reversed and spending on travel recovered from the postSeptember 11 slump. As is often the
case, the amplitude of the recent cycle
in trade has been greater than that of real
GDP. In 2001, stagnant real GDP in the
United States and abroad was coupled
with declines of IIV2 percent in real
exports and 8 percent in real imports.
Last year, moderate growth of both
foreign and domestic real GDP was
exceeded by gains of 5 percent and
9 percent, respectively, in our real
exports and imports. The faster growth
of imports relative to exports over the
past two years was consistent with the
historical pattern in which the responsiveness of imports to income is greater
in the United States than in the rest of
the world. Although the dollar depreciated on balance last year, the lagged
effects of its prior appreciation over the
two previous years contributed to the
faster growth in imports relative to
exports in 2002.
Real exports of goods posted a strong
gain in the second quarter of 2002 after
six consecutive quarters of decline.
However, as output growth slowed
abroad, exports decelerated in the third
quarter and then fell in the fourth
quarter. On balance, exports of goods
rose about 2 percent over the course
of the year, reversing only a small
portion of the previous year's decline.
Not surprisingly, the increase in goods
exports in 2002 was concentrated in the
destinations where GDP growth was
strongest—Canada, Mexico, and several
developing Asian economies. A gain of
12 percent in real exports of services
in 2002 more than reversed the previous year's decline and reflected both
a pickup in tourism and an increase in
other private services. Export prices
turned up in the second quarter after a
year of decline and continued to rise at a
moderate pace in the second half.
The very rapid growth of real imports
of goods in the first half of last year was
a reaction to the revival of U.S. activity,
and they gained about 9 percent over
the year. The particularly large gains
in imports of consumer goods and automotive products reflected the buoyancy of U.S. consumption expenditures.
Imports of most major categories of
capital goods also increased on balance over the year. However, as with
exports, import growth was considerably stronger in the first half of the year
than in the second. This pattern likely
reflected the deceleration in U.S. GDP,
along with the effects of some depreciation of the dollar. In addition, there
may have been some shifting of import
demand from later in the year to the
earlier months as it began to appear
more likely that labor contract negotiations at West Coast ports would not
go smoothly.1 Imports of services more
than reversed their 2001 decline over
the course of the year, and gains were
recorded for both travel and other private services. Prices of non-oil imports
turned up in the second quarter after
declining over the preceding four quar1. The dispute between the Pacific Maritime
Association and the International Longshore and
Warehouse Union eventually led to an eleven-day
port closure in late September and early October
that ended when President Bush invoked the TaftHartley Act. Although the monthly pattern of trade
was influenced by the closure, the overall level of
imports for the year does not appear to have been
much affected.
Economic and Financial Developments in 2002 and Early 2003
ters, as a result of the weaker exchange
rate and a turnaround in prices of internationally traded commodities.
The spot price of West Texas intermediate crude oil climbed above $35 per
barrel in early 2003, its highest level
since the beginning of 2000. Oil prices
had fallen to around $20 per barrel during 2001 amid general economic weakness, but they began rising in February and March of last year in response
to both improving global economic activity as well as a production-limiting
agreement between OPEC and several
major non-OPEC producers. Even
though production in a number of OPEC
and non-OPEC countries in fact
exceeded the agreed limits last year,
heightened tensions in the Middle East
along with severe political turmoil in
Venezuela continued to put upward
pressure on prices. The pressure intensified late in the year as a strike in
Venezuela that began on December 2
virtually shut down that country's oil
industry, and Venezuelan oil production
was still well below pre-strike levels in
early 2003. Concern over a possible war
with Iraq, along with a very low level
of crude oil inventories in the United
States, has helped to keep spot prices
high. Also in response to the heightened
tensions, the price of gold shot up about
30 percent over the past year.
The Financial Account
The increase in the current account deficit in 2002 was about equal on balance
to the stepped-up foreign official purchases of U.S. assets, as changes in
the components of private capital flows
were offsetting. Private foreign purchases of U.S. securities were about
$360 billion at an annual rate through
November, a volume similar to last
year's total. However, there was some
shift in the composition of flows away
23
from equities and toward Treasury securities. This shift may have reflected the
damping of equity demand caused by
slower economic growth and continued
concern about corporate governance and
accounting. Over the same period, purchases by private U.S. investors of foreign securities declined nearly $100 billion. Accordingly, the net balance of
private securities trading recorded a
sharp increase in net inflows.
In contrast, net foreign direct investment inflows fell about $70 billion
between 2001 and 2002. Foreign investment in the United States and investment abroad by U.S. residents both
declined, but the decline in flows into
the United States was considerably
larger, as merger activity slowed and
corporate profits showed little vigor.
U.S. direct investment abroad held up
fairly well in 2002, a result largely
reflecting retained earnings.
The Labor Market
Employment and Unemployment
Labor markets appeared to stabilize last
spring after the sharp deterioration of
2001 and early 2002. Employment on
private payrolls, which had declined an
average of 160,000 per month in 2001,
leveled off in the spring and moved
slightly higher over the summer. But
labor demand weakened again as the
economy softened later in the summer,
and private employment declined about
80,000 per month on average in the last
four months of the year. Private payrolls rebounded nearly 150,000 in January, though the magnitude of both the
especially sharp decline in December
and the rebound in January likely was
exaggerated by difficulties in adjusting
for the normal seasonal movements in
employment during these months.
24
89th Annual Report, 2002
The manufacturing sector continued Measures of Labor Utilization
to be the weakest segment of the labor
market; even during the spring and early
summer, when the overall labor market
seemed to be improving, factory payrolls contracted on average. Declines
in factory employment were more
pronounced—at about 50,000 per
month—toward the end of the year.
Employment at help-supply firms and in
liJxMJ_LLU_LLU.ilillilLL]
LJ
wholesale trade—two sectors in which
2003
1973
1983
1993
activity closely tracks that of manufacNOTE. The data extend through January 2003. The
turing proper—rose over the summer
civilian rate is the number of civilian unemployed
but also turned down again later in the divided by the civilian labor force. The augmented rate
year. And employment in retail trade, adds to the numerator and the denominator of the
rate the number of those who are not in the labor
though quite erratic, leveled off over the civilian
force but want a job. The small break in the augmented
summer before declining further in the rate in January 1994 arises from the introduction of a
fall. However, employment in services redesigned survey. For the civilian rate, the data are
monthly; for the augmented rate, the data are quarterly
other than help supply grew reasonably through December 1993 and monthly thereafter.
steadily throughout the year and rose
nearly 50,000 per month after March;
health services and education services fits have expired to be more selective in
contributed more than half of those job accepting job offers and provides them
gains. The finance and real estate sec- with an incentive not to withdraw from
tors also added jobs last year, probably the labor force. In addition, as would be
because of the surge in mortgage refi- expected in a still-weak labor market,
nancings and high levels of activity in the labor force participation rate moved
housing markets. Last year's job losses lower last year.
in the private sector were partially offset
by an increase in government employ- Productivity and Labor Costs
ment that averaged about 20,000 per
month; the increase resulted mostly Labor productivity rose impressively in
from hiring by states and munici- 2002. Output per hour in the nonfarm
palities, but it also reflected hiring in business sector increased an estimated
the fall by the Transportation Security
Administration.
Change in Output Per Hour
Overall employment moved lower,
Percent, annual rate
on net, and the unemployment rate
increased a little less than Vz percentage
point over the year, to 6 percent, before
dropping back to 5.7 percent in Janu- 6
ary 2003. The unemployment rate
probably has been boosted slightly by
the federal temporary extended unemployment compensation program. By
extending benefits for an additional
_L_... J.
1. . . - L . . 1 . : .
1992 1994 1996 1998 2000 2002
three months, the program allows unemployed individuals whose regular beneNOTE. Nonfarm business sector.
l l -•••••• III !
Economic and Financial Developments in 2002 and Early 2003
33/4 percent from the fourth quarter
of 2001 to the fourth quarter of 2002.
Labor productivity typically suffers in
an economic downturn as businesses
reduce hours worked by proportionally
less than the decline in output; conversely, productivity typically rebounds
early in an expansion as labor is brought
back toward fuller utilization. During
the most recent downturn, however,
productivity held up comparatively well,
a performance that makes last year's
surge all the more impressive. Indeed,
productivity rose at an average annual
rate of nearly 3 percent over the past
two years, faster than the average pace
of increase during the late 1990s.
Very likely, the rapid pace of last
year's productivity growth was due
in part to the special circumstances
that developed after the September 11
attacks. Businesses cut labor substantially in late 2001 and early 2002 amid
widespread fear of a sharp decline in
demand; when demand held up better
than expected, businesses proved able to
operate satisfactorily with their existing
workforces. Moreover, the fact that this
step-up in productivity was not reversed
later in the year suggests that at least a
portion of it is sustainable. The recent
rapid growth in productivity may derive
in part from ongoing improvements
in the use of the vast amount of capital
installed in earlier years, and it may also
stem from organizational innovations
induced by the weak profit environment.
Indicators of hourly compensation
sent mixed signals last year. The rise
in the employment cost index (ECI) for
hourly compensation in private nonfarm
businesses, 3VA percent, was 1 percentage point lower than the increase in
2001. Compensation increases likely
were damped last year by the soft labor
market and expectations of lower consumer price inflation. The wages and
salaries component and the benefits
25
component of the ECI both posted
smaller increases last year. The deceleration was less pronounced for the
benefits component, however, which
was boosted by further large increases
in employers' health insurance costs.
According to the ECI, health insurance
costs, which constitute about 6 percent
of overall compensation, rose 10 percent
last year after having risen about 9 percent in each of the preceding two years.
An alternative measure of compensation costs is compensation per hour
in the nonfarm business sector, which is
derived from information in the national
income and product accounts. According to this measure, hourly compensation rose 4V4 percent last year—a little
more than the increase in the ECI and up
from a much smaller increase in 2001.
One important difference between these
two measures of compensation is that
the ECI omits stock options, while nonfarm compensation per hour captures
the value of these options upon exercise.
The very small increase in the latter
measure in 2001 likely reflects, in part,
a drop in option exercises in that year,
and the larger increase in 2002 may
point to a firming, or at least to a smaller
rate of decline, of these exercises.
Prices
The chain-type price index for personal
consumption expenditures (PCE) rose
about 2 percent last year, compared with
an increase of Wi percent in 2001. This
step-up in consumer price inflation
resulted from a jump in energy prices.
Outside of the energy sector, consumer
price inflation was pushed lower last
year by continued slack in labor and
product markets as well as by expectations of future inflation that appeared to
be lower in 2002 than in most of 2001.
The increase in PCE prices excluding
food and energy, which was just 13A per-
26
89th Annual Report, 2002
Alternative Measures of Price Change
Percent
Price measure
Chain-type
Gross domestic product
Gross domestic purchases
Personal consumption
expenditures
Excluding food and energy . . .
Chained CPI
Excluding food and energy . . .
Fixed-weight
Consumer price index
Excluding food and energy ...
2001
2002
2.0
1.3
1.3
1.6
1.5
1.9
1.2
1.8
1.9
1.7
1.9
1.6
1.9
2.7
2.3
2.1
NOTE. Changes are based on quarterly averages and
are measured to the fourth quarter of the year indicated
from the fourth quarter of the preceding year.
cent, was about lA percentage point less
than in 2001. The price index for GDP
was less affected by last year's rise in
energy prices than was the PCE measure; much of the energy price increase
was attributable to higher prices of
imported oil, which are not included
in GDP because they are not part
of domestic production. On net, GDP
prices rose only \lA percent last year,
a deceleration of 3A percentage point
that reflected not just the deceleration
in core consumer prices but also considerably smaller increases for prices of
construction.
The upturn in consumer energy prices
in 2002 was driven by a jump in crude
oil prices. Gasoline prices increased
some 25 percent from December 2001
to December 2002; prices of fuel oil
increased considerably as well. By contrast, consumer prices of natural gas
posted only a modest rise after declining
sharply in 2001, and electricity prices
moved lower. More recently, the rise
in crude oil prices since mid-December,
together with cold weather, has
increased the demand for natural gas
and has led to higher spot gas prices;
the higher spot prices for both oil and
gas are likely to be boosting consumer
energy prices early this year.
The PCE price index for food and
beverages increased only Wi percent
last year; the increase followed a 3 percent rise in 2001 that reflected supplyrelated price increases for many livestock products including beef, poultry,
and dairy products. But livestock supplies had recovered by early last year,
and a drought-induced selloff of cattle
herds last summer pushed prices still
lower.
The prices of goods other than food
and energy items decelerated sharply
last year. Prices for apparel, new and
used motor vehicles, and a wide range
of other durable goods all declined
noticeably and, on average, at a faster
pace than in 2001. Price increases
for services were much larger than for
goods and slowed less from the previous year. Both tenants' rent and
the imputed rent of owner-occupied
housing—categories that account for a
sizable share of services—rose significantly less last year than they did in
2001. But many other services prices
posted increases in 2002 that were about
the same as in 2001. Information on
medical prices was mixed. According to
the CPI, the price of medical services
continued to accelerate, rising 5l/i percent last year. But the increase in
the PCE measure of medical services
prices was less than 3 percent, a smaller
increase than in 2001. One reason for
this difference is that the prices of services paid for by Medicare and Medicaid are included in the PCE index but
not in the CPI (because services provided by Medicare and Medicaid do not
represent out-of-pocket costs to consumers and so are outside of the CPFs
scope), and Medicare reimbursement
rates for physicians were reduced last
year.
Despite the acceleration in medical
prices in the CPI but not in the PCE
price index, the CPI excluding food and
Economic and Financial Developments in 2002 and Early 2003
energy decelerated notably more than
did the core PCE price index between
2001 and 2002. The two price measures
differ in a number of respects, but much
of last year's greater deceleration in the
CPI can be traced to the fact that the
CPI suffers from a form of "substitution
bias" that is not present in the PCE
index. The CPI, being a fixed-weight
price index, overstates increases in the
cost of living because it does not adequately take into account the fact that
consumers tend to substitute away from
goods that are rising in relative price; by
contrast, the PCE price index does a
better job of taking this substitution into
account. Last year, the Bureau of Labor
Statistics began to publish a new index
called the chained CPI; like the PCE
price index, the chained CPI does a
more complete job of taking consumer
substitution into account, but it is otherwise identical to the official CPI. In
2001, an unusually large gap between
increases in the official CPI and the
chained CPI arose, pointing to very
large substitution bias in the official CPI
in that year. This gap narrowed in 2002,
indicating that substitution bias declined
between the two years. (Final estimates
of the chained CPI are not yet available;
the currently available data for both
2001 and 2002 are preliminary and subject to revision.)
Survey measures of expected inflation generally ran a little lower in 2002
than in 2001. According to the Michigan
SRC, median one-year inflation expectations plummeted after the September 11
attacks, but by early 2002, expectations returned to the 23A percent range
that had prevailed during the previous
summer. These expectations gradually
moved lower over the course of last
year and now stand around 2Vi percent. Meanwhile, the Michigan SRC's
measure of five- to ten-year inflation
expectations remained steady at about
27
23/4 percent during 2002, a rate a little
lower than the 3 percent inflation expectations that had prevailed through most
of 2001.
U.S. Financial Markets
Developments in financial markets last
year were shaped importantly by sharp
declines, on net, in equity prices and
most long-term interest rates and by
periods of heightened market volatility.
In contrast to 2001, when the Federal
Reserve eased the stance of monetary
policy eleven times, last year saw one
reduction in the intended federal funds
rate—in early November—and interest
rates on short-term Treasury securities
had moved little until then. Longer-term
interest rates, by contrast, were more
volatile. Investors' optimism about
future economic prospects pressured
longer-term Treasury bond yields higher
early in 2002. But as the year progressed, that optimism faded when
the economy failed to gather much
momentum, and longer-term Treasury
yields ended the year appreciably lower.
Softer-than-expected readings of the
economic expansion, a marked deterioration in corporate credit quality, concerns about corporate governance, and
heightened geopolitical tensions made
investors especially wary about risk.
Lower-rated firms found credit substantially more expensive, as risk spreads on
speculative-grade debt soared for most
of the year before narrowing somewhat
over the last few months. Even for
higher-quality firms, risk spreads widened temporarily during the tumultuous
conditions that prevailed in financial
markets over the summer. In addition,
commercial banks tightened standards
and terms for business borrowers, on
net, in 2002, and risk spreads on business loans remained in an elevated range
throughout the year. Increased caution
28
89th Annual Report, 2002
on the part of investors was particularly
acute in the commercial paper market,
where the riskiest issuers discontinued
their programs.
Federal borrowing surged last year,
while private borrowing was held down
by the significantly reduced credit needs
of business borrowers. Declines in
longer-term interest rates during the
first half of the year created incentives
for both businesses and households to
lock in lower debt-service obligations
by heavily tapping corporate bond and
home mortgage markets, respectively.
While mortgage borrowing remained
strong, businesses sharply curtailed their
issuance of longer-term debt during the
second half of 2002 amid the nervousness then prevailing in the financial
markets.
Interest Rates
Reflecting an unchanged stance of
monetary policy over most of last year,
short-term market interest rates moved
little until early November, when the
FOMC lowered the target federal funds
rate Vi percentage point, and other shortterm interest rates followed suit. Yields
on intermediate- and long-term Treasury securities, by contrast, declined
Interest Rates on Selected Treasury
Securities
Percrent
—
7
Ten-year
—fj^/^v
6
5
1
\VJW* —
Two-year
-
3
1
Three-month
:oo2
4
2003
NOTE. The data are daily and extend through
February 5, 2003.
as much as Wi percentage points, on
net, in 2002. Longer-term interest rates
began last year under upward pressure,
as signs that the economy had bottomed
out started to nudge rates higher in the
final weeks of 2001. Positive economic
news pushed interest rates up appreciably further during the first quarter of
2002. The increase in longer-term interest rates was consistent with the sharp
upward tilt of money market futures
rates, which suggested that market participants expected that the FOMC would
almost double the intended level of the
funds rate by year's end. However, as
readings on the strength of the economic
expansion came in on the soft side,
investors substantially trimmed their
expectations for policy tightening, and
yields on longer-term Treasury securities turned down in the spring.
The slide in longer-term Treasury
yields intensified over the summer amid
weaker-than-expected economic data,
heightened geopolitical tensions, fresh
revelations of corporate malfeasance,
and disappointing news about near-term
corporate profits. In concert, these
developments prompted investors to
mark down their expectations for economic growth and, consequently, their
anticipated path for monetary policy. A
widespread retrenchment in risk-taking
sent yields on speculative-grade corporate bonds sharply higher and kept those
on the lower rungs of investment grade
from declining, even as longer-term
nominal Treasury yields fell to very low
levels by the end of July.
The uneventful passing of the Securities and Exchange Commission's
August 14 deadline for officers of large
companies to certify corporate financial
statements somewhat assuaged investors' anxieties about corporate governance problems. But subsequent news
suggesting that the economy was losing momentum and a flare-up in ten-
Economic and Financial Developments in 2002 and Early 2003
sions with Iraq further boosted demand
for Treasury securities. The FOMC's
decision at the August meeting—to
leave the intended federal funds rate
unchanged but to judge the balance
of risks to the outlook as weighted
toward economic weakness—pulled the
expected path of the funds rate lower,
and longer-term Treasury yields sank to
forty-year lows in early autumn. A high
degree of investor uncertainty about the
future path of monetary policy was evidenced by implied volatilities of shortterm interest rates derived from option
prices, which soared to record levels in
early autumn. The size of the FOMC's
November cut in the target federal funds
rate and the shift to balance in its assessment of risks surprised market participants, but the policy easing appeared to
lead investors to raise the odds that the
economy would pick up from its sluggish pace. Generally positive economic
news and rising equity prices over the
remainder of the year also bolstered confidence and prompted market participants to mark up the expected path for
monetary policy and push up longerterm Treasury yields.
Yields on higher-quality investmentgrade corporate bonds generally tracked
those on Treasuries of comparable maturity last year, although risk spreads on
these instruments widened moderately
over the summer and early autumn
before narrowing over the remainder
of the year. Interest rates on belowinvestment-grade corporate debt, by
contrast, increased for much of last year,
as spreads over Treasuries ballooned in
response to mounting concerns about
corporate credit quality, historically low
recovery rates on defaulted bonds, and
revelations of improper corporate governance; credit risk spreads widened in all
speculative sectors but especially in telecom and energy. By the summer, investors' retreat from risk-taking had wid
29
ened bid-asked spreads in the corporate
bond market enough to impair trading. Risk spreads on speculative-grade
bonds narrowed considerably over the
year's final quarter and in early 2003,
though they remain elevated by historical standards; risk spreads for the
weaker speculative-grade credits remain
exceptionally wide, as investors evidently anticipate a continued high level
of defaults and low recovery rates.
Equity Markets
Equity prices were buffeted last year by
considerable fluctuations in investors'
assessments of the outlook for the
economy and corporate earnings and
by doubts about the quality and transparency of corporate balance sheets.
Net declines in stock prices in 2002
exceeded those posted during either of
the preceding two years. Worries about
the pervasiveness of questionable corporate governance and a deterioration in
the earnings outlook—especially in the
technology sector—depressed equity
prices in early 2002. The positive tenor
of economic data, however, managed
to outweigh those concerns, and stock
prices staged a rally halfway through the
first quarter, with the gains tilted toward
"old economy" firms. But the rebound
Major Stock Price Indexes
Januan 2. 2001 = 100
^Nasdaq
Wilshire5000
S&P 500
2001
2002
—
125
—
100
-
75
—
50
2003
NOTE. The data are daily and extend through
February 5, 2003.
30
89th Annual Report, 2002
was short lived. Share prices started to
tumble in early spring across all sectors
as weaker-than-expected economic data
eroded investors' confidence in the
strength of the economic expansion.
These developments were reinforced by
first-quarter corporate earnings reports
that, though mostly matching or exceeding investors' expectations, painted a
bleak picture of prospective sales and
profits.
Over the spring and summer, accounting scandals, widespread warnings
about near-term corporate profitability,
and heightened geopolitical tensions
intensified the slide in stock prices. Particularly large declines in share prices
were posted for technology firms, whose
prospects for sales and earnings were
especially gloomy. Equity prices were
boosted briefly by the uneventful passing of the August 14 deadline to certify
financial statements, but they quickly
reversed course on continued concerns
about the pace of economic growth and
corporate earnings and the escalating possibility of military action against
Iraq. By early October, equity indexes
sank to their lowest levels since the
spring of 1997, and implied stock price
volatility on the S&P 100 surged to its
highest reading since the stock market
crash of 1987. The drop in stock prices
widened the gap between the expected
year-ahead earnings-price ratio for the
S&P 500 and the real ten-year Treasury
yield—one simple measure of the equity
premium—to levels not seen since the
mid-1990s.
Share prices turned around in late
October, as the third-quarter corporate
earnings reports were not as weak as
investors had originally feared. Equity
prices were also given a boost in early
November by the larger-than-expected
monetary policy easing, and the rally
was sustained over the remainder of the
year by the generally encouraging tone
Implied S&P 100 Volatility
— 50
— 40
—
30
—
20
—
10
i 1 i i i 1 i i I 1 i i i I i ii
1997
1999
2001
2003
NOTE. The data are daily and extend through
February 5, 2003. The series shown is the implied
volatility of the S&P 100 stock price index as calculated
from the prices of options that expire over the next
several months.
SOURCE. Chicago Board Options Exchange.
of economic data. Greater confidence
among investors in the economic outlook also helped bring down the implied
volatility on the S&P 100 significantly
by year-end, although it remains at
an elevated level by historical standards.
Despite the fourth-quarter rebound,
broad equity indexes were down, on net,
about 20percent in 2002, while the techheavy Nasdaq lost more than 30 percent.
The decline in equity prices during the first three quarters of 2002 is
estimated to have erased more than
$31/2 trillion in household wealth, a loss
of nearly 9 percent of total household
net worth, although the fourth-quarter
rise in stock prices restored about
$600 billion. Still, the level of household net worth at the end of last year
was more than 40 percent higher than it
was at the start of the bull market in
1995. Equity prices maintained their
upward momentum during the first half
of January 2003 but then fell sharply
amid the looming prospects of military
action against Iraq and a still-gloomy
outlook for corporate earnings. Broad
stock price indexes have lost almost
5 percent this year; however, solid
fourth-quarter earnings from many
Economic and Financial Developments in 2002 and Early 2003
prominent technology companies helped
brighten investors' sentiment regarding
that sector, and the Nasdaq is down
about 3 percent this year.
Debt and Financial Intermediation
A deceleration of business borrowing
slowed growth of the debt of nonfederal sectors about 1 percentage point in
2002, to 6x/2 percent. By contrast, the
decline in interest rates last year kept
borrowing by households and state and
local governments brisk. At the federal
level, weak tax receipts and an acceleration in spending pushed debt growth to
IVi percent last year after a slight contraction in 2001.
For the year as a whole, corporate
borrowing was quite weak, mainly
because of sagging capital expenditures,
a drying up of merger and acquisition
activity, and a reliance on liquid assets.
Although businesses tapped bond markets in volume over the first half of the
year, subsequent concerns about the
reliability of financial statements and
the quality of corporate governance and
deteriorating credit worthiness ruined
investors' appetite for corporate debt in
the summer and early autumn. Households, by contrast, flocked to the mortgage markets to take advantage of low
mortgage rates throughout the year, and
strong motor vehicle sales supported
the expansion of consumer credit. For
depository institutions, the net effect of
these developments was an acceleration of credit to 6V2 percent last year,
2 percentage points above the pace
of 2001. The growth of credit at thrift
institutions moderated, though the slowdown can be attributed for the most
part to a large thrift institution's conversion to a bank charter. The growth of
credit at commercial banks accelerated
to 63/4 percent—a significant increase
from the anemic pace in 2001; the
31
pickup was driven by large acquisitions of securities, especially mortgagebacked securities, as well as a surge in
home equity and residential real estate
lending.
By contrast, business lending at commercial banks dropped 7 percent last
year after falling almost 4 percent in
2001; last year's decline kept overall
loan growth for 2002 to about 5 percent.
In the October Senior Loan Officer
Opinion Survey on Bank Lending Practices, respondents noted that the decline
in commercial and industrial (C&I)
lending since the beginning of the year
reflected not only the limited funding
needs of creditworthy borrowers that
found bond financing or a runoff of
liquid assets more attractive, but also a
reduction in the pool of creditworthy
borrowers. Over the course of last year,
banks reported some additional net
tightening of standards and terms on
C&I loans, mainly in response to greater
uncertainty about the economic outlook
and rising corporate bond defaults,
although the proportions of banks that
reported doing so declined noticeably.
Direct measures of loan pricing conditions from the Federal Reserve's quarterly Survey of Terms of Business Lending also indicated that banks were
cautious lenders last year, as the average
spread of C&I loan rates over market
interest rates on instruments of comparable maturity remained wide, and
spreads on new higher-risk loans
declined only slightly from the lofty levels that prevailed over the first half of
the year. Although bank lenders were
wary about business borrowers, especially toward lower-rated credits, they
did not significantly constrict the supply
of loans: Most small firms surveyed by
the National Federation of Independent
Businesses in 2002 reported that they
experienced little or no difficulty satisfying their borrowing needs.
32
89th Annual Report, 2002
Loan quality at commercial banks
improved overall last year. Loan delinquency rates edged down through the
third quarter of 2002—the latest
period for which Call Report data are
available—in response to better performance of residential real estate and consumer loans and a stable delinquency
rate on C&I loans. Despite the improvement in consumer loan quality, domestic
banks imposed somewhat more stringent credit conditions when lending
to households, according to the survey
on bank lending practices. Moderate net
proportions of surveyed institutions
tightened credit standards and terms for
credit card and other consumer loans
throughout last year. The net fraction of
banks that tightened standards on residential mortgage loans rose late in the
year to the highest share in the past
decade, but nonetheless remained quite
low. Commercial banks generally registered strong profit gains last year,
although steep losses on loans to energy
and telecommunications firms significantly depressed profits at several large
bank holding companies. Despite the
increased rate of provisioning for loan
losses, the banking sector's profitability
stayed in the elevated range recorded
for the past several years, as a result of
the robust fee income from mortgage
and credit card lending, effective cost
controls, and the relatively inexpensive funding offered by inflows of core
deposits. As of the third quarter of last
year, virtually all assets in the banking
sector were at well-capitalized institutions, and the substitution of securities for loans on banks' balance sheets
helped edge up risk-based capital ratios.
The financial condition of insurance
companies, by contrast, worsened notably last year. Both property and casualty
insurers and life and health insurers
sustained significant investment losses
from the decline in equity prices and the
deterioration in corporate credit quality.
However, these negative pressures were
offset somewhat by the continued strong
growth of insurance premiums, and both
sectors of the insurance industry stayed
fairly well capitalized in 2002.
Monetary Aggregates
The broad monetary aggregates decelerated noticeably last year after surging in
2001. Short-term market interest rates,
which had declined swiftly during 2001,
were stable over the first half of the
year; deposit rates, in a typical pattern
of lagged adjustment, continued to fall.
Consequently, the opportunity cost of
holding M2 assets increased, especially
for its liquid deposit (checking and savings accounts) and retail money fund
components, thereby restraining the
demand for such assets. After decelerating in the first half of the year, M2
rebounded significantly in the second
half, because of a surge in liquid deposits and retail money market mutual
funds. The strength in both components
partly reflected elevated volatility in
equity markets against the backdrop of
a still-low opportunity cost of holding
such deposits. In addition, another wave
M2 Growth Rate
Percent, annual rate
—
1990
1994
10
11
1998
—
6
—
4
2002
NOTE. M2 consists of currency, travelers checks,
demand deposits, other checkable deposits, savings
deposits (including money market deposit accounts),
small-denomination time deposits, and balances in retail
money market funds.
Economic and Financial Developments in 2002 and Early 2003
of mortgage refinancing boosted M2
growth during this period. (Refinancings cause prepayments to accumulate temporarily in deposit accounts
before being distributed to investors
in mortgage-backed securities.) All
told, over the four quarters of the year,
M2 increased 7 percent, a pace that
exceeded the expansion of nominal
income. As a result, M2 velocity—the
ratio of nominal GDP to M2—declined
for the fifth year in a row, roughly in
line with the drop in the opportunity
cost of M2 over this period.
Reflecting in part the slowing of
its M2 component, M3—the broadest
money aggregate—expanded 6V2 percent in 2002, a pace well below the
123/4 percent advance posted in 2001.
Growth in M3 was also held down
by a sharp deceleration of institutional
money funds, as their yields dropped to
close alignment with short-term market
interest rates. This effect was only partly
offset by the pickup in needs to fund
bank credit, which resulted in an acceleration in the issuance of managed liabilities, including large time deposits.
M3 velocity continued to decline in
2002.
New Discount Window Programs
On October 31, 2002, following a threemonth public comment period, the
Board of Governors approved changes
to its Regulation A that established
two new types of loans to depository
institutions—primary and secondary
credit—and discontinued the adjustment
and extended credit programs. The new
programs were implemented on January 9, 2003. The seasonal credit program was not altered.
The primary reason for adopting the
new programs was to eliminate the subsidy to borrowing institutions that was
implicit in the basic discount rate, which
33
since the late 1960s had usually been set
below market interest rates. The subsidy required Federal Reserve Banks to
administer credit extensions heavily in
order to ensure that borrowing institutions used credit only in appropriate
circumstances—specifically, when they
had exhausted other reasonably available funding sources. That administration was necessarily somewhat subjective and consequently difficult to apply
consistently across Reserve Banks. In
addition, the heavy administration was
one factor that caused depository institutions to become reluctant to use the
window even in appropriate conditions.
Also, depository institutions were concerned at times about being marked with
a "stigma" if market analysts and counterparties inferred that the institution
was borrowing from the window and
suspected that the borrowing signaled
that the institution was having financial
difficulties. The resulting reluctance to
use the window reduced its usefulness
in buffering shocks to the reserve market and in serving as a backup source
of liquidity to depository institutions,
and thus undermined its performance as
a monetary policy tool.
To address these issues, the Board of
Governors specified that primary credit
may be made available at an abovemarket interest rate to depository institutions in generally sound financial condition. The above-market interest rate
eliminates the implicit subsidy. Also,
restricting eligibility for the program
to generally sound institutions should
reduce institutions' concerns that their
borrowing could signal financial
weakness.
The Federal Reserve set the initial
primary credit rate at 2.25 percent,
100 basis points above the FOMC's target federal funds rate as of January 9,
2003. The target federal funds rate
remained unchanged, and thus the adop-
34
89th Annual Report, 2002
tion of the new programs did not represent a change in the stance of monetary
policy. In the future, the primary credit
rate will be adjusted from time to time
as appropriate, using the same discretionary procedure that was used in the
past to set the adjustment credit rate.
The Federal Reserve also established
procedures to reduce the primary credit
rate to the target federal funds rate in a
national emergency, even if key policymakers are unavailable.
Institutions that do not qualify for
primary credit may obtain secondary
credit when the borrowing is consistent
with a prompt return to market sources
of funds or is necessary to resolve severe
financial difficulties. The interest rate
on secondary credit is set by formula 50 basis points above the primary credit rate. The rate was set
initially at 2.75 percent. Because secondary credit borrowers are not in
sound financial condition, extensions of
secondary credit usually involve some
administration.
International Developments
The international economy rebounded
in 2002 after a stagnant performance in
2001, but recovery was uneven in both
timing and geographical distribution.
Growth abroad picked up sharply in the
first half of last year, as a strong rally
in the high-tech exporting economies in
developing Asia was joined by robust
growth in Canada and, to a lesser extent,
Mexico. Japan also posted respectable
growth in the first half, largely as a
result of a surge of exports. However,
performance in the euro area remained
sluggish, and several South American
economies experienced difficulties, with
full-fledged crises in Argentina and
Venezuela and mounting concerns about
prospects for Brazil. As the U.S. economy decelerated in the second half, the
rapid pace of recovery slowed in developing Asia and in Canada, while performance remained lackluster in much of
the rest of the world.
Monetary policy actions abroad also
diverged across countries in 2002 as
authorities reacted to differing economic
conditions. In Canada, official interest
rates were raised in three steps by July
amid concerns that buoyant domestic
demand and sharply rising employment would ignite inflationary pressures. Monetary authorities in Australia
and Sweden also increased policy rates
in the first half of the year. However, as
economic conditions weakened around
the world in the second half, official
interest rates were held constant in Canada and Australia and were lowered
in Sweden. Monetary policy was held
steady throughout 2002 in the United
Kingdom, where growth was moderate
and inflation subdued, but official interest rates were lowered 25 basis points,
to 3.75 percent, in early February 2003
in response to concerns about the prospects for global and domestic demand.
The European Central Bank (ECB) held
rates constant through most of the year,
as inflation remained above the ECB's
2 percent target ceiling, but rates were
lowered 50 basis points in December as
the euro area's already weak recovery
appeared to be stalling. Japanese shortterm interest rates remained near zero,
while authorities took some limited further steps to stimulate demand through
nontraditional channels. Monetary policy was tightened in both Mexico and
Brazil in response to concerns about
the inflationary effects of past currency
depreciation.
Yield curves in the major foreign
industrial countries steepened and
shifted up in the first quarter of 2002
in response to generally favorable economic news, but later they flattened out
and moved back down as the outlook
Economic and Financial Developments in 2002 and Early 2003
Equity Indexes in Selected
Foreign Industrial Countries
Week ending January 5, 2001 = 100
—
100
Euro area
United Kingdom \ / w "r
2002
2001
2003
NOTH. The data are weekly. The last observations are
the average of trading days through February 5, 2003.
deteriorated. Similarly, equity prices in
the major foreign industrial economies
held up well early in the year but then
declined along with the U.S. stock market and ended the year down sharply
from the previous year. The performance of the stock markets in the
emerging-market economies was mixed.
Share prices in Brazil and Mexico fell
sharply in the second and third quarters
but then showed some improvement
toward the end of the year. In the Asian
emerging-market economies, equity
prices rose in the first half of 2002 on
a general wave of optimism, especially
in the high-technology producing econoEquity Indexes in Selected
Emerging Markets
Week ending Jan uary5.2001 = 100
. M e x i c o j.1
120
\
k r^s r\
A/
\
100
80
Argentina
2001
.
V/
2002
A
60
Brazil
NOTE. The data are weekly. The last observations are
the average of trading days through February
2003
5, 2003.
mies; equity prices began to decline
around midyear as global demand softened but posted modest rebounds late in
the year.
The foreign exchange value of the
dollar continued its mild upward trend
into the early part of 2002, as it appeared
that the United States was poised to lead
a global economic recovery. However,
the dollar weakened sharply in the late
spring and early summer amid deepening concerns about U.S. corporate
governance and profitability. Around
that time market analysts also appeared
to become more worried about the
growing U.S. current account deficit and
its potential negative influence on the
future value of the dollar. The dollar
rebounded somewhat around midyear as
growth prospects for other major economies, particularly in the euro area,
appeared to dim; the dollar dropped
back again late in the year, as geopolitical tensions intensified, and continued
to depreciate in early 2003. In nominal
terms the dollar has declined about
5 percent on balance over the past year,
with depreciations against the currencies of the major industrial countries
and several of the developing Asian
economies partly offset by appreciation
against the currencies of several Latin
American countries.
Industrial Economies
Developing Asia
A
35
The Canadian economy recorded the
strongest performance among the major
foreign industrial countries last year
despite some slowing in the second half.
The strength, which was largely homegrown, reflected robust growth of consumption and residential construction
as well as an end to inventory runoffs
early in the year. The expansion was
accompanied by very rapid increases in
employment and utilization of capacity,
and the core inflation rate breached the
36
89th Annual Report, 2002
upper end of the government's 1 percent
to 3 percent target range near the end of
the year. The Canadian dollar appreciated against the U.S. dollar in the first
half of the year, but it dropped back
somewhat in the second half as the
economy slowed; by the end of the year
it was up only slightly on balance. The
Canadian dollar has moved up somewhat more so far this year.
The Japanese economy recorded positive growth during 2002, although it was
not enough to fully reverse the decline
in output that occurred in 2001. Despite
about 10 percent appreciation of the yen
against the dollar in 2002, Japanese
growth was driven largely by exports,
with smaller contributions from both
increased consumption and a slower
pace of inventory reduction. In contrast,
private investment continued to decline,
although not as sharply as in 2001.
Labor market conditions remained quite
depressed, and consumer prices continued to fall. Little progress was made on
the serious structural problems that have
plagued the Japanese economy, including the massive and growing amount
of bad loans on the books of Japanese
banks. A new set of official measures
that aims at halving the value of bad
loans within two and a half years was
U.S. Dollar Exchange Rate against
Selected Major Currencies
Week ending January 5, 2001 = 100
Japanese yen
—
110
—
100
—
Euro
90
dollar
2001
2002
2003
NOTH. The data are weekly. Exchange rates are in
foreign currency units per dollar. Last observations are
the average of trading days through February 5, 2003.
announced in the fall, but the details
of this plan are still not fully specified.
In September, the Bank of Japan
announced a plan to buy shares from
banks with excessive holdings of equity,
which would help to reduce bank
exposure to stock market fluctuations.
Because the transactions are to occur at
market prices, there would be no net
financial transfer to the banks. Near the
end of last year the Bank of Japan (BOJ)
raised its target range for bank reserves
at the BOJ from ¥10-15 trillion to
¥15-20 trillion, increased the monthly
amount of its outright purchases of longterm government bonds, and broadened the range of collateral that can be
used for market operations. In December the monetary base was up about
20 percent from a year earlier, a rise
partially reflecting the increased level
of bank reserves at the BOJ. However,
the twelve-month rate of base money
growth was considerably below the
36 percent pace registered in April.
Broad money growth remains subdued.
Economic performance in the euro
area was quite sluggish last year.
Although exports were up sharply,
growth in consumption was modest,
and private investment declined. The
area's lackluster economic performance
pushed the unemployment rate up by
several tenths of a percentage point by
the end of the year. Economic weakness
was particularly pronounced in some of
the larger countries—Germany, Italy,
the Netherlands, and, to a lesser extent,
France. In contrast, growth in Spain
and some of the smaller euro-area
countries—Ireland, Portugal, Finland,
and Greece—was much more robust.
Headline inflation jumped to a bit above
2Vi percent early in the year, owing to
higher food and energy prices and in
small part to the introduction of euro
notes and coins. Increased slack in the
economy, however, together with the
Economic and Financial Developments in 2002 and Early 2003
15 percent appreciation of the euro by
the end of the year, helped to mitigate
inflation concerns, and the ECB lowered its policy interest rate in December. The euro continued to appreciate in
early 2003.
Economic growth in the United Kingdom held up better than in the other
major European countries last year, and
sterling strengthened about 10 percent
versus the dollar. However, the expansion remained uneven, with the services
sector continuing to grow more rapidly
than the smaller manufacturing sector. Despite tight labor markets, inflation remained a bit below the Bank of
England's target of 2J/2 percent for most
of the past year. A sharp rise in housing
prices has, however, raised some concern about the possibility of a real estate
price bubble. The British government
announced its intention to complete a
rigorous assessment of its criteria for
joining the European Monetary Union
(EMU) by the middle of this year and, if
they are met, to hold a referendum on
entry.
approved in September 2002, $6 billion
of which was disbursed by the end of
the year. However, financial conditions
improved markedly after Lula won the
election in late October and appointed
a cabinet perceived to be supportive of
orthodox fiscal and monetary policies,
including greater central bank independence. By January 2003 the real had
reversed about one-fourth of its previous decline against the dollar, and bond
spreads had fallen sharply. However,
the new administration still faces some
major challenges. In particular, serious
concerns remain over the very large
quantity and relatively short maturity
of the outstanding government debt. In
addition, last year's currency depreciation fueled a rise in inflation that has
U.S. Dollar Exchange Rates and Bond
Spreads for Selected Emerging Markets
Januarys, 2001 = 100
Janua ry 5. 2001 = 100
Exchange rates
360 —
180
Brazilian real
280
Emerging-Market Economies
The Brazilian economy posted a surprisingly strong rebound in 2002 despite a
major political transition and accompanying turbulence in financial markets.
The Brazilian real depreciated sharply
between May and October, and sovereign bond spreads climbed to 2,400
basis points as it became increasingly
likely that Luiz Inacio Lula da Silva
(Lula), the Workers' Party candidate,
would win the presidential election.
Given some of the past stances of the
party, this possibility fueled concerns
among foreign investors about a potential erosion of fiscal and monetary discipline. In response to the sharp deterioration in financial conditions facing
Brazil, a $30 billion IMF program was
37
140
J Mexican
200
Argentine peso!
120
1
[
j
100
Korean won
60
,.,.,,.,1,,,,
Percentage points
i
Percentage points
Bond spreads
80
Argentina
60
40
rJ'\kf
,m. _
f\
Mexico
20
2001
v
2002
20
15
10
5
2003
NOTE. The data are weekly averages that are indexed
to the week ending January 5, 2001. Exchange rates (top
panel) are in foreign currency units per dollar. Bond
spreads (bottom panel) are the J.P. Morgan Emerging
Market Bond Index (EMBI+) spreads over U.S.
Treasuries. Last observations are the average of trading
days through February 5, 2003.
38
89th Annual Report, 2002
prompted several increases in the monetary policy interest rate. In January the
government raised the upper bound of
its inflation target range for this year to
8.5 percent from 6.5 percent, although
the target for next year was lowered
at the same time to 5.5 percent from
6.25 percent.
Argentine GDP contracted further in
2002 after declining 10 percent in 2001.
The currency board arrangement that
had pegged the peso at a one-to-one rate
with the dollar collapsed early last year;
the peso lost nearly three-fourths of its
value by late June, and sovereign bond
spreads spiked to more than 7,000 basis
points. By early 2002, the banking system had become effectively insolvent as
a result of the plunging peso, the weak
economy, and the government's default
on debt that the banks held mostly involuntarily. Confronted with this situation,
the government forced the conversion
of the banks' dollar-denominated assets
and liabilities to pesos and also mandated the rescheduling of a large share
of deposits. As a result of these and
other measures, confidence in the banking system, already shaken, was further
impaired. Financial and economic conditions eventually stabilized in the second half of the year, but there are no
signs yet of a sustained recovery. The
government also defaulted on obligations to multilateral creditors in late
2002 and early 2003. In January, Argentina and the International Monetary
Fund reached agreement on a $6.6 billion short-term program that will go
to meeting Argentina's payments to
the IMF at least through the elections
expected in the spring and also to clearing its overdue obligations to the multilateral development banks.
Venezuela experienced extreme economic and political turmoil over the past
year. In February 2002 the central bank
abandoned the bolivar's crawling peg to
the dollar, and the bolivar depreciated
sharply. Opponents of President Hugo
Chavez mounted a short-lived coup in
April and declared a national strike in
early December. The strike brought the
already-weak economy to a standstill,
and output in the key oil industry plummeted. The strike abated in early February in all sectors but oil. In response to
the strike, Chavez increased his control
of the state-owned oil company and oil
production began rising in early 2003,
but it was still well below pre-strike
levels. With the exchange rate plunging
in late January, the government suspended currency trading for two weeks
before establishing a fixed exchange rate
regime and some restrictions on foreign
currency transactions.
One of the few bright spots in Latin
America last year was the Mexican
economy. Boosted by the U.S. recovery,
growth was moderate for the year as a
whole despite some late slowing. However, financial conditions deteriorated
somewhat after midyear as market
participants reevaluated the strength of
the North American recovery. Mexican
stock prices slid about 25 percent
between April and September, and sovereign bond spreads widened nearly
200 basis points to around 430 basis
points over the same period. Nevertheless, the Mexican economy did not
appear to be much affected by spillovers
from the problems elsewhere in Latin
America; bond spreads dropped sharply
between October and the end of the
year to around 300 basis points, a level
considerably lower than elsewhere in
the region. The peso depreciated about
12 percent against the dollar over the
course of last year. The decline fueled
an increase in twelve-month inflation to
more than 5!/2 percent by year-end. The
acceleration put inflation above the government target rate of AVi percent and
well above the ambitious 3 percent tar-
Economic and Financial Developments in 2002 and Early 2003
get set for 2003. In response to increasing inflation, the Bank of Mexico has
tightened monetary policy four times
since September 2002. The peso has
continued to depreciate in early 2003,
and bond spreads have moved back up a
bit.
The Asian emerging-market economies generally performed well in 2002,
although there were significant differences within the region. Outside
of China, the strongest growth was
recorded in South Korea, which benefited in the first half of the year from
both an upturn in global demand for
high-tech products and a surge in
domestic demand, particularly consumption. However, consumer confidence
deteriorated at the end of the year as tensions over North Korea intensified; the
uneasy situation, as well as the substantial existing consumer debt burden, pose
significant risks to growth in consumption this year. The Korean won appreciated sharply against the dollar between
April and midyear in response to
improving economic conditions; it then
dropped back in late summer and early
fall as perceptions about the strength of
the global recovery were adjusted downward. However, the won turned back up
against the dollar late last year.
39
The performance of the ASEAN-5
economies—Indonesia, Malaysia, the
Philippines, Singapore, and Thailand—
also was generally robust in 2002,
although the overall softening in global
demand in the second half of the year
was evident there as well. The secondhalf slowing in production was particularly pronounced in Singapore, which is
heavily dependent on exports of hightechnology products. Taiwan, another
high-technology producer, also showed
a significant deceleration in output
between the first and second halves of
the year. Both of these economies experienced some mild deflation in 2002,
although prices turned up toward the
end of the year.
Although the Hong Kong economy
did not show as much improvement as
most other emerging Asian economies
in the first half of last year, it recorded
very strong growth in the third quarter.
Nevertheless, prices continued to fall for
the fourth consecutive year. The mainland Chinese economy, which again outperformed the rest of the region in 2002,
enjoyed surging investment by the government and by foreign investors as well
as robust export growth. The Chinese
economy continued to experience mild
deflation last year.
•
41
Monetary Policy Report of July 2002
Monetary Policy and the
Economic Outlook
The pace of economic activity in the
United States picked up noticeably in
the first half of 2002 as some of the
powerful forces that had been restraining spending for the preceding year and
a half abated. With inventories in many
industries having been brought into
more comfortable alignment with sales,
firms began boosting production around
the turn of the year to stem further runoffs of their stocks. And while capital
spending by businesses has yet to show
any real vigor, the steep contraction of
the past year or so appears to have come
to an end. Household spending, as it has
throughout this cyclical episode, continued to trend up in the first half. With
employment stabilizing, the increases
in real wages made possible by gains
in labor productivity and the effects of a
variety of fiscal actions have provided
noticeable support to disposable incomes. At the same time, low interest
rates have buoyed the purchase of durable goods and the demand for housing.
Growth was not strong enough to forestall a rise in the unemployment rate,
and slack in product and labor markets,
along with declining unit costs as productivity has soared, has helped to keep
core inflation low. The exceptionally
strong performance of productivity over
the past year provides further evidence
of the U.S. economy's expanded capacNOTE. The discussion in this section consists
of the text and tables from the Monetary Policy
Report submitted to the Congress on July 16,
2002; the charts from this report (as well as earlier
reports) are available on the Board's web site, at
www.federalreserve.gov/boarddocs/hh.
ity to provide growth over the longer
haul.
The Federal Reserve had moved
aggressively in 2001 to counter the
weakness that had emerged in aggregate
demand; by the end of the year, it had
lowered the federal funds rate to
PA percent, the lowest level in forty
years. With only tentative signs that
activity was picking up, the Federal
Open Market Committee (FOMC)
decided to retain that unusual degree
of monetary accommodation by leaving the federal funds rate unchanged at
its January meeting. Confirmation of an
improvement in activity was evident by
the time of the March meeting, and the
FOMC moved toward an assessment
that the risks to the outlook were balanced between its long-run goals of
price stability and maximum sustainable economic growth, a view maintained through its June meeting. The
durability and strength of the expansion
were recognized to depend on the trajectory of final sales. The extent of a
prospective strengthening of final sales
was—and still is—uncertain, however,
and with inflation likely to remain contained, the Committee has chosen to
maintain an accommodative stance of
policy, leaving the federal funds rate at
its level at the end of last year.
The economy expanded especially
rapidly early in the year. As had been
anticipated, much of the first quarter's
strength in production resulted from the
efforts of firms to limit a further drawdown of inventories after the enormous
liquidation in the fourth quarter of 2001.
With respect to first-quarter sales, purchases of light motor vehicles dropped
back from their extraordinary fourth-
42
89th Annual Report, 2002
quarter level, but other consumer spending increased substantially. Housing
starts, too, jumped early in the year—
albeit with the help of weather conditions favorable for building in many
parts of the country—and spending on
national defense moved sharply higher.
All told, real GDP is now estimated to
have increased at an annual rate in
excess of 6 percent in the first quarter.
Economic activity appears to have
moved up further in recent months but
at a slower pace than earlier in the year.
Industrial production has continued to
post moderate gains, and nonfarm payrolls edged up in the second quarter
after a year of nearly steady declines.
However, several factors that had contributed importantly to the outsized gain
of real output in the first quarter appear
to have made more modest contributions to growth in the second quarter.
Available data suggest that the swing in
inventory investment was considerably
smaller in the second quarter than in the
first. Consumer spending has advanced
more slowly of late, and while the construction of new homes has expanded
further, its contribution to the growth of
real output has not matched that of earlier in the year.
Notable crosscurrents remain at work
in the outlook for economic activity.
Although some of the most recent indicators have been encouraging, businesses still appear to be reluctant to add
appreciably to workforces or to boost
capital spending, presumably until they
see clearer signs of improving prospects
for sales and profits. These concerns, as
well as ongoing disclosures of corporate
accounting irregularities and lapses in
corporate governance, have pulled down
equity prices appreciably on balance
this year. The accompanying decline
in net worth is likely to continue to
restrain household spending in the
period ahead, and less favorable finan
cial market conditions could reinforce
business caution.
Nevertheless, a number of factors are
likely to boost activity as the economy
moves into the second half of 2002.
With the inflation-adjusted federal funds
rate barely positive, monetary policy
should continue to provide substantial
support to the growth of interestsensitive spending. Low interest rates
also have allowed businesses and households to strengthen balance sheets by
refinancing debt on more favorable
terms. Fiscal policy actions in the form
of lower taxes, investment incentives,
and higher spending are providing considerable stimulus to aggregate demand
this year. Foreign economic growth
has strengthened and, together with a
decline in the foreign exchange value
of the dollar, should bolster U.S. exports.
Finally, the exceptional performance of
productivity has supported household
and business incomes while relieving
pressures on price inflation, a combination that augurs well for the future.
Monetary Policy, Financial
Markets, and the Economy
over the First Half of 2002
The information reviewed by the FOMC
at its meeting of January 29 and 30
seemed on the whole to indicate that
economic activity was bottoming out
and that a recovery might already be
under way. Consumer spending had held
up remarkably well, and the rates of
decline in manufacturing production and
business purchases of durable equipment and software had apparently moderated toward the end of 2001. In addition, the expectation that the pace of
inventory runoff would slow after several quarters of substantial and growing
liquidation constituted another reason
for anticipating that economic activity
would improve in the period imme-
Monetary Policy Report of July 2002
diately ahead. Nonetheless, looking
beyond the near term, the FOMC faced
considerable uncertainty about the
strength of final demand. Because
household spending had not softened to
the usual extent during the recession,
it appeared likely to have only limited
room to pick up over coming quarters.
Intense competitive pressures were
thought to be constraining the growth of
profits, which could damp investment
and equity prices. At the same time, the
outlook for continued subdued inflation
remained favorable given the reduced
utilization of resources and the further pass-through of earlier declines in
energy prices. Taken together, these conditions led the FOMC to leave the stance
of monetary policy unchanged, keeping
its target for the federal funds rate at
l3/4 percent. In light of the tentative
nature of the evidence suggesting that
the upturn in final demand would be
sustained, the FOMC decided to retain
its assessment that the more important
risk to achieving its long-run objectives
remained economic weakness—the possibility that growth would fall short of
the rate of increase in the economy's
potential and that resource utilization
would fall further.
When the FOMC met on March 19,
economic indicators had turned even
more positive, providing encouraging
evidence that the economy was recovering from last year's recession. Consumer spending had remained brisk in
the early part of the year, the decline in
business expenditures on equipment and
software appeared to have about run its
course, and housing starts had turned
back up. Industrial production, which
had been falling for nearly a year and a
half, increased in January and February
as businesses began to meet more of the
rise in sales from current production and
less from drawing down inventories.
Indications that an expansion had taken
43
hold led to noticeable increases in broad
stock indexes and in long-term interest
rates. But the strength of the recovery
remained unclear. The outlook for business fixed investment—which would
be one key to the strength of economic
activity once the thrust from inventory
restocking came to an end—was especially uncertain, with anecdotal reports
indicating that businesses remained
hesitant to enter into major long-term
commitments. While the FOMC believed that the fiscal and monetary policies already in place would continue to
stimulate economic activity, it considered the questions surrounding the outlook for final demand over the quarters
ahead still substantial enough to justify
the retention of the current accommodative stance of monetary policy, particularly in light of the relatively high unemployment rate and the prospect that
the lack of price pressures would persist.
Given the positive tone of the available economic indicators, the FOMC
announced that it considered the risks to
achieving its long-run objectives as now
being balanced over the foreseeable
future.
By the time of the May 7 FOMC
meeting, it had become evident that economic activity had expanded rapidly
early in 2002. But the latest statistical
data and anecdotal reports suggested
that the expansion was moderating considerably in the second quarter and that
the extent to which final demand would
strengthen was still unresolved. Business sentiment remained gloomy as
many firms had significantly marked
down their own forecasts of growth in
sales and profits over coming quarters.
These revised projections, along with
the uncertainty surrounding the robustness of the overall economic recovery, had contributed to sizable declines
in market interest rates and weighed
heavily on equity prices, which had
44
89th Annual Report, 2002
dropped substantially between the
March and May meetings. The outlook
for inflation had remained benign
despite some firming in energy prices,
as excess capacity in labor and product
markets held the pricing power of many
firms in check, and the apparent strong
uptrend in productivity reduced cost
pressures. In these circumstances, the
FOMC decided to keep the federal funds
rate at its accommodative level of
l3/4 percent and maintained its view that,
against the background of its long-run
goals of price stability and sustainable
economic growth, the risks to the outlook remained balanced.
Over the next seven weeks, news on
the economy did little to clarify questions regarding the vigor of the ongoing
recovery. The information received in
advance of the June 25-26 meeting of
the FOMC continued to suggest that
economic activity had expanded in the
second quarter, but both the upward
impetus from the swing in inventory
investment and the growth in final
demand appeared to have diminished. In
financial markets, heightened concerns
about accounting irregularities at prominent corporations and about the outlook
for profits had contributed to a substantial decline in equity prices and correspondingly to a further erosion in household wealth. But some cushion to the
effects on aggregate demand of the
decline in share prices had been provided by the fall in the foreign exchange
value of the dollar and the drop in longterm interest rates. Although the FOMC
believed that robust underlying growth
in productivity, as well as accommodative fiscal and monetary policies, would
continue to support a pickup in the rate
of increase of final demand over coming quarters, the likely degree of the
strengthening remained uncertain. The
FOMC decided to keep unchanged
its monetary policy stance and its view
that the risks to the economic outlook
remained balanced.
Economic Projections
for 2002 and 2003
The members of the Board of Governors
and the Federal Reserve Bank presidents, all of whom participate in the
deliberations of the FOMC, expect the
economy to expand rapidly enough over
the next six quarters to erode current
margins of underutilized capital and
labor resources. The central tendency of
the forecasts for the increase in real
GDP over the four quarters of 2002 is
Economic Projections for 2002 and 2003
Percent
Indicator
Federal Reserve Governors
and
Reserve Bank presidents
Central
tendency
Range
2002
Change, fourth quarter
to fourth quarter1
Nominal GDP
Real GDP
PCE chain-type price
index
Average level,
fourth quarter
Civilian unemployment
rate
41/2-51/2
3-4
43/4-5V4
31/2-33/4
l l /4-2
lV2-l3/4
5V6-6l/4
53/4-6
2003
Change, fourth quarter
to fourth quarter1
Nominal GDP
Real GDP
PCE chain-type price
index
Average level,
fourth quarter
Civilian unemployment
rate
4i/2_6
3V4-4V4
5-53/4
VA-A
1-2V4
l'/2-l3/4
5-6
5VAT-51A
1. Change from average for fourth quarter of previous
year to average for fourth quarter of year indicated.
Monetary Policy Report of July 2002
3J/2 percent to 33A percent, and the central tendency for real GDP growth in
2003 is 3Vi percent to 4 percent. The
central tendency of the projections of
the civilian unemployment rate, which
averaged just under 6 percent in the
second quarter of 2002, is that it stays
close to this figure for the remainder
of the year and then moves down to
between 5V4 percent and 5V2 percent by
the end of 2003.
Support from monetary and fiscal
policies, as well as other factors, should
lead to a strengthening in final demand
over coming quarters. Business spending on equipment and software will
likely be boosted by rising sales,
improving profitability, tax incentives,
and by the desire to acquire new capital embodying ongoing technological
advances. Improving labor market conditions and a robust underlying trend in
productivity growth should further bolster household income and contribute to
an uptrend in spending. In addition, the
liquidation of last year's inventory overhangs has left businesses in a position to
begin rebuilding stocks as they become
more persuaded that the recovery in
final sales will be sustained.
Most FOMC participants expect
underlying inflation to remain close to
recent levels through the end of 2003.
Core inflation should be held in check
by productivity gains that hold down
cost increases, a lack of pressure on
resources, and well-anchored inflation
expectations. Overall inflation, which
was depressed last year by a notable
decline in energy prices, is likely to run
slightly higher this year. In particular,
the central tendency of the projections
of the increase in the chain-type index
for personal consumption expenditures
over the four quarters of both 2002
and 2003 is IV2 percent to PA percent,
compared with last year's pace of
1 VA percent.
45
Economic and Financial
Developments in 2002
The pace of economic activity picked
up considerably in the first half of 2002
after being about unchanged, on balance, in the second half of 2001. Final
sales advanced modestly as substantial
gains in household and government
spending were partly off-set by weak
business fixed investment and a widening gap between imports and exports.
In addition, inventory liquidation slowed
sharply as businesses stepped up production to bring it more closely in line
with the pace of final sales. The increase
in real GDP was particularly rapid early
in the year, with the first-quarter gain
elevated by a steep reduction in the
pace of the inventory run-off, a surge
in defense spending, and a weatherinduced spurt in construction. Real GDP
is currently estimated to have risen at an
annual rate of just over 6 percent in the
first quarter and appears to have posted
a more moderate gain in the second
quarter.
Private payroll employment declined
through April, and at midyear the unemployment rate stood somewhat above
its average in the fourth quarter of 2001.
Core inflation—which excludes the
direct influences of the food and energy
sectors—remained subdued through
May, held down by slack in resource
utilization and continued sizable
advances in labor productivity. Overall
inflation was boosted by a surge in
energy prices in March and April, but
energy prices have since retreated a bit.
Inflation expectations remained in check
in the first half of this year.
As judged by declines in most interest
rates over the first half of the year, financial market participants have marked
down their expectation of the vigor of
the economic expansion. Interest rates,
along with most equity indexes, rose
46
89th Annual Report, 2002
noticeably toward the end of the first
quarter in reaction to generally strongerthan-expected economic data. But Treasury yields and equity prices more than
rolled back those increases on renewed
questions about the strength of the
rebound in the economy, including
growing uncertainty regarding prospective corporate profits and concerns about
escalating geopolitical tensions and
about the governance and transparency
of U.S. corporations. Private demands
on credit markets moderated in the first
half of the year, as businesses substantially curbed their net borrowing. For
the most part, this reduction reflected
further declines in business investment,
a pickup in operating profits, and a
return to net equity issuance. But, in
addition, lenders became more cautious
and selective, especially for borrowers
of marginal credit quality.
Market perceptions that the recovery in the United States might turn out
to be less robust than anticipated also
put downward pressure on the foreign
exchange value of the dollar as measured against the currencies of our major
trading partners, especially during the
second quarter of 2002. Central banks in
some foreign countries, including Canada, tightened policy as growth firmed.
The euro-area economy recovered modestly during the first half, and some
brighter signs were evident in Japan. In
contrast, the dollar strengthened on balance against the currencies of our other
important trading partners; in particular,
the Mexican peso lost ground, and
financial markets reacted to political and
economic problems in several South
American countries.
The Household Sector
Household spending began the year on a
strong note and continued to rise in the
second quarter. Further gains in dis
posable income have supported a solid
underlying pace of spending. The
decline in stock prices in the first half of
2002 reduced household wealth, and the
debt-service burden remained high, but
financial stress among households to
date has been limited.
Consumer Spending
Real consumer expenditures increased
at an annual rate of 3V4 percent in the
first quarter. Demand for motor vehicles
dropped from an extraordinary fourthquarter pace, but purchases remained
supported in part by continued large
incentive packages. Outlays for other
goods and services advanced smartly in
the first quarter. In the second quarter,
the rate of increase in consumer spending looks to have eased somewhat.
Motor vehicle purchases were little
changed, and most other major categories of consumer spending likely posted
smaller gains than earlier in the year.
Real disposable personal income
moved sharply higher in the first quarter
and appears to have risen a little further
in the second quarter. Wages and salaries have increased only moderately this
year. But tax payments have fallen
markedly; last year's legislation lowered withheld tax payments again this
year, and final payments this spring on
tax obligations for 2001 were substantially below last year's level (likely
related at least in part to a decline in
capital gains realized last year). All told,
real disposable income increased at an
annual rate of 8 percent between the
fourth quarter of last year and May.
However, household net worth has
likely fallen further because the negative effect of the decline in stock prices
has been only partly offset by an apparent continued appreciation in the value
of residential real estate. According to
the flow of funds accounts, by the end
Monetary Policy Report of July 2002
of the first quarter, the ratio of household net worth to disposable income had
reversed close to two-thirds of its run-up
in the second half of the 1990s; this ratio
has undoubtedly registered additional
declines since the end of March. Consumer sentiment improved over the first
several months of the year, with indexes
from both the Conference Board and
the Michigan Survey Research Center
reversing last fall's sharp deterioration.
However, both indexes have given up
some of those gains more recently.
The personal saving rate increased in
the first half of this year, as the decline
in wealth over the past two years likely
held down consumer spending relative
to disposable personal income. In May,
the saving rate stood at 3 percent of
disposable income, up from an average
of Wi percent over 2001. Movements
in the saving rate have been very erratic
over the past year, reflecting cyclical
factors, the timing of tax cuts, and
adjustments in incentives to purchase
motor vehicles.
Residential Investment
Real residential investment increased
at an annual rate of about 15 percent
in the first quarter, and the level of activity appears to have remained robust
in the second quarter. The first-quarter
surge was spurred partly by unseasonably warm and dry winter weather,
which apparently encouraged builders
to move forward some of their planned
construction. At the same time, underlying housing activity has been supported by the gains in income and confidence noted above, and, importantly, by
low interest rates on mortgages. In the
single-family sector, starts averaged an
annual rate of 1.35 million units over
the first five months of the year—up
6V2 percent from the already buoyant
pace registered in 2001. Sales of exist
47
ing homes jumped in early 2002 after
moving sideways during the preceding
three years; sales of new homes have
also been running quite high in recent
months.
Home prices have continued to move
up strongly. For example, over the year
ending in the first quarter, the constantquality price index for new homes
rose 5lA percent, and the repeat-sales
price index for existing homes was up
62/4 percent. Despite these increases,
low mortgage rates have kept housing
affordable. Rates on thirty-year conventional fixed-rate loans averaged less than
7 percent in the first half of this year,
and rates on adjustable-rate loans continued the downtrend that began in early
2001. The share of median household
income required to finance the purchase
of a median-price house is close to its
average for the past ten years and well
below the levels that prevailed in the
1970s and 1980s.
In the multifamily sector, housing
starts averaged 340,000 units at an
annual rate over the first five months of
the year, a pace close to the average of
the previous five years. However, conditions in this market have deteriorated
somewhat during the past year. In the
first quarter, the vacancy rate for apartments spiked to the highest level since
the late 1980s, and rents and property
values were below year-earlier readings.
Household Finance
As it did last year, household debt
appears to have expanded at more than
an 8 percent annual rate during the first
half of 2002. Although consumer credit
(debt not secured by real estate) has
increased, the bulk of the expansion in
household debt has come from a sizable
buildup of home mortgage debt. Refinancing activity has fallen below last
year's record pace, but it has remained
48
89th Annual Report, 2002
strong as households have continued to
extract a portion of the accumulated
equity in their homes.
The aggregate household debt-service
burden—the ratio of estimated minimum scheduled payments on mortgage
and consumer debt to disposable personal income—although still elevated,
has moved little this year. The effect of
the fast pace of household borrowing on
the debt burden has been offset by lower
interest rates and the brisk growth in
disposable income. On balance, indicators of credit quality do not suggest
much further deterioration in the financial condition of households. While
delinquency rates for subprime borrowers have risen further for auto loan pools
and have stayed high for mortgages,
mortgage delinquencies for all borrowers have changed little, and delinquencies on credit card accounts at banks
have not risen significantly since the
mid-1990s. The number of personal
bankruptcy filings also has essentially
moved sideways this year, albeit at a
historically high rate. Lenders have
apparently reacted to these indicators
of household credit quality by tightening standards for consumer loans, as
reported on the Federal Reserve's Senior
Loan Officer Opinion Surveys. Standards for mortgage loans, however, have
changed little, and, on the whole, credit
appears to have remained readily available to the household sector.
The Business Sector
Spending in the business sector appears
to have bottomed out recently, but a
strong recovery has not yet taken hold.
Real business fixed investment, which
declined sharply last year, fell again in
the first quarter, but seems to have
firmed in the second quarter. Excess
capacity in some sectors and uncertainty
about the pace of the economic expan
sion are likely still restraining equipment demand, but rising output, improving corporate profits, and continuing
technological advances appear to be
working in the opposite direction. Many
businesses have worked off their excess
stocks, and the substantial inventory
runoff that began in the first quarter of
last year seems to be drawing to a close.
The combination of higher profits and
weak investment spending has led to a
drop in borrowing by the nonfinancial
business sector thus far this year.
Fixed Investment
Real business spending on equipment
and software (E&S) was little changed
in the first quarter after having dropped
sharply last year. In the high-tech category, real expenditures moved up in the
first quarter after a double-digit decline
in 2001. Outlays for computers posted
large gains in inflation-adjusted terms in
both the fourth and first quarters; many
businesses apparently postponed computer replacement over much of last year
but now seem to be taking advantage
of ongoing technological progress and
the associated large declines in prices.
In contrast, real expenditures for
communications equipment were little
changed in the first quarter after having plunged by one-third during 2001.
Excess capacity in the provision of telecom services is continuing to weigh
heavily on the demand for communications equipment. Business outlays for
software edged down in real terms in the
first quarter.
Real spending on transportation
equipment dropped in the first quarter.
Outlays for aircraft shrank dramatically
as the reduction in orders after last
year's terrorist attacks began to show
through to spending. Outlays for motor
vehicles fell sharply early in the year
owing to weakness in the market for
Monetary Policy Report of July 2002
heavy trucks and a reported reduction in
fleet sales to rental companies related to
the downturn in air travel. Real E&S
spending outside of the high-tech and
transportation categories moved up in
the first quarter after sizable declines in
the three preceding quarters. This pattern probably reflects the deceleration
and subsequent acceleration in business
output, which is an important determinant of spending in this category.
In the second quarter, real E&S
spending likely rose, borne along by
increases in sales and a rebound in
profits. Incoming data on orders and
shipments suggest that real outlays for
high-tech equipment advanced and that
expenditures for other nontransportation
equipment also rose. Spending on aircraft probably contracted further, but
orders for heavy trucks surged this
spring, as some companies reportedly
shifted purchases forward in anticipation of stricter emissions requirements
that are scheduled to take effect in the
fall. Because of lags in the ordering and
building of new equipment, the provision for partial expensing in the Job
Creation and Worker Assistance Act
passed by the Congress in early March
will likely bolster investment spending
gradually.
Real outlays for nonresidential structures registered a very large decline in
the first quarter after having slipped
appreciably in 2001. Outlays for office
and industrial structures, lodging facilities, and public utilities dropped substantially. Vacancy rates for offices
jumped in the first quarter to their highest level since the mid-1990s; in addition, rents and property values were
noticeably below their levels one year
earlier. Vacancy rates have risen dramatically in the industrial sector as well.
Construction of drilling structures also
contracted sharply in the first quarter,
thereby continuing the downtrend that
49
began in the middle of last year in the
wake of the decline in the prices of oil
and natural gas from their peaks a few
quarters earlier. Incoming data point to
further declines in spending for nonresidential structures in the second quarter.
Inventory Investment
Businesses ran off inventories at an
annual rate of nearly $30 billion in the
first quarter. This drawdown followed a
much larger liquidation—at an annual
rate of roughly $120 billion—in the
fourth quarter, and the associated
step-up in production contributed almost
3Vi percentage points to the first-quarter
increase in real GDR Book-value data
on inventories outside of the motor vehicle sector point to a further slackening
of the drawdown more recently. Since
last fall, inventory-sales ratios have
more than reversed the run-up that
occurred as the economy softened. Currently, inventories do not appear to be
excessive for the economy as a whole,
although industry reports suggest that
overhangs persist in a few areas. In contrast to inventories in other sectors,
motor vehicle stocks increased in the
first half of this year, as automakers
boosted production in order to rebuild
stocks that had been depleted by the
robust pace of sales in late 2001. Motor
vehicle inventories were no longer lean
as of the middle of this year.
Corporate Profits and Business
Finance
The economic profits of the U.S. nonfinancial corporate sector grew 5 percent
at a quarterly rate in the first quarter of
this year after a surge of 133/4 percent
in the fourth quarter of 2001. The corresponding ratio of profits to sector GDP
has edged up to 8% percent, reversing a
portion of the steep decline registered
50
89th Annual Report, 2002
over the preceding few years but
remaining well below its peak in the
mid-1990s. Early indicators point to further profit gains in the second quarter.
The rise in profits since late 2001,
combined with weak capital expenditures and low share repurchase and cashfinanced merger activities, have helped
keep nonfinancial corporations' need for
external funds (the financing gap) below
the average of last year. In addition,
corporations have turned to the equity
markets to raise a portion of their
needed external funds: Corporations
have sold more new equity than they
have retired this year—the first period
of net equity issuance in nearly a
decade. They have used much of these
funds to repay debt. As a result, the
growth of nonfinancial business debt
appears to have slowed considerably in
the first half of 2002 after rapid gains in
preceding years.
Much of the growth in nonfinancial
business debt this year has been concentrated in the corporate bond market
(though issuance has not been quite so
strong as in 2001), as firms have taken
advantage of historically attractive
yields. Many corporations have used the
proceeds of their bond offerings to pay
down commercial and industrial (C&I)
loans at banks and commercial paper. In
recent months, however, net corporate
bond issuance has slowed, and the contraction in short-term funding appears to
have moderated.
About one fifth of total bond offerings over the first half of 2002 have
been in the speculative-grade market.
This fraction is about unchanged from
last year but still well below the proportions seen in the latter half of the 1990s,
and speculative-grade bond offerings
have been concentrated in the higher
quality end of that market. Troubles in
the two largest sectors of the market—
telecommunications and energy—have
continued to weigh on issuance this
year.
Although many businesses have
apparently substituted bond debt for
shorter-term financing by choice, others, especially investment-grade firms
in the telecommunications sector, have
done so by necessity: They were pushed
out of the commercial paper market or
otherwise encouraged by investors and
credit-rating agencies to curb their reliance on short-term sources of financing
to limit the associated rollover risk.
Indeed, commercial paper outstanding
ran off sharply in February and early
March, when several companies that
were perceived as having questionable
accounting practices were forced to tap
bank lines to pay off maturing commercial paper. With lower-quality borrowers leaving the market in the face of
elevated risk spreads, commercial paper
outstanding shrank nearly 30 percent in
the first half of the year after a sizable
decline in 2001.
Some firms that exited the commercial paper market turned, at least temporarily, to banks as an alternative.
Nonetheless, on net, commercial and
industrial loans at banks have declined
this year, reflecting borrowers' preference for lengthening the maturity of
their liabilities and the overall reduction
in the demand for external financing,
noted earlier. To a more limited extent, a
somewhat less receptive lending environment probably also weighed on business borrowing at banks. In particular,
banks continued to tighten terms and
standards on C&I loans on net over
the first half of this year, although the
fraction of banks that reported having
done so fell noticeably in the Federal
Reserve's Senior Loan Officer Opinion
Survey in April. Banks have also
imposed stricter underwriting standards
and higher fees and spreads on backup
lines of credit for commercial paper over
Monetary Policy Report of July 2002
most of 2001 and early 2002; banks
cited increased concerns about the creditworthiness of issuers and a higher likelihood of lines being drawn down.
Indicators of credit quality still point
to some trouble spots in the nonfinancial
business sector. The ratio of net interest
payments to cash flow has trended up
since the mid-1990s for the nonfinancial corporate sector as a whole, with
increases most pronounced for weaker
speculative-grade firms. The default rate
on outstanding corporate bonds has
remained quite elevated by historical
standards. By contrast, although the
delinquency rate on C&I loans at banks
has risen a bit further this year, it has
stayed well below rates observed in the
early 1990s. In part, however, this performance may be attributable to more
aggressive loan sales and charge-offs
than in the past. It may be that problems
have risen more for large firms than
for smaller ones, as the increase in C&I
loan delinquencies over recent quarters
was limited to large banks, where loans
to larger firms are more likely to be
held. Credit rating downgrades continued to outpace upgrades by a substantial
margin, as was the case in the last quarter of 2001. Spreads of corporate bond
yields over those on comparable Treasuries have remained high by historical
standards and have risen considerably
across the credit-quality spectrum for
telecom firms. Corporate bond spreads
also widened, though to a much smaller
extent, for a few highly rated firms in
other industries owing to concerns about
their accounting practices.
After having surged late last year,
growth in commercial mortgage debt
dropped back in the first half of this year
amid a sharp decline in construction
activity. Issuance of commercial mortgage backed securities (CMBS), a major
component of commercial mortgage
finance, has been especially weak.
51
Nonetheless, investor appetite for
CMBS has apparently been strong, as
yield spreads have narrowed this year.
Delinquency rates on CMBS pools,
which had been rising during the early
part of the year, seem to have stabilized
in recent months, and delinquency rates
on commercial mortgages held by banks
and insurance companies have remained
near their historical lows.
The low level of risk spreads for
CMBS suggests that concerns about terrorism insurance have not been widespread in the market for commercial
mortgages, and responses to the Federal
Reserve's Senior Loan Officer Opinion
Survey in April indicate that most
domestic banks required insurance on
less than 10 percent of the loans being
used to finance high-profile or heavytraffic properties. Nonetheless, that
fraction was much higher at a few
banks, and some credit-rating agencies
have placed certain CMBS issues—
mainly those backed by high-profile
properties—on watch for possible
downgrade because of insufficient terrorism insurance.
The Government Sector
The federal unified budget moved into
deficit in fiscal 2002 after having posted
a substantial surplus in fiscal 2001. The
deterioration reflects a sharp drop in tax
collections (resulting in part from the
effects of the economic downturn, the
decline in stock prices, and legislated
tax cuts) and unusually large supplemental spending measures. As a consequence, federal debt held by the public
increased in the first half of the year
after rapid declines during the previous
several years. The budgets of states and
localities have also been strained by economic events, and many state and local
governments have taken steps to relieve
these pressures.
52
89th Annual Report, 2002
Federal Government
Over the first eight months of fiscal year
2002 (October through May) the unified
budget recorded a deficit of $147 billion, compared with a surplus of
$137 billion over the same period of
fiscal year 2001. Nominal receipts were
12 percent lower than during the same
period of fiscal 2001, and daily Treasury
data since May suggest that receipts
have remained subdued. Individual tax
payments are running well below last
year's pace; this weakness reflects general macroeconomic conditions, the legislated changes in tax policy, and the
decline in stock prices and consequent
reduction in capital gains realizations in
2001. The extent of the weakness was
not widely anticipated—this spring's
nonwithheld tax payments, which
largely pertain to last year's liabilities,
generated the first substantial negative
April surprise in revenue collections in
a number of years. Corporate tax payments have also dropped from last
year's level because of weak profits and
the business tax provisions included in
the Job Creation and Worker Assistance
Act of 2002.
Nominal federal outlays during the
first eight months of fiscal 2002 were
10 percent higher than during the same
period last year; excluding a drop in net
interest payments owing to the current
low level of interest rates, outlays were
up 14 percent. The rate of increase was
especially large for expenditures on
income security, health, and national and
homeland defense. Real federal expenditures for consumption and gross investment, the part of government spending
that is a component of real GDP, rose at
an annual rate of roughly IIV2 percent
in the first calendar quarter of 2002 as
defense spending surged. The available
data suggest that real federal expenditures for consumption and gross invest
ment increased further in the second
quarter.
Federal saving, which equals the unified budget surplus adjusted to conform
to the accounting practices followed
in the national income and product
accounts, has fallen considerably since
the middle of last year. Net federal saving, which accounts for the depreciation
of government capital, turned negative
in the first quarter of this year. At the
same time, the net saving of households,
businesses, and state and local governments has moved up from its trough of
last year. On balance, net national saving as a share of GDP has held roughly
steady in the past several quarters after
having moved down sharply since 1999.
Federal debt held by the public, which
had been declining rapidly over the past
few years, grew at a 3V4 percent annual
rate in the first quarter of 2002 and is
estimated to have increased considerably more in the second quarter. The
ratio of federal government debt held
by the public to nominal GDP fell only
slightly in the first quarter following
several years of steep declines. In
response to the changing budget outlook, the Treasury suspended its buyback operations through mid-August
and increased the number of auctions
of new five-year notes and ten-year
indexed securities.
During the second quarter, the Treasury took unusual steps to avoid breaching its statutory borrowing limit
of $5.95 trillion. In early April, it
temporarily suspended investments in
the Government Securities Investment
Fund—the so-called G-fund of the Federal Employees' Retirement System.
Incoming individual nonwithheld tax
receipts later that month allowed the
Treasury to reinvest the G-fund assets
with an adjustment for interest. Late
in May, the Treasury declared a debt
ceiling emergency, which allowed it to
Monetary Policy Report of July 2002
disinvest a portion of the Civil Service
Retirement and Disability Fund, in addition to the G-fund, to keep its debt from
breaching the statutory limit. At the time
of the declaration, the Treasury indicated that disinvestments from these two
funds, combined with other stopgap
measures, would be sufficient to keep
it from breaching the debt ceiling only
through late June. The Congress
approved legislation raising the statutory borrowing limit to $6.4 trillion on
June 27.
State and Local Governments
Slow growth of revenue resulting from
the economic downturn has also generated a notable deterioration in the fiscal
position of many state and local governments over the past year. In response,
many states and localities have been
trimming spending plans and, in some
cases, raising taxes and fees. In addition,
many states have been dipping into
rainy-day and other reserve funds.
Together, these actions are helping to
move operating budgets toward balance.
Real consumption and investment
spending by state and local governments
rose at an annual rate of 4V4 percent in
the first quarter, but available data suggest that outlays were little changed
in the second quarter. Outlays for consumption items seem to have held to
only moderate increases in the first half
of this year, a step-down from last year's
more robust gains. Investment spending
rose briskly in the first quarter and
retreated in the second quarter; this
pattern largely reflects the contour of
construction expenditures, which were
boosted early in the year by unseasonably warm and dry weather.
Debt growth in the state and local
government sector has slowed so far in
2002 from last year's very rapid pace.
States and localities have continued
53
to borrow heavily in bond markets to
finance capital expenditures and to
refund existing obligations, including
short-term debt issued last year. The
overall credit quality of the sector has
remained high despite the fiscal stresses
associated with the recent economic
slowdown, and yield ratios relative to
Treasuries have changed little this year,
on net.
The External Sector
Stronger growth in the United States
contributed to a widening of U.S. external deficits in the first quarter of this
year. The United States has continued
to receive large net private financial
inflows in 2002, but both inflows and
outflows have been at lower levels than
in recent years.
Trade and the Current Account
The U.S. deficit on trade in goods and
services widened about $27 billion in
the first quarter, to nearly $380 billion
at an annual rate, as a surge in imports
overwhelmed a slower expansion of
exports. U.S. net investment income
decreased $33 billion to a slight deficit
position after recording modest surpluses in all four quarters last year. The
U.S. deficit on other income and transfers widened about $9 billion, to nearly
$70 billion at an annual rate. The U.S.
current account, which is the sum of the
above, recorded a deficit in the first
quarter of $450 billion at an annual rate,
4.3 percent of GDP and nearly $70 billion larger than the deficit in the fourth
quarter of 2001.
Real exports of goods and services
increased 3 percent at an annual rate in
the first quarter, after five quarters of
decline. This improvement resulted from
a very large step-up in service receipts,
as payments by foreign travelers moved
54
89th Annual Report, 2002
back up to near pre-September 11 levels
and other private service receipts
increased as well. The real value of
exported goods contracted in the first
quarter, but at only a 3Vi percent annual
rate. Goods exports had declined much
more steeply in the previous three quarters under the effects of slower output
growth abroad, continued appreciation
of the dollar, and plunging global
demand for high-tech products. The
better performance in the first quarter of
2002 included a markedly slower rate
of decline of machinery exports and a
small increase in exported aircraft.
While exports of computers continued
to fall, exports of semiconductors rose
for the first time in nearly two years.
Export prices continued to edge down in
the first quarter.
U.S. real imports of goods and services expanded in the first quarter at an
8 percent annual rate. As was the case
with exports, a substantial part of the
increase came from larger service
payments related to increased travel
abroad by U.S. residents. Reflecting the
rebound in U.S. economic activity,
imports of real goods rose at about a
4 percent pace in the first quarter of
2002, the first increase in four quarters,
as a decline in oil imports was more
than offset by a substantial increase in
imports of other goods. Growth of nonoil imports was led by increased imports
of computers, autos, and consumer
goods. The price of imported non-oil
goods declined at about a 2lA percent
annual rate, in line with its trend in
2001; prices fell for a wide range of
capital goods and industrial supplies.
Declining demand during the second
half of last year put the price of West
Texas intermediate (WTI) crude oil in
December 2001 at around $19 per barrel, its lowest level since mid-1999.
Unusually warm winter weather in the
United States—along with low prices—
helped keep the value of oil imports
at a very low level in the first quarter.
But oil prices began to rise in February
and March as global economic activity
picked up and as OPEC reduced its
production targets in an agreement
with five major non-OPEC producers
(Angola, Mexico, Norway, Oman, and
Russia). Oil prices remained firm in the
second quarter around $26 per barrel
amid turmoil in the Middle East, a onemonth suspension of oil exports by Iraq,
disruption of supply from Venezuela,
and increasing global demand. The price
of gold also has reacted to heightened
geopolitical tensions and moved up
more than 13 percent over the first half
of 2002.
The Financial Account
The shift in the pattern of U.S. international financial flows observed in the
second half of 2001 continued into the
first quarter of this year. Influenced
by increased economic uncertainty,
questions about corporate governance
and accounting, and sagging share
prices, foreign demand for U.S. equities
remained weak. Foreign net purchases
of U.S. bonds slowed; although purchases of corporate bonds continued
to be robust, demand for agency and
Treasury bonds slackened. Nonetheless,
because U.S. net purchases of foreign
securities also fell off, the contribution
of net inflows through private securities
transactions to financing the U.S. current account deficit remained at a high
level. Preliminary and incomplete data
for the second quarter of 2002 suggest a
continuation of this pattern.
Slower economic activity, both in the
United States and abroad, and reduced
merger activity caused direct investment
inflows and outflows to drop sharply
late last year. Direct investment inflows,
which were strong through the first half
Monetary Policy Report of July 2002
of 2001, plummeted in the second half.
U.S. direct investment abroad stayed at
a high level through the third quarter
but then fell sharply. Both inflows and
outflows remained weak in the first
quarter of 2002. Available data point to
a pickup of capital inflows from official
sources during the first half of 2002, as
the recent weakening of the foreign
exchange value of the dollar prompted
some official purchases.
The Labor Market
Labor markets weakened further in the
first few months of the year; they now
appear to have stabilized but have yet to
show signs of a sustained and substantial pickup. Growth of nominal compensation slowed further in the first part
of the year after having decelerated
in 2001. With productivity soaring in
recent quarters, unit labor costs have
fallen sharply.
Employment and Unemployment
After having fallen an average of nearly
160,000 per month in 2001, private payroll employment declined at an average
monthly rate of 88,000 in the first quarter and was about unchanged in the second quarter. Employment losses in the
manufacturing sector have moderated in
recent months, and employment in the
help supply services industry—which
provides many of its workers to the
manufacturing sector—has increased.
These two categories, which were a
major locus of weakness last year,
gained an average of 11,000 jobs per
month over the past three months, compared with an average loss of 76,000
jobs per month in the first quarter of the
year and 163,000 jobs per month over
2001.
Apart from manufacturing and help
supply, private payrolls fell 12,000 per
55
month in the first quarter and declined
8,000 per month in the second quarter.
In the second quarter, hiring in construction fell by the same amount as in
the first quarter. Retail employment
declined somewhat after rising a bit in
the first quarter, and the employment
gain in services other than help supply
was slightly smaller than in the first
quarter. However, employment losses in
several other categories abated in the
second quarter.
The unemployment rate in the second
quarter averaged 5.9 percent, up from a
reading of 5.6 percent in both the fourth
quarter of last year and the first quarter
of this year. The higher unemployment
rate in recent months is consistent with
weak employment gains, and it probably
was boosted a bit by the federal temporary extended unemployment compensation program. Because this program provides additional benefits to individuals
who have exhausted their regular state
benefits, it encourages unemployed individuals to be more selective about taking a job offer and likely draws some
people into the labor force to become
eligible for these benefits.
Productivity and Labor Costs
Labor productivity has increased rapidly
in recent quarters. After rising at an
average annual rate of around 1 percent
in the first three quarters of last year,
output per hour in the nonfarm business
sector jumped at an annual rate of
5Vi percent in the fourth quarter of last
year and 8V2 percent in the first quarter
of this year. Productivity likely continued to rise in the second quarter, albeit
at a slower pace. Labor productivity
often rises briskly in the early stages of
economic recoveries, but what makes
the recent surge unusual is that it followed a period of modest increases,
rather than declines. In earlier postwar
56
89th Annual Report, 2002
recessions, productivity deteriorated as
firms retained more workers than may
have been required to meet reduced
production needs. The strength in productivity growth around the beginning
of this year suggests that employers
may have doubted the durability of the
pickup in sales and, therefore, deferred
new hiring until they became more convinced of the vigor of the expansion.
Smoothing through the recent cyclical
fluctuations, productivity advanced at an
average annual rate of close to 2>Vi percent between the fourth quarter of 2000
and the first quarter of this year.
Although this pace is unlikely to be
sustained, it further bolsters the view
that the underlying trend in productivity
has moved up since the first half of the
1990s.
The employment cost index (ECI) for
private nonfarm businesses increased
just under 4 percent during the twelve
months ended in March of this year,
after rising about AXA percent in the preceding twelve-month period. The recent
small step-down likely reflects the
lagged effects of the greater slack in
labor markets and lower consumer price
inflation. The wages and salaries component and the benefits component of
the ECI both decelerated by lA percentage point relative to the preceding year.
The slowing in benefits costs occurred
despite a 2Vi percentage point pickup
in health insurance cost inflation, to a
10^2 percent rate of increase.
Nominal compensation per hour in
the nonfarm business sector—an alternative measure of compensation based
on the national income and product
accounts—rose 3!/2 percent during the
year ending in the first quarter. This rate
represented a sharp slowing from the
IVA percent pace recorded four quarters
earlier, which likely had been boosted
significantly by stock options; stock
options are included in this measure at
their value when exercised. The deceleration in this measure of compensation
is much more dramatic than in the ECI
because the ECI does not include stock
options. The moderate increase in nominal compensation combined with the
spike in productivity growth led unit
labor costs to drop at an annual rate in
excess of 5 percent in the first quarter,
after a decline of 3 percent in the fourth
quarter.
Information about the behavior of
compensation in more recent months
is limited. Readings on average hourly
earnings of production or nonsupervisory workers suggest a further deceleration in wages: The twelve-month change
in this series was 3lA percent in June,
3
A percentage point below the change
for the preceding twelve months.
Prices
A jump in energy prices in the spring
pushed up overall inflation in the first
part of 2002, but core inflation remained
subdued. The chain-type price index
for personal consumption expenditures
(PCE) increased at an annual rate of
2VA percent over the first five months
of the year, compared with a rise of just
over 1 percent for the twelve months of
2001. Core PCE prices rose at an annual
rate of just over IV2 percent during the
first five months of this year, which was
the pace recorded for 2001.
Energy prices rose sharply in March
and April but have turned down more
recently. Gasoline prices spiked in those
two months, as crude oil costs moved
higher and retail gasoline margins
surged. Since April, gasoline prices
have, on balance, reversed a small part
of this rise. Natural gas prices stayed
low in early 2002 against a backdrop of
very high inventories; however, these
prices have, on average, moved higher
in more recent months. Electricity prices
Monetary Policy Report of July 2002
have dropped this year, a move reflecting deregulation of residential prices in
Texas as well as lower prices for coal
and natural gas, which are used as inputs
in electricity generation. All told, energy
prices increased at an annual rate of
20 percent over the first five months of
the year, reversing a little more than half
of last year's decline.
Consumer food prices increased at
an annual rate of IV2 percent between
December and May. A poor winter crop
of vegetables pushed up prices early
this year, but supplies subsequently
increased and prices came down. In
addition, consumer prices for meats and
poultry, which began to weaken late last
year, remained subdued this spring.
Core inflation was held down over
the first five months of the year by continued softness in goods prices, including a significant decline in motor vehicle prices. Non-energy services prices
continued to move up at a faster pace
than core goods prices, although the
very sizable increases in residential rent
and the imputed rent of owner-occupied
housing have eased off in recent months.
The rate of increase in core consumer
prices has been damped by several
forces. One is the lower level of
resource utilization that has prevailed
over the past year. Core price increases
were also held down by declines in nonoil import prices and the lagged effects
of last year's decline in energy prices on
firms' costs. In addition, inflation expectations have stayed in check: The Michigan Survey Research Center index of
median expected inflation over the subsequent year has rebounded from last
fall's highly unusual tumble, but its
average in recent months of 2% percent
is below the average reading of 3 percent in 2000.
Like core PCE inflation, inflation
measured by the core consumer price
index (CPI) has remained subdued.
57
However, the levels of inflation corresponding to these two alternative measures of consumer prices are markedly
different: Core PCE inflation was about
IV2 percent over the twelve months
ended in May, while core CPI inflation
was about 2Vi percent. This gap is more
than Vi percentage point larger than the
average difference between these inflation measures during the 1990s (based
on the current methods used to construct
the CPI instead of the official published
CPI). The larger differential arises from
several factors. First, the PCE price
index (unlike the CPI) includes several
components for which market-based
prices are not available, such as checking services provided by banks without
explicit charges; the imputed prices for
these components have increased considerably less rapidly in the past couple
of years than previously. Second, the
substantial acceleration in shelter costs
since the late 1990s has provided a
larger boost to the CPI than to the PCE
price index because housing services
have a much larger weight in the CPI.
Third, PCE medical services prices—
which are largely based on producer
price indexes rather than information
from the CPI—have increased more
Alternative Measures of Price Change
Percent
Price measure
Chain-type
Gross domestic product
Gross domestic purchases
Personal consumption
expenditures
Excluding food and energy ...
Fixed-weight
Consumer price index
Excluding food and energy . . .
2000
to
2001
2001
to
2002
2.3
2.2
1.4
.7
2.4
1.9
.7
1.3
3.4
2.7
1.2
2.5
NOTE. Changes are based on quarterly averages and
are measured from Ql to Ql.
58
89th Annual Report, 2002
slowly than CPI medical services prices
over the past couple of years.
The chain-type price index for gross
domestic purchases—which captures
prices paid for consumption, investment,
and government purchases—rose at an
annual rate of roughly 1 percent in the
first quarter of 2002, putting the fourquarter change at 3A percent. This pace
represents a marked slowing relative to
the 2lA percent rise in the year-earlier
period, owing to both a drop in energy
prices (as the decline in the second half
of 2001 was only partly offset by the
increase this spring) and more rapid
declines in the prices of investment
goods such as computers. The GDP
price index rose at an annual rate of
1V4 percent in the first quarter and was
up almost IV2 percent relative to the
first quarter of last year. The GDP price
index decelerated somewhat less than
the index for gross domestic purchases,
in part because declining oil prices
receive a smaller weight in U.S. production than in U.S. purchases.
U.S. Financial Markets
Market interest rates have moved lower,
on net, since the end of 2001, as market
participants apparently viewed the ongoing recovery as likely to be less robust
than they had been expecting late last
year. Such a reassessment of the strength
of economic activity and associated
business earnings, along with worries
about the accuracy of published corporate financial statements, weighed
heavily on major equity indexes, which
dropped 12 to 31 percent. The debt
of the nonfinancial sectors expanded
at a moderate pace, but lenders have
imposed somewhat firmer financing
terms, especially on marginal borrowers.
Households' preferences for safer
assets, which had intensified following
last year's terrorist attacks, diminished
early in 2002, as evidenced by strong
flows into both equity and bond mutual
funds. Equity fund inflows lessened in
May and turned into outflows in June,
however, as concerns about the strength
and accuracy of corporate earnings
reports mounted. But the net shift
toward longer-term assets this year
appears to have contributed to a significant deceleration in M2, which has also
been slowed by reduced mortgage refinancing activity and a leveling out of the
opportunity cost of holding M2 assets.
Interest Rates
Uncertain about the robustness of the
economic recovery, the FOMC opted to
retain its accommodative policy stance
over the first half of 2002, leaving
its target for the federal funds rate at
l3/4 percent. Market participants, too,
have apparently been unsure about the
strength of the recovery, and shifts in
their views of the economic outlook
have played a significant role in movements in market interest rates so far this
year. During the first quarter of the year,
news on aggregate spending and output
came in well above expectations, and
Treasury coupon yields rose between
35 and 65 basis points. The second quarter, however, brought renewed concerns
about the economic outlook, compounded by sharp declines in equity
prices. In recent months, Treasury coupon yields have more than reversed their
earlier increases and are now 40 to
50 basis points below their levels at the
end of 2001.
Survey measures of long-term inflation expectations have been quite stable
this year, implying that real rates
changed about as much as nominal
rates. The spread between nominal
and inflation-indexed Treasury yields,
another gauge of investors' expectations
about inflation, has moved over a rela-
Monetary Policy Report of July 2002
tively wide range since the end of 2001,
but, on net, it has edged up only slightly.
Even the small widening of this spread
likely overstates a shift in sentiment
regarding future price pressures in the
economy. In mid-February, the Treasury reassured investors that it would
continue to issue indexed debt, an
announcement that was reinforced in
May when the Treasury made public its
decision to add one more auction of
ten-year indexed notes to its annual
schedule of offerings. This reafFirmation
of the Treasury's commitment to issue
indexed securities may have pulled
indexed yields down by bolstering the
actual and expected liquidity of the
market.
Yields on longer-maturity bonds issued by investment-grade corporations
have stayed close to their lows of the
past ten years, but speculative-grade
yields remained near the high end of
their range since the mid-1990s. Spreads
relative to Treasury yields have widened
most recently for both investment- and
speculative-grade bonds as concerns
about corporate earnings reporting
intensified. Such concerns have also
played a prominent role in the commercial paper market, especially early this
year, when investors, who had become
increasingly worried about accounting
scandals, imposed high premiums on
lower-quality borrowers. Subsequently,
however, many such borrowers either
left the commercial paper market or
reduced their reliance on commercial paper financing, and the average
yield spread on second-tier commercial
paper over top-tier paper has narrowed
considerably.
Interest rates on car loans have
changed little, on net, this year, and
mortgage rates have moved lower. However, according to the Federal Reserve's
Survey of Terms of Business Lending,
interest rates on C&I loans at domestic
59
banks have moved a bit higher this year,
as banks have raised the spread of the
average interest rate on business loans
over the target federal funds rate. The
wider spread reflects higher risk premiums on C&I loans to lower-quality borrowers; spreads for higher-quality borrowers have changed little on net.
Equity Markets
After falling in January in reaction
to pessimistic assessments of expected
business conditions over the coming
year—especially in the tech sector—
stock prices rebounded smartly toward
the end of the first quarter on strongerthan-expected macroeconomic data.
Most first-quarter corporate earnings
releases met or even exceeded market
participants' expectations, but many
firms included sobering guidance on
sales and earnings prospects in those
announcements. These warnings, combined with mounting questions about
corporate accounting practices, worries
about threats of domestic terrorism, and
escalating geopolitical tensions, have
taken a considerable toll on equity prices
since the end of March. On net, all
major equity indexes are down substantially so far this year. Share prices
in the telecom and technology sectors
have performed particularly poorly, and,
on July 10, the Nasdaq was 31 percent
lower than at the end of 2001. The
Wilshire 5000, a broad measure of
equity prices, fell I8V2 percent over the
same period, returning to a level 40 percent below its historical peak reached in
March 2000.
Declining share prices pulled down
the price-earnings ratio for the S&P 500
index (calculated using operating profits
expected over the coming year). Nonetheless, the ratio remained elevated
relative to its typical values before the
mid-1990s, suggesting that investors
60
89th Annual Report, 2002
continued to anticipate rapid long-term
growth in corporate profits.
Monetary Policy Instruments
At its March 19 meeting, the FOMC
assessed the priorities, given limited
resources, it should attach to further
studies of the feasibility of outright purchases for the System Open Market
Account (SOMA) of mortgage-backed
securities guaranteed by the Government National Mortgage Association
(GNMA-MBS) and the addition of foreign sovereign debt securities to the
list of collateral eligible for U.S. dollar
repurchase agreements by the System.
As noted in the February and July 2001
Monetary Policy Reports to the Congress, such alternatives could prove
useful if outstanding Treasury debt obligations were to become increasingly
scarce relative to the necessary growth
in the System's portfolio, and the
FOMC had requested that the staff
explore these options. Noting that many
of the staff engaged in these studies
were also involved in contingency planning, which had been intensified after
the September 11 attacks, the FOMC
decided to give the highest priority
to such planning. Federal budgetary
developments over the past year meant
that constraints on Treasury debt supply would not become as pressing
an issue as soon as the FOMC had
previously thought. Still, given the
inherent uncertainty of budget forecasts, the likely significant needs
for large SOMA operations in coming years, and the lead times required
to implement new procedures, the
FOMC decided that the exploratory
work on the possible addition of outright purchases of GNMA-MBS should
go forward once it was possible to do so
without impeding contingency planning
efforts.
The Federal Reserve also addressed
possible changes to the structure of its
discount window facility. On May 17,
2002, the Federal Reserve Board
released for public comment a proposed
amendment to the Board's Regulation A
that would substantially revise its
discount window lending procedures.
Regulation A currently authorizes the
Federal Reserve Banks to operate
three main discount window programs:
adjustment credit, extended credit, and
seasonal credit. The proposed amendment would establish two new discount
window programs called primary credit
and secondary credit as replacements
for adjustment and extended credit. The
Board also requested comment on the
continued need for the seasonal program
but did not propose any substantive
changes to the program.
The proposal envisions that primary
credit would be available for very short
terms, ordinarily overnight, to depository institutions that are in generally
sound financial condition at an interest
rate that would usually be above shortterm market interest rates, including
the federal funds rate; currently, the discount rate is typically below money
market interest rates. The requirement
that only financially sound institutions
should have access to primary credit
should help reduce the stigma currently
associated with discount window borrowings. In addition, because the proposed discount rate structure will eliminate the incentive that currently exists
for depository institutions to borrow to
exploit a positive spread between shortterm money market rates and the discount rate, the Federal Reserve will be
able to reduce the administrative burden
on borrowing banks. As a result, depository institutions should be more likely
to turn to the discount window when
money markets tighten significantly,
enhancing the window's ability to serve
Monetary Policy Report of July 2002
61
The proportion of total credit supplied by depository institutions over
the first half of the year is estimated to
have been near its lowest value since
1993. Although banks have continued
to acquire securities at about the same
rapid pace observed in 2001, the shift
in household and business preferences
toward longer-term sources of credit
greatly reduced the demand for bank
loans. As noted, banks' loans to businesses ran off considerably, as corporate
borrowers turned to the bond market in
volume to take advantage of favorable
long-term interest rates. Growth of real
estate loans slowed markedly this year,
partly as outlays for nonresidential
structures declined, but growth of consumer loans was fairly well maintained.
With some measures of credit quality in
the business and household sectors still
pointing to pockets of potential strain,
loan-loss provisions remained high at
banks and weighed on profits. NonetheDebt and Financial Intermediation
less, bank profits in the first quarter
Growth of the debt of domestic nonfi- stayed in the elevated range observed
nancial sectors other than the federal over the past several years, and virtually
government is estimated to have slowed all banks—98 percent by assets—
during the first half of 2002, as busi- remained well capitalized.
Among nondepository financial internesses' needs for external funds
declined further owing to weak capital mediaries, government-sponsored enterspending, continuing inventory liqui- prises (GSEs) curtailed their net lending
dation, and rising profits. In addition, (net acquisition of credit market instrugrowth in consumer credit moderated ments) during the first quarter of the
following a surge in auto financing late year, but available data suggest that
last year. On balance, nonfederal debt insurance companies more than made
expanded at a 5Vi percent annual rate in up for the shortfall. The GSEs appeared
the first quarter of the year after grow- to continue to restrain their net lending
ing IVi percent in 2001. In contrast, the in the second quarter, in part as yields
stock of federal debt held by the public, on mortgage-backed securities, which
which had contracted slightly in 2001, are a major component of their holdings
grew ?>lA percent at an annual rate in the of financial assets, compared less favorfirst quarter and expanded further in the ably to yields on the debt they issue.
second quarter, as federal tax revenues Net lending by insurance providers in
fell short of expectations and govern- the first quarter was especially strong
ment spending increased substantially. among life insurance companies, which
The sharp rise in federal debt outstand- experienced a surge in sales late last
year in the aftermath of the Septeming followed a few years of declines.
as a marginal source of reserves for the
overall banking system and as a backup
source of liquidity for individual depository institutions. Secondary credit would
be available, subject to Reserve Bank
approval and monitoring, for depository
institutions that do not qualify for primary credit.
The proposed amendment is intended
to improve the functioning of the discount window and the money market
more generally. Adoption of the proposal would not entail a change in the
stance of monetary policy. It would not
require a change in the FOMC's target
for the federal funds rate and would not
affect the overall level of market interest
rates. The comment period on the proposal ends August 22, 2002. If the
Board then votes to revise its lending
programs, the changes likely would take
place several months later.
62
89th Annual Report, 2002
ber 11 terrorist attacks. Net lending by
the GSEs amounted to 14 percent of the
net funds raised by both the financial
and nonfinancial sectors in the credit
markets in the first quarter of 2002, and
the figure for insurance companies was
10 percent; depository credit accounted
for 13 percent of all net borrowing over
the same period.
Monetary Aggregates
The broad monetary aggregates decelerated considerably during the first half
of this year. M2 rose 4!/2 percent at an
annual rate after having grown 10V4 percent in 2001. Several factors contributed
to the slowing in M2. Mortgage refinancing activity, which results in prepayments that temporarily accumulate
in deposit accounts before being distributed to investors in mortgage-backed
securities, moderated over the first half
of this year. In addition, the opportunity
cost of holding M2 assets has leveled
out in recent months, so the increase in
this aggregate has been more in line
with income. Because the rates of return
provided by many components of M2
move sluggishly, the rapid declines in
short-term market interest rates last
year temporarily boosted the attractiveness of M2 assets. In recent months,
however, yields on M2 components
have fallen to more typical levels
relative to short-term market interest
rates. Lastly, precautionary demand for
M2, which was high in the aftermath of
last year's terrorist attacks, seems to
have unwound in 2002, with investors
shifting their portfolios back toward
longer-term assets such as equity and
bond mutual funds. With growth in
nominal GDP picking up significantly
this year, M2 velocity—the ratio of
nominal GDP to M2—rose about
1V2 percent at an annual rate in the first
quarter of 2002, in sharp contrast to the
large declines registered throughout
2001.
M3—the
broadest
monetary
aggregate—grew 3V2 percent at an
annual rate through the first six months
of the year after rising 12% percent in
2001. Most of this deceleration, apart
from that accounted for by M2, resulted
from the weakness of institutional
money market funds, which declined
slightly, after having surged about
50 percent last year. Yields on these
funds tend to lag market yields somewhat, and so the returns on the funds,
like those on many M2 assets, became
less attractive as their yields caught up
with market rates.
International Developments
Signs that economic activity abroad had
reached a turning point became clearer
during the first half of 2002, but recovery has been uneven and somewhat tepid
on average in the major foreign industrial countries. Improving conditions in
the high-tech sector have given a boost
to some emerging-market economies,
especially in Asia, but several Latin
American economies have been troubled
by a variety of adverse domestic developments. Foreign financial markets
became increasingly skittish during the
first half of the year amid worries about
global political and economic developments, including concerns about corporate governance and accounting triggered by U.S. events. Oil prices reversed
a large part of their 2001 decline.
During the first half, monetary
authorities in some foreign countries
where signs of recovery were most
evident and possible future inflation
pressures were becoming a concern—
Canada, Australia, New Zealand, and
Sweden, among others—began to roll
back a portion of last year's easing, raising expectations that policy tightening
Monetary Policy Report of July 2002
might become more widespread. However, policy was held steady at the European Central Bank (ECB) and the Bank
of England. The Bank of Japan (BOJ)
maintained short-term interest rates near
zero and kept balances of bank deposits
at the BOJ at elevated levels. Yield
curves in most foreign industrial countries became a bit steeper during the first
quarter as long-term rates rose in reaction to news suggesting stronger U.S.
growth and improving prospects for global recovery. Since then, long-term rates
have edged lower, on balance, in part as
investors shifted out of equity investments. Foreign equities performed
well in most countries early in the year,
but share prices in many countries
have fallen since early in the second
quarter—in some cases more steeply
than in the United States. The broad
stock indexes for the major industrial
countries are down since the beginning
of the year, except in Japan, where stock
prices, on balance, are about unchanged.
High-tech stocks have been hit especially hard.
During the first quarter of 2002, the
foreign exchange value of the dollar
(measured by a trade-weighted index
against the currencies of major industrial countries) appeared to react primarily to shifting market views about the
relative strength of the U.S. recovery
and its implications for the timing and
extent of future monetary tightening.
Despite some fluctuations in this period,
the dollar stayed fairly close to the more
than sixteen-year high reached in January. In the second quarter, however,
the dollar trended downward as earlier
market enthusiasm about U.S. recovery
dimmed. Concerns about profitability,
corporate governance, and disclosure
at U.S. corporations appeared to dampen
the attraction of U.S. securities to investors, as did worries that the United
States was particularly vulnerable to
63
the consequences of global geopolitical
developments. With U.S. investments
perceived as becoming less attractive,
the financing requirements of a large
and growing U.S. current account deficit
also seemed to emerge as a more prominent negative factor. The dollar has lost
more than 9 percent against the major
currencies since the end of March and is
down, on balance, more than 8 percent
so far in 2002. In contrast, the dollar has
gained about 2 percent this year, on a
weighted-average basis, against the currencies of our other important trading
partners.
The dollar's exchange rate against the
Japanese yen was quite volatile in the
first half and, on balance, the dollar has
fallen more than 10 percent since the
beginning of the year. Although Japan's
domestic economy continued to struggle
with deflation and severe structural
problems, including mounting bad loans
in the financial sector and growing
bankruptcies, some indicators (including strong reported first-quarter GDP, a
firming of industrial production, and a
somewhat better reading on business
sentiment in the BOJ's second-quarter
Tankan survey) suggested that a cyclical recovery has begun. The yen's
rise occurred despite downgradings of
Japan's government debt by leading
rating services in April and May and
several episodes of intervention sales of
yen in foreign exchange markets by
Japanese authorities in May and June.
Japanese stock prices, which had fallen
to eighteen-year lows in early February,
turned up later as economic prospects
became less gloomy. At midyear, the
TOPIX index was about where it was at
the start of the calendar year.
After declining in the final quarter of
2001, euro-area GDP appears to have
increased in the first half, though at only
a modest rate. Exports firmed and inventory de-stocking appeared to be winding
64
89th Annual Report, 2002
down, but consumption remained weak.
The pace of activity varied across
countries, with growth in Germany—the
euro area's largest economy—lagging
behind. Despite lackluster area-wide
growth, concerns about inflation became
increasingly prominent. For most of the
first half, euro-area headline inflation
persisted at or above the ECB's 2 percent target limit, partly on higher energy
and food price inflation; even excluding
the effects of those two components,
inflation picked up somewhat during the
period. Inflation concerns also were
fanned by difficult labor market negotiations this spring, but the strength of the
euro may blunt inflationary pressures
to some extent. The new euro notes and
coins were introduced with no noticeable difficulties at the beginning of the
year, but the euro drifted down against
the dollar for several weeks thereafter.
Since then, however, the euro has
reversed direction and moved steadily
higher. On balance, the dollar has lost
nearly 11 percent against the euro so far
in 2002.
The United Kingdom seemed to
weather last year's slump better than
most industrial countries, as strength
in consumption counteracted weakness
in investment and net exports, though
growth did weaken in the last quarter of
2001 and into the first quarter of 2002.
Notable increases in industrial production and continued strength in the service sector indicate that growth picked
up in the second quarter. Household borrowing has increased briskly, supported
by rapid increases in housing prices, and
unemployment rates remain near record
lows. At the same time, retail price
inflation has remained below the Bank
of England's 2J/2 percent target. Sterling
has fallen nearly 5 percent against the
euro since the beginning of the year,
while it has gained more than 6 percent
against the dollar. Elsewhere in Europe,
the exchange value of the Swiss franc
has been driven up by flows into Swiss
assets prompted in part by uncertainties
about global political developments. The
Swiss National Bank eased its official
rates in May to counteract this pressure and provide support for the Swiss
economy.
Economic recovery appears to be
well under way in Canada. Real GDP
increased 6 percent at an annual rate in
the first quarter, and other indicators
point to continued strong performance in the second quarter. Canadian exports—particularly automotive
exports—benefited early in the year
from the firming of U.S. demand, but
the expansion has become more widespread, and employment growth has
been strong. Although headline consumer price inflation has remained in
the bottom half of the Bank of Canada's
target range of 1 percent to 3 percent,
core inflation has crept up this year.
In April, the Bank of Canada increased
its overnight rate 25 basis points, citing
stronger-than-expected growth in both
the United States and Canada, and it
increased that rate again by the same
amount in June. The Canadian dollar,
which had been at a historically low
level against the U.S. dollar in January,
moved up quite steeply in the second
quarter and has gained about 5 percent
for the year so far.
The Mexican economy was hit hard
by the global slump in 2001 and especially by the weaker performance of the
U.S. economy. Mexican exports stabilized early this year as U.S. activity
picked up, and other indicators also now
suggest that the Mexican economy is
beginning to recover. In February,
despite the weak level of activity at the
time, the Bank of Mexico tightened
monetary policy to keep inflation on
track to meet its 4V2 percent target for
2002, and the Mexican peso moved up a
Monetary Policy Report of July 2002
bit against the dollar during February
and March. In April, with inflation
apparently under control, the central
bank eased policy, and since then the
peso has moved down substantially.
Against the dollar, the decline since the
beginning of the year has amounted to
almost 7 percent. After rising through
April, Mexican share prices also fell
sharply, leaving them at midyear about
unchanged from their end-2001 levels.
Financial and economic conditions
deteriorated significantly in Argentina
this year. The Argentine peso was devalued in January and then allowed to float
in early February; since then, it has lost
more than 70 percent of its value versus
the dollar. The peso's fall severely
strained balance sheets of Argentine
issuers of dollar-based obligations. Various stop-gap measures intended to
restrict withdrawals from bank accounts
and to force conversion of dollardenominated loans and deposits into
peso-denominated form put banks and
depositors under further stress. Meanwhile, economic activity has continued
to plummet, and the government has
struggled to gain support for reforms
that would address chronic fiscal imbalances. Since late 2001, the government
has been servicing its obligations only
to its multilateral creditors, and spreads
on Argentina's international debt have
soared to more than 65 percentage
points.
In recent months financial markets
elsewhere in the region have become
65
more volatile. Brazilian markets have
been roiled by political uncertainties
related to national elections coming
in the fall. Attention has focused on
vulnerabilities associated with Brazil's
large outstanding stock of debt, much
of which is short-term. Since April, the
value of the real against the dollar has
fallen nearly 20 percent, and Brazilian
spreads have widened substantially. Several other South American countries,
including Uruguay and Venezuela, also
have been beset by growing financial
and economic problems.
Asian economies that rely importantly
on exports of computers and semiconductors (Korea, Singapore, Malaysia,
and Taiwan) have grown quite vigorously so far this year, a buoyancy
reflecting in part the recent turnaround
of conditions in the technology sector
and stronger U.S. growth. The currencies of several countries of this group
have moved up against the dollar. In
Korea, the expansion has been more
broad-based, as domestic demand was
fairly resilient during the recent global
downturn and has remained firm. China,
which is less dependent on technology
exports, has continued to record strong
growth as well. Other countries in the
region also have started to recover from
steep slowdowns or contractions in
2001, although Hong Kong has continued to be troubled by the collapse of
property prices. Most stock markets in
the region have recorded gains so far
this year.
Federal Reserve Operations
69
Consumer and Community Affairs
Among the Federal Reserve's responsibilities in the areas of consumer and
community affairs are
• Supervising banks to ensure their
compliance with the regulations
• Writing and interpreting regulations
to implement federal laws intended to
protect and inform consumers
• Investigating complaints from the
public about bank compliance with
the regulations
• Promoting community development in
historically underserved markets.
These responsibilities are carried out
by members of the Board of Governors,
the Board's Division of Consumer and
Community Affairs, and the consumer
and community affairs staffs at the Federal Reserve Banks.
Supervision for Compliance
with Consumer Protection and
Community Reinvestment Laws
Activities Related to the
Community Reinvestment Act
The Community Reinvestment Act
(CRA) requires that the Board and other
banking agencies encourage financial
institutions to help meet the credit needs
of the local communities in which they
do business, consistent with safe and
sound business practices. To carry out
this mandate, the Federal Reserve
• Examines state member banks to
assess compliance with the CRA
• Analyzes applications for mergers and
acquisitions by state member banks
and bank holding companies in relation to CRA performance
• Disseminates information on community development techniques to bankers and the public through Community Affairs Offices at the Reserve
Banks.
Examination for
Compliance with the CRA
The Federal Reserve assesses the CRA
performance of state member banks during examinations for compliance with
consumer protection regulations. By
statute, banks with assets of less then
$250 million that were rated "satisfactory" for CRA performance in their
most recent examination are examined
not more than once every forty-eight
months, and those that were rated "outstanding" for CRA purposes in their
most recent examination are examined
not more than once every sixty months.
Banks with assets of $250 million
or more that were rated "satisfactory"
or "outstanding" in their most recent
examination are examined not more than
once every twenty-four months. During
the 2002 reporting period, the Federal
Reserve conducted 312 CRA examinations. Of the banks examined, 40 were
rated "outstanding" in meeting community credit needs, 270 were rated "satisfactory," 1 was rated "needs to
improve," and 1 was rated as being in
"substantial noncompliance."x
1. The 2002 reporting period was from July 1,
2001, through June 30, 2002.
70
89th Annual Report, 2002
Analysis of Applications for
Mergers and Acquisitions in
Relation to the CRA
During 2002, the Board of Governors
considered applications for several significant banking mergers:
• In June, the Board approved an application by Royal Bank of Canada
(Montreal, Canada) and RBC Centura
Bank, Inc. (Rocky Mount, North
Carolina), to acquire Eagle Baneshares, Inc., and its subsidiary,
Tucker Federal Bank (both in Tucker,
Georgia).
• In October, the Board approved an
application by Citigroup, Inc. (New
York, New York), to acquire Golden
State Bancorp, Inc. (San Francisco,
California).
• In December, the Board approved
an application by Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A.
(Rabobank Nederland Utrecht, The
Netherlands) to acquire VIB Corp.
and its subsidiary, Valley Independent
Bank (both in El Centro, California).
Comments were received from the
public on each of these applications.
Many commenters expressed concern
that the proposed merger or acquisition
could lead to decreased lending levels
in low-income communities, including mortgage, small-business, and community development lending; abusive
lending practices; the provision of costly
and inadequate banking services to
low-income consumers; and the closure of branch offices in low-income
communities.
In the case of the Royal Bank of
Canada application, the bank subsidiary
of Eagle Bancshares, Tucker Federal
Bank, had received a CRA rating in
2001 of "needs to improve" from its
primary supervisor, the Office of Thrift
Supervision. The Board considered
information indicating that Tucker Federal Bank's CRA performance had
improved since then and noted that
Tucker would be merged into RBC Centura Bank (which had a CRA rating of
"satisfactory") upon consummation of
the merger of the holding company.
In the Citigroup case, many of the
public commenters' concerns related to
the activities of Citigroup's subprime
lending subsidiaries. A special examination of those activities, by the Federal
Reserve Bank of New York, was still
under way at the time. In acting on the
application, the Board noted that a careful review of the record indicated that
Citigroup, on balance, had a satisfactory record of compliance and concluded that the ongoing examination
of the subprime subsidiaries did not
warrant delay or denial. The Board indicated that many of the issues raised by
commenters could be more adequately
addressed through the special examination. The Board noted, moreover, that if
violations or other concerns were identified during the special examination, the
Board has broad authority to enforce
compliance with fair lending and other
applicable laws through the supervisory
process.
In the third application, the Board
found that the CRA record of the
depository institution was consistent
with approval.
The Board acted on other bank and
bank holding company applications that
involved protests by members of the
public concerning CRA performance;
one also involved a bank having a
CRA rating lower than "satisfactory."
Another thirty-three applications raised
other issues related to CRA, fair lend-
Consumer and Community Affairs
ing, or compliance with consumer credit
protection laws and regulations.2
Other Consumer Compliance
Activities
The Division of Consumer and Community Affairs' Compliance Oversight
Section supports and oversees the supervisory efforts of the Federal Reserve
Banks to ensure that consumer protection laws and regulations are fully and
fairly enforced. Section staff provide
guidance and expertise to the Reserve
Banks on consumer protection regulations, enforcement techniques, examiner training, and emerging issues. They
develop, update, and revise examination
policies, procedures, and guidelines
and review Reserve Bank supervisory
reports and work products. Section staff
also participate in interagency activities
designed to promote uniformity in
examination principles and standards.
Examinations are the Federal Reserve's primary means of enforcing
bank compliance with consumer protection laws. During the reporting
period, the Reserve Banks conducted 387 consumer compliance
examinations—316 of state member
banks and 71 of foreign banking organizations.3 To assess the effectiveness of
2. In addition, nine applications involving other
CRA issues, fair lending issues, or compliance
with consumer credit protection laws and regulations were withdrawn in 2002. Other applications
were handled by the Reserve Banks under authority delegated to them by the Board.
3. The foreign banking organizations examined
by the Federal Reserve are organizations operating
under section 25 or 25 (a) of the Federal Reserve
Act (Edge Act and agreement corporations) and
state-chartered commercial lending companies
owned or controlled by foreign banks. These institutions are not subject to the Community Reinvestment Act and typically engage in relatively few
activities that are covered by consumer protection
laws.
71
the Reserve Banks' consumer compliance supervision program, Division staff
visited each Reserve Bank during the
year to review documents developed
by Reserve Bank consumer compliance
examiners during bank examinations
and other supervisory activities.
Also during 2002, the Board issued
guidance for Reserve Bank examiners
on consumer protection laws and regulations. For example, the Board clarified
the signature provisions of Regulation B, which implements the Equal
Credit Opportunity Act, and provided
supplemental guidance to assist examiners in writing CRA performance evaluations for large banks.
Fair Lending
Under the Equal Credit Opportunity
Act, the Board refers any violation that
it has reason to believe constitutes
a "pattern or practice" of discrimination
to the Department of Justice. During
2002 the Board made six such referrals.
Two involved violations of the prohibition against requiring an applicant's
spouse to sign a credit obligation (unless
the spouse is a co-applicant or the
spouse's signature is necessary under
state law to permit the creditor to take
possession of the property in case of
default). Two other referrals involved
discrimination on the basis of marital
status by lenders that combined the
income of married joint applicants but
not the income of unmarried joint applicants. One of the two lenders was also
found to have priced loans on the basis
of marital status. A fifth referral resulted
from a lender's practice of failing to
consider child support a source of
income and imposing a minimum
income requirement, which had a disparate impact on the basis of sex. The
sixth referral involved a lender that
72
89th Annual Report, 2002
engaged in a pattern or practice of
redlining (discouraging loan applications from consumers living in minority
neighborhoods) in a major city.
In 2001 the Board supplemented
interagency procedures for fair lending examinations with alternative
procedures for banks having lowdiscrimination-risk profiles. Typically,
such banks are stable community banks,
commonly specializing in commercial
or agricultural lending, that are located
in suburban or rural markets having a
low percentage of minority residents.
The alternative procedures facilitate
the allocation of resources for moreintensive analysis of institutions that
have higher-risk profiles. During 2002,
roughly 25 percent of all fair lending
examinations were conducted using the
alternative procedures.
Flood Insurance
The National Flood Insurance Reform
Act of 1994 substantially amended the
National Flood Insurance Act of 1968,
which created the National Flood Insurance Program (NFIP). The amendments
sought to increase compliance with
federal flood insurance requirements,
increase participation in the NFIP,
increase income to the National Flood
Insurance Fund, and decrease the financial burden on the federal government,
taxpayers, and victims resulting from
floods. Under the amendments, the Federal Reserve Board and the other federal
financial institution supervisory agencies are required to impose civil money
penalties when they find a pattern or
practice of violations of the NFIP. Any
such civil money penalties are remitted
to the Federal Emergency Management
Agency for deposit in the National
Flood Mitigation Fund.
During the 2002 reporting period, the
Board imposed civil money penalties on
two state member banks for violations
of the Board's Regulation H, which
implements the National Flood Insurance Act: In October 2001, a consent
order assessing penalties of $10,500 was
issued against Mcllroy Bank and Trust
(Fayetteville, Arkansas), and in April
2002, a consent order assessing penalties of $10,000 was issued against Community Bank of Granbury (Granbury,
Texas).
Coordination with
Other Federal Banking Agencies
Member agencies of the Federal Financial Institutions Examination Council
(FFIEC) develop uniform examination
principles, standards, procedures, and
report formats.4 In 2002, the FFIEC
issued examiner guidance under the
Real Estate Settlement Procedures Act
regarding settlement service mark-ups
and unearned fees. The FFIEC is in the
process of revising examination procedures related to the Truth in Lending
Act, the Home Ownership and Equity
Protection Act, the Home Ownership
Counseling Act, and the Homeowners
Protection Act.
In 2001, the Federal Reserve joined
with the Federal Deposit Insurance
Corporation (FDIC), the Office of the
Comptroller of the Currency (OCC), and
the Office of Thrift Supervision (OTS)
to publish an advance notice of proposed rulemaking, seeking public comment on a wide range of questions
related to revising the Community Reinvestment Act. In 2002, the agencies
reviewed the comments and weighed
various possible amendments to the
4. The FFIEC member agencies are the Board
of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, the Office
of the Comptroller of the Currency, the Office of
Thrift Supervision, and the National Credit Union
Administration.
Consumer and Community Affairs
regulations. At year-end 2002, they were
reaching a final decision about whether
to issue a proposed rule and, if so, what
changes to propose. They were weighing whether any change with the
potential for substantial benefits would
be justified in light of the burdens of
implementation.
Also in 2002, the Board, the OCC,
and the FDIC conducted the annual
update for the host-state loan-to-deposit
ratios used to determine compliance
with section 109 of the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994.
Consumer and CRA Training
for Bank Examiners
Ensuring that financial institutions comply with laws and regulations that protect consumers and encourage community reinvestment is an important part of
the bank examination and supervision
process. As the number and complexity
of consumer financial transactions grow,
training for examiners of the state member banks under the Federal Reserve's
supervisory responsibility becomes even
more important.
Federal Reserve bank examiners are
employees of the Federal Reserve
Banks, which carry out compliance
supervision under authority delegated by
the Board. Their training, however, is a
shared responsibility of the Board and
the Reserve Banks. Individuals seeking
to become commissioned examiners for
the Federal Reserve must complete a
formal course of training. Assistant
examiners complete three levels of
course work, with attention to internal
controls, information technology, risk
management, risk-focused examination
techniques, and integrated supervision
concepts. In addition to passing two
proficiency examinations, examiners
must exhibit strong analytical, critical
73
thinking, and decisionmaking skills.
Commissioned examiners serve as
"examiners in charge" of bank examinations.
To help ensure that supervision staff
have the knowledge and skills needed to
be successful in an evolving financial
industry, the System must continually
identify, develop, coordinate, and review
training and development opportunities.
At least every three years, Board and
Reserve Bank staff review the core consumer affairs curriculum, updating subject matter and adding new elements
as appropriate. Each course is updated
periodically to take account of major
technical changes as well as changes
in instructional delivery techniques. The
staff also look for opportunities to
deliver courses via alternative channels
such as the Internet or other distancelearning technologies.
The core consumer affairs curriculum
comprises five courses focused on various consumer laws, regulations, and
examining concepts. In 2002, these
courses were offered in twelve sessions
to more than 200 consumer compliance
examiners:
• Consumer Compliance Examinations I. Emphasizes examination procedures and the practical application
of banking regulations; focuses on the
consumer laws and regulations that
govern financial institution operational procedures and non-real-estate
lending. The course is geared toward
assistant examiners with three to six
months of examination experience.
• Consumer Compliance Examinations II. Equips assistant examiners
with the fundamental skills needed to
determine compliance with the basic
elements of consumer laws and regulations governing real estate transactions; also covers System policies
74
89th Annual Report, 2002
on all major aspects of the consumer
compliance risk-focused examination
process. Assistant examiners have six
to twelve months of examination
experience when they complete the
course.
• Fair Lending Examination Techniques. Provides assistant examiners
with the skills and knowledge needed
to plan and conduct a risk-focused fair
lending examination. Assistant examiners generally have eighteen months
of examination experience when they
complete the course.
• Community Reinvestment Act Examination Techniques. Prepares assistant
examiners to write performance evaluations for the CRA portion of consumer compliance examinations. Students must be familiar with the CRA
regulation and CRA examination
procedures.
• Commercial Lending Essentials for
Consumer Affairs. Optional training
opportunity. Familiarizes assistant
examiners with basic techniques for
underwriting and pricing commercial
loans, including identifying the bank's
credit culture and risk profile.
In addition to providing core training,
the training program emphasizes the
importance of continuing professional
development. Opportunities for continuing development might include special
projects and assignments, self-study programs, rotational assignments, instructing at System schools, or mentoring.
Reporting on Home Mortgage
Disclosure Act Data
The Home Mortgage Disclosure Act
(HMDA) requires that mortgage lenders
covered by the act collect and make
public certain data about their home purchase, home improvement, and refinancing loan transactions. Depository institutions generally are covered if (1) they
are located in metropolitan areas,
(2) they met the asset threshold at the
end of the preceding calendar year (for
2001, assets of more than $31 million;
for 2002, more than $32 million), and
(3) they originated at least one home
purchase loan (or refinancing) in the
preceding calendar year. For-profit
mortgage companies are covered if
(1) they are located in metropolitan
areas, (2) they had assets of more than
$10 million (when combined with the
assets of any parent company) at the end
of the preceding calendar year or originated 100 or more home purchase loans
and refinancings in the preceding
calendar year, and (3) their home purchase loan originations and refinancings
accounted for 10 percent or more of
their total loans by dollar volume in the
preceding calendar year.
In 2002, a total of 6,659 depository
institutions and affiliated mortgage companies and 972 independent mortgage
companies reported HMDA data for
calendar year 2001. Lenders submitted
information about the disposition of loan
applications, the geographic location of
the properties related to loan applications and loans, and, in most cases, the
race or national origin, income, and sex
of applicants and borrowers. The FFIEC
processed the data and produced disclosure statements on behalf of the FFIEC
member agencies and the Department
of Housing and Urban Development
(HUD).
The FFIEC prepared individual disclosure statements for each lender that
reported data—one statement for each
metropolitan area in which the lender
had offices and reported loan activity.
In 2002, the FFIEC prepared more than
53,000 disclosure statements, reporting
Consumer and Community Affairs
data for calendar year 2001.5 Each institution made its disclosure statement
public in July, and reports containing aggregate data for all mortgage
and home improvement loans in each
of 330 metropolitan areas were made
available at central depositories.6 FFIEC
member agencies, the reporting institutions, HUD, the Department of Justice
(DOJ), and members of the public use
these data. The data also assist HUD,
the DOJ, and state and local agencies in
responding to allegations of lending discrimination and in targeting lenders for
further inquiry.
The HMDA data reported for 2001
covered 27.6 million loans and applications, about 44 percent more than in
2000. The greater volume was due primarily to an increase of about 120 percent in refinancing activity. The number
of home purchase loans covered by
HMDA and extended in 2001, compared with 2000, increased 8 percent
for Hispanics, 4 percent for Asians, and
1 percent for whites but fell 7 percent
for blacks. The precise change for
Native Americans could not be determined because of reporting errors in the
2000 data. Over the period 1993 through
2001, the number of home purchase
loans extended increased 158 percent
for Hispanics, 92 percent for Asians,
76 percent for blacks, 28 percent for
Native Americans, and 26 percent for
whites.
For each income category, the number of home purchase loans reported
5. The FFIEC also compiles information on
applications for private mortgage insurance (PMI)
similar to the information on home mortgage lending collected under HMDA. Lenders typically
require PMI for conventional mortgages that
involve small down payments.
6. Central depository sites include libraries,
universities, and city planning offices. A list of
the sites can be found at www.ffiec.gov/hmdacf/
centdep/default2.cfm.
75
was higher in 2001 than in 2000; the
increase was 2 percent for lower-income
and higher-income applicants and 4 percent for middle-income applicants. From
1993 through 2001, the number of home
purchase loans to lower-, middle-, and
upper-income applicants increased
82 percent, 50 percent, and 60 percent
respectively.
In 2001, 32 percent of Hispanic applicants and 29 percent of black applicants
for home purchase loans reported
under HMDA sought governmentbacked mortgages; the comparable figures were 16 percent for white and for
Native American applicants and 8 percent for Asian applicants. Twenty-seven
percent of lower-income applicants for
home purchase loans, compared with
9 percent of higher-income applicants,
applied for government-backed mortgages in 2001.
Overall, the denial rate for conventional home purchase loans (that is,
loans that are not government-backed)
was 21 percent in 2001. The rate rose
steadily from 1993 through 1998 but has
fallen since then. In 2001, denial rates
for conventional home purchase loans
reported under HMDA were 36 percent
for black applicants, 35 percent for
Native American applicants, 23 percent
for Hispanic applicants, 16 percent for
white applicants, and 11 percent for
Asian applicants. Each of these rates
was lower than the comparable rate for
2000.
Agency Reports on Compliance
with Consumer Protection Laws
and Regulations
The Board is required to report annually
on compliance with consumer protection laws by entities supervised by the
various federal agencies. This section
summarizes data collected from the
twelve Federal Reserve Banks, the
76
89th Annual Report, 2002
FF1EC member agencies, and other federal enforcement agencies.7
Regulation B
(Equal Credit Opportunity)
The FFIEC agencies reported that
83 percent of the institutions examined
during the 2002 reporting period were in
compliance with Regulation B, the same
percentage as for the 2001 reporting
period. Of the institutions not in full
compliance, 81 percent had five or
fewer violations. The most frequent violations involved failure to take one or
more of the following actions:
• Provide a written notice of credit
denial or other adverse action containing a statement of the action taken,
the name and address of the creditor,
a notice of rights, and the name and
address of the federal agency that
enforces compliance
• Provide a statement of reasons for
credit denial or other adverse action
that is specific and indicates the principal reasons for the adverse action
• Collect information for monitoring
purposes about the race or national
origin and sex of the applicants seeking credit primarily for the purchase
or refinancing of a principal residence
• Notify the credit applicant of the
action taken within the time frames
specified in the regulation.
Three formal enforcement actions
containing provisions relating to Regulation B were issued during the 2002
7. Because the agencies use different methods
to compile the data, the information presented
here supports only general conclusions. The 2002
reporting period was from July 1, 2001, through
June 30, 2002.
reporting period—two by the OTS and
one by the OCC. The Federal Trade
Commission settled one action and continued its litigation against a mortgage
lender for alleged violations of the Equal
Credit Opportunity Act (ECOA) and
Regulation B. The alleged violations
include failing to take written applications for mortgage loans, failing to provide rejected applicants with written
notice of adverse action, failing to collect required information about the race
or national origin and sex of applicants
for mortgage loans; and, when providing notice of adverse action, failing to
give the name and address of the federal
agency that administers compliance with
the ECOA.
The other agencies that enforce the
ECOA—the Farm Credit Administration (FCA), the Department of
Transportation, the Securities and
Exchange Commission, the Small
Business Administration, and the Grain
Inspection, Packers and Stockyards
Administration of the Department of
Agriculture—reported substantial compliance among the entities they supervise. The FCA's examination and
enforcement activities revealed violations of the ECOA mostly related to
creditors' failure to collect information
in mortgage applications for monitoring
purposes and failure to comply with
rules regarding adverse action notices.
No formal enforcement actions relating
to Regulation B were initiated by these
agencies.
Regulation E
(Electronic Fund Transfers)
The FFIEC agencies reported that
approximately 92 percent of the institutions examined during the 2002 reporting period were in compliance with
Regulation E, compared with 95 percent for the 2001 reporting period.
Consumer and Community Affairs
The most frequent violations involved
failure to comply with the following
requirements:
11
Regulation Z
(Truth in Lending)
• Credit the customer's account in the
amount of the alleged error within ten
business days of receiving the error
notice, if more time is needed to conduct the investigation
The FFIEC agencies reported that
77 percent of the institutions examined
during the 2002 reporting period were
in compliance with Regulation Z, compared with 79 percent for the 2001
reporting period. Of the institutions not
in full compliance, 73 percent had five
or fewer violations, compared with
75 percent for the 2001 reporting period.
The most frequent violations involved
failure to take one or more of the following actions:
• Report the results of the investigation
to the consumer within three business
days after its completion.
• Accurately disclose the finance
charge, taking any prepaid finance
charges into account
The agencies did not issue any formal
enforcement actions relating to Regulation E during the reporting period.
• Accurately disclose the number,
amounts, and timing of payments
scheduled to repay the obligation
Regulation M
(Consumer Leasing)
• Ensure that if the disclosed finance
charge (which affects other disclosures) is understated, the amount disclosed is understated by no more than
$100
• Determine whether an error occurred,
and transmit the results of the investigation to the consumer within ten
business days
The FFIEC agencies reported that more
than 99 percent of the institutions examined during the 2002 reporting period
were in compliance with Regulation M,
which is comparable to the level of compliance for the 2001 reporting period.
The few violations noted involved failure to adhere to specific disclosure
requirements. The agencies did not issue
any formal enforcement actions relating
to Regulation M during the reporting
period.
Regulation P
(Privacy of
Consumer Financial Information)
July 2001 through June 2002 marked
the first full year of implementation of
Regulation P. Examinations found few
violations, and no formal enforcement
actions were issued.
• Ensure that disclosures reflect the
terms of the legal obligation between
the parties
• Provide the index value for the periodic adjustments to variable-rate
loans.
Three formal enforcement actions
containing provisions relating to Regulation Z were issued during the 2002
reporting period—two by the OTS and
one by the OCC. In addition, 174 institutions supervised by the Federal
Reserve, the FDIC, or the OTS were
required, under the Interagency Enforcement Policy on Regulation Z, to refund
a total of approximately $1.2 million
78
89th Annual Report, 2002
to consumers for the 2002 reporting
period. During the reporting period, the
FTC continued its efforts to curb abusive practices by some subprime mortgage lenders, entering into three settlements, initiating three legal actions,
and pursuing litigation against one
creditor for alleged violations of the
Truth and Lending Act (TILA) and the
Home Ownership and Equity Protection
Act.
The Department of Transportation
(DOT) concluded its investigation of
five cases involving air carriers for possible violations of the TILA. All five
cases involved the timeliness of processing requests for credit card refunds. Four
of the cases were closed with warning
letters; in the fifth case, DOT entered
into a consent order that directed the
carrier to cease and desist from further
violations of the refund provisions of
the TILA and assessed a civil penalty of
$25,000. In addition, the DOT continued to prosecute a cease-and-desist consent order issued in 1993 against a travel
agency and a charter operator. The complaint alleged that the two organizations
had violated Regulation Z by routinely
failing to send credit statements for
refund requests to credit card issuers
within seven days of receiving fully
documented credit refund requests from
customers. The case remained pending
because the principal of the company
was serving a prison sentence for
an unrelated airline bankruptcy fraud
conviction.
Regulation AA
(Unfair or Deceptive Acts
or Practices)
The three banking regulators with
responsibility for enforcing Regulation AA's Credit Practices Rule—the
Federal Reserve, the OCC, and the
FDIC—reported that 99 percent of insti
tutions examined during the 2002
reporting period were in compliance, the
same proportion as for the 2001 reporting period. Among the institutions not
in full compliance, the most frequently
cited violations involved
• Failing to provide a clear, conspicuous
disclosure regarding a cosigner's liability for a debt
• Entering into a consumer credit contract containing a nonpossessory security interest in household goods, a
practice barred by Regulation AA.
No formal enforcement actions relating to Regulation AA were issued during the reporting period.
Regulation CC
(Availability of Funds and
Collection of Checks)
The FFIEC agencies reported that
90 percent of institutions examined during the 2002 reporting period were in
compliance with Regulation CC, compared with 91 percent for the 2001
reporting period. Among the institutions
not in full compliance, the most frequently cited violations involved the
failure to take one or more of the following actions:
• Make funds from certain checks, both
local and nonlocal, available for withdrawal within the times prescribed by
the regulation
• Provide a written notice explaining
why an exception to the institution's
availability policy was invoked
• Provide a written notice when the
depository bank extended the time for
making funds available for withdrawal
Consumer and Community Affairs
• Follow special procedures when
invoking the exception for large-dollar
deposits.
No formal enforcement actions relating to Regulation CC were issued during the reporting period.
Regulation DD
(Truth in Savings)
The FFIEC agencies reported that
87 percent of institutions examined during the 2002 reporting period were in
compliance with Regulation DD, compared with 88 percent for the 2001
reporting period. Among the institutions
not in full compliance, the most frequently cited violations involved
• Advertisements that were inaccurate
or misleading (or both)
• Use of the phrase "annual percentage
yield" in an advertisement without
disclosing additional terms and conditions of customer accounts
• Failure to provide notice before maturity for automatically renewing time
accounts having a term of more than
one month.
No formal enforcement actions relating to Regulation DD were issued during the reporting period.
Implementation of
Statutes Designed to
Inform and Protect Consumers
Changes in the Collection of
Data on Home Mortgage Loans
The past decade has witnessed important developments in mortgage markets,
spurred in part by improvements in
79
technology and information-processing
capabilities. Prominent among these
developments have been the movement
to risk-based pricing of mortgage credit
and the growth of new channels for
loan applications, funding, and origination. In 2002, the Board took note of
these changes in carrying out a review
of Regulation C, which implements
the Home Mortgage Disclosure Act
(HMDA).
The express purposes of HMDA are
to
• Provide the public and government
officials with data that will help show
whether lenders are serving the homelending needs of the neighborhoods
and communities in which they are
located
• Help government officials target
public investment to promote private
investment where it is needed
• Provide data that assist in identifying
possible discriminatory lending patterns and enforcing antidiscrimination
statutes.
Regulation C requires lenders to
report data about each mortgage loan
application or origination (including
loan amount, type, and purpose), each
applicant or borrower (including race
or ethnicity, sex, and income), and each
property (including location and occupancy status). These data are made
available to the public after identifying
information is removed to protect consumers' privacy.
In 2002, the Board concluded that
significant changes to Regulation C
were needed to keep pace with developments in the mortgage-lending market.
One change was to broaden the types of
data collected to include data on loan
pricing. This change will aid both in
80
89th Annual Report, 2002
deterring discrimination and in helping data users better understand the
mortgage market, particularly the
subprime market. Over the years, the
focus of concerns about discrimination
has shifted from lenders' decisions to
approve or deny applications to lenders'
loan-pricing practices. The widespread
adoption of risk-based pricing has
focused attention on the fairness of lenders' pricing decisions. Obtaining information about loan pricing is critical to
ensuring the continued utility of the
HMDA data.
Beginning January 1, 2004, lenders
will report rate spreads for loans that
exceed a certain price threshold (for first
lien loans, prices must be reported if the
difference between the loan's annual
percentage rate and the yield on Treasury securities with comparable maturities is 3 percentage points or more; for
subordinate lien loans, if the difference
is 5 percentage points or more). Lenders
will also report whether a loan meets the
price-based triggers of the Home Ownership and Equity Protection Act, which
requires that borrowers of high-priced
loans be given special disclosures and
other protections.
The Board also revised Regulation C
to reflect another major change in the
mortgage market—the increasing availability of preapproval programs. Preapproval programs offer the possibility of
conditional approval of a mortgage loan
before a borrower has chosen a property, enabling the borrower to demonstrate to potential home sellers that
the borrower will likely be able to obtain
a loan. Regulation C will require lenders to report preapproval requests that
are evaluated under programs in which
the lender gives approved applicants
a written commitment letter, good for
a set period and for up to a fixed dollar
amount. Beginning January 1, 2004,
lenders will identify preapproval
requests that are approved and result in
loan originations as well as requests that
are denied. Lenders may, but will not be
required to, report preapproval requests
that are approved but not accepted by
the applicant.
In addition, the Board revised the
categories for identifying the race and
national origin of applicants and borrowers to conform to categories used by
the Bureau of the Census and other federal agencies. Following guidance provided by the Office of Management and
Budget, the Board will permit an applicant to select more than one race and
will distinguish between race and Hispanic ethnicity; these changes take effect
January 1, 2004.
In response to the growing number of telephone applications and the
increasing proportion of loan applications for which information on applicant
race, ethnicity, or sex is missing, the
Board mandated collection of such data
on telephone applications; this rule,
which parallels the rule for mail and
Internet applications, took effect January 1, 2003.
Finally, the Board made several
changes to improve the consistency
and utility of the HMDA data. These
changes include simplifying the definitions of loan types and distinguishing
loans for manufactured homes from
loans for site-built homes.
Revisions to
Truth in Lending Regulations
In April 2002, the Board revised the
official staff commentary to Regulation Z (Truth in Lending) to clarify how
creditors that place Truth in Lending
Act disclosures in the same document
as the credit contract can satisfy the
requirement to provide the disclosures before consummation and in a
form the consumer can keep. The revi-
Consumer and Community Affairs
sions also provide guidance on disclosing costs for certain credit insurance
policies.
The Board also took the following
regulatory actions during the year:
• Raised from $480 to $488 the total
dollar amount of points and fees that
triggers additional requirements for
certain mortgage loans under the
Home Ownership and Equity Protection Act, effective in January 2003, to
reflect changes in the consumer price
index, as prescribed by the statute.
• Maintained at $32 million the exemption threshold for depository institutions required to collect data in 2003
under the Home Mortgage Disclosure
Act, in keeping with the consumer
price index for urban wage earners
and clerical workers (CPI-W), as prescribed by the statute.
Economic Effects of the
Electronic Fund Transfer Act
As required by the Electronic Fund
Transfer Act (EFTA), the Board monitors the effects of the act on institutions'
compliance costs and the benefits of the
act to consumers.
Approximately 85 percent of U.S.
households have or use one or more
electronic fund transfer (EFT) service—
for example, an ATM card, a debit card,
or direct deposit. The proportion of
households using EFT services has
grown over the past ten years at an
annual rate of 2 percent to 3 percent,
according to data from the Board's
Survey of Consumer Finances (the most
recent data available were from 1998;
data from the 2001 survey are to be
released in 2003).
Automated teller machines remain the
most widely used EFT service. About
two-thirds of U.S. households have an
81
ATM card. In 2002, the number of ATM
transactions per month averaged almost
1.2 billion, an increase of nearly 3 percent from 2001. The number of installed
ATMs rose nearly 9 percent, to about
352,000.
Direct deposit is also widely used.
About 60 percent of U.S. households
have funds deposited directly into their
checking or savings accounts. Use of the
service is particularly common in the
public sector: Approximately 72 percent
of all government payments in fiscal
year 2002 were made using electronic
funds transfer, including 79 percent of
social security payments, 98 percent of
federal salary and retirement payments,
and 39 percent of federal income tax
refunds.
Direct bill payment is a less widely
used EFT payment mechanism. About
36 percent of U.S. households have payments automatically deducted from their
accounts.
About one-third of U.S. households
use debit cards, which consumers use at
merchant terminals to debit their checking or savings accounts. These point-ofsale (POS) systems account for a fairly
small share of electronic transactions,
but their use has continued to grow
rapidly. The average number of POS
transactions per month rose almost
39 percent, from 304.0 million in 2001
(revised from previously reported data)
to 421.7 million in 2002, though the
number of POS terminals fell, to
3.5 million.
Electronic check conversion is a
variation of electronic funds transfer
whereby a check is used as the source
of information for a one-time electronic
payment from the consumer's checking
account via EFT. During 2002, Board
staff helped develop and distribute
consumer information to explain the
process (www.federalreserve.gov/pubs/
checkcon v/default .htm).
82
89th Annual Report, 2002
The incremental costs associated with
the Electronic Fund Transfer Act are
difficult to quantify because no one
knows how industry practices would
have evolved in the absence of statutory
requirements. The benefits of the EFTA
are also difficult to measure because
they cannot be isolated from consumer
protections that would have been provided in the absence of regulation. The
available evidence suggests no serious
consumer problems with the EFTA (see
the section "Agency Reports on Compliance with Consumer Protection Laws
and Regulations").
Consumer Complaints
The Federal Reserve investigates complaints against state member banks and
forwards to the appropriate enforcement
agency complaints that involve other
creditors and businesses. Each Reserve
Bank investigates complaints against
state member banks in its District.
The Board provides guidance to the
Reserve Banks on complaint program
policies and procedures through advisory letters and periodic updates to the
Consumer Complaint Manual. In 2002,
the Board issued guidance and new
codes for identifying complaints and
inquiries about electronic check conversion transactions and the sale of insurance by state member banks. The Board
also clarified procedures for investigating complaints alleging unlawful credit
discrimination. In addition, the Board
established supplemental procedures to
help the Reserve Banks focus and expedite investigations.
In 2002 the Board initiated a workflow study of the Federal Reserve's
complaint-handling process to identify
ways to maximize efficiency and effectiveness. The study is expected to be
completed by early spring 2003.
The Board also established an advisory group to assess the Federal
Reserve's complaints and inquiry
database—Complaints Analysis Evaluation System and Reports (CAESAR).
The advisory group is organized into
two subcommittees: one to develop and
implement improvements to data entry
and reporting processes, and the other to
analyze the adequacy of the complaint
and inquiry code structure. Enhancements to CAESAR will be implemented
in the first quarter of 2003.
Complaints against
State Member Banks
In 2002 the Federal Reserve received
just over 5,700 complaints from consumers. The majority (63 percent)
related to practices that are not subject
to federal regulation (see next section, "Unregulated Practices"). About
48 percent of the complaints received
were against state member banks (see
tables). Of the complaints against state
member banks, 66 percent involved loan
functions: 3 percent alleged discrimination on a basis prohibited by law
(race, color, religion, national origin,
sex, marital status, age, the fact that the
applicant's income comes from a public
assistance program, or the fact that the
applicant has exercised a right under
the Consumer Credit Protection Act),
and 63 percent concerned other creditrelated practices, such as the imposition
of annual membership fees, or credit
denial on a basis not prohibited by law
(for example, credit history or length of
residence). Twenty-four percent of the
complaints against state member banks
involved disputes about interest on
deposits and general deposit account
practices, and the remaining 10 percent
concerned disputes about electronic
fund transfers, trust services, or other
Consumer and Community Affairs
83
Consumer Complaints against State Member Banks and Other Institutions Received by the
Federal Reserve System, 2002
Subject
State member
banks
Other
institutionsx
Total
66
0
64
0
0
12
0
36
1
76
0
0
4
0
102
1
140
0
0
16
0
617
2
29
72
375
64
374
1
25
48
201
17
991
3
54
120
576
81
Fair Housing Act
Flood insurance rules
Regulations T, U, and X
Real Estate Settlement Procedures Act
Unregulated practices
1
3
0
20
1,440
5
10
0
14
2,128
6
13
0
34
3,568
Total
2,765
2,940
5,705
Regulation
Regulation
Regulation
Regulation
Regulation
Regulation
Regulation
B (Equal Credit Opportunity)
C (Home Mortgage Disclosure Act)
E (Electronic Fund Transfers)
H (Bank Sales of Insurance)
M (Consumer Leasing)
P (Privacy of Consumer Financial Information)
Q (Payment of Interest)
Regulation Z (Truth in Lending)
Regulation BB (Community Reinvestment)
Regulation CC (Expedited Funds Availability)
Regulation DD (Truth in Savings)
Fair Credit Reporting Act
Fair Debt Collection Practices Act
1. Complaints against these institutions were referred
to the appropriate regulatory agencies.
practices. Information on the outcomes
of the investigations of these complaints
is provided in the table.
During 2002, the Federal Reserve
completed the investigation of 86 complaints against state member banks that
were pending at year-end 2001 and
found four violations of regulations.
In the vast majority of cases, the bank
had correctly handled the customer's
account; notwithstanding, the bank in
many cases chose to reimburse or otherwise accommodate the consumer.
Also during the year, the Federal
Reserve handled more than 2,000
inquiries about consumer credit and
banking policies and practices. In
responding to these inquiries, the Board
and Reserve Banks gave specific explanations of laws, regulations, and banking practices and provided relevant
printed materials on consumer issues.
Unregulated Practices
As required by section 18(f) of the Federal Trade Commission Act, the Board
monitors complaints about banking
practices that are not subject to existing
regulations, focusing on those that concern possible unfair or deceptive practices. In 2002 the Board received more
than 1,400 complaints that involved
unregulated practices. The categories
that received the most complaints
involved checking and credit card
accounts: Consumers alleged that unauthorized withdrawals were made from
their checking accounts (101), disputed
amounts withdrawn (155), and complained about insufficient-funds charges
and procedures (141); they also complained about fees associated with credit
card accounts (149) and about debtcollection tactics (109). The remainder
84
89th Annual Report, 2002
Consumer Complaints Received by the Federal Reserve System,
by Subject of Complaint, 2002
Complaints against state member banks
Total
Not investigated
Investigated
Bank legally correct
Subject of complaint
Number
Loans
Discrimination alleged
Real estate loans
Credit cards
Other loans
Other type of complaint
Real estate loans
Credit cards
Other loans
Deposits
Electronic fund transfers
Trust services
Other
Total
Percent
No reimbursement
or other
accommodation
Goodwill
reimbursement or
other
accommodation
19
20
27
1
1
1
2
8
0
1
1
2
6
8
12
0
2
0
508
1,007
227
18
37
8
16
7
10
37
7
22
211
340
91
92
429
29
658
64
30
205
24
2
1
7
21
3
1
7
83
5
4
21
272
20
11
84
112
15
1
22
2,765
100
75
183
1,055
702
of the complaints concerned unregulated practices in other areas: Consumers complained about credit denials
attributed to credit history, failure to
remove the lien on property for which
the mortgage had been paid off, and
poor customer service.
Complaint Referrals to HUD
In accordance with a memorandum of
understanding between HUD and the
federal bank regulatory agencies, in
2002 the Federal Reserve referred to
HUD ten complaints alleging state
member bank violations of the Fair
Housing Act. In two of the ten cases
the Federal Reserve's investigations
revealed no evidence of illegal discrimination. In a third case the bank had
made an error regarding the consumer's
Unable
Explanation
to obtain
of law
sufficient
provided
information
to consumer
from
consumer
adverse action notice, which the bank
subsequently corrected. The remaining
seven cases are pending.
Advice from the
Consumer Advisory Council
The Board's Consumer Advisory
Council—whose members are drawn
from consumer and community organizations, the financial services industry, academic institutions, and state
agencies—advises the Board on matters
concerning laws administered by the
Board and other issues related to consumer financial services. Council meetings are open to the public.
In 2002, the Council met in March,
June, and October. The rules implementing the Community Reinvestment Act
(CRA) were a major topic at the March
Consumer and Community Affairs
85
Consumer Complaints Received—Continued
Complaints against state member banks
Investigated
Customer
error
Bank
error
Factual or
contractual
dispute—
resolvable
only by
the courts
Possible
bank
violation—
bank took
corrective
action
Matter in
litigation
Pending,
December 31
Referred to
other
agencies
Total
complaints
0
0
0
0
1
1
0
0
2
2
0
1
0
0
0
8
0
9
19
7
10
38
27
37
0
1
1
75
79
42
13
16
4
10
8
1
11
1
4
43
119
23
498
795
521
1,006
1,802
748
2
0
0
2
74
6
2
14
27
0
4
9
10
9
0
0
14
1
3
2
43
5
4
44
475
76
21
518
1,133
140
51
723
6
294
75
41
36
298
2,940
5,705
and June meetings. In March, Council
members commented on the investment
test, data collection, and the small-bank
test. Some members considered the
existing investment test to be sufficient,
while others preferred that a separate
community development test replace the
investment test. Regarding data collection for small-business and small-farm
lending, some members emphasized
that gathering quality data is a substantial burden for small banks and questioned the overall benefits of collecting
detailed data. Members also commented
on the appropriate size-definition of
"small bank." In June, Council members considered the effectiveness of
the evaluation criteria for community
development performance in terms of
changing community dynamics. Members also noted the importance of con
text in evaluating a bank's CRA performance and emphasized that bankers
should review the performance context
with regulators at the beginning of
examinations.
In March, Council members discussed Regulation C, which implements
the Home Mortgage Disclosure Act.
They provided views on issues still
under review after the Board's January
2002 revisions to the regulation, including the appropriate threshold for collecting price data on higher cost loans; a
proposal to require lenders to ask telephone applicants their race, ethnicity,
and sex; and a proposal to report lien
status for applications and originated
loans. A discussion of Regulation B,
which implements the Equal Credit
Opportunity Act, focused on proposed
changes to the definition of "creditor"
86
89th Annual Report, 2002
and the prohibition against data notation for non-mortgage credit. Members
provided both supporting and opposing
views on removing the prohibition
against data notation.
In June, Council members discussed
the rules implementing the privacy provisions of the Gramm-Leach-Bliley
Act. Members commented on the effectiveness of the required privacy notices
in light of the notices' length and complexity. Other comments concerned the
low rates of response to the notices.
Also in June, Council members discussed financial literacy and noted the
challenges of designing and delivering
financial literacy training in an environment of technological advances and
expanding financial products. They
emphasized that no single solution or
design works for all consumers and that
a broad approach to training and delivery systems is necessary to reach those
in need of training.
At the October meeting, the amendments proposed by the Department of
Housing and Urban Development to its
Regulation X, which implements the
Real Estate Settlement Procedures Act
(RESPA), were a topic of discussion.
Council members focused on whether
the proposed "guaranteed mortgage
package agreement" and the proposed
revisions to the good-faith estimate
would benefit financial institutions and
consumers during the mortgage selection process. Members also addressed
inconsistencies between the Board's
Truth in Lending Act disclosure rules
and HUD's proposed RESPA rules.
The Council also discussed identity
theft and access to credit cards during
the October meeting. Regarding identity
theft, members considered the adequacy
of current laws and whether potential
legislative, regulatory, or industry solutions would be effective in combating
identify theft. Many members agreed
that limiting the use and display of personal identifiers (such as social security
numbers) and providing additional tools
to identity-theft victims to clear their
credit records would be beneficial. The
discussion of access to credit cards
focused on consumers who may not
have the ability to repay their debt, particularly students.
Promotion of Community
Development in Historically
Underserved Markets
In 2002, the community affairs function
within the Federal Reserve System
expanded its activities to promote economic growth and financial literacy in
historically underserved markets. The
structure and mission of the community
affairs program was conceived to help
financial institutions meet their responsibilities under the Community Reinvestment Act, and Community Affairs
Offices around the System continued
during the year to hold CRA roundtables with bankers and community
development organizations to increase
understanding of CRA-related policy
issues and investment tools. However,
community affairs programs have broadened to respond to the evolving financial and regulatory needs of diverse
groups and communities. Reserve Bank
Community Affairs Offices focus on
providing information and investment
opportunities to low- and moderateincome communities within their Districts, while the Board's Community
Affairs Office brings a national perspective, engaging in projects that have significant implications for public policy.
In 2002, System community affairs
programs also addressed financial
education, financial services for Native
Americans, banking for immigrant communities, emerging issues and opportu-
Consumer and Community Affairs
nities in community development, and
community development finance.
Promotion of Financial Education
Consumers who are well informed on
financial matters are generally able to
make better decisions for their families,
increasing their economic security and
well-being. In turn, secure families are
better able to contribute to vital, thriving
communities, further fostering community economic development. As a consequence, financial education has risen on
the agendas of educators, community
groups, businesses, government agencies, and policymakers.
The Board supported a wide range of
activities promoting financial education
in 2002, including conducting research,
sponsoring meetings, providing training,
and preparing educational materials.
Staff in the Board's Division of Consumer and Community Affairs prepared
articles for the Journal of Family and
Consumer Sciences and the Federal
Reserve Bulletin ("Financial Literacy:
An Overview of Practice, Research, and
Policy," www.federalreserve.gov/pubs/
bulletin/2002/11021ead.pdf) summarizing efforts in research, fieldwork, and
public policy that further the goal of
creating financially literate consumers.
Research initiated by Board staff
investigated consumers' financial management practices and their engagement
in the financial services marketplace,
consumers' choices of financial institutions for home-secured loans, consumers' efforts at comparison shopping,
and consumers' complaint actions with
respect to problems with credit cards.
During the year, partnerships with
other agencies and organizations were
formed to undertake a variety of financial education initiatives. Board staff
collaborated with the National Endow
87
ment for Financial Education in a
national symposium on financial literacy and provided training on consumer
credit management for Air Force Command financial specialists. Consumer
education materials on financial privacy,
developed in collaboration with other
government agencies, were launched
during National Consumer Protection
Week 2002 (www.federalreserve.gov/
pubs/privacy/default.htm).
Across the Federal Reserve System,
Community Affairs Offices organized
programs to heighten employee awareness of fundamental financial management concepts. At the Board, community affairs staff organized lunch-andlearn sessions on savings and budgeting
and joined with staff of the Management Division to identify best practices
in employee financial education. The
Federal Reserve Bank of St. Louis
held information sessions focused on
employee housing and credit resources,
and several Reserve Banks hosted Consumer Protection Week activities for
their employees.
Reserve Banks in Atlanta, Boston,
Chicago, Cleveland, Philadelphia, and
San Francisco supported financial education initiatives in their Districts. For
example, the San Francisco Reserve
Bank published a compendium of
financial literacy resources for bankers interested in offering financial education programs that serve their local
markets (www.frbsf.org/community/
webresources/bankersguide.pdf). The
Chicago Reserve Bank coordinated
asset-building workshops in Illinois
and southeastern Wisconsin to provide
information on investment approaches
for low- and moderate-income persons.
And the Boston, Atlanta, and Chicago
Reserve Banks hosted workshops in
their communities on the benefits of the
federal Earned Income Tax Credit and
Assets for Independence programs as
88
89th Annual Report, 2002
Lending in Indian Country
Overcoming challenges to development requires leadership, commitment, creativity, and flexibility. . . . [T]he vision of tribal leaders and the involvement of
partners have helped to bring the new ideas, as well as the capital and technical
assistance, necessary to create viable economies in Indian Country.
Mark W. Olson, Member, Board of Governors
November 18, 2002
Extension of economic development into
underserved communities often rests on
gaining an understanding of local culture
and history. With such an understanding, lenders, developers, and local leaders can bridge the information and credit
gaps to facilitate the flow of capital and
other resources that support growth and
development.
Understanding local culture and history
is especially critical to overcoming the
challenges of lending on Indian reservations and tribal lands, collectively known
as Indian Country. In many Native American communities, misunderstanding, mistrust, and discrimination have historically hindered the development of the
infrastructures—governmental, physical,
educational, and financial—needed to support market-based economies. Further,
many tribal communities are underserved
by financial institutions, a situation that
limits their access to the credit and capital
vital to their growth and development. As
a result, many tribal communities struggle
with significant social and economic challenges, as seen in high rates of unemployment, inadequate housing, and low educational attainment.
Sovereignty is a central issue in economic development in Indian Country. As
wealth-creation vehicles for low-income
families.
Programs in Cooperation
with Native Americans
In 2002, the community affairs function
addressed credit and lending barriers
sovereign nations, Native American communities have the right to self-govern and
to adjudicate contractual disputes in their
own tribal courts. While the exercise of
sovereignty preserves the right of tribal
self-governance, it also creates a complex
legal environment that results in uncertainty for lenders and investors, who seek
consistency in their evaluation of risk and
the likely return on investment. At the
same time, some tribal members are unfamiliar with the requirements and expectations of lenders and other private-sector
investors. These competing forces—the
business need for certainty and predictability on one hand and unfamiliarity with
lender and investor needs on the other—
can disrupt the flow of information
between Native American communities
and the banking industry, impairing the
operation of an efficient market.
The Role of the Federal Reserve
Staff of the Community Affairs Offices
(CAOs) at the Board of Governors and
several Federal Reserve Banks have
worked with tribal leaders and bankers for
nearly a decade to address the factors that
hinder lending and discourage financial
investments in Indian Country. CAO staff
faced by Native American populations
through sponsorship of the Federal
Reserve System's first national conference on banking opportunities on Indian
reservations and tribal lands (see box
"Lending in Indian Country"). System
staff continued to facilitate meetings and
workshops and to convene task forces to
Consumer and Community Affairs
have sought to increase communication
and highlight opportunities for profitable
relationships and development in Indian
Country by creating mutually beneficial partnerships. They have fostered the
exchange of information through workshops on sovereign lending, articles in
Reserve Bank newsletters, assistance in
designing a financial training curriculum
for Native American students, and support
for the development of regulations and procedures that govern secured credit transactions. At the national level, CAO staff
at the Board have served on federal task
forces that helped develop policy to
improve funding opportunities in Indian
Country.
Through ongoing relationships with
tribal leaders and bankers, the Federal
Reserve has gained valuable insight into
the cultural and legal issues and the concerns of all parties. This insight led to
recognition by the Federal Reserve and its
Native American partners of a need for a
national dialogue on lending in Indian
Country.
Pathway to a National Conference
To promote a national dialogue, the Federal Reserve and its tribal partners began
planning a conference that could serve as
a catalyst, stimulating new partnerships
and creative initiatives in Native American
communities across the country. An advisory committee made up of tribal leaders,
lenders, community development practitioners, attorneys, and academics knowledgeable about Indian Country issues was
formed by the Community Affairs Officers
discuss financing of housing and small
businesses on tribal lands and financial literacy within tribal communities.
Through a national interagency Native
American task force, Board staff began
planning for a policy development
forum on financial literacy in Indian
Country scheduled for May 2003.
89
of the Board and participating Reserve
Banks (the Reserve Banks of Chicago,
Kansas City, Minneapolis, and San Francisco). The committee helped ensure that
agenda topics were culturally sensitive and
accurately portrayed the credit needs and
concerns of Native American communities
and at the same time emphasized the critical role of banks in creating economic
opportunity in Indian Country. To promote
the partnerships between lenders and communities that are essential to the growth
and stabilization of local economies, the
conference agenda was developed to highlight ways in which creative economic
development efforts—financed by leveraging funds from government loan and guarantee programs with bank credit—can
result in safe, sound lending transactions.
The conference, held on November 1820, 2002, in Scottsdale, Arizona, drew
more than 400 participants. It provided a
forum for financiers, tribal leaders, and
economic developers to discuss innovative
development opportunities in Indian Country. The conference format employed
"talking circles;' a discussion method
unique to the Native American culture that
invites tribal members to enter into dialogue following each plenary session.
Breakout sessions addressed related issues
integral to development in Indian Country, including commercial codes, bank formation, regulatory matters, and wealthbuilding strategies. The breakout sessions
afforded an opportunity to explore more
fully the topics addressed in panel discussions, enabling the building of partnerships
to effect sustainable economic revitalization in Indian Country,
Banking for
Immigrant Communities
Major demographic changes and population shifts have been the impetus
for several Federal Reserve initiatives
involving immigrant banking markets.
Seven Reserve Banks—Atlanta, Boston,
90
89th Annual Report, 2002
Chicago, Dallas, Kansas City, New
York, and Richmond—sponsored programs and outreach meetings during
2002 to heighten financial institutions'
awareness of the credit and financial
service needs of Hispanic communities.
English and Spanish versions of materials on Electronic Transfer Accounts (an
account designed by the U.S. Treasury
for recipients of federal benefits), the
matricula consular card for Mexican
nationals seeking banking services, and
financial literacy ("Building Wealth: A
Beginner's Guide to Securing Your
Financial Future") are available on the
Dallas Reserve Bank's web site (at
www.dallasfed.org/htm/ca/pubs.html).
Through other activities, the Chicago
Reserve Bank addressed the needs of
the Asian-American community, and
the Minneapolis Reserve Bank, the
needs of Islamic and Hmong immigrant
communities.
Emerging Issues and Opportunities
The Federal Reserve in 2002 conducted
programs and held conferences on
emerging issues in community development to encourage research and discussion among academics and practitioners.
Among the topics discussed were
• Community development and smart
growth (affordable housing, brownfields redevelopment, transit systems,
and urban revitalization)
• Microenterprise development in small
cities and towns
• Entry-level employment opportunities
in technology for low- and moderateincome persons
• Financial innovation in community
development
• Loss mitigation
prevention
and
foreclosure
• Sustaining and revitalizing communities affected by economic downturns.
Community Development
Federal Reserve outreach activities and
programs in rural markets continued in
2002. Initiatives included conferences
on community development challenges
and opportunities for rural residents
and business owners, rural policy, and
opportunities for public-private partnerships to further economic development
in rural communities. Board staff continued to work with the Rural Home Loan
Partnership, an interagency group committed to increasing affordable housing
in rural communities.
Small-business development is an
important component of efforts to
rebuild and strengthen communities.
Several Reserve Banks held workshops
to provide information on opportunities
for business development and partnerships with local community development organizations. Reserve Banks also
provided technical assistance and information on the mechanics of accessing
tax credits for small businesses and for
commercial development. Board staff
participated on a task force sponsored
by the Department of Commerce to
explore development and capital formation for minority microentrepreneurs.
The community affairs function continued to expand its presence in the
international arena. Board staff participated with the Organisation for Economic Co-operation and Development
(OECD), a body of international groups
working to build partnerships and identify collaborative approaches to development, and delivered remarks at an
OECD conference in England on the use
of private finance for community build-
Consumer and Community Affairs
ing. Board staff also held meetings with
officials from Indonesia, Japan, Yugoslavia, New Zealand, and Russia to discuss community development policies
and strategies.
The preservation of affordable housing remains a central issue for the Federal Reserve. During 2002, Board staff
served in various capacities to support
the housing activities of the Federal
Reserve's external partners. For exam-
91
ple, Board staff served as the Federal
Reserve liaison to the Local Initiatives
Support Corporation advisory board's
Center for Home Ownership. Board
staff also provided support to Governor
Edward Gramlich in his role as chairman of the board of directors for the
Neighborhood Reinvestment Corporation, a national nonprofit organization
charged by Congress with revitalizing
older, distressed communities.
•
93
Banking Supervision and Regulation
The U.S. banking system exhibited considerable strength in 2002, producing
record earnings while absorbing significant deterioration in asset quality,
lackluster revenues from financialmarket activities, and the effects of economic weakness more generally. This
remarkable performance is attributable
in part to historically low interest
rates; it also reflects the benefits of
fundamentally strong balance sheets
and prudent capitalization as well as
the industry's continuing enhancements
to risk-management processes and
capabilities.
Industry earnings rose 20 percent for
the year, supported by robust growth in
low-cost core deposits, continued profitability from consumer lending and mortgage banking operations, and improved
operating efficiency. Elevated credit
costs and reversals in market-sensitive
lines of business offset some of this
improvement.
Nonperforming assets rose over the
year, particularly at large, complex institutions. The rise was fueled by a series
of high-profile bankruptcies and continuing weak economic growth. The
effect on banks of these bankruptcies
was somewhat muted, however, as
bondholders rather than banks absorbed
much of the credit costs associated with
these high-profile borrowers. Creditprotection instruments also played a
role in reducing bank credit losses.
Banks thus appear to have benefited
significantly from their ability to disperse risk through credit derivatives,
the syndicated loan market, loan sales,
and securitization activities, combined
with better risk-management and riskmeasurement systems.
Net interest margins widened moderately for the year, a result of low interest
rates and growth in low-cost core deposits. Demand for business loans was
weak, leading to a $70 billion (or 7 percent) decline in aggregate commercial
and industrial loans outstanding. With
supply boosted by historically low mortgage rates, banks added significantly
to their holdings of one- to four-family
mortgage loans and pass-through securities. Loans outstanding under home
equity lines of credit grew nearly 40 percent, the third consecutive year that
these balances have risen by more than
20 percent. Commercial real estate lending, especially lending to finance nonfarm nonresidential properties, multifamily housing, and new construction,
also grew rapidly.
The economic environment also
affected the way in which banks funded
their operations. During this period
of low interest rates and soft equity
prices, many households shifted funds
into interest-bearing bank transaction
accounts at the same time many banks
undertook significant initiatives to bolster core deposit growth. By the end of
2002, money market deposit accounts
and savings deposits accounted for
nearly 30 percent of the industry's funding. Capital remains a key strength of
the industry, as the total risk-based capital ratio remained at about 12.7 percent.
Non-interest revenues from the origination of mortgages for sale to others
were a major positive for the industry,
as were service charges on rapidly growing deposit accounts. Market-sensitive
revenues were again weak, consistent
with the overall softness in equity markets. Most banks supported their earn-
94
89th Annual Report, 2002
ings by taking significant securities
gains, in some cases associated with
adjustments to the institution's interest
rate risk profile.
Banks also reported significant gains
in operating efficiency, attributable in
part to a change in accounting practice that reduced expenditures to amortize goodwill. Special charges offset
some of these gains at a small number
of large institutions related to restructuring and potential litigation-related
expenses.
Work continued toward finalizing
a new international capital standard,
with approval of the new framework
expected in 2003 and implementation
of the new rules in 2007. This year's
efforts included an unprecedented coordinated effort among supervisors and
bankers in the G-10 countries to
assemble detailed information on the
risk profiles of individual banks and the
measured risks associated with these
positions.
Bankers and supervisors enter 2003
in a strong position but with a cautious
outlook. Both the positive and negative
influences seen in 2002 appear likely to
subside. By year-end 2002, asset quality
was showing signs of some improvement at most banks and possible signs
of economic improvement and some
recovery in equity markets were emerging. Charge-offs on consumer loans
remained generally stable, as available
evidence continued to suggest that
household debt burdens were manageable. Bankers expect credit quality to
stabilize and ultimately to improve in
the coming year, although an uncertain
economy and geopolitical concerns may
continue to affect the activities and outlook of both households and businesses.
Despite these uncertainties, the fundamental strengths of the industry leave it
well positioned to support, and benefit
from, an economic recovery.
Scope of Responsibilities for
Supervision and Regulation
The Federal Reserve is the federal
supervisor and regulator of all U.S. bank
holding companies (including financial
holding companies formed under the
authority of the Gramm-Leach-Bliley
Act) and of state-chartered commercial
banks that are members of the Federal
Reserve System. In overseeing these
organizations, the Federal Reserve seeks
primarily to promote their safe and
sound operation and their compliance
with laws and regulations, including the
Bank Secrecy Act and consumer protection and civil rights laws.1
The Federal Reserve also has responsibility for the supervision of all Edge
Act and agreement corporations; the
international operations of state member
banks and U.S. bank holding companies;
and the operations of foreign banking
companies in the United States.
The Federal Reserve exercises important regulatory influence over entry into
the U.S. banking system and the structure of the system through its administration of the Bank Holding Company
Act, the Bank Merger Act (with regard
to state member banks), the Change in
Bank Control Act (with regard to bank
holding companies and state member
banks), and the International Banking
1. The Board's Division of Consumer and
Community Affairs is responsible for coordinating
the Federal Reserve's supervisory activities with
regard to the compliance of banking organizations
with consumer protection and civil rights laws. To
carry out this responsibility, the Federal Reserve
trains a number of its bank examiners in the evaluation of institutions with regard to such compliance. The chapter of this volume covering consumer and community affairs describes these
regulatory responsibilities. Compliance with other
banking statutes and regulations, which is treated
in this chapter, is the responsibility of the Board's
Division of Banking Supervision and Regulation
and the Federal Reserve Banks, whose examiners
also check for safety and soundness.
Banking Supervision and Regulation
Act. The Federal Reserve is also responsible for imposing margin requirements
on securities transactions. In carrying
out these responsibilities, the Federal
Reserve coordinates its supervisory
activities with other federal banking
agencies, state agencies, functional
regulators, and the bank regulatory
agencies of other nations.
Supervision for
Safety and Soundness
To ensure the safety and soundness
of banking organizations, the Federal
Reserve conducts on-site examinations
and inspections and off-site surveillance
and monitoring. It also undertakes
enforcement and other supervisory
actions.
Examinations and Inspections
The Federal Reserve conducts examinations of state member banks, the U.S.
branches and agencies of foreign banks,
and Edge Act and agreement corporations. In a process distinct from
examinations, it conducts inspections of
holding companies and their nonbank
subsidiaries. Pre-examination planning
and on-site review of operations are
integral parts of the overall effort to
ensure the safety and soundness of
financial institutions. Whether it is an
examination or an inspection, the review
entails (1) an assessment of the quality
of the processes in place to identify,
measure, monitor, and control risks,
(2) an appraisal of the quality of the
institution's assets, (3) an evaluation of
management, including an assessment
of internal policies, procedures, controls, and operations, (4) an assessment
of the key financial factors of capital,
earnings, liquidity, and sensitivity to
market risk, and (5) a review for compliance with applicable laws and regula
95
tions. The table provides information on
the examinations and inspections conducted by the Federal Reserve during
the past five years.
State Member Banks
At the end of 2002, 949 state-chartered
banks (excluding nondepository trust
companies and private banks) were
members of the Federal Reserve System. These banks represented approximately 12 percent of all insured U.S.
commercial banks and held approximately 27 percent of all insured commercial bank assets in the United States.
The guidelines for Federal Reserve
examinations of state member banks
are fully consistent with section 10 of
the Federal Deposit Insurance Act, as
amended by section 111 of the Federal
Deposit Insurance Corporation Improvement Act of 1991 and by the Riegle
Community Development and Regulatory Improvement Act of 1994. A fullscope, on-site examination of these
banks is required at least once a year;
exceptions are certain well-capitalized,
well-managed institutions having assets
of less than $250 million, which may be
examined once every eighteen months.
Bank Holding Companies
At year-end 2002, a total of 5,963 U.S.
bank holding companies were in operation, of which 5,135 were top-tier bank
holding companies. These organizations
controlled 6,278 insured commercial
banks and held approximately 94 percent of all insured commercial bank
assets in the United States.
Federal Reserve guidelines call for
annual inspections of large bank holding
companies as well as smaller companies
that have significant nonbank assets.
In judging the financial condition of
the subsidiary banks owned by holding
96
89th Annual Report, 2002
State Member Banks and Holding Companies, 1998-2002
Entity/Item
State member banks
Total number
Total assets (billions of dollars)
Number of examinations
By Federal Reserve System .
By state banking agency
Top-tier bank holding companies
Large (assets of more than $1 billion)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System'
On site
Off site
By state banking agency
Small (assets of $1 billion or less)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System
On site 2
Off site
By state banking agency
Financial holding companies
Domestic
Foreign
2002
2001
2000
1999
1998
949
1,863
814
550
264
970
1,823
816
561
255
991
1,645
899
610
289
1,010
1,423
858
551
307
994
1,312
820
511
309
329
7,483
439
431
385
46
312
6,905
413
409
372
37
4
309
6,213
352
346
309
37
6
283
5,625
332
329
298
31
3
273
5,136
290
281
262
19
9
4,806
821
3,726
3,625
264
3,361
101
4,816
768
3,486
3,396
730
2,666
90
4,800
716
3,347
3,264
835
2,429
83
4,831
679
3,064
2,973
684
2,289
91
4,880
647
3,257
3,178
723
2,455
79
602
30
567
23
462
21
NOTE. Data for prior periods have been updated.
1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.
2. In 2002, the supervisory program for small bank
holding companies was revised, resulting in more
inspections being performed off site versus on site.
See text section "Bank Holding Companies" for more
information.
. . . Not applicable.
companies, Federal Reserve examiners
consult examination reports prepared
by the federal and state banking authorities that have primary responsibility
for the supervision of those banks,
thereby minimizing duplication of effort
and reducing the burden on banking
organizations.
Small, noncomplex bank holding
companies—those that have consolidated assets of $1 billion or less—are
subject to a special supervisory program that was implemented in 1997 and
modified in 2002.2 The program permits
a more flexible approach to supervision
of such companies. If all of a company's
subsidiary depository institutions have
composite and management ratings of
"satisfactory" or better, and if no material outstanding issues at the holding
company or consolidated level are otherwise indicated, only a composite rating
and a management rating based on the
ratings of the lead subsidiary depository
institution are assigned to the company.
In 2002, the Federal Reserve conducted
3,361 reviews of such bank holding
companies. If a company's subsidiary
depository institutions have ratings
lower than "satisfactory" or other significant supervisory issues, a more thorough off-site review of the organization
is conducted using surveillance results
and other information. If the informa-
2. Refer to SR letter 02-01 for a discussion of
the factors considered in determining whether a
bank holding company is complex or noncomplex.
Banking Supervision and Regulation
tion obtained off site from these sources
is not sufficient to determine the overall
financial condition of the holding company and to assign the composite and
management ratings, the holding company is subject to increased supervisory
review that may include an on-site
review and off-site monitoring.
While the 2002 modifications to the
special supervisory program principally
affect the supervision of small holding
companies, they also promote moreeffective use of targeted on-site reviews
to fulfill the requirements for, when
necessary, the full-scope inspection of
larger holding companies—those with
consolidated assets of $1 billion to
$5 billion. In general, the modifications
direct Reserve Banks to use surveillance
results and other information to focus
attention and resources on holding companies that warrant increased scrutiny.
Financial Holding Companies
Under the Gramm-Leach-Bliley Act,
the Federal Reserve has supervisory
oversight authority and responsibility
for bank holding companies, including those that operate as financial holding companies. The statute streamlines
the Federal Reserve's supervision of all
bank holding companies and sets forth
parameters for the relationship between
the Federal Reserve and other regulators. The statute differentiates between
the Federal Reserve's relations with
regulators of depository institutions and
its relations with functional regulators
(that is, regulators for insurance, securities, and commodities).
As of year-end 2002, 602 domestic
bank holding companies and 30 foreign
banking organizations had financial
holding company status. Of the domestic institutions, 37 financial holding
companies had consolidated assets of
$15 billion or more; 90, between $1 bil
97
lion and $15 billion; 85, between
$500 million and $1 billion; and 390,
less than $500 million.
Specialized Examinations
The Federal Reserve conducts specialized examinations of banking organizations in the areas of information technology, fiduciary activities, transfer agent
activities, and government and municipal securities dealing and brokering. The
Federal Reserve also conducts specialized examinations of certain entities,
other than banks, brokers, or dealers,
that extend credit subject to the Board's
margin regulations.
With passage of the Gramm-LeachBliley Act in 1999, the Federal Reserve
ceased conducting routine annual
examinations of securities underwriting
and dealing activities through so-called
section 20 subsidiaries of bank holding
companies. Under the act, the Federal
Reserve is generally required to rely on
the supervisory activities of the functional regulator for broker-dealer subsidiaries unless the Board has cause
to believe that a broker-dealer poses
a material risk to an insured depository
affiliate. No such examinations for cause
were conducted during 2002.
Information Technology Activities
In recognition of the importance of
information technology to safe and
sound operations in the financial industry, the Federal Reserve reviews the
information technology activities of
supervised financial institutions as well
as certain independent data centers that
provide information technology services
to these institutions. Several years ago,
the information technology reviews of
banking institutions were integrated into
the overall supervisory process, and thus
all safety and soundness examinations
98
89th Annual Report, 2002
Adoption of Rules Governing Transactions with Affiliates
In 2002, the Federal Reserve Board issued
a new regulation that addresses transactions between insured depository institutions and their affiliates. The new
regulation—Regulation W (Transactions
between Member Banks and Their
Affiliates)—implements sections 23A and
23B of the Federal Reserve Act. It takes
effect April 1,2003.
Background
Sections 23A and 23B of the Federal
Reserve Act are designed to protect depository institutions from losses in transactions
with their affiliates. They also limit a
depository institution's ability to transfer to
its affiliates the subsidy arising from the
institution's access to the federal safety
net. Section 23A subjects covered transactions between depository institutions and
their affiliates (for example, loans from a
depository institution to or for the benefit
of an affiliate, and purchases of assets by a
depository institution from an affiliate) to
quantitative limits and collateral requirements. Section 23B requires that depository institutions conduct most transactions
with affiliates on terms and under circumstances that are substantially the same as
those granted to nonaffiliates—that is, a
depository institution may not grant its
affiliate more favorable terms and conditions than it would grant a similarly situated nonaffiliate in a comparable transaction. This provision is commonly referred
to as the "market terms requirement."
Before adoption of Regulation W, the
statutory provisions of sections 23A and
23B of the Federal Reserve Act had been
implemented by means of Board interpretations and informal staff guidance. Having a
comprehensive and consistent application
of the statutory provisions became especially important with passage in 1999 of
the Gramm-Leach-Bliley Act (GLBA).
GLBA not only provided for broader affiliations among financial services providers
but emphasized, in the statutory and regulatory frameworks it established, the importance of limitations on affiliate transactions
as a means of protecting depository institutions from losses in their transactions with
affiliates.
Key Provisions of Regulation W
Key provisions of Regulation W, and some
of the important exemptions from the rule,
are described below.
Derivatives Transactions and
Intraday Credit
Derivatives transactions between a depository institution and its affiliates are not
subject to the quantitative limitations and
collateral requirements of section 23A.
They are, however, subject to the market
terms requirement of section 23B. In addition, depository institutions are required to
adopt policies and procedures under section 23A to manage the credit exposure
arising from their derivatives transactions
with affiliates.
Intraday extensions of credit by depository institutions to affiliates also are subject to the market terms requirement of
section 23B. However, such extensions
of credit are exempt from the quantitative
limits and collateral requirements of section 23A if the depository institution adopts
policies and procedures to manage its
credit exposure to affiliates in such transactions and has no reason to believe that
the affiliate receiving intraday credit would
have difficulty repaying the loan.
Scope of Application—
Foreign Banking Organizations
To help ensure a competitive playing field
for U.S. depository institutions vis-a-vis
foreign banking organizations operating in
the United States, Regulation W applies to
transactions between the U.S. branches and
Banking Supervision and Regulation
agencies of a foreign bank and the foreign
bank's affiliates engaged in the United
States in securities underwriting and dealing, insurance underwriting, merchant
banking, and insurance company investment. The issue of competitive equity
arises most strongly in connection with
these activities—activities that a U.S. bank
cannot engage in directly or through an
operating subsidiary.
Scope of Application—
Financial Subsidiaries
Congress amended section 23A in 1982 to
provide that under the statute, subsidiaries
of a depository institution generally are
not affiliates of the institution. This provision was based on the premise that subsidiaries of a depository institution generally
are consolidated with the depository institution and are engaged only in activities
that the depository institution may conduct
directly.
In 1999, GLBA authorized depository
institutions to own financial subsidiaries
that engage in activities that the parent
institution may not conduct directly. GLBA
also amended section 23A to define a
financial subsidiary of a bank as an affiliate
of the bank—and thus subjected transactions between the bank and its financial subsidiaries to the limitations of
sections 23A and 23B. Section 23A, as
amended by GLBA, defines a financial
subsidiary as a subsidiary of any state or
national bank that is engaged in an activity
that is not permissible for national banks
(other than a subsidiary that federal law
specifically authorizes national banks to
control). A subsidiary of a financial subsidiary is also a financial subsidiary.
Exceptions to the definition of a financial subsidiary are included in Regulation W for (1) insurance agency subsidiaries of banks, (2) subsidiaries of statechartered banks that engage in activities
that the parent state bank may engage in
directly under federal and state law, and
(3) subsidiaries of state-chartered banks
that engage in activities that the subsidiary
99
was legally conducting before Regulation W was issued.
Loan Purchases
For some years, the Board has allowed a
depository institution to purchase a loan
from an affiliate if the institution makes an
independent evaluation of the borrower's
creditworthiness before the affiliate extends
the loan and if the institution commits to
purchasing the loan before the affiliate
extends the loan. In 1995, Board staff
expressly limited the availability of this
exemption to institutions whose loan purchases from any one affiliate represented
no more than 50 percent of the dollar
amount of the loans made by that affiliate.
This condition was designed to prevent
bank holding companies from using the
exemption extensively to fund their nonbank lending affiliates.
Regulation W retains this 50 percent
limitation but allows the institution's primary federal regulator, on a case-by-case
basis, to restrict loan purchases even more
if appropriate to protect the safety and
soundness of the institution.
At the time Regulation W was adopted,
the Board sought comment on a proposed
rule that would prevent a depository institution from using this exemption if its purchases of loans from an affiliate under the
exemption exceeded 100 percent of the
institution's capital stock and surplus.
Conclusion
A key premise of the Gramm-LeachBliley Act is that sections 23A and 23B of
the Federal Reserve Act limit the risk to
depository institutions of the broader affiliations permitted by GLBA and make extensive prior-transaction review by the bank
regulatory agencies unnecessary. In light
of the greater role of these statutory
provisions in risk management, Federal
Reserve examiners and other supervisory
staff have been directed to review intercompany transactions for compliance with
the statute and Regulation W frequently
and rigorously.
100 89th Annual Report, 2002
are now expected to include a review
of information technology risks and
activities. During 2002, the Federal
Reserve was the lead agency in two
examinations of large, multiregional
data processing servicers examined in
cooperation with the other federal banking agencies.
Fiduciary Activities
The Federal Reserve has supervisory responsibility for institutions that
together hold more than $15 trillion
of assets in various fiduciary capacities.
During on-site examinations of fiduciary activities, the institution's compliance with laws, regulations, and general
fiduciary principles and potential conflicts of interest are reviewed; its management and operations, including its
asset- and account-management, riskmanagement, and audit and control procedures, are also evaluated. In 2002,
Federal Reserve examiners conducted
194 on-site fiduciary examinations.
Transfer Agents and
Securities Clearing Agencies
As directed by the Securities Exchange
Act of 1934, the Federal Reserve conducts specialized examinations of those
state member banks and bank holding
companies that are registered with the
Board as transfer agents. Among other
things, transfer agents countersign and
monitor the issuance of securities, register the transfer of securities, and
exchange or convert securities. On-site
examinations focus on the effectiveness of the institution's operations and
its compliance with relevant securities
regulations. During 2002, the Federal
Reserve conducted on-site examinations
at 30 of the 98 state member banks and
bank holding companies that were registered as transfer agents. Also during
the year the Federal Reserve examined
1 state member limited-purpose trust
company acting as a national securities
depository.
Government and Municipal Securities
Dealers and Brokers
The Federal Reserve is responsible for
examining state member banks and foreign banks for compliance with the Government Securities Act of 1986 and with
Department of the Treasury regulations
governing dealing and brokering in
government securities. Thirty-five state
member banks and 10 state branches of
foreign banks have notified the Board
that they are government securities dealers or brokers not exempt from Treasury's regulations. During 2002 the Federal Reserve conducted 9 examinations
of broker-dealer activities in government securities at these institutions.
These examinations are generally conducted concurrently with the Federal
Reserve's examination of the state member bank or branch.
The Federal Reserve is also responsible for ensuring compliance with the
Securities Act Amendments of 1975 by
state member banks and bank holding
companies that act as municipal securities dealers, which are examined pursuant to the Municipal Securities Rulemaking Board's rule G-16 at least once
each two calendar years. Of the 27 entities that dealt in municipal securities
during 2002, 8 were examined during
the year.
Securities Credit Lenders
Under the Securities Exchange Act of
1934, the Federal Reserve Board is
responsible for regulating credit in certain transactions involving the purchase
or carrying of securities. In addition to
examining banks under its jurisdiction
Banking Supervision and Regulation
for compliance with the Board's margin
regulations as part of its general examination program, the Federal Reserve
maintains a registry of persons other
than banks, brokers, and dealers who
extend credit subject to those regulations. The Federal Reserve may conduct
specialized examinations of these lenders if they are not already subject to
supervision by the Farm Credit Administration, the National Credit Union
Administration, or the Office of Thrift
Supervision.
At the end of 2002, 795 lenders other
than banks, brokers, or dealers were registered with the Federal Reserve. Other
federal regulators supervised 166 of
these lenders, and the remaining 629
were subject to limited Federal Reserve
supervision. On the basis of regulatory
requirements and annual reports, the
Federal Reserve exempted 281 lenders
from its on-site inspection program. The
securities credit activities of the remaining 348 lenders were subject to either
biennial or triennial inspection. One
hundred twenty-seven inspections were
conducted during the year, compared
with 65 in 2001.
Enforcement Actions
and Civil Money Penalties
In 2002 the Federal Reserve completed
18 enforcement cases involving 32 sepparate actions, such as cease-and-desist
orders, written agreements, removal and
prohibition orders, and civil money penalties. The Board of Governors collected
$60,829 in civil money penalties. All
funds collected were remitted to the
Department of the Treasury.
All final enforcement orders issued
by the Board and all written agreements
executed by the Reserve Banks in
2002 are available to the public and
are posted on the Board's web site
www.federalreserve.gov/boarddocs/
101
enforcement). In addition to formal
enforcement actions, the Reserve
Banks in 2002 completed 116 informal
enforcement actions, such as resolutions
with boards of directors and memorandums of understanding.
Risk-Focused Supervision
In recent years the Federal Reserve
has created several programs aimed at
enhancing the effectiveness of the supervisory process. The main objective of
these initiatives has been to sharpen the
focus on (1) those business activities
posing the greatest risk to banking organizations and (2) the organizations'
management processes for identifying,
measuring, monitoring, and controlling
risk.
Regional Banking Organizations
The risk-focused supervision program
for regional banking organizations
applies to institutions having a management structure organized by function or
business line, a broad array of products,
and operations that span multiple supervisory jurisdictions. For smaller regional
banking organizations, the supervisory program may be implemented with
a point-in-time inspection. For larger
institutions, it may take the form of a
series of targeted reviews. For the largest, most complex institutions, the process is continuous, as described in the
next section. To minimize burden on the
institution, work is performed off site to
the greatest extent possible. Additionally, to minimize the number of requests
for information from the institution,
examiners make use of public and regulatory financial reports, market data,
information from automated surveillance screening systems (see section
"Surveillance and Risk Assessment"),
and internal management reports.
102 89th Annual Report, 2002
Large, Complex Banking Organizations
The Federal Reserve applies a riskfocused
supervision program to
large, complex banking organizations
(LCBOs).3 The key features of the
LCBO supervision program are (1) identifying those LCBOs that are judged, on
the basis of their shared risk characteristics, to present the highest level of
supervisory risk to the Federal Reserve
System, (2) maintaining continual supervision of these institutions to keep
current the Federal Reserve's assessment of each organization's condition,
(3) assigning to each LCBO a supervisory team composed of Reserve Bank
staff members who have skills appropriate for the organization's risk profile
(the team leader is the central point of
contact, has responsibility for only one
LCBO, and is supported by specialists
skilled in evaluating the risks of LCBO
business activities and functions), and
(4) promoting Systemwide and interagency information-sharing through an
automated system.
Supporting the supervision process
is an automated application and
database—the Banking Organization
National Desktop (BOND)—that was
developed to facilitate real-time, secure
information-sharing and collaboration
across the Federal Reserve System and
with certain other federal and state
regulators. During 2002, BOND was
enhanced to include the capability of
searching and accessing supervisory
documents using web-based technology.
BOND performance and functionality
were also improved to promote analysis
across institutions.
3. For an overview of the Federal Reserve's
LCBO program, see Lisa M. DeFerrari and
David E. Palmer, "Supervision of Large Complex
Banking Organizations," Federal Reserve Bulletin, vol. 87 (February 2001), pp. 47-57.
During the year, the Federal Reserve,
the Office of the Comptroller of the
Currency, and the Securities and
Exchange Commission formed an interagency working group to assess
whether, in light of the post-September 11 risk environment, additional
guidance on business resumption is
needed. The agencies held a series of
meetings with financial institutions and
core clearing and settlement organizations to discuss lessons learned and the
need for improving the resilience of the
financial system after a wide-scale disruption. In September 2002, the working group published for comment a
Draft Interagency White Paper on Sound
Practices to Strengthen the Resilience of
the U.S. Financial System.4 The agencies are continuing to work with representatives of the industry to identify
sound practices and plan to issue a final
paper in 2003.
Community Banks
The risk-focused supervision program
for community banks emphasizes the
review of activities having the highest level of risk to an institution and
provides a tiered approach to the examination of these activities. Examination
procedures are tailored to the characteristics of the bank, keeping in
mind its size, complexity, and risk profile. The examination procedures entail
both off-site and on-site work, including planning, completion of a preexamination visit, preparation of a
detailed scope-of-examination memorandum, thorough documentation of
the work done, and preparation of an
examination report tailored to the
scope and findings of the examination.
The framework for risk-focused super4. Federal Register, vol. 67, no. 172 (Sept. 5,
2002), pp. 56835-56842.
Banking Supervision and Regulation
vision of community banks was developed jointly with the Federal Deposit
Insurance Corporation and has been
adopted by the Conference of State
Bank Supervisors.
Surveillance and Risk Assessment
The Federal Reserve uses automated
screening systems to monitor the financial condition and performance of state
member banks and bank holding companies between on-site examinations. The
screening systems analyze supervisory
data and regulatory financial reports
to identify companies that appear to
be weak or deteriorating. This analysis
helps to direct examination resources to
institutions that exhibit higher risk profiles. Screening systems also assist in
the planning of examinations by identifying companies that are engaging in
new or complex activities.
In addition to using automated screening systems, the Federal Reserve prepares quarterly Bank Holding Company Performance Reports for use in
monitoring and inspecting supervised
banking organizations. The reports contain, for individual bank holding companies, financial statistics and comparisons with peer companies. They are
compiled from data provided by large
bank holding companies in quarterly
regulatory reports (FR Y-9C and
FR Y-9LP). During 2002, information
on securitization and asset sales activities was added to the report to help
examiners and analysts evaluate the
potential risks of these activities.
Among the new information collected
is detail on the volume and composition of securitization activities, the volume and composition of retained credit
exposures, and delinquencies of and net
losses on securitized assets. Also during the year the Federal Reserve substantially expanded the information on
103
insurance activities collected via the
report.
Historically, paper copies of the Bank
Holding Company Performance Reports
have been provided to individual bank
holding companies and to state banking agencies. Effective with the March
2002 report, paper distribution was
replaced by electronic distribution of
non-confidential information via the
Board's National Information Center
web site. The change was made to
improve the efficiency and timeliness of
distribution of the reports and to provide
broader access to the reports by public
users.
The Federal Reserve works through
the Federal Financial Institutions
Examination Council (FFIEC) Task
Force on Surveillance Systems to coordinate surveillance activities with the
other federal banking agencies.5 During
the year, the task force added to the
Uniform Bank Performance Report several items on securitization activities
substantially similar to the items added
to the Bank Holding Company Performance Report. Also during the year, the
task force adopted a web-based distribution system for the Uniform Bank Performance Report.
International Activities
The Federal Reserve supervises the foreign branches of and overseas investments by member banks, Edge Act and
agreement corporations, and bank holding companies; and investments by bank
holding companies in export trading
companies. It also supervises the activities that foreign banking organizations
5. The member agencies of the FFIEC are the
Board of Governors, the Federal Deposit Insurance Corporation (FDIC), the National Credit
Union Administration (NCUA), the Office of the
Comptroller of the Currency (OCC), and the
Office of Thrift Supervision (OTS).
104 89th Annual Report, 2002
conduct through entities in the United
States, including branches, agencies,
representative offices, and subsidiaries.
Foreign Operations of
U.S. Banking Organizations
The Federal Reserve examines the
international operations of state member
banks, Edge Act corporations, and bank
holding companies principally at the
U.S. head offices of these organizations,
where the ultimate responsibility for
their foreign offices lies. In 2002 the
Federal Reserve examined 1 foreign
branch of a state member bank and
4 foreign subsidiaries of Edge Act corporations and bank holding companies.
The examinations abroad were conducted with the cooperation of the
supervisory authorities of the countries
in which they took place; when appropriate, the examinations were coordinated with the Office of the Comptroller
of the Currency. Examiners also make
visits to the overseas offices of U.S.
banks to obtain financial and operating
information and, in some instances,
to evaluate their efforts to implement
corrective measures or to test their
adherence to safe and sound banking
practices.
At the end of 2002, 61 member banks
were operating 855 branches in foreign countries and overseas areas of the
United States; 31 national banks were
operating 652 of these branches, and
30 state member banks were operating the remaining 203. In addition,
16 nonmember banks were operating
17 branches in foreign countries and
overseas areas of the United States.
Edge Act and Agreement Corporations
Edge Act corporations are international
banking organizations chartered by the
Board to provide all segments of the
U.S. economy with a means of financing international business, especially
exports. Agreement corporations are
similar organizations, state chartered or
federally chartered, that enter into an
agreement with the Board to refrain
from exercising any power that is
not permissible for an Edge Act
corporation.
Under sections 25 and 25A of the
Federal Reserve Act, Edge Act and
agreement corporations may engage in
international banking and foreign financial transactions. These corporations,
most of which are subsidiaries of member banks, may (1) conduct a deposit
and loan business in states other than
that of the parent, provided that the business is strictly related to international
transactions, and (2) make foreign
investments that are broader than those
made by member banks because they
may invest in foreign financial organizations, such as finance companies and
leasing companies, as well as in foreign
banks.
Edge Act and agreement corporations numbered 80 and were operating
12 branches at year-end 2002. These
corporations are examined annually.
U.S. Activities of Foreign Banks
The Federal Reserve has broad authority
to supervise and regulate the U.S. activities of foreign banks that engage in
banking and related activities in the
United States through branches, agencies, representative offices, commercial
lending companies, Edge Act corporations, commercial banks, and certain
nonbank companies. Foreign banks continue to be significant participants in the
U.S. banking system.
As of year-end 2002, 193 foreign
banks from 55 countries were operating
253 state-licensed branches and agencies (of which 10 were insured by the
Banking Supervision and Regulation
Federal Deposit Insurance Corporation)
as well as 52 branches licensed by the
Office of the Comptroller of the Currency (of which 6 had FDIC insurance).
These foreign banks also directly owned
16 Edge Act and agreement corporations and 3 commercial lending companies; in addition, they held an equity
interest of at least 25 percent in 86 U.S.
commercial banks.
Altogether, the U.S. offices of these
foreign banks at the end of 2002 controlled approximately 18 percent of
U.S. commercial banking assets. These
foreign banks also operated 92 representative offices; an additional 57 foreign banks operated in the United
States solely through a representative
office.
State-licensed and federally licensed
branches and agencies of foreign banks
are examined on site at least once every
eighteen months, either by the Federal
Reserve or by a state or other federal
regulator; in most cases, on-site examinations are conducted at least once
every twelve months, but the period
may be extended to eighteen months
if the branch or agency meets certain
criteria.
The Federal Reserve conducts a joint
program for supervising the U.S. operations of foreign banking organizations
in cooperation with the other federal
banking agencies and state banking
agencies. The program has two main
parts. One part focuses on the examination process for those foreign banking
organizations that have multiple U.S.
operations and is intended to improve
coordination among the various U.S.
supervisory agencies. The other part
is a review of the financial and operational profile of each organization to
assess its general ability to support its
U.S. operations and to determine what
risks, if any, the organization poses
through its U.S. operations. Together,
105
these two processes provide critical
information to U.S. supervisors in a
logical, uniform, and timely manner.
The Federal Reserve conducted or participated with state and federal regulatory authorities in 307 examinations
during 2002.
Technical Assistance
In 2002 the Federal Reserve System
continued to provide technical assistance on bank supervisory matters
to foreign central banks and supervisory authorities. Technical assistance
involves visits by System staff members
to foreign authorities as well as consultations with foreign supervisors who
visit the Board or the Reserve Banks.
Technical assistance in 2002 was concentrated in Latin America, Asia, and
former Soviet bloc countries.
During the year, the Federal Reserve
offered supervision training courses in
Washington, D.C., and in a number of
foreign jurisdictions exclusively for foreign supervisory authorities. System
staff also took part in technical assistance and training missions led by the
International Monetary Fund, the World
Bank, the Inter-American Development Bank, the Asian Development
Bank, the Basel Committee on Banking
Supervision, and the Financial Stability
Institute.
Supervisory Policy
Within the supervisory policy function,
the Federal Reserve develops guidance
for examiners and financial institutions
as well as regulations for financial institutions under the supervision of the Federal Reserve. Staff members also participate in international supervisory forums
and provide support for the work of the
Federal Financial Institutions Examination Council.
106 89th Annual Report, 2002
Capital Adequacy Standards
During 2002, the Federal Reserve,
together with the other federal banking
agencies, issued two final rules amending the agencies' regulatory capital
guidelines and issued guidance on a
number of policy topics. One final rule
established the regulatory capital treatment of equity investments in nonfinancial companies held by banking organizations. The other final rule reduced
from 100 percent to 20 percent the risk
weight applied, under the agencies'
risk-based capital guidelines, to certain
claims on qualifying securities firms.
The Federal Reserve, together with the
other federal banking agencies, also
issued policy guidance on management of country risk and asset securitization and draft guidance on credit
card lending. The Federal Reserve also
clarified that preferred stock covered
by certain hedging arrangements is not
includable in regulatory capital. In addition, the Federal Reserve issued guidance introducing a new statistical loansampling methodology for community
banks.
Capital for Nonfinancial
Equity Investments
In January, the Federal Reserve, together
with the OCC and the FDIC, adopted a
final rule governing the regulatory capital treatment of equity investments in
nonfinancial companies held by banks,
bank holding companies, and financial holding companies. The final rule
subjects covered equity investments to
a capital charge that increases in steps
as the banking organization's level of
concentration in equity investments
increases. Agency monitoring also
increases as the level of concentration in equity investments increases.
A summary of the key provisions of
the new capital rule was published in
SR letter 02-4 on March 4, 2002.
Claims on Securities Firms
In April, the federal banking agencies
issued final rules amending the riskbased capital standards for banks, bank
holding companies, and savings associations by reducing from 100 percent to
20 percent the risk weight accorded to
certain claims on, and claims guaranteed
by, qualifying securities firms having
high investment-grade ratings in countries that are members of the Organisation for Economic Co-operation and
Development. The change brings the
risk weight in line with a 1998 revision
to the Basel Capital Accord. Qualifying
U.S. securities firms are broker-dealers
registered with the Securities and
Exchange Commission (SEC) that are in
compliance with the SEC's net capital
rule. The Board's final rule also applies
a 20 percent risk weight to certain collateralized claims on qualifying securities firms.
Management of Country Risk
In February, the Federal Reserve and
the other federal banking agencies published guidance for banking organizations concerning the elements of an
effective country risk management process. The interagency guidance builds
on the findings of a 1998 study by the
Interagency Country Exposure Review
Committee on the country risk management practices of U.S. banks, supplementing and strengthening previous
guidance and ensuring that banking
organizations' management of risks
arising from their international activities are appropriately and adequately
addressed during the examination process. The guidance was contained in
SR letter 02-5, issued March 8, 2002.
Banking Supervision and Regulation
Credit Card Lending
In July, under the auspices of the Federal Financial Institutions Examination
Council, the federal banking agencies
issued draft guidance on account management and loss allowance for credit
card lending. The draft guidance
describes the agencies' expectations
regarding prudent risk-management
practices for credit card activities,
particularly with regard to credit-line
management, over-limit accounts, and
workouts. It also addresses income recognition and loss-allowance practices in
connection with credit card lending.
Hedging of Preferred Stock Issued
through Special-Purpose Entities
In March, the Federal Reserve issued
guidance clarifying that preferred stock
issued through special entities owned by
bank holding companies is not includable in tier 1 capital if it is covered by
certain hedging derivatives contracts. To
be included in tier 1 capital, the Federal
Reserve requires that the provisions of
such preferred stock permit a banking
organization to defer dividends for up
to five years, a feature that allows bank
holding companies to conserve cash in
times of financial and liquidity pressure.
Some hedging derivatives contracts contravene this policy by requiring a bank
holding company to make contract payments on the derivative to its counterparty during periods of deferral on the
preferred stock while providing for the
deferral of payments to the bank holding
company by the counterparty.
Statistical Loan Sampling
at Community Banks
In October, the Federal Reserve issued
guidance introducing a statistical sampling method to increase the compre
107
hensiveness and effectiveness of credit
review in examinations of certain community banks. In addition, the guidance
clarified that loan reviews conducted
as part of full-scope Federal Reserve
examinations are expected to comply
with existing Federal Reserve guidance or with the new loan-sampling
guidance.
Securitization Guidance
In May 2002, the federal banking
agencies released several policy statements on securitization-related issues.
The guidance builds on the agencies'
final rules for "Capital Treatment of
Recourse, Direct Credit Substitutes, and
Residual Interests in Asset Securitizations," which were issued in November 2001. The agencies also issued a
question-and-answer document responding to some questions that have arisen
regarding their rules.
• One policy statement clarified the
risk-based capital treatment of accrued
interest receivables for banking organizations that securitize credit card
receivables through trusts and record
as an on-balance-sheet asset the interest and fee income due on the securitized receivables. Because such
amounts of interest and fee income
generally must be paid to the trust for
payment to holders of senior positions
in a securitization before any amount
is returned to the banking organization, the banking organization must
treat the accrued interest receivable
as a residual for purposes of riskbased capital. This treatment results
in the banking organization's being
required, under the recourse provisions of the agencies' capital rules,
to hold "dollar-for-dollar" capital
against the receivable amount.
108 89th Annual Report, 2002
In another policy statement, the agencies advised examiners and banking
organizations that the use by banking
organizations of adverse supervisory
actions or negative changes in supervisory thresholds as triggers for the
early amortization or transfer of servicing in securitizations constitutes an
unsafe and unsound banking practice.
Examples of such supervisory triggers include a downgrade in a banking organization's CAMELS rating,
an enforcement action, or a downgrade in a bank's "prompt corrective
action" capital category. The supervisory concern arises because a banking
organization that triggers such a provision is likely to already be subject to
financial and liquidity pressure. Triggering an early amortization or transfer of servicing in a securitization can
create or exacerbate liquidity and
earnings problems that may lead to
further deterioration in the banking
organization's financial condition.
A third policy statement was intended
to aid examiners and banking organizations in identifying instances of
"implicit recourse," a term that generally refers to a banking organization's
providing greater credit support to a
securitization than is required contractually. Because banking organizations' risk-based capital requirements
generally are based on their maximum
credit exposure under contract, such
capital requirements do not capture
the additional credit risk being undertaken by the organization through its
implicit recourse actions. This guidance identifies several types of
implicit recourse and supervisory
actions that the agencies may take to
address banking organizations' provision of implicit recourse.
Interagency Advisory on
Accounting for Accrued Interest
Receivable Related to Credit Card
Securitizations
In December 2002, the Federal Reserve
and the other federal banking agencies
issued guidance regarding the appropriate accounting treatment for financial institutions that record an asset
commonly referred to as accrued interest receivable (AIR) in connection
with the securitization of credit card
receivables. Consistent with generally
accepted accounting principles, the
guidance clarifies that when the terms of
the securitization legally isolate the
institution's (seller's) right to the AIR,
the seller generally should report the
AIR as a subordinated retained interest
when accounting for the sale of credit
card receivables. This means that the
value of the AIR, at the date the receivables are transferred to the trust, must be
adjusted on the basis of its relative fair
(market) value.
Business Continuity
In 2002, in response to the events
of September 11, 2001, the Federal
Reserve developed a business-continuity
risk profile that provides a consistent
framework for benchmarking businesscontinuity programs and serves as a tool
in conducting targeted examinations of
business-continuity planning. Federal
Reserve examiners plan to pilot test the
business-continuity risk profile in 2003,
with the goal of identifying areas for
improvement at individual institutions
and developing a profile of businesscontinuity programs at large, complex
banking organizations supervised by the
Federal Reserve.
Banking Supervision and Regulation
International Guidance on
Supervisory Policies
As a member of the Basel Committee on
Banking Supervision (Basel Committee), the Federal Reserve in 2002 participated in efforts to revise the international capital regime and to develop
international supervisory guidance. The
Federal Reserve's goals in these activities are to advance sound supervisory
policies for internationally active banking institutions and to improve the stability of the international banking system. The efforts are described in the
following sections.
Capital Adequacy
The Federal Reserve continued to participate in a number of technical working groups of the Basel Committee in
efforts to develop a new capital accord.
These groups worked to develop a
revised consultative paper based on further deliberations of the committee and
on comments received by the committee
on its January 2001 consultative paper
and on technical papers subsequently
issued by the working groups. The committee and working groups also continued formal and informal communication with the banking industry and other
interested parties, including the launching of a third quantitative impact study,
referred to as QIS 3. QIS 3 was undertaken with the goal of ensuring the efficacy of the Basel Committee's proposals and gathering information helpful in
assessing whether further modifications
are necessary before the committee's
planned release of a revised consultative
paper in spring 2003.
In addition, in October 2002, a committee working group issued a second
working paper on asset securitization,
109
following issuance of a first paper in
October 2001. The purpose of the second paper was to discuss and seek feedback on some revisions to the securitization framework discussed in the
two consultative papers. In December 2002, a committee working group
issued a paper on pillar III—market
discipline—in order to seek feedback on
the latest proposals on disclosure.
Risk Management
The Federal Reserve contributed to several supervisory policy papers, reports,
and recommendations issued by the
Basel Committee during 2002. These
documents were generally aimed at
improving the supervision of banking
organizations' risk-management practices. The paper "Management and
Supervision of Cross-Border Electronic
Banking Activities" (issued in October)
was prepared for the purposes of identifying banks' risk-management responsibilities with respect to cross-border
banking and focusing attention on the
need for effective home country supervision of, and continued international
cooperation regarding, electronic banking. The paper "Sound Practices for the
Management and Supervision of Operational Risk" (issued in July) outlines a
set of principles that provide a framework for the effective management and
supervision of operational risk. The
framework is intended for use by banks
and supervisory authorities when evaluating policies and practices related to
the management of operational risk.
The report "Supervisory Guidance in
Dealing with Weak Banks" (issued in
March) provides practical guidance for
banking supervisors in their work with
weak banks. The guidance includes discussions of problem identification, cor-
110 89th Annual Report, 2002
rective action, resolution techniques,
and exit strategies.
Internal Control, Accounting,
and Disclosure
The Federal Reserve participates in
the Basel Committee's Task Force on
Accounting Issues and the Transparency
Group and represents the Basel Committee at international meetings on the
issues addressed by these groups. In
particular, the Federal Reserve in 2002
represented the Basel Committee at
meetings of the committee of the International Accounting Standards Board
(IASB) that works to improve guidance
on accounting for financial instruments.
In addition, a representative of the Federal Reserve participates in the IASB's
Standards Advisory Council.
During 2002 the Federal Reserve also
contributed to several reports, papers,
and comment letters on internal control,
accounting, and disclosure that were
issued by the Basel Committee, including a proposed amendment to the
International Accounting Standard on
financial instruments, the International
Accounting Standard on disclosures for
financial statements of financial institutions, guidance on international loanloss reserving, and a survey of bank
disclosure practices.
Joint Forum
In its work with the Basel Committee,
the Federal Reserve also continued its
participation in the Joint Forum—a
group made up of representatives of the
committee, the International Organization of Securities Commissions, and the
International Association of Insurance
Supervisors. The Joint Forum works to
increase mutual understanding of issues
related to the supervision of firms operating in each of the financial sectors.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act (GLBA)
repealed those provisions of the GlassSteagall Act and the Bank Holding
Company Act that restricted the ability
of bank holding companies to affiliate
with securities firms and insurance
companies. The provisions of GLBA,
together with the Federal Reserve's
implementing regulations, establish conditions that a bank holding company or
a foreign bank must meet to be deemed
a financial holding company and to
engage in expanded activities.
In addition to controlling depository
institutions, a financial holding company may engage in securities underwriting and dealing, serve as an insurance agent and insurance underwriter,
act as a futures commission merchant,
and engage in merchant banking. Permissible activities also include activities
that the Board and the Secretary of the
Treasury jointly determine to be financial in nature or incidental to financial
activities and activities that the Federal
Reserve determines are complementary
to a financial activity and do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally. During 2002,
the Federal Reserve continued its efforts
to ensure that supervisory policies
applied to banking institutions are consistent with the provisions of GLBA.
In its role as holding company supervisor, the Federal Reserve in 2002 continued to host cross-sector meetings with
representatives of the banking agencies,
securities and commodities and futures
authorities, and state insurance commissions. Cross-sector forums provide
an opportunity for multiple supervisors
(both federal and state) to discuss issues
of common interest and to enhance communication and cooperation. Topics discussed in 2002 included corporate gov-
Banking Supervision and Regulation
ernance, the initiatives of the Securities
and Exchange Commission in implementing the Sarbanes-Oxley Act, and
other topics of mutual interest across the
sectors.
Sarbanes-Oxley Act
In October 2002, the Federal Reserve
issued a supervisory letter (SR letter 0220) to give banking organizations
information on the provisions of the
Sarbanes-Oxley Act that set forth standards for audits, financial reporting and
disclosure, and corporate governance at
public companies. The provisions apply
to public companies, including banks
and bank holding companies, that have a
class of securities registered under section 12 of the Securities Exchange Act
of 1934 or are otherwise required to
file periodic reports under section 5(d)
of the 1934 act. The Federal Reserve
staff is working with the other banking
agencies to clarify the applicability of
Sarbanes-Oxley to banking organizations. The staff is also considering the
need for additional standards to reaffirm
the important duties and responsibilities of banking organizations' boards of
directors and executive officers.
Efforts to Enhance Transparency
The Federal Reserve has long supported
sound accounting policies and meaningful public disclosure by banking and
financial organizations to improve market discipline and foster stable financial markets. Effective market discipline
can serve as an important complement to bank supervision and regulation. The more informative the information released by financial institutions,
the better the evaluation of counterparty
risks by market participants can be and
the better their adjustments to the availability and pricing of funds will be.
111
Thus, transparency can promote efficiency in financial markets and sound
practices by banks. The Federal Reserve
also seeks to strengthen audit and control standards for banks; the quality of
management information and financial
reporting is dramatically affected by
internal control systems, including internal and external audit programs.
During 2002, the Federal Reserve
Board commented on a proposed
Financial Accounting Standards Board
(FASB) standard concerning specialpurpose entities. The Board supports
FASB's objective to increase transparency, particularly with respect to
off-balance-sheet risk exposures that
special-purpose entities can pose to
organizations and market participants.
To further advance objectives related
to transparency, the Federal Reserve
works with other regulators, the
accounting profession, and a wide variety of market participants, both domestically and internationally. During 2002,
the Federal Reserve also worked with
the Securities and Exchange Commission to coordinate an enforcement action
against an institution for deficiencies in
public and regulatory reports and internal controls. Additionally, the Federal
Reserve provided guidance to financial
organizations that faced possible interruption in audit services as a result of
problems at a large accounting firm.
Bank Holding Company
Regulatory Financial Reports
The Federal Reserve requires that U.S.
bank holding companies submit periodic regulatory financial reports. These
reports, the FR Y-9 series and the
FR Y - l l and FR 2314 series for nonbank subsidiaries, provide information
essential to the supervision of the organizations and the formulation of regula-
112 89th Annual Report, 2002
tions and supervisory policies. The Federal Reserve also uses the information
in responding to requests from the Congress and the public for information on
bank holding companies and their nonbank subsidiaries.
The FR Y-9 series of reports provides standardized financial statements
for the consolidated bank holding company. The reports are used to detect
emerging financial problems, review
performance and conduct pre-inspection
analysis, monitor and evaluate risk profiles and capital adequacy, evaluate
proposals for bank holding company
mergers and acquisitions, and analyze
the holding company's overall financial condition. The nonbank subsidiary series of reports aids the Federal
Reserve in determining the condition
of bank holding companies that are
engaged in nonbanking activities and in
monitoring the volume, nature, and condition of their nonbanking subsidiaries.
In March 2002, several revisions to
the FR Y-9C report were implemented
to make it consistent with revisions to
the bank Call Report and to conform to
changes in generally accepted accounting principles. Also, the relevance of the
FR Y-9 series of reports was improved
by revising the existing items and adding new items related to new activities and other developments that may
expose institutions to new or different
types of risk. In addition, a new report
(FR Y-9ES) was created to collect
information annually from bank holding
companies that are employee stock ownership plans.
In December 2002, the nonbank reporting framework for non-functionallyregulated nonbank subsidiaries of U.S.
bank holding companies was streamlined.6 The revised framework provides
6. Non-functionally-regulated nonbank subsidiaries are distinguished from functionally regulated
essential information for supervising
and regulating nonbank subsidiaries and
reduces burden. Under the new framework, bank holding companies file a
detailed report (FR Y - l l or FR 2314)
for their more-significant nonbank subsidiaries quarterly or annually, depending on total assets or other reporting
criteria. Bank holding companies must
also file, annually, an abbreviated, fouritem report (FR Y-11S or FR 2314S)
for their smaller nonbank subsidiaries.
The smallest nonbank subsidiaries,
nearly three-fifths of all nonbank subsidiaries, are now exempt from all filing
requirements.
In addition, functionally regulated
nonbank subsidiaries generally are no
longer required to file individual nonbank subsidiary reports with the Federal
Reserve. In keeping with provisions of
the Gramm-Leach-Bliley Act, the Federal Reserve will rely on reports and
information provided to the primary
regulator. The Federal Reserve will continue to collect limited information on
nonbank subsidiaries of bank holding
companies on a consolidated basis in
FR Y-9 reports.
Federal Financial Institutions
Examination Council
During 2002, the Federal Reserve continued its active participation as a member of the Federal Financial Institutions
Examination Council. Among other
activities, the FFIEC revised the bank
Call Reports, issued a revised examination framework for information technology service providers, and revised the
information systems manual.
nonbank subsidiaries, which are entities whose
primary regulator is an organization other than
the Federal Reserve, namely, the Securities and
Exchange Commission, the Commodity Futures
Trading Commission, state insurance commissioners, or state securities departments.
Banking Supervision and Regulation
Bank Call Reports
As the federal supervisor of state member banks, the Federal Reserve, acting in
concert with the other federal banking
agencies through the FFIEC, requires
banks to submit quarterly Reports of
Condition and Income (Call Reports).
Call Reports are the primary source of
data for the supervision and regulation
of banks and for the ongoing assessment
of the overall soundness of the nation's
financial structure. Call Report data,
which also serve as benchmarks for
the financial information required by
many other Federal Reserve regulatory
financial reports, are widely used by
state and local governments, state banking supervisors, the banking industry,
securities analysts, and the academic
community.
For the 2002 reporting period, the
FFIEC implemented several revisions to
the Call Report. The principal revisions
included
• Breaking down several existing balance sheet and income statement
items into greater detail to facilitate
supervision and to implement two
new accounting standards
• Collecting new information on the fair
value of credit derivatives, the volume
of merchant credit card sales, and the
amount of past-due loans and leases
held for sale.
The FFIEC also revised the Report
of Assets and Liabilities of U.S.
Branches and Agencies of Foreign
Banks (FFIEC 002), effective with the
June 2002 report, to maintain consistency with the Call Report.
In November, the Federal Reserve
and the other federal banking agencies
proposed a small number of revisions to
the Call Report for March 2003 report
113
ing. The revisions would add several
items related to bank credit card activities, break down two existing items to
provide more detail to address safety
and soundness considerations, and add
a supplement to the report that would
enable the agencies to collect a limited
amount of data from certain banks in the
event of an immediate and critical need
for specific information. The proposed
revisions also include a few processing
changes to implement a new Call Report
business model the agencies plan to
institute in 2004.
Information Technology
Also in 2002, the FFIEC issued a
revised framework for the interagency
examination program for information
technology service providers. Examinations of these providers of information
technology and processing services to
financial institutions are conducted by
the Federal Reserve or other financial
institution supervisory agencies under
the Bank Service Company Act. The
revised framework is designed to promote a more risk-based rationale for
conducting such examinations by identifying and analyzing material supervisory risks to financial institutions that
use the services of these companies. It
includes risk-focused criteria for determining the examination schedule and
the scope of the exams. The revised
framework was implemented as a twoyear pilot program that began in January
2002.
In addition, in 2002 the FFIEC began
to prepare for the issuance of revisions
to the FFIEC information systems
manual, last updated in 1996. A project
plan for the development of individual
booklets to replace the current manual's chapters was established. Federal
Reserve and other agency examiners
participated in field testing the booklets
114 89th Annual Report, 2002
on technology service providers, information security, and business continuity.
Field testing of booklets on outsourcing, audits, electronic banking, wholesale payment systems, retail payment
systems, and Fedline is scheduled for
early 2003. Booklets on management,
development and programming, and
operations are scheduled for development in 2003.
Supervisory Information
Technology
The Supervisory Information Technology (SIT) function within the Board's
Division of Banking Supervision and
Regulation facilitates the management
of information technology within the
Federal Reserve's supervision function.
Its goals are to ensure that
• IT initiatives support a broad range of
supervisory activities without duplication or overlap
• The underlying IT architecture fully
supports those initiatives
• The supervision function's use of
technology leverages the resources
and expertise available more broadly
within the Federal Reserve System
• Practices that maximize supervision's
business value and cost effectiveness
are identified, analyzed, and approved
for implementation.
SIT works through assigned staff at
the Board of Governors and the Reserve
Banks and through a Systemwide committee structure that ensures that key
staff members throughout the Federal
Reserve System participate in identifying requirements and setting priorities
for IT initiatives.
SIT Project Management
In 2002, the SIT project management
staff made significant progress in identifying opportunities for enhancing business value through the use of information technology. In March, the
supervision function received approval
to implement a Systemwide technology
platform for scheduling examination
resources. The staff provided substantial
resources and leadership in developing
a business case and evaluating technology alternatives for the deployment
of an enterprise document management
system. Staff members also provided
substantial assistance and resources to
support modernization of the Shared
National Credit Program. The modernization is an interagency effort aimed at
reducing examination costs and improving the timeliness and reliability of data
associated with the review of large,
syndicated credit facilities of commercial banks. The staff continued to assess
opportunities to improve the delivery
of information technology services for
supervision in conjunction with efforts
of Board and Reserve Bank internal IT
providers.
National Information Center
The National Information Center (NIC)
is the Federal Reserve's comprehensive
repository for supervisory, financial, and
banking structure data and documents.
NIC includes the National Examination
Data (NED) system, which provides
supervisory personnel and state banking
authorities with access to NIC data, and
the Central Document and Text Repository, which contains documents supporting the supervisory process.
In 2002, the NED system was modified in accordance with a policy change
regarding the supervision program for
small bank holding companies, to com-
Banking Supervision and Regulation
plement the web-enabled NED application, and to add functionality that further
supports the supervision of banking
institutions. Changes to the production
application were also made to accommodate changes in the commercial
bank Call Report and the bank holding
company FR Y-9 reports. A new version of the Central Document and Text
Repository was implemented to handle
a larger volume of documents.
Staff Development
The Federal Reserve System's staff
development program trains staff
members at the Board of Governors,
the Reserve Banks, and state banking
departments who have supervisory and
regulatory responsibilities; students
from foreign supervisory authorities
attend training sessions on a spaceavailable basis. The program's goal is,
in part, to provide greater cross training
in the agencies. Training is offered at
the basic, intermediate, and advanced
levels in the four disciplines of bank
supervision: bank examinations, bank
holding company inspections, surveillance and monitoring, and applications
analysis. Classes are conducted in
Washington, D.C., and at other locations
and are sometimes held jointly with
other regulators.
The System also participates in training offered by the FFIEC and by certain
other regulatory agencies. The System's
involvement includes assisting in the
development of basic and advanced
training in relation to emerging issues as
well as in specialized areas such as trust
activities, international banking, information technology, municipal securities
dealing, capital markets, payment systems risk, white collar crime, and real
estate lending. In addition, the System
co-hosts the World Bank Seminar for
students from developing countries.
115
In 2002 the Federal Reserve trained
2,748 students in System schools, 492 in
schools sponsored by the FFIEC, and
52 in other schools, for a total of 3,292,
including 214 representatives of foreign
central banks (table). The number of
training days in 2002 totaled 16,824.
The System gave scholarship assistance to the states for training their
examiners in Federal Reserve and
FFIEC schools. Through this program,
454 state examiners were trained—
345 in Federal Reserve courses, 92 in
FFIEC courses, and 17 in other courses.
A staff member seeking an examiner's commission is required to take a
first proficiency examination, as well
as a second proficiency examination in
one of three specialty areas: safety and
soundness, consumer affairs, or information technology (table). At the end of
2002, the System had 1,234 field examiners, of which 892 were commissioned
(table).
Regulation of the
U.S. Banking Structure
The Board of Governors administers the
Bank Holding Company Act, the Bank
Merger Act, the Change in Bank Control Act, and the International Banking
Act as they apply to bank holding companies, financial holding companies,
member banks, and foreign banking
organizations. In doing so, the Federal
Reserve acts on a variety of proposals
that directly or indirectly affect the
structure of U.S. banking at the local,
regional, and national levels; the international operations of domestic banking
organizations; and the U.S. banking
operations of foreign banks.
Bank Holding Company Act
Under the Bank Holding Company Act,
a corporation or similar organization
116 89th Annual Report, 2002
Training Programs for Banking Supervision and Regulation, 2002
Number of sessions conducted
Program
Total
Regional
9
7
4
16
10
18
7
5
1
16
10
18
Other schools
Loan analysis
Examination management
Real estate lending seminar
Specialized lending seminar
Senior forum for current banking and regulatory issues
Banking applications
2
1
2
1
3
6
1
0
2
0
Principles of fiduciary supervision
Commercial lending essentials for consumer affairs
Consumer compliance examinations I
Consumer compliance examinations II
CRA examination techniques
Fair lending examination techniques
3
3
2
2
2
3
1
3
0
2
2
2
3
2
13
13
7
1
3
0
10
13
6
1
Schools or seminars conducted by the Federal Reserve
Core schools
Banking and supervision elements
Operations and analysis
Bank management
Report writing
Management skills
Conducting meetings with management
Foreign banking organizations
Information systems continuing education
Capital markets seminars
Technology risk integration
Leadership dynamics
Seminar for senior supervisors of foreign central banks l
Other agencies conducting courses2
Federal Financial Institutions Examination Council
The Options Institute
1. Conducted jointly with the World Bank.
must obtain the Federal Reserve's
approval before forming a bank holding company through the acquisition
of one or more banks in the United
States. Once formed, a bank holding
company must receive Federal Reserve
approval before acquiring or establishing additional banks. The act also
identifies other activities permissible
for bank holding companies; depending on the circumstances, these activities may or may not require Federal
Reserve approval in advance of their
commencement.
When reviewing a bank holding company application or notice that requires
prior approval, the Federal Reserve
34
2
2. Open to Federal Reserve employees.
considers the financial and managerial
resources of the applicant, the future
prospects of both the applicant and the
firm to be acquired, the convenience and
needs of the community to be served,
the potential public benefits, the competitive effects of the proposal, and the
applicant's ability to make available to
the Board information deemed necessary to ensure compliance with applicable law. In the case of a foreign banking
organization seeking to acquire control
of a U.S. bank, the Federal Reserve also
considers whether the foreign bank is
subject to comprehensive supervision or
regulation on a consolidated basis by its
home country supervisor. Data on deci-
Banking Supervision and Regulation 111
Results of Proficiency Examinations, 2002
Result
Second proficiency exam
First
proficiency
exam
Safety and
soundness
Consumer
affairs
Information
technology
Passed .
Failed
133
17
82
15
29
0
3
2
Total ...
150
97
29
5
sions regarding domestic and international applications in 2002 are shown in
the accompanying table.
Bank holding companies generally
may engage in only those activities that
the Board has previously determined to
be closely related to banking under section 4(c)(8) of the act. Since 1996, the
act has provided an expedited priornotice procedure for certain permissible
nonbank activities and for acquisitions
of small banks and nonbank entities.
Since that time the act also has permitted well-run bank holding companies
that satisfy certain criteria to commence
certain other nonbank activities on a de
novo basis without first obtaining Federal Reserve approval.
Since 2000, the Bank Holding Company Act has permitted the creation
of a special type of bank holding company called a financial holding company. Financial holding companies are
allowed to engage in a broader range of
nonbank activities than are traditional
bank holding companies. Among other
things, they may affiliate with securit-
ies firms and insurance companies and
may engage in certain merchant banking activities. Bank holding companies
seeking financial holding company status must file a written declaration with
the Federal Reserve System; most declarations are acted upon by one of the
Reserve Banks under delegated authority. In 2002, 82 domestic financial holding company declarations and 7 foreign
bank declarations were approved.
Financial holding companies do not
have to obtain the Board's prior
approval to engage in or acquire a company engaged in certain new financial
activities that are permissible under the
Gramm-Leach-Bliley Act. Instead, the
financial holding company must notify
the Board within thirty days after commencing the new activity or acquiring
a company engaged in the new activity.
A financial holding company may also
engage in certain other activities that
have been determined to be financial in
nature or incidental to a financial activity or that are determined to be complementary to a financial activity.
Trends in Reserve Bank Supervision Levels, 1998-2002
Type of staff
Field examination staff
Commissioned field staff
2002
2001
2000
1999
1998
1,234
892
1,242
861
1,172
786
1,216
893
1,250
933
118 89th Annual Report, 2002
Decisions by the Federal Reserve on Domestic and International Applications, 2002
Action under authority delegated
by the Board of Governors
Direct action
by the
Board of Governors
Proposal
Approved
Formation of bank
holding
company
....
Merger of bank
holding
company
Acquisition or
retention of
bank
Acquisition of
nonbank
Merger of bank
Change in control
Establishment of a
branch, agency,
or representative
office by a
foreign bank
Other
Total
Denied
Director of the
Office
Division of Banking of the
Supervision and Secretary
Regulation
Permitted Approved
Denied
Federal
Reserve Banks
Total
Approved Approved Permitted
6
0
0
0
0
0
144
58
208
2
0
0
0
0
2
28
12
44
7
1
0
0
0
2
85
41
136
0
7
0
0
0
0
3
0
1
0
0
0
0
0
0
8
1
0
0
78
0
101
0
160
112
86
161
2
58
0
0
0
0
19
54
0
0
0
88
0
464
0
453
21
1,117
82
1
4
73
0
101
799
825
1,885
Bank Merger Act
The Bank Merger Act requires that
all proposals involving the merger of
insured depository institutions be acted
on by the appropriate federal banking
agency. If the institution surviving the
merger is a state member bank, the Federal Reserve has primary jurisdiction.
Before acting on a merger proposal, the
Federal Reserve considers the financial and managerial resources of the
applicant, the future prospects of the
existing and combined institutions, the
convenience and needs of the community to be served, and the competitive
effects of the proposed merger. It also
considers the views of certain other
agencies regarding the competitive factors involved in the transaction. During
2002, the Federal Reserve approved
86 merger applications.
When the FDIC, the OCC, or the
OTS has jurisdiction over a merger, the
Federal Reserve is asked to comment on
the competitive factors. By using standard terminology in assessing competitive factors in merger proposals, the four
agencies have sought to ensure consistency in administering the Bank Merger
Act. The Federal Reserve submitted
515 reports on competitive factors to the
other agencies in 2002.
Change in Bank Control Act
The Change in Bank Control Act
requires persons seeking control of a
U.S. bank or bank holding company to
obtain approval from the appropriate
federal banking agency before completing the transaction. The Federal Reserve
is responsible for reviewing changes in
the control of state member banks and
Banking Supervision and Regulation
bank holding companies. In its review,
the Federal Reserve considers the financial position, competence, experience,
and integrity of the acquiring person;
the effect of the proposed change on the
financial condition of the bank or bank
holding company being acquired; the
effect of the proposed change on competition in any relevant market; the completeness of information submitted by
the acquiring person; and whether the
proposed change would have an adverse
effect on the federal deposit insurance
funds. As part of the process, the Federal Reserve may contact other regulatory or law enforcement agencies for
information about acquiring persons.
The appropriate federal banking agencies are required to publish notice of
each proposed change in control and to
invite public comment, particularly from
persons located in the markets served by
the institution to be acquired.
In 2002, the Federal Reserve
approved 161 changes in control of
state member banks and bank holding
companies.
119
operations; the managerial resources
of the foreign bank; whether the home
country supervisor shares information
regarding the operations of the foreign
bank with other supervisory authorities;
whether the foreign bank has provided
adequate assurances that information
concerning its operations and activities
will be made available to the Board, if
deemed necessary to determine and
enforce compliance with applicable law;
whether the foreign bank has adopted
and implemented procedures to combat
money laundering and whether the home
country of the foreign bank is developing a legal regime to address money
laundering or is participating in multilateral efforts to combat money laundering; and the record of the foreign bank
with respect to compliance with U.S.
law.
In 2002, the Federal Reserve
approved 21 applications by foreign
banks to establish branches, agencies,
and representative offices in the United
States.
International Banking Act
Overseas Investments by
U.S. Banking Organizations
The International Banking Act, as
amended by the Foreign Bank Supervision Enhancement Act of 1991, requires
foreign banks to obtain Federal Reserve
approval before establishing branches,
agencies, commercial lending company
subsidiaries, or representative offices in
the United States.
In reviewing proposals, the Federal
Reserve generally considers whether
the foreign bank is subject to comprehensive supervision or regulation on a
consolidated basis by its home country
supervisor. It also considers whether the
home country supervisor has consented
to the establishment of the U.S. office;
the financial condition and resources of
the foreign bank and its existing U.S.
U.S. banking organizations may engage
in a broad range of activities overseas.
Many of the activities are conducted
indirectly through Edge Act and agreement corporation subsidiaries. Although
most foreign investments are made
under general consent procedures that
involve only after-the-fact notification
to the Board, large and other significant
investments require the prior approval
of the Board. Excluding proposals relating to large domestic mergers, the Board
in 2002 approved 23 proposals for
significant overseas investments by
U.S. banking organizations. The Federal
Reserve also approved 1 application to
acquire an Edge Act corporation, 1
application to extend the corporate exist-
120 89th Annual Report, 2002
ence of an existing Edge Act corporation, and 1 application to establish or
acquire a new agreement corporation.
the Federal Reserve reviewed 10 stock
repurchase proposals by bank holding
companies; all were approved by a
Reserve Bank under delegated authority.
Applications by Member Banks
State member banks must obtain Federal
Reserve approval to establish domestic
branches, and all member banks (including national banks) must obtain Federal
Reserve approval to establish foreign
branches. When reviewing proposals to
establish domestic branches, the Federal
Reserve considers the scope and nature
of the banking activities to be conducted. When reviewing proposals for
foreign branches, the Federal Reserve
considers, among other things, the condition of the bank and the bank's experience in international banking. In 2002,
the Federal Reserve acted on new and
merger-related branch proposals for
836 domestic branches and granted prior
approval for the establishment of 5 new
foreign branches.
State member banks must also obtain
Federal Reserve approval to establish
financial subsidiaries. These subsidiaries
may engage in activities that are financial in nature or incidental to financial activities, including securities- and
insurance agency-related activities. In
2002, 3 applications for financial subsidiaries were approved.
Stock Repurchases by
Bank Holding Companies
A bank holding company may repurchase its own shares from its shareholders. When the company borrows
money to buy the shares, the transaction increases the company's debt
and decreases its equity. The Federal
Reserve may object to stock repurchases
by holding companies that fail to meet
certain standards, including the Board's
capital adequacy guidelines. In 2002,
Public Notice of
Federal Reserve Decisions
Most decisions by the Federal Reserve
that involve a bank holding company,
a bank merger, a change in control, or
the establishment of a new U.S. banking
presence by a foreign bank are effected
by an order or an announcement. Orders
state the decision, the essential facts
of the application or notice, and the
basis for the decision; announcements
state only the decision. All orders and
announcements are made public immediately; they are subsequently reported
in the Board's weekly H.2 statistical
release and in the monthly Federal
Reserve Bulletin. The H.2 release also
contains announcements of applications
and notices received by the Federal
Reserve but not yet acted on. For each
pending application and notice, the
related H.2A contains the deadline
for comments. In 2002, the Board's
web site (www.federalreserve.gov) continued to provide information on orders
and announcements.
Timely Processing of
Applications
The Federal Reserve sets internal target
time frames for the processing of applications. The setting of targets promotes
efficiency at the Board and the Reserve
Banks and reduces the burden on applicants. Generally, the length of the target
period ranges from 12 days to 60 days,
depending on the type of application or
notice filed. In 2002, 93 percent of decisions were made within the target time
period.
Banking Supervision and Regulation
Enforcement of
Other Laws and Regulations
The Federal Reserve's enforcement
responsibilities also extend to financial
disclosures by state member banks;
securities credit; and efforts, under the
Bank Secrecy Act, to counter money
laundering.
Financial Disclosures by
State Member Banks
State member banks that issue securities
registered under the Securities Exchange
Act of 1934 must disclose certain information of interest to investors, including
annual and quarterly financial reports
and proxy statements. By statute, the
Board's financial disclosure rules must
be substantially similar to those of the
Securities and Exchange Commission.
At the end of 2002, 17 state member
banks were registered with the Board
under the Securities Exchange Act.
121
Several regulatory agencies enforce
the Board's securities credit regulations.
The SEC, the National Association of
Securities Dealers, and the national
securities exchanges examine brokers
and dealers for compliance with Regulation T. With respect to compliance
with Regulation U, the federal banking
agencies examine banks under their
respective jurisdictions; the Farm Credit
Administration, the National Credit
Union Administration, and the Office
of Thrift Supervision examine lenders
under their respective jurisdictions; and
the Federal Reserve examines other
Regulation U lenders.
Since 1990 the Board has published
a nonexclusive list of foreign stocks
that are eligible for margin treatment
at broker-dealers on the same basis as
domestic margin securities. In 2002 the
foreign list was revised in March and
September.
Anti-Money Laundering
Securities Credit
Under the Securities Exchange Act, the
Board is responsible for regulating
credit in certain transactions involving
the purchase or carrying of securities.
The Board's Regulation T limits the
amount of credit that may be provided
by securities brokers and dealers when
the credit is used to trade debt and
equity securities. The Board's Regulation U limits the amount of credit that
may be provided by lenders other than
brokers and dealers when the credit is
used to purchase or carry publicly held
equity securities if the loan is secured
by those or other publicly held equity
securities. The Board's Regulation X
applies these credit limitations, or margin requirements, to certain borrowers
and to certain credit extensions, such as
credit obtained from foreign lenders by
U.S. citizens.
The Department of the Treasury's regulation (31 CFR 103) implementing
the Currency and Foreign Transactions
Reporting Act (commonly referred to as
the Bank Secrecy Act, or BSA) requires
banks and other types of financial institutions to file certain reports and maintain certain records. These documents
record information on persons involved
in large currency transactions and on
suspicious activity related to possible
violations of federal law, including
money laundering, terrorism, and other
financial crimes. The act is a primary
tool in the fight against money laundering; its requirements inhibit money
laundering by creating a paper trail of
financial transactions that helps law
enforcement and regulators identify and
trace the proceeds of illegal activity.
In addition to the specific requirements of the Bank Secrecy Act, the
122 89th Annual Report, 2002
Board's Regulation H (12 CFR 208.63)
requires each banking organization
supervised by the Federal Reserve to
develop a written program for BSA
compliance that is formally approved
by the institution's board of directors.
The compliance program must (1) establish a system of internal controls to
ensure compliance with the act, (2) provide for independent compliance testing, (3) identify individuals responsible
for coordinating and monitoring day-today compliance, and (4) provide training for personnel as appropriate. To
monitor compliance, each Reserve Bank
designates senior, experienced examiners as BSA and anti-money-laundering
contacts. During examinations of state
member banks and U.S. branches and
agencies of foreign banks, examiners review the institution's compliance
with the BSA and determine whether
adequate procedures and controls to
guard against money laundering are in
place.
The Board has a Special Investigations Section in the Division of Banking
Supervision and Regulation that conducts financial investigations, provides
expertise to the U.S. law enforcement community for investigation and
training initiatives, and offers training
to various foreign central banks and
government agencies; section staff also
speak at banking conferences to promote best practices in the industry with
respect to anti-money-laundering initiatives. Internationally, section staff have
provided anti-money-laundering training and technical assistance to countries
in Asia, eastern Europe, South and
Central America, and the Caribbean.
Staff members have also participated
extensively in numerous multilateral
anti-money-laundering initiatives such
as the Financial Action Task Force
and the Basel Committee on Banking
Supervision.
In 2002, the Federal Reserve continued to provide expertise and guidance
to the BSA Advisory Group, a committee established by the Congress at the
Department of the Treasury that seeks to
reduce unnecessary burdens created by
the BSA and to increase the utility of
data gathered under the act to aid regulators and law enforcement. The Federal Reserve also assisted the Treasury
Department in providing feedback to
financial institutions on the reporting of
suspicious activity.
Since the terrorist attacks of September 11, 2001, and continuing through
2002, the Federal Reserve has played an
important role in many joint activities
with bank supervisory and law enforcement authorities and the banking community, both domestically and abroad,
to combat money laundering and terrorist financing. The Federal Reserve Bank
of New York created a dedicated e-mail
system for financial institutions to
report matches on the law enforcement
list of "suspected terrorists" and, at the
request of law enforcement and pursuant to subpoenas, searched the records
of Fedwire for information related to the
terrorist acts. In addition, multi-agency
teams led by various U.S. government
agencies were deployed to foreign countries to analyze bank and other financial
records. On several of these occasions,
senior Reserve Bank examiners traveled
and worked with the teams. In the wake
of the terrorist attacks, the FBI formed
a multi-agency law enforcement task
force to trace the transactions and assets
of terrorists; staff of the Special Investigations Section participate in the task
force.
To address the mandates of the USA
PATRIOT Act, the Federal Reserve
issued a number of supervisory letters to
all domestic and foreign banking organizations under its supervision on such
topics as private and correspondent
Banking Supervision and Regulation
123
Extensions of Credit by State Member Banks to their Executive Officers, 2001 and 2002
Number
Amount (dollars)
Range of interest
rates charged
(percent)
2001
October 1-December 31
727
64,965,000
1.0-20.0
2002
January 1-March 31
April 1-June 30
July 1-September 30
October 1-December 31
620
632
740
644
65,557,000
69,260,000
78,073,000
72,668,000
2.0-19.8
3.0-19.8
2.0-19.8
2.0-19.8
Period
SOURCE. Call Reports.
banking as well as new informationsharing protocols. The letters described
the act's requirements in these areas and
the new rules that have been or will be
issued.
At the request of Treasury Department staff, and consistent with statutory
requirements for consultation, the Federal Reserve continues to actively assist
in the development of many other new
rules related to the PATRIOT Act. The
Federal Reserve's Patriot Act Working
Group, which is composed of senior,
experienced Bank Secrecy Act/antimoney-laundering examiners from
throughout the System, met several
times during 2002. The group worked
on interim examination procedures relative to the act's provisions and are continuing to develop a new training curriculum for examiners.
Extensions of Credit to
Executive Officers
Under section 22(g) of the Federal
Reserve Act, a state member bank must
include in its quarterly Call Report
information on all extensions of credit
by the bank to its executive officers
since the date of the preceding report.
The accompanying table summarizes
this information for 2002.
Federal Reserve Membership
At the end of 2002, 2,977 banks were
members of the Federal Reserve System
and were operating 50,095 branches.
These banks accounted for 38 percent
of all commercial banks in the United
States and for 74 percent of all commercial banking offices.
•
125
Federal Reserve Banks
The Federal Reserve Banks and their
Branches carry out a number of System
operations, including operating a nationwide payments system, distributing the
nation's currency and coin, and serving
as fiscal agent and depository to the
United States.
Major Initiatives
During 2002, the Federal Reserve System took a number of significant steps
to enhance further its resilience in
case of emergency. It worked to ensure
market liquidity, continuity of Federal
Reserve operations, and effective Federal Reserve communications. In addition, it supported two efforts to increase
the resilience of the private sector's
financial system infrastructure.
While the Reserve Banks have historically worked to ensure the continuity
of their operations, they undertook several projects in 2002 to reassess the
adequacy of their business-continuity
plans and to make them more robust.
The Banks strengthened their ability to
provide liquidity by enhancing backup
for open market operations and the discount window. As a result, the Federal
Reserve is better positioned to provide
necessary market liquidity, helping to
ensure that payment systems and financial markets can continue to function
smoothly during a financial crisis.
In addition, the Reserve Banks evaluated their Fedwire contingency plans,
their business-continuity planning process, staff concentration and leadership
succession, telecommunications and network contingency, and the physical
security of their facilities and personnel.
Moreover, the Reserve Banks are better
positioned to meet public demand for
cash in the event of an emergency.
During the year, the Reserve Banks
and the Board also reviewed and
enhanced their mechanisms for crisis
communications between the Board,
Federal Reserve offices, other government agencies, financial industry participants, System employees, the media,
and the general public.
The events of September 11, 2001,
illustrated the interdependence among
participants in the financial system and
the way that business concentration,
both market-based and geographic, can
intensify disruptions. The New York
Reserve Bank contributed to two white
papers on these matters that the Board,
together with other regulatory agencies,
published for comment during the year.
One paper discussed sound practices to
increase the resilience of critical U.S.
financial markets in the face of a
regional disaster. The other paper considered potential structural changes in
the way settlement services for government securities are provided and presented a framework for discussing issues
that need to be further explored. In
response to public comments on the latter paper, the Board in November created a private-sector working group to
explore ways the clearing banks for government securities could substitute for
each other should the services of either
be interrupted or terminated. The working group was asked to submit a report
to the Board before the end of 2003.
The Reserve Banks also worked to
improve the efficiency of their operations through a strategy of standardization and consolidation of a variety
of information systems, operations, and
126 89th Annual Report, 2002
programs. For example, the Reserve
Banks are standardizing and consolidating a number of financial management
applications for budgeting, cost accounting, and accounts payable. In addition,
efforts are under way to move separate
human resources information and payroll systems in each of the twelve Districts into common systems located in
a single District. The Reserve Banks
have also initiated efforts to consolidate their electronic access customersupport function as well as human
resources operations into fewer sites.
Finally, the Reserve Banks are implementing a standard health insurance
program and have adopted a standard
prescription drug plan. The expected
benefits of these consolidations and
standardized programs include lower
administrative and operating costs and
improved functionality.
Developments in
Federal Reserve Priced Services
The Monetary Control Act of 1980
requires that the Federal Reserve set
fees for providing "priced services" to
depository institutions that, over the
long run, recover all the direct and indirect costs of providing the services
as well as the imputed costs, such as
the income taxes that would have been
paid and the return on equity that would
have been earned had the services been
provided by a private firm. The imputed
costs and imputed profit are collectively
referred to as the private-sector adjustment factor (PSAF).1 Over the past ten
1. In addition to income taxes and the return on
equity, the PSAF is made up of three imputed
costs: interest on debt, sales taxes, and assessments for deposit insurance by the Federal Deposit
Insurance Corporation. Also allocated to priced
services are assets and personnel costs of the
Board of Governors that are related to priced
years, the Federal Reserve Banks have
recovered 98.8 percent of their priced
services costs, including the PSAF
(table).
Overall, fees charged in 2002 for
priced services increased approximately
1.3 percent from 2001. 2 Revenue from
priced services amounted to $916.3 million, other income related to priced services was $2.1 million, and costs related
to priced services totaled $891.7 million, resulting in net income of
$26.6 million and a recovery rate of
93.3 percent of costs, including the
PSAF.3
Commercial Check
Collection Service
In 2002, operating expenses and
imputed costs for the Reserve Banks'
check collection service totaled
$751.2 million, while revenue amounted
to $759.2 million and other income was
$1.7 million, resulting in net income of
$9.7 million. In 2001, by comparison,
operating expenses and imputed costs
totaled $754.4 million, while revenue
amounted to $764.7 million and other
income was $28.5 million, resulting
in net income of $38.9 million. The
decline in check service revenue in 2002
services; in the pro forma statements at the end of
this chapter, Board expenses are included in operating expenses and Board assets are part of longterm assets.
2. Based on a chained Fisher Ideal price index
not adjusted for quality changes.
3. Financial data reported throughout this
chapter—revenue, other income, cost, net revenue, and income before taxes—can be linked to
the pro forma statements at the end of this chapter.
Other income is revenue from investment of clearing balances net of earnings credits, an amount
termed net income on clearing balances. Total cost
is the sum of operating expenses, imputed costs
(interest on debt, interest on float, sales taxes, and
the Federal Deposit Insurance Corporation assessment), imputed income taxes, and the targeted
return on equity.
Federal Reserve Banks 127
Priced Services Cost Recovery, 1993-2002
Millions of dollars except as noted
Revenue from
services'
Year
1993
1994
1995 .
1996
1997
. . .
1998
1999
2000
2001
2002
1993-2002
Operating
expenses and
imputed costs2
Targeted return
on equity
Total
costs
Cost recovery
(percent)3
774.5
767.2
765.2
815.9
818.8
820.4
760.2
752.7
746.4
752.8
17.5
21.0
31.5
42.9
54.3
837.9
781.2
784.2
789.3
807.1
92.4
98.2
97.6
103.4
101.5
839.8
867.6
922.8
960.4
918.3
743.2
775.7
818.2
901.9
891.7
66.8
57.2
98.4
109.2
92.5
809.9
832.9
916.6
1,011.1
984.3
103.7
104.2
100.7
95.0
93.3
591.4
8,554.4
98.8
8,450.5
7,963.0
NOTE. In this and other tables in this chapter, components may not sum to totals or yield percentages shown
because of rounding. Amount in bold is a restatement due
to errors in previously reported data.
1. For the ten-year period, includes revenue from services of $8,183.0 million and other income and expense
(net) of $267.5 million.
2. For the ten-year period, includes operating expenses
of $7,114.7 million, imputed costs of $489.7 million, and
imputed income taxes of $265.1 million. Also includes
the effect of one-time accounting changes net of taxes of
$74.1 million for 1993 and $19.4 million for 1995.
3. Revenue from services divided by total costs.
was largely the result of declining volume and customers' moving to lowermargin products. The Reserve Banks
handled 16.6 billion checks in 2002,
a decrease of 1.9 percent from 2001
(table). The decline in Reserve Bank
check volume appears to be consistent
with nationwide trends away from the
use of checks and toward greater use of
electronic payment methods.4 Although
the Reserve Banks took steps to reduce
check operating costs in 2002, the
reductions were largely offset by
lower-than-expected returns on pension
credits.
To address the apparent continuing
decline in check volumes, the Reserve
Banks are developing a business and
operational strategy that will position
the service to achieve its financial and
payment system objectives over the long
term. In 2002, the Banks contracted
with a consultant to analyze their checkprocessing infrastructure. The analysis
defined criteria for balancing efficient
provision of service in a decliningvolume environment with the need to
provide an adequate level of service
nationwide. The Banks have used these
criteria to develop potential options as
to the number, location, and operational
capabilities of its check-processing
sites. Subsequently, the Reserve Banks
announced that they are reducing their
check service operating costs through a
combination of measures: streamlining
their check-management structures,
reducing staff, decreasing the number of
check-processing locations, and increas-
4. The Federal Reserve System's recent retail
payments research suggests that the number of
checks written in the United States has been
declining since the mid-1990s. See Geoffrey R.
Gerdes and Jack K. Walton II, "The Use of
Checks and Other Noncash Payment Instruments in the United States," Federal Reserve
Bulletin, vol. 88 (August 2002), pp. 360-74. (The
article is available on the Board's web site at
www.federalreserve.gov/pubs/bulletin/default.htm.)
During the late 1990s, the volume of checks processed by the Reserve Banks rose, albeit slowly,
suggesting that the proportion of interbank checks
cleared through the Reserve Banks increased.
128 89th Annual Report, 2002
Activity in Federal Reserve Priced Services, 2002, 2001, and 2000
Thousands of items
Percent change
Service
Commercial check
Funds transfer
Securities transfer
Commercial ACH
Noncash
Cash transportation
2002
16,586,804
117,133
8,480
4,986,152
333
9
2001
16,905,016
115,308
6,708
4,448,361
412
18
2000
16,993,800
111,175
5,666
3,812,191
519
19
2001 to 2002
2000 to 2001
-1.9
1.6
26.4
12.1
-19.2
-52.5
-.5
3.7
18.4
16.7
-20.7
-7.0
NOTE. Activity in commercial checks is the total number of commercial checks collected, including processed
and fine-sort items; in funds transfers and securities transfers, the number of transactions originated on line and off
line; in commercial ACH, the total number of commercial
items processed; in noncash services, the number of items
on which fees were assessed; and in cash transportation,
the number of registered mail shipments and FRBarranged armored carrier stops.
Amount in bold is restatement of previously reported
data.
ing processing capacity in other locations. The Reserve Banks will continue
to provide check services nationwide.
The volume of checks for which the
Federal Reserve office that serves the
depositing bank is not the office that
serves the paying bank increased
4.4 percent, from 3.6 billion in 2001 to
3.7 billion in 2002. Of all the checks
presented by the Reserve Banks to paying banks, 22.0 percent (approximately
3.6 billion checks) were presented electronically, compared with 21.7 percent
in 2001. The Reserve Banks captured
images of 8.1 percent of the checks they
collected, the same percentage as in
2001.
The Reserve Banks continued in 2002
a check modernization project begun
in 2000 to install uniform software and
hardware for check processing, check
imaging, and check adjustments in all
Reserve Bank offices and to give
depository institutions web-based access
to check services. The Reserve Banks
expect to recover the cost of the project
over the long run because the modernization effort will increase operating efficiency and make it possible to
offer additional services to depository
institutions.
Commercial Automated
Clearinghouse Services
Reserve Bank operating expenses and
imputed costs for commercial automated
clearinghouse (ACH) services totaled
$62.5 million in 2002. Revenue from
ACH operations and other income
totaled $71.8 million, resulting in net
income of $9.3 million. The Reserve
Banks processed 5.0 billion commercial
ACH transactions (worth $13.1 trillion),
an increase of 12.1 percent from 2001.
Consolidation of customer support
activities to two Reserve Bank offices
was completed during 2002. These two
Banks now share responsibility for
supporting all ACH operations, including ensuring the timely and accurate
processing of payments, maintaining the
integrity of the ACH application, monitoring file processing, and responding to
customers' questions. Before consolidation, these responsibilities were handled
by each of the twelve Reserve Banks.
Fedwire Funds and
National Settlement Services
Reserve Bank operating expenses and
imputed costs for the Fedwire Funds
Federal Reserve Banks 129
and National Settlement Services
totaled $53.5 million in 2002. Revenue
from these operations totaled $58.6 million, and other income amounted to
$0.1 million, resulting in net income of
$5.2 million.
Fees Paid by Depository Institutions for
Selected Federal Reserve Priced Services,
2001 and 2002
Dollars
2001
2002
.33
.24
.16
15.00
.31
.22
.15
15.00
.95
12.00
60-100
.80
14.00
60-100
Account maintenance
Per issue
Per account
.45
15.00
.41
15.00
Transfers, each2
Off-line surcharge
.70
25.00
.66
25.00
40.00
40.00
4.75
2.50
4.75
2.50
Cash letters
(flat fee, by number of
envelopes of coupons)3
1-5
6-50
7.50
15.00
7.50
15.00
Return items, each
20.00
20.00
Item
FEDWIRE FUNDS TRANSFERS,
BY VOLUME TIER 1
Fedwire Funds Service
The Reserve Banks' Fedwire Funds
Service allows depository institutions
to draw on their reserve or clearing balances at the Reserve Banks and transfer
funds to other institutions that maintain
accounts at the Reserve Banks. In 2002,
the number of Fedwire funds transfers
originated by depository institutions
increased 1.6 percent from 2001, to
approximately 117.1 million. The
Reserve Banks reduced the transfer fees
for each of the volume-based tiers
(table). The off-line funds transfer surcharge remained unchanged.5
The final phase of consolidation of
the operations of the Fedwire Funds
Service was completed in May. Also
during 2002, the Reserve Banks
improved the resilience of the service
by increasing the readiness of a third
data processing center. In the event of
an outage at the primary or secondary site or at both sites, resources at
the third site are available to support
same-day recovery of Fedwire applications. This enhancement adds to the
already robust contingency capabilities
provided by the primary and secondary
sites. The three sites are distant from
each other.
In December, the Board requested
comment on a proposal to expand the
operating hours for the on-line Fedwire
Funds Service. Under the proposal, the
5. Depository institutions that do not have an
electronic connection to the Fedwire funds transfer system can originate transfers via "off-line"
telephone instructions.
Tier (number of
transfers per month)2
1 (1 to 2,500)
2 (2,501 to 80,000)
3 (80,001 and more)
Off-line surcharge
NATIONAL SETTLEMENT
SERVICES
Entries, each
Files, each
Minimum per month
FEDWIRE SECURITIES
TRANSFERS
NONCASH COLLECTION
Bonds, each
Deposit envelopes
(per envelope of coupons)3
1-5
6-50
1. Rates apply only to their specified volume tiers.
2. Originated and received.
3. Deposits and cash letters may contain no more than
50 envelopes of coupons.
service would open at 9:00 p.m. eastern
time (ET), three and one-half hours
earlier than the current opening time
of 12:30 a.m. ET. The earlier opening
time is intended to facilitate the functioning and continued development of
the payments system and to increase
efficiency and reduce risk in making
payments and settlements. The proposal
does not affect the Fedwire Securities
Service.
130 89th Annual Report, 2002
National Settlement Service
Private clearing arrangements that
exchange and settle transactions may
use the Reserve Banks' National Settlement Service to settle their transactions.
The Reserve Banks provide settlement
services to approximately seventy local
and national private arrangements, primarily check clearinghouse associations
but also other types of arrangements.
In 2002, the Reserve Banks processed
more than 415,000 settlement entries
for these arrangements.
Fedwire Securities Service
The Fedwire Securities Service allows
participants to electronically transfer
securities issued by the U.S. Treasury,
federal government agencies, and other
entities to other participants in the
United States.6 Reserve Bank operating
expenses and imputed costs for providing this service totaled $21.5 million in
2002. Revenue and other income totaled
$23.8 million, resulting in net income of
$2.3 million. Approximately 8.5 million
transfers were processed by the service
during the year, an increase of 26.4 percent from 2001. The basic per-transfer
fee for transfers originated and received
by participants and the monthly account
maintenance fees were lowered, while
the off-line securities transaction surcharge remained unchanged.
Conversion of Government National
Mortgage Association (Ginnie Mae)
6. The expenses, revenues, and volumes
reported here are for transfers of securities issued
by federal government agencies, governmentsponsored enterprises, and international institutions. When the Reserve Banks provide transfer,
account maintenance, and settlement services for
U.S. Treasury securities, they are acting as fiscal
agents of the United States. The Treasury Department assesses fees on depository institutions for
some of these services. For details, see the section
"Fiscal Agency Services" later in this chapter.
securities to the Fedwire system was
completed in March; the securities are
now transferred and settled on the Fedwire Securities Service. The final phase
of consolidation of the operations of the
Fedwire Securities Service, an effort to
reduce costs, was completed in May.
Operational support for processing joint
custody collateral was also consolidated
in May.
Also during 2002, the Reserve Banks
increased the readiness of a third data
processing center for the Fedwire Securities Service to serve as a backup in
the event of an outage at the primary
or secondary site or both. Processing
resources at the third site are available
to support same-day recovery of the
Fedwire applications. This enhancement to the third site adds to the
already robust contingency capabilities
provided by the primary and secondary
sites. The three sites are distant from
each other.
Noncash Collection Service
The Reserve Banks provide a service
to collect and process municipal bearer
bonds and coupons issued by state and
local governments (referred to as "noncash" items). The service, which is centralized at one Federal Reserve office,
processed 333,000 noncash transactions in 2002. Operating expenses and
imputed costs for noncash operations
totaled $1.5 million in 2002, and revenue totaled $1.7 million, resulting in net
income of $0.2 million.
Special Cash Services
The Reserve Banks charge fees for
providing special cash-related services,
such as packaging currency in a
nonstandard way. These services—
collectively referred to as "special cash
services"—account for a very small
Federal Reserve Banks
proportion (less than 1 percent) of the
total cost of cash services provided to
depository institutions by the Reserve
Banks. Operating expenses and imputed
costs for special cash services totaled
$1.4 million in 2002. Revenue and other
income also totaled $1.4 million, resulting in no net income.
Float
Federal Reserve float decreased in 2002
to a daily average of -$318.6 million,
from a daily average of $604.6 million
in 2001.7 The Federal Reserve includes
the cost of or income from float associated with priced services as part of the
fees for those services.
Developments in
Currency and Coin
The Reserve Banks received 34.7 billion notes from circulation in 2002, a
3.1 percent increase from 2001, and
made payments of 35.4 billion notes
to circulation in 2002, a 2.9 percent
increase from 2001. The Banks received
43.4 billion coins from circulation in
2002, a 9.3 percent increase from 2001,
and made payments of 58.6 billion coins
to circulation in 2002, a 3.0 percent
increase from 2001.
The Reserve Banks enhanced their
national business-continuity framework
for the cash services function during the
year. This effort included the refinement
of operating procedures, expansion of
the crisis partner network for the Banks,
and continuation of cash contingency
testing.
Also during the year, the Federal
Reserve worked closely with the Bureau
of Engraving and Printing as prepara7. Float results from differences in the timing
of exchanges of debits and credits (settlements)
between entities in financial transactions.
131
tions continued for the introduction of a
new currency design, which includes
new and enhanced security features.
Developments in
Fiscal Agency and
Government Depository Services
The total cost of providing fiscal agency
and depository services to the Treasury
and other government agencies in 2002
amounted to $308.5 million, compared
with $285.4 million in 2001 (table). The
majority of these costs were incurred on
behalf of the Treasury. Treasury-related
costs were $269.4 million in 2002, compared with $246.5 million in 2001, an
increase of 9.3 percent. The cost of providing services to other government
agencies was $39.1 million, compared
with $38.9 million in 2001. In 2002,
as in 2001, the Treasury and other
government agencies reimbursed the
Reserve Banks for costs to provide these
services.
Fiscal Agency Services
As fiscal agents, the Reserve Banks provide to the Treasury services related to
the federal debt. For example, they
issue, transfer, reissue, exchange, and
redeem marketable Treasury securities
and savings bonds; they also process
secondary market transfers initiated by
depository institutions. Additionally, the
Reserve Banks support Treasury and
other government agencies in their
efforts to modernize government payment and accounting systems.
Marketable Treasury Securities
Reserve Bank operating expenses for
activities related to marketable Treasury
securities (Fedwire Securities Service,
TreasuryDirect, marketable issues, and
132 89th Annual Report, 2002
Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services,
2002, 2001, and 2000
Thousands of dollars
Agency and service
2002
2001
2000
DEPARTMENT OF THE TREASURY
Bureau of the Public Debt
Savings bonds
TreasuryDirect and Treasury coupons
Commercial book entry
Marketable Treasury issues
Computer applications and infrastructure development
and support
Other services
Total
68,888.3
33,953.6
8,830.1
14,597.6
69,569.8
36,610.1
9,998.1
11,366.8
70,786.7
42,372.4
13,924.6
14,224.3
2,349.6
2,385.8
131,005.0
222.4
1,255.7
129,022.9
96.8
141,404.7
Financial Management Service
Treasury tax and loan and Treasury general account
Government check processing
Automated clearinghouse
Government agency deposits
Fedwire funds transfers
Computer applications and infrastructure development
and support
Other services
Total
30,111.0
30,284.4
6,280.0
2,082.2
201.4
31,106.0
30,310.2
9,665.2
2,272.9
199.2
38,649.0
31,866.9
10,799.1
2,218.8
182.9
46,782.6
8,173.1
123,914.7
27,281.3
3,490.2
104,324.9
21,209.6
5,805.8
110,732.2
Other Treasury
Total
Total, Treasury
14,471.2
269,390.9
13,149.8
246,497.5
10,362.8
262,499.7
10,240.8
13,197.2
16,463.7
OTHER FEDERAL AGENCIES
Department of Agriculture
Food coupons
U.S. Postal Service
Postal money orders
Miscellaneous agencies
Other services
Total, other agencies
12,381.6
11,255.0
9,213.5
16,494.1
39,116.5
14,434.0
38,886.2
13,747.1
39,424.3
Total reimbursable expenses
308,507.4
285,383.7
301,924.0
NOTE. Amounts in bold are restatements due to reclassification of previously reported data.
. . . Not applicable
Treasury coupons) totaled $57.4 million, a 1.0 percent decrease from 2001.
The Reserve Banks processed 167,000
tenders for Treasury securities (excluding tenders processed by the Treasury,
which were previously included in this
figure), compared with 181,000 in 2001,
and handled 2.5 million reinvestment
requests, compared with 2.8 million in
2001.
The Reserve Banks operate two bookentry securities systems for Treasury
securities: the Fedwire Securities Service, which provides custody and transfer services, and TreasuryDirect, which
provides custody services only.8 Almost
98 percent of the total par value of Treasury securities outstanding at year-end
2002 was held by the Fedwire Securities
Service. The Reserve Banks in 2002
originated 8.3 million transfers of Treasury securities, a 6.2 percent increase
from 2001.
TreasuryDirect customers may sell
their securities for a fee through SellDirect, a program operated by one of the
Reserve Banks. The Bank sold nearly
8. TreasuryDirect was designed for individuals
who plan to hold their securities until maturity.
Federal Reserve Banks
14,000 securities worth $589.8 million
in 2002, compared with nearly 15,000
securities worth $699.9 million in 2001.
It collected more than $464,000 in fees
on behalf of the Treasury, a decrease of
9.1 percent from the almost $510,000 in
fees collected in 2001.
Savings Bonds
Reserve Bank operating expenses for
savings
bond
activities
totaled
$68.9 million in 2002, a decrease of
1.0 percent from 2001. The Banks
printed and mailed 37.2 million savings
bonds on behalf of the Treasury's Bureau of the Public Debt, a 1.5 percent
decrease from 2001. They issued nearly
4.7 million new Series I (inflationindexed) savings bonds and 27.9 million
new Series EE savings bonds. In addition, the Banks processed approximately
618,000 redemption, reissue, and
exchange transactions, a 9.7 percent
increase from 2001. Reserve Bank staff
responded to 1.6 million service calls
from owners of savings bonds, approximately the same number as in 2001.
Depository Services
The Reserve Banks maintain the Treasury's funds account, accept deposits of
federal taxes and fees, pay checks drawn
on the Treasury's account, and make
electronic payments on behalf of the
Treasury.
133
interest rate being determined by auction. This pilot program added approximately $3.0 million to the Treasury's
investment income.
Payments Processed for the Treasury
Reserve Bank operating expenses
related to government payments
amounted to $38.8 million in 2002. The
Banks processed 883.2 million ACH
transactions for the Treasury, a decrease
of 1.9 percent from 2001, and nearly
140,000 Fedwire funds transfers, a
decrease of 10.2 percent from 2001.
They also processed 289.3 million paper
government checks, a decrease of
16.3 percent from 2001. In addition, the
Banks issued 368,000 fiscal agency
checks, a decrease of 15.5 percent from
2001.
During the year, the Reserve Banks
assisted Treasury's efforts to facilitate
electronic payments to the federal government. The Banks operate Pay.gov, a
Treasury program that allows members
of the public to pay the government
over the Internet. The Banks also operate the Treasury's Paper Check Conversion program, whereby checks written
to government agencies are converted at
the point of sale into ACH transactions.
In 2002, the first full year of operation
for both programs, the Reserve Banks
originated nearly 215,000 ACH transactions through the programs, a significant
increase from the 10,000 originated in
2001.
Federal Tax Payments
Reserve Bank operating expenses
related to federal tax payments in
2002 totaled $30.1 million. The Federal
Reserve enhanced the Treasury tax and
loan program at midyear by pilot testing
the Term Investment Option, whereby
the Treasury can place investments with
depository institutions for a set term, the
Services Provided to Other Entities
The Reserve Banks provide fiscal
agency and depository services to other
domestic and international agencies
when they are required to do so by the
Secretary of the Treasury or when they
are required or permitted to do so by
federal statute. One such service is the
134 89th Annual Report, 2002
provision of food coupon services for
the Department of Agriculture. Reserve
Bank operating expenses for food coupon services in 2002 totaled $10.2 million, 22.4 percent lower than in 2001.
The Banks redeemed 500.5 million food
coupons, a decrease of 14.7 percent
from 2001.
As fiscal agents of the United States,
the Reserve Banks also process all
postal money orders deposited by banks
for collection. In 2002, they processed
216.5 million postal money orders, a
decrease of 5.6 percent from 2001.
Electronic Access
The Federal Reserve continued in 2002
to improve electronic access for depository institutions and to offer web-based
applications for imaging checks, ordering cash, and processing savings bonds.
Specifically, the Reserve Banks made
the strategic decision to deliver services
using web-based technologies in the
next two years and to discontinue development of the FedLine for Windows NT
operating system. This strategic direction will allow the Banks to provide
more-flexible access to the full array of
financial information and transaction
services, including high-risk Fedwire
and ACH, and to improve the quality of
financial services.
To complement the move to webbased electronic access, the Reserve
Banks plan to consolidate the customer
support function for electronic access at
each Reserve Bank to two sites during
2003 and 2004. The consolidation is
expected to improve the efficiency and
consistency of customer support.
Information Technology
Implementation of frame relay technology on the telecommunications network
connecting the Reserve Bank offices to
each other and to depository institutions
is substantially complete. The technology has improved the speed, reliability,
and performance of the depository institutions' electronic connections during
contingencies as well as the capacity
and flexibility to support new electronic
services using web-based technologies.
Also, several major cost-reduction
initiatives to centralize or standardize
information technology utilities and
resources common to the Reserve Banks
have begun. Projects are under way to
standardize certain local area network
components as well as desktop hardware and software to facilitate interoperability, improve network efficiency, and
increase productivity. Certain Reserve
Banks are supporting common information technology functions such as desktop standardization and management,
remote access, and incident response.
These initiatives are expected to contribute to a System effort to reduce information technology costs over the long term.
Examinations of the
Federal Reserve Banks
Section 21 of the Federal Reserve Act
requires the Board of Governors to order
an examination of each Federal Reserve
Bank at least once a year. The Board
engages a public accounting firm to perform an annual audit of the combined
financial statements of the Reserve
Banks (see the section "Federal Reserve
Banks Combined Financial Statements").
The public accounting firm also audits
the annual financial statements of each
of the twelve Banks. The Reserve Banks
use the framework established by the
Committee of Sponsoring Organizations
of the Treadway Commission (COSO)
in assessing their internal controls over
financial reporting, including the safeguarding of assets. Within this framework, each Reserve Bank provides an
Federal Reserve Banks 135
assertion letter to its board of directors
annually confirming adherence to the
COSO standards, and a public accounting firm certifies management's assertion and issues an attestation report to
the Bank's board of directors and to the
Board of Governors.
The firm engaged for the audits of the
individual and combined financial statements of the Reserve Banks for 2002
was PricewaterhouseCoopers
LLP
(PwC). Fees for these services totaled
$1.0 million. To ensure auditor independence, the Board requires that PwC be
independent in all matters relating to the
audit. Specifically, PwC may not perform services for the Reserve Bank or
others that would place it in a position of auditing its own work, making management decisions on behalf
of the Reserve Banks, or in any other
way impairing its audit independence.
In 2002 the Reserve Banks engaged
PwC for advisory services totaling
$176,600 for project management advisory services related to the System's
check modernization project. The Board
believes that these advisory services do
not directly affect the preparation of
the financial statements audited by PwC
and are not incompatible with the services provided by PwC as an independent auditor.
The Board's annual examination of
the Reserve Banks in 2002 included a
wide range of off-site and on-site oversight activities conducted by the Division of Reserve Bank Operations and
Payment Systems. Division staff monitors the activities of each Reserve Bank
on an ongoing basis and conducts
on-site reviews according to the division's risk-assessment methodology.
The 2002 examination also included
assessing the efficiency and effectiveness of the internal audit function.
Each year, to assess compliance with
the policies established by the Federal
Reserve's Federal Open Market Committee (FOMC), the division also examines the accounts and holdings of the
System Open Market Account at the
Federal Reserve Bank of New York and
the foreign currency operations conducted by that Bank. In addition, a public accounting firm certifies the schedule of participated asset and liability
accounts and the related schedule of participated income accounts at year-end.
Division personnel follow up on the
results of these audits. The FOMC
receives the external audit reports and
the report on the division's follow-up.
Income and Expenses
The accompanying table summarizes
the income, expenses, and distributions
of net earnings of the Federal Reserve
Banks for 2001 and 2002.
Income in 2002 was $26,760 million,
compared with $31,871 million in 2001.
Expenses totaled $2,862 million ($2,071
million in operating expenses, $156 million in earnings credits granted to
depository institutions, $205 million in
assessments for expenditures by the
Board of Governors, and $430 million for the cost of new currency).
Revenue from priced services was
$916.3 million.
The profit and loss account showed a
net profit of $2,149 million. The profit
was due primarily to unrealized gains on
assets denominated in foreign currencies revalued to reflect current market
exchange rates. Statutory dividends paid
to member banks totaled $484 million,
$56 million more than in 2001; the
increase reflects an increase in the capital and surplus of member banks and a
consequent increase in the paid-in capital stock of the Reserve Banks.
Payments to the U.S. Treasury in the
form of interest on Federal Reserve
notes totaled $24,496 million in 2002,
136 89th Annual Report, 2002
Income, Expenses, and Distribution of Net Earnings
of the Federal Reserve Banks, 2002 and 2001
Millions of dollars
2002
2001
Current income
Current expenses
Operating expenses1
Earnings credits granted
26,760
2,227
2,071
156
31,871
2,085
1,834
250
Current net income
Net additions to (deductions from, - ) current net income
Assessments by the Board of Governors
For expenditures of Board
For cost of currency
24,533
2,149
635
205
430
29,786
-1,117
634
295
339
Net income before payments to Treasury
Dividends paid
Transferred to surplus
26,048
484
1,068
28,035
428
518
Payments to Treasury2
24,496
27,089
Item
1. Includes a net periodic credit for pension costs of
$157 million in 2002 and $331 million in 2001.
2. Interest on Federal Reserve notes.
down from $27,089 million in 2001; the
payments equal net income after the
deduction of dividends paid and of the
amount necessary to bring the surplus of
the Reserve Banks to the level of capital
paid in.
In the "Statistical Tables" section of
this volume, table 5 details the income
and expenses of each Reserve Bank for
2002, and table 6 shows a condensed
statement for each Bank for the years
1914 through 2002. A detailed account
of the assessments and expenditures of
the Board of Governors appears in the
section "Board of Governors Financial
Statements."
The average rate of interest earned
on the Reserve Banks' holdings of government securities declined to 4.11 percent, from 5.46 percent in 2001, and
the average rate of interest earned on
loans declined to 1.94 percent, from
3.18 percent.
Holdings of Securities and Loans
Federal Reserve Bank Premises
The Reserve Banks' average daily holdings of securities and loans during 2002
amounted
to
$621,834
million,
an increase of $62,511 million from
2001 (table). Holdings of U.S. government securities increased $62,795 million, and holdings of loans decreased
$284 million.
In 2002, design work continued for the
Dallas Reserve Bank's new Houston
Branch building and the Chicago Bank's
Detroit Branch building. Also, the Board
approved the purchase of property for
the new Detroit Branch building and a
new building program for the Kansas
City Bank. The St. Louis Reserve Bank
Volume of Operations
Table 8 in the "Statistical Tables" section shows the volume of operations in
the principal departments of the Federal
Reserve Banks for the years 1999
through 2002.
Federal Reserve Banks
137
Securities and Loans of the Federal Reserve Banks, 2000-2002
Millions of dollars except as noted
Item and year
Average daily holdings3
2000
2001
2002
Earnings4
2000
2001
2002
Total
U.S.
government
securitiesx
528,139
559,323
621,834
527,774
558,926
621,721
365
397
113
32,760
30,536
25,527
32,737
30,523
25,525
23
13
2
6.20
5.46
4.11
6.20
5.46
4.11
6.27
3.18
1.94
Average interest rate (percent)
2000
2001
2002
Loans2
1. Includes federal agency obligations.
2. Does not include indebtedness assumed by the Federal Deposit Insurance Corporation.
3. Based on holdings at opening of business.
4. Earnings have not been netted with the interest expense on securities sold under agreements to
repurchase.
continued to analyze its long-term planning options for its headquarters facility.
The multiyear renovation program at
the New York Reserve Bank's headquarters building continued, including
the cleaning and repair of the exterior
stonework. The improvement program
for the main chiller plant in the headquarters building was completed, and
the annex building in New York City
was sold.
At all facilities, security enhancement
programs were undertaken as a result of
the events of September 11, 2001.
>
138 89th Annual Report, 2002
Pro Forma Financial Statements for Federal Reserve Priced Services
Pro Forma Balance Sheet for Priced Services, December 31, 2002 and 2001
Millions of dollars
Short-term assets (Note 1)
Imputed reserve requirements
on clearing balances
Investment in marketable securities . . .
Receivables
Materials and supplies
Prepaid expenses
Items in process of collection
Total short-term assets
1,047.8
9,051.3
78.7
3.4
34.8
6,958.6
Long-term assets (Note 2)
Premises .
Furniture and equipment
Leases and leasehold improvements ..
Prepaid pension costs
Total long-term assets
475.0
179.2
91.2
809.2
Long-term liabilities
Long-term debt
Postretirement/postemployment
benefits obligation
Total long-term liabilities
10,490.3
473.0
176.1
88.1
760.8
1,554.6
1,498.0
18,729.3
11,988.3
8,524.5
1,855.7
20.8
89.2
10,550.2
6,886.4
.0
83.9
10,490.3
17,520.5
519.7
.0
257.8
272.3
Total liabilities
Equity
Total liabilities and equity (Note 3) . . .
NOTE. Components may not sum to totals because of
rounding.
860.8
7,747.3
76.5
3.1
30.5
1,772.1
17,174.7
Total assets
Short-term liabilities
Clearing balances and balances
arising from early credit
of uncollected items
Deferred-availability items
Short-term debt
Short-term payables
Total short-term liabilities
2001
2002
Item
272.3
777.4
17,792.8
11,267.7
936.4
720.6
18,729.3
11,988.3
The accompanying notes are an integral part of these
pro forma priced services financial statements.
Federal Reserve Banks
139
Pro Forma Income Statement for Federal Reserve Priced Services, 2002 and 2001
Millions of dollars
Item
2001
2002
Revenue from services provided
to depository institutions (Note 4) ...
Operating expenses (Note 5)
Income from operations
Imputed costs (Note 6)
Interest on float
Interest on debt
Sales taxes
FDIC insurance
Income from operations after
imputed costs
Other income and expenses (Note 7)
Investment income
Earnings credits
Income before income taxes
Imputed income taxes (Note 8)
Net income
MEMO: Targeted return on equity (Note 9)
916.3
876.0
40.2
-6.8
.0
11.4
.0
926.5
814.9
111.7
15.5
32.0
12.6
.0
4.6
60.1
51.6
35.6
148.9
-146.8
NOTE. Components may not sum to totals because of
rounding.
2.1
37.7
11.0
26.6
92.5
273.3
-239.4
33.9
85.4
26.9
58.5
109.2
The accompanying notes are an integral part of these
pro forma priced services financial statements.
Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2002
Millions of dollars
Total
Commercial
check
collection
Fedwire
funds
Fedwire
securities
Commercial
ACH
Noncash
services
Cash
services
Revenue from services
(Note 4)
916.3
759.2
58.6
23.7
71.7
1.7
1.4
Operating expenses
(Note 5)
876.0
744.3
50.7
20.3
58.0
L4
L4
Item
Income from operations
40.2
14.9
7.9
3.5
13.7
.2
-.0
Imputed costs (Note 6)
4.6
2.9
.7
.3
.7
.0
_Q
Income from operations
after imputed costs
35.6
12.0
7.3
3.1
13.0
Other income and expenses,
net (Note 7)
-.0
2.1
1.7
.1
.0
.2
.0
.0
Income before income taxes ..
37.7
13.7
7.4
3.2
13.2
.2
-.0
Imputed income taxes
(Note 8)
11.0
4.0
2.2
.9
3.9
.1
-.0
Net income ...
26.6
9.7
5.2
2.3
9.3
.2
-.0
MEMO: Targeted return on
equity (Note 9)
92.5
78.2
5.5
2.2
6.5
.1
.1
NOTE. Components may not sum to totals because of
rounding.
The accompanying notes are an integral part of these
pro forma priced services financial statements.
140 89th Annual Report, 2002
FEDERAL RESERVE BANKS
NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES
(1) SHORT-TERM ASSETS
The imputed reserve requirement on clearing balances
held at Reserve Banks by depository institutions reflects a
treatment comparable to that of compensating balances
held at correspondent banks by respondent institutions.
The reserve requirement imposed on respondent balances
must be held as vault cash or as non-earning balances
maintained at a Reserve Bank; thus, a portion of priced
services clearing balances held with the Federal Reserve
is shown as required reserves on the asset side of the
balance sheet. Another portion of the clearing balances
is used to finance short-term and long-term assets. The
remainder of clearing balances is assumed to be invested
in three-month Treasury bills, shown as investment in
marketable securities.
Receivables are (1) amounts due the Reserve Banks for
priced services and (2) the share of suspense-account and
difference-account balances related to priced services.
Materials and supplies are the inventory value of shortterm assets.
Prepaid expenses include salary advances and travel
advances for priced-service personnel.
Items in process of collection is gross Federal Reserve
cash items in process of collection (CIPC) stated on a
basis comparable to that of a commercial bank. It reflects
adjustments for intra-System items that would otherwise
be double-counted on a consolidated Federal Reserve
balance sheet; adjustments for items associated with nonpriced items, such as those collected for government
agencies; and adjustments for items associated with
providing fixed availability or credit before items are
received and processed. Among the costs to be recovered
under the Monetary Control Act is the cost of float, or net
CIPC during the period (the difference between gross
CIPC and deferred-availability items, which is the portion
of gross CIPC that involves a financing cost), valued at
the federal funds rate.
(2) LONG-TERM ASSETS
Consists of long-term assets used solely in priced services, the priced-services portion of long-term assets
shared with nonpriced services, and an estimate of the
assets of the Board of Governors used in the development
of priced services. Effective Jan. 1, 1987, the Reserve
Banks implemented the Financial Accounting Standards
Board's Statement of Financial Accounting Standards
No. 87, Employers' Accounting for Pensions (SFAS 87).
Accordingly, the Reserve Banks recognized credits to
expenses of $48.4 million in 2002 and $101.0 million in
2001 and corresponding increases in this asset account.
(3) LIABILITIES AND EQUITY
Under the matched-book capital structure for assets,
short-term assets are financed with clearing balances in
2002 and short-term payables and short-term debt in
2001. Long-term assets are financed with clearing balances in 2002, and in 2001 with long-term debt and
equity in a proportion equal to the ratio of long-term debt
to equity for the fifty largest bank holding companies,
which are used in the model for the private-sector adjust-
ment factor (PSAF). The PSAF consists of the taxes that
would have been paid and the return on capital that would
have been provided had priced services been furnished by
a private-sector firm. Other short-term liabilities include
clearing balances maintained at Reserve Banks and
deposit balances arising from float. Other long-term liabilities consist of accrued postemployment and postretirement benefits costs and obligations on capital leases.
(4)
REVENUE
Revenue represents charges to depository institutions for
priced services and is realized from each institution
through one of two methods: direct charges to an institution's account or charges against its accumulated earnings credits.
(5) OPERATING EXPENSES
Operating expenses consist of the direct, indirect, and
other general administrative expenses of the Reserve
Banks for priced services plus the expenses for staff
members of the Board of Governors working directly on
the development of priced services. The expenses for
Board staff members were $5.1 million in 2002 and
$4.9 million in 2001. The credit to expenses under
SFAS 87 (see note 2) is reflected in operating expenses.
The income statement by service reflects revenue,
operating expenses, and imputed costs. Certain corporate
overhead costs not closely related to any particular priced
service are allocated to priced services in total based on
an expense-ratio method, but are allocated among priced
services based on management decision. Corporate overhead was allocated among the priced services during
2002 and 2001 as follows (in millions):
2002
2001
Check
ACH
Fedwire funds
Fedwire securities
Noncash services
Special cash services
40.3
4.1
3.3
1.9
.1
.1
43.5
4.4
3.5
1.9
.1
.0
Total
49.7
53.4
(6) IMPUTED COSTS
Imputed costs consist of interest on float, interest on debt,
sales taxes, and the FDIC assessment. Interest on float is
derived from the value of float to be recovered, either
explicitly or through per-item fees, during the period.
Float costs include costs for checks, book-entry securities, noncash collection, ACH, and funds transfers.
Interest is imputed on the debt assumed necessary to
finance priced-service assets. There was no debt in 2002
because clearing balances fund short-term and long-term
debt. The sales taxes and FDIC assessment that the Federal Reserve would have paid had it been a private-sector
firm are among the components of the PSAF (see note 3).
Float cost or income is based on the actual float
incurred for each priced service. Other imputed costs are
allocated among priced services according to the ratio of
operating expenses less shipping expenses for each ser-
Federal Reserve Banks
vice to the total expenses for all services less the total
shipping expenses for all services.
The following list shows the daily average recovery of
actual float by the Reserve Banks for 2002 in millions of
dollars:
Total float
Unrecovered float
Float subject to recovery
Sources of recovery of float
Income on clearing balances
As-of adjustments
Direct charges
Per-item fees
-9.3
68.6
-77.9
-8.2
-309.3
430.8
-809.8
Unrecovered float includes float generated by services
to government agencies and by other central bank services. Float recovered through income on clearing balances is the result of the increase in investable clearing
balances; the increase is produced by a deduction for float
for cash items in process of collection, which reduces
imputed reserve requirements. The income on clearing
balances reduces the float to be recovered through other
means. As-of adjustments and direct charges refer to float
that is created by interterritory check transportation and
the observance of non-standard holidays by some depository institutions. Such float may be recovered from the
depository institutions through adjustments to institution
141
reserve or clearing balances or by billing institutions
directly. Float recovered through direct charges and peritem fees is valued at the federal funds rate; credit float
recovered through per-item fees has been subtracted from
the cost base subject to recovery in 2002.
(7) OTHER INCOME AND EXPENSES
Consists of investment income on clearing balances and
the cost of earnings credits. Investment income on clearing balances represents the average coupon-equivalent
yield on three-month Treasury bills applied to the total
clearing balance maintained, adjusted for the effect of
reserve requirements on clearing balances. Expenses for
earnings credits granted to depository institutions on their
clearing balances are derived by applying the average
federal funds rate to the required portion of the clearing
balances, adjusted for the net effect of reserve requirements on clearing balances.
(8) INCOME TAXES
Imputed income taxes are calculated at the effective tax
rate derived from the PSAF model (see note 3).
(9) RETURN ON EQUITY
The after-tax rate of return on equity that the Federal
Reserve would have earned had it been a private business
firm, as derived from the PSAF model (see note 3).
143
The Board of Governors and the
Government Performance and Results Act
Under the Government Performance and
Results Act of 1993 (GPRA), federal
agencies are required to prepare, in consultation with the Congress and outside
stakeholders, a strategic plan covering a
multiyear period and to submit annual
performance plans and performance
reports. Though not covered by the act,
the Board of Governors is voluntarily complying with many of the act's
mandates.
Strategic and Performance Plans
and Performance Report
The Board's current strategic plan in
the GPRA format, released in December 2001, covers the period 2001-05.
The document articulates the Board's
mission, sets forth major goals for the
period, outlines strategies for achieving
those goals, and discusses the environment and other factors that could affect
their achievement. The strategic plan
also addresses issues that cross agency
jurisdictional lines, identifies key quantitative measures of performance, and
discusses performance evaluation.
The 2002-03 performance plan and
the 2000-01 performance report were
posted on the Board's public web site
in November 2002 for access by the
Congress, the public, and the General
Accounting Office. The performance
plan sets forth specific targets for some
of the performance measures identified in the strategic plan (except those
associated with the monetary policy
function). The performance plan also
describes the operational processes and
resources needed to meet those targets
and discusses validation of data and verification of results. The performance
report indicates that the Board generally
met its goals for 2000-01. A scheduling
problem with state bank regulatory
agencies was cited as a reason for not
meeting all of the goals. Accordingly,
the Board is implementing a new scheduling system that will help resolve
the problem.
The strategic plan, performance plan,
and performance report are available
on the Board's public web site
(www.federalreserve.gov/boarddocs
/rptcongress). The Board's mission
statement and a summary of the goals
and objectives set forth in the strategic
and performance plans are given below.
Mission
The mission of the Board is to foster the
stability, integrity, and efficiency of the
nation's monetary, financial, and payment systems so as to promote optimal
macroeconomic performance.
Goals and Objectives
The Federal Reserve has three primary
goals with interrelated and mutually
reinforcing elements:
Goal
To conduct monetary policy that promotes the achievement of maximum
sustainable long-term growth and the
price stability that fosters that goal.
144 89th Annual Report, 2002
Objectives
• Stay abreast of recent developments
and prospects in the U.S. economy
and financial markets and in those
abroad, so that monetary policy decisions will be well informed
• Enhance our knowledge of the structural and behavioral relationships in
the macroeconomic and financial
markets, and improve the quality of
the data used to gauge economic
performance, through developmental
research activities
• Implement monetary policy effectively in rapidly changing economic
circumstances and in an evolving
financial market structure
• Contribute to the development of U.S.
international policies and procedures,
in cooperation with the Department of
the Treasury and other agencies
• Promote understanding of Federal
Reserve policy among other government policy officials and the general
public.
Goal
To promote a safe, sound, competitive,
and accessible banking system and
stable financial markets.
Objectives
• Provide comprehensive and effective
supervision of U.S. banks, bank and
financial holding companies, foreign
banking organizations with U.S.
operations, and related entities
• Promote overall financial stability,
manage and contain systemic risk, and
ensure that emerging financial crises
are identified early and successfully
resolved
• Improve efficiency and effectiveness
and reduce burden on supervised
institutions
• Promote equal access to banking
services
• Administer and ensure compliance
with consumer protection statutes
relating to consumer financial transactions (Truth in Lending, Truth in
Savings, Consumer Leasing, and
Electronic Funds Transfer) to carry
out congressional intent, striking the
proper balance between protection of
consumers and burden to the industry.
Goal
To provide high-quality professional
oversight of Reserve Bank operations
and to foster the integrity, efficiency,
and accessibility of U.S. payment and
settlement systems.
Objectives
• Develop sound, effective policies
and regulations that foster payment
system integrity, efficiency, and
accessibility
• Produce high-quality assessments of
Federal Reserve Bank operations,
projects, and initiatives that help Federal Reserve management foster and
strengthen sound internal control
systems and efficient and effective
performance
• Conduct research and analysis that
contributes to policy development
and increases the Board's and others'
understanding of payment system
dynamics and risk.
Interagency Coordination
Interagency coordination helps focus
efforts to eliminate redundancy and
lower costs. As mandated by the Government Performance and Results Act
and in conformance with past practice,
the Board has worked closely with other
federal agencies to consider plans and
The Board of Governors and the Government Performance and Results Act
145
strategies for programs, such as bank
supervision, that transcend the jurisdiction of each agency. Coordination with
the Department of the Treasury and
other agencies is evident throughout
both the strategic and performance
plans. Much of the Board's formal effort
to plan jointly has been made through
the Federal Financial Institutions
Examination Council (FFIEC), a group
made up of the five federal agencies that
regulate depository institutions.1 In
addition, a coordinating committee of
representatives of the chief financial
officers of the five agencies has been
created to address and report on issues
related to those general goals and objectives that cross agency functions, programs, and activities. This working
group has been meeting since June
1997. These and similar planning efforts
can eliminate redundancy and significantly lower the government's costs for
data processing and other activities, as
well as lower depository institutions'
costs for complying with federal regulations, while enhancing public access to
the data.
•
1. The FFIEC consists of the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, the National
Credit Union Administration, the Office of the
Comptroller of the Currency, and the Office of
Thrift Supervision. It was established in 1979 pursuant to title X of the Financial Institutions Regulatory and Interest Rate Control Act of 1978. The
FFIEC is a formal interagency body empowered to
prescribe uniform principles, standards, and report
forms for the federal examination of financial
institutions and to make recommendations to promote uniformity in the supervision of financial
institutions. The FFIEC also provides uniform
examiner training and has taken a lead in developing standardized software needed for major data
collection programs to support the requirements of
the Home Mortgage Disclosure Act and the Community Reinvestment Act.
147
Federal Legislative Developments
On November 26, 2002, President Bush
signed the Terrorism Risk Insurance Act
of 2002 into law. Section 301 of that
act amended section 11 of the Federal
Reserve Act (12 U.S.C. 248) to enhance
the Board's ability to respond to emergency situations. Before the amendment, the Federal Reserve Act allowed
the Board to take five types of actions
only upon the affirmative vote of at
least five Board members. Among the
actions requiring supermajority approval
was Board authorization of a Federal
Reserve Bank to extend credit to a
nondepository institution in unusual
and exigent circumstances under section 13(3) of the Federal Reserve Act.
See 12 U.S.C. §343; see also 12 U.S.C.
§§248(b), 347a, and 461(b)(3) and
These five-member voting requirements could have impaired the Board's
ability to act in an emergency. The Terrorism Risk Insurance Act amended
these requirements in two respects. First,
it allows fewer than five Board members, by unanimous vote, to approve any
action that would otherwise require a
five-member vote if fewer than five
members are in office at the time of the
action (that is, if more than two seats on
the Board are vacant). Second, it allows
those members of the Board that are
available to approve a loan to a nondepository institution under section 13(3)
of the Federal Reserve Act if these
available members unanimously determine that (1) unusual and exigent circumstances exist and the borrower is
unable to secure adequate credit accommodations from other sources; (2) action
on the loan is necessary to prevent,
correct, or mitigate serious harm to the
economy or the stability of the U.S.
financial system; (3) all available telephonic, telegraphic, and other means
have been used to attempt to contact
the other members of the Board; and
(4) action on the loan request is necessary before the other Board members
can be contacted. At least two Board
members must be available and participate in the emergency loan approval,
and any loan made by a Reserve Bank
under this emergency procedure must be
payable upon demand.
•
Records
151
Record of Policy Actions
of the Board of Governors
Regulation A
Extensions of Credit
by Federal Reserve Banks
Regulation D
Reserve Requirements
of Depository Institutions
October 31, 2002—Amendments
The Board amended Regulations A and
D to implement new discount window
programs, effective January 9, 2003.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
The revisions to Regulation A replace
the adjustment and extended credit programs with new primary and secondary
credit programs, reorganize and streamline the rule, and would facilitate a
reduction of the primary credit rate in
the event of a financial emergency. The
Board also amended Regulation D to
conform the calculation of penalties for
reserve deficiencies, which are based on
the discount rate, to the new discount
rate framework.
Under the new primary credit program, the Federal Reserve Banks offer
very short term credit, at an interest rate
above the targeted federal funds rate, as
a backup source of liquidity to depository institutions that are in generally
sound financial condition. The Reserve
Banks establish the primary credit rate
at least every two weeks, subject to
review and determination by the Board,
through the same procedure that had
been used to set the adjustment credit
rate. A secondary credit program,
with an interest rate initially 50 basis
points above the primary credit rate, is
available in appropriate circumstances
to depository institutions that do not
qualify for primary credit.
The revisions are intended to improve
the functioning of the discount window
and do not indicate a change in the
stance of monetary policy. The seasonal
credit program, used mainly by small
banks that have pronounced seasonal
funding needs, remains essentially
unchanged.
Regulation C
Home Mortgage Disclosure
January 23, 2002—Amendments
The Board approved amendments to
Regulation C, which implements the
Home Mortgage Disclosure Act, to
expand the amount of data and number of lenders subject to the reporting
requirements of the act, effective January 1, 2003.
Votes for this action: Messrs. Ferguson,
Meyer, and Gramlich, Ms. Bies, and
Mr. Olson.
The Home Mortgage Disclosure Act
requires covered lenders to collect,
report, and publicly disclose certain data
on home purchase and home improvement loans (both loans they originate
and those they purchase) and applications that do not result in originations.
These data include the race, ethnicity,
sex, and income of the applicants and
152 89th Annual Report, 2002
borrowers and the location of the property. The amendments require, among
other things, that lenders report loanpricing data showing the spread between
the annual percentage rate charged for
originated loans and the rate on U.S.
Treasury securities having comparable
maturity periods, if the spread equals
or exceeds certain thresholds set by
the Board. Lenders are also required to
identify loans subject to the Home Ownership and Equity Protection Act and
report denials of applications for credit
received through certain preapproval
programs. In addition, the amendments
expand the regulation's coverage of
nondepository lenders by adding a
dollar-volume test of $25 million in
total home purchase loan originations
(including refinancings of home purchase loans) for the preceding year.
The Board published for comment a
proposal that reporting thresholds for
first-lien loans be set at 3 percentage
points above the U.S. Treasury rate and
5 percentage points above that rate for
subordinate-lien loans. The Board also
requested public comment on requiring
lenders to collect, for applications and
originated loans, data on whether the
application or loan is secured by a first
or subordinate lien on a dwelling or is
unsecured (the lien status) and requiring
lenders to request, for loan applications
made by telephone, the race, ethnicity,
and sex of the applicant.
May 2, 2002—Delay of Effective
Date and Interim Amendment
The Board extended the effective date
for most of the amendments to Regulation C, which expand the amount of data
and number of lenders subject to the
reporting requirements of the Home
Mortgage Disclosure Act, from January 1, 2003, to January 1, 2004. The
Board also adopted an interim amend
ment to require reporters under the act
to use 2000 census data, effective January 1, 2003.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
The Board extended for one year the
effective date of amendments approved
on January 23, 2002, as discussed
above, to give institutions sufficient time
to implement the new reporting requirements. The extension allows institutions
to fully implement the new rules without jeopardizing the quality and usefulness of the data and without incurring
substantial additional implementation
costs that could be avoided by a delay
in the effective date. The Board also
adopted an interim amendment to
improve the accuracy and usefulness
of the data submitted under the act by
requiring reporters to use 2000 census
data, effective January 1, 2003.
June 3, 2002—Amendments
The Board approved amendments to
implement the following proposals
made in connection with the January
2002 amendments to Regulation C:
establish reporting thresholds for loanpricing data and require reporting of
lien-status data, effective January 1,
2004, and require lenders to request
additional information in telephone
applications, effective January 1, 2003.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
As discussed above, the Board
approved amendments to the data collection requirements of Regulation C on
January 23, 2002. It also published for
comment proposals that would establish thresholds for reporting loan-pricing
Record of Policy Actions of the Board of Governors 153
data based on a rate spread (between the
annual percentage rate on a loan and the
yield on comparable U.S. Treasury securities) of 3 percentage points for firstlien loans and 5 percentage points for
subordinate-lien loans; require lenders
to report the lien status of applications
and originated loans; and require lenders to request the race, ethnicity, and
sex of telephone applicants. The Board
approved these proposals with the effective dates indicated.
Regulation D
Reserve Requirements of
Depository Institutions
October 1, 2002—Amendments
The Board amended Regulation D to
increase the amount of net transaction accounts at depository institutions
to which a lower reserve requirement
applies (low reserve tranche) and the
amount of reservable liabilities exempt
from reserve requirements (reservable
liabilities exemption level) for 2003,
effective for the reserve computation
period beginning November 26, 2002,
for institutions reporting weekly.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
Under the Monetary Control Act of
1980, depository institutions, Edge and
agreement corporations, and U.S. agencies and branches of foreign banks are
subject to reserve requirements set by
the Board. The act directs the Board to
adjust annually the amount of the low
reserve tranche on the basis of percentage changes in net transaction accounts
at all depository institutions over the
one-year period ending on the most
recent June 30. The growth in total
net transaction accounts from June 30,
2001, to June 30, 2002, warranted an
increase in the low reserve tranche
from $41.3 million to $42.1 million,
and the Board amended Regulation D
accordingly.
The Garn-St Germain Depository
Institutions Act of 1982 establishes a
zero percent reserve requirement on the
first $2 million of an institution's reservable liabilities. The act also provides for
annual adjustments to that exemption
amount based on percentage increases
in reservable liabilities at all depository
institutions over the one-year period
ending on the most recent June 30.
The growth in total reservable liabilities from June 30, 2001, to June 30,
2002, warranted an increase in the
reservable liabilities exemption level
from $5.7 million to $6 million, and
the Board amended Regulation D
accordingly.
For institutions that report weekly, the
amendments adjusting the low reserve
tranche and the reservable liabilities
exemption level are effective for the
fourteen-day reserve computation period
beginning Tuesday, November 26, 2002,
and for the corresponding fourteen-day
reserve maintenance period beginning
Thursday, December 26, 2002. For institutions that report quarterly, the amendments are effective for the seven-day
reserve computation period beginning
Tuesday, December 17, 2002, and for
the corresponding seven-day reserve
maintenance period beginning Thursday, January 16, 2003.
Nonexempt depository institutions
that have total reservable liabilities
greater than the amount exempted from
reserve requirements ($6 million in
2003) report either weekly or quarterly
depending on the amount of their total
deposits. To ease the reporting burden
on small institutions, the Board requires
nonexempt depository institutions with
total deposits below a specified level
154
89th Annual Report, 2002
(nonexempt deposit cutoff level) to
report their deposits and reservable liabilities quarterly or less frequently,
while larger institutions must report
weekly. 1 To reflect the growth of total
deposits at all depository institutions
from June 30, 2001, to June 30, 2002,
the Board increased the nonexempt
deposit cutoff level from $106.9 million
to $112.3 million, to be implemented in
September 2003.
Exempt institutions (those with total
reservable liabilities equal to or less
than the reservable liabilities exemption
level of $6 million in 2003) with at least
$6 million in total deposits may report
annually, and exempt institutions with
less than $6 million in total deposits are
not required to file deposit reports.
Regulation H
Membership of State Banking
Institutions in the Federal Reserve
System
May 30, 2002—Amendments
The Board amended Regulation H to
include any branch of a bank controlled
by an out-of-state bank holding company under the prohibition against using
interstate branches primarily for deposit
production, effective October 1, 2002.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
Regulation H implements the provision of the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 that prohibits a bank from establishing or acquiring a branch outside
its home state primarily for the purpose
of deposit production. That act also
provides guidelines for determining
whether the bank is reasonably helping
to meet the credit needs of the communities served by the branch. Congress
enacted the prohibition to ensure that
the authorization for interstate branches
would not result in banks' taking deposits from a community without reasonably helping to meet the credit needs of
that community.
The Gramm-Leach-Bliley Act of
1999 expands the prohibition against
deposit-production offices to include
any branch of a bank controlled by an
out-of-state bank holding company. The
Board, the Federal Deposit Insurance
Corporation, and the Office of the
Comptroller of the Currency jointly
amended their regulations on June 5,
2002, to conform to the expanded
prohibition.
Regulation H
Membership of State Banking
Institutions in the Federal Reserve
System
Regulation Y
Bank Holding Companies and
Change in Bank Control
January 28, 2002—Amendments
1. All U.S. branches and agencies of foreign
banks and Edge and agreement corporations are
required to submit the Report of Transaction
Accounts, Other Deposits, and Vault Cash
(FR 2900) weekly regardless of size. In addition,
depository institutions that obtain funds from nonUS, sources or that have foreign branches or international banking facilities continue to be required
to file the Report of Certain Eurocurrency Transactions (FR 2950/FR 2951) at the same frequency
as they file the FR 2900 report.
The Board reduced, for state member
banks and bank holding companies, the
risk weighting in capital standards for
certain claims on securities firms, effective July 1, 2002.
Votes for this action: Messrs. Greenspan,
Ferguson, Meyer, and Gramlich, Ms. Bies,
and Mr. Olson.
Record of Policy Actions of the Board of Governors 155
The Board, the Federal Deposit Insurance Corporation, the Office of the
Comptroller of the Currency, and the
Office of Thrift Supervision jointly
amended their risk-based capital standards for supervised banking and savings institutions on March 27, 2002, to
reduce the risk weight applied to certain
claims on, and claims guaranteed by,
qualifying securities firms incorporated
in the United States and in other countries that are members of the Organisation for Economic Co-operation
and Development (OECD). The Federal
Deposit Insurance Corporation and the
Office of Thrift Supervision also conformed their capital standards to those
of the other agencies by permitting a
zero percent risk weight for certain
claims on qualifying securities firms that
are collateralized by (1) cash on deposit
in the lending institution or (2) securities issued or guaranteed by the U.S.
government or its agencies or OECD
central governments.
Regulation K
International Banking Operations
December 30, 2002—Amendments
The Board amended provisions of Regulation K on international lending supervision to conform to technical changes
adopted by the other federal banking
agencies, effective February 10, 2003.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
Subpart D of Regulation K, which
implements the International Lending
Supervision Act of 1983, governs international lending by state member banks,
bank holding companies, and Edge and
agreement corporations engaged in
banking and specifies when reserves are
required for particular international
assets. The amendments conform these
provisions to those of the other federal banking agencies by eliminating
requirements for a particular accounting
method for fees on international loans
and requiring instead that institutions
follow generally accepted accounting
principles (GAAP) for such fees.
Regulation W
Transactions between Member
Banks and Their Affiliates
October 31, 2002—New
Regulation
The Board approved new Regulation W,
which comprehensively implements sections 23A and 23B of the Federal
Reserve Act, effective April 1, 2003.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
Sections 23A and 23B of the Federal
Reserve Act restrict loans by a member
bank to its affiliates, asset purchases
by a member bank from its affiliates,
and certain other transactions between a
member bank and its affiliates. The purpose of the statute is to limit a member
bank's risk of loss in transactions with
affiliates and to limit a member bank's
ability to transfer to its affiliates the
benefits arising from its access to the
federal safety net. Regulation W unifies
in one document previous interpretations of sections 23A and 23B as
well as new interpretations of the
statute, including interpretations that
address derivative transactions, intraday extensions of credit, and financial
subsidiaries.
The Board also approved a preamble
to Regulation W that provides a detailed
explanation of the rule. In addition, the
Board published for comment a pro-
156 89th Annual Report, 2002
posed rule that would limit the current
exemption from section 23 A for certain
loan purchases from an affiliate.
Policy Statements and
Other Actions
February 11, 2002—Statement on
Equity Hedging Activities by State
Member Banks
The Board issued a statement indicating
that it would not apply section 9 of the
Federal Reserve Act to prohibit a state
member bank from acquiring equity
securities to hedge its bank-permissible
equity derivative transactions if such
transactions are conducted in accordance with the same restrictions applicable to national banks, effective February 21, 2002.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
Section 9 of the Federal Reserve Act
provides that state member banks are
subject to the same limitations and conditions on the purchase, sale, underwriting, and holding of investment securities
and stock that apply to national banks.
The Office of the Comptroller of the
Currency has determined that national
banks may acquire equity securities to
hedge their exposure to customer-driven
equity derivative transactions lawfully
entered into by the bank. Such transactions may include equity swaps, equityindex swaps, equity-index deposits, and
equity-linked loans. Accordingly, the
statement provides that the Board would
not apply section 9 of the act to prohibit
a state member bank from purchasing
equity securities to hedge risks arising from equity derivative transactions
entered into by the bank with an unaffili
ated third party if such purchases are
made under the same conditions and
restrictions applicable to national banks.
A state member bank must receive the
prior approval of the Board's Director
of the Division of Banking Supervision
and Regulation to engage in equity
hedging activities and must conduct
its equity derivative and equity hedging
activities in accordance with applicable
law.
April 5, 2002—System Regulations
for Federal Reserve Law
Enforcement Officers
The Board approved regulations governing the exercise of law enforcement
authority by designated Federal Reserve
System personnel, effective June 7,
2002.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
The USA PATRIOT Act of 2001
amended section 11 of the Federal
Reserve Act to provide federal law
enforcement authority for protection
personnel at the Federal Reserve Banks,
and for special agents in the Protective
Services Unit and security officers at the
Board. The implementing regulations,
which were subsequently approved by
the Attorney General of the United
States in accordance with the act, authorize designated on-duty personnel to
carry firearms when protecting System
personnel, property, or operations; make
arrests for violations of federal law; and
obtain law enforcement information.
The regulations also contain specific
training requirements and rules governing the use of law enforcement authority. The Board delegated authority to
each Reserve Bank to designate law
enforcement personnel.
Record of Policy Actions of the Board of Governors 157
April 18, 2002—Joint Agency
Statement on Parallel-Owned
Banking Organizations
The Board approved an interagency
statement on the potential risks posed by
parallel-owned banking organizations
and the supervisory approach to address
those risks, effective April 23, 2002.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Mr. Olson.
The Board, the Federal Deposit Insurance Corporation, the Office of the
Comptroller of the Currency, and the
Office of Thrift Supervision jointly
issued a statement on parallel-owned
banking organizations on April 23,
2002. A parallel-owned banking organization is created when a U.S. depository
institution and a foreign bank are both
controlled directly or indirectly by one
person or a group of persons rather than
by a bank or thrift holding company
subject to supervision by a federal regulator. Accordingly, each of the organization's banks is supervised by only the
regulatory authority for the home country of the bank. The interagency statement contains guidance on identifying
parallel-owned banking organizations,
reviews the risks associated with them,
and discusses actions that the agencies
may take to minimize those risks. It also
describes the agencies' approach to
applications and notices filed by U.S.
depository institutions in parallel-owned
banking organizations.
August 13, 2002—Policy Statement
on Payments System Risk
The Board decided not to adopt two
proposed changes to its payments system risk policy that would (1) lower
self-assessed net debit caps and eliminate two-week average caps and
(2) reject all payments with settlementday finality that would cause an institution to exceed its daylight overdraft
capacity level.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
These proposed changes were among
several modifications to its payments
system risk policy that the Board had
published for comment in June 2001
after a broad review of the policy. An
institution's net debit cap refers to the
maximum dollar amount of uncollateralized daylight overdrafts that it may incur
in its Federal Reserve account. A daylight overdraft occurs when a depository
institution's Federal Reserve account
is in a negative position at any time
during the business day.
Although the Board chose not to
implement the two proposals in the foreseeable future, it will continue to analyze the benefits and potential drawbacks of a third proposed modification:
a two-tiered pricing system for daylight overdrafts in which institutions
that pledge collateral to the Federal
Reserve Banks would pay a lower fee
on their collateralized daylight overdrafts than on their uncollateralized daylight overdrafts.
Discount Rates in 2002
During 2002, the Board of Governors
approved one change in the basic discount rate charged by the Federal
Reserve Banks. On November 6, the
basic rate was reduced by Vi percentage
point to a level of % percent. The rates
for seasonal and extended credit, which
were recalculated biweekly in accordance with market-related formulas,
exceeded the basic rate by different
amounts during the year. On October 31,
158 89th Annual Report, 2002
the Board approved new discount
window programs, effective January 9,
2003.
recovery over the coming year. There
were no further decisions on the basic
discount rate in 2002.
Basic Discount Rate
Structure of Discount Rates
The Board's decisions on the basic discount rate were made against the background of the policy actions of the Federal Open Market Committee (FOMC)
and related economic and financial
developments. These developments are
reviewed more fully in other parts of
this Report, including the minutes of the
FOMC meetings held in 2002.
The basic discount rate was the rate
normally charged on loans to depository
institutions for short-term adjustment
credit, and it continued to be set on
the basis of general monetary policy
considerations. The Federal Reserve
Banks provided two other types of discount window credit: (1) seasonal credit,
whose purpose was to assist smaller
institutions in managing liquidity needs
that arose from regular seasonal swings
in loans and deposits, and (2) extended
credit, which was available in appropriate circumstances to depository institutions that experienced somewhat longerterm liquidity needs. The rates on both
types of credit were calculated every
two weeks in accordance with formulas
based on market interest rates. Under
those formulas, the rates charged for
seasonal credit in 2002 were somewhat
higher than the basic discount rate, and
the rate on extended credit was 50 basis
points higher than that for seasonal
credit. During 2002, the rate for seasonal credit ranged from a high of
1.85 percent to a low of 1.30 percent,
and the rate for extended credit ranged
from a high of 2.35 percent to a low of
1.80 percent. At the end of 2002, the
structure of discount rates was as follows: a basic rate of 0.75 percent for
short-term adjustment credit and rates of
1.30 percent for seasonal credit and
1.80 percent for extended credit.
Reduction in the Basic Rate in
November 2002
Before November 6, the Board reviewed, but took no action on, requests
by a number of Federal Reserve Banks
to raise or lower the basic discount rate.
The Board's decision on November 6
was consistent with its practice in recent
years generally to adjust the basic rate
when the FOMC makes changes to its
target for the federal funds rate. Underlying the decisions on both rates in 2002
was the persistence of a high degree of
uncertainty about the outlook for continued economic recovery in the context
of an uneven pace of expansion and,
particularly over the summer and fall, a
predominance of downside risks to the
economy. By early November, generally
disappointing information on the performance of the economy seemed to
presage a longer-lasting spell of subpar
economic growth than had been anticipated earlier. Although the stance of
monetary policy was already accommodative, the FOMC and the Board on
November 6 approved relatively sizable
reductions of Vi percentage point in the
target rate for the federal funds rate and
the basic discount rate to enhance the
prospects of a strengthening economic
Board Votes
Under the Federal Reserve Act, the
boards of directors of the Federal
Reserve Banks are required to establish
rates on loans to depository institutions
Record of Policy Actions of the Board of Governors 159
at least every fourteen days and must
submit the rates to the Board of Governors for review and determination. During 2002, the Reserve Banks submitted,
on the same schedule, requests to renew
the formulas based on short-term market
interest rates for calculating the rates
on seasonal and extended credit. Votes
on the reestablishment of the formulas
for these flexible rates are not shown in
this summary. All votes taken by the
Board of Governors during 2002 were
unanimous.
Vote on the Basic Discount Rate
November 6, 2002. Effective this date,
the Board approved actions taken by the
directors of the Federal Reserve Banks
of New York, Dallas, and San Francisco
to reduce the basic discount rate by
Vi percentage point to 3A percent. The
same decrease was approved for the
remaining Federal Reserve Banks, effective November 7, 2002.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
New Discount Window Programs
On October 31, 2002, the Board
amended its Regulation A to establish
two new forms of discount window
credit, primary and secondary credit, to
replace adjustment and extended credit,
effective January 9, 2003. Primary credit
will be made available for very short
terms as a backup source of liquidity to
depository institutions that, in the judg-
ment of the lending Federal Reserve
Bank, are in generally sound financial
condition. Primary credit will be
extended at a rate above the federal
funds rate to be established at least every
two weeks, subject to the Board's
review and determination. By applying
an above-market rate and restricting
eligibility to generally sound institutions, the primary credit program is
expected to substantially reduce the
need for the Federal Reserve to review
the funding situations of borrowers and
monitor their use of borrowed funds.
Secondary credit will be available in
appropriate circumstances to depository
institutions that do not qualify for primary credit. When the new programs
were approved, the Board expected that
Reserve Banks would initially establish
a primary credit rate at a level 100 basis
points above the federal funds target
rate and a secondary credit rate at a level
50 basis points above the primary rate.2
The seasonal credit program was not
affected by these changes. The rate on
seasonal credit will continue to be set by
a formula based on market interest rates.
Votes for this action: Messrs. Greenspan,
Ferguson, and Gramlich, Ms. Bies, and
Messrs. Olson, Bernanke, and Kohn.
•
2. On January 7, 2003, the Board of Governors
approved requests by the twelve Reserve Banks to
establish primary credit rates of 2lA percent and
secondary credit rates of 23A percent, which were
100 basis points and 150 basis points respectively
above the FOMC's target rate for the federal funds
rate.
161
Minutes of Federal Open Market
Committee Meetings
The policy actions of the Federal Open
Market Committee, contained in the
minutes of its meetings, are presented in
the ANNUAL REPORT of the Board of
Governors pursuant to the requirements
of section 10 of the Federal Reserve
Act. That section provides that the
Board shall keep a complete record of
the actions taken by the Board and by
the Federal Open Market Committee on
all questions of policy relating to open
market operations, that it shall record
therein the votes taken in connection
with the determination of open market
policies and the reasons underlying each
policy action, and that it shall include in
its annual report to the Congress a full
account of such actions.
The minutes of the meetings contain
the votes on the policy decisions made
at those meetings as well as a resume of
the information and discussions that led
to the decisions. The summary descriptions of economic and financial conditions are based on the information that
was available to the Committee at the
time of the meetings rather than on data
as they may have been revised later.
Members of the Committee voting for
a particular action may differ among
themselves as to the reasons for their
votes; in such cases, the range of their
views is noted in the minutes. When
members dissent from a decision, they
are identified in the minutes and a summary of the reasons for their dissent is
provided.
Policy directives of the Federal Open
Market Committee are issued to the
Federal Reserve Bank of New York as
the Bank selected by the Committee to
execute transactions for the System
Open Market Account. In the area of
domestic open market operations, the
Federal Reserve Bank of New York
operates under three sets of instructions
from the Federal Open Market Committee: an Authorization for Domestic
Open Market Operations, Guidelines for
the Conduct of System Open Market
Operations in Federal Agency Issues,
and a Domestic Policy Directive. (A
new Domestic Policy Directive is
adopted at each regularly scheduled
meeting.) In the foreign currency area,
the Committee operates under an
Authorization for Foreign Currency
Operations, a Foreign Currency Directive, and Procedural Instructions with
Respect to Foreign Currency Operations. These policy instruments are
shown below in the form in which they
were in effect at the beginning of 2002.
Changes in the instruments during the
year are reported in the minutes for the
individual meetings.
Authorization for Domestic
Open Market Operations
In Effect January 1, 2002
1. The Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York, to the extent necessary to carry out the most recent domestic
policy directive adopted at a meeting of the
Committee:
(a) To buy or sell U.S. Government
securities, including securities of the Federal
Financing Bank, and securities that are direct
obligations of, or fully guaranteed as to
principal and interest by, any agency of the
162 89th Annual Report, 2002
United States in the open market, from or to
securities dealers and foreign and international accounts maintained at the Federal
Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System Open Market Account at market prices,
and, for such Account, to exchange maturing
U.S. Government and Federal agency securities with the Treasury or the individual
agencies or to allow them to mature without
replacement; provided that the aggregate
amount of U.S. Government and Federal
agency securities held in such Account
(including forward commitments) at the
close of business on the day of a meeting of
the Committee at which action is taken with
respect to a domestic policy directive shall
not be increased or decreased by more than
$12.0 billion during the period commencing
with the opening of business on the day following such meeting and ending with the
close of business on the day of the next such
meeting;
(b) To buy U.S. Government securities
and obligations that are direct obligations of,
or fully guaranteed as to principal and interest by, any agency of the United States, from
dealers for the account of the Federal
Reserve Bank of New York under agreements for repurchase of such securities or
obligations in 65 business days or less, at
rates that, unless otherwise expressly authorized by the Committee, shall be determined
by competitive bidding, after applying reasonable limitations on the volume of agreements with individual dealers; provided that
in the event Government securities or agency
issues covered by any such agreement are
not repurchased by the dealer pursuant to the
agreement or a renewal thereof, they shall be
sold in the market or transferred to the System Open Market Account;
(c) To sell U.S. Government securities
and securities that are direct obligations of,
or fully guaranteed as to principal and interest by, any agency of the United States to
dealers for System Open Market Account
under agreements for the resale by dealers of
such securities or obligations in 65 business
days or less, at rates that, unless otherwise
expressly authorized by the Committee, shall
be determined by competitive bidding, after
applying reasonable limitations on the volume of agreements with individual dealers.
2. In order to ensure the effective conduct
of open market operations, the Federal Open
Market Committee authorizes the Federal
Reserve Bank of New York to lend on an
overnight basis U.S. Government securities
held in the System Open Market Account to
dealers at rates that shall be determined by
competitive bidding but that in no event shall
be less than 1.0 percent per annum of the
market value of the securities lent. The Federal Reserve Bank of New York shall apply
reasonable limitations on the total amount of
a specific issue that may be auctioned, and
on the amount of securities that each dealer
may borrow. The Federal Reserve Bank
of New York may reject bids which could
facilitate a dealer's ability to control a single
issue as determined solely by the Federal
Reserve Bank of New York.
3. In order to ensure the effective conduct of
open market operations, while assisting in
the provision of short-term investments for
foreign and international accounts maintained at the Federal Reserve Bank of New
York, the Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York (a) for System Open
Market Account, to sell U.S. Government
securities to such foreign and international
accounts on the bases set forth in paragraph l(a) under agreements providing for
the resale by such accounts of those securities within 65 business days or less on terms
comparable to those available on such transactions in the market; and (b) for New York
Bank account, when appropriate, to undertake with dealers, subject to the conditions
imposed on purchases and sales of securities
in paragraph l(b), repurchase agreements in
U.S. Government and agency securities, and
to arrange corresponding sale and repurchase
agreements between its own account and
foreign and international accounts maintained at the Bank. Transactions undertaken
with such accounts under the provisions of
this paragraph may provide for a service fee
when appropriate.
4. In the execution of the Committee's decision regarding policy during any intermeeting period, the Committee authorizes and
directs the Federal Reserve Bank of
New York, upon the instruction of the Chairman of the Committee, to adjust somewhat
Minutes of FOMC Meetings
in exceptional circumstances the degree of
pressure on reserve positions and hence the
intended federal funds rate. Any such adjustment shall be made in the context of the
Committee's discussion and decision at its
most recent meeting and the Committee's
long-run objectives for price stability and
sustainable economic growth, and shall be
based on economic, financial, and monetary developments during the intermeeting
period. Consistent with Committee practice, the Chairman, if feasible, will consult
with the Committee before making any
adjustment.
Guidelines for the Conduct of
System Open Market Operations
in Federal Agency Issues
In Effect January 1, 2002
1. System open market operations in Federal agency issues are an integral part of total
System open market operations designed to
influence bank reserves, money market conditions, and monetary aggregates.
2. System open market operations in Federal agency issues are not designed to support individual sectors of the market or
to channel funds into issues of particular
agencies.
Domestic Policy Directive
In Effect January 1, 20021
The Federal Open Market Committee seeks
monetary and financial conditions that will
foster price stability and promote sustainable
growth in output. To further its long-run
objectives, the Committee in the immediate
future seeks conditions in reserve markets
consistent with reducing the federal funds
rate to an average of around PA percent.
The Committee also approved the
sentence below for inclusion in the press
statement to be released shortly after the
December 11, 2001, meeting:
1. Adopted by the Committee at its meeting on
December 11, 2001.
163
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks continue to be weighted mainly
toward conditions that may generate economic weakness in the foreseeable future.
Authorization for Foreign
Currency Operations
In Effect January 1, 2002
1. The Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York, for System Open Market
Account, to the extent necessary to carry out
the Committee's foreign currency directive
and express authorizations by the Committee pursuant thereto, and in conformity with
such procedural instructions as the Committee may issue from time to time:
A. To purchase and sell the following
foreign currencies in the form of cable transfers through spot or forward transactions on
the open market at home and abroad, including transactions with the U.S. Treasury, with
the U.S. Exchange Stabilization Fund established by Section 10 of the Gold Reserve
Act of 1934, with foreign monetary authorities, with the Bank for International Settlements, and with other international financial
institutions:
Canadian dollars
Danish kroner
Euro
Pounds sterling
Japanese yen
Mexican pesos
Norwegian kroner
Swedish kronor
Swiss francs
B. To hold balances of, and to have
outstanding forward contracts to receive or
to deliver, the foreign currencies listed in
paragraph A above.
C. To draw foreign currencies and to
permit foreign banks to draw dollars under
the reciprocal currency arrangements listed
in paragraph 2 below, provided that drawings by either party to any such arrangement
shall be fully liquidated within 12 months
after any amount outstanding at that time
was first drawn, unless the Committee,
because of exceptional circumstances, specifically authorizes a delay.
164 89th Annual Report, 2002
D. To maintain an overall open position in all foreign currencies not exceeding
$25.0 billion. For this purpose, the overall
open position in all foreign currencies is
defined as the sum (disregarding signs) of
net positions in individual currencies. The
net position in a single foreign currency is
defined as holdings of balances in that currency, plus outstanding contracts for future
receipt, minus outstanding contracts for
future delivery of that currency, i.e., as the
sum of these elements with due regard to
sign.
ing operating arrangements with foreign
central banks on System holdings of foreign
currencies, the Federal Reserve Bank of
New York shall not commit itself to maintain
any specific balance, unless authorized by
the Federal Open Market Committee. Any
agreements or understandings concerning the
administration of the accounts maintained by
the Federal Reserve Bank of New York with
the foreign banks designated by the Board
of Governors under Section 214.5 of Regulation N shall be referred for review and
approval to the Committee.
2. The Federal Open Market Committee directs the Federal Reserve Bank of
New York to maintain reciprocal currency
arrangements ("swap" arrangements) for the
System Open Market Account for periods up
to a maximum of 12 months with the following foreign banks, which are among those
designated by the Board of Governors of the
Federal Reserve System under Section 214.5
of Regulation N, Relations with Foreign
Banks and Bankers, and with the approval of
the Committee to renew such arrangements
on maturity:
5. Foreign currency holdings shall be invested to ensure that adequate liquidity is
maintained to meet anticipated needs and so
that each currency portfolio shall generally
have an average duration of no more than
18 months (calculated as Macaulay duration). When appropriate in connection with
arrangements to provide investment facilities
for foreign currency holdings, U.S. Government securities may be purchased from foreign central banks under agreements for
repurchase of such securities within 30 calendar days.
Foreign bank
Bank of Canada .
Bank of Mexico .
Amount
of arrangement
(millions of
dollars equivalent)
2,000
3,000
Any changes in the terms of existing swap
arrangements, and the proposed terms of any
new arrangements that may be authorized,
shall be referred for review and approval to
the Committee.
3. All transactions in foreign currencies
undertaken under paragraph l.A. above
shall, unless otherwise expressly authorized
by the Committee, be at prevailing market
rates. For the purpose of providing an investment return on System holdings of foreign
currencies, or for the purpose of adjusting
interest rates paid or received in connection
with swap drawings, transactions with foreign central banks may be undertaken at
nonmarket exchange rates.
4. It shall be the normal practice to arrange
with foreign central banks for the coordination of foreign currency transactions. In mak
6. All operations undertaken pursuant to
the preceding paragraphs shall be reported
promptly to the Foreign Currency Subcommittee and the Committee. The Foreign
Currency Subcommittee consists of the
Chairman and Vice Chairman of the Committee, the Vice Chairman of the Board of
Governors, and such other member of the
Board as the Chairman may designate (or in
the absence of members of the Board serving
on the Subcommittee, other Board members
designated by the Chairman as alternates,
and in the absence of the Vice Chairman of
the Committee, his alternate). Meetings of
the Subcommittee shall be called at the
request of any member, or at the request of
the Manager, System Open Market Account
("Manager"), for the purposes of reviewing
recent or contemplated operations and of
consulting with the Manager on other matters relating to his responsibilities. At the
request of any member of the Subcommittee,
questions arising from such reviews and consultations shall be referred for determination
to the Federal Open Market Committee.
7. The Chairman is authorized:
A. With the approval of the Committee, to enter into any needed agreement or
Minutes of FOMC Meetings 165
understanding with the Secretary of the Treasury about the division of responsibility for
foreign currency operations between the System and the Treasury;
B. To keep the Secretary of the Treasury fully advised concerning System foreign currency operations, and to consult with
the Secretary on policy matters relating to
foreign currency operations;
C. From time to time, to transmit
appropriate reports and information to the
National Advisory Council on International
Monetary and Financial Policies.
8. Staff officers of the Committee are authorized to transmit pertinent information on
System foreign currency operations to appropriate officials of the Treasury Department.
9. All Federal Reserve Banks shall participate in the foreign currency operations for
System Account in accordance with paragraph 3 G(l) of the Board of Governors'
Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks
dated January 1, 1944.
Foreign Currency Directive
In Effect January 1, 2002
1. System operations in foreign currencies
shall generally be directed at countering disorderly market conditions, provided that
market exchange rates for the U.S. dollar
reflect actions and behavior consistent with
the IMF Article IV, Section 1.
2. To achieve this end the System shall:
A. Undertake spot and forward purchases and sales of foreign exchange.
B. Maintain
reciprocal
currency
("swap") arrangements with selected foreign central banks.
C. Cooperate in other respects with
central banks of other countries and with
international monetary institutions.
currencies, and to facilitate operations of the
Exchange Stabilization Fund.
C. For such other purposes as may be
expressly authorized by the Committee.
4. System foreign currency operations shall
be conducted:
A. In close and continuous consultation and cooperation with the United States
Treasury;
B. In cooperation, as appropriate, with
foreign monetary authorities; and
C. In a manner consistent with the obligations of the United States in the International Monetary Fund regarding exchange
arrangements under the IMF Article IV.
Procedural Instructions with
Respect to Foreign Currency
Operations
In Effect January 1, 2002
In conducting operations pursuant to the
authorization and direction of the Federal
Open Market Committee as set forth in the
Authorization for Foreign Currency Operations and the Foreign Currency Directive,
the Federal Reserve Bank of New York,
through the Manager, System Open Market
Account ("Manager"), shall be guided by
the following procedural understandings
with respect to consultations and clearances
with the Committee, the Foreign Currency
Subcommittee, and the Chairman of the
Committee. All operations undertaken pursuant to such clearances shall be reported
promptly to the Committee.
1. The Manager shall clear with the Subcommittee (or with the Chairman, if the
Chairman believes that consultation with the
Subcommittee is not feasible in the time
available):
A. To adjust System balances in light
of probable future needs for currencies.
A. Any operation that would result in a
change in the System's overall open position
in foreign currencies exceeding $300 million
on any day or $600 million since the most
recent regular meeting of the Committee.
B. To provide means for meeting System and Treasury commitments in particular
B. Any operation that would result in a
change on any day in the System's net posi-
3. Transactions may also be undertaken:
166 89th Annual Report, 2002
tion in a single foreign currency exceeding
$150 million, or $300 million when the
operation is associated with repayment of
swap drawings.
C. Any operation that might generate a
substantial volume of trading in a particular
currency by the System, even though the
change in the System's net position in that
currency might be less than the limits specified in l.B.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
D. Any swap drawing proposed by a
foreign bank not exceeding the larger of
(i) $200 million or (ii) 15 percent of the size
of the swap arrangement.
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
2. The Manager shall clear with the Committee (or with the Subcommittee, if the
Subcommittee believes that consultation
with the full Committee is not feasible in the
time available, or with the Chairman, if the
Chairman believes that consultation with
the Subcommittee is not feasible in the time
available):
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and St. Louis
respectively
A. Any operation that would result in a
change in the System's overall open position
in foreign currencies exceeding $1.5 billion
since the most recent regular meeting of the
Committee.
B. Any swap drawing proposed by
a foreign bank exceeding the larger of
(i) $200 million or (ii) 15 percent of the
size of the swap arrangement.
3. The Manager shall also consult with the
Subcommittee or the Chairman about proposed swap drawings by the System and
about any operations that are not of a routine
character.
Meeting Held on
January 29-30, 2002
A meeting of the Federal Open Market
Committee was held in the offices of the
Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, January 29, 2002, at
2:30 p.m. and continued on Wednesday,
January 30, 2002, at 9:00 a.m.
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter,2 Deputy General Counsel
Ms. Johnson, Economist
Mr. Reinhart, Economist
Mr. Stockton, Economist
Mr. Connors, Ms. Cumming,
Messrs. Howard, Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, Rosenblum, Sniderman,
and Wilcox, Associate Economists
Mr. Kos, Manager, System Open
Market Account
Mr. Winn, Assistant to the Board,
Office of Board Members,
Board of Governors
Mr. Skidmore, Special Assistant to the
Board, Office of Board Members,
Board of Governors
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board of
Governors
2. Attended Tuesday session only.
Minutes ofFOMC Meetings, January
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division of
Research and Statistics, Board of
Governors
Messrs. Kamin3 and Whitesell,
Deputy Associate Directors,
Divisions of International Finance
and Monetary Affairs respectively,
Board of Governors
Messrs. Gagnon3 and ReifSchneider,3
Assistant Directors, Divisions of
International Finance and
Research and Statistics
respectively, Board of Governors
Mr. Small,3 Section Chief, Division of
Monetary Affairs, Board of
Governors
4
Mr. Morton, Senior Economist,
Division of International Finance,
Board of Governors
Messrs. Lebow4 and Williams,3 Senior
Economists, Division of Research
and Statistics, Board of Governors
Messrs. Ahearn3 and Wright,3
Economists, Division of
International Finance, Board of
Governors
Mr. Zakrajsek,4 Economist, Division
of Monetary Affairs, Board of
Governors
Ms. Low, Open Market Secretariat
Assistant, Office of Board
Members, Board of Governors
Mr. Lyon, First Vice President, Federal
Reserve Bank of Minneapolis
3. Attended portion of meeting relating to the
discussion of monetary policy near the zero bound
on nominal interest rates.
4. Attended portion of meeting relating to the
above discussion and to the Committee's review
of the economic outlook.
167
Messrs. Beebe, Eisenbeis, Fuhrer,
Goodfriend, Hakkio, Hunter,
Ms. Krieger, and Mr. Rasche,
Senior Vice Presidents, Federal
Reserve Banks of San Francisco,
Atlanta, Boston, Richmond,
Kansas City, Chicago, New York,
and St. Louis respectively
In the agenda for this meeting, it was
reported that advices of the election of
the following members and alternate
members of the Federal Open Market
Committee for the period commencing
January 1, 2002, and ending December 31, 2002, had been received and that
these individuals had executed their
oaths of office.
The elected members and alternate
members were as follows:
William J. McDonough, President of the
Federal Reserve Bank of New York,
with Jamie B. Stewart, Jr., First Vice
President of the Federal Reserve Bank
of New York, as alternate.
Anthony M. Santomero, President of the
Federal Reserve Bank of Philadelphia,
with J. Alfred Broaddus, Jr., President
of the Federal Reserve Bank of Richmond, as alternate.
Jerry L. Jordan, President of the Federal
Reserve Bank of Cleveland, with
Michael H. Moskow, President of the
Federal Reserve Bank of Chicago, as
alternate.
Robert D. McTeer, Jr., President of the Federal Reserve Bank of Dallas, with Jack
Guynn, President of the Federal
Reserve Bank of Atlanta, as alternate.
Gary H. Stern, President of the Federal
Reserve Bank of Minneapolis, with
Robert T. Parry, President of the Federal Reserve Bank of San Francisco, as
alternate.
By unanimous vote, the following
officers of the Federal Open Market
Committee were elected to serve until
168
89th Annual Report, 2002
the election of their successors at the
first regularly scheduled meeting of the
Committee after December 31, 2002,
with the understanding that in the event
of the discontinuance of their official
connection with the Board of Governors
or with a Federal Reserve Bank, they
would cease to have any official connection with the Federal Open Market
Committee:
Alan Greenspan
William J. McDonough
Donald L. Kohn
Normand R.V. Bernard
Gary P. Gillum
Michelle A. Smith
J. Virgil Mattingly, Jr.
Thomas C. Baxter, Jr.
Karen H. Johnson
Vincent R. Reinhart
David J. Stockton
Chairman
Vice Chairman
Secretary and
Economist
Deputy Secretary
Assistant
Secretary
Assistant
Secretary
General Counsel
Deputy General
Counsel
Economist
Economist
Economist
Thomas A. Connors, Christine Cumming,
David H. Howard, David E. Lindsey,
Loretta J. Mester, Stephen D. Oliner,
Arthur J. Rolnick, Harvey Rosenblum,
Mark S. Sniderman, and David W.
Wilcox, Associate Economists
By unanimous vote, the Federal
Reserve Bank of New York was selected
to execute transactions for the System
Open Market Account until the adjournment of the first regularly scheduled
meeting of the Committee after December 31, 2002.
By unanimous vote, Dino Kos was
selected to serve at the pleasure of the
Committee as Manager, System Open
Market Account, on the understanding
that his selection was subject to being
satisfactory to the Federal Reserve Bank
of New York.
Secretary's note: Advice subsequently
was received that the selection of Mr. Kos
as Manager was satisfactory to the board
of directors of the Federal Reserve Bank of
New York.
By unanimous vote, the Authorization for Domestic Open Market Operations was reaffirmed in the form shown
below.
Authorization for Domestic
Open Market Operations
(Reaffirmed January 29, 2002)
1. The Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York, to the extent necessary to carry out the most recent domestic
policy directive adopted at a meeting of the
Committee:
(a) To buy or sell U.S. Government
securities, including securities of the Federal
Financing Bank, and securities that are direct
obligations of, or fully guaranteed as to principal and interest by, any agency of the
United States in the open market, from or to
securities dealers and foreign and international accounts maintained at the Federal
Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System
Open Market Account at market prices, and,
for such Account, to exchange maturing U.S.
Government and Federal agency securities
with the Treasury or the individual agencies
or to allow them to mature without replacement; provided that the aggregate amount of
U.S. Government and Federal agency securities held in such Account (including forward
commitments) at the close of business on the
day of a meeting of the Committee at which
action is taken with respect to a domestic
policy directive shall not be increased or
decreased by more than $12.0 billion during
the period commencing with the opening of
business on the day following such meeting
and ending with the close of business on the
day of the next such meeting.
(b) To buy U.S. Government securities
and obligations that are direct obligations of,
or fully guaranteed as to principal and interest by, any agency of the United States, from
dealers for the account of the Federal
Reserve Bank of New York under agreements for repurchase of such securities or
obligations in 65 business days or less, at
rates that, unless otherwise expressly autho-
Minutes of FOMC Meetings, January 169
rized by the Committee, shall be determined
by competitive bidding, after applying reasonable limitations on the volume of agreements with individual dealers; provided that
in the event Government securities or agency
issues covered by any such agreement are
not repurchased by the dealer pursuant to the
agreement or a renewal thereof, they shall be
sold in the market or transferred to the System Open Market Account.
(c) To sell U.S. Government securities
and obligations that are direct obligations of,
or fully guaranteed as to principal and interest by, any agency of the United States to
dealers for System Open Market Account
under agreements for the resale by dealers of
such securities or obligations in 65 business
days or less, at rates that, unless otherwise
expressly authorized by the Committee, shall
be determined by competitive bidding, after
applying reasonable limitations on the volume of agreements with individual dealers.
2. In order to ensure the effective conduct
of open market operations, the Federal Open
Market Committee authorizes the Federal
Reserve Bank of New York to lend on an
overnight basis U.S. Government securities
held in the System Open Market Account to
dealers at rates that shall be determined by
competitive bidding but that in no event shall
be less than 1.0 percent per annum of the
market value of the securities lent. The Federal Reserve Bank of New York shall apply
reasonable limitations on the total amount of
a specific issue that may be auctioned, and
on the amount of securities that each dealer
may borrow. The Federal Reserve Bank
of New York may reject bids which could
facilitate a dealer's ability to control a single
issue as determined solely by the Federal
Reserve Bank of New York.
3. In order to ensure the effective conduct
of open market operations, while assisting in
the provision of short-term investments for
foreign and international accounts maintained at the Federal Reserve Bank of New
York, the Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York (a) for System Open
Market Account, to sell U.S. Government
securities to such foreign and international
accounts on the bases set forth in paragraph l(a) under agreements providing for
the resale by such accounts of those securities in 65 business days or less on terms
comparable to those available on such transactions in the market; and (b) for New York
Bank account, when appropriate, to undertake with dealers, subject to the conditions
imposed on purchases and sales of securities
in paragraph l(b), repurchase agreements in
U.S. Government and agency securities, and
to arrange corresponding sale and repurchase
agreements between its own account and
foreign and international accounts maintained at the Bank. Transactions undertaken
with such accounts under the provisions of
this paragraph may provide for a service fee
when appropriate.
4. In the execution of the Committee's
decision regarding policy during any intermeeting period, the Committee authorizes
and directs the Federal Reserve Bank of New
York, upon the instruction of the Chairman
of the Committee, to adjust somewhat in
exceptional circumstances the degree of
pressure on reserve positions and hence the
intended federal funds rate. Any such adjustment shall be made in the context of the
Committee's discussion and decision at its
most recent meeting and the Committee's
long-run objectives for price stability and
sustainable economic growth, and shall be
based on economic, financial, and monetary developments during the intermeeting
period. Consistent with Committee practice, the Chairman, if feasible, will consult
with the Committee before making any
adjustment.
By unanimous vote, the Committee
approved until the Committee's first
regularly scheduled meeting in 2003 a
further extension of the temporary suspension of paragraphs 3 to 6 of the
Guidelines for the Conduct of System
Open Market Operations in Federal
Agency Issues. For the year ahead, the
Guidelines therefore continued to read
as shown below:
Guidelines for the Conduct of
System Open Market Operations
in Federal Agency Issues
(Reaffirmed January 29, 2002)
1. System open market operations in Federal agency issues are an integral part of total
System open market operations designed to
170 89th Annual Report, 2002
influence bank reserves, money market conditions, and monetary aggregates.
2. System open market operations in
Federal agency issues are not designed to
support individual sectors of the market or
to channel funds into issues of particular
agencies.
By unanimous vote, the Authorization for Foreign Currency Operations
was reaffirmed in the form shown
below.
Authorization for Foreign
Currency Operations
(Reaffirmed January 29, 2002)
1. The Federal Open Market Committee
authorizes and directs the Federal Reserve
Bank of New York, for System Open Market
Account, to the extent necessary to carry out
the Committee's foreign currency directive
and express authorizations by the Committee
pursuant thereto, and in conformity with
such procedural instructions as the Committee may issue from time to time:
A. To purchase and sell the following
foreign currencies in the form of cable transfers through spot or forward transactions on
the open market at home and abroad, including transactions with the U.S. Treasury, with
the U.S. Exchange Stabilization Fund established by Section 10 of the Gold Reserve Act
of 1934, with foreign monetary authorities, with the Bank for International Settlements, and with other international financial
institutions:
Canadian dollars
Danish kroner
Euro
Pounds sterling
Japanese yen
Mexican pesos
Norwegian kroner
Swedish kronor
Swiss francs
B. To hold balances of, and to have
outstanding forward contracts to receive or
to deliver, the foreign currencies listed in
paragraph A above.
C. To draw foreign currencies and to
permit foreign banks to draw dollars under
the reciprocal currency arrangements listed
in paragraph 2 below, provided that drawings by either party to any such arrangement
shall be fully liquidated within 12 months
after any amount outstanding at that time
was first drawn, unless the Committee,
because of exceptional circumstances, specifically authorizes a delay.
D. To maintain an overall open position in all foreign currencies not exceeding
$25.0 billion. For this purpose, the overall
open position in all foreign currencies is
defined as the sum (disregarding signs) of
net positions in individual currencies. The
net position in a single foreign currency is
defined as holdings of balances in that currency, plus outstanding contracts for future
receipt, minus outstanding contracts for
future delivery of that currency, i.e., as the
sum of these elements with due regard to
sign.
2. The Federal Open Market Committee directs the Federal Reserve Bank of
New York to maintain reciprocal currency
arrangements ("swap" arrangements) for the
System Open Market Account for periods up
to a maximum of 12 months with the following foreign banks, which are among those
designated by the Board of Governors of the
Federal Reserve System under Section 214.5
of Regulation N, Relations with Foreign
Banks and Bankers, and with the approval of
the Committee to renew such arrangements
on maturity:
Foreign bank
Bank of Canada
Bank of Mexico
Amount of
arrangement
(millions of
dollars equivalent)
2,000
3,000
Any changes in the terms of existing swap
arrangements, and the proposed terms of any
new arrangements that may be authorized,
shall be referred for review and approval to
the Committee.
3. All transactions in foreign currencies
undertaken under paragraph LA. above
shall, unless otherwise expressly authorized
by the Committee, be at prevailing market
rates. For the purpose of providing an investment return on System holdings of foreign
currencies, or for the purpose of adjusting
interest rates paid or received in connection
with swap drawings, transactions with foreign central banks may be undertaken at
nonmarket exchange rates.
4. It shall be the normal practice to
arrange with foreign central banks for the
coordination of foreign currency transac-
Minutes of FOMC Meetings, January 111
tions. In making operating arrangements foreign currency operations between the Syswith foreign central banks on System hold- tem and the Treasury;
ings of foreign currencies, the Federal
B. To keep the Secretary of the TreaReserve Bank of New York shall not commit sury fully advised concerning System foritself to maintain any specific balance unless eign currency operations and to consult with
authorized by the Federal Open Market the Secretary on policy matters relating to
Committee. Any agreements or understand- foreign currency operations;
ings concerning the administration of the
C. From time to time, to transmit
accounts maintained by the Federal Reserve appropriate reports and information to the
Bank of New York with the foreign banks National Advisory Council on International
designated by the Board of Governors under Monetary and Financial Policies.
Section 214.5 of Regulation N shall be
8. Staff officers of the Committee are
referred for review and approval to the authorized to transmit pertinent informaCommittee.
tion on System foreign currency operations
5. Foreign currency holdings shall be to appropriate officials of the Treasury
invested to ensure that adequate liquidity is Department.
maintained to meet anticipated needs and so
9. All Federal Reserve Banks shall parthat each currency portfolio shall generally ticipate in the foreign currency operations
have an average duration of no more than for System Account in accordance with para18 months (calculated as Macaulay dura- graph 3 G(l) of the Board of Governors'
tion). When appropriate in connection with Statement of Procedure with Respect to Forarrangements to provide investment facilities eign Relationships of Federal Reserve Banks
for foreign currency holdings, U.S. Govern- dated January 1, 1944.
ment securities may be purchased from foreign central banks under agreements for
By unanimous vote, the Foreign Currepurchase of such securities within 30 calrency
Directive was reaffirmed in the
endar days.
form
shown
below.
6. All operations undertaken pursuant to
the preceding paragraphs shall be reported
promptly to the Foreign Currency Subcommittee and the Committee. The Foreign Cur- Foreign Currency Directive
rency Subcommittee consists of the Chair- (Reaffirmed January 29, 2002)
man and Vice Chairman of the Committee,
1. System operations in foreign currenthe Vice Chairman of the Board of Governors, and such other member of the Board cies shall generally be directed at countering
as the Chairman may designate (or in the disorderly market conditions, provided that
absence of members of the Board serving on market exchange rates for the U.S. dollar
the Subcommittee, other Board members reflect actions and behavior consistent with
designated by the Chairman as alternates, the IMF Article IV, Section 1.
2. To achieve this end the System shall:
and in the absence of the Vice Chairman
A. Undertake spot and forward purof the Committee, his alternate). Meetings
of the Subcommittee shall be called at the chases and sales of foreign exchange.
B. Maintain
reciprocal
currency
request of any member, or at the request of
the Manager, System Open Market Account ("swap") arrangements with selected for("Manager"), for the purposes of reviewing eign central banks.
recent or contemplated operations and of
C. Cooperate in other respects with
consulting with the Manager on other mat- central banks of other countries and with
ters relating to his responsibilities. At the international monetary institutions.
request of any member of the Subcommittee,
3. Transactions may also be undertaken:
questions arising from such reviews and conA. To adjust System balances in light
sultations shall be referred for determination of probable future needs for currencies.
to the Federal Open Market Committee.
B. To provide means for meeting System and Treasury commitments in particular
7. The Chairman is authorized:
A. With the approval of the Commit- currencies and to facilitate operations of the
tee, to enter into any needed agreement or Exchange Stabilization Fund.
C. For such other purposes as may be
understanding with the Secretary of the Treasury about the division of responsibility for expressly authorized by the Committee.
172 89th Annual Report, 2002
4. System foreign currency operations
shall be conducted:
A. In close and continuous consultation and cooperation with the United States
Treasury;
B. In cooperation, as appropriate, with
foreign monetary authorities; and
C. In a manner consistent with the obligations of the United States in the International Monetary Fund regarding exchange
arrangements under the IMF Article IV.
By unanimous vote, the Procedural
Instructions with Respect to Foreign
Currency Operations, in the form shown
below, were reaffirmed.
Procedural Instructions with
Respect to Foreign
Currency Operations
(Reaffirmed January 29, 2002)
In conducting operations pursuant to the
authorization and direction of the Federal
Open Market Committee as set forth in the
Authorization for Foreign Currency Operations and the Foreign Currency Directive,
the Federal Reserve Bank of New York,
through the Manager, System Open Market
Account ("Manager"), shall be guided by
the following procedural understandings
with respect to consultations and clearances
with the Committee, the Foreign Currency
Subcommittee, and the Chairman of the
Committee. All operations undertaken pursuant to such clearances shall be reported
promptly to the Committee.
1. The Manager shall clear with the Subcommittee (or with the Chairman, if the
Chairman believes that consultation with the
Subcommittee is not feasible in the time
available):
A. Any operation that would result in a
change in the System's overall open position
in foreign currencies exceeding $300 million
on any day or $600 million since the most
recent regular meeting of the Committee.
B. Any operation that would result in a
change on any day in the System's net position in a single foreign currency exceeding $150 million, or $300 million when the
operation is associated with repayment of
swap drawings.
C. Any operation that might generate a
substantial volume of trading in a particular
currency by the System, even though the
change in the System's net position in that
currency might be less than the limits specified in l.B.
D. Any swap drawing proposed by a
foreign bank not exceeding the larger of
(i) $200 million or (ii) 15 percent of the size
of the swap arrangement.
2. The Manager shall clear with the Committee (or with the Subcommittee, if the
Subcommittee believes that consultation
with the full Committee is not feasible in the
time available, or with the Chairman, if the
Chairman believes that consultation with the
Subcommittee is not feasible in the time
available):
A. Any operation that would result in a
change in the System's overall open position
in foreign currencies exceeding $1.5 billion
since the most recent regular meeting of the
Committee.
B. Any swap drawing proposed by a
foreign bank exceeding the larger of (i) $200
million or (ii) 15 percent of the size of the
swap arrangement.
3. The Manager shall also consult with
the Subcommittee or the Chairman about
proposed swap drawings by the System and
about any operations that are not of a routine
character.
On January 17, 2002, copies of the
continuing rules, regulations, and other
instructions of the Committee had been
distributed with the advice that, in
accordance with procedures approved
by the Committee, they were being
called to the Committee's attention
before the January 29-30 organization
meeting to give members an opportunity
to raise any questions they might have
concerning them. Members were asked
to indicate if they wished to have any
of the instruments in question placed
on the agenda for consideration at this
meeting, and no requests for consideration were received. Accordingly, all of
these instruments remained in effect in
their existing form.
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Minutes of FOMC Meetings, January
Committee held on December 11, 2001,
were approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange
markets. There were no open market operations in foreign currencies
for the System's account in the period
since the previous meeting of the
Committee.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and federal
agency obligations during the period
December 11, 2002, to January 29,
2002. By unanimous vote, the Committee ratified these transactions.
At this meeting, members discussed
staff background analyses of the implications for the conduct of policy if the
economy were to deteriorate substantially in a period when nominal shortterm interest rates were already at very
low levels. Under such conditions, while
unconventional policy measures might
be available, their efficacy was uncertain, and it might be impossible to
ease monetary policy sufficiently
through the usual interest rate process to
achieve System objectives. The members agreed that the potential for such an
economic and policy scenario seemed
highly remote, but it could not be dismissed altogether. If in the future such
circumstances appeared to be in the process of materializing, a case could be
made at that point for taking preemptive
easing actions to help guard against
the potential development of economic
weakness and price declines that could
be associated with the so-called "zero
bound" policy constraint.
The Committee then turned to a discussion of the economic and financial
outlook and the implementation of
monetary policy over the intermeeting
period ahead.
173
The information reviewed at this
meeting indicated that economic activity probably steadied in the fourth
quarter after a sizable drop in the
summer. Final demand appeared to
have increased appreciably, reflecting
strength in consumer spending and a
smaller decline in business purchases of
durable equipment and software. However, businesses met a good part of the
pickup in final demand through a large
runoff of inventories, and as a consequence manufacturing activity and payroll employment continued to weaken
late in the year, though at a slower pace.
Falling energy prices and widespread
discounting of goods held down consumer price inflation.
The labor market deteriorated somewhat further in December, and the
unemployment rate continued to climb,
to 5.8 percent. Private nonfarm payrolls
fell considerably, with manufacturing
again experiencing the largest job
losses, but the decrease was less than in
previous months and aggregate hours
worked by private production workers
leveled out after six months of decline.
Recent data on initial claims for unemployment insurance pointed to a further
moderation in employment losses in
January.
Industrial production edged down in
December after having fallen sharply
in previous months. A number of
industries experienced further reductions in output, with weakness most
pronounced in consumer nondurables
and business equipment. In contrast,
motor vehicle assemblies rose to
a still higher rate, presumably in
response to the robust sales of the
preceding two months, and the production of semiconductors and computers continued to strengthen. The
rate of utilization of total manufacturing capacity declined a little further
in December, and the average rate
174 89th Annual Report, 2002
for the fourth quarter was at its lowest
quarterly level since 1983.
Growth of consumer spending
strengthened considerably late in the
year after a slow advance in the third
quarter. A surge in purchases of motor
vehicles in response to attractive financing incentives was a key factor in
the pickup, but expenditures on goods
other than motor vehicles evidently also
accelerated slightly. By contrast, spending on services expanded at a reduced
pace, owing at least in part to relatively
low demand for residential heating
services.
Despite unseasonably warm and dry
autumn weather, residential construction
slowed somewhat in the fourth quarter.
For the year as a whole, though, homebuilding and home sales remained relatively brisk as very low mortgage rates
tended to offset the effects of a weakening job market and sluggish growth
in personal income. An apparent consequence of reduced income growth and
of lower equity prices was a change in
the mix of single-family homebuilding,
with less emphasis on construction of
high-priced homes.
Business expenditures on durable
equipment and software contracted
less rapidly in the fourth quarter, and
monthly data indicated that such spending might be bottoming out late in the
year despite further decreases in business output and continuing weakness in
corporate cash flows. Business purchases of motor vehicles accounted for
some of the improvement, and expenditures for computers and related equipment apparently recorded a small gain.
Elsewhere, though, acquisitions of communications equipment were still on a
downward trend, and business spending
in sectors other than high technology
and transportation remained weak. Nonresidential construction declined sharply
further in the fourth quarter despite
favorable weather over much of the
country. Spending on industrial structures plunged, reflecting low capacity
utilization in manufacturing and rising
vacancy rates. Office building activity
also fell as increasing amounts of available space and uncertainties regarding
rents and property values weighed on
the office market.
Nonfarm inventory liquidation apparently was very rapid in the fourth quarter, but inventory-sales ratios remained
elevated in an environment of weak
sales. The book value of manufacturing
and trade inventories plunged in October and November (latest data), but
progress in getting inventory overhangs
under control was limited. In manufacturing, the sector's stock-shipments
ratio persisted at a high level despite
continuing sizable rundowns in inventories since the spring. Wholesalers
apparently stepped up their runoffs of
excess stocks in recent months, yet the
aggregate inventory-sales ratio for the
sector had fallen only slightly since midyear. Retailers made greater progress
in reducing inventories, and despite
relatively sluggish sales the sector's
inventory-sales ratio dropped considerably and appeared to be at a fairly comfortable level.
The U.S. trade deficit in goods and
services narrowed slightly on balance
in October and November (latest data)
from the third-quarter level (adjusted to
exclude large, one-time payments by
foreign insurers related to the events
of September 11) as the value of imports
for the two-month period fell by more
than the value of exports. The available
information suggested further slight
slippage of economic activity in the
foreign industrial countries in the
fourth quarter. The Japanese economy
remained very weak, economic activity
in the euro area and Canada seemed
to have contracted, and growth in the
Minutes ofFOMC Meetings, January
United Kingdom apparently slowed.
There were some indications, however,
of a brighter economic outlook ahead in
the euro area, Canada, and the United
Kingdom that would result in part from
monetary easing actions that their
respective central banks had taken. Economic conditions in the major emergingmarket countries were mixed. There
were increasing signs of a recovery in
developing Asia, especially in some of
the countries that had been hurt by the
global high-tech slump, but conditions
in Latin America remained relatively
weak, with the Argentine economy having deteriorated further.
Consumer price inflation was quite
low at year-end. With energy prices
declining, both the consumer price
index (CPI) and the personal consumption expenditure (PCE) chain-type price
index edged down on balance in
November and December. Moreover,
excluding the effects of volatile oil
prices, core consumer price inflation
was held down late in the year by widespread discounting of goods. Consumer
price inflation as measured by the core
PCE index declined somewhat on a
year-over-year basis, while core CPI
inflation increased slightly in 2001. At
the producer level, core prices for finished goods changed little in November
and December, and the index for core
producer inflation slowed noticeably last
year. With regard to labor costs, growth
of average hourly earnings of production or nonsupervisory workers picked
up in November and December, but the
average wage increase for the year was
moderate and slightly less than that for
2000.
At its meeting on December 11, 2001,
the Committee adopted a directive that
called for implementing conditions
in reserve markets consistent with a
decrease of 25 basis points in the
intended level of the federal funds rate,
175
to about l3/4 percent. The members also
agreed that the balance of risks remained
weighted toward conditions that could
generate economic weakness in the
foreseeable future. The members noted
that there were preliminary signs of
some abatement of the contractionary
forces acting on the economy, but they
believed that a subpar economic performance was likely to persist for a time.
They also recognized that the stance of
policy was already quite accommodative and that much of the effect of recent
monetary easing actions was yet to be
felt. In the circumstances, they saw a
modest further reduction of the federal
funds rate as providing some added
insurance against a more extended contraction of the economy at little risk of a
pickup in inflation.
Federal funds traded at rates close to
the Committee's target level of 13A percent during the intermeeting period. The
Committee's action had been widely
anticipated, but the financial markets
evidently interpreted the announcement
as indicating that the FOMC's assessment of the economic outlook was
weaker than had been assumed. Corporate announcements of downward revisions to forecasts of future revenues
and capital spending also contributed to
some marking down by market participants of prospects for economic activity.
Yields on Treasury coupon securities
declined slightly over the intermeeting
period, risk spreads on corporate debt
securities changed little, and major
indexes of equity prices edged lower on
balance.
In foreign exchange markets, the
trade-weighted value of the dollar in
terms of the major foreign currencies
increased somewhat on balance over
the intermeeting period and reached
its highest level since the mid-1980s.
Weakness of the Japanese yen was an
important factor in that rise, as market
176 89th Annual Report, 2002
participants focused on continuing
problems in the Japanese economy and
on comments by Japanese officials that
seemed to signal a willingness to accept
a weaker value for the yen. The dollar
also appreciated slightly against the
euro, perhaps reflecting a market view
that the U.S. economy was likely to lead
the rebound from the global slowdown.
In addition, the exchange value of the
dollar increased slightly in terms of an
index of the currencies of other important trading partners, in part because of
the depreciation of the Argentine peso.
Growth of M2 slowed slightly in
December from November's robust pace
and moderated considerably further in
the early weeks of January. The brisk
expansion of liquid deposits over recent
months had been associated with the
effects of mortgage refinancing activity
and the substantial decline in the opportunity costs of such deposits that was
related to previous easing actions. The
currency component of M2 also had
been strong in the latter part of 2001,
largely the result of a pickup in demand
for U.S. currency abroad. The debt of
the domestic nonfinancial sectors was
estimated to have expanded at a slightly
slower rate in December, reflecting
some moderation in business debt
financing, a slightly slower pace of
household borrowing, and little net borrowing by the federal government.
The staff forecast prepared for this
meeting suggested that economic activity likely would start to turn up early
in 2002 as inventory liquidation tapered
off, and would gather strength only
gradually. The monetary ease and fiscal
stimulus already in place would provide
impetus for the recovery, though the
wealth effects of earlier reductions in
equity prices, sluggish growth abroad,
and the dollar's strength would tend to
offset some of that support for a time.
The gradual strengthening of the recov
ery would be associated with a marked
slowing in the contraction of business
capital investment and the added consumer purchasing power arising from
recent declines in oil prices. Economic
expansion was projected to strengthen
appreciably by the second half of 2002
and subsequently, as the climate for
business fixed investment continued to
improve and as a strengthening of foreign economies led to somewhat greater
demand for U.S. exports. The unemployment rate would begin to edge down.
Subpar expansion over the next few
quarters was expected to foster an appreciable further easing of pressures on
resources and some moderation in core
consumer price inflation.
In the Committee's discussion of current and prospective economic conditions, members commented that the
recent information was more positive
than they had anticipated and seemed
on the whole to indicate that economic
activity was bottoming out and a recovery might already be under way. Important impetus to economic activity in the
period immediately ahead likely would
be provided by a turnaround in inventory investment following several quarters of increasingly large liquidation that
had culminated in the outsized decline
in inventories reported for the fourth
quarter. Looking beyond the near term,
members expressed considerable uncertainty about the prospective strength of
final demand. The stimulus from fiscal and monetary actions taken in 2001,
the impetus to growth from the inducement to new investment provided by
improving technology, and the persisting uptrend in household spending
would support the economic recovery.
However, household spending had been
relatively robust during the cyclical
downturn and likely had only limited
room for a pickup over coming quarters,
and intense competitive pressures could
Minutes of FOMC Meetings, January 111
well constrain profits, investment, and
equity prices. As a result, the members
were concerned that the acceleration in
final demand could be modest, at least
for a time. Against this background, the
prospects for continued low inflation
remained favorable, given the currently
reduced utilization of resources and
indeed the prospect for some added
slack should economic growth remain
below potential in coming quarters, as
many members anticipated. Moreover,
the further passthrough of earlier
declines in energy prices would continue to ease pressures on prices and
costs more generally throughout the
economy.
In preparing for the semi-annual
monetary policy report to the Congress,
the Board members and Reserve Bank
presidents provided their individual projections for the growth of GDP, civilian
unemployment, and consumer price
inflation for the year 2002. They projected that the economy would begin to
recover this year from the generally mild
downturn experienced in 2001, but the
pace of expansion would pick up only
gradually and the unemployment rate
would climb somewhat further. The central tendency of their forecasts of growth
in real GDP for 2002 was 2Vi to 3 percent, measured as the change between
the fourth quarter of 2001 and the fourth
quarter of 2002, while their forecasts of
the civilian unemployment rate in the
fourth quarter of the year were centered
on 6 to 6x/4 percent. The forecasts
of consumer price inflation this year, as
measured by the PCE chain-type price
index, were narrowly clustered around
lx/2 percent.
With regard to the prospective course
of the projected recovery, members generally anticipated that a positive swing
in inventory investment abetted by
further growth in consumer spending
would provide an important upward
thrust to the expansion over the nearer
term. The inventory correction that had
occurred over the past year was of a
magnitude that would inevitably result
in a reduced rate of liquidation and an
eventual restocking unless, contrary to
current expectations, consumer spending were to weaken markedly. The
accompanying fillip to production and
incomes would have positive feedback
effects over time on household expenditures and business investment. The
extent and timing of the turnaround in
inventory investment for the economy
as a whole were subject to a considerable degree of uncertainty, but members
noted that some firms already appeared
to have adjusted their inventories to
what they viewed as acceptable levels,
and there were indications that some
manufacturing firms were making
efforts to rebuild inventories in the context of improving orders. More generally, however, business firms appeared
to have remained very cautious in setting their inventory investment plans.
The evidence of unexpected strength
in overall final demand indicated by the
just-released GDP report was supported
by anecdotal commentary from around
the nation. Regional economic reports
were somewhat mixed in that declining
activity still characterized conditions in
some areas, but the pace of the declines
appeared to have moderated in those
areas and improved conditions were
noted in other parts of the country.
Business sentiment, while still quite
depressed in some areas, was described
in many reports as having shifted toward
cautious optimism.
Concerning prospective developments in final demand in major sectors
of the economy, several members underscored what they viewed as the key role
of household expenditures. Such spending had held up remarkably well in the
face of major adverse developments,
178 89th Annual Report, 2002
including sharp declines in stock market wealth and rising unemployment,
that were exacerbated by the events
of September 11. But with households
remaining confident about the future and
equity prices having rebounded from
their post-attack declines, sustained
growth in household expenditures was
seen as a likely prospect. Such spending also would be supported in part
by some strengthening or less weakness
in other important sectors of the economy. Some members nonetheless cited
a number of potential negatives relating
to the prospects for consumer spending, including the possibility of adverse
effects on consumer confidence of further anticipated increases in unemployment and the risk that generally disappointing business profits or more
widespread downward restatements of
reported profits might generate sizable
declines in stock market prices and consumer wealth. Moreover, the unusually
large sales of motor vehicles and to a
degree other durable goods during the
closing months of 2001 might have borrowed to some extent from sales in coming months. On balance, the positive
and negative factors bearing on the outlook for consumer spending suggested
that moderate growth was a reasonable
expectation.
Residential construction expenditures, like household spending for consumer goods and services, had held
up well despite the cyclical downturn
in employment and sizable net losses
in stock market wealth. Low mortgage
interest rates and, in recent months,
favorable weather conditions had provided vital support to this sector of the
economy. Recent housing activity,
including record sales in some areas,
suggested persisting underlying strength
in residential construction. Even so, the
large additions to the supply of new
homes in earlier years tended to indi
cate that additional impetus, if any, from
housing construction would be limited
over the next several quarters.
The outlook for business capital
expenditures was improving, but anecdotal reports suggested that business
executives were still notably cautious
in formulating their spending plans,
and indications of accelerating capital
investment were still quite limited. In
the high-tech sector, positive signs were
noted in the demand for computers and
peripherals, but the outlook for communications equipment was still very negative. Business spending for other equipment was also expected to remain soft.
On balance, the capital investment sector seemed likely to retard the overall
advance in economic activity during the
quarters immediately ahead as many
firms continued to pare excess capacity
and businesses awaited clearer indications of rising demand and profits.
Beyond the nearer term, however, the
favorable outlook for productivity
growth and related profit opportunities
pointed to a revival of robust capital
spending. Indeed, past experience suggested that once a rebound in capital
spending took hold it easily could
exceed current forecasts of moderate
acceleration.
Fiscal policy would continue to provide substantial stimulus to the economy this year in light of the ongoing
effects of the tax reduction measures
enacted in 2001 and the sharp increase
in federal government spending in
train. This outlook did not incorporate
the possible enactment of further tax
cut legislation, whose prospects now
seemed to be remote. A partial offset
to federal government stimulus was
the likelihood of considerably reduced
spending growth at the state and local
government levels, where numerous
government entities were experiencing severe budget strains associated
Minutes of FOMC Meetings, January
with recession-related weakness in tax
revenues.
The external sector of the economy
was seen as a source of some potential downside for the domestic economy in the period just ahead. Generally weak foreign economies and the
recent strength of the dollar in foreign
exchange markets were expected to continue to restrain U.S. exports. Economic
recoveries in many foreign nations
seemed likely over the course of this
year, but the strength of those recoveries
was subject to considerable uncertainty,
and the risk that serious difficulties in
some important economies might spread
could not be overlooked. Recovery
abroad, notably in some key U.S. trading partners, would be tied to an
important extent to the course of U.S.
economic activity and would not be
providing much impetus to U.S. exports
over coming quarters. At this point signs
of an upturn in foreign trade were not
entirely lacking, notably in some hightech goods, but those indications were
still very limited.
Inflation was likely to remain quite
subdued. Indeed, core inflation could
well edge lower. The indirect effects of
the declines that had occurred in energy
prices would continue to hold down
other input prices and be passed on more
fully to final purchasers. More generally, the low rate of resource utilization anticipated over the year ahead, rising productivity, and highly competitive
market pricing could be expected to
moderate price pressures. Against that
background, members continued to view
the greater risks to the economy as those
relating to concerns about economic
activity rather than prices.
In the Committee's discussion of policy for the intermeeting period ahead, all
the members agreed that recent developments argued for keeping the stance of
policy unchanged at this time. Monetary
179
policy had been eased substantially over
the past year, and, with the real federal
funds rate at an unusually low level,
policy seemed well positioned to support an economic recovery as the forces
restraining demand abated. In fact, a
growing number of indicators pointed to
a reduction in the pressures holding back
the economy and to an emerging business recovery. In these circumstances, a
pause seemed desirable to monitor the
still-incomplete effects of the Committee's easing over the past year—a significant part of which had been implemented in recent months—and the
contours of the turnaround in economic
activity.
All the members indicated that they
could support the issuance of a public
statement indicating that the risks
remained tilted toward economic weakness. Although the economy was probably strengthening, a variety of factors
could well keep the pace of expansion
below the rate of growth of potential
for a while, even at the current policy
stance. Moreover, inflation was running
at a fairly low rate and quite possibly
would edge down a little further over
coming quarters. In these circumstances,
the risk to achieving the Committee's
objective for fostering sustainable economic growth seemed to be greater than
to its objective of maintaining reasonable price stability. In the view of a few
members, an argument could be made
for moving to a balanced-risks statement, given that they could envisage
developments that could strengthen the
economy beyond their current forecasts.
However, they agreed that a shift to
balanced risks in conjunction with an
unchanged policy stance could at this
point be misread in financial markets as
an indication of a much more optimistic
view of the economic outlook than the
members currently entertained. Such an
interpretation might foster unwarranted
180 89th Annual Report, 2002
and counterproductive adjustments in
financial markets. In any event, emerging economic conditions in line with
the members' current forecasts would
provide ample opportunity to shift to
a balanced-risks statement at a future
meeting when it might be more clearly
appropriate.
At the conclusion of this discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive:
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the federal funds rate at an average of around
PA percent.
The votes encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting.
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks continue to be weighted mainly
toward conditions that may generate economic weakness in the foreseeable future.
Votes for this action: Messrs. Greenspan,
McDonough, Ms. Bies, Messrs. Ferguson,
Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Vote against this
action: None. Absent and not voting:
Mr. Meyer.
Disclosure Policy
In accordance with the Committee's
routine practice of reviewing its rules
and regulations at its first regular meet
ing of each year, the members discussed
their policies regarding the extent of the
information that is released to the public about its discussions and decisions
along with the timing of the release of
such information. They noted that the
changes in disclosure policy and practices implemented in recent years,
including the announcement of policy
actions and brief explanations of the
basis for those actions, have served both
the Federal Reserve and the public well.
They also believed that it would be
appropriate to explore whether there
might be scope for some further evolution in the Committee's policies in the
direction of greater transparency, though
additional study and analysis would
be needed. They agreed to discuss the
issues further at a future meeting.
It also was agreed that the next meeting of the Committee would be held on
Tuesday, March 19, 2002.
The meeting adjourned at 12:30 p.m.
on January 30, 2002.
Donald L. Kohn
Secretary
Meeting Held on
March 19, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, March 19, 2002, at
9:00 a.m.
PresentMr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Minutes of FOMC Meetings, March 181
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
Mr. Reinhart, Economist
Mr. Stockton, Economist
Mr. Connors, Ms. Cumming,
Messrs. Howard and Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, Rosenblum, Sniderman,
and Wilcox, Associate Economists
Mr. Kos, Manager, System Open
Market Account
Mr. Winn, Assistant to the Board,
Office of Board Members, Board
of Governors
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board
of Governors
Mr. Whitesell, Deputy Associate
Director, Division of Monetary
Affairs, Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Mr. English, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Skidmore, Special Assistant to
the Board, Office of Board
Members, Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Office of Board
Members, Board of Governors
Ms. Pianalto and Mr. Stewart, First
Vice Presidents, Federal Reserve
Banks of Cleveland and New York
respectively
Messrs. Beebe, Eisenbeis, Fuhrer,
Goodfriend, Hakkio, Hunter, and
Rasche, Senior Vice Presidents,
Federal Reserve Banks of
San Francisco, Atlanta, Boston,
Richmond, Kansas City, Chicago,
and St. Louis respectively
Ms. Hargraves, Vice President, Federal
Reserve Bank of New York
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on January 29-30,
2002, were approved.
By notation vote completed on
March 19, 2002, the members of the
Federal Open Market Committee voted
unanimously to accept the Report of
Examination of the System Open Market Account conducted as of the close of
business on November 14, 2001, by the
Division of Reserve Bank Operations
and Payment Systems of the Board of
Governors.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities
issued or fully guaranteed by federal
agencies during the period January 30,
2002, through March 18, 2002. By
unanimous vote, the Committee ratified
these transactions.
182 89th Annual Report, 2002
At this meeting the staff requested
Committee guidance on the priorities,
given limited staff resources, it should
attach to further studies of the feasibility of outright purchases for the System Open Market Account (SOMA) of
mortgage-backed securities guaranteed
by the Government National Mortgage Association (GNMA-MBS) and
the addition of foreign sovereign debt
securities to the list of collateral eligible for U.S. dollar repurchase agreements by the System. Such alternatives
could prove useful if outstanding Treasury debt obligations were to become
increasingly scarce relative to the necessary growth in the System's portfolio,
and the Committee had previously
requested initial staff exploration of
these options. Noting that many of the
staff engaged in these studies were also
involved in contingency planning, which
had been intensified after the September 11 attacks, the consensus of
the members was to give the highest
priority to such planning. All the members preferred continued reliance to the
extent feasible on direct Treasury debt
for outright System transactions, and
they were persuaded that budget developments over the last year meant that
constraints on Treasury debt supplies
would not become as pressing an issue
as soon as they had previously thought.
Still, given the inherent uncertainty of
budget forecasts, the likely significant
needs for large SOMA operations in
coming years and the lead times needed
to implement new procedures, the Committee decided that the study of alternative market instruments should go
forward once it was possible to do so
without impeding the contingency planning effort. With regard to the two proposed alternatives for broadening the
System's options for open market operations, the members instructed the staff to
give a higher priority to further exami
nation of outright purchases of GNMAMBS. Although these securities have a
number of shortcomings as an outright
investment vehicle from the System's
perspective, the market for GNMAMBS was well developed and the securities were guaranteed by the full faith
and credit of the U.S. government.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting indicated that economic activity had turned up in the final quarter
of last year and strengthened further
since then. Consumer spending on
goods other than motor vehicles was
brisk in the early part of this year,
business purchases of equipment and
software appeared to be beginning to
recover from their marked decline of
last year, and housing starts turned back
up. Amid signs that most firms had
worked down their inventories to more
comfortable levels, industrial production increased slightly after having
declined for nearly a year and a half,
and payroll employment appeared to be
bottoming out. Inflation remained low
despite some firming of energy prices.
Private nonfarm payroll employment
moved up in February, retracing part
of January's drop. Layoffs in manufacturing slowed further, the construction
industry added back some workers in
February, and the retail trade and services sectors continued to hire in both
months. The unemployment rate edged
down again in February to 5.5 percent,
and initial claims for unemployment
insurance continued to drop.
Industrial production increased somewhat in January and February after a
steep decline from its June 2000 peak.
Manufacturing output rose in both
months, and the factory operating rate
Minutes of FOMC Meetings, March 183
moved up slightly from its low level at
year-end. The pickup in manufacturing
this year was spread across several
major industries, including chemicals,
computers and semiconductors, paper,
and tobacco. In addition, output of communications equipment steadied after
having plunged for more than a year. In
contrast, production of motor vehicles
and parts changed little over January
and February after a surge late in 2001.
Consumer spending remained strong
in the early part of the year, despite a
sizable drop in purchases of light vehicles in January that was followed by a
rebound in February as manufacturers
switched from attractive financing terms
to cash rebates. Outlays for retail items
other than motor vehicles expanded further in February after the large increases
recorded in the two prior months. Outlays for services continued to rise
moderately in January (latest data).
Consumer purchases were supported by
a sizable gain in disposable personal
income in January, and readings on consumer sentiment were close to their historical averages.
Residential construction had been
very strong in the past several months,
with new starts reaching their highest
level in almost two years. The strength
in homebuilding was associated in part
with unusually warm and dry weather,
but very low mortgage rates also continued to play an important role.
Business spending on durable equipment and software appeared to be turning upward after a marked moderation
in the fourth quarter of the steep decline
recorded in the two previous quarters.
Shipments and orders of nondefense
capital goods were unexpectedly strong
in January. There were signs of recovery
in the high-tech sector, with shipments
of computers and peripherals increasing
for a fifth straight month, but shipments
of communications equipment turned
down in January after a December
bounce. Shipments in most other sectors
recorded increases and were particularly
robust for machinery, engines, and turbines. Business demand for motor vehicles remained mixed, with fleet sales
of light vehicles higher and purchases
of medium and heavy trucks somewhat
weaker. Nonresidential construction
remained in a slump, with spending on
new office buildings and industrial
structures down sharply in an environment of elevated vacancy rates.
The pace of liquidation of manufacturing and trade inventories, excluding
motor vehicles, slowed in January after
a very rapid rundown in the fourth quarter, and with sales higher the aggregate
inventory-sales ratio declined to its lowest level since midyear 2000. Manufacturers' stocks were drawn down sharply
further in January, and the sector's
stock-to-shipments ratio fell appreciably. At the wholesale level, the rate
of inventory runoff slowed somewhat,
but the sector's inventory-sales ratio
declined further. The level of inventories at the retail level increased somewhat despite a rise in sales, and the
sector's aggregate inventory-sales ratio
was at an historically low level.
The U.S. trade deficit in goods and
services widened somewhat in January.
The value of exports changed little but
the value of imports rose appreciably, to
about the November level. The available
information indicated that economic
activity in the foreign industrial countries showed little net change in the
fourth quarter. The Canadian economy
rebounded from a weak third quarter,
but economic expansion in the United
Kingdom nearly came to a halt in the
fourth quarter, economic activity in the
euro area slipped a little, and the Japanese economy recorded a steep drop.
There were indications, however, of a
gradually improving economic outlook
184 89th Annual Report, 2002
in several of these economies in the first
quarter as a consequence of previous
monetary policy easing actions that their
respective central banks had taken and
from the effects of an improved economic performance in the United States.
Among the major emerging-market
countries, the exports of a number of
Asian economies were benefiting from
the nascent recovery in high-tech
industries around the world. In Latin
America, although Argentina remained
in a steep downward trend, the Mexican
and Brazilian economies seemed to be
recovering from weakness in the fourth
quarter.
Consumer price inflation picked up a
bit in January as energy prices posted
their first increase since September.
However, on a year-over-year basis,
core price inflation as measured by the
consumer price index leveled out at a
moderate rate, while core PCE (personal consumption expenditure) price
inflation declined appreciably. Labor
costs also appeared to have decelerated
recently. The employment cost index for
hourly compensation in private industry
rose moderately in the fourth quarter of
last year and for the year as a whole.
Both the salary and benefits components
recorded slightly smaller increases last
year. Average hourly earnings of production and nonsupervisory workers
advanced only slightly in January and
February of this year, and the average
wage increase during the twelve months
through February was slightly lower
than that for the twelve-month period
ending in February 2001.
At its meeting on January 29-30,
2002, the Committee adopted a directive
that called for implementing conditions
in reserve markets consistent with keeping the intended level of the federal
funds rate at 13A percent. The members
noted that policy had been eased substantially over the past year and that the
inflation-adjusted federal funds rate was
at an unusually low level. As a result,
policy was positioned to support an economic recovery as forces restraining
aggregate demand abated. Nonetheless,
the members agreed that there were factors that might keep the pace of expansion below the rate of growth of potential for a while, and thus the balance
of risks continued to be tilted toward
economic weakness in the foreseeable
future.
The federal funds rate remained close
to the Committee's target level of
1% percent during the intermeeting
period. However, short-term market
rates increased slightly over the intermeeting interval, and yields on longerterm Treasury instruments and highgrade corporate bonds rose by more.
The rise in rates was sparked initially
by market participants' reading of the
Committee's press statement as suggesting greater-than-expected optimism
about the economy going forward. That
assessment was subsequently strengthened by data on spending and output
released during the intermeeting interval
that came in well above market expectations. Speculative-grade bond yields fell
somewhat in reaction to the improved
economic outlook and the perceived
reduction of credit risk. Most major
indexes of equity prices moved up
sharply on the bullish economic reports.
In foreign exchange markets, the
trade-weighted value of the dollar in
terms of the major foreign currencies
eased slightly on balance over the intermeeting period. The dollar fell more
against the yen than the euro despite
negative economic news from Japan and
the disappointing reaction to the Japanese government's announcement of an
"anti-deflation" package. The exchange
value of the dollar changed little in
terms of an index of the currencies of
other important trading partners, in part
Minutes ofFOMC Meetings, March 185
because of the further depreciation of
the Argentine peso.
Expansion of M2 rebounded somewhat in February from January's lackluster rate, but growth in the early part
of the year was down sharply from the
robust pace of late last year. The slowdown apparently was related to the ebbing effect of earlier declines in opportunity costs of holding M2 assets and
to the shift of large amounts of money
from retail money market funds into
bond and equity mutual funds as concerns about volatility in financial markets eased. Reduced demand for mortgage refinancing also seemed to have
contributed to the deceleration of M2.
The debt of the domestic nonfmancial
sectors was estimated to have increased
at a relatively slow rate in January,
reflecting weak demand for business
debt financing and little net borrowing
by the federal government.
The staff forecast prepared for this
meeting suggested that economic activity was expanding briskly in the early
months of the year after having turned
up and increased modestly in the fourth
quarter. Elevated household spending
and a shift from inventory liquidation to
accumulation would provide significant
impetus for the recovery in the context
of the substantial monetary ease and fiscal stimulus already in place. Moreover,
the recently enacted federal incentive
for new business equipment investment along with the outlook for continued robust gains in productivity were
expected to help boost business capital spending. At the same time, stilldepressed equity prices, limited growth
abroad, and the dollar's strength would
tend to hold down the pace of recovery.
On balance, recent developments suggested that the course of final sales now
had a more positive contour over the
forecast horizon and that resource utilization would rise somewhat more than
anticipated earlier despite higher projected growth in structural productivity.
Even so, overall activity would remain
below estimates of the economy's
potential output for some time, and the
persistence of underutilized resources
was expected to keep downward pressure on core price inflation.
In the Committee's discussion of current and prospective economic developments, members commented that the
decidedly positive information received
over the intermeeting period provided
strong evidence that an economic recovery was now under way, though its prospective strength remained subject to
substantial uncertainty. In this regard it
was noted that the economy was undergoing significant structural changes and
those changes were adding to the usual
difficulty of projecting the trajectory of
economic activity after a turning point.
Unexpected strength in household
expenditures, much reduced weakness
in business capital spending, and substantial slowing in inventory liquidation had produced an earlier upturn in
economic activity than many had anticipated. A further strengthening of inventory investment would probably generate appreciable further growth in
business activity over the quarters just
ahead. Once the ongoing inventory correction was completed, however, it was
not clear to what extent final demand
in key sectors of the economy, notably
business capital investment, would
provide support for further economic
growth. While the members agreed that
the stimulative fiscal and monetary policies currently in place would undergird
further economic expansion, most continued to anticipate a relatively subdued
rate of expansion that would only gradually erode current margins of underutilized productive resources. The members viewed the outlook for core price
inflation as still quite benign, largely
186 89th Annual Report, 2002
reflecting the ample availability of labor
and other producer resources to accommodate rising economic activity and the
favorable prospects for further robust
growth in productivity.
Anecdotal commentary from around
the country was somewhat less positive
on the whole than the recent macroeconomic data for the nation. Business conditions were reported to be improving in
most areas and industries, but the pickup
was uneven, with continued weakness
still characterizing numerous industries.
Many business contacts, although somewhat less pessimistic about the economic outlook, still did not appear to be
anticipating a strong upturn this year.
Gradual recovery was reported in the
depressed tourism and travel industries.
The manufacturing sector, where much
of the economy's weakness had been
concentrated, was displaying increased
signs of stabilizing, with activity actually picking up in a number of industries
and some firms anticipating increases
in their payrolls over the next several months after experiencing large
declines. However, employers in manufacturing and other sectors of the economy generally remained cautious in
their hiring policies and in their plans
for capital spending.
In their discussion of developments in
key expenditure sectors of the economy,
members commented that inventory
investment was likely to remain a pivotal factor in the nearer-term performance of the economy. Firms had
moved rapidly to correct earlier inventory imbalances. Data indicating a very
large drawdown of inventories in the
fourth quarter and further, albeit much
diminished, liquidation in January along
with anecdotal commentary suggested
that inventories were now close to
desired levels in many industries, notably in the retail sector, and the swing
toward smaller drawdowns was giving
a boost to industrial production. Looking ahead, inventory investment likely
would turn toward accumulation as
business firms facing brisk demand and
depleted stocks stepped up their new
orders, providing a source of significant
strength in fostering economic recovery
over the near term.
A major uncertainty in the economic
outlook was the extent to which growth
in final demand by households and business firms would provide ongoing support for the expansion as the impetus
from inventory investment dissipated.
The prospects for consumer spending
remained favorable against the backdrop of a solid uptrend in disposable
incomes associated to an important
extent with an improving employment
picture, robust underlying growth in
labor productivity, and the further
phase-in of personal income tax cuts
enacted in 2001. Consumer confidence
had improved considerably in recent
months and consumer expenditures had
displayed surprising strength. Members
nonetheless cited some negatives in the
outlook for consumer spending including the possibilities that a negative stock
market wealth effect stemming from
large earlier declines and the somewhat
elevated rate of unemployment would
weigh on consumer confidence. Importantly, because consumer spending for
automobiles and other consumer durables had been well maintained through
the extended period of economic weakness, further gains in such expenditures
were likely to be limited over coming
quarters in contrast to the typical surge
in past economic recoveries. Moreover,
energy price increases, especially if they
were to become more pronounced,
would tend to hold back household
spending. On balance, members saw
moderate further growth in consumer
spending as a reasonable prospect for
coming quarters.
Minutes of FOMC Meetings, March 187
After a lull during the fall of 2001,
housing activity had displayed renewed
vigor in recent months, in part as a consequence of widely favorable weather
conditions. Indeed, single-family construction was described as a particularly
bright sector in a number of local economies. Looking ahead, the favorable
factors affecting consumer spending
more generally along with relatively low
mortgage interest rates were expected to
sustain a high level of housing expenditures this year. In keeping with the outlook for consumer durables, however, a
long period of active housing construction suggested that significant additional
strength in housing was unlikely in coming quarters.
The members generally viewed business fixed investment spending as the
key to the strength of economic activity
once the thrust from inventory restocking had run its course. The outlook for
business capital expenditures would be
governed to an important extent by business expectations regarding sales and
profits. After the steep declines in business investment over the past year, anecdotal reports from around the country
provided scattered indications of an
upturn but no evidence at this point of
any broad-based improvement. According to such reports and despite the
strength of recent economic statistics,
which had boosted the economic forecasts of many observers, business confidence remained at a low level, evidently
reflecting a weak outlook for profits
in the business community in the context of strong competitive pressures.
Negative factors bearing on the outlook for investment in capital equipment included the persistence of large
margins of excess capacity in many
industries. The outlook for commercial
and other nonresidential construction
seemed even less promising, at least for
the next several quarters, given high
vacancy rates in commercial structures
in many parts of the nation. Members
nonetheless cited some positives in this
outlook that included the favorable
effects on incentives to purchase capital
equipment stemming from the outlook
for relatively rapid growth in productivity and the recent passage of legislation
providing a temporary tax incentive for
investments in equipment and software.
On balance, a substantial pickup in overall capital spending seemed likely to be
delayed in the absence of surprising
strength in final demand, but a wide
range of possible outcomes could not
be ruled out for this key sector of the
economy.
Several members referred to the currently high degree of fiscal policy stimulus, which had been augmented by
recent legislation. Much of the added
stimulus from the investment incentive
component of that legislation was not
likely to be felt for some period and
might occur at a time when the economy
would already be expanding at a solid
pace. Federal spending was increasing
rapidly and its growth could taper off
more slowly than current budget estimates implied. An at least partially offsetting factor was the prospect that state
and local government expenditures
would increase at a reduced pace this
year amid widespread budget pressures
that had emerged as tax receipts weakened along with the economy. However,
some reports indicated that spending on
local infrastructure projects was continuing at a solid pace in some parts of
the nation.
Members saw a number of downside risks from potential developments
abroad. In particular, concern was
expressed about heightened tensions in
the Middle East and their possible
impact on oil markets and the cost of
energy. For a variety of reasons, oil
prices already had risen appreciably
188 89th Annual Report, 2002
since the start of the year. With regard to
the outlook for foreign trade, members
reported some indications of an improving volume of trade with some Asian
nations. However, the nation's net
export position could deteriorate further
when much of the impetus to world
economic growth was coming from the
U.S. economy.
The members expected price pressures to remain relatively contained over
the next several quarters in the context
of what they anticipated would be only
a gradual reduction of the excess capacity in labor and product markets as
the recovery progressed. Moreover, the
prospects of relatively robust growth
in productivity in a highly flexible and
competitive economy likely would moderate the extent of any potential buildup
in inflationary pressures in the future.
Members nonetheless mentioned some
potential negatives in this outlook, notably the possibility of rising wage pressures as labor markets became more
fully employed and upward price pressures stemming from increasing steel,
energy, and insurance costs.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members supported a proposal
to maintain an unchanged policy stance,
with the target for the federal funds rate
staying at VA percent. While the economy currently appeared to be expanding
at a fairly vigorous pace, the advance
importantly reflected a temporary swing
in inventory investment and considerable uncertainty surrounded the outlook for final demand over the quarters
ahead. Against this background, the
members judged the currently accommodative stance of monetary policy to
be appropriate for now, especially in
light of the relatively high unemployment rate, low capacity utilization rates
in numerous industries, and quiescent
inflation pressures.
Looking ahead, however, the stance
of policy would need to be adjusted at
some point to provide less stimulus as
the members gained more confidence
that the recovery was becoming better
entrenched and the risks had shifted
toward rising inflationary pressures. The
need to adjust monetary policy during
the early stages of a recovery presented
a special challenge with regard to its
timing and extent in that raising rates
prematurely or too precipitately could
weaken or abort the recovery, while
waiting too long could risk a pickup in
inflationary pressures later. Members
concluded that the Committee would be
in a better position to assess the appropriate timing of a policy change at the
May meeting when it would have more
information to gauge the economy's
performance in two critical areas,
namely developments relating to inventory investment and the implications
of trends in sales and profits for capital
investment. A reference to the Committee's currently accommodative policy stance in the press announcement
to be issued shortly after this meeting
would alert the public to the need to
firm policy at some point in the future.
All the members indicated that they
could accept a proposal to move the
balance of risks statement from potential weakness to a neutral position. It
was clear that significant downside risks
remained in the economy even apart
from any major unanticipated shocks
to business and consumer confidence,
but in light of the strength of the recent
economic information nearly all the
members agreed that a balanced risks
statement now best represented their
consensus regarding the economic outlook over the foreseeable future. Members noted that a neutral statement did
not preclude a tightening policy move
should the latter seem warranted by rapidly evolving economic conditions.
Minutes of FOMC Meetings, May
At the conclusion of this discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive:
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the federal funds rate at an average of around
PA percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are balanced with respect to prospects for both goals in the foreseeable future.
Votes for this action: Messrs. Greenspan,
McDonough, Ms. Bies, Messrs. Ferguson,
Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Votes against this
action: None.
Disclosure Policy
By unanimous vote, the Committee
approved a proposal to include the vote
on monetary policy in the press statement released after every meeting,
beginning with this meeting. In addition to identifying the voters, the press
release would indicate the policy preferences of dissenters, if any. Such
information could prove useful to market participants, who on occasion had
employed indirect and frequently misleading information to gauge the Committee's vote before it was released
189
as part of the minutes after the next
meeting.
It was agreed that the next meeting of
the Committee would be held on Tuesday, May 7, 2002.
The meeting adjourned at 1:30 p.m.
Donald L. Kohn
Secretary
Meeting Held on
May 7, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, May 7, 2002, at 9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Reinhart, Economist
Mr. Stockton, Economist
190 89th Annual Report, 2002
Mr. Connors, Ms. dimming,
Messrs. Howard and Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, Rosenblum, and Wilcox,
Associate Economists
Mr. Kos, Manager, System Open
Market Account
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board of
Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division
of Research and Statistics,
Board of Governors
Mr. Whitesell, Deputy Associate
Director, Division of Monetary
Affairs, Board of Governors
Mr. Clouse, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Mr. Skidmore, Special Assistant
to the Board, Office of Board
Members, Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Office of Board
Members, Board of Governors
Mr. Barron, First Vice President,
Federal Reserve Bank of Atlanta
Messrs. Eisenbeis, Fuhrer, Goodfriend,
Hakkio, Hunter, Judd, and
Ms. Perelmuter, Senior Vice
Presidents, Federal Reserve
Banks of Atlanta, Boston,
Richmond, Kansas City, Chicago,
San Francisco, and New York
respectively
Messrs. Altig and Coughlin, Vice
Presidents, Federal Reserve
Banks of Cleveland and St. Louis
respectively
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on March 19, 2002,
were approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. TTiere were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities
issued or fully guaranteed by federal
agencies during the period March 19,
2002, through May 6, 2002. By unanimous vote, the Committee ratified these
transactions.
By unanimous vote, the Committee
approved the extension for one year
beginning in December 2002 of the
System's reciprocal currency ("swap")
arrangements with the Bank of Canada
and the Bank of Mexico. The arrangement with the Bank of Canada is in the
amount of $2 billion equivalent and that
with the Bank of Mexico in the amount
of $3 billion equivalent. Both arrangements are associated with the Federal
Reserve's participation in the North
American Framework Agreement. The
early vote to renew the System's participation in the swap arrangements maturing in December relates to the provision
that each party must provide six months
prior notice of an intention to terminate
its participation.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting indicated that economic activity expanded rapidly early in the year.
Consumer spending increased moder-
Minutes of FOMC Meetings, May
ately after large gains around the turn
of the year, business outlays on durable equipment and software apparently
steadied after a long decline, and singlefamily housing activity persisted at a
relatively high level. Industrial production picked up in response to the
advance in final demand and a slowdown in the runoff of excess inventory
stocks. The demand for labor began to
firm in April. Available information
suggested that labor productivity had
risen substantially in the first quarter.
Although the recent surge in energy
prices boosted headline consumer inflation in the first quarter, core measures of
inflation had trended lower over the past
year.
Private nonfarm payroll employment
turned up in April after having posted
small declines in February and March
and steep reductions earlier. Job gains in
April were spread across a wide range
of industries. The services sector registered a sizable increase, with much of
that rise occurring in the temporary-help
industry that provides many of its workers to the manufacturing sector. In addition, layoffs continued to slow in the
manufacturing sector, and some industries recorded their first solid advances
in employment in more than a year.
By contrast, the construction industry
posted another large job decline as hiring again fell short of the usual seasonal
rise. Despite the pickup in private payrolls, the unemployment rate rose to
6.0 percent in April, perhaps reflecting
to an important extent the incentives
created by the new federal program of
extended unemployment benefits for
some jobless workers to continue, or
resume, looking for work.
Industrial production increased for a
third straight month in March after the
lengthy decline from its June 2000 peak.
In the manufacturing sector, output in
the first quarter retraced a little more
191
than half of its fourth-quarter plunge.
The gain was widespread across market
groups and industries. High-tech equipment, notably computers and semiconductors, and motor vehicles and parts
led the upturn with very large increases,
while the telecommunications and aircraft industries weakened sharply further. Capacity utilization in manufacturing continued to rise in March from its
low level at year-end, but at the end of
the first quarter it was still substantially
below its long-run average.
Consumer spending was well maintained in the first quarter, supported
by sizable gains in disposable income.
Demand for light motor vehicles
remained robust, though somewhat
below the fourth-quarter pace, in an
environment of continued aggressive
manufacturer pricing and low financing
rates. Expenditures on a wide range of
other consumer goods and services
expanded briskly.
Residential housing activity surged
in the first three months of the year,
evidently spurred by unusually mild
winter weather and low mortgage rates.
Starts of single-family homes reached
a twenty-three-year high in February
before moderating somewhat in March,
but multifamily starts were only slightly
above the relatively slow pace in 2001.
New home sales moderated a bit in the
first quarter from the very strong pace of
the fourth quarter, while quarterly sales
of existing homes rose on the strength of
a record high in February.
Business outlays for durable equipment and software had changed little
thus far this year following the steep
decline recorded in 2001. Spending on
computer equipment continued to rise
rapidly in the first quarter, and outlays
for communications equipment generally stabilized after a large and lengthy
decline. By contrast, business purchases
of both motor vehicles and aircraft
192 89th Annual Report, 2002
slowed sharply. In the nonresidential
construction sector, investment slumped
in office buildings, industrial structures,
lodging facilities, and in drilling and
mining. Moreover, available information indicated that this sector would
remain depressed: Vacancy rates for
office and industrial buildings continued
to rise, with deterioration in the office
sector especially pronounced in areas
dominated by high-tech firms, and property values and rents for retail space and
warehouses weakened.
The pace of liquidation of manufacturing and trade inventories slowed
sharply in January and February after a
notably large contraction in the fourth
quarter, and the aggregate inventorysales ratio declined a bit further. Stocks
of manufacturers continued to fall
through March (latest data). Wholesalers also continued to reduce their
inventories during January and February
(latest data), and the sector's inventorysales ratio dropped further. At the retail
level, stocks jumped in January and February, but almost all of the increase
occurred at automotive dealers. The
inventory-sales ratio for retail trade
edged up over the two months but was
still at a relatively low level.
The U.S. trade deficit in goods and
services widened in January and February, reflecting a considerably larger
expansion in the value of imports than
in that of exports. The rise in imports
related in part to the royalties and
license fees paid to the International
Olympics Committee for the rights to
broadcast the Winter Olympic Games.
With regard to economic activity
abroad, the available information indicated that, on balance, foreign economic
output had rebounded in the first quarter. The economies of the technologysensitive Asian countries had already
turned up in the fourth quarter and
seemed to have grown rapidly in the
early months of the year. The Canadian
economy appeared to have expanded
robustly in the first quarter, and economic activity in Europe evidently had
turned upward. By contrast, available
indicators suggested that the Japanese
economy was still contracting, though at
a less rapid rate.
Although higher energy prices continued to push up headline consumer price
inflation in March, inflation had moved
downward over the past twelve months.
Both the overall consumer price index
(CPI) and the personal consumption
expenditure (PCE) chain-linked index
decelerated significantly over the past
year. Moreover, excluding their volatile
food and energy components, both measures of inflation also fell over the past
year. At the producer level, prices for
finished goods echoed the pattern of
consumer prices: Both total and core
finished goods inflation decelerated on a
year-over-year basis. Labor cost growth,
as measured by hourly compensation in
private industry, also appeared to have
slowed a bit over the latest twelvemonth period.
At its meeting on March 19, 2002,
the Committee adopted a directive that
called for maintaining conditions in
reserve markets consistent with keeping
the intended level of the federal funds
rate at VA percent. With the economy
expanding at a significant pace, the
Committee now saw the risks to achieving its long-term goals as balanced.
Members noted that the impetus for
the economic advance was to a large
extent a temporary swing in inventory
investment rather than a clear and substantial upswing in final demand. As
a result, the outlook for the economy
remained somewhat uncertain, and the
current accommodative stance of policy
continued to be viewed as appropriate. The members contemplated, however, that the stance of monetary policy
Minutes of FOMC Meetings, May
would have to become less accommodative once clearer evidence emerged
that a healthy expansion was firmly
established.
The federal funds rate remained close
to the Committee's target level of
PA percent during the intermeeting
period. However, doubts about the
strength of the recovery owing to the
tone of the Committee's press statement
along with mixed incoming data on final
demand, announcements of weakerthan-expected corporate earnings, and
heightening tensions in the Middle East
prompted declines in yields on shortto intermediate-term Treasury securities. Yields on investment-grade bonds
tended to edge higher, however, in the
wake of concerns about the transparency of the accounting statements of
some firms. Most major indexes of
equity prices moved down sharply in
response to the outlook for a weaker
economic recovery and the adverse
implications for corporate profits of
economic and other developments.
In foreign exchange markets, the
trade-weighted value of the dollar in
terms of the major foreign currencies
eased somewhat over the intermeeting
period. Much of the dollar's decline
occurred late in the period in response to
the mixed character of U.S. economic
data and relatively small declines in
benchmark longer-term yields abroad.
The dollar rose slightly on average in
terms of an index of the currencies of
other important trading partners, in part
because of the further depreciation of
the Argentine peso.
M2 and M3 contracted in March and
April. The declines evidently reflected
in part the rising opportunity costs of
holding M2 assets as yields on the
components of M2 declined in lagged
response to the earlier easing of monetary policy and fostered transfers out of
M2 funds, especially from retail money
193
market funds to stock and bond mutual
funds. Reduced demand for mortgage
refinancing and lower nonwithheld federal payments also contributed importantly to the weakness in the broad
monetary aggregates.
The staff forecast prepared for this
meeting suggested that the expansion in
economic activity was slowing substantially in the current quarter but would
pick up in the second half of the year
and continue at a moderate pace next
year. An emerging shift by businesses
from inventory liquidation to some
replenishment of stocks would help
boost activity over the next several
quarters, but the ongoing recovery
would depend increasingly on growth in
spending by households and businesses.
Such spending would be fostered by
the monetary ease and fiscal stimulus
already in place and abetted by vigorous
anticipated growth in structural productivity, which would support household incomes and business investment
incentives. With a relatively robust
contour for the course of final sales over
the forecast horizon, the pressure on
resources would rise somewhat despite
the anticipated higher growth of structural productivity. Nonetheless, activity
would remain below the economy's
potential for a period ahead and the persistence of underutilized resources was
expected to contribute to damped core
consumer price inflation.
In the Committee's discussion of current and prospective economic developments, members commented that
recently available statistical data and
anecdotal reports suggested that the
expansion in business activity was continuing. However, it had slowed considerably from its pace earlier in the year
when it had received substantial impetus
from a marked slowing in the runoff of
inventories. How much final demand
would strengthen going forward was
194 89th Annual Report, 2002
still uncertain. A pause in the expansion
was not an unusual development during
the early stages of a cyclical recovery,
and the members generally viewed a
pickup in growth as a reasonable expectation. The currently stimulative stance
of both fiscal and monetary policy
would tend to undergird final demand,
especially in the context of an economy that had exhibited a marked degree
of resilience and strength in underlying productivity growth that would
bolster household incomes and provide
incentives for business capital spending. Members noted, however, that an
already high level of consumer spending
pointed to more limited than usual scope
for further growth in such spending, and
gloomy business sentiment in the face
of disappointing sales and profits raised
a question about the extent to which
business investment would help to lift
final demand over coming quarters.
Given growth in economic activity
broadly in line with current expectations, inflation was likely to remain
benign for some time in the context of
an apparently strong uptrend in structural labor productivity, excess capacity
in many labor and product markets, and
a related absence of pricing power in
generally very competitive markets.
In their review of developments and
prospects in key expenditure sectors of
the economy, members commented that
household spending had continued to
be well maintained. In the consumer
area, recent anecdotal reports provided
a somewhat mixed, but on the whole
positive, picture of consumer spending
across the nation. Sales of motor vehicles had moderated after a surge during
the closing months of 2001, but they
remained relatively high and other consumer outlays had continued to increase.
Looking ahead, some growth in overall
consumer spending appeared likely in
association with the now more firmly
entrenched economic expansion. However, the pickup likely would be limited
inasmuch as household spending had
remained elevated through the period of
economic weakness. Members commented that such an outlook was subject to uncertainties in both directions.
On the upside, faster-than-anticipated
growth could well materialize in an
environment of monetary and fiscal policy ease and of gradually firming labor
markets and rising productivity that
would be boosting income growth. On
the other hand, employment growth had
been very sluggish to date, with employers remaining quite cautious in their hiring practices, and continued softness
in labor markets could damp consumer
confidence. The run-up in energy prices
also was a negative for household purchasing power.
Household expenditures on new
homes were likewise at an elevated
level, although members reported weakness in some price segments and geographic areas of the housing market. In
general, however, housing displayed
ongoing strength in response to low
mortgage rates, with rising prices in
many areas, and the downside risks to
this sector of the economy appeared
to be limited. At the same time, members anticipated that growth, if any,
in homebuilding activity would be subdued over the next several quarters after
an extended period of strong expansion.
The members generally viewed business fixed investment as the key sector
that would determine the strength of the
expansion. Such investment had contracted further in the first quarter, but
the decline was the smallest in a year.
Looking ahead, the members anticipated
a sluggish and delayed upturn in capital expenditures in the next few quarters against the backdrop of persistently
gloomy business sentiment and large
margins of excess capacity in numerous
Minutes of FOMC Meetings, May
industries. Many business contacts commented on their unwillingness to expand
capacity until they saw persuasive evidence of growing sales and profits.
Accordingly, much of their current
investment spending was focused on
cost-saving equipment and software in
an effort to bolster profits in a stable
price environment that made it difficult to pass on rising costs. The recent
passage of temporary legislation that
permitted a partial acceleration of tax
expensing was expected to provide some
impetus to capital investments, but the
legislation appeared to have had little
effect thus far. With regard to the outlook for nonresidential construction,
members saw little prospect of any
material increase in such construction
over the next several quarters, given
widespread anecdotal and statistical
reports of high vacancy rates and excess
capacity.
The markedly reduced pace of inventory liquidation in the first quarter of the
year accounted for much of the step-up
in GDP growth in that quarter and provided a strong indication that the period
of inventory liquidation under way for
more than a year probably was coming
to an end. Indeed, anecdotal reports suggested that efforts to rebuild inventories
were now being undertaken in a number
of industries, such as steel and motor
vehicles, and one regional survey indicated that businesses planned to accumulate inventories over the next six
months. However, businesses remained
quite cautious about the outlook for
sales, and many firms might also be in
the process of adapting to much reduced
levels of inventories in relation to sales
rather than restoring earlier inventorysales ratios. A shift to inventory stocking in the near term, possibly in the
current quarter, was seen as a reasonable
expectation, but with numerous firms
having already moved production into
195
closer alignment with sales, members
anticipated much less impetus to overall
economic activity from inventories over
coming quarters.
Recent and immediately prospective
legislation had increased the fiscal
stimulus in the federal budget, and
members commented that the current
dynamics of the budget process could
result in larger increases in government
spending than foreseen in recent budget
estimates. In this regard some expressed
concern about the longer-term implications of what they saw as a decline
in fiscal discipline. At the state and
local government levels, however, deteriorating fiscal positions in 2001 had
impelled many states and localities to
curb spending and raise various taxes
and fees.
Although foreign economic activity
appeared to be picking up to some
extent and the dollar had edged lower,
net exports were expected to remain a
negative factor in the growth of the
domestic economy. Members cited
anecdotal reports that tended to support
statistical evidence of strengthening
economies in Europe and a number of
developing Asian nations. Nonetheless, given a recovery in U.S. domestic
demand approximating their current
forecasts, growth in imports likely
would exceed that of exports by a wide
margin over the forecast horizon.
The outlook for inflation remained
favorable. Nearly all measures of total
and core prices had decelerated over
the past year, and in the context of forecasts implying a continued sizable gap
between actual and potential output,
the risk that inflationary pressures would
intensify significantly over coming
quarters appeared to be quite limited;
indeed, inflation might edge a bit lower
in the early stages of the expansion. The
deceleration in labor costs over the
past several quarters, evidence of a
196 89th Annual Report, 2002
surprisingly strong uptrend in structural
labor productivity, low and stable inflation expectations, and the widespread
absence of pricing power in highly
competitive markets were signs that
upside inflation risks in the period ahead
were relatively small. The members
recognized nonetheless that there were
upward pressures on costs in a number of areas. These included significant increases in energy costs in
recent months, evidence of an upturn in
some industrial prices, sharp increases
in many insurance costs, continuing
upward pressures on medical costs, and
modest recent declines in the foreign
exchange value of the dollar. With the
stance of monetary policy currently
quite accommodative, the members
saw the need for careful monitoring of
the potential for rising inflation pressures as the economic recovery gained
momentum.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members agreed on the desirability of maintaining an unchanged policy
stance, with the target federal funds rate
staying at 13A percent. The economic
recovery was clearly continuing, but
its rate of advance had moderated considerably and the economy's future
course was subject to a marked degree
of uncertainty. While the longer-term
outlook for a strengthening economy
remained favorable, a firming of policy
at this time would be premature and
would incur an undue risk to a healthy
expansion. The members recognized
that monetary policy exerted its effects
with a considerable lag and that the
current stance of policy probably was
inconsistent with the Committee's inflation objective over time. However, current inflation pressures were subdued
and were expected to remain so for a
considerable period, thereby providing
adequate opportunity to evaluate ongo
ing developments and tighten policy as
needed later.
All the members favored the retention
of a neutral balance of risks statement to
be released shortly after this meeting.
Against the longer-term inflation risks
inherent in the current stance of policy,
the members weighed the possibility
that the expansion could be relatively
subdued for a time, damping prices
further and failing to reduce margins of
underutilized resources. In any event, a
neutral statement regarding the risks to
the economy in the foreseeable future
would not preclude a preemptive tightening adjustment in the stance of policy
stance should new evidence bearing on
the strength of the expansion and the
outlook for inflation warrant such a policy move.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive.
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the
federal funds rate at an average of around
P/4 percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are balanced with respect to prospects for both goals in the foreseeable future.
Minutes of FOMC Meetings, June
Votes for this action: Messrs. Greenspan,
McDonough, Ms. Bies, Messrs. Ferguson,
Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Votes against this
action: None.
It was agreed that the next meeting
of the Committee would be held on
Tuesday-Wednesday, June 25-26,2002.
The meeting adjourned at 12:15 p.m.
Donald L. Kohn
Secretary
Meeting Held on
June 25-26, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, June 25, 2002, at 2:30 p.m.
and continued on Wednesday, June 26,
2002, at 9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Moskow, and Parry,
Alternate Members of the Federal
Open Market Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and St. Louis
respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
197
Mr. Reinhart, Economist
Mr. Stockton, Economist
Mr. Connors, Ms. Cumming,
Messrs. Howard and Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, Rosenblum, Sniderman,
and Wilcox, Associate Economists
Mr. Kos, Manager, System Open
Market Account
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board
of Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division
of Research and Statistics,
Board of Governors
Messrs. Freeman5 and Whitesell,
Deputy Associate Directors,
Divisions of International Finance
and Monetary Affairs respectively,
Board of Governors
Mr. English, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Messrs. ReifSchneider6 and Wascher,6
Assistant Directors, Division
of Research and Statistics,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Mr. Brayton,6 Ms. Dynan,5
Messrs. Lebow6 and Roberts,6
Senior Economists, Division
of Research and Statistics,
Board of Governors
Mr. Bomfim,5 Senior Economist,
Division of Monetary Affairs,
Board of Governors
5. Attended portion of meeting relating to the
discussion of economic developments.
6. Attended portion of meeting relating to a
special agenda discussion of inflation.
198 89th Annual Report, 2002
Mr. Skidmore, Special Assistant to
the Board, Office of Board
Members, Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Office of Board
Members, Board of Governors
Mr. Barron, First Vice President,
Federal Reserve Bank of Atlanta
Messrs. Eisenbeis, Fuhrer, Goodfriend,
Hakkio, Hunter, Judd,
Ms. Krieger, and Mr. Rasche,
Senior Vice Presidents, Federal
Reserve Banks of Atlanta, Boston,
Richmond, Kansas City, Chicago,
San Francisco, New York, and
St. Louis respectively
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on May 7, 2002, were
approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the
System's account in the period since the
previous meeting.
The Manager also reported on recent
developments in domestic financial
markets and on System open market
transactions in government securities
and securities issued or fully guaranteed
by federal agencies during the period
May 7, 2002, through June 24, 2002. By
unanimous vote, the Committee ratified
these transactions.
The Committee voted unanimously to
update its longstanding authorization
for the Federal Reserve Bank of New
York to enter into agreements that would
enable another Federal Reserve Bank to
conduct System open market operations
on a temporary basis in an emergency
after designation by the Committee or
the Chairman.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting indicated that economic activity continued to expand in recent
months, though at a slower pace than
earlier in the year. Consumer purchases,
residential housing outlays, and government spending recorded smaller gains,
but business investment in durable
equipment and software appeared to be
leveling out after a long decline. Industrial production continued to pick up.
Employment had risen a little, but not
enough to lower the unemployment
rate, and labor productivity seemed to
be trending sharply upward. The surge
in energy prices this year had boosted
headline inflation, but core measures of
inflation had trended lower.
Private nonfarm payroll employment
edged up in April and May after a slowdown in the first quarter in the pace of
layoffs and job separations. Hiring was
relatively brisk in the services sector in
the April-May period, with most of the
advances occurring in the temporaryhelp industry. Manufacturing payrolls
recorded small declines in both months,
while the number of jobs in construction
steadied in May after a large drop in
April. The civilian unemployment rate
moved down somewhat, to 5.8 percent
in May, but the average rate for the
April-May period remained above the
level in the two previous quarters.
Industrial production rose for a fifth
straight month in May. In manufacturing, output increases in April and May
continued to be spread widely across
market groups and industries. The hightech sector, notably computers and semiconductors, and the motor vehicles and
parts sector remained strong, while the
telecommunications and aircraft indus-
Minutes of FOMC Meetings, June
tries weakened further. Capacity utilization in manufacturing in May was a
little above its depressed level at yearend, but substantially below its long-run
average.
Growth of consumer spending slowed
appreciably in April and May from the
brisk pace of the first quarter. Retail
sales slumped in May after a sizable
rise in April, largely reflecting weaker
spending at apparel stores and general
merchandise outlets and an apparent
pause in purchases of light motor vehicles after an April surge. Real outlays
on services in April (latest data) were
unchanged.
Residential housing activity remained
elevated during April and May. Housing starts jumped in May after a small
decline in April. The strength in starts
over the two months evidently reflected
the persistence of very positive homebuying attitudes arising at least in part
from low mortgage rates. In May, sales
of new single-family homes established
a new record high, and sales of existing
single-family homes were only slightly
below the peak reached in the first
quarter.
The decline in business outlays for
durable equipment and software had
moderated further in the first quarter,
and the available information suggested
that spending on equipment and software was turning upward in the second
quarter. Shipments of nondefense capital goods other than aircraft rose in April
and May; shipments of computers and
peripherals remained strong, shipments
of communications equipment were still
weak, and shipments of other durable
goods continued to advance. In the
nonresidential construction sector, outlays for office and industrial structures,
lodging facilities, and public utilities
declined substantially. In addition,
expenditures for drilling and mining
continued to drop. By contrast, construc
199
tion of retail space, warehouses, and
institutional structures picked up.
Liquidation of manufacturing and
trade inventories continued in April
at about the pace of the first quarter,
and the aggregate inventory-sales ratio
declined further. In manufacturing, the
rate of liquidation slowed substantially,
and the aggregate stock-shipments ratio
for the sector was at a very low level.
Wholesalers ran down their inventories
in April at a somewhat faster rate than in
the first quarter; the sector's inventorysales ratio fell sharply further to a relatively low level. Retailers boosted their
stocks slightly in April, with all of the
increase occurring at automotive dealers. The sector's aggregate inventorysales ratio edged up in April but
remained relatively low.
The U.S. trade deficit in goods and
services widened somewhat in April
from both the March and the firstquarter levels, as the value of imports
increased significantly more than that of
exports. The rise in imports from March
to April reflected higher prices for
imported oil along with greater demand
for a wide range of goods. The monthly
step-up in exports was also broadly
spread across categories of goods. With
regard to economic activity abroad, the
available information indicated that, on
balance, foreign economic output had
rebounded in the first half of the year,
though the pace of recovery was uneven
across regions and countries. Australia,
Canada, and emerging Asia had experienced strong growth; the euro area also
was expanding, but at a slower rate; and
Japan appeared to have experienced a
limited upturn in its economy. In South
America, Brazil's economy was expanding but its financial markets had come
under considerable stress, and elsewhere
on the continent economic activity was
generally weak, particularly in Argentina and Venezuela.
200 89th Annual Report, 2002
Both the consumer price index and
the personal consumption expenditure
chain-linked index indicated that consumer price inflation was moderate
during the April-May period. Moreover,
both measures showed that core price
inflation during the first five months
of the year had been a bit lower than in
2001. At the producer level, prices for
core finished goods changed little over
April and May and decelerated on a
year-over-year basis. Labor costs, as
measured by the average hourly earnings of production or nonsupervisory
workers, also decelerated.
At its meeting on May 7, 2002, the
Committee adopted a directive that
called for maintaining conditions in
reserve markets consistent with keeping
the intended level of the federal funds
rate at 13A percent, and it also retained a
neutral balance of risks statement. The
Committee's press statement, with its
language indicating that the Committee remained uncertain about the extent
and timing of the strengthening of final
demand, was viewed by market participants as expressing less confidence
in the strength of the recovery than had
been expected, and yields on Treasury
securities declined slightly in response.
Subsequently, investors became more
risk averse in reaction to a mixture of
economic data releases, growing geopolitical tensions, further warnings
about terrorism, and additional revelations regarding questionable corporate
accounting practices. Yields on Treasury securities dropped somewhat on net
over the period, rates on lower-quality
bonds rose, and equity prices fell
sharply further. The federal funds rate
remained close to the Committee's target level of P/4 percent during the intermeeting period.
In foreign exchange markets, the
trade-weighted value of the dollar in
terms of the major foreign currencies
dropped somewhat over the intermeeting period. The dollar's decline against
the major foreign currencies occurred as
questions about the strength of U.S. economic recovery and corporate earnings
and the related lowering of expectations
for near-term monetary tightening led to
concerns that net foreign capital inflows
might not be consistent with a stable
exchange value for the dollar in the context of growing U.S. net international
indebtedness. By contrast, the dollar
rose slightly on average in terms of an
index of the currencies of other important trading partners, notably the currencies of several Latin American countries
that were experiencing political and economic problems.
Growth of the broad monetary aggregates picked up in May owing to the
unwinding of distortions from final tax
payments and, apparently, to falling
equity prices. The heightened volatility
of equity markets may have enhanced
the attractiveness of safe and liquid M2
assets, including liquid deposits and
retail money market funds.
The staff forecast prepared for this
meeting suggested that the expansion of
economic activity would pick up in the
last half of the year from the sluggish
pace of the second quarter and reach
a relatively brisk pace next year. The
considerable monetary ease and fiscal
stimulus already in place and the continuing sizable gains in productivity
would provide significant impetus for
spending, though weakness in equity
prices would tend to offset some of that
support. With business capital stocks
moving closer to desired levels, investment spending would be boosted by a
gradually improving outlook for sales
and profits, low financing costs, and the
temporary federal tax incentive for
investment in new equipment and software. A more robust contour for final
sales over the forecast horizon would
Minutes of FOMC Meetings, June 201
lead to somewhat greater pressure on
resource margins, despite the expected
strong growth of structural productivity, though the level of activity would
remain below the economy's potential for some time. The persistence of
underutilized resources was expected to
foster some moderation in core price
inflation.
In the Committee's discussion of current and prospective economic conditions, members commented that there
had been little change since the May
meeting in the factors bearing on what
they viewed as a favorable outlook for
a pickup in the expansion. Although
financial markets, and perhaps business and household confidence, had
been shaken by revelations of accounting irregularities, the economy had
continued to expand and the prospects
for accelerating aggregate demand
remained positive. Some members
observed, however, that they had
expected to see firmer indications of a
strengthening recovery by the time of
this meeting. The degree of impetus
from decelerating inventory liquidation
and growth in final demand had moderated during the spring, and anecdotal
and other evidence indicated that the
performance of various industries and
firms had remained uneven. Looking
ahead, the timing and strength of an
upturn in the expansion remained subject to considerable uncertainty, but
in the absence of major further adverse
shocks to confidence the members
anticipated that economic activity would
accelerate over coming months to a
pace in the vicinity of, and perhaps
somewhat above, the rate of growth
of the economy's potential. In support
of this view, members cited the accommodative stance of both fiscal and
monetary policy and the continuation
of impressive growth in productivity
that should buttress household incomes
and spending and encourage a pickup
in business investment. The strength
in productivity also would help to
hold down cost and price pressures
and, given an economic expansion and
resource utilization in line with the
members' forecasts, would reinforce the
prospect that core price inflation would
remain low.
In preparation for the midyear monetary policy report to Congress, the members of the Board of Governors and the
presidents of the Federal Reserve Banks
submitted individual projections of the
growth of GDP, the rate of unemployment, and the rate of inflation for the
years 2002 and 2003. The forecasts of
the rate of expansion in real GDP had
central tendencies of V/i to 33/4 percent
for 2002, implying growth in the second
half of the year at a rate close to that
currently estimated for the first half, and
3V2 to 4 percent for 2003. These rates of
growth were expected to keep the civilian rate of unemployment in a central
tendency of 53/4 to 6 percent in the
fourth quarter of 2002 before it fell to
5V4 to 5!/2 percent by the fourth quarter
of 2003. Forecasts of the rate of inflation, as measured by the chain-type
price index for personal consumption
expenditures, pointed to little change
from recent inflation levels and were
centered on a range of VA to \3A percent for both this year and 2003.
With imbalances in inventories apparently largely worked off and the contribution of inventory investment to the
expansion likely diminishing in coming
quarters, final demand would play its
usual primary role in determining the
strength of the expansion. In that regard,
consumer spending was seen as likely to
provide some continuing, though moderate, impetus to the growth of the economy. A favorable factor in this outlook
cited by members was the ability and
willingness of households to extract siz-
202 89th Annual Report, 2002
able financing resources for consumer
and other expenditures by drawing on
the appreciated equity in their homes
in one form or another. The ample availability of credit to most consumers
was another positive factor. Although
consumer confidence as measured by
national surveys recently had declined
somewhat from relatively elevated levels, reports of strength in motor vehicle
sales and in other retail sales in several
parts of the nation in recent weeks suggested that consumer spending was continuing to be well maintained. The members recognized that a typical recoveryperiod surge in consumer spending was
unlikely inasmuch as expenditures had
registered solid growth through the economic downturn, implying an absence
of significant pent-up demands. Moreover, forecasts of even moderate growth
in spending were subject to downside
risks emanating, for example, from possible further shocks to confidence and
household wealth should weakness in
stock prices persist, and from political
turmoil overseas and threats of terrorism
at home.
Homebuilding, though down after an
unsustainable surge earlier in the year,
had been well maintained in recent
months. Recent statistics supported by
widespread anecdotal reports pointed to
persisting strength in housing activity,
though there were indications of softness in high-priced homes in at least
some parts of the country. Looking forward, members expected a high level
of home construction to continue. A
key factor in this outlook was the ready
availability of mortgage financing to
most borrowers at very attractive rates.
Members also referred to growing
population pressures, abetted by sizable
immigration, on increasingly scarce
buildable land in numerous areas. On
balance, however, given its already
robust level, housing was not seen as
likely to provide much added stimulus
to the expansion.
A pickup in business spending was
viewed as a key to sustained solid
growth, and questions about the timing and strength of such a pickup was
a major source of uncertainty about
the pace of the expansion in coming
quarters. The preconditions for a
robust advance in investment spending
appeared to be largely in place, including the evident progress over the past
several quarters in adjusting capital
stocks to desired levels, the temporary
tax incentive, and the need for competitive reasons to take advantage of the
availability of increasingly productive
equipment. In fact, recent orders and
shipments data suggested an upturn in
spending for new equipment, but the
improvement was still quite limited,
unevenly distributed across industries,
and not yet firmly indicative of a sustained advance. While the members
expected further gains in spending on
equipment, they continued to report
widespread pessimism among their business contacts, though exceptions had
begun to emerge, and the persistence of
a high degree of caution that was leading business executives to defer numerous investment projects until they saw
more conclusive evidence of stronger
sales and profits.
The outlook for nonresidential construction activity remained bleak amid
indications of a widespread overhang of
available space and attendant declines in
rents and property values. Indeed, the
drop in such construction did not appear
to have run its course for the nation as a
whole. Even so, the ongoing adjustment
of nonresidential capacity to demand
had been substantial in recent quarters
and likely would give way to a modest
recovery during the year ahead.
For the economy as a whole, the liquidation of business inventories appeared
Minutes of FOMC Meetings, June 203
to be near completion in the current
quarter, and some rebuilding in association with forecasts of moderate expansion in sales seemed a likely prospect
for coming quarters. The restocking was
expected to proceed gradually, given the
probable persistence of a relatively high
degree of uncertainty and caution in the
business community. Such an outlook
implied that inventory investment would
supply positive but limited impetus to
the expansion over the forecast horizon.
The federal tax cuts and large
increases in federal spending legislated
over the past year were expected to
provide support for aggregate demand
over the projection period. Some members expressed concern, however, about
what they perceived to be the erosion of
long-term fiscal discipline and increasing prospects that federal deficits would
persist even after the economy recovered, with adverse effects on the domestic savings available for investment.
Concurrently, however, at the state and
local government level where budget
flexibility was more limited, sizable
budgetary shortfalls likely would hold
down expenditures and induce some tax
increases, with restraining effects over a
period of time.
With regard to the outlook for the
external sector of the economy, the sizable decline in the foreign exchange
value of the dollar since the start of the
year had given rise to market forecasts
of appreciable further depreciation. The
factors that governed the exchange value
of the dollar were complex, and historically forecasts of trends in exchange
rates had not been reliable. To the extent
that the depreciation of the dollar was
not reversed or that it continued, it
would of course tend to boost net
exports. Exports would in any event be
likely to strengthen somewhat as a consequence of the evidently improving
economies of a number of the nation's
important trading partners. Indeed,
members provided anecdotal reports of
better export markets for a number of
U.S. products. At the same time, however, severe problems being experienced
by a number of large countries in South
America raised the specter of a deepening financial crisis within that region
and the possibility of more widespread
contagion.
Given their anticipation of strong productivity growth and continuing slack
in labor and other markets, members
expected inflation to remain low over
the next several quarters. An underlying
factor in the good inflation performance
of recent years and its extension into
the future was the continuing absence of
pricing power throughout the economy,
evidently related in part to increased
price competition in markets around
the world stemming from globalization.
Members cited examples of rising prices
for a few products, notably steel, and the
possibility that energy prices might raise
costs. They also referred to the potential
for upward pressure on prices associated
with the recent depreciation of the dollar. Nonetheless, with rising productivity and moderate wage gains likely continuing to help hold down unit labor
costs, the outlook for subdued inflation
remained promising, especially for the
nearer term.
The discussion of the inflation outlook was held against the backdrop of
an earlier consideration at this meeting of the factors behind the decline in
inflation in the 1990s and the value of
structural models for forecasting inflation. Most Committee members, while
acknowledging the deficiencies of structural models, viewed them as useful in
their efforts to understand how the inflation process was changing and also as
input to inflation forecasts. The members saw greater productivity growth,
changing labor markets, and increased
204 89th Annual Report, 2002
competition in product markets as having played a part along with monetary policy in lowering inflation. They
agreed that more research—across countries as well as across time—was needed
before they could become more confident about the value and stability of
such models.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members agreed that recent
developments argued for maintaining an
unchanged policy stance, with the target
for the federal funds rate remaining at
l3/4 percent. The members saw favorable prospects for a significant acceleration in the expansion from the reduced
pace in the current quarter, but considerable uncertainty still surrounded the timing and strength of the pickup. In the
current situation, retention of the currently accommodative policy stance was
desirable to counter the lingering effects
of financial and other shocks to the
economy that were continuing to exert
a depressing impact on output and
resource use. Inflation was still edging
down, inflation expectations appeared to
be low and stable, and going forward
the members' forecasts for growth and
productivity implied that unit costs and
prices would remain subdued for some
time.
A number of members noted that the
current policy stance was too accommodative to be consistent over time with
the Committee's objectives of price
stability and maximum sustainable economic growth. Economic performance
in line with their current forecasts would
at some point require an adjustment
to policy toward a less accommodative
stance once more definitive indications
of sustained strengthening started to
emerge. And given the lags in monetary
policy such an adjustment would probably need to be made at a time when
the incoming economic information was
still somewhat mixed. Still, in current
circumstances, there was little risk of
triggering an increase in inflation by
waiting for a better reading on the
course of the economy. Some members
were concerned that markets might not
fully appreciate the inevitability of eventual policy tightening. However, others
pointed out that market participants
seemed to have little doubt about the
Committee's determination to keep
inflation low and in that context markets
were likely to anticipate Committee
action once incoming information suggested it was becoming appropriate.
The members said that they could see
risks on both sides of their forecasts,
which indicated that growth would pick
up and inflation would remain low over
coming quarters at the current stance
of policy. Accordingly, they agreed to
retain an assessment of balanced risks to
their long-term objectives in the Committee's post-meeting press release.
Such a statement would not be an
impediment to adjusting policy should a
significant and unanticipated change in
economic conditions materialize in the
near term.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive.
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the federal funds rate at an average of around
PA percent.
The vote encompassed approval of
the sentence below for inclusion in the
Minutes of FOMC Meetings, August
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are balanced with respect to prospects for both goals in the foreseeable future.
Votes for this action: Messrs. Greenspan,
McDonough, Ms. Bies, Messrs. Ferguson,
Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Votes against this
action: None.
It was agreed that the next meeting of
the Committee would be held on Tuesday, August 13, 2002.
The meeting adjourned on June 26,
2002, at 11:40 a.m.
Vincent R. Reinhart
Secretary
Meeting Held on
August 13, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, August 13, 2002, at
9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Bernanke
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. Kohn
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
205
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Mr. Connors, Ms. Cumming,
Messrs. Howard and Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, and Wilcox, Associate
Economists
Mr. Kos, Manager, System Open
Market Account
Mr. Winn, Assistant to the Board,
Office of Board Members,
Board of Governors
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board
of Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Divisions
of Research and Statistics,
Board of Governors
Mr. Whitesell, Deputy Associate
Director, Division of Monetary
Affairs, Board of Governors
Mr. Clouse, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Mr. Skidmore, Special Assistant
to the Board, Office of Board
Members, Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Office of Board
Members, Board of Governors
206 89th Annual Report, 2002
Messrs. Connolly and Stewart,
First Vice Presidents, Federal
Reserve Banks of Boston and
New York
Messrs. Goodfriend, Hakkio, Hunter,
and Rasche, Senior Vice
Presidents, Federal Reserve
Banks of Richmond, Kansas City,
Chicago, and St. Louis
respectively
Messrs. Bryan, Cox, and Cunningham,
Ms. Hargraves,
Messrs. Rudebusch and Tootell,
Vice Presidents, Federal Reserve
Banks of Cleveland, Dallas,
Atlanta, New York, San Francisco,
and Boston respectively
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on June 25-26, 2002,
were approved.
By unanimous vote, Vincent R. Reinhart was elected as Secretary and Economist of the Committee for the period
until the first regularly scheduled meeting in 2003.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities issued or fully guaranteed by federal agencies during the period June 26,
2002, through August 12, 2002. By
unanimous vote, the Committee ratified
these transactions.
The Committee then turned to a discussion of the economic and financial outlook and the conduct of monetary policy over the intermeeting period
ahead.
The information reviewed at this
meeting indicated that economic activity expanded only slightly in the second
quarter. Businesses added a bit to their
inventory positions after an extended
period of sizable declines, but final sales
changed little: business capital spending weakened somewhat further while
growth in consumer spending, residential housing expenditures, and government outlays slowed. The scant information available for the third quarter,
principally July's very strong motor
vehicle sales, suggested that domestic
demand was still recovering but relatively sluggishly. Industrial production
had continued to advance since the first
quarter, but the demand for labor services had increased only slightly and the
unemployment rate had risen. Importantly, labor productivity continued on
a strong upward trend. Overall price
inflation had fallen sharply over the past
year, largely reflecting developments in
the food and energy sectors, and core
inflation had eased a little.
Private nonfarm payroll employment
inched up in July after a mild increase in
June, though aggregate hours worked by
production or nonsupervisory workers
declined steeply. The help-supply portion of the services sector and the construction industry recorded substantial
net job losses over the June-July period,
but manufacturing registered its smallest payroll decline in two years in July,
and hiring was relatively brisk in services other than help-supply. The civilian unemployment rate edged up in
June, to 5.9 percent, and was unchanged
in July.
Industrial production jumped in June,
and gains in output were widespread
across market groups and industries.
However, the limited available information indicated that output leveled out
in July after six consecutive months of
increases. Capacity utilization in manu-
Minutes of FOMC Meetings, August 207
facturing moved a little higher in June
but remained substantially below its
long-run average.
Retail sales were relatively brisk in
June and July despite plunging equity
prices and an apparently marked erosion in consumer confidence. Households spent heavily on motor vehicles in
response to incentives offered by auto
manufacturers, and their expenditures on
other retail categories were generally
well maintained.
Residential housing activity remained
strong in the second quarter, buoyed by
a very favorable mortgage financing
environment. The pace of homebuilding
in the quarter continued well above that
seen during the past few years even
though single-family housing starts in
June did not reach the elevated May
level. Sales of new single-family homes
in June remained at a record high, but
sales of existing homes declined noticeably. In the multifamily sector, June
starts were in the lower end of their
range over recent quarters. Market conditions in the condominium and cooperative apartment portion of the housing
sector appeared to be favorable, but
rising vacancy rates and weaker rents
apparently hindered the rental apartment
segment.
Business investment in equipment
and structures declined further in the
second quarter as the continuing downdraft in nonresidential construction more
than offset a pickup in business spending for durable equipment and software. Despite gradually improving
fundamentals—rising output and profits, new tax incentives, and a low cost of
capital—firms remained cautious about
stepping up their investments in equipment and software, and recent data on
orders and shipments of nondefense
capital goods coupled with anecdotal
reports suggested further lackluster
gains in spending in coming months. In
the nonresidential construction sector,
outlays for office, industrial, and other
structures, lodging facilities, and public
utilities declined substantially further.
By contrast, construction of institutional
structures was up again in the second
quarter.
Nonfarm inventory investment turned
slightly positive in the second quarter
after several quarters of heavy liquidation. Success in pruning inventories had
resulted in inventory-sales ratios that
generally were at very low levels across
the manufacturing, wholesale, and retail
sectors. There appeared to be only a few
industries with still sizable inventory
overhangs.
The U.S. trade deficit in goods and
services widened further in May and for
the April-May period. The expansion of
the deficit over the two months reflected
a sharp rise in the value of imports that
exceeded a sizable gain in the value
of exports. The step-up in imports
was spread widely across almost all
the major trade categories, with notable
increases in motor vehicles, consumer
goods, and machinery. The advance in
exports was primarily in automotive
parts, industrial supplies, and capital
equipment. With regard to economic
activity abroad, the available information, which is released in many cases
only with a considerable lag, indicated
that foreign economic output generally
continued to rebound during the first
half of the year, though the pace of
recovery was uneven across regions and
countries. Growth was strong in Canada, the United Kingdom, and emerging
Asia, but expansion in the euro area
and Japan remained sluggish, owing to
continued weakness in final domestic
demand. In South America, economic
and financial conditions had deteriorated significantly during the intermeeting period, especially in Brazil and Uruguay, and economic activity remained
208 89th Annual Report, 2002
particularly weak in Argentina and
Venezuela.
Consumer price inflation trended
down over the past year. Much of the
drop reflected developments in the
food and energy sectors, but core inflation also eased a little. In May and June,
both the consumer price and the chainweighted personal consumption indexes
exhibited little change in total and core
prices. Moreover, at the producer level,
inflation in core finished goods was at a
low rate in the May-June period and the
past twelve months. With regard to labor
costs, the employment cost index for
hourly compensation of private industry
workers increased at a somewhat faster
rate during the three months ended in
June, reflecting a surge in benefit costs.
From a somewhat longer perspective,
however, growth of compensation costs
over the twelve months ended in June
was the same as in the previous twelvemonth period.
At its meeting on June 25-26, 2002,
the Committee adopted a directive that
called for maintaining conditions in
reserve markets consistent with keeping
the intended level of the federal funds
rate at 13A percent, and it also retained a
neutral balance of risks statement. There
was little market reaction to the Committee's rate decision or its statement.
Instead, market participants focused
their attention on further revelations
of corporate malfeasance, fears that
more earnings restatements would
be announced in the run-up to the
August 14 deadline for certifying corporate financial statements, and concerns that second-half corporate earnings might prove disappointing. In this
environment, equity prices plunged
before recovering somewhat later in the
intermeeting period; on net, the major
broad equity indexes were down substantially. Yields on Treasury securities
also fell markedly on balance in volatile
trading, as investors sought a safe haven
for their funds and trimmed their expectations about the path for the intended
federal funds rate in coming quarters.
However, doubts about corporate balance sheets and the prospects for earnings growth led to steep increases in
corporate debt yields, particularly for
lower-quality issues.
In foreign exchange markets, the
trade-weighted value of the dollar
changed little on balance in terms of
the major foreign currencies over the
intermeeting period, though early in
the period the dollar declined sharply
against those currencies amid further
disclosures of U.S. corporate accounting
irregularities and concerns about the
strength of the U.S. recovery. Against
the background of a similar combination
of disappointing concerns, European
stock prices dropped more than those in
the United States, while Japanese equity
prices declined less as incoming data
seemed to point to a mild pickup of
economic activity in Japan. Across all
the major industrial economies, investors tended to shift funds toward less
risky instruments and to lower their
expectations for policy rates. The dollar
also was little changed on balance
against the index of currencies of other
important trading partners, even though
several South American countries were
experiencing difficult financial and
political problems.
Borrowing by domestic nonfinancial businesses had been weak recently,
likely reflecting deteriorating conditions
in credit markets and reduced requirements for funds to finance capital spending projects. Growth of M2 surged in
July in association with large inflows to
liquid deposits and retail money market
funds.
The staff forecast prepared for this
meeting suggested that, in light of
weaker-than-expected incoming eco-
Minutes of FOMC Meetings, August 209
nomic data, the expansion of economic
activity would pick up gradually over
the next year and a half from the very
sluggish pace of the second quarter. The
considerable monetary ease and fiscal
stimulus already in place and the continuing sizable gains in structural productivity would provide significant
impetus for spending, though the persisting volatility and weakness in equity
prices would tend to offset some of that
support. Inventory overhangs appeared
to have been largely eliminated and
business capital stocks to have moved
closer to desired levels. As a consequence, a gradually improving outlook
for sales and profits, low financing
costs, and the temporary federal tax
incentive for investment in new equipment and software were expected to
boost business investment spending.
However, a less robust pickup in final
sales was now expected over the forecast period, which would put somewhat
less pressure on resource margins than
had been anticipated previously, and the
level of activity would remain below
the economy's potential for a somewhat
longer time. The persistence of underutilized resources was expected to foster
some moderation in core price inflation.
In the Committee's discussion of current and prospective economic developments, members commented that
much of the incoming information on
economic activity had been disappointing, and many indicated that they had
marked down their growth forecasts for
the months ahead. Even so, with recent
weakness concentrated in volatile highfrequency data that might well prove to
be transitory and with business and consumer confidence unlikely to deteriorate
further in the absence of a major shock
to the economy, members continued to
place favorable odds on an underlying
outlook of strengthening expansion.
Factors cited for this positive outlook
included the stimulative stances of fiscal and monetary policy, the apparent
completion in most industries of efforts
to bring inventories and capital facilities
into desired alignment with expected
sales, and the support to consumer
incomes and business incentives provided by the continued rise in structural
productivity. Further gains in productivity and the prospect for relatively contained demand pressures on resources,
which were likely to be somewhat more
limited for a time than members had
anticipated earlier, would contribute to
keeping price inflation subdued.
A number of members commented on
financial developments that appeared to
be holding back the pace of the expansion. While prices in equity markets had
turned up from their recent lows, the
cumulative losses in financial wealth
incurred since early 2000 clearly were
having an adverse impact on expenditures by households and the higher cost
of equity capital was inhibiting business investment. The declines in equity
prices had been accompanied by a
heightened degree of risk aversion that
had led to widened credit spreads in
financial markets and the curtailment
of credit availability to potential borrowers whose repayment prospects were
viewed as questionable. To an extent
that was difficult to determine, the current skittishness in debt and equity markets reflected lender and investor reactions to the ongoing revelations of
corporate governance failures. Those
reactions, which were proving to be
more severe and probably would be
longer-lasting than many had anticipated, appeared to be contributing to
more cautious business spending and
hiring, at least temporarily. It was
unclear when the associated uncertainties would diminish and confidence
would begin to rebuild, though the
outlook might come into better focus
210 89th Annual Report, 2002
after the mid-August SEC deadline for
the certification of financial statements
by corporate executives. On the positive side, home mortgage financing
remained widely available at low interest rates and was providing important
support to household spending. More
generally, interest costs had declined for
borrowers with acceptable credit ratings, and the overall condition of the
banking system remained sound with
bank credit widely available. Moreover,
for many households, the negative
wealth effects stemming from losses on
equities were offset, at least to some
extent, by continuing increases in home
equity values. These ongoing factors
suggested to some members that the
effects of the financial restraints on economic activity might be fairly limited at
this point.
In their review of demand prospects
in key sectors of the economy, members
noted that household spending was continuing to play a key role in sustaining
the expansion. Retail sales, buttressed
by strength in motor vehicles, had been
well maintained in recent months
despite survey evidence of declining
consumer confidence. The extraction of
funds from increases in home equity
evidently remained an important source
of financing for household expenditures,
especially including outlays for home
modernization. Looking ahead, the
anticipated pickup in employment and
related gains in incomes, undergirded
by continued robust growth in structural
productivity, was seen as supporting further expansion in consumer spending.
Some members commented, however,
that the declines in equity wealth and
the possible persistence of turmoil in
equity markets might continue to
restrain the pickup in consumer expenditures in the months ahead.
In the housing sector, low mortgage
interest rates remained a key factor in
sustaining homebuilding activity at a
relatively elevated level. Housing markets continued to exhibit strength across
much of the country, with few indications of any moderation except for sales
of high-priced homes. It was noted that,
in the absence of an unanticipated downturn in general economic activity, underlying pressures for housing as the population expanded coupled with the
scarcity of viable homebuilding sites in
urban areas likely would preclude any
substantial decline in housing activity or
housing prices in the foreseeable future.
The weakness in business fixed
investment was still a depressant on
overall economic activity, though the
decline in business outlays had abated
since the latter part of 2001; indeed,
spending for equipment and software
had edged up in the second quarter. With
excess stocks of capital inventories
seemingly worked down to more acceptable levels in many industries and with
expansion in final sales expected to
become more firmly established, an
acceleration in spending for equipment
and software was likely in store. As they
had at earlier meetings, however, members observed that business sentiment
remained extraordinarily cautious on the
whole and that business firms in most
industries continued to direct their
investment spending primarily toward
enhancing the productivity of their
operations rather than also increasing
capacity. Exceptions cited by members
included the enlargement of production
facilities by some firms in industries
that were currently enjoying vigorous
demand, such as producers of motor
vehicles. How soon the gloom surrounding the outlook for a pickup in sales and
profits and the associated concerns in
financial markets would dissipate was
subject to substantial uncertainty, but
increasing needs for capital as the
economy continued to expand, further
Minutes of FOMC Meetings, August
growth in investment opportunities in
conjunction with the uptrend in structural productivity, and the temporary tax
incentive provision for equipment and
software likely would support a sustained recovery in investment expenditures over coming quarters that would
provide essential impetus for lifting economic growth.
The prospects for an upturn in nonresidential construction appeared to
many to be more bleak. Reports from
around the nation pointed to high, and
in many areas still rising, vacancy rates
for commercial and industrial space, and
hotel construction continued to be held
down by the problems afflicting the
travel industry. Against this backdrop,
overall nonresidential building activity
seemed likely to decline further over the
next several quarters.
Business inventories edged up in the
second quarter after declining persistently since early 2001. Indeed, the
strengthening was sufficient to account
for the small advance in GDP in the
latest quarter. With inventories now
apparently close to desired levels in
many sectors of the economy and reportedly below such levels for some retailers, the expected strengthening in final
sales would probably foster some inventory accumulation over coming quarters,
thereby adding impetus to the projected
growth of the economy.
Government spending also was
expected to provide ongoing stimulus to
the expansion, especially given the prospects for further spending initiatives
in forthcoming federal legislation. In
addition, already enacted income tax
cuts and the tax expensing provision for
certain investment outlays would help
to support both consumer and business expenditures. Concurrently, though,
state and local governments facing large
shortfalls in revenues in a sluggish economy were holding down the overall
211
growth in their expenditures. Anecdotal
reports suggested, however, that sizable
spending on a variety of construction
projects was continuing, financed in
part through bond issues. On balance,
the government sector was expected to
remain a positive factor in the economic
recovery.
The depreciation of the dollar and
overall strengthening in foreign economic activity were projected to foster
moderate added growth in U.S. exports
over the next several quarters. However,
recent developments, including indications of weaker-than-projected economic recovery in Europe, growing
questions about the outlook for several
important economies in South America,
and the continued sluggish performance
of the Japanese economy, threatened
to limit the improvement in exports, at
least over the nearer term. Providing a
partial counterweight were anecdotal
reports indicating sizable growth in U.S.
exports to a number of Asian countries.
The outlook for inflation remained
very favorable in the context of continuing slack in labor markets and robust
growth in structural productivity. Under
these conditions, increases in trend unit
labor costs were likely to remain subdued over the next several quarters
despite likely further escalation in
the cost of worker healthcare benefits. Indeed, the risks of any significant
run-up in inflation appeared to have
receded, and more time than anticipated
earlier was likely to elapse before the
expansion reached a pace that would
begin to reduce margins of underutilized
labor and other producer resources.
Even so, examples of rising cost and
price pressures were not entirely absent.
In addition to healthcare insurance costs,
these pressures included insurance
costs more generally, steel prices, some
materials costs, and, in association with
the dollar's depreciation, some upward
212 89th Annual Report, 2002
pressures on import prices. On balance
and barring a major supply shock to the
economy, members saw little reason
for concern about the prospect of an
increase in inflation in the foreseeable
future.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members were in favor of an
unchanged policy stance consistent with
retaining a target rate of PA percent
for the federal funds rate. Although
some economic and financial indicators
had deteriorated since the June meeting
and the members generally had scaled
down their economic forecasts, they
continued to see favorable prospects
for a strengthening economy over time.
To be sure, a further significant weakening in economic prospects—for
example, that might be associated with
additional deterioration in financial
markets—might well call for a policy
response, but for now the members
viewed the current degree of monetary
accommodation as appropriately calibrated to provide the stimulus needed
to foster a solid expansion that would
bring the economy to fuller resource
utilization.
All the members indicated that they
could accept, and most said they preferred, a proposal to shift the Committee's assessment of the risks to the
economy from the currently neutral
statement to one that was tilted toward
weakness in the foreseeable future. A
few expressed a preference to retain the
current balanced risks statement for the
press release to be issued shortly after
this meeting. In support of this view,
they underscored the considerable
uncertainty surrounding the outlook for
financial and economic conditions and
the prospect that many observers in
financial markets could misread a shift
in the Committee's assessment of the
risks to the outlook as a signal that the
Committee was contemplating easing
in the near term. All the members
agreed, however, on the desirability
of communicating in some form—
whether in the text of the post-meeting
press release or through a shift in the
risks statement or both—their view
that the expansion recently had been
less robust than expected and that
for the foreseeable future the risks
of a more extended period of subpar
growth had increased while those of
inflation had declined. Several also
commented that while the shift under
consideration might raise expectations
of some easing in coming months, those
expectations and related market adjustments would be shaped principally by
the tenor of the incoming economic
information.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive.
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the
federal funds rate at an average of around
VA percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are weighted mainly toward conditions that may generate economic weakness
in the foreseeable future.
Minutes ofFOMC Meetings, September 213
Votes for this action: Messrs. Greenspan,
McDonough, Bernanke, Ms. Bies,
Messrs. Ferguson, Gramlich, Jordan,
Kohn, McTeer, Olson, Santomero, and
Stern. Votes against this action: None.
It was agreed that the next meeting of
the Committee would be held on Tuesday, September 24, 2002.
The meeting adjourned at 12:40 p.m.
Vincent R. Reinhart
Secretary
Meeting Held on
September 24, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, September 24, 2002, at
9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Bernanke
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. Kohn
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Messrs. Connors, Howard, and
Lindsey, Ms. Mester,
Messrs. Oliner, Rolnick,
Rosenblum, Sniderman, and
Wilcox, Associate Economists
Mr. Kos, Manager, System Open
Market Account
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board
of Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division
of Research and Statistics,
Board of Governors
Mr. Whitesell, Deputy Associate
Director, Division of Monetary
Affairs, Board of Governors
Mr. Clouse, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics,
Board of Governors
Mr. Skidmore, Special Assistant to the
Board, Office of Board Members,
Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Division of Monetary
Affairs, Board of Governors
Mr. Moore, First Vice President,
Federal Reserve Bank of
San Francisco
Messrs. Eisenbeis, Fuhrer, Hakkio,
Judd, Lacker, and Steindel, Senior
Vice Presidents, Federal Reserve
Banks of Atlanta, Boston,
Kansas City, San Francisco,
Richmond, and New York
respectively
214 89th Annual Report, 2002
Messrs. Coughlin, Elsasser, and
Sullivan, Vice Presidents, Federal
Reserve Banks of St. Louis,
New York, and Chicago
respectively
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on August 13, 2002,
were approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities issued or fully guaranteed by federal
agencies during the period August 13,
2002, through September 23, 2002. By
unanimous vote, the Committee ratified
these transactions.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting indicated that the economy
continued to expand in the third quarter,
though the tenor of incoming reports
was mixed. Data on household and business spending had been solid for the
most part, and residential construction
remained high. Motor vehicle production provided a sizable boost to economic activity, but other factory output changed little on net. Employment
continued to expand unevenly, while
labor productivity remained on a strong
upward trend. Overall price inflation
had fallen over the past year, reflecting
favorable developments in the food and
energy sectors and a decline in core
inflation.
Aggregate labor market conditions
had been mixed in recent months. While
nonfarm payroll employment registered
further small gains in July and August,
the aggregate hours worked by production or nonsupervisory workers declined
on balance over the two-month period.
The manufacturing and retail trade sectors registered sharp job losses in
August, but those were more than offset
by hiring in the services and construction sectors. A hefty increase in government jobs at the federal, state, and local
levels also boosted payroll employment.
The civilian unemployment rate fell to
5.7 percent in August despite advances
in claims for unemployment insurance.
Industrial production declined in
August, largely offsetting July's rise.
Excluding motor vehicles, manufacturing output was unchanged in both July
and August after sizable advances in the
first half of the year. Production in the
high-tech sector jumped in August,
the manufacture of aircraft and parts fell
further, and output in the remainder of
the industrial sector was mixed. Capacity utilization in manufacturing changed
little in August and was substantially
below its long-run average.
Retail sales remained relatively brisk
in August despite further decreases in
stock prices and consumer confidence.
Households boosted their already high
level of spending on motor vehicles in
response to zero percent financing and
larger cash incentives offered by auto
manufacturers, and household purchases
of goods other than motor vehicles continued to advance at a moderate pace.
According to the latest available data,
outlays for services rose moderately in
July.
Residential housing activity slowed a
little in July and August from the robust
pace of the second quarter as further
declines in mortgage rates apparently
helped to support housing activity in
Minutes of FOMC Meetings, September 215
an environment of sluggish employment
and diminishing household wealth.
Starts of single-family units fell in
August to their lowest rate since last
November, while starts in the multifamily sector in the July-August period
were at their average rate for the first
half of the year. Sales of new singlefamily homes posted a record high in
July, and the inventory of unsold new
homes remained low. Sales of existing
single-family homes in July partially
retraced a large drop in June.
Based on the limited information
available, business investment in equipment and software seemed to be advancing at a solid pace in the third quarter.
This reflected an acceleration in spending that was associated importantly with
notably stronger motor vehicle sales
and a halt to the contraction in aircraft
expenditures. Outside the transportation
sector, outlays on equipment continued
to expand at a moderate pace; in addition, the level of orders in July (latest
data) moved above shipments for the
first time since early last year, and
the backlog of unfilled orders edged
up. Nonresidential construction activity remained on a steep downtrend in
July, with further reductions of spending
in all major categories except office
buildings.
The book value of manufacturing and
trade inventories excluding motor vehicles registered a second straight monthly
gain in July after many months of heavy
liquidation. Despite die rise in stocks,
gains in sales and shipments drove
inventory-sales ratios to even lower levels across the manufacturing, wholesale,
and retail sectors. Survey and anecdotal
information suggested that few industries were burdened with sizable inventory overhangs.
The U.S. trade deficit in goods and
services narrowed appreciably in July
after two quarters of large increases.
The smaller deficit in July reflected continued strong expansion of the value of
exports coupled with a decrease in the
value of imports. The step-up in goods
exports occurred mostly in motor vehicles and aircraft, while the gain in
exports of services was spread across
travel and other private services. The
decline in imports was concentrated in
consumer and capital goods, royalties,
and license fees. The very limited available information on economic activity
abroad in the third quarter suggested
continued sluggish expansion in the euro
area and Japan, moderate growth in the
United Kingdom, further brisk recovery in Canada, and ongoing recovery
in emerging Asia. Conditions in South
America remained fragile: Economic
activity was still very weak in Argentina
and Venezuela, and the Brazilian economy had been adversely affected by the
turbulence in financial markets, though
those markets had stabilized recently.
By contrast, Mexico experienced brisk
growth in the second quarter.
Despite a slight pickup in consumer
price inflation in August, the increase
in consumer prices (measured by either
the consumer price index or the chainindexed personal consumption expenditure index) for the year ending in August
was considerably smaller than that
for the previous twelve-month period.
Much of the drop in inflation reflected
developments in the food and energy
sectors, but core inflation also declined
noticeably. Producer prices for core finished goods likewise signaled a drop in
inflation over the last year. With regard
to labor costs, average hourly earnings
of production or nonsupervisory workers decelerated sharply over the twelve
months ended in August, reflecting the
effects of both the rise in unemployment
and the drop in consumer price inflation.
At its meeting on August 13, 2002,
the Committee retained a directive that
216 89th Annual Report, 2002
called for maintaining conditions in
reserve markets consistent with keeping
the intended level of the federal funds
rate at 13A percent, but it shifted from a
statement of a neutral balance of risks
to one that was tilted toward economic
weakness in the foreseeable future.
Market participants read the tilt and the
wording of the announcement as indicating that economic activity in the coming
months likely would be weaker than had
been expected, and some short-term
interest rates eased slightly while broad
indexes of equity prices moved lower.
The following day's deadline for the
recertification of corporate financial
statements passed uneventfully and
equity markets rallied. Subsequently,
however, a weaker tone to incoming
data on production and employment, a
gloomier outlook for business profits,
and heightening tensions over Iraq
seemed to lead investors to revise down
their outlook for the economy. Over the
intermeeting period, intermediate- and
longer-term Treasury security yields and
broad equity indexes fell considerably
on balance.
In foreign exchange markets, the
trade-weighted value of the dollar in
terms of the major foreign currencies
appreciated slightly on balance over the
intermeeting period as projections for
growth of foreign industrial countries,
particularly Germany and Japan, were
marked down more than those for the
United States. The dollar moved within
narrow ranges against most major currencies but rose somewhat against the
yen and the currencies of other important trading partners.
M2 growth remained elevated in
August, though somewhat below July's
rapid pace. Much of the strength of the
aggregate's liquid components likely
was associated with the continuing
historically low opportunity costs of
holding such deposits, the recent surge
in mortgage refinancing activity, and
the safe haven provided from volatile
equity prices. Borrowing by domestic
nonfinancial businesses remained weak,
likely reflecting reduced requirements
for funds to finance capital spending
projects and perhaps the improved tone
in the corporate bond market and a modest increase in the issuance of corporate
debt.
The staff forecast prepared for this
meeting suggested that, in light of
weaker-than-expected incoming economic data, the expansion of economic
activity would pick up more gradually
but would still reach a relatively brisk
pace late next year. The considerable
monetary ease and fiscal stimulus
already in place, continuing gains in
structural productivity, and improving
business confidence would provide
significant impetus for spending. Inventory overhangs appeared to have been
largely eliminated, and business capital
stocks appeared to have moved closer
to desired levels. As a consequence, a
gradually improving outlook for sales
and profits, low financing costs, and
the temporary federal tax incentive for
investment in new equipment and software were expected to boost business
investment spending. However, a less
robust pickup in final sales was now
expected over the forecast period, which
would put somewhat less pressure
on resource margins than had been
anticipated previously, and the level of
activity would remain below that of
the economy's potential for a longer
time. The persistence of underutilized
resources was expected to foster some
moderation in core price inflation.
In the Committee's discussion of current and prospective economic conditions, members commented that economic growth appeared to have picked
up in the third quarter but that the most
recent information had been mixed, rais-
Minutes ofFOMC Meetings, September
ing questions about whether the pace
of the expansion going forward would
be strong enough to erode margins
of underutilized labor and capital
resources. For now, a high degree of
business caution in the context of
substantial uncertainties, exacerbated
recently by apparently increased concerns about the geopolitical outlook,
continued to restrain business investment and hiring. Even so, the economy
appeared to be well positioned for solid
gains over time in light of the progress that had been made in bringing
inventories and capital stocks into better alignment with sales, the stimulus
provided by accommodative fiscal and
monetary policies, and the implications
of the strong uptrend in productivity for
profitable investment opportunities and
growth in consumer incomes. With the
growth of economic activity nonetheless
expected to remain below the economy's potential for some time, pressures
on labor and other resources would
be limited and in turn wage and price
increases likely would continue to edge
lower.
In their review of developments in
and prospects for key sectors of the
economy, members commented that
household spending had continued to be
well maintained. Buttressed by exceptional strength in sales of motor vehicles, consumer spending had displayed
solid growth during the summer months.
While survey indicators of consumer
confidence had declined this year, the
high levels of consumer spending on
homes, motor vehicles, and other bigticket items were, in the view of at least
some members, perhaps a better gauge
of consumer confidence. The value of
homes had continued to rise in most
areas, and unusually low interest rates
were inducing people to refinance mortgages and in the process to extract and
spend some of the embedded equity
217
gains. Increasing home equity values
probably were also providing some
counterweight to the impact on consumer spending of the negative wealth
effects associated with the declines in
stock market prices since the spring
of 2000. Other positive factors cited
as helping to undergird the persisting
strength in consumer spending included
reductions in federal income tax rates;
the availability of financing for consumer durable goods at relatively attractive interest rates, including zero interest rates for selected motor vehicles; and
the cumulative effects of productivity
gains on current and expected real consumer incomes. Looking ahead, sales of
motor vehicles likely would moderate to
some extent over coming months from
their currently unsustainable levels, and
some members referred to indications
of slower growth in retail sales in late
summer and somewhat downbeat forecasts for coming months reported by a
number of retailer contacts. Moreover,
the absence of significant growth in
employment, should it persist, could
at some point have significant adverse
repercussions on consumer spending.
On balance, consumer spending was
seen as likely to remain a positive but
possibly a more limited source of support for the expansion over the next
several quarters.
In the context of sustained growth
in incomes, low mortgage interest rates,
by facilitating the extraction of homeowners' equity, had played a key role
in inducing a high level of spending
on residential structures and home
improvement expenditures. Tending to
confirm currently available data on
housing activity, members cited persisting anecdotal reports of robust home
sales and residential construction in
many regions, though indications of
softening were noted in some areas
and market segments, particularly in the
218 89th Annual Report, 2002
high-price sector of the housing market.
Some members questioned whether generally rising housing prices and elevated
levels of refinancings would persist.
However, given the anticipated continuation of accommodative conditions in
mortgage markets and forecasts of rising incomes, the overall outlook for
housing remained favorable.
Business fixed investment remained
a significant question mark in the outlook for economic expansion. Recent
readings on business spending for
equipment and software pointed to
gradual improvement, but nonresidential construction activity continued to be
severely depressed in many areas. It was
unclear whether the recent strength in
orders and shipments signaled a significant acceleration in capital outlays, and
in this regard the new information that
would become available in the next few
weeks might provide important evidence
on the outlook for capital spending and
thus for the performance of the economy more generally. At least for now,
however, anecdotal reports suggested
that a high degree of caution continued
to characterize business investment
decisions in the face of an elevated level
of uncertainty. Much of the current
spending for equipment and software
reportedly represented replacement
demand largely associated with the short
useful lives of various types of equipment, and there appeared to be little
spending that would entail capital deepening. At the same time, several positive
factors in the outlook for capital spending could be cited including the greater
productivity of new capital equipment,
the temporary accelerated expensing tax
incentives, generally strong business
cash positions, and the relatively rapid
depreciation of existing capital equipment. For the present, however, business
contacts widely reported that because
of prevailing uncertainties they were
deferring major investment initiatives
until they saw clear evidence of an
increased need for capital to meet growing demand.
Business firms appeared to be in the
process of moving from inventory liquidation to accumulation, and the available evidence suggested that inventory
positions were getting tighter. Accordingly, prospective growth in final
demand would have to be met through
increased production. And as demand
rose over the next several quarters,
businesses were expected to accumulate inventories to maintain desired
inventory-sales ratios, adding in the
process some limited impetus to the
growth of GDP.
The growth of economic activity in
most major foreign countries appeared
to be falling below expectations earlier
in the year, with adverse implications
for U.S. exports. Among those nations,
only Canada had experienced a robust
economic recovery thus far this year.
Current forecasts continued to anticipate
strengthening activity abroad, but as in
the case of the U.S. economy substantial
uncertainties surrounded the timing and
pace of the improvement.
In the context of limited demand pressures on labor and other resources, current forecasts continued to point to quite
low and perhaps declining inflation over
the next several quarters, although there
appeared to be significant crosscurrents in the outlook for prices. Rapid
increases in healthcare and other insurance costs and the lagged passthrough
of large increases in oil prices would
tend to maintain upward pressure on
prices. Tending to oppose those forces,
though, were the effects on resource
use of an extended period of economic
activity below the economy's potential
as well as the effects of robust productivity gains on costs, apparently declining inflation expectations, and the per-
Minutes of FOMC Meetings, September 219
sistent absence of pricing power in
highly competitive markets. Indeed, the
members did not rule out the emergence
of appreciably lower inflation. In this
regard, some observed that a significant
decline in inflation from current levels
could imply an unwelcome tightening of monetary policy in real terms.
In addition, further sizable disinflation
that resulted in a nominal inflation rate
near zero could create problems for
the implementation of monetary policy
through conventional means in the event
of an adverse shock to the economy that
called for negative real policy interest
rates.
In the Committee's discussion of policy for the intermeeting period ahead, all
but two of the members endorsed a proposal to maintain an unchanged policy
stance. In the view of all the members,
current forecasts clearly were subject to
the risk that economic growth would not
be sufficient to reduce excess capacity
in labor and capital markets. However,
the members who favored a steady policy course noted that the recent data on
household and business spending had
been a bit stronger than expected and
that a number of factors pointed to solid
growth over time. In these circumstances, they believed that in the context
of prevailing uncertainties more evidence of subpar expansion was desirable before policy was eased further. It
was noted in this regard that the information that would become available
over the next several weeks should provide an improved basis for assessing
the recent anecdotal reports from around
the nation that pointed to a possibly
slowing expansion. Several members
indicated that if compelling evidence
of a weak economy were to materialize they would be prepared to ease
promptly. Two members preferred an
immediate easing action because they
were persuaded by what they viewed as
already strong evidence of a persisting
unsatisfactory, and perhaps weakening,
economic performance. While the current stance of policy was already accommodative, they felt that greater stimulus
was now called for to foster an acceptable pace of economic expansion.
All the members agreed that the risks
to the economy remained tilted toward
weakness and that such an assessment
needed to be incorporated in the statement to be released shortly after today's
meeting. The members also accepted a
proposal to add a reference in the statement regarding what they viewed as
recently heightened geopolitical risks
that appeared to constitute a major
source of the uncertainty currently prevailing in the economy. The addition
was not intended to signal that any particular policy response would be forthcoming in the event of a crisis. Rather,
consistent with its usual practice, the
Committee would assess the implications of any such development for
the domestic economy before deciding
on an action. Indeed, if the geopolitical
uncertainties were to ease significantly
along with what already were apparently diminishing concerns about corporate governance issues, the resulting
improvement in business and consumer
sentiment could generate a more robust
economic expansion.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive.
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with maintaining the
220
89th Annual Report, 2002
federal funds rate at an average of around
13A percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks continue to be weighted mainly
toward conditions that may generate economic weakness in the foreseeable future.
Votes for this action: Messrs. Greenspan,
McDonough, Bernanke, Ms. Bies, Messrs.
Ferguson, Jordan, Kohn, Olson, Santomero, and Stern. Votes against this
action: Messrs. Gramlich and McTeer.
Messrs. Gramlich and McTeer dissented because they preferred to ease
monetary policy at this meeting. The
economic expansion, which resumed
almost a year ago, had recently lost
momentum, and job growth had been
minimal over the past year. With inflation already low and likely to decline
further in the face of economic slack
and rapid productivity growth, the
potential cost of additional stimulus
seemed low compared with the risk of
further weakness.
It was agreed that the next meeting
of the Committee would be held on
Wednesday, November 6, 2002.
The meeting adjourned at 1:30 p.m.
Votes for this action: Messrs. Greenspan,
Bernanke, Ms. Bies, Messrs. Ferguson, Gramlich, Jordan, Kohn, McTeer,
Olson, Santomero, and Stern. Votes
against this action: None. Abstention:
Mr. McDonough.
Vincent R. Reinhart
Secretary
Meeting Held on
November 6, 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Wednesday, November 6, 2002, at
9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Bernanke
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. Kohn
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Notation Vote
By notation vote completed on September 30, 2002, the Committee authorized Vice Chairman McDonough to
accept the "Decoration of Merit" honor
to be awarded by the government of
Argentina.
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Minutes of FOMC Meetings, November 221
Messrs. Howard, Lindsey, Ms. Mester,
Messrs. Oliner, Rosenblum,
Sniderman, and Wilcox, Associate
Economists
Mr. Kos, Manager, System Open
Market Account
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board of
Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division
of Research and Statistics, Board
of Governors
Messrs. Kamin and Whitesell, Deputy
Associate Directors, Divisions of
International Finance and
Monetary Affairs respectively,
Board of Governors
Mr. Clouse, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics, Board
of Governors
Mr. Nelson,7 Senior Economist,
Division of Monetary Affairs,
Board of Governors
Mr. Skidmore, Special Assistant to the
Board, Office of Board Members,
Board of Governors
Mr. Forte,7 Senior Technical Editor,
Division of Research and
Statistics, Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Division of Monetary
Affairs, Board of Governors
Mr. Varvel, First Vice President,
Federal Reserve Bank of
Richmond
7. Attended portion of meeting relating to the
discussion of alternatives to holding Treasury
securities in the System Open Market Account.
Mr. Lang, Executive Vice President,
Federal Reserve Bank of
Philadelphia
Messrs. Eisenbeis, Fuhrer, Goodfriend,
Hakkio, Hunter, Judd,
Ms. Perelmuter, and Mr. Rasche,
Senior Vice Presidents, Federal
Reserve Banks of Atlanta, Boston,
Richmond, Kansas City, Chicago,
San Francisco, New York, and
St. Louis respectively
Mr. Peach, Vice President, Federal
Reserve Bank of New York
Mr. Weber, Senior Research Officer,
Federal Reserve Bank of
Minneapolis
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on September 24, 2002,
were approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities
issued or fully guaranteed by federal
agencies during the period September 24, 2002, through November 5,
2002. By unanimous vote, the Committee ratified these transactions.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting suggested that economic
growth had slowed from the moderate
pace of the third quarter. Residential
construction activity remained high, but
222 89th Annual Report, 2002
consumer spending had softened and
business investment was still sluggish.
Industrial production had slipped in
recent months and private payroll
employment had changed little, while
labor productivity remained on a strong
upward trend. Overall price inflation
had fallen over the past year, reflecting
both favorable developments in the food
and energy sectors and a continuing
decline in core inflation.
Aggregate labor market conditions
weakened further in October. Private
nonfarm payroll employment declined
in September and October after four previous months of modest gains in hiring.
The number of jobs in manufacturing
and related industries continued to fall,
with losses widely spread. The construction, transportation, and utilities industries also registered further job losses.
By contrast, the services sector continued to expand despite job reductions in
the help-supply industry, and the strong
housing market and mortgage refinancing activity led to brisk hiring in the
finance, insurance, and real estate industries. Total hours worked by private production workers moved down in October, and initial claims for unemployment
insurance were at a relatively elevated
rate. The civilian unemployment rate
rose to 5.7 percent in October.
Industrial
production
decreased
slightly further in September, and available weekly information pointed to
another reduction in output in October.
Softness in the manufacturing sector
was widespread. In the high-tech sector,
output continued to rise, but much less
rapidly than earlier in the year. Motor
vehicle assemblies ebbed a little from
the robust third-quarter pace. Elsewhere
in manufacturing, production weakened
in many categories, including commercial aircraft, non-auto consumer goods,
and various types of business equipment. Capacity utilization in manufac
turing edged lower in September and
was substantially below its long-run
average.
In the context of limited gains in personal income and declining consumer
confidence, retail sales weakened in
September after two months of robust
increases. The earlier gains were fueled
mainly by very large manufacturer discounts on 2002 models of motor vehicles. Incentives on 2003 models were
smaller in September, and consumer
response was tepid. Retail sales of nonauto goods also decreased in September
after having registered only modest
growth in July and August. Outlays for
services edged up in September.
Residential housing activity, supported by mortgage rates near historical
lows, remained very strong in September despite an environment of sluggish
employment and declining household
wealth. Starts of single-family units
reached a twenty-three year high in September, and starts in the multifamily
sector were a little above their average
since January of this year. Sales of new
homes edged up to a record level in
September, and sales of existing homes
continued to be brisk, though a little
below the exceptional pace of the first
half of the year. The strength of housing
demand was also reflected in further
rapid gains in home prices.
Business fixed investment edged up
in the third quarter, as a pickup in expenditures for equipment and software
nearly offset a further sharp decline in
spending on nonresidential structures.
The return to positive growth of spending for equipment and software was led
by robust business outlays for computers and peripheral equipment and for
motor vehicles. By contrast, investment
in telecommunications equipment and
aircraft remained on a steep downward
trend. Nonresidential construction activity also continued to decline rapidly,
Minutes of FOMC Meetings, November 223
with considerable further reductions in
all major categories.
The book value of manufacturing and
trade inventories excluding motor vehicles registered consecutive gains in July
and August after months of heavy liquidation. Despite the recent accumulation,
inventory-sales ratios in most industries
were at, or near, historic lows.
The U.S. trade deficit in goods and
services widened in August, and the
average deficit for July and August
was virtually unchanged from that for
the second quarter. The value of both
imports and exports changed little in
the July-August period. The available
information on economic activity abroad
in the third quarter suggested mixed
results. Canada apparently grew briskly,
and the United Kingdom recorded
further moderate economic expansion.
In the euro area and Japan, growth
appeared to be weakening. The pace of
recovery in most of emerging Asia also
appeared to have slowed, though China
evidently remained on a path of robust
expansion. In South America, economic
conditions generally remained fragile.
Economic activity was still very weak
in Argentina and Venezuela, and the
Brazilian economy continued to be
adversely affected by uncertainties concerning the economic policies of the
incoming government. Mexico has been
largely unaffected by the financial and
political problems of major South
American countries, but it nonetheless
experienced slower economic growth in
the third quarter.
Consumer price inflation continued to
trend downward in September. The rise
in consumer prices for the year ending
in September was considerably smaller
than that for the previous twelvemonth period. While much of that drop
reflected developments in the food
and energy sectors, core inflation also
declined noticeably. Judged by con
sumer surveys, slower price increases
over the past year apparently led consumers to lower their expectations
of near-term inflation. At the producer
level, prices for core finished goods
likewise decelerated over the twelve
months ended in September. With
regard to labor costs, growth in average
hourly earnings of production or nonsupervisory workers declined significantly
over the twelve months ended in September, evidently reflecting the effects
of both the rise in unemployment and
the drop in consumer price inflation.
At its meeting on September 24,
2002, the Committee adopted a directive
that called for maintaining conditions in
reserve markets consistent with keeping
the federal funds rate around 13A percent, and it also retained a balance of
risks statement that was tilted toward
economic weakness in the foreseeable
future. Market participants had anticipated the unchanged policy stance and
risk assessment, but the inclusion in
the policy announcement of a reference
to heightened geopolitical risks led to
downward revisions to expectations for
the future path of the federal funds rate.
The subsequent release of better-thanexpected news on profits for several
major corporations buoyed equity prices
and lifted market interest rates and predicted policy rates. Later in the intermeeting period, weaker-than-anticipated
economic data along with press reports
suggesting that the FOMC was inclined
to ease by year-end led again to downward revisions of the expected path of
the federal funds rate target. Over the
intermeeting period as a whole, broad
equity indexes registered sizable gains
and intermediate- and longer-term bond
yields increased somewhat.
The dollar traded in a narrow range
in foreign exchange markets during
the intermeeting period. It depreciated
slightly in terms of an index of major
224 89th Annual Report, 2002
foreign currencies and was little
changed on balance against the currencies of other important trading partners.
M2 grew more moderately on average in September and October, with
aggregate spending apparently softening, the effects of past monetary easing
actions wearing off, and significantly
weaker foreign demand for currency
emerging. By contrast, the high level of
mortgage refinancing activity provided
a continuing boost to deposit growth.
The staff forecast prepared for this
meeting suggested that, in light of further weaker-than-expected incoming
economic data, the expansion of economic activity would be relatively
muted for some time. Moreover, current
and prospective sluggish economic
growth among major trading partners
would damp U.S. exports, and businesses and households were likely to
hold their spending down while faced
with the possibility of a military conflict
as well as persisting concerns about
the near-term course of economic activity and corporate earnings. Nonetheless, those restraining influences were
expected to abate over time and economic activity strengthen gradually. The
considerable monetary ease and fiscal
stimulus already in place, continuing
gains in structural productivity, and
anticipated improvement in business
confidence would provide significant
impetus for spending. Inventory overhangs already had been largely eliminated, and business capital stocks had
moved closer to desired levels. As a
consequence, a slowly improving outlook for sales and profits, low financing
costs, and the temporary federal tax
incentive for investment in new equipment and software were expected to
boost business investment spending.
Even so, a less robust pickup in final
sales was now expected over the forecast period, which would put somewhat
less pressure on resource margins than
had been anticipated previously, and
the level of activity would remain below
the economy's potential for a longer
time. The persistence of underutilized
resources was expected to foster a slight
moderation in core price inflation.
In the Committee's discussion of
current and prospective economic conditions, members commented that the
recent data on the performance of the
economy had been disappointing and
had tended to confirm widespread anecdotal indications that economic growth
had slowed to a pace well below that
experienced earlier in the year. Even
so, the members acknowledged that
the economy had displayed remarkable
resiliency over the past year despite
being subjected to severe adverse
shocks. While the latter clearly had
taken their toll on confidence, notably in
the business sector, consumer spending
had held up relatively well. Business
investment expenditures continued to be
constrained by a high degree of uncertainty and related caution. Looking
beyond the near term, the members
anticipated that as the prevailing uncertainties began to diminish, the economy's resiliency abetted by broadly
accommodative monetary and fiscal
polices and the continuation of a strong
uptrend in productivity would underpin
a gradual economic recovery. Indeed,
some members commented that an even
more robust recovery could not be ruled
out in the absence of further major
shocks to confidence. With pressures on
labor and other resources expected to be
limited over coming quarters, inflation
was likely to remain subdued and perhaps even to edge a little lower.
In their review of developments and
prospects in key expenditure sectors
of the economy, members noted that
consumer spending appeared to have
decelerated since midsummer, while an
Minutes of FOMC Meetings, November 225
anticipated and hopefully compensating
strengthening in business investment
had not yet materialized. Factors cited
by the members that appeared to help
account for the recent softness in
consumer demand included substantial
decreases in equity wealth, declining
consumer confidence in the context of
geopolitical and other uncertainties, the
waning effects of earlier income tax
cuts, and the failure of the most recent
round of motor vehicle sales incentives
to maintain the extraordinary level of
sales seen during the summer. Looking
ahead, some members referred to subdued expectations among their retailer
contacts regarding the upcoming holiday season, with sales prospects likely
to be held back at least marginally
by the lingering effects of the recent
West Coast dock strike on the availability of merchandise. There also was
some question as to whether funds
extracted from rising home equity
values would continue to provide as
important a source of financing for
purchases of consumer durables as they
had for some time unless mortgage
interest rates declined from their already
low levels. Members also mentioned a
number of favorable factors bearing on
the longer-term outlook for consumer
spending. These included the prospect
of strengthening consumer confidence
if geopolitical uncertainties began to
dissipate, the gradual diminution of the
negative wealth effects from earlier
stock market declines, and importantly
the outlook for continued robust growth
in structural labor productivity and its
favorable effects over time on wages
and salaries.
High and persisting uncertainty and
concomitant aversion to risk among
business executives apparently continued to hold down business investment
spending. While such expenditures
remained at a high level, members saw
few signs of a significant pickup in the
nearer term. Apart from notably adverse
business sentiment and disappointing
growth in sales and profits, factors that
were curbing capital expenditures cited
by members included persisting capital
overhangs stemming from what were
now seen as excessive earlier buildups
in equipment and software and substantial idle capacity in many industrial and
commercial structures. Some divergence
of opinion was expressed regarding
the overall extent of capital overhangs,
though it was clearly evident in some
industries and in high vacancy rates in
nonresidential buildings in many areas
of the country. Looking to the future, the
timing and strength of a decisive upturn
in capital expenditures, a key factor in
the outlook for some improvement in
the performance of the overall economy,
would depend critically on the dissipation of prevailing uncertainties, including those associated with geopolitical
risks, and increasing prospects for profits. In the latter regard, it was suggested
that in the context of rising productivity,
profits could prove to be stronger than
many now expected, with favorable
implications for cash flows and in turn
investment activity.
Cautious business attitudes and expectations of sluggish sales over coming
months were inducing business firms
to continue to hold down what were
already generally lean inventories.
Nonetheless, some members commented
that inventory accumulation was likely
to provide some limited impetus to the
economy over the next several quarters
to the extent that an acceleration in economic activity occurred and businesses
sought to maintain an acceptable balance between their inventories and sales.
Indeed, with inventories at unusually
low levels in many industries, efforts
to rebuild such inventories appeared
inevitable.
226 89th Annual Report, 2002
Housing activity had remained at a
generally elevated level in recent
months and in the context of low mortgage interest rates likely would continue
to provide important support to the
economy over the forecast period. Most
regional reports indicated persisting
strength in the housing sector, though
there was evidence of modestly flagging
activity in some areas. In this regard,
it was noted that the declining trend
in mortgage interest rates probably
would not continue once forecasts of
a strengthening economic expansion
began to materialize. Indeed, the rise in
bond yields since the September meeting associated with the improvement
in the stock market had induced a small
increase in mortgage rates from their
very low levels. At some point the
extraordinary levels of cash-outs from
mortgage refinancings and home sales
would undoubtedly moderate, with
adverse implications for spending on
home improvements and consumer
durables more generally. Still, household spending probably would continue
to be supported by the increases in
income and wealth associated with
strengthening economic expansion and
rising productivity.
Members commented that fiscal policy remained accommodative, but an
analysis cited at this meeting suggested
that the stimulus embodied in current
legislation had diminished considerably
since earlier in the year. Reference also
was made to the partial expensing provision of the tax legislation enacted in
March of this year, which was seen as
a positive but not in itself a compelling
factor in inducing expenditures on business equipment and software. Some
members observed that further federal
tax cuts, should they be enacted, would
likely take effect too late to foster much
added spending over the year ahead. At
the state and local government levels,
efforts to control very large deficits
likely would lead to tax and spending
legislation that would offset at least part
of the remaining stimulus inherent in the
federal budget.
Members commented that little if any
stimulus could be expected from the
export sector of the economy in light
of current and prospective shortfalls in
the economic performance of important
U.S. trading partners. Indeed, recent
forecasts incorporated downward revisions to the growth of overall foreign
economic activity.
With the economy evidently on a
lower-than-anticipated growth path and
with slack in labor and product markets
at elevated levels, members anticipated
that inflation would remain quite subdued over the year ahead even in the
context of some anticipated acceleration
in economic activity. Indeed, the prospect of some persisting slack in resource
use over coming quarters pointed to
further disinflation. In this regard, some
members referred to the possibility,
which they viewed as remote, of a
period of deflation in the event of a
strongly negative demand shock.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members favored a proposal to
reduce the target for the intended federal
funds rate by 50 basis points to \lA percent. While the current stance of monetary policy was still accommodative and
was providing important support to economic activity, the members were concerned that the generally disappointing
data since the previous meeting, reinforcing the general thrust of the anecdotal evidence in recent months, pointed
to a longer-lasting spell of subpar economic performance than they had anticipated earlier. In the circumstances, a
relatively aggressive easing action could
help to ensure that the current soft spot
in the economy would prove to be tern-
Minutes of FOMC Meetings, November 227
porary and enhance the odds of a robust
rebound in economic activity next year.
A further reason cited by some members
for a sizable easing move related to their
perceptions of a diminishing stimulus
from earlier policy easing actions and
indications that overall financial conditions, including bank lending terms, had
become more restrictive this year even
though the nominal federal funds rate
target had not been changed since late
2001. The members agreed that monetary policy could do little to improve
the performance of the economy in the
near term, but some emphasized that a
50 basis point easing likely would feed
through to some degree to market interest rates, with favorable implications for
spending next year.
Members commented that the potential costs of a policy easing action that
later proved not to have been needed
were quite limited in that there was little
risk that such a move would foster inflationary pressures under likely economic
conditions over the next several quarters. Moreover, the policy easing could
readily be unwound without significant effects on financial markets if the
reversal appeared to be warranted by
growing pressures on resources in a
strengthening economy. In contrast, a
failure to take an action that was needed
because of a faltering economic performance would increase the odds of a
cumulatively weakening economy and
possibly even attendant deflation. An
effort to offset such a development,
should it appear to be materializing,
would present difficult policy implementation problems.
All the members indicated that, in
light of the contemplated 50 basis point
easing action, they could support a shift
in the Committee's assessment of the
risks to the economy from tilted toward
economic weakness to balanced for
the foreseeable future, although some
voiced reservations about the need for
such a shift. The economy probably
would continue to underperform in the
period immediately ahead, but in the
absence of unpredictable adverse shocks
this sluggish performance was more
likely to be balanced by subsequent economic strength in light of the policy
action. A 50 basis point move would
tend to have a more pronounced effect
than usual in financial markets, at least
initially, because it would be largely
unexpected and would come after an
extended hiatus in implementing policy
changes. In the view of many members,
retaining the assessment that the risks
were tilted toward weakness would raise
the odds of an overreaction in financial
markets, which might well misread the
Committee's decision as a sign that the
members were more concerned about
the potential for greater economic weakness than was in fact the case and that
therefore the Committee currently saw a
likely need for further easing later. Some
members saw a lesser risk of such a
development, partly because of widespread market expectations that even
with a sizable reduction in the intended
federal funds rate the Committee would
not change its assessment of unbalanced
risks to the economy in present circumstances. Although they had at least
a marginal preference for retaining
the current tilt toward weakness, these
members were willing to accept a balanced statement in light of the uncertainties that surrounded prospective market
reactions. While the possible market
response was not a primary factor determining the desirability of a policy
action, the Committee needed to take it
into account in gauging the potential
effects of particular policy moves.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
228 89th Annual Report, 2002
to execute transactions in the System
Account in accordance with the following domestic policy directive:
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve
markets consistent with reducing the federal funds rate to an average of around
\lA percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are balanced with respect to prospects for both goals in the foreseeable future.
Votes for this action: Messrs. Greenspan, McDonough, Bernanke, Ms. Bies,
Messrs. Ferguson, Gramlich, Jordan,
Kohn, McTeer, Olson, Santomero, and
Stern. Votes against this action: None.
Use of Alternative Assets
in Open Market Operations
At this meeting the Committee provided
further guidance to the staff on priorities
for the continuing study of alternatives
to Treasury securities in the conduct of
System open market operations. At its
meeting in March of this year, the Committee had reaffirmed its preference for
the use of Treasury securities to implement the System's monetary policy,
contingent upon the continued availability of a sufficient outstanding volume
of such obligations to accommodate
the System's very large operations. As
was already apparent at the time of the
March meeting, fiscal policy develop
ments made it clear that earlier concerns
about a contracting supply of securities
in the U.S. government securities market
would not likely impose constraints on
the System's open market operations in
the near term.
Even so, the members expressed a
consensus in favor of continuing to
study alternatives to Treasury obligations for potential future use. Pursuant to the Committee's instructions
in March, the staff had activated its
study of the possible employment of
mortgage-backed securities guaranteed
by the Government National Mortgage
Association (Ginnie Maes) in outright
System open market operations. Such
obligations were already being utilized
for temporary additions to the System's
portfolio through repurchase agreements. During their discussion at this
meeting, the members recognized that
outright purchases of Ginnie Maes for
permanent additions to the System's
portfolio would present a number of
difficulties and would require extensive
preparations for their effective integration, if deemed desirable at a later date,
into the conduct of outright System open
market operations. Still, in view of their
possible advantages in helping to meet
SOMA portfolio objectives at some
point in the future, the Committee
instructed the staff to continue to focus
available resources on the possible use
of Ginnie Maes for such operations. The
Committee also decided to discontinue
further consideration of the possible use
of foreign sovereign debt obligations
as collateral for repurchase agreements
in light of the problems that were
envisaged in the employment of such
securities.
At this meeting the Committee also
reviewed work that had been done on
the potential use of an auction credit
facility (ACF) that could serve as a
partial substitute for Treasury or other
Minutes ofFOMC Meetings, December 229
securities. In addition, the Committee
reviewed a study that considered
whether an ACF might be adapted for
use in a contingency (CACF) as a full
substitute for open market operations.
Many of the members commended the
staff for its careful assessment of the
potential for such operations. The members concluded, however, that significant resources should not be assigned
at this time to the further study of these
alternatives to open market operations
given the prospects for an enlarged
supply of Treasury obligations, the
decision to focus on Ginnie Maes, and
the introduction of a new discount
window program, the System's primary
credit facility, scheduled for implementation in early 2003. In addition, the
CACF had been made unnecessary by
the implementation of contingency plans
and backup facilities since September
2001. The members concurred with the
staff's recommendation that the staff
studies prepared for the Committee in
January 2001, when it discussed in
detail various alternatives to holding
U.S. government securities, should be
released to the public after light editing
was completed.
It was agreed that the next meeting of
the Committee would be held on Tuesday, December 10, 2002.
The meeting adjourned at 1:55 p.m.
Vincent R. Reinhart
Secretary
Meeting Held on
December 109 2002
A meeting of the Federal Open Market
Committee was held in the offices of
the Board of Governors of the Federal
Reserve System in Washington, D.C.,
on Tuesday, December 10, 2002, at
9:00 a.m.
Present:
Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Bernanke
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. Kohn
Mr. McTeer
Mr. Olson
Mr. Santomero
Mr. Stern
Messrs. Broaddus, Guynn, Moskow,
and Parry, Alternate Members
of the Federal Open Market
Committee
Mr. Hoenig, Ms. Minehan, and
Mr. Poole, Presidents of the
Federal Reserve Banks of
Kansas City, Boston, and
St. Louis respectively
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Mr. Connors, Ms. dimming,
Messrs. Howard and Lindsey,
Ms. Mester, Messrs. Oliner,
Rolnick, Rosenblum, Sniderman,
and Wilcox, Associate Economists
Mr. Kos, Manager, System Open
Market Account
Messrs. Ettin and Madigan, Deputy
Directors, Divisions of Research
and Statistics and Monetary
Affairs respectively, Board of
Governors
Messrs. Slifman and Struckmeyer,
Associate Directors, Division
of Research and Statistics,
Board of Governors
Mr. Whitesell, Deputy Associate
Director, Division of Monetary
Affairs, Board of Governors
230 89th Annual Report, 2002
Mr. Clouse, Assistant Director,
Division of Monetary Affairs,
Board of Governors
Mr. Simpson, Senior Adviser, Division
of Research and Statistics, Board
of Governors
Mr. Skidmore, Special Assistant to the
Board, Office of Board Members,
Board of Governors
Ms. Low, Open Market Secretariat
Assistant, Division of Monetary
Affairs, Board of Governors
Ms. Holcomb, First Vice President,
Federal Reserve Bank of Dallas
Messrs. Eisenbeis, Fuhrer, Goodfriend,
Green, Hakkio, and Rasche,
Senior Vice Presidents, Federal
Reserve Banks of Atlanta, Boston,
Richmond, Chicago, Kansas City,
and St. Louis respectively
Messrs. Elsasser and Furlong, Vice
Presidents, Federal Reserve Banks
of New York and San Francisco
respectively
By unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on November 6, 2002,
were approved.
The Manager of the System Open
Market Account reported on recent
developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the
previous meeting.
The Manager also reported on developments in domestic financial markets
and on System open market transactions
in government securities and securities
issued or fully guaranteed by federal
agencies during the period November 6,
2002, through December 9, 2002. By
unanimous vote, the Committee ratified
these transactions.
The Committee then turned to a discussion of the economic and financial
outlook and the conduct of monetary
policy over the intermeeting period
ahead.
The information reviewed at this
meeting suggested that economic
growth had been sluggish on balance
since midsummer. Housing demand
remained strong, but business fixed
investment was still in the doldrums
and consumer spending had flagged in
late summer before apparently picking
up somewhat in the autumn. Payroll
employment had changed little since
midyear, and industrial production still
seemed to be on a downward trend.
Most price indexes continued to indicate
that inflation had declined over the past
year.
Private nonfarm payroll employment
remained stagnant in the third quarter
and edged down in October and November. Job losses in manufacturing were
again large in the two months, and
employment declined in construction
and in the wholesale and retail trade
industries. By contrast, services (except
help-supply) and the finance, insurance,
and real estate grouping recorded further solid gains. The unemployment rate
rose to 6 percent in November, a level
more consonant with other recent labor
market indicators. Labor productivity in
the nonfarm business sector continued
to climb briskly, with the advance over
the last four quarters being the largest
since 1973.
Industrial production dropped sharply
further in October, with roughly half
of the decline related to a slowdown in
motor vehicle assemblies and the manufacture of related parts. The rest of the
manufacturing sector also was weak on
balance, with output down in almost all
market groups. The high-tech sector was
an exception, although the rise in output of computers and semiconductors in
Minutes of FOMC Meetings, December 231
October was smaller than earlier in the
year and the production of communications equipment continued to fall.
Consistent with the poor performance
of industrial production, capacity utilization in manufacturing fell again in October and remained substantially below its
long-run average.
Against the backdrop of smaller gains
in disposable personal income and
low readings on consumer confidence,
growth of consumer spending had been
quite sluggish in the last several months.
Much of the weakness reflected a falloff
in spending on new motor vehicles in
September and October, largely because
of reduced manufacturer discounts.
Apart from motor vehicles, personal
consumption expenditures picked up in
October following two months of softness. Increases in outlays for services in
September and October remained modest and about equal to the average rate
of rise earlier in the year.
Housing starts dropped moderately in
October, which was an unusually wet
month across much of the country. However, residential housing activity had
been very strong on balance this year
despite an environment of sluggish
employment and declining household
wealth. Mortgage rates near historical
lows had provided important support for
single-family housing demand, and sales
of new and existing homes had remained
buoyant. In the multifamily sector, starts
plunged in October to the slowest pace
in almost six years. While some of the
decline likely was attributable to inclement weather, apartment vacancy rates
had risen significantly over the past
year, perhaps partly in response to the
single-family housing boom.
Business spending on equipment and
software increased moderately in the
third quarter, but the recent monthly
pattern of data on shipments and orders
for nondefense capital goods, along
with anecdotal reports from businesses,
signaled renewed weakness. Shipments
of nondefense capital goods rebounded
in October, led by a rise in computing
equipment. In contrast, shipments of
communications equipment plunged.
Construction in the nonresidential sector
slowed sharply further in the third quarter, but a few signs, including a rise in
activity in October, suggested some
moderation in the rate of decline.
The aggregate book value of manufacturing inventories changed little in
October: declines in stocks of many
types of durable goods were offset by
modest stockbuilding of nondurables,
and the ratio of stocks to shipments
remained very low. Anecdotal information suggested that disruptions of West
Coast dock operations stemming from a
labor dispute had been quite small.
The U.S. trade deficit in goods and
services changed little in September and
the third quarter. The available information on economic activity abroad in the
third quarter indicated that economic
expansion remained moderate in the
United Kingdom and sluggish in the
euro area. Economic growth subsided
somewhat from elevated second-quarter
rates in Canada, Japan, and emerging
Asia. Economic conditions in South
America were generally still fragile.
Core consumer price inflation, as
measured by the consumer price index
(CPI) and the chain-weighted personal
consumption expenditure (PCE) index,
continued to trend lower in October.
Inflation, in terms of both indexes, was
down over the last twelve months when
compared with the previous twelvemonth period. At the producer level,
core price inflation for finished goods
over the twelve months ended in October was at a very low rate. With regard
to labor costs, average hourly earnings
of production or nonsupervisory workers increased moderately in November,
232 89th Annual Report, 2002
and the growth in those earnings over
the last twelve months fell considerably,
evidently reflecting the slack in labor
markets.
At its meeting on November 6, 2002,
the Committee adopted a directive that
called for lowering the target for the
intended federal funds rate by 50 basis
points, to \lA percent. The Committee
also agreed that, in light of the decision
to ease, it would be appropriate to indicate in the press release that the risks
were balanced for the foreseeable future.
Market participants had expected a
25 basis point cut and retention of a
statement of risks toward weakness.
The unexpectedly large reduction in the
federal funds rate target led to an initial
decline in Treasury coupon yields. That
drop was reversed when market participants apparently focused on the shift to
balanced risks and concluded that the
odds of pronounced economic weakness
had fallen. The subsequent release of
better-than-expected economic data and
earnings news provided reassurance to
investors, though more mixed economic
reports became available late in the
intermeeting period. Over the period as
a whole, major equity indexes registered
mixed changes, and yields on longerterm Treasury bonds increased somewhat. In private debt markets, rates
on investment-grade debt issues eased
a little, and those on speculative-grade
bonds fell considerably more.
The dollar appreciated slightly in
terms of an index of major foreign currencies, principally against the yen, and
changed little against the currencies of
other important trading partners. The
dollar edged lower against most major
currencies in the aftermath of the policy
easing on November 6, but those losses
were subsequently retraced after the
release of U.S. economic data that were
seen as suggesting relatively better economic conditions in the United States.
M2 growth slowed a little in November from October's elevated pace. The
further advance again was concentrated
in liquid deposits. The low level of
opportunity costs and heavy mortgage
financing continued to support the
demand for liquid assets.
The staff forecast prepared for this
meeting suggested that the expansion of
economic activity would be relatively
muted over the near term. Faced with
heightened geopolitical tensions as well
as persisting concerns about the nearterm course of economic activity and
corporate earnings, businesses and
households were likely to hold down
their spending, and the outlook for continued sluggish economic growth among
most major trading partners would damp
U.S. exports. However, those restraining
influences were expected to abate over
time, and the considerable monetary
ease and fiscal stimulus already in place,
continuing strong gains in structural productivity, and anticipated improvement
in business confidence would provide
significant impetus to spending. Inventory overhangs had been largely eliminated and business capital stocks had
moved closer to desired levels. As a
consequence, a slowly improving outlook for sales and profits, low financing costs, and the temporary federal tax
incentive for investment in new equipment and software were expected to
provide a gradual boost to business
investment spending. The persistence of
underutilized resources was expected to
foster a slight moderation in core price
inflation.
In the Committee's discussion of current and prospective economic conditions, members noted that the recent
information had continued on the whole
to suggest quite sluggish economic
growth. Uncertainties about the outlook
remained substantial, and downside
risks stemming from potential shocks,
Minutes of FOMC Meetings, December 233
notably those associated with a high
level of geopolitical risks, could not be
dismissed. Nonetheless, the behavior of
financial markets in recent weeks suggested that investor concerns about an
actual downturn in the economy had
diminished, as data on economic developments took on a more mixed tone
after having been somewhat negative for some time. The improvement
in financial markets reinforced the
members' expectations that a gradual
strengthening of the economic expansion was likely over coming quarters,
with the growth in economic activity
gaining momentum over time in the
absence of major adverse shocks to business and consumer confidence. Their
assessment took account of the currently
very accommodative stance of monetary
policy, likely further fiscal policy stimulus, and the positive effects on business and consumer spending of a strong
uptrend in labor productivity. With
regard to the outlook for inflation, the
gap between actual and potential output
was anticipated to diminish only slowly
unless aggregate demand expanded
much more rapidly than the members
currently foresaw. Given the persistence
of limited pressures on resources, cost
and price increases were expected to
remain subdued and possibly to edge
lower.
The improvement of overall conditions in financial markets had provided
an additional positive element to the
economic outlook. The improvement
began before the November meeting and
had been given added impetus by the
Committee's sizable easing at that meeting. The general calming of financial
markets was reflected in some decline
in risk spreads from very high levels
and sizable new issuance in private bond
markets; in equity markets, issuance
had edged up and stock prices, though
recently declining somewhat, were still
well above the lows of early October.
Some of this improvement in financial
markets seemed to be related to apparently lessening concerns about new
revelations of corporate governance
issues as a result of the passage of time
without further significant incidents.
In addition, many business firms had
continued to enhance their prospects
for rising profits through productivity
improvements and debt restructurings
that were strengthening their balance
sheets and liquidity. Concurrently, indicators of credit quality in the household
sector appeared to have remained essentially stable. Reference also was made to
the continued robust growth in reserve
and money measures.
The better tone in financial markets
might also have been signaling a modest
reduction in uncertainty and risk aversion among business executives from
the extraordinarily elevated levels that
had been constraining investment spending. Lingering excess capacity in a
number of industries undoubtedly was
continuing to inhibit new investment
outlays as well. The members agreed
that a pickup in capital spending
remained the essential factor in the outlook for substantial strengthening of
economic activity. On the positive side,
spending for business equipment had
turned up since early this year, and with
efforts to reduce excess capacity seemingly well under way or completed in
many industries, further firming in such
capital expenditures was anticipated
as the year 2003 progressed. However,
nonresidential building was expected to
continue to lag, especially given high
vacancy rates in industrial and office
structures in many major markets.
The household sector of the economy
had continued to provide major support
to the recovery in economic activity.
The increase in consumer spending evidently had moderated in the current
234 89th Annual Report, 2002
quarter, largely as a result of a decline in
sales of motor vehicles from an extraordinary pace during the summer. However, the latest information on retail
sales, including anecdotal reports,
pointed to some improvement in recent
weeks, and key measures of consumer
confidence had turned up from their
recent lows. While some uncertainty
surrounded the prospects for consumer
spending, members cited continued sizable increases in income, more stable
wealth-to-income ratios, and the ongoing stimulus of equity extractions from
housing as favorable factors in the outlook for consumer expenditures.
Housing activity had continued to display solid overall strength, though members mentioned weakness in multifamily
construction and the high-end sector
of the single-family market. Historically
low mortgage interest rates along with
rising incomes evidently were continuing to sustain the robust demand for
housing. In addition, large extractions of
equity from appreciated housing values
continued to foster not only added consumer spending but also improvement
in the financial condition of many
households through debt consolidation
and repayments and reduced interest
charges. However, there were anecdotal
indications of decreasing refinancing
activity in the housing sector.
The outcome of the recent Congressional elections had fostered expectations that fiscal policy might be more
expansive than previously anticipated,
although the size, timing, and composition of federal budget initiatives were
subject to substantial uncertainty. Members commented that added fiscal stimulus might prove to be a useful complement to an accommodative monetary
policy in the period immediately ahead
when economic activity was likely to
remain below the economy's potential.
In this regard, some observed that addi
tional stimulus on the federal level
would be an offset to measures that were
being taken by numerous state and local
governments to address severe budget
deficits. At the same time, a number of
members expressed the hope that new
fiscal legislation would not endanger the
prospects for federal budget discipline
over the longer run, given the desirability of supporting national saving and
capital accumulation.
With regard to the external sector,
members commented that the growth
of the nation's important trading partners had remained sluggish, and there
seemed to be little basis for anticipating any appreciable impetus to the U.S.
economy from significant strengthening
in demand for U.S. exports. Indeed,
economic growth abroad was widely
viewed as dependent to a significant
extent on the performance of the U.S.
economy. Conditions in some major
Latin American countries were especially problematic, and adverse developments there could have negative
repercussions on international financial
markets and trade.
Members believed that the economy
probably would continue to operate with
significant margins of slack in both
labor and product markets. Moreover, in
an environment characterized by highly
competitive markets and the absence
of pricing power, business firms would
persist in their efforts to hold down or
reduce costs, with favorable implications for productivity. In these circumstances, inflation pressures could be
expected to remain subdued and some
further disinflation might well occur.
In this regard, members commented
that appreciable disinflation seemed
unlikely, but if that were to occur it
could present difficult problems for
monetary policy. One member noted,
however, that declining inflation or even
some deflation in the context of rapid
Minutes of FOMC Meetings, December 235
growth in productivity could turn out to
be relatively benign.
In the Committee's discussion of policy for the intermeeting period ahead,
all the members endorsed a proposal to
retain the current stance of policy. The
members agreed that, given what was
now a quite accommodative policy following the relatively aggressive easing
move in November, monetary policy
was well positioned to support a
strengthening economic expansion in
line with their expectations for coming
quarters. Although it was uncertain how
long the current period of below-par
growth would persist, the economic outlook remained subject to upside as well
as downside risks. Indeed, all the members also supported the retention of the
current balanced-risks statement in the
post-meeting press release, with some
commenting that recent developments
had established a firmer basis for such
a risk assessment than at the November meeting when it was adopted. The
November easing had contributed to
some improvement in financial markets
that, in conjunction with prospects for
further stimulus from fiscal policy,
should bolster the anticipated acceleration of economic activity. At the same
time, the members saw little risk of
any significant increase in inflationary
pressures over the foreseeable future.
Against this background, the members
concluded that there was no need to
change the stance of monetary policy;
they would continue to assess emerging economic and financial developments, retaining the flexibility to adjust
monetary policy as emerging conditions
might warrant.
At the conclusion of the discussion,
the Committee voted to authorize and
direct the Federal Reserve Bank of New
York, until it was instructed otherwise,
to execute transactions in the System
Account in accordance with the following domestic policy directive:
The Federal Open Market Committee
seeks monetary and financial conditions that
will foster price stability and promote sustainable growth in output. To further its
long-run objectives, the Committee in the
immediate future seeks conditions in reserve
markets consistent with maintaining the federal funds rate at an average of around
1 VA percent.
The vote encompassed approval of
the sentence below for inclusion in the
press statement to be released shortly
after the meeting:
Against the background of its long-run
goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that
the risks are balanced with respect to prospects for both goals in the foreseeable future.
Votes for this action: Messrs. Greenspan, McDonough, Bernanke, Ms. Bies,
Messrs. Ferguson, Gramlich, Jordan,
Kohn, McTeer, Olson, Santomero, and
Stern. Votes against this action: None.
It was agreed that the next meeting
of the Committee would be held on
Tuesday-Wednesday, January 28-29,
2003.
The meeting adjourned at 12:05 p.m.
Vincent R. Reinhart
Secretary
237
Litigation
During 2002, the Board of Governors
was a party in three lawsuits or appeals
filed that year and was a party in seven
other cases pending from previous
years, for a total of ten cases; in 2001,
the Board had been a party in a total
of twenty cases. None of the lawsuits or
appeals filed in 2002 raised questions
under the Bank Holding Company Act.
As of December 31, 2002, six cases
were pending.
Litigation under the
Gramm-Leach-Bliley Act
Trans Union LLC v. Federal Trade
Commission, et al, No. 01-5202 (D.C.
Circuit, filed June 4, 2001), was an
appeal of a district court order upholding challenged provisions of the interagency rule Privacy of Consumer Financial Information (145 F. Supp. 2d 6,
April 30, 2001). On July 16, 2002, the
court of appeals affirmed the district
court's decision upholding the regulation (295 F.3d 42).
Other Actions
Sedgwick v. United States, No. 02-5378
(D.C. Circuit, filed November 26,
2002), is an appeal of the dismissal of
appellant's claim for a declaratory judgment under the Federal Tort Claims Act
and the Constitution regarding the banking agencies' alleged failure to intervene on his behalf in civil litigation
involving a regulated institution.
Albrecht v. Board of Governors,
No. 02-5235 (D.C. Circuit, filed October 18, 2002), is an appeal of a district
court order dismissing a challenge to
the pension funding method applicable
to certain Board employees under the
Board's retirement plan.
Caesar v. United States, No. 02-0612
(EGS) (D. District of Columbia,
removed on April 1, 2002, from the
Superior Court of the District of Columbia), is an action seeking damages for
personal injury.
Community Bank & Trust v. United
States, No. 01-571C (Court of Federal
Claims, filed October 3, 2001), is an
action challenging on constitutional
grounds the failure to pay interest on
reserve accounts held at Federal Reserve
Banks.
Laredo National Bancshares, Inc. v.
Whalen v. Board of Governors, No. 01CV-134 (S. D. Texas, removed on September 5, 2001, from Webb County,
Texas, district court), was a third-party
petition seeking indemnification or contribution from the Board in connection
with a claim asserted against defendant
Whalen that alleged tortious interference with a contract. On September 27,
2002, the district court dismissed all
claims against the individual third-party
defendants, granted the United States'
motion to substitute the United States
for the third-party defendants, and dismissed all claims against the Board and
the United States.
Radfar v. United States, No.
l:01CV1292 (D. District of Columbia,
filed June 11,2001), was an action under
the Federal Tort Claims Act for injury
on Board premises. On October 3, 2002,
the action was dismissed on the stipulation of the parties.
Artis v. Greenspan, No. 01-0400 (D.
District of Columbia, filed February 22,
2001), is an employment discrimination
action. An identical action, No. 99-2073
238 89th Annual Report, 2002
(EGS) (D. District of Columbia, filed
August 3, 1999), was consolidated with
this action on August 15, 2001.
Howe v. Bank for International Settlements, No. 00CV12485 (RCL) (D. Massachusetts, filed December 7, 2000),
was an action seeking damages in connection with gold market activities and
the repurchase by the Bank for International Settlements of its privately owned
shares. On March 26, 2002, the district
court granted the defendants' motion to
dismiss the action.
In Fraternal Order of Police v. Board
of Governors, No. 98-3116 (D. District
of Columbia, filed December 22, 1998),
plaintiffs seek a declaratory judgment
regarding the Board's labor policy governing Federal Reserve Banks.
•
Federal Reserve System
Organization
Federal Reserve System Organization 241
Board of Governors
December 31,2002
Members
Term expires
January 31,
Alan Greenspan, of New York,
Chairman1
2006
Roger W. Ferguson, Jr., of
Massachusetts, Vice Chairman1
2014
Edward M. Gramlich, of Virginia .. 2008
Mark W. Olson, of Maryland
2010
Susan S. Bies, of Tennessee
2012
Ben S. Bernanke, of New Jersey . . . .2004
Donald L. Kohn, of Virginia
2016
Officers
OFFICE OF BOARD MEMBERS
Donald J. Winn, Assistant to the Board
and Director
Lynn S. Fox, Assistant to the Board
Michelle A. Smith, Assistant to the Board
Winthrop P. Hambley, Deputy
Congressional Liaison
John Lopez, Special Assistant
to the Board
Rosanna Pianalto-Cameron, Special
Assistant to the Board
David Skidmore, Special Assistant
to the Board
LEGAL DIVISION
J. Virgil Mattingly, Jr., General Counsel
Scott G. Alvarez, Associate General
Counsel
Richard M. Ashton, Associate
General Counsel
Kathleen M. O'Day, Associate General
Counsel
Stephanie Martin, Assistant General
Counsel
Ann Misback, Assistant General Counsel
Stephen L. Siciliano, Assistant General
Counsel
1. The designations as Chairman and Vice
Chairman expire on June 20, 2004, and October 5,
2003, respectively, unless the service of these
members of the Board shall have terminated
sooner.
LEGAL DIVISION—Continued
Katherine H. Wheatley, Assistant General
Counsel
Cary K. Williams, Assistant General
Counsel
OFFICE OF THE SECRETARY
Jennifer J. Johnson, Secretary
Robert deV. Frierson, Deputy Secretary
Margaret M. Shanks, Assistant Secretary
DIVISION OF
INTERNATIONAL FINANCE
Karen H. Johnson, Director
David H. Howard, Deputy Director
Thomas A. Connors, Associate Director
Dale W. Henderson, Associate Director
Richard T. Freeman, Deputy Associate
Director
William L. Helkie, Senior Adviser
Steven B. Kamin, Deputy Associate
Director
Jon W. Faust, Assistant Director
Joseph E. Gagnon, Assistant Director
Michael P. Leahy, Assistant Director
D. Nathan Sheets, Assistant Director
Ralph W. Tryon, Assistant Director
DIVISION OF MONETARY AFFAIRS
Vincent R. Reinhart, Director
David E. Lindsey, Deputy Director
Brian F. Madigan, Deputy Director
William C. Whitesell, Deputy Associate
Director
James A. Clouse, Assistant Director
William B. English, Assistant Director
Richard D. Porter, Senior Adviser
Normand R.V. Bernard, Special Assistant
to the Board
242 89th Annual Report, 2002
Board of Governors—Continued
DIVISION OF RESEARCH
AND STATISTICS
David J. Stockton, Director
Edward C. Ettin, Deputy Director
David W. Wilcox, Deputy Director
Myron L. Kwast, Associate Director
Stephen D. Oliner, Associate Director
Patrick M. Parkinson, Associate Director
Lawrence Slifman, Associate Director
Charles S. Struckmeyer, Associate Director
Joyce K. Zickler, Deputy
Associate Director
J. Nellie Liang, Assistant Director
Stuart Wayne Passmore, Assistant Director
David L. Reifschneider, Assistant Director
Janice Shack-Marquez, Assistant Director
William L. Wascher III, Assistant Director
Alice Patricia White, Assistant Director
Glenn B. Canner, Senior Adviser
David S. Jones, Senior Adviser
Thomas D. Simpson, Senior Adviser
DIVISION OF BANKING SUPERVISION
AND REGULATION
Richard Spillenkothen, Director
Stephen C. Schemering, Deputy Director
Herbert A. Biern, Senior Associate
Director
Roger T. Cole, Senior Associate Director
William A. Ryback, Senior Associate
Director
Gerald A. Edwards, Jr., Associate Director
Stephen M. Hoffman, Jr., Associate
Director
James V. Houpt, Associate Director
Jack P. Jennings, Associate Director
Michael G. Martinson, Associate Director
Molly S. Wassom, Associate Director
Howard A. Amer, Deputy Associate
Director
Norah M. Barger, Deputy Associate
Director
Betsy Cross-Jacowski, Deputy Associate
Director
Deborah P. Bailey, Assistant Director
Barbara J. Bouchard, Assistant Director
Desmond, Assistant Director
DigitizedAngela
for FRASER
James A. Embersit, Assistant Director
Charles H. Holm, Assistant Director
William G. Spaniel, Assistant Director
David M. Wright, Assistant Director
William C. Schneider, Jr., Project Director,
National Information Center
DIVISION OF CONSUMER
AND COMMUNITY AFFAIRS
Dolores S. Smith, Director
Glenn E. Loney, Deputy Director
Sandra F. Braunstein, Senior Associate
Director
Maureen P. English, Associate Director
Adrienne D. Hurt, Associate Director
Irene Shawn McNulty, Associate Director
DIVISION OF FEDERAL RESERVE
BANK OPERATIONS AND PAYMENT
SYSTEMS
Louise L. Roseman, Director
Paul W. Bettge, Associate Director
Jeffrey C. Marquardt, Associate Director
Kenneth D. Buckley, Assistant Director
Joseph H. Hayes, Jr., Assistant Director
Edgar A. Martindale III, Assistant Director
Marsha W. Reidhill, Assistant Director
Jeff J. Stehm, Assistant Director
Jack K. Walton II, Assistant Director
OFFICE OF STAFF DIRECTOR
FOR MANAGEMENT
Stephen R. Malphrus, Staff Director for
Management
Sheila Clark, Equal Employment
Opportunity Programs Director
MANAGEMENT DIVISION
William R. Jones, Director
Stephen J. Clark, Associate Director
Darrell R. Pauley, Associate Director
David L. Williams, Associate Director
Christine M. Fields, Assistant Director
Billy J. Sauls, Assistant Director
Donald A. Spicer, Assistant Director
Federal Reserve System Organization 243
Board of Governors—Continued
DIVISION OF
INFORMATION TECHNOLOGY
Marianne M. Emerson, Deputy Director
Maureen T. Hannan, Associate Director
Tillena G. Clark, Assistant Director
Geary L. Cunningham, Assistant Director
Wayne A. Edmondson, Assistant Director
Po Kyung Kim, Assistant Director
Susan F. Marycz, Assistant Director
Sharon L. Mowry, Assistant Director
Raymond Romero, Assistant Director
Robert F. Taylor, Assistant Director
OFFICE OF INSPECTOR GENERAL
Barry R. Snyder, Inspector General
Donald L. Robinson, Deputy Inspector
General
244 89th Annual Report, 2002
Federal Open Market Committee
December 31,2002
Members
A L A N GREENSPAN, Chairman, Board of
Governors
WILLIAM J. MCDONOUGH, Vice
Chairman, President, Federal Reserve
Bank of New York
B E N S. BERNANKE, Board of Governors
SUSAN SCHMIDT BIES, Board of
Governors
ROGER W. FERGUSON, JR., Board of
Governors
EDWARD M. GRAMLICH, Board of
Governors
JERRY L. JORDAN, President, Federal
Reserve Bank of Cleveland
DONALD L. KOHN, Board of Governors
ROBERT D. MCTEER, JR., President,
Federal Reserve Bank of Dallas
MARK W. OLSON, Board of Governors
ANTHONY M. SANTOMERO, President,
Federal Reserve Bank of Philadelphia
GARY H. STERN, President, Federal
Reserve Bank of Minneapolis
Alternate Members
J. ALFRED BROADDUS, JR., President,
Federal Reserve Bank of Richmond
JACK GUYNN, President, Federal Reserve
Bank of Atlanta
MICHAEL H. MOSKOW, President,
Federal Reserve Bank of Chicago
ROBERT T. PARRY, President, Federal
Reserve Bank of San Francisco
JAMIE B. STEWART, JR., First Vice
President, Federal Reserve Bank of
New York
Officers
VINCENT R. REINHART, Secretary and
Economist
NORMAND R.V. BERNARD, Deputy
Secretary
GARY P. GILLUM, Assistant Secretary
MICHELLE A. SMITH, Assistant Secretary
J. VIRGIL MATTINGLY, JR., General Counsel
THOMAS C. BAXTER, JR., Deputy General
Counsel
KAREN H. JOHNSON, Economist
DAVID J. STOCKTON, Economist
THOMAS A. CONNORS, Associate Economist
CHRISTINE M. CUMMING, Associate
Economist
DAVID H. HOWARD, Associate Economist
DAVID E. LINDSEY, Associate Economist
LORETTA J. MESTER, Associate Economist
STEPHEN D. OLINER, Associate Economist
ARTHUR J. ROLNICK, Associate Economist
HARVEY ROSENBLUM, Associate Economist
MARK S. SNIDERMAN, Associate Economist
DAVID W. WILCOX, Associate Economist
DINO Kos, Manager, System Open Market
Account
During 2002 the Federal Open Market Committee held eight regularly scheduled meetings (see "Minutes of Federal Open Market
Committee Meetings" in this volume.)
Federal Reserve System Organization 245
Federal Advisory Council
December 31,2002
Members
District 1—DAVID A. SPINA, Chairman and
District 10—CAMDEN R. FINE, President
and Chief Executive Officer, Midwest
Independent Bank, Jefferson City,
Missouri
Chief Executive Officer, State Street
Corporation, Boston, Massachusetts
District 11—RICHARD W. EVANS, JR., ChairDistrict 2—DAVID A. COULTER, Vice Chairman and Chief Executive Officer, Frost
man, J.P. Morgan Chase & Co., New
National Bank, San Antonio, Texas
York, New York
District 3—RUFUS A. FULTON, JR., Chair-
man and Chief Executive Officer, Fulton Financial Corporation, Lancaster,
Pennsylvania
District 4—DAVID A. DABERKO, Chairman
and Chief Executive Officer, National City
Corporation, Cleveland, Ohio
District 5—L.M. BAKER, JR., Chairman
and Chief Executive Officer, Wachovia
Corporation, Winston-Salem, North
Carolina
District 6—L. PHILLIP HUMANN, Chairman,
President, and Chief Executive Officer,
SunTrust Banks, Inc., Atlanta, Georgia
District 7—ALAN G. MCNALLY, Chairman
and Chief Executive Officer, Harris
Bankcorp, Inc., Chicago, Illinois
District 8—DAVID W. KEMPER, Chairman,
President, and Chief Executive Officer,
Commerce Bancshares, Inc., St. Louis,
Missouri
District 9—R. SCOTT JONES, Vice Chair-
man, Associated Bank Minnesota, Red
Wing, Minnesota
District 12—MICHAEL E. O'NEILL, Chair-
man, Chief Executive Officer, and
President, Bank of Hawaii, Honolulu,
Hawaii
Officers
DAVID A. DABERKO, President
L.M. BAKER, JR., Vice President
JAMES E. ANNABLE, Co-Secretary
WILLIAM J. KORSVIK, Co-Secretary
The Federal Advisory Council, which is
composed of one representative of the banking industry from each of the twelve Federal
Reserve Districts, is required by the Federal
Reserve Act to meet in Washington at least
four times each year and is authorized by the
act to consult with, and advise, the Board
of Governors on all matters within the jurisdiction of the Board. The council met on
January 31-February 1, May 2-3, September 5-6, and December 5-6, 2002. The
Board met with the council on February 1,
May 3, September 6, and December 6, 2002.
246 89th Annual Report, 2002
Consumer Advisory Council
December 31,2002
Members
ANTHONY ABBATE, President and Chief
Executive Officer, Interchange Bank,
Saddle Brook, New Jersey
JANIE BARRERA, President and Chief Executive Officer, ACCION Texas, San
Antonio, Texas
KENNETH P. BORDELON, Chief Executive
Officer, E Federal Credit Union, Baton
Rouge, Louisiana
TERESA
A. BRYCE,
General
Counsel,
Nexstar Financial Corporation, St. Louis,
Missouri
MANUEL CASANOVA, JR., Executive Vice
President, International Bank of Commerce, Brownsville, Texas
CONSTANCE CHAMBERLIN, President and
Chief Executive Officer, Housing
Opportunities Made Equal, Richmond,
Virginia
ROBERT M. CHEADLE, Legislative Counsel,
The Chickasaw Tribal Legislature, Ada,
Oklahoma
ROBIN COFFEY, Vice President, Harris Trust
and Savings Bank, Chicago, Illinois
LESTER W M . FIRSTENBERGER, Attorney at
Law, Pittsfield, New Hampshire
THOMAS FITZGIBBON, Senior Vice President,
MB Financial Bank, Chicago, Illinois
LARRY HAWKINS, President and Chief
Executive Officer, Unity National Bank,
Houston, Texas
EARL JAROLIMEK, Vice President/Corporate
Compliance Officer, Community First
Bankshares, Fargo, North Dakota
J. PATRICK LIDDY, Director of Compliance,
Fifth Third Bancorp, Cincinnati, Ohio
RUHI MAKER, Senior Attorney, Law Office
of Rochester, Rochester, New York
OSCAR MARQUIS, Attorney, Hunton and Wil-
liams, Park Ridge, Illinois
PATRICIA
MCCOY,
Professor
of
Law,
Massachusetts Institute of Technology,
Cambridge, Massachusetts
JEREMY NOWAK, Chief Executive Officer,
The Reinvestment Fund, Philadelphia,
Pennsylvania
ELIZABETH
RENUART,
Staff
Attorney,
National Consumer Law Center, Boston,
Massachusetts
DEBRA S. REYES, President, Neighborhood
Lending Partners, Inc., Tampa, Florida
BENSON ROBERTS, Vice President for Policy,
Local Initiatives Support Corporation,
Washington, District of Columbia
AGNES BUNDY SCANLAN, Managing Direc-
tor and Chief Compliance Officer,
FleetBoston
Financial,
Boston,
Massachusetts
RUSSELL SCHRADER, Senior Vice President
and Assistant General Counsel, Visa
U.S.A., San Francisco, California
FRANK TORRES III, Legislative Counsel,
Consumers Union, Washington, District
of Columbia
HUBERT VAN TOL, Co-Director, Fairness in
Rural Lending, Sparta, Wisconsin
Officers
DOROTHY BROADMAN, Chair
Director of Corporate Citizenship
Capital One Financial Corporation
Falls Church, Virginia
RONALD REITER, Vice Chair
Supervising Deputy Attorney General
California Department of Justice
San Francisco, California
The Consumer Advisory Council was established pursuant to the 1976 amendments to
the Equal Credit Opportunity Act to advise
the Board of Governors on consumer financial services. It is composed of academics,
state and local government officials, representatives of the financial industry, and representatives of consumer and community
interests. The council met with members of
the Board on March 14, June 27, and October 24, 2002.
Federal Reserve System Organization 247
Thrift Institutions Advisory Council
December 31,2002
Members
JOHN B. DICUS, President, Capitol Federal
Savings Bank, Topeka, Kansas
RONALD S. ELIASON, President and Chief
EVERETT STILES, President
and Chief
Executive Officer, Macon Bank, Franklin,
North Carolina
DAVID L. VIGREN, President and Chief
Executive Officer, Utah Community Federal Credit Union, Provo, Utah
Executive Officer, ESL Federal Credit
Union, Rochester, New York
KAREN L. MCCORMICK, President and Chief
MARK H. WRIGHT, President and Chief
Executive Officer, First Federal Savings
and Loan Association, Port Angeles,
Washington
Executive Officer, USAA Federal Savings
Bank, San Antonio, Texas
JAMES F. MCKENNA, President and Chief
Executive Officer, North Shore Bank,
FSB, Brookfield, Wisconsin
CHARLES C. PEARSON, JR., Co-Chairman
and Chief Executive Officer, Waypoint
Bank, Harrisburg, Pennsylvania
Officers
MARK H. WRIGHT, President
KAREN L. MCCORMICK, Vice President
The Thrift Institutions Advisory Council,
which is composed of representatives from
KEVIN E. PIETRINI, President and Chief
credit unions, savings and loan associations,
Executive Officer, Queen City Federal and savings banks, consults with, and adSavings Bank, Virginia, Minnesota
vises, the Board of Governors on issues perHERBERT M. SANDLER, Chairman and Chief taining to the thrift industry and on various
Executive Officer, World Savings Bank, other matters within the Board's jurisdiction.
The members of the council met with the
FSB, Oakland, California
Board on March 1, July 12, and DecemWILLIAM J. SMALL, Chairman and Chief
Executive Officer, First Federal Bank, ber 13, 2002.
Defiance, Ohio
248 89th Annual Report, 2002
Federal Reserve Banks and Branches
December 31,2002
Officers
Chairman1
Deputy Chairman
President
First Vice President
BOSTON2
William 0. Taylor
James J. Norton
Cathy E. Minehan
Paul M. Connolly
NEW YORK2
Peter G. Peterson
Gerald M. Levin
Patrick P. Lee
William J. McDonough
Jamie B. Stewart, Jr.
PHILADELPHIA
Charisse R. Lillie
Glenn A. Schaeffer
Anthony M. Santomero
William H. Stone, Jr.
CLEVELAND2
David H. Hoag
Robert W Mahoney
George C. Juilfs
Charles E. Bunch
Jerry L. Jordan
Sandra Pianalto
Jeremiah J. Sheehan
Wesley S.
Williams, Jr.
George L. Russell, Jr.
James F. Goodmon
J. Alfred Broaddus, Jr.
Walter A. Varvel
John F. Wieland
Paula Lovell
V. Larkin Martin
Marsha G. Rydberg
Rosa Sugranes
Beth Dortch Franklin
R. Glenn Pumpelly
Jack Guynn
Patrick K. Barron
CHICAGO2
Robert J. Darnall
W. James Farrell
Michael H. Moskow
Gordon R.G.
Werkema
Detroit
Timothy D. Leuliette
ST. LOUIS
Charles W. Mueller
Walter L.
Metcalfe, Jr.
A. Rogers Yarnell II
J. Stephen Barger
Russell Gwatney
William Poole
W. LeGrande Rives
Ronald N. Zwieg
Linda Hall Whitman
Thomas 0. Markle
Gary H. Stern
James M. Lyon
BANK or Branch
Buffalo
Cincinnati
Pittsburgh
RICHMOND2
Baltimore
Charlotte
ATLANTA
Birmingham
Jacksonville
Miami
Nashville
New Orleans
Little Rock
Louisville
Memphis
MINNEAPOLIS
Helena
Vice President
in charge of Branch
Barbara L. Walter3
Barbara B. Henshaw
Robert B. Schaub
William J. Tignanelli3
Dan M. Bechter3
James M. McKee3
Lee C. Jones
Christopher L. Oakley
James T. Curry III
MelvynK. Purcell3
Robert J.Musso 3
Glenn Hansen3
Robert A. Hopkins
Thomas A. Boone
Martha Perine Beard
Samuel H. Gane
Federal Reserve System Organization 249
Federal Reserve Banks and Branches—Continued
Chairman1
Deputy Chairman
President
First Vice President
Terrence P. Dunn
Richard H. Bard
Robert M. Murphy
Patricia B. Fennell
Bob L. Gottsch
Thomas M. Hoenig
Richard K. Rasdall
H.B. Zachry, Jr.
Patricia M.
Patterson
Gail S. Darling
Edward O. Gaylord
Ron R. Harris
Robert D. McTeer, Jr.
Helen E. Holcomb
Robert T. Parry
John F. Moore
Los Angeles
Portland
Nelson C. Rising
George M. Scalise
William D. Jones
Nancy Wilgenbusch
Salt Lake City
Seattle
H. Roger Boyer
Boyd E. Givan
BANK or Branch
KANSAS CITY
Denver
Oklahoma City
Omaha
DALLAS
El Paso
Houston
San Antonio
SAN FRANCISCO
Vice President
in charge of Branch
MaryAnn F. Hunter3
Dwayne E. Boggs
Steven D. Evans
Sammie C. Clay
Robert Smith IIP
James L. Stull3
MarkL. Mullinix4
Richardson B.
Hornsby
Andrea P. Wolcott
David K. Webb3
NOTE. A current list of these officers appears each
month in the Federal Reserve Bulletin.
1. The Chairman of a Federal Reserve Bank serves, by
statute, as Federal Reserve Agent.
2. Additional offices of these Banks are located at
Windsor Locks, Connecticut; Utica at Oriskany, New
York; East Rutherford, New Jersey; Columbus, Ohio;
Charleston, West Virginia; Columbia, South Carolina;
Indianapolis, Indiana; Milwaukee, Wisconsin; Des
Moines, Iowa; and Peoria, Illinois.
3. Senior Vice President
4. Executive Vice President
Conference of Chairmen
Conference of Presidents
The chairmen of the Federal Reserve Banks
are organized into the Conference of Chairmen, which meets to consider matters of
common interest and to consult with, and
advise, the Board of Governors. Such meetings, attended also by the deputy chairmen,
were held in Washington on May 29 and 30,
and on December 4 and 5, 2002.
The members of the Executive Committee of the Conference of Chairmen during 2002 were Peter G. Peterson, chair;
Charisse R. Lillie, vice chair; and Robert J.
Darnall, member.
On December 5, 2002, the conference
elected its Executive Committee for 2003;
it named Robert J. Darnall as chair, Wesley S. Williams, Jr., as vice chair, and Ronald N. Zweig as the third member.
The presidents of the Federal Reserve Banks
are organized into the Conference of Presidents, which meets periodically to consider
matters of common interest and to consult
with, and advise, the Board of Governors.
J. Alfred Broaddus, Jr., President of the
Federal Reserve Bank of Richmond, served
as chair of the conference in 2002, and
Michael H. Moskow, President of the Federal Reserve Bank of Chicago, served as its
vice chair. Betty M. Fahed, of the Federal
Reserve Bank of Richmond, served as its
secretary, and Valerie J. Van Meter, of the
Federal Reserve Bank of Chicago, served as
its assistant secretary.
On October 29, 2002, the conference
elected Michael H. Moskow as its chair for
2003-04, and elected Cathy E. Minehan,
250 89th Annual Report, 2002
President of the Federal Reserve Bank
of Boston, as its vice chair.
Conference of First
Vice Presidents
The Conference of First Vice Presidents of
the Federal Reserve Banks was organized in
1969 to meet periodically for the consideration of operations and other matters.
Paul M. Connolly, First Vice President of
the Federal Reserve Bank of Boston, served
as chair of the conference in 2002, and
Walter A. Varvel, First Vice President of the
Federal Reserve Bank of Richmond, served
as its vice chair. David K. Park, of the Federal Reserve Bank of Boston, served as its
secretary, and Janice E. Clatterbuck, of the
Federal Reserve Bank of Richmond, served
as its assistant secretary.
Directors
The following list of directors of Federal
Reserve Banks and Branches shows for each
director the class of directorship, the director's principal organizational affiliation, and
the date the director's term expires. Each
Federal Reserve Bank has a nine-member
board: three Class A and three Class B directors, who are elected by the stockholding
member banks, and three Class C directors,
who are appointed by the Board of Governors of the Federal Reserve System.
Class A directors represent the stockholding member banks in each Federal Reserve
District. Class B and Class C directors represent the public and are chosen with due, but
not exclusive, consideration to the interests
of agriculture, commerce, industry, services,
labor, and consumers; they may not be officers, directors, or employees of any bank or
bank holding company. In addition, Class C
directors may not be stockholders of any
bank or bank holding company.
For the election of Class A and Class B
directors, the Board of Governors classifies
the member banks of each Federal Reserve
District into three groups. Each group, which
comprises banks with similar capitalization,
elects one Class A director and one Class B
director. Annually, the Board of Governors
designates one of the Class C directors as
chair of the board and Federal Reserve Agent
of each District Bank, and it designates
another Class C director as deputy chair.
Federal Reserve Branches have either five
or seven directors, a majority of whom are
appointed by the parent Federal Reserve
Bank; the others are appointed by the Board
of Governors. One of the directors appointed
by the Board is designated annually as chair
of the board of that Branch in a manner
prescribed by the parent Federal Reserve
Bank.
For the name of the chair and deputy chair
of the board of directors of each Reserve
Bank and of the chair of each Branch, see
the preceding table, "Officers of Federal
Reserve Banks and Branches."
Federal Reserve System Organization 251
Directors
BANK or Branch
Director
DISTRICT 1—BOSTON
Class A
David S. Outhouse
Richard C. White
Lawrence K. Fish
Class B
Orit Gadiesh
Sherwin Greenblatt
Blenda J. Wilson
Class C
William O. Taylor
James J. Norton
Samuel 0 . Thier, M.D
DISTRICT 2—NEW YORK
Class A
George W. Hamlin IV
Sanford I. Weill
Jill M. Considine
Class B
Ann M. Fudge
Jerry I. Speyer
Ronay Menschel
Class C
Albert J. Simone
Gerald M. Levin
Peter G. Peterson
Titlp
Term expires
Dec. 31
President and Chief Executive Officer,
First and Ocean National Bank,
Newburyport, Massachusetts
Chairman, President, and Chief Executive Officer,
Community National Bank, Derby, Vermont
Chairman, President, and Chief Executive Officer,
Citizens Financial Group, Inc.,
Providence, Rhode Island
2002
Chairman, Bain & Company, Inc.,
Boston, Massachusetts
Past President, Bose Corporation,
Framingham, Massachusetts
President and Chief Executive Officer,
Nellie Mae Education Foundation,
Quincy, Massachusetts
2002
Chairman Emeritus, The Boston Globe,
Boston, Massachusetts
Vice President, AFL-CIO, Washington, D.C.
President and Chief Executive Officer,
Partners HealthCare System, Inc.,
Boston, Massachusetts
2002
2003
2004
2003
2004
2003
2004
President and Chief Executive Officer,
The Canandaigua National Bank and Trust Company,
Canandaigua, New York
Chairman and Chief Executive Officer, Citigroup Inc.,
New York, New York
Chairman and Chief Executive Officer,
The Depository Trust Company,
New York, New York
2002
Former Executive Vice President, Kraft Foods, Inc., and
Former President, Coffee and Cereals Division,
Tarrytown, New York
President and Chief Executive Officer,
Tishman Speyer Properties, New York, New York
Chairman, Phipps Houses, New York, New York
2002
President, Rochester Institute of Technology,
Rochester, New York
Retired Chief Executive Officer,
AOL Time Warner Inc., New York, New York
Chairman, The Blackstone Group, New York, New York
2003
2004
2003
2004
2002
2003
2004
252 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Titif
1111C
Buffalo Branch
Appointed by the
Federal Reserve Bank
Geraldine C. Ochocinska ... Director, Region 9, UAW, Buffalo, New York
President and Chief Executive Officer,
Peter G. Humphrey
Financial Institutions, Inc., Warsaw, New York
Maureen Torrey Marshall .. Co-Owner, Torrey Farms, Inc., Elba, New York
Emerson L. Brumback
Executive Vice President, M&T Bank Corp.,
Buffalo, New York
Appointed by the
Board of Governors
PatrickP.Lee
Chairman and Chief Executive Officer, IMC, Inc.,
Buffalo, New York
President, St. John Fisher College, Rochester, New York
Katherine E. Keough
Marguerite D. Hambleton .. President and Chief Executive Officer,
AAA Western and Central New York,
Williamsville, New York
DISTRICT 3—
PHILADELPHIA
Class A
Frank Kaminski, Jr.
Term expires
Dec. 31
2002
2003
2003
2004
2002
2003
2004
Retired Chairman, Atlantic Central Bankers Bank,
Camp Hill, Pennsylvania
President and Chief Operating Officer,
Pennsville National Bank, Pennsville, New Jersey
Chairman, President, and Chief Executive Officer,
Harleysville National Corporation,
Harleysville, Pennsylvania
2002
Chairman and Chief Executive Officer,
Penn Mutual Life Insurance Co.,
Horsham, Pennsylvania
President and Chief Executive Officer,
Doris M. Damm
ACCU Staffing Services, Cherry Hill, New Jersey
P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer,
Townsends, Inc., Wilmington, Delaware
2002
Robert J. Vanderslice
Walter E. Daller, Jr.
Class B
Robert E. Chappell
Class C
Ronald J. Naples
Glenn A. Schaeffer
Charisse R. Lillie
Chairman and Chief Executive Officer,
Quaker Chemical Corporation,
Conshohocken, Pennsylvania
President Emeritus,
Pennsylvania Building and Construction Trades
Council, Harrisburg, Pennsylvania
Chair, Litigation Department,
Ballard Spahr Andrews & Ingersoll,
Philadelphia, Pennsylvania
2003
2004
2003
2004
2002
2003
2004
Federal Reserve System Organization 253
BANK or Branch
Director
Title
DISTRICT 4—CLEVELAND
Class A
Tiney M. McComb
Chairman and President, Heartland BancCorp,
Gahanna, Ohio
Stephen P. Wilson
President and Chief Executive Officer,
Lebanon Citizens National Bank, Lebanon, Ohio
John R. Cochran
Chairman and Chief Executive Officer,
FirstMerit Corporation, Akron, Ohio
Class B
David L. Nichols
President and Chief Operating Officer,
Rich's/Lazarus/Goldsmith's, Atlanta, Georgia
Cheryl L. Krueger-Horn .... President and Chief Executive Officer,
Cheryl&Co., Westerville, Ohio
Wayne R. Embry
Former President and Chief Operating Officer,
Cleveland Cavaliers, Cleveland, Ohio
Class C
Phillip R. Cox
Robert W. Mahoney
David H. Hoag
Cincinnati Branch
Appointed by the
Federal Reserve Bank
V. Daniel Radford
Mary Ellen Slone
Bick Weissenrieder
James H. Booth
Appointed by the
Board of Governors
George C. Juilfs
Charles Whitehead
Herbert R. Brown
Pittsburgh Branch
Appointed by the
Federal Reserve Bank
Georgia Berner
Peter N. Stephans
Term expires
Dec. 31
2002
2003
2004
2002
2003
2004
President and Chief Executive Officer,
Cox Financial Corporation, Cincinnati, Ohio
Retired Chairman and Chief Executive Officer,
Diebold, Incorporated, Canton, Ohio
Former Chairman, The LTV Corporation,
Cleveland, Ohio
2002
Executive Secretary-Treasurer, Cincinnati AFL-CIO
Labor Council, Cincinnati, Ohio
Chief Executive Officer and Chairman,
Meridian Communications, Lexington, Kentucky
Chairman of the Board and Chief Executive Officer,
Hocking Valley Bank, Athens, Ohio
President, Czar Coal Corporation, Lovely, Kentucky
2002
Chairman and Chief Executive Officer,
SENCORP, Newport, Kentucky
President, Ashland Inc. Foundation,
Covington, Kentucky
Senior Vice President, Western and Southern Life
Insurance Company, Cincinnati, Ohio
2002
President, Berner International Corp.,
New Castle, Pennsylvania
Chairman and Chief Executive Officer,
Trigon Incorporated, McMurray, Pennsylvania
2003
2004
2002
2003
2004
2003
2004
2002
2002
254 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Kristine N. Molnar
Michael J. Hagan
Appointed by the
Board of Governors
Charles E. Bunch
James I. Mitnick
Robert 0. Agbede
DISTRICT 5—RICHMOND
Class A
Fred L. Green III
William W. Duncan, Jr.
Eddie Canterbury
Class B
W. Henry Harmon
James E. Haden
Joe Edens
Class C
Jeremiah J. Sheehan
Wesley S. Williams, Jr.
Irwin Zazulia
Baltimore Branch
Appointed by the
Federal Reserve Bank
Dyan Brasington
William L. Jews
Kenneth C. Lundeen
Donald P. Hutchinson
Titif
1 lllc
President and Chief Executive Officer,
WesBanco Bank, Inc., Wheeling, West Virginia
President and Chief Executive Officer,
Iron and Glass Bank, Pittsburgh, Pennsylvania
Term expires
Dec. 31
2003
2004
President and Chief Operating Officer,
PPG Industries, Inc., Pittsburgh, Pennsylvania
Senior Vice President, Turner Construction Company,
Pittsburgh, Pennsylvania
President and Chief Executive Officer,
Advanced Technology Systems, Inc.,
Pittsburgh, Pennsylvania
2002
Chairman, President, and Chief Executive Officer,
The National Bank of South Carolina,
Columbia, South Carolina
President and Chief Executive Officer,
St. Michaels Bank, St. Michaels, Maryland
President and Chief Executive Officer,
Logan Bank & Trust Company, Logan, West Virginia
2002
President and Chief Executive Officer,
Triana Energy, LLC, Charleston, West Virginia, and
Union Drilling, Inc., Bridgeville, Pennsylvania
President and Chief Executive Officer,
Martha Jefferson Hospital, Charlottesville, Virginia
Chairman, Edens & Avant, Columbia, South Carolina
2002
Retired Chairman, Reynolds Metals Company,
Richmond, Virginia
Partner, Covington & Burling, Washington, D.C.
Retired President and Chief Executive Officer,
Hecht's, Arlington, Virginia
2002
President, Technology Council of Maryland,
Rockville, Maryland
President and Chief Executive Officer,
CareFirst BlueCross BlueShield,
Owings Mills, Maryland
President, C. J. Langenfelder & Son, Inc.,
Baltimore, Maryland
President and Chief Executive Officer,
SunTrust Bank, Maryland,
Baltimore, Maryland
2002
2003
2004
2003
2004
2003
2004
2003
2004
2003
2003
2004
Federal Reserve System Organization 255
BANK or Branch
Director
Appointed by the
Board of Governors
George L. Russell, Jr.
William C. Handorf
Owen E. Herrnstadt
Charlotte Branch
Appointed by the
Federal Reserve Bank
Lucy J. Reuben
Elleveen T. Poston
Cecil W. Sewell, Jr
William H. Nock
Appointed by the
Board of Governors
Michael A. Almond
Jim Lowry
James F. Goodmon
DISTRICT 6—ATLANTA
Class A
Richard G. Hickson
William G. Smith, Jr.
James F. Beall
Class B
Egbert L. J. Perry
John Dane III
Suzanne E. Boas
Titlf
1 lllc
Term expires
Dec. 31
Law Offices of Peter G. Angelos, Baltimore, Maryland
Professor of Finance, School of Business and Public
Management, The George Washington University,
Washington, D.C.
Director, International Department,
International Association of Machinists and
Aerospace Workers, AFL-CIO,
Upper Marlboro, Maryland
2002
2003
Provost and Vice Chancellor for Academic Affairs,
North Carolina Central University,
Durham, North Carolina
President, Quality Transport, Inc.,
Lake City, South Carolina
Chairman Emeritus, RBC Centura Banks, Inc.,
Rocky Mount, North Carolina
President and Chief Executive Officer,
Sumter National Bank, Sumter, South Carolina
2002
President and Chief Executive Officer,
Charlotte Regional Partnership,
Charlotte, North Carolina
President, High Point Chevrolet Jeep,
High Point, North Carolina
President and Chief Executive Officer,
Capitol Broadcasting Company, Inc.,
Raleigh, North Carolina
2002
Chairman and Chief Executive Officer,
Trustmark Corporation, Jackson, Mississippi
President and Chief Executive Officer,
Capital City Bank Group, Inc., Tallahassee, Florida
Chairman, President, and Chief Executive Officer,
Farmers & Merchants Bank, Centre, Alabama
Chairman and Chief Executive Officer,
The Integral Group, LLC, Atlanta, Georgia
President and Chief Executive Officer,
Trinity Yachts LLC, New Orleans, Louisiana
President, Consumer Credit Counseling Service of
Greater Atlanta, Inc., Atlanta, Georgia
2004
2003
2003
2004
2003
2004
2002
2003
2004
2002
2003
2004
256 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Class C
John F. Wieland
Title
Term expires
Dec. 31
Chief Executive Officer and Chairman,
John Wieland Homes and Neighborhoods, Inc.,
Atlanta, Georgia
President, Lovell Communications, Inc.,
Nashville, Tennessee
President and Chief Executive Officer,
Georgia Power Company, Atlanta, Georgia
2002
Senior Executive Vice President, Alabama Banking
Group Head, Commercial Banking Group Head,
AmSouth Bank, Birmingham, Alabama
Owner and Managing General Agent,
Hundley Batts & Associates, HuntsviUe, Alabama
International Representative, Laborers' International
Union of Norm America, Gadsden, Alabama
Chairman, The Monroe County Bank,
Monroeville, Alabama
2002
Managing Partner, Martin Farm, Couitland, Alabama
President, Welborn and Associates, Inc.,
Lookout Mountain, Tennessee
Catherine Sloss Crenshaw .. President, Sloss Real Estate Group, Inc.,
Birmingham, Alabama
2002
2003
Paula Lovell
David M. Ratcliffe
Birmingham Branch
Appointed by the
Federal Reserve Bank
W.Charles Mayer III
Hundley Batts, Sr.
James Austin Vickery
John B. Barnett III
Appointed by the
Board of Governors
V. Larkin Martin
W. Miller Welborn
Jacksonville Branch
Appointed by the
Federal Reserve Bank
Jerry M. Smith
Robert L. Fisher
Michael W. Poole
Harvey R. Heller
Appointed by the
Board of Governors
Marsha G. Rydberg
William E. Flaherty
Julie K. Hilton
2003
2004
2003
2003
2004
2004
Chairman and President, First National Bank of
Alachua, Alachua, Florida
President and Chief Executive Officer,
MacDill Federal Credit Union, Tampa, Florida
Principal, Poole Carbone Eckbert, Inc.,
Winter Park, Florida
President, Heller Brothers Packing Corp.,
Winter Garden, Florida
2002
Partner, The Rydberg Law Firm, Tampa, Florida
Retired Chairman, Blue Cross and Blue Shield of
Florida, Inc., Jacksonville, Florida
Vice President and Co-Owner,
Paradise Found Resorts & Hotels,
Panama City Beach, Florida
2002
2003
2003
2003
2004
2004
Federal Reserve System Organization 257
BANK or Branch
Director
Miami Branch
Appointed by the
Federal Reserve Bank
D. Keith Cobb
James W. Moore
Miriam Lopez
Rudy E. Schupp
Appointed by the
Board of Governors
Mark T. Sodders
Brian E. Keeley
Rosa Sugranes
Nashville Branch
Appointed by the
Federal Reserve Bank
Michael B. Swain
Emil Hassan
James W. Spradley, Jr.
Sam O. Franklin III
Appointed by the
Board of Governors
Beth Dortch Franklin
Whitney Johns Martin
F. Rodney Lawler
New Orleans Branch
Appointed by the
Federal Reserve Bank
C. R. Cloutier
Ten G. Fontenot
David Guidry
David E. Johnson
Titlp
l Hie
Term expires
Dec. 31
Managing Director, Cobb Consulting Group,
Ft. Lauderdale, Florida
Managing Partner, Riverside Capital, LLC,
Fort Myers, Florida
President and Chief Executive Officer,
TransAtlantic Bank, Miami, Florida
Consultant, Florida Operations, Wachovia, N.A.,
North Palm Beach, Florida
2002
President, Lakeview Farms, Inc., Pahokee, Florida
President and Chief Executive Officer,
Baptist Health South Florida, Coral Gables, Florida
Chairman, Iberia Tiles Corp., Miami, Florida
2002
2003
President and Chief Executive Officer,
First National Bank of Oneida, Oneida, Tennessee
Senior Vice President, North American Manufacturing,
Purchasing, Quality and Logistics,
Nissan North America, Inc., Smyrna, Tennessee
President, Standard Candy Company, Inc.,
Nashville, Tennessee
Chairman, SunTrust Bank, Nashville,
Nashville, Tennessee
2002
2002
2003
2004
2004
2003
2003
2004
President and Chief Executive Officer,
Star Transportation, Inc., Nashville, Tennessee
Chairman and Chief Executive Officer,
Capital Across America, Nashville, Tennessee
Co-Founder and Chief Executive Officer,
Lawler-Wood, LLC, Knoxville, Tennessee
2002
President and Chief Executive Officer,
MidSouth Bank, Lafayette, Louisiana
President and Chief Executive Officer,
Woman's Hospital, Baton Rouge, Louisiana
President and Chief Executive Officer,
Guico Machine Works, Inc., Harvey, Louisiana
Chairman and Chief Executive Officer,
The First Bancshares, Inc., and
the First National Bank of South Mississippi,
Hattiesburg, Mississippi
2002
2003
2004
2003
2003
2004
258 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Appointed by the
Board of Governors
R. Glenn Pumpelly
Ben Tom Roberts
Dave Dennis
DISTRICT 7—CHICAGO
Class A
William A. Osborn
Robert R. Yohanan
Alan R. Tubbs
Class B
Connie E. Evans
Jack B.Evans
James H. Keyes
Class C
Robert J. Darnall
W. James Farrell
MilesD. White
Detroit Branch
Appointed by the
Federal Reserve Bank
IrmaB. Elder
MarkT. Gaffney
David J. Wagner
Robert E. Churchill
Appointed by the
Board of Governors
Edsel B. Ford II
Timothy D. Leuliette
IrvinD.Reid
Title
Term expires
Dec. 31
President and Chief Executive Officer,
Pumpelly Oil Inc., Sulphur, Louisiana
Senior Executive Vice President/Owner,
Roberts Brothers, Inc., Realtors, Mobile, Alabama
President, Specialty Contractors & Assoc, Inc.,
Gulfport, Mississippi
2002
Chairman and Chief Executive Officer,
Northern Trust Corporation and
The Northern Trust Company, Chicago, Illinois
Managing Director and Chief Executive Officer,
First Bank & Trust, Evanston, Illinois
President, Maquoketa State Bank and
Ohnward Bancshares Inc., Maquoketa, Iowa
2002
2003
2004
2003
2004
President and Chief Executive Officer,
WSEP Ventures, Chicago, Illinois
President, The Hall-Perrine Foundation,
Cedar Rapids, Iowa
Chairman and Chief Executive Officer,
Johnson Controls, Inc., Milwaukee, Wisconsin
2002
Retired Chairman and Chief Executive Officer,
Inland Steel Industries, Inc., Chicago, Illinois
Chairman and Chief Executive Officer,
Illinois Tool Works Inc., Glenview, Illinois
Chairman and Chief Executive Officer,
Abbott Laboratories, Abbott Park, Illinois
2002
President, Elder Ford, Troy, Michigan
President, Michigan AFL-CIO, Lansing, Michigan
Chairman, Fifth Third Bank, Grand Rapids, Michigan
Chairman and Chief Executive Officer,
Citizens National Bank, Cheboygan, Michigan
2002
2002
2003
2004
Board Director, Ford Motor Company,
Dearborn, Michigan
President and Chief Executive Officer,
Metaldyne, Plymouth, Michigan
President, Wayne State University, Detroit, Michigan
2002
2003
2004
2003
2004
2003
2004
Federal Reserve System Organization 259
BANK or Branch
Director
DISTRICT 8—ST. LOUIS
Class A
Lunsford W. Bridges
Bradley W. Small
Lewis F. Mallory, Jr
Class B
Joseph E. Gliessner, Jr
Robert L. Johnson
Bert Greenwalt
Class C
Gayle P. W. Jackson
Walter L. Metcalfe, Jr.
Charles W. Mueller
Little Rock Branch
Appointed by the
Federal Reserve Bank
David R. Estes
Everett Tucker III
Raymond E. Skelton
Lawrence A. Davis, Jr.
Appointed by the
Board of Governors
A. Rogers Yarnell II
Vacancy
Vick M. Crawley
Louisville Branch
Appointed by the
Federal Reserve Bank
Thomas W. Smith
Marjorie Z. Soyugenc
Frank J. Nichols
Titip
1 lllc
President and Chief Executive Officer,
Metropolitan National Bank, Little Rock, Arkansas
President and Chief Executive Officer,
The Farmers and Merchants National Bank,
Nashville, Illinois
Chairman and Chief Executive Officer,
National Bank of Commerce, Starkville, Mississippi
Executive Director, New Directions Housing Corp.,
Louisville, Kentucky
Chairman and Chief Executive Officer,
Johnson Bryce, Inc., Memphis, Tennessee
Partner, Greenwalt Company, Hazen, Arkansas
Managing Director, FondElec Clean Energy Group, Inc.,
St. Louis, Missouri
Chairman, Bryan Cave LLP, St. Louis, Missouri
Chairman and Chief Executive Officer,
Ameren Corporation, St. Louis, Missouri
President and Chief Executive Officer, First State Bank,
Lonoke, Arkansas
Chairman, Moses Tucker Real Estate, Inc.,
Little Rock, Arkansas
Regional President, U.S. Bank, N.A.,
Little Rock, Arkansas
Chancellor, University of Arkansas at Pine Bluff,
Pine Bluff, Arkansas
President, Yarnell Ice Cream Co., Inc., Searcy, Arkansas
Plant Manager, Baxter Healthcare Corporation,
Mountain Home, Arkansas
President, Thomas W. Smith & Associates, Inc.,
Danville, Kentucky
Executive Director and Chief Executive Officer,
Welborn Foundation, Evansville, Indiana
Chairman, President, and Chief Executive Officer,
Community Financial Services, Inc.,
Benton, Kentucky
Term expires
Dec. 31
2002
2003
2004
2002
2003
2004
2002
2003
2004
2002
2002
2003
2004
2002
2003
2004
2002
2002
2003
260 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
David H. Brooks
Appointed by the
Board of Governors
J. Stephen Barger
Norman E. Pfau, Jr.
Cornelius A. Martin
Memphis Branch
Appointed by the
Federal Reserve Bank
James A. England
TomA. Wright
E. C. Neelly III
Walter L. Morris, Jr.
Appointed by the
Board of Governors
Mike P. Sturdivant, Jr.
Russell Gwatney
Gregory M. Duckett
DISTRICT 9—
MINNEAPOLIS
Class A
Roger N. Berglund
Dan M. Fisher
Kay Clevidence
Class B
Rob L. Wheeler
D. Greg Heineman
Jay F. Hoeschler
Tiflp
Term expires
Dec. 31
Chairman and Chief Executive Officer,
Stock Yards Bank & Trust Company,
Louisville, Kentucky
2004
Executive Secretary-Treasurer,
Kentucky State District Council of Carpenters,
Frankfort, Kentucky
President and Chief Executive Officer,
Geo. Pfau's Sons Company, Inc.,
Jeffersonville, Indiana
President and Chief Executive Officer,
Martin Management Group,
Bowling Green, Kentucky
2002
Chairman, President, and Chief Executive Officer,
Decatur County Bank, Decaturville, Tennessee
Chairman, President, and Chief Executive Officer,
Enterprise National Bank, Memphis, Tennessee
Management Consultant, First American National Bank,
Iuka, Mississippi
President, H&M Lumber Co., Inc.,
West Helena, Arkansas
2002
2003
2004
2002
2003
2004
Partner, Due West, Glendora, Mississippi
President, Gwatney Companies, Memphis, Tennessee
Senior Vice President and Corporate Counsel,
Baptist Memorial Health Care Corporation,
Memphis, Tennessee
2002
2003
2004
Chairman and President, Dakota Western Bank,
Bowman, North Dakota
Chief Information Officer, Community First Bankshares,
Inc., Fargo, North Dakota
President, Farmers State Bank, Victor, Montana
2002
Vice President, Wheeler Mfg. Co., Inc.,
Lemmon, South Dakota
Chairman, Williams Insurance Agency,
Sioux Falls, South Dakota
President, Hoeschler Corporation, La Crosse, Wisconsin
2002
2003
2004
2003
2004
Federal Reserve System Organization 261
BANK or Branch
Director
Class C
Linda Hall Whitman
Ronald N. Zwieg
Frank L. Sims
Helena Branch
Appointed by the
Federal Reserve Bank
Emil W. Erhardt
Marilyn F. Wessel
Richard E. Hart
Appointed by the
Board of Governors
William P. Underriner
Tom Markle
DISTRICT 10—
KANSAS CITY
Class A
Dennis E. Barrett
Bruce A. Schriefer
Jeffrey L. Gerhart
Titif
11 lie
Chief Executive Officer, QuickMedx, Inc.,
Minneapolis, Minnesota
President, United Food & Commercial Workers,
Local 653, Plymouth, Minnesota
Corporate Vice President, Transportation Cargill, Inc.,
Wayzata, Minnesota
Terrence P. Dunn
Richard H. Bard
2002
2003
2004
Chairman and President, Citizens State Bank,
Hamilton, Montana
Dean and Director, Museum of the Rockies,
Bozeman, Montana
President, Senior Lender, and Director,
Mountain West Bank, Kalispell, Montana
2002
President, Underriner Motors, Billings, Montana
President and Chief Executive Officer,
Markle's Inc., Glasgow, Montana
2002
2003
Vice Chairman, FirstBank Holding Company
of Colorado, Lakewood, Colorado
President, Bankers' Bank of Kansas, Wichita, Kansas
President and Chief Executive Officer,
First National Bank, Newman Grove, Nebraska
2002
Class B
Paula Marshall-Chapman ... Chief Executive Officer, The Bama Companies, Inc.,
Tulsa, Oklahoma
President and Chief Executive Officer,
Hans C. Helmerich
Helmerich & Payne, Inc., Tulsa, Oklahoma
President, Spearhead Ranch Company,
Frank Moore
Douglas, Wyoming
Class C
Rhonda Holman
Term expires
Dec. 31
Vice President, Kauffman Center for Entrepreneurial
Leadership at the Ewing Marion Kauffman
Foundation, Kansas City, Missouri
President and Chief Executive Officer,
J. E. Dunn Construction Company,
Kansas City, Missouri
Founder and Manager, IdeaSpring, LLC,
Denver, Colorado
2002
2003
2003
2004
2002
2003
2004
2002
2003
2004
262 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Denver Branch
Appointed by the
Federal Reserve Bank
Virginia K. Berkeley
John W.Hay III
Kathryn A. Paul
Thomas Williams
Appointed by the
Board of Governors
Kathleen Avila
Robert M. Murphy
James A. King
Oklahoma City Branch
Appointed by the
Federal Reserve Bank
Robert A. Funk
Russell W. Teubner
Robert R. Gilbert III
W. Carlisle Mabrey III
Appointed by the
Board of Governors
J. Clifford Hudson
Patricia B. Fennell
Title
President, Colorado Business Bank N. A.,
Denver, Colorado
President, Rock Springs National Bank,
Rock Springs, Wyoming
President, Delta Dental Plan of Colorado,
Denver, Colorado
President and Chief Executive Officer,
Williams Group LLC, Golden, Colorado
2002
Managing Member, Avila Retail Development &
Management, Albuquerque, New Mexico
President, Sandia Properties Ltd., Co.,
Albuquerque, New Mexico
Chief Executive Officer, BT, Inc., Riverton, Wyoming
2002
Chairman and Chief Executive Officer,
Express Personnel Services International,
Oklahoma City, Oklahoma
Founder and Director, Esker, Inc., StiUwater, Oklahoma
President and Chief Operating Officer,
The F&M Bank & Trust Company, Tulsa, Oklahoma
President and Chief Executive Officer,
Citizens Bank & Trust Co., Okmulgee, Oklahoma
2002
Chairman and Chief Executive Officer, Sonic Corp.,
Oklahoma City, Oklahoma
Executive Director, Latino Community Development
Agency, Oklahoma City, Oklahoma
2002
Vacancy
Omaha Branch
Appointed by the
Federal Reserve Bank
Judith A. Owen
President and Chief Executive Officer,
Wells Fargo Bank Nebraska, N.A., Omaha, Nebraska
Frank L. Hayes
President, Hayes & Associates, L.L.C., CPAs,
Omaha, Nebraska
Chairman, President, and Chief Executive Officer,
H. H. Kosman
Platte Valley National Bank, Scottsbluff, Nebraska
CynthiaHardinMilligan ... Dean, College of Business Administration,
University of Nebraska-Lincoln, Lincoln, Nebraska
Term expires
Dec. 31
2003
2003
2004
2003
2004
2003
2004
2004
2003
2004
2002
2003
2003
2004
Federal Reserve System Organization 263
Term expires
Dec. 31
BANK or Branch
Director
Appointed by the
Board of Governors
Bob L. Gottsch
A. F. Raimondo
Timothy Sandos
DISTRICT 11—DALLAS
Class A
Kenneth T. Murphy
Matthew T. Doyle
David S. Barnard
Class B
Malcolm Gillis
Judy Ley Allen
Julie Spicer England
Class C
Patricia M. Patterson
H. B. Zachry, Jr.
Ray L. Hunt
El Paso Branch
Appointed by the
Federal Reserve Bank
Melissa W. O'Rourke
James D. Renfrow
Ron C. Helm
F. James Volk
Appointed by the
Board of Governors
James Haines
Gail Darling
Cecilia 0. Levine
Vice President, Gottsch Feeding Corporation,
Hastings, Nebraska
Chairman and Chief Executive Officer,
Behlen Mfg. Co., Columbus, Nebraska
Former Vice President and State Executive OfficerNebraska, Qwest Communications,
Omaha, Nebraska
2002
Chairman, President, and Chief Executive Officer,
First Financial Bankshares, Inc., Abilene, Texas
Vice Chairman and Chief Executive Officer,
Texas First Bank, Texas City, Texas
Chairman, National Bank, Gatesville, Texas
2002
President, Rice University, Houston, Texas
Partner, Allen Investments, Houston, Texas
Vice President, Texas Instruments, Dallas, Texas
2002
2003
2004
President, Patterson Investments, Inc., Dallas, Texas
Chairman and Chief Executive Officer,
H. B. Zachry Company, San Antonio, Texas
Chairman, President, and Chief Executive Officer,
Hunt Consolidated, Inc., Dallas, Texas
2002
2003
President, Charlotte's Inc., El Paso, Texas
President and Chief Executive Officer,
The Carlsbad National Bank, Carlsbad, New Mexico
Owner, Helm Cattle Company, Van Horn, Texas
President and Chief Executive Officer,
State National Bank, El Paso, Texas
2002
2002
Director and Vice Chairman, El Paso Electric Company,
El Paso, Texas
President, Gail Darling Inc., El Paso, Texas
President, MFI International Mfg., LLC,
USA/Mexico Strategic Alliance, El Paso, Texas
2003
2004
2003
2004
2004
2003
2004
2002
2003
2004
264 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Houston Branch
Appointed by the
Federal Reserve Bank
RayB.Nesbitt
PriscillaD.Slade
Alan R. Buckwalter III
Richard W. Weekley
Appointed by the
Board of Governors
Lupe Fraga
Vacancy
Edward 0. Gaylord
San Antonio Branch
Appointed by the
Federal Reserve Bank
Mary Rose Cardenas
Daniel B. Hastings, Jr.
Arthur R. Emerson
R. Tom Roddy
Appointed by the
Board of Governors
Patty Puig Mueller
Marvin L. Ragsdale
Ron R. Harris
DISTRICT 12—
SAN FRANCISCO
Class A
E. Lynn Caswell
Richard C. Hartnack
Richard W. Decker, Jr.
Title
President (Retired), Exxon Chemical Company,
Houston, Texas
President, Texas Southern University, Houston, Texas
Chairman and Chief Executive Officer,
Chase J.P. Morgan Bank, South Region,
Houston, Texas
Chairman, Weekley Development Company,
Houston, Texas
President and Chief Executive Officer,
Tejas Office Products, Inc., Houston, Texas
Chairman, Jacintoport Terminal Company,
Houston, Texas
Term expires
Dec. 31
2002
2002
2003
2004
2002
2003
2004
Vice President, Cardenas Motors, Inc.,
Brownsville, Texas
President and Owner, Daniel B. Hastings, Inc.,
Laredo, Texas
Chairman and Chief Executive Officer,
Groves Rojas Emerson, San Antonio, Texas
Chairman Clear Lake National Bank,
San Antonio, Texas
2002
Vice President-Finance, Mueller Energetics Corp.,
Corpus Christi, Texas
President, Iron Workers District Council of the State
of Texas, Georgetown, Texas
President and Chief Executive Officer,
Pervasive Software, Inc., Austin, Texas
2002
Chairman and Managing Director, Zurich American
Trust Co., AG, Laguna Niguel, California
Vice Chairman, Union Bank of California,
Los Angeles, California
Chairman and Co-Founder, Belvedere Capital Partners,
LLC, San Francisco, California
2002
2002
2003
2004
2003
2004
2003
2004
Federal Reserve System Organization 265
BANK or Branch
Director
Class B
Robert S. Attiyeh
Barbara L. Wilson
JackMcNally
Class C
George M. Scalise
Nelson C. Rising
Sheila D. Harris
Los Angeles Branch
Appointed by the
Federal Reserve Bank
John H. Gleason
Linda Griego
D. Linn Wiley
Russell Goldsmith
Appointed by the
Board of Governors
Lori R. Gay
Lonnie Kane
William D. Jones
Portland Branch
Appointed by the
Federal Reserve Bank
L. Martin Brantley
Vacancy
Peter 0. Kohler
George J. Passadore
Titip
11L1C
Term expires
Dec. 31
Senior Vice President, Chief Financial Officer (Retired),
and Consultant, Amgen, Inc.,
Thousand Oaks, California
Idaho and Regional Vice President (Retired),
Qwest Corporation, Boise, Idaho
Business Manager (Retired), IBEW Local Union 1245,
and Principal, JKM Consulting,
Sacramento, California
2002
2003
2004
President, Semiconductor Industry Association,
San Jose, California
Chairman and Chief Executive Officer,
Catellus Development Corporation,
San Francisco, California
Director, Arizona Department of Housing,
Phoenix, Arizona
2002
Regional President, California and Texas,
Del Webb Group, Phoenix, Arizona
Managing Partner, Engine Co. No. 28,
Los Angeles, California
President and Chief Executive Officer,
Citizens Business Bank, Ontario, California
Chairman and Chief Executive Officer,
City National Bank, Beverly Hills, California
2002
President, Los Angeles Neighborhood Housing
Services, Inc., Los Angeles, California
President, Karen Kane, Inc., Los Angeles, California
Chairman, President, and Chief Executive Officer,
CityLink Investment Corporation,
San Diego, California
President and General Manager (Retired),
Oregon's 12-KPTV, Portland, Oregon
President, Oregon Health & Science University,
Portland, Oregon
Chairman-Oregon, Wells Fargo Bank, Portland, Oregon
2003
2004
2003
2003
2004
2002
2003
2004
2002
2002
2003
2004
266 89th Annual Report, 2002
Directors—Continued
BANK or Branch
Director
Appointed by the
Board of Governors
Nancy Wilgenbusch
Patrick Borunda
Karla S. Chambers
Salt Lake City Branch
Appointed by the
Federal Reserve Bank
Maria Garciaz
J. Pat McMurray
Peggy A. Stock
Curtis H. Harris
Appointed by the
Board of Governors
H. Roger Boyer
William C. Glynn
Gary L. Crocker
Seattle Branch
Appointed by the
Federal Reserve Bank
James C. Hawkanson
Mary E. Pugh
Betsy Lawer
Peter H. van Oppen
Appointed by the
Board of Governors
Boyd E. Givan
David W. Wyckoff
Mic R. Dinsmore
11UC
Term expires
Dec. 31
President, Marylhurst University, Marylhurst, Oregon
Principal, The Navigator Group, Vancouver, Washington
Vice President, Stahlbush Island Farms, Inc.,
Corvallis, Oregon
2002
2003
2004
Executive Director, Salt Lake Neighborhood Housing
Services, Inc., Salt Lake City, Utah
President and Chief Executive Officer,
Idaho Region, Wells Fargo, Boise, Idaho
President Emeritus, Westminster College,
Salt Lake City, Utah
Chairman, President, and Chief Executive Officer,
Barnes Banking Company, Kaysville, Utah
2002
Chairman, The Boyer Company, Salt Lake City, Utah
President, Intermountain Industries, Inc., Boise, Idaho
Chairman, ARUP Laboratories, Salt Lake City, Utah
2002
2003
2004
Chairman (Retired), The Commerce Bank of
Washington, N.A., Seattle, Washington
President, Pugh Capital Management, Inc.,
Seattle, Washington
Vice Chair and Chief Operating Officer,
First National Bank Alaska, Anchorage, Alaska
Chairman and Chief Executive Officer,
Advanced Digital Information Corp.,
Redmond, Washington
2002
Senior Vice President and Chief Financial Officer
(Retired), The Boeing Company, Seattle, Washington
Chairman and Chief Executive Officer,
Wyckoff Farms, Inc., Grandview, Washington
Chief Executive Officer, Port of Seattle,
Seattle, Washington
2002
2002
2003
2004
2002
2003
2004
2003
2004
Members of the Board of Governors, 1913-2002 267
Members of the Board of Governors, 1913-2002
Appointed Members
Federal Reserve
District
Date initially took
oath of office
Charles S. Hamlin
Boston
Paul M. Warburg
Frederic A. Delano
W.P.G. Harding
Adolph C. Miller
New York
Chicago
Atlanta
San Francisco
Albert Strauss
Henry A. Moehlenpah
Edmund Platt
New York
Chicago
New York
David C. Wills
John R. Mitchell
Milo D. Campbell
Daniel R. Crissinger
George R. James
Cleveland
Minneapolis
Chicago
Cleveland
St. Louis
Edward H. Cunningham
Roy A. Young
Eugene Meyer
Wayland W. Magee
Eugene R. Black
M.S. Szymczak
Chicago
Minneapolis
New York
Kansas City
Atlanta
Chicago
JJ. Thomas
Marriner S. Eccles
Kansas City
San Francisco
Joseph A. Broderick
John K. McKee
Ronald Ransom
Ralph W. Morrison
Chester C. Davis
New York
Cleveland
Atlanta
Dallas
Richmond
Ernest G. Draper
Rudolph M. Evans
James K. Vardaman, Jr.
Lawrence Clayton
Thomas B. McCabe
Edward L. Norton
Oliver S. Powell
Wm. McC. Martin, Jr.
New York
Richmond
St. Louis
Boston
Philadelphia
Atlanta
Minneapolis
New York
A.L. Mills, Jr.
San Francisco
J.L. Robertson
Kansas City
C. Canby Balderston
Paul E. Miller
Philadelphia
Minneapolis
Aug. 10, 1914 Reappointed in 1916 and 1926. Served
until Feb. 3, 1936.2
Aug. 10, 1914 Term expired Aug. 9, 1918.
Aug. 10, 1914 Resigned July 21, 1918.
Aug. 10, 1914 Term expired Aug. 9, 1922.
Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934
from the Richmond District. Served
until Feb. 3, 1936.2
Oct. 26, 1918 Resigned Mar. 15, 1920.
Nov. 10, 1919 Term expired Aug. 9, 1920.
June 8, 1920 Reappointed in 1928. Resigned Sept. 14,
1930.
Sept. 29, 1920 Term expired Mar. 4, 1921.
May 12, 1921 Resigned May 12, 1923.
Mar. 14, 1923 Died Mar. 22, 1923.
Resigned Sept. 15, 1927.
May 1, 1923
May 14, 1923 Reappointed in 1931. Served until Feb. 3,
1936.3
May 14, 1923 Died Nov. 28, 1930.
Resigned Aug. 31, 1930.
Oct. 4, 1927
Sept. 16, 1930 Resigned May 10, 1933.
May 18, 1931 Term expired Jan. 24, 1933.
May 19, 1933 Resigned Aug. 15, 1934.
June 14, 1933 Reappointed in 1936 and 1948. Resigned
May 31, 1961.
June 14, 1933 Served until Feb. 10, 1936.2
Nov. 15, 1934 Reappointed in 1936, 1940, and 1944.
Resigned July 14, 1951.
Feb. 3, 1936
Resigned Sept. 30, 1937.
Feb. 3, 1936
Served until Apr. 4, 1946.2
Feb. 3, 1936
Reappointed in 1942. Died Dec. 2, 1947.
Feb. 10, 1936 Resigned July 9, 1936.
June 25, 1936 Reappointed in 1940. Resigned Apr. 15,
1941.
Mar. 30, 1938 Served until Sept. 1, 1950.2
Mar. 14, 1942 Served until Aug. 13, 1954.2
Apr. 4, 1946
Resigned Nov. 30, 1958.
Feb. 14, 1947 Died Dec. 4, 1949.
Apr. 15, 1948 Resigned Mar. 31, 1951.
Sept. 1, 1950 Resigned Jan. 31, 1952.
Sept. 1, 1950 Resigned June 30, 1952.
April 2, 1951 Reappointed in 1956. Term expired
Jan. 31, 1970.
Feb.18,1952 Reappointed in 1958. Resigned Feb. 28,
1965.
Feb. 18, 1952 Reappointed in 1964. Resigned Apr. 30,
1973.
Aug. 12, 1954 Served through Feb. 28, 1966.
Aug. 13, 1954 Died Oct. 21, 1954.
Name
Other dates1
268 89th Annual Report, 2002
Appointed Members—Continued
Federal Reserve
District
Date initially took
oath of office
Chas. N. Shepardson
G.H. King, Jr.
Dallas
Atlanta
George W. Mitchell
Chicago
J. Dewey Daane
Sherman J. Maisel
Andrew F. Brimmer
William W.Sherrill
Richmond
San Francisco
Philadelphia
Dallas
Arthur F. Burns
New York
John E. Sheehan
Jeffrey M. Bucher
Robert C. Holland
Henry C. Wallich
Philip E. Coldwell
Philip C. Jackson, Jr.
J. Charles Partee
Stephen S. Gardner
David M. Lilly
G. William Miller
Nancy H. Teeters
Emmett J. Rice
Frederick H. Schultz
Paul A. Volcker
Lyle E. Gramley
Preston Martin
Martha R. Seger
Wayne D. Angell
Manuel H. Johnson
H. Robert Heller
Edward W. Kelley, Jr.
Alan Greenspan
John P. LaWare
David W.Mullins, Jr.
Lawrence B. Lindsey
Susan M. Phillips
Alan S. Blinder
Janet L. Yellen
Laurence H. Meyer
Alice M. Rivlin
Roger W. Ferguson, Jr.
Edward M. Gramlich
Susan S. Bies
Mark W. Olson
Ben S. Bernanke
Donald L. Kohn
St. Louis
San Francisco
Kansas City
Boston
Dallas
Atlanta
Richmond
Philadelphia
Minneapolis
San Francisco
Chicago
New York
Atlanta
Philadelphia
Kansas City
San Francisco
Chicago
Kansas City
Richmond
San Francisco
Dallas
New York
Boston
St. Louis
Richmond
Chicago
Philadelphia
San Francisco
St. Louis
Philadelphia
Boston
Richmond
Chicago
Minneapolis
Atlanta
Kansas City
Mar. 17, 1955 Retired Apr. 30, 1967.
Mar. 25, 1959 Reappointed in 1960. Resigned Sept. 18,
1963.
Aug. 31, 1961 Reappointed in 1962. Served until
Feb. 13, 1976.2
Nov. 29, 1963 Served until Mar. 8, 1974.2
Apr. 30, 1965 Served through May 31, 1972.
Mar. 9, 1966
Resigned Aug. 31, 1974.
May 1, 1967
Reappointed in 1968. Resigned Nov. 15,
1971.
Jan. 31, 1970 Term began Feb. 1, 1970. Resigned
Mar. 31, 1978.
Jan. 4, 1972
Resigned June 1, 1975.
June 5, 1972
Resigned Jan. 2, 1976.
June 11, 1973 Resigned May 15, 1976.
Mar. 8,1974
Resigned Dec. 15, 1986.
Oct. 29, 1974 Served through Feb. 29,1980.
July 14, 1975 Resigned Nov. 17, 1978.
Jan. 5, 1976
Served until Feb. 7, 1986.2
Feb. 13, 1976 Died Nov. 19, 1978.
June 1, 1976
Resigned Feb. 24, 1978.
Mar. 8, 1978
Resigned Aug. 6, 1979.
Sept. 18, 1978 Served through June 27, 1984.
June 20, 1979 Resigned Dec. 31, 1986.
July 27, 1979 Served through Feb. 11, 1982.
Aug. 6, 1979 Resigned August 11, 1987.
May 28, 1980 Resigned Sept. 1, 1985.
Mar. 31, 1982 Resigned April 30, 1986.
July 2, 1984
Resigned March 11, 1991.
Feb. 7, 1986
Served through Feb. 9, 1994.
Feb. 7, 1986
Resigned August 3, 1990.
Aug. 19, 1986 Resigned July 31, 1989.
May 26, 1987 Resigned Dec. 31, 2001.
Aug. 11, 1987 Reappointed in 1992.
Aug. 15, 1988 Resigned April 30, 1995.
May 21, 1990 Resigned Feb. 14, 1994.
Nov. 26, 1991 Resigned Feb. 5, 1997.
Dec. 2, 1991
Served through June 30, 1998.
June 27, 1994 Term expired Jan. 31, 1996.
Aug. 12, 1994 Resigned Feb. 17, 1997.
June 24, 1996 Term expired Jan. 31, 2002.
June 25, 1996 Resigned July 16, 1999.
Nov. 5, 1997
Reappointed in 2001.
Nov. 5, 1997
Dec. 7, 2001
Dec. 7, 2001
Aug. 5, 2002
Aug. 5, 2002
Name
Other dates1
Members of the Board of Governors, 1913-2002
269
Appointed Members—Continued
Term
Name
Chairmen3
Charles S. Hamlin
W.RG. Harding
Daniel R. Crissinger
Roy A. Young
Eugene Meyer
Eugene R. Black
Marriner S. Eccles
Thomas B. McCabe
Wm. McC. Martin, Jr.
Arthur F. Burns
G.William Miller
Paul A. Volcker
Alan Greenspan
Aug. 10, 1914-Aug. 9, 1916
Aug. 10,1916-Aug. 9, 1922
May 1, 1923-Sept. 15, 1927
Oct. 4, 1927-Aug. 31, 1930
Sept. 16,1930-May 10,1933
May 19, 1933-Aug. 15, 1934
Nov. 15, 1934-Jan. 31, 19484
Apr. 15, 1948-Mar. 31, 1951
Apr. 2, 1951-Jan. 31, 1970
Feb. 1, 1970-Jan. 31, 1978
Mar. 8, 1978-Aug. 6, 1979
Aug. 6, 1979-Aug. 11, 1987
Aug. 11, 1987- 5
Vice Chairmen3
Frederic A. Delano
Paul M. Warburg
Albert Strauss
Edmund Platt
J.J. Thomas
Ronald Ransom
C. Canby Balderston
J.L. Robertson
George W. Mitchell
Stephen S. Gardner
Frederick H. Schultz
Preston Martin
Manuel H. Johnson
David W. Mullins, Jr.
Alan S. Blinder
Alice M. Rivlin
Roger W. Ferguson, Jr.
Aug. 10, 1914-Aug. 9, 1916
Aug. 10, 1916-Aug. 9, 1918
Oct. 26, 1918-Mar. 15, 1920
July 23, 1920-Sept. 14, 1930
Aug. 21, 1934-Feb. 10, 1936
Aug. 6, 1936-Dec. 2, 1947
Mar. 11, 1955-Feb. 28, 1966
Mar. 1, 1966-Apr. 30, 1973
May 1, 1973-Feb. 13, 1976
Feb. 13, 1976-Nov. 19, 1978
July 27, 1979-Feb. 11, 1982
Mar. 31, 1982-Apr. 30, 1986
Aug. 4, 1986-Aug. 3, 1990
July 24, 1991-Feb. 14, 1994
June 27, 1994-Jan. 31, 1996
June 25, 1996-July 16, 1999
Oct. 5, 1999-
NOTE. Under the original Federal Reserve Act, the
Federal Reserve Board was composed of five appointed
members, the Secretary of the Treasury (ex-officio chairman of the Board), and the Comptroller of the Currency.
The original term of office was ten years; the five original
appointed members had terms of two, four, six, eight, and
ten years. In 1922 the number of appointed members was
increased to six, and in 1933 the term of office was raised
to twelve years. The Banking Act of 1935 changed the
name to the Board of Governors of the Federal Reserve
System and provided that the Board be composed of
seven appointed members; that the Secretary of the Treasury and the Comptroller of the Currency continue to
serve until Feb. 1, 1936; that the appointed members in
office on Aug. 23, 1935, continue to serve until Feb. 1,
1936, or until their successors were appointed and had
qualified; and that thereafter the terms of members be
fourteen years and that the designation of Chairman and
Vice Chairman of the Board be for four years.
1. Date following "Resigned" and "Retired" denotes
final day of service.
2. Successor took office on this date.
3. Before Aug. 23, 1935, Chairmen and Vice Chairmen were designated Governor and Vice Governor.
4. Served as Chairman Pro Tempore from February 3,
1948, to April 15, 1948.
5. Served as Chairman Pro Tempore from March 3,
1996, to June 20, 1996.
270 89th Annual Report, 2002
Ex-Officio Members
Name
Term
Secretaries of the Treasury
W.G. McAdoo
Carter Glass
David F. Houston
Andrew W. Mellon
Ogden L. Mills
William H. Woodin
Henry Morgenthau, Jr.
Dec. 23, 1913-Dec. 15, 1918
Dec. 16, 1918-Feb. 1, 1920
Feb. 2, 1920-Mar. 3, 1921
Mar. 4, 1921-Feb. 12, 1932
Feb. 12, 1932-Mar. 4, 1933
Mar. 4, 1933-Dec. 31, 1933
Jan. 1, 1934-Feb. 1, 1936
Comptrollers of the Currency
John Skelton Williams
Daniel R. Crissinger
Henry M. Dawes
Joseph W. Mclntosh
J.W Pole
J.F.T. O'Connor
Feb. 2, 1914-Mar. 2, 1921
Mar. 17, 1921-Apr. 30, 1923
May 1, 1923-Dec. 17, 1924
Dec. 20, 1924-Nov. 20, 1928
Nov. 21, 1928-Sept. 20, 1932
May 11, 1933-Feb. 1, 1936
Statistical Tables
272
89th Annual Report, 2002
1. Statement of Condition of the Federal Reserve Banks,
by Bank, December 31, 2002 and 2001
Millions of dollars
Total
Boston
Item
2002
2001
2002
11,039
2,200
988
11,045
2,200
1,047
533
115
45
546
115
54
40
0
34
0
0
0
2
0
39,500
50,250
10
0
10
0
1
0
1
0
629,406
0
668,956
11,498
1,542
551,675
0
601,969
3,829
1,512
36,062
0
36,062
1,002
91
33,146
0
33,149
317
91
16,913
20,112
0
733,249
14,559
20,819
0
656,980
964
973
-6,558
33,227
757
1,076
-2,362
33,743
759,256
104,983
654,273
751,540
139,783
611,757
32,969
4,065
28,905
1,208
35,614
3,808
31,806
22,541
4,420
136
1,156
28,254
10,666
2,205
716,488
17,478
6,645
61
828
25,012
3,131
2,395
642,295
1,212
0
2
61
1,274
832
135
32^55
626
0
2
40
668
283
149
32,906
8,380
8,380
0
733,249
7,373
7,312
0
656,980
436
436
0
33,227
418
418
0
33,743
Federal Reserve notes outstanding
Less: Held by Bank not subject to collateralization
Collateralized Federal Reserve notes
759,256
101,559
657,696
751,540
138,0006
613,539
Collateral for Federal Reserve notes
Gold certificate account
Special drawing rights certificate account
Other eligible assets
U.S. Treasury and federal agency securities
Total collateral
11,039
2,200
0
644,458
657,696
11,045
2,200
0
600,2946
2001
ASSETS
Gold certificate account
Special drawing rights certificate account
Coin
Loans
To depository institutions
Other
Securities purchased under agreements
to resell (triparty)
Federal agency obligations
Bought outright
Held under repurchase agreements
U.S. Treasury securities
Bought outright'
Held under repurchase agreements
Total loans and securities
Items in process of collection
Bank premises
Other assets
Denominated in foreign currencies 2
Other3
Interdistrict settlement account
Total assets
LIABILITIES
Federal Reserve notes outstanding (issued to Bank) .
Less: Notes held by Federal Reserve Bank
Federal Reserve notes, net
Securities sold under agreements to repurchase
Deposits
Depository institutions
U.S. Treasury, general account
Foreign, official accounts
Other4
Total deposits
Deferred credit items
Other liabilities and accrued dividends5
Total liabilities
21,091
CAPITAL ACCOUNTS
Capital paid in
Surplus
Other capital accounts
Total liabilities and capital accounts
FEDERAL RESERVE NOTE STATEMENT
For notes see end of table.
613,539*
Statistical Tables 273
1.—Continued
2002
2002
2001
Richmond
Cleveland
Philadelphia
New York
2001
2002
2001
2002
2001
4,364
874
33
4,451
874
63
430
83
61
454
83
44
522
104
43
538
104
61
819
147
144
741
147
165
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
0
39,500
50,250
4
0
4
0
0
0
0
0
1
0
1
0
1
0
1
0
247,647
0
287,151
992
185
225,984
0
276,239
473
177
24,202
0
24,203
494
50
22,659
0
22,660
526
49
34,727
0
34,728
764
153
32,298
0
32,298
218
152
49,089
0
49,090
917
129
32,957
0
32,958
174
132
3,465
9,292
24,567
330,923
3,099
9,787
-29,004
266,158
510
743
-5,391
21,182
481
810
-2,239
22,868
1,531
989
-5,818
33,015
996
1,087
-2,008
33,448
4,048
1,515
-3,052
53,757
3,544
1,231
13,211
52,304
329,740
24,922
304,818
8,299
293,294
41,528
251,766
25,517
6,893
18,624
811
28,335
6,562
21,773
32,587
4,417
28,170
1,164
34,936
4,316
30,620
54,372
9,023
45,349
1,645
55,438
10,230
45,208
7,571
4,420
112
330
12,433
1,069
686
327,305
3,092
6,645
37
447
10,221
381
782
263,150
577
0
1
49
626
556
99
20,717
413
0
1
29
443
100
110
22,425
1,393
0
3
72
1,467
685
125
31,610
1,103
0
2
30
1,135
224
139
32,118
1,381
0
7
191
1,579
808
229
49,610
3,191
0
7
70
3,269
109
205
48,790
1,809
1,809
0
330,923
1,504
1,504
0
266,158
233
233
0
21,182
221
221
0
22,868
702
702
0
33,015
665
665
0
33,448
2,073
2,073
0
53,757
1,757
1,757
0
52,304
274
89th Annual Report, 2002
1. Statement of Condition of the Federal Reserve Banks,
by Bank, December 31, 2002 and 2001— Continued
Millions of dollars
Atlanta
Chicago
Item
2002
2001
2001
2002
ASSETS
Gold certificate account
Special drawing rights certificate account
Coin
Loans
To depository institutions
Other
Securities purchased under agreements
to resell (triparty)
Federal agency obligations
Bought outright
Held under repurchase agreements
US. Treasury securities
Bought outright1
Held under repurchase agreements
Total loans and securities
Items in process of collection
Bank premises
Other assets
Denominated in foreign currencies2
Other3
Interdistrict settlement account
Total assets
926
166
103
871
166
113
1,080
212
126
1,028
212
117
0
7
0
6
0
15
0
1
0
1
0
1
0
1
0
44,816
0
44,825
748
279
37,935
0
37,943
149
281
74,069
0
74,076
1,169
116
62,482
0
62,497
526
105
1,231
1,258
-1,692
47,844
1,046
1,278
7,088
48,934
1,827
1,980
-14,583
66,004
1,333
2,005
6,071
73,895
59,126
16,757
42,368
1,502
65,085
18,763
46,323
63,905
7,397
56,508
2,482
74,543
6,424
68,119
1,735
0
2
133
1,870
972
182
46,894
1,169
0
2
37
1,208
138
196
47,864
3,943
0
3
123
4,069
997
232
64,289
3,498
0
3
44
3,544
386
258
72,308
475
475
0
47,844
535
535
0
48,934
858
858
0
66,004
793
793
0
73,895
0
LIABILITIES
Federal Reserve notes outstanding (issued to Banks)
Less: Notes held by Federal Reserve Banks
Federal Reserve notes, net
Securities sold under repurchase agreements
Deposits
Depository institutions
U.S. Treasury, general account
Foreign, official accounts
Other4
Total deposits
Deferred credit items
Other liabilities and accrued dividends5
Total liabilities
CAPITAL ACCOUNTS
Capital paid in
Surplus
Other capital accounts
Total liabilities and capital accounts
NOTE. Components may not sum to totals because of
rounding
1. Includes securities loaned—fully guaranteed by U.S.
Treasury securities pledged with Federal Reserve Banks—
and excludes securities sold and scheduled to be bought
back under matched sale-purchase transactions, which
were discontinued in December 2002.
2. Valued daily at market exchange rates.
3. The System total includes depository institution overdrafts of $3 million for 2002 and $22 million for 2001.
Statistical Tables 275
1.—Continued
Minneapolis
St. Louis
2002
2001
2002
Kansas City
2001
2002
Dallas
2001
2002
San Francisco
2001
2002
2001
346
71
59
343
71
58
179
30
35
143
30
31
309
66
66
317
66
69
485
98
163
477
98
128
1,046
234
111
1,136
234
144
11
0
3
0
7
0
3
0
2
0
3
0
0
0
0
0
5
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
0
1
0
22,380
0
22,392
695
44
19,884
0
19,888
215
43
9,839
0
9,846
612
127
1,721
0
1,725
526
123
18,605
0
18,608
870
50
17,028
0
17,031
236
49
13,969
0
13,969
624
142
10,001
0
10,001
202
137
54,001
0
54,006
2,608
176
55,580
0
55,581
267
171
343
624
-3,554
21,021
291
655
721
22,286
343
295
4,063
15,530
563
122
12,065
15,329
440
526
-2,244
18,691
378
575
-358
18^63
378
434
14,306
30,599
398
385
4,041
15,866
1,833
1,484
-43
61,456
1,673
1,807
-7,226
53,788
22,002
3,088
18,914
750
24,022
2,586
21,435
15,088
1,785
13,304
330
16,070
2,015
14,055
19,979
3,854
16,125
623
21,077
4,117
16,960
36,839
8,424
28,416
468
33,441
19,062
14,378
67,131
14,359
52,772
1,810
69,686
20,372
49,314
480
0
1
34
514
346
99
20,623
344
0
1
22
366
79
107
21,988
430
0
1
2
433
713
72
14,851
460
0
0
462
457
57
15,031
822
0
1
33
855
598
88
18,289
758
0
1
24
783
135
103
17,981
727
0
1
24
752
505
85
30,226
695
0
1
31
727
349
83
15,538
2,273
0
3
105
2,381
2,584
173
59,719
2,129
0
3
54
2,187
490
206
52,196
199
199
0
21,021
149
149
0
22,286
340
340
0
15,530
180
118
0
15,329
201
201
0
18,691
191
191
0
18,363
186
186
0
30,599
164
164
0
15,866
868
868
0
61,456
796
796
0
53,788
4. Includes international organization deposits of
$100 million for 2002 and $127 million for 2001. These
deposits are held solely by the Federal Reserve Bank of
New York.
5. Includes exchange-translation account reflecting the
monthly revaluation at market exchange rates of foreign
exchange commitments.
6. Amounts are restatements due to changes in previously reported data.
. . . Not applicable.
276
89th Annual Report, 2002
2. Federal Reserve Open Market Transactions, 2002
Millions of dollars
Type of security and transaction
Apr.
Jan.
Feb.
Mar.
Outright transactions (excluding matched transactions)
Treasury bills
Gross purchases
Gross sales
Exchanges
New bills
Redemptions
2,772
0
55,521
55,521
0
1,042
0
54,619
54,619
0
3,013
0
48,483
48,483
0
1,047
0
45,376
45,376
0
Others within 1 year
Gross purchases
Gross sales
Maturity shift
Exchanges
Redemptions
0
0
5,850
-5,766
0
2,894
0
7,537
-8,432
0
1,455
0
0
0
0
2,709
0
14,515
-15,522
0
0 to 5 years
Gross purchases
Gross sales
Maturity shift
Exchanges
2,872
0
-5,850
5,766
1,101
0
-6,283
7,679
2,181
0
0
0
1,142
0
-14,515
15,522
5 to 10 years
Gross purchases
Gross sales
Maturity shift
Exchanges
0
0
0
0
334
0
-501
753
637
0
0
0
1,670
0
0
0
582
0
0
0
1,054
0
-753
0
291
0
0
0
210
0
0
0
6,226
0
0
6,425
0
0
7,577
0
0
6,777
0
0
6,226
6,425
7,577
6,777
U.S. TREASURY SECURITIES
More than 10 years
Gross purchases
Gross sales
Maturity shift
Exchanges
All maturities
Gross purchases
Gross sales
Redemptions
Net change in U.S. Treasury securities
Statistical Tables 277
2.—Continued
May
June
July
Aug.
3,524
0
70,978
70,978
0
3,656
0
53,015
53,015
0
4,838
0
45,828
45,828
0
529
0
63,083
63,083
0
2,826
0
6,714
-9,031
0
0
0
0
0
0
1,104
0
11,052
-14,183
0
1,439
0
-1,620
8,639
0
0
0
0
259
0
-5,094
391
Sept.
Oct.
Nov.
Dec.
Total
750
0
53,314
53,314
0
0
0
62,947
62,947
0
250
0
51,394
51,394
0
0
0
53,374
53,374
0
21,421
0
657,931
657,931
0
445
0
8,987
-5,040
0
1,286
0
11,174
-15,189
0
0
0
6,143
-5,435
0
0
0
3,688
-1,419
0
0
0
0
0
0
12,720
0
0
0
0
1,755
0
-11,052
13,283
1,921
0
-629
3,396
0
0
-11,174
15,189
0
0
-6,143
5,435
0
0
-2,380
1,308
339
0
0
0
12,748
0
0
0
542
0
0
0
577
0
0
900
690
0
-6,714
1,645
51
0
0
0
0
0
0
0
0
0
722
111
314
0
0
0
5,074
0
0
0
0
0
0
0
0
0
0
0
63
0
0
0
80
0
-1,645
0
0
0
0
0
0
0
0
0
0
0
-2,030
0
0
0
0
0
2,280
0
0
0
8,048
0
0
4,198
0
0
8,336
0
0
3,665
0
0
2,087
0
0
0
0
0
250
0
0
653
0
0
54,242
0
0
8,048
4,198
8,336
3,665
2,087
0
250
653
54,242
278
89th Annual Report, 2002
2. Federal Reserve Open Market Transactions, 2002—Continued
Millions of dollars
Jan.
Feb.
Repurchase agreementsx
Gross purchases
Gross sales
118,550
131,300
101,749
104,750
70,850
75,849
102,200
100,200
Matched sale-purchase agreements
Gross purchases
Gross sales
407,791
404,296
367,906
368,060
393,273
393,151
436,936
437,881
0
0
0
0
0
0
0
0
-9,255
-3,155
^,877
1,056
-3,030
3,270
2,700
7,833
Type of security and transaction
Mar.
Apr.
FEDERAL AGENCY OBLIGATIONS
Outright transactions
Gross purchases
Gross sales
Redemptions
Net change in agency obligations
TEMPORARY TRANSACTIONS
Reverse repurchase agreements2
Gross purchases
Gross sales
Net change in temporary transactions
Total net change in System Open Market Account.
NOTE. Sales, redemptions, and negative figures reduce
holdings of the System Open Market Account; all other
figures increase such holdings. Components may not sum
to totals because of rounding.
1. Cash value of agreements, which are collateralized
by U.S. government and federal agency securities.
2. Cash value of agreements, which are collateralized
by U.S. Treasury securities.
Statistical Tables 279
2.—Continued
May
June
July
Sept.
Aug.
Nov.
Oct.
Dec.
Total
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
106,426
109,926
98,850
94,850
68,750
81,250
84,000
80,500
93,500
94,750
72,000
77,250
113,501
101,501
112,750
101,750
1,143,126
1,153,876
466,807
469,046
447,555
448,330
513,400
511,902
495,729
497,031
449,250
449,986
429,029
425,399
378,381
377,535
195,565
175,820
4,981,624
4,958,437
0
0
0
0
0
0
0
0
0
0
0
0
0
0
231,272
252,363
231,272
252,363
-5,738
3,225
-11,002
2,198
-1,986
-1,620
12,847
9,654
-8,654
2,310
7,423
-2,666
5,863
101
-1,620
13,096
10^07
45,588
280
89th Annual Report, 2002
3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities,
December 31, 2000-02
Millions of dollars
December 31
Change
Description
2002
2001
2000
2001 to
2002
2000 to
2001
629,406
574363
532,815
54,543
42,048
153,311
73,372
136,695
68,567
130,710
69,143
16,616
4,805
5,985
-576
96,827
172,758
53,300
79,840
83,785
153,158
53,338
79,320
73,812
132,792
55,461
70,896
13,042
19,600
-38
520
9,973
20,366
-2,123
8,424
226,682
297,893
104,832
205,262
265,941
103,660
199,854
240,177
92,784
21,420
31,952
1,172
5,408
25,764
10,876
Held outright1
10
10
130
By remaining maturity
1 year or less
More than 1 year through 5 years
More than 5 years through 10 years
More than 10 years
10
0
0
0
0
10
0
0
0
130
0
0
By issuer
Federal Home Loan Banks
Federal National Mortgage Association
0
10
0
10
0
130
39,500
50,250
43,375
-10,750
6,875
23,188
0
21,112
0
-23,188
0
2,076
0
U.S. TREASURY SECURITIES
Held outright1
By remaining maturity
Bills
1-90 days
91 days to 1 year
Notes and bonds
1 year or less
More than 1 year through 5 years
More than 5 years through 10 years
More than 10 years
By type
Bills
Notes
Bonds
FEDERAL AGENCY SECURITIES
-120
10
-10
0
0
0
-120
0
0
0
-120
TEMPORARY TRANSACTIONS
Repurchase agreements2
Matched sale-purchase agreements
Foreign official and international accounts
Dealers
Reverse repurchase agreements3
Foreign official and international accounts
Dealers
NOTE. Components may not sum to totals because of
rounding.
1. Excludes the effects of temporary transactions—
repurchase agreements and matched sale-purchase agreements (MSPs).
21,091
0
21,091
0
2. Cash value of agreements, which are coUateralized
by U.S. government and federal agency securities.
3. Cash value of agreements, which are collateralized
by U.S. Treasury securities.
Statistical Tables 281
4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks,
December 31, 2002
President
Federal Reserve
Bank (including
Branches)
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco . . .
Federal Reserve
Information
Technology .
Office of
Employee
Benefits . . . .
Total
Other officers
Employees
Total
Number
Salary
(dollars)1
247,500
313,300
224,300
244,500
242,400
267,900
272,700
228,7002
254,100
248,600
240,200
327,800
Number
Salaries
(dollars)1
Fulltime
Parttime
Salaries
(dollars)1
Number
Salaries
(dollars)1
74
260
57
55
90
92
95
75
42
71
55
76
10,151,114
42,919,160
7,533,500
7,015,525
11,104,700
12,117,100
12,630,586
8,874,497
5,587,900
8,993,500
6,767,400
11,444,250
1,111
2,896
1,120
1,317
1,894
1,981
1,943
1,172
1,163
1,544
1,340
2,125
152
65
50
43
93
33
72
76
120
58
67
44
63,320,113
183,014,637
51,228,840
57,433,719
88,778,343
84,533,525
104,536,952
51,492,774
54,199,997
71,205,673
60,871,423
121,423,179
1,338
3,222
1,228
1,416
2,078
2,107
2,111
1,324
1,326
1,674
1,463
2,246
73,718,727
226,247,097
58,986,640
64,693,744
100,125,443
96,918,525
117,440,238
60,595,971
60,041,997
80,447,773
67,879,023
133,195,229
0
29
3,981,500
694
9
49,766,522
732
53,748,022
0
6
1,117,250
26
0
1,870,401
32
2,987,651
3,112,000
1,077
150,237,982
20,326
882
1,043,676,098
22,297
1,197,026,080
1. Annualized salary liability based on salaries in effect
on December 31, 2002.
2. The annualized salary for the President of the Federal Reserve Bank of St. Louis was reported incorrectly
as $218,000 in table 4 of the 2001 Annual Report. The
correct annualized salary was $218,600.
282
89th Annual Report, 2002
5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002
Thousands of dollars
Item
Total
Boston
New York
Philadelphia
Cleveland
CURRENT INCOME
Loans
U.S. Treasury and federal
agency securities
Foreign currencies
Priced services
Other
2,197
33
47
25,524,901
271,904
916,252
44,860
1,458,648
15,409
53,983
1,190
10,397,780
55,833
100,154
27,125
984,126
8,247
45,672
1,409,402
24,242
66,456
1,552
Total
26,760,113
1,529,263
10,580,938
1,038,932
1,501,865
1,342,260
363,660
-155,062
67,352
57,719
110,683
79,730
38,401
170
4,244
2,555
4,391
252,819
123,407
-156,844
5,621
6,515
11,735
65,558
23,909
120
1,250
2,012
2,645
68,413
25,904
167
3,789
3,696
10,361
85,830
14,143
52,155
1,841
2,233
3,000
4,747
1,952
8,986
1,537
361
3,475
2,129
718
3,085
29,310
78,985
30,892
37,033
31,984
4,739
4,698
2,628
802
945
4,391
13,638
5,495
13,441
5,869
1,556
3,223
2,523
320
1,433
-451
6,325
2,058
394
2,790
Equipment
Purchases
Rentals
Depreciation
Repairs and maintenance
26,284
35,723
107,661
93,156
2,108
1,252
5,098
6,151
3,384
1,834
15,564
9,554
1,305
748
5,279
5,203
1,407
307
5,113
5,976
Earnings-credit costs
Other
Recoveries
Expenses capitalized2
155,939
67,230
-77,915
-18,950
10,518
4,138
-12,948
-758
50,293
12,231
-8,927
-4,795
8,416
3,099
-2,692
-735
12,214
3,698
-2,614
-1,163
2,536,073
-308,995
2,227,078
165,934
-25,357
140,578
380,911
-69,250
311,661
130,546
-20,049
110,498
154,315
-25,606
128,709
213
CURRENT EXPENSES
Salaries and other personnel
expenses
Retirement and other benefits
Net periodic pension costs1 .
Fees
Travel
Software expenses
Postage and other shipping
costs
Communications
Materials and supplies
Building expenses
Taxes on real estate
Property depreciation
Utilities
Rent
Other
Total
Reimbursements
Net expenses
For notes see end of table.
Statistical Tables 283
5.—Continued
Chicago
St. Louis
111
579
303
532
202
69
90
1,833,772
65,150
80,322
2,212
1,772,097
19,780
125,385
1,767
2,926,105
29,094
107,553
3,876
896,686
5,515
52,560
963
306,580
5,825
53,126
321
751,643
7,070
70,427
601
529,587
6,158
62,663
555
2,258,474
29,581
97,952
3,819
1,981,467
1,919,140
3,067,208
956,026
366,384
829,944
599,031
2,389,915
171,467
-139,475
245
25,485
7,700
43,704
124,472
44,305
164
6,844
6,779
5,061
125,025
45,324
142
6,564
6,027
11,643
65,440
39,423
142
794
2,966
4,181
63,947
35,902
130
6,289
3,969
2,747
90,381
38,514
158
1,588
4,183
3,284
76,707
33,243
135
1,663
3,300
3,950
158,300
54,803
211
3,220
8,018
6,979
3,713
1,526
6,163
47,709
1,186
5,805
4,458
1,806
4,962
2,845
907
3,410
3,021
721
1,786
4,329
727
3,202
2,483
919
3,544
7,016
1,087
4,736
1,918
7,095
2,898
14,353
3,740
3,892
10,074
2,726
890
3,138
2,833
6,597
2,347
2,743
5,271
383
4,288
1,612
1,028
999
3,790
4,161
1,677
142
1,464
603
4,014
1,321
1,471
764
2,502
5,967
2,190
1,272
2,662
3,153
8,905
3,419
178
2,909
3,725
27,637
29,373
18,819
2,618
858
10,193
11,976
2,732
896
7,669
9,473
1,548
196
4,575
3,911
1,546
764
3,915
3,540
1,617
235
6,007
3,362
1,633
238
4,366
5,190
2,662
759
10,509
10,000
20,328
9,536
-26,858
-3,156
6,806
6,477
-3,598
-1,256
19,946
7,340
-5,521
-701
3,392
3,293
-1,735
-665
3,575
3,076
-807
-549
5,469
4,254
-1,534
-1,528
3,689
4,051
-6,203
-531
11,294
6,038
^,478
-3,113
229,936
-36,300
193,637
297,117
-13,223
283,894
267,575
-11,282
256,293
142,934
-38,277
104,657
144,808
-22,468
122,340
172,421
-15,959
156,462
152,970
-11,610
141,361
296,605
-19,617
276,988
Richmond
Atlanta
Minneapolis Kansas City
Dallas
San Francisco
284
89th Annual Report, 2002
5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002—Continued
Thousands of dollars
Item
Total
Boston
New York
Philadelphia
Cleveland
24,533,035
1,388,686
10,269,277
928,434
1,373,156
76,527
4,512
30,852
3,063
4,377
2,082,516
3,484
2,162,527
119,799
4
124,315
424,785
3,235
458,872
62,129
1
65,194
193,518
3
197,899
0
0
0
0
0
0
0
0
0
0
-13,068
-118
-749
0
-749
-5,144
-82
-5,225
-503
-2
-504
-721
-2
-724
123,566
453,647
64,689
197,175
13
205,111
429,568
11,443
22,487
42,920
177,353
6,098
15,310
18,179
21,611
26,047,684
1,478,321
10,502,637
971,716
1,530,542
483,596
25,830
103,843
13,810
41,266
24,495,490
1,434,682
10,093,923
946,441
1,451,626
PROFIT AND LOSS
Current net income
Additions to and deductions
from (-) current net income3
Profits on sales of U.S. Treasury
and federal agency
securities
Profits on foreign exchange
transactions
Other additions
Total additions
Losses on sales of U.S. Treasury
and federal agency
securities
Losses on foreign exchange
transactions
Interest expense on reverse
repurchase agreements
Other deductions
Total deductions
Net addition to or
deduction from (-)
current net income
Cost of unreimbursed Treasury
services
Assessments by Board
Board expenditures4
Cost of currency
Net income before payment to
U.S. Treasury
Dividends paid
Payments to U.S. Treasury
(interest on Federal
Reserve notes)
-13,186
2,149,341
Transferred to/from surplus
1,068,598
17,809
304,871
11,465
37,650
Surplus, January 1
Surplus, December 31
7,311,522
8,380,120
418,391
436,200
1,504,031
1,808,902
221,361
232,826
664,687
702,337
NOTE. Components may not sum to totals because of
rounding.
1. Reflects the effect of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions (SFAS
87). The System Retirement Plan for employees is
recorded on behalf of the System on the books of the
Federal Reserve Bank of New York, resulting in a
reduction in expenses of $157,159 thousand. The Benefit
Equalization Retirement Plan and the Supplemental
Employees Retirement Plan are recorded by each Federal
Reserve Bank.
2. Includes expenses for labor and materials capitalized and depreciated or amortized as charges to activities
in the periods benefited.
3. Includes reimbursement from the U.S. Treasury for
uncut sheets of Federal Reserve notes, gains and losses on
the sale of Reserve Bank buildings, counterfeit currency
that is not charged back to the depositing institution, and
stale Reserve Bank checks that are written off.
4. For additional details, see the chapter "Board of
Governors Financial Statements."
Statistical Tables 285
5.—Continued
Richmond
Atlanta
Chicago
St. Louis
Minneapolis Kansas City
Dallas
San Francisco
1,787,830
1,635,246
2,810,915
851,369
244,044
673,481
457,671
2,112,927
5,134
5,332
8,804
2,744
624
2,322
1,513
7,250
497,533
5
502,671
151,846
69
157,247
228,679
10
237,493
42,341
0
45,085
38,067
21
38,713
54,179
8
56,509
45,396
21
46,930
224,243
106
231,599
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
-1,020
-8
-1,028
-926
-13
-938
-1,538
-1
-1,540
-465
-1
^66
-204
-1
-205
-386
-2
-388
-290
-4
-294
-1,122
-1
-1,123
501,643
156,308
235,953
44,619
38,507
56,121
46,636
230,477
0
0
0
0
0
0
0
0
49,899
31,701
14,135
32,022
21,687
48,058
4,401
15,044
4,786
9,848
5,221
11,929
4,488
9,828
21,854
34,378
2,207,873
1,745,398
2,977,124
876,542
267,918
712,452
489,990
2,287,171
120,193
27,873
49,156
11,179
18,777
11,785
10,372
49,511
1,771,878
1,776,865
2,863,517
815,379
27,580
690,973
457,352
2,165,275
315,802
-59,340
64,451
49,984
221,561
9,694
22,267
72,386
1,757,409
2,073,211
534,584
475,244
793,150
857,601
149,052
199,035
118,076
339,637
190,959
200,652
164,015
186,282
795,807
868,193
286
89th Annual Report, 2002
6. Income and Expenses of the Federal Reserve Banks, 1914-2002
Thousands of dollars
Federal Reserve Bank
and period
Current
income
Net
expenses
Net additions
or
deductions (-) 1
Assessments by
Board of Governors
Board
expenditures
Costs
of currency
All Banks
1914-15 .
1916
1917
1918
1919
2,173
5,218
16,128
67,584
102,381
2,018
2,082
4,922
10,577
18,745
6
-193
-1,387
-3,909
^,673
302
192
238
383
595
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
181,297
122,866
50,499
50,709
38,340
41,801
47,600
43,024
64,053
70,955
27,549
33,722
28,837
29,062
27,768
26,819
24,914
24,894
25,401
25,810
-3,744
-6,315
-4,442
-8,233
-6,191
-4,823
-3,638
-2,457
-5,026
-4,862
710
741
723
703
663
709
722
779
698
782
1,714
1,845
806
3,099
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
36,424
29,701
50,019
49,487
48,903
42,752
37,901
41,233
36,261
38,501
25,358
24,843
24,457
25,918
26,844
28,695
26,016
25,295
25,557
25,669
-93
311
-1,413
-12,307
-4,430
-1,737
486
-1,631
2,232
2,390
810
719
729
800
1,372
1,406
1,680
1,748
1,725
1,621
2,176
1,479
1,106
2,505
1,026
1,477
2,178
1,757
1,630
1,356
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
43,538
41,380
52,663
69,306
104,392
142,210
150,385
158,656
304,161
316,537
25,951
28,536
32,051
35,794
39,659
41,666
50,493
58,191
64,280
67,931
11,488
721
-1,568
23,768
3,222
-830
-626
1,973
-34,318
-12,122
1,704
1,840
1,746
2,416
2,296
2,341
2,260
2,640
3,244
3,243
1,511
2,588
4,826
5,336
7,220
4,710
4,482
4,562
5,186
6,304
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
275,839
394,656
456,060
513,037
438,486
412,488
595,649
763,348
742,068
886,226
69,822
83,793
92,051
98,493
99,068
101,159
110,240
117,932
125,831
131,848
36,294
-2,128
1,584
-1,059
-134
-265
-23
-7,141
124
98,247
3,434
4,095
4,122
4,100
4,175
4,194
5,340
7,508
5,917
6,471
7,316
7,581
8,521
10,922
6,490
4,707
5,603
6,374
5,973
6,384
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1,103,385
941,648
1,048,508
1,151,120
1,343,747
1,559,484
1,908,500
2,190,404
2,764,446
3,373,361
139,894
148,254
161,451
169,638
171,511
172,111
178,212
190,561
207,678
237,828
13,875
3,482
-56
615
726
1,022
996
2,094
8,520
-558
6,534
6,265
6,655
7,573
8,655
8,576
9,022
10,770
14,198
15,020
7,455
6,756
8,030
10,063
17,230
23,603
20,167
18,790
20,474
22,126
For notes see end of table.
Statistical Tables 287
6.—Continued
Payments to U.S. Treasury
Dividends
paid
Tra n sfprrpd
Tra n ^fPTTPH
to surplus
(section 13b)
to surplus
(section 7)
Jl lullalClICU
Interest on
Federal Reserve
notes
Statutory
transfers 2
1 IdllolCilCU
217
1,743
6,804
5,541
5,012
1,134
'.'.'.
2,704
'. '. '.
5.654
6,120
6,307
6,553
6,682
6,916
7,329
7,755
8,458
9,584
60,725
59,974
10,851
3,613
114
59
818
250
2,585
4,283
82,916
15,993
-660
2,546
-3,078
2,474
8,464
5,044
21,079
22,536
10,269
10,030
9,282
8,874
8,782
8,505
7,830
7,941
8,019
8,110
17
-2,298
-7,058
11,021
-917
6,510
607
353
2,616
1,862
4,534
8,215
8,430
8,669
8,911
9,500
10,183
10,962
11,523
11,920
12,329
2,011
' 298
227
177
120
25
82
141
198
245
327
248
67
36
'.
'.
' iJ34
48,334
70,652
. '.
'.
.
75,284
166,690
193,146
-60
28
103
67
-419
-426
-54
-4
50
135
201
262
28
87
17,617
571
3,554
40,327
48,410
81,970
81,467
8,366
18,523
21,462
13,083
13,865
14,682
15,558
16,442
17,712
18,905
20,081
21,197
22,722
196,629
254,874
291,935
342,568
276,289
251,741
401,556
542,708
524,059
910,650
21,849
28,321
46,334
40,337
35,888
32,710
53,983
61,604
59,215
-93,601
23,948
25,570
27,412
28,912
30,782
32,352
33,696
35,027
36,959
39,237
896,816
687,393
799,366
879,685
1,582,119
1,296,810
1,649,455
1,907,498
2,463,629
3,019,161
42,613
70,892
45,538
55,864
-465,823
27,054
18,944
29,851
30,027
39,432
288
89th Annual Report, 2002
6. Income and Expenses of the Federal Reserve Banks, 1914-2002—Continued
Thousands of dollars
Federal Reserve Bank
and period
Current
income
Net
expenses
Net additions
or
deductions (-) 1
Assessments by
Board of Governors
Board
expenditures
Costs
of currency
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
3,877,218
3,723,370
3,792,335
5,016,769
6,280,091
6,257,937
6,623,220
6,891,317
8,455,309
10,310,148
276,572
319,608
347,917
416,879
476,235
514,359
558,129
568,851
592,558
625,168
11,442
94,266
^9,616
-80,653
-78,487
-202,370
7,311
-177,033
-633,123
-151,148
21,228
32,634
35,234
44,412
41,117
33,577
41,828
47,366
53,322
50,530
23,574
24,943
31,455
33,826
30,190
37,130
48,819
55,008
60,059
68,391
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
12,802,319
15,508,350
16,517,385
16,068,362
18,068,821
18,131,983
17,464,528
17,633,012
19,526,431
22,249,276
718,033
814,190
926,034
1,023,678
1,102,444
1,127,744
1,156,868
1,146,911
1,205,960
1,332,161
-115,386
-372,879
-68,833
-400,366
-412,943
1,301,624
1,975,893
1,796,594
-516,910
1,254,613
62,231
63,163
61,813
71,551
82,116
77,378
97,338
81,870
84,411
89,580
73,124
82,924
98,441
152,135
162,606
173,739
180,780
170,675
164,245
175,044
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
23,476,604
22,553,002
20,235,028
18,914,251
20,910,742
25,395,148
25,164,303
26,917,213
28,149,477
29,346,836
1,349,726
1,429,322
1,474,531
1,657,800
1,795,328
1,818,416
1,947,861
1,976,453
1,833,436
1,852,162
2,099,328
405,729
-987,788
-230,268
2,363,862
857,788
-1,676,716
-2,611,570
1,906,037
-533,557
103,752
109,631
128,955
140,466
146,866
161,348
162,642
174,407
178,009
213,790
193,007
261,316
295,401
355,947
368,187
370,203
402,517
364,454
408,544
484,959
2000
2001
2002
33,963,992
31,870,721
26,760,113
1,971,688
2,084,708
2,227,078
-1,500,027
-1,117,435
2,149,328
188,067
295,056
205,111
435,838
338,537
429,568
Total, 1914-2002
594,417,190
42,492,506
4,378,548
3,568,694
6,851,034
Aggregate for each Bank,
1914-2002
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
32,275,936
202,526,500
22,370,492
37,468,955
46,000,087
30,459,421
74,551,863
20,723,931
9,732,977
22,223,280
27,466,412
68,617,336
160,569
1,460,696
105,590
236,225
144,329
358,501
572,925
74,585
74,234
125,301
402,746
662,846
145,739
882,397
153,563
249,593
394,978
284,947
428,964
92,904
107,309
127,656
201,661
498,980
394,515
2,331,851
265,160
412,717
567,281
412,472
810,225
253,781
107,030
252,836
298,097
745,068
Total
594,417,190
4,378,548
3,568,694
6,851,034
2,857,036 4
6,360,769
2,329,674
2,702,150
3,766,672
4,335,205
5,448,459
2,188,134
2,068,590
2,774,287
2,780,416
4,881,114
42,492,506
NOTE. Components may not sum to totals because of
rounding.
. . . Not applicable.
1. For 1987 and subsequent years, includes the cost of
services provided to the Treasury by Federal Reserve
Banks for which reimbursement was not received.
2. Represents transfers made as a franchise tax from
1917 through 1932; transfers made under section 13b of
the Federal Reserve Act from 1935 through 1947; and
transfers made under section 7 of the Federal Reserve Act
for 1996 and 1997.
Statistical Tables 289
6.—Continued
Payments to U.S. Treasury
Dividends
Statutory
transfers2
Interest on
Federal Reserve
notes
to surplus
(section 13b)
Transferred
to surplus
(section 7)
41,137
43,488
46,184
49,140
52,580
54,610
57,351
60,182
63,280
67,194
3,493,571
3,356,560
3,231,268
4,340,680
5,549,999
5,382,064
5,870,463
5,937,148
7,005,779
9,278,576
32,580
40,403
50,661
51,178
51,483
33,828
53,940
45,728
47,268
69,141
70,355
74,574
79,352
85,152
92,620
103,029
109,588
117,499
125,616
129,885
11,706,370
14,023,723
15,204,591
14,228,816
16,054,095
17,796,464
17,803,895
17,738,880
17,364,319
21,646,417
56,821
76,897
78,320
106,663
161,996
155,253
91,954
173,771
64,971
130,802
140,758
152,553
171,763
195,422
212,090
230,527
255,884
299,652
343,014
373,579
5,5l'7,*716
20,658,972
17,785,942
0
23,608,398
20,777,552
16,774,477
15,986,765
20,470,011
23,389,367
14,565,624
0
8,774,994
25,409,736
180,292
228,356
402,114
347,583
282,122
283,075
635,343
831,705
731,575
479,053
409,614
428,183
483,596
0
0
0
25,343,892
27,089,222
24,495,490
4,114,865
517,580
1,068,598
5,986,552
44,113,958
483,309,206
-4
258,431
1,488,080
264,879
433,911
715,222
452,324
703,616
156,577
189,630
207,085
311,869
804,928
2,579,504
17,307,161
1,312,118
2,827,043
3,083,928
2,713,230
4,593,811
1,833,837
416,227
1,249,703
1,510,802
4,686,594
25,577,909
172,945,225
17,775,458
30,091,201
34,535,320
21,850,351
61,904,183
15,971,723
6,432,657
17,419,748
22,440,242
56,365,188
135
-433
291
-10
-72
5
12
-27
65
-9
55
-17
5,986,552
44,113,958
483309,206
-4
3. The $12,473,792 thousand transferred to surplus
was reduced by direct charges of $500 thousand for
charge-off on Bank premises (1927), $139,300 thousand
for contributions to capital of the Federal Deposit Insurance Corporation (1934), $4 thousand net upon elimination of section 13b surplus (1958), and $106,000 thousand (1996), $107,000 thousand (1997), and
Digitized$3,752,000
for FRASER
thousand (2000) transferred to the Treasury
12,473,792 3
623,235
2,672,148
374,939
988,575
3,081,086
769,388
1,235,517
301,585
485,704
317,276
326,015
1,298,326
12,473,7923
as statutorily required; and was increased by transfer of
$11,131 thousand from reserves for contingencies (1955),
leaving a balance of $8,380,120 thousand on December 31, 2002.
4. This amount is reduced $2,653,914 thousand, which
is related to the System Retirement Plan. See note 1,
table 5.
290
89th Annual Report, 2002
7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks
and Branches, December 31, 2002
Thousands of dollars
Acquisition costs
Federal Reserve
Bank or
Branch
Land
Buildings
(including
vaults)1
Building machinery and
equipment
Total
2
Net
book
value
BOSTON
22,074
102,508
17,448
142,030
91,350
NEW YORK
19,853
198,609
5,113
49,615
3,662
268,077
9,663
180,477
4,829
2,561
67,471
10,783
80,814
49,590
Buffalo
PHILADELPHIA .
CLEVELAND
Cincinnati
Pittsburgh
RICHMOND
Baltimore
Charlotte
3,112
2,247
1,658
118,732
19,190
14,092
23,275
9,652
11,753
145,118
31,089
27,503
118,565
14,244
19,743
10,051
6,482
3,130
68,019
27,271
28,233
35,797
4,929
4,891
113,868
38,682
36,254
79,932
23,536
25,749
ATLANTA
Birmingham
Jacksonville
Miami
Nashville
New Orleans
22,770
7,110
1,730
3,746
629
3,776
148,994
45,481
18,489
15,013
3,673
8,489
15,571
3,239
3,011
3,876
3,197
4,320
187,335
55,830
23,231
22,635
7,498
16,584
181,488
53,262
16,118
14,132
3,743
10,617
CHICAGO
Detroit
4,994
4,565
132,171
8,945
17,734
3,814
154,900
17,325
102,980
12,743
ST. LOUIS
Little Rock
Louisville
Memphis
700
1,148
800
1,136
30,497
7,278
4,761
7,783
9,021
2,982
2,068
4,151
40,218
11,408
7,629
13,069
22,337
8,834
4,309
8,895
MINNEAPOLIS ..
Helena
14,581
2,621
103,282
9,640
13,494
937
131,358
13,198
116,293
10,447
KANSAS CITY ..
Denver
Oklahoma City . . .
Omaha
2,416
3,188
646
6,535
20,848
8,798
11,328
12,080
9,404
5,068
3,493
2,359
32,668
17,054
15,467
20,974
15,102
9,917
8,904
16,388
DALLAS
El Paso
Houston
San Antonio
29,049
262
0
482
107,984
3,476
7,145
7,584
20,375
1,018
0
2,825
157,408
4,756
7,145
10,892
124,835
2,503
7,145
7,192
SAN FRANCISCO
15,600
4,981
2,884
495
380
89,732
67,489
12,199
9,546
13,220
19,536
11,429
3,251
2,113
4,699
124,868
83,899
18,334
12,154
18,298
80,569
60,048
13,886
8,867
12,867
209,278
1,565,166
344,790
2,119,234
1,542,435
Los Angeles
Portland
Salt Lake City ....
Seattle
Total
NOTE. Components may not sum to totals because of
rounding.
1. Includes expenditures for construction at some
offices, pending allocation to appropriate accounts.
2. Excludes charge-offs of $17,699 thousand before
1952.
Other
real
estate 3
48
26,667
26,716
3. Covers acquisitions for banking-house purposes and
Bank premises formerly occupied and being held pending
sale.
. . . Not applicable.
Statistical Tables 291
8. Operations in Principal Departments of the Federal Reserve Banks, 1999-2002
Operation
2002
Millions of pieces (except as noted)
Currency processed
Currency destroyed
Coin received'
Checks handled
U.S. government checks
Postal money orders
Other
Government securities transfers
Transfer of funds
Automated clearinghouse transactions
Commercial
Government
Food stamps redeemed
Millions of dollars
Currency processed
Currency destroyed
Coin received1
Checks handled
U.S. government checks
Postal money orders
Other
Government securities transfers
Transfer of funds
Automated clearinghouse transactions
Commercial
Government
Food stamps redeemed
2000
1999
34,208
8,363
4,621
33,740
7,850
6,321
31,505
8,179
5,138
29,032
7,257
6,719
289
216
16,587
17
115
346
229
16,905
15
112
262
230
16,994
14
108
288
226
17,075
13
103
4,986
883
500
4,448
900
587
3,812
838
686
3,344
809
1,158
565,302
92,511
602
540,746
86,298
767
542,567
112,164
666
444,234
82,951
778
307,627
30,161
15,033,298
228,907,121
405,761,750
333,849
30,461
14,853,072
212^43,034
423,606,365
282,791
30,036
13,849,084
188,133,178
379,756,389
306,077
29,118
13,788,037
179,486,282
343,381,658
13,135,350
2,711,384
2,543
12,707,247
2,528,562
2,989
11,619,954
2,404,491
3,414
10,862,424
2,233,279
6,221
NOTE. Amounts in bold are restatements due to errors
in previously reported data.
2001
1. Does not include coin activity at Federal Reserve
off-site coin terminals.
292
89th Annual Report, 2002
9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions,
December 31, 2002
Extended credit3
Reserve Bank
All Federal Reserve Banks
Adjustment
credit1
Seasonal
credit2
0.75
1.30
1. Adjustment credit is available on a short-term basis
to help depository institutions meet temporary needs for
funds that cannot be met through reasonable alternative
sources. Adjustment credit is usually provided at the
basic discount rate, but under certain circumstances a
special rate or rates above the basic discount rate may be
applied. Effective January 9, 2003, the adjustment credit
program will be discontinued.
2. Seasonal credit is available to help smaller depository institutions meet regular seasonal needs for funds
that cannot be met through special industry lenders and
that arise from a combination of expected patterns of
movement in their deposits and loans. The discount rate
on seasonal credit takes into account rates on market
sources of funds and ordinarily is reestablished on the
first business day of each two-week reserve maintenance
period; however, it is never lower than the discount rate
applicable to adjustment credit. Until January 9,2003, see
section 201.3(b) of Regulation A. Effective January 9,
2003, see section 201.4(c) of Regulation A.
First thirty
days of
borrowing
After thirty
days of
borrowing
0.75
1.80
3. Extended credit is available to depository institutions
if similar assistance is not reasonably available from other
sources, when exceptional circumstances or practices
involve only a particular institution, or when an institution is experiencing difficulties adjusting to changing
market conditions over a longer period of time.
Extended-credit loans outstanding more than thirty
days will be charged a flexible rate somewhat above rates
on market sources of funds; the rate will always be at
least 50 basis points above the discount rate applicable to
adjustment credit. The flexible rate is reestablished on the
first business day of each two-week reserve maintenance
period. At the discretion of the Federal Reserve Bank, the
flexible rate may be charged on extended-credit loans that
are outstanding less than thirty days. Effective January 9,
2003, the extended credit program will be discontinued.
Statistical Tables 293
10. Reserve Requirements of Depository Institutions, December 31, 2002
Requirements
Type of deposit
Net transaction accounts'
$0 million-$6 million2
More than $6 million-$42.1 million3
More than $42.1 million4
Percentage of deposits
Effective date
0
3
10
12-26-02
12-26-02
12-26-02
Nonpersonal time deposits5
0
12-27-90
Eurocurrency liabilities6
0
12-27-90
NOTE. Required reserves must be held in the form of
deposits with Federal Reserve Banks or vault cash. Nonmember institutions may maintain reserve balances with a
Federal Reserve Bank indirectly, on a pass-through basis,
with certain approved institutions. For previous reserve
requirements, see earlier editions of the Annual Report or
the Federal Reserve Bulletin. Under the Monetary Control Act of 1980, depository institutions include commercial banks, savings banks, savings and loan associations,
credit unions, agencies and branches of foreign banks,
and Edge Act corporations.
1. Transaction accounts include all deposits against
which the account holder is permitted to make withdrawals by negotiable or transferable instruments, payment
orders of withdrawal, or telephone or preauthorized transfers for the purpose of making payments to third persons
or others. However, accounts subject to the rules that
permit no more than six preauthorized, automatic, or
other transfers per month (of which no more than three
may be by check, draft, debit card, or similar order
payable directly to third parties) are savings deposits, not
transaction accounts.
2. Under the Garn-St Germain Depository Institutions
Act of 1982, the Board adjusts the amount of reservable
liabilities subject to a zero percent reserve requirement
each year for the succeeding calendar year by 80 percent
of the percentage increase in the total reservable liabilities
of all depository institutions, measured on an annual basis
as of June 30. No corresponding adjustment is made in
the event of a decrease. The exemption applies only to
accounts that would be subject to a 3 percent reserve
requirement. Effective with the reserve maintenance
period beginning December 26, 2002, for depository
institutions that report weekly, and with the reserve maintenance period beginning January 16, 2003, for institu-
tions that report quarterly, the exemption was raised from
$5.7 million to $6.0 million.
3. The Monetary Control Act of 1980 requires that the
amount of transaction accounts against which the 3 percent reserve requirement applies be modified annually by
80 percent of the percentage change in transaction
accounts held by all depository institutions, determined as
of June 30 each year. Effective with the reserve maintenance period beginning December 26, 2002, for depository institutions that report weekly, and with the reserve
maintenance period beginning January 16, 2003, for institutions that report quarterly, the amount was increased
from $41.3 million to $42.1 million.
4. The reserve requirement was reduced from 12 percent to 10 percent on April 2, 1992, for institutions that
report weekly, and on April 16, 1992, for institutions that
report quarterly.
5. For institutions that report weekly, the reserve requirement on nonpersonal time deposits with an original
maturity of less than 1.5 years was reduced from 3 percent to 1.5 percent for the maintenance period that began
December 13, 1990, and to zero for the maintenance
period that began December 27, 1990. For institutions
that report quarterly, the reserve requirement on nonpersonal time deposits with an original maturity of less than
1.5 years was reduced from 3 percent to zero on January 17, 1991.
The reserve requirement on nonpersonal time deposits
with an original maturity of 1.5 years or more has been
zero since October 6, 1983.
6. The reserve requirement on eurocurrency liabilities
was reduced from 3 percent to zero in the same manner
and on the same dates as the reserve requirement on
nonpersonal time deposits with an original maturity of
less than 1.5 years (see note 5).
294
89th Annual Report, 2002
11. Initial Margin Requirements under Regulations T, U, and X
Percent of market value
Effective date
1934, Oct. 1
1936, Feb. 1
Apr. 1
1937, Nov. 1
1945, Feb. 5
July 5
1946, Jan. 21 .
1947, Feb. 21
1949, Mar. 3
1951, Jan. 17
1953, Feb. 20
1955, Jan. 4 .
Apr. 23
1958, Jan. 16
Aug. 5
Oct. 16
1960, July 28
1962, July 10
1963, Nov. 6
1968, Mar. 11
June 8
1970, May 6
1971, Dec. 6
1972, Nov. 24
1974, Jan. 3 .
Margin
stocks
25-45
25-55
55
40
50
75
100
75
50
75
50
60
70
50
70
90
70
50
70
70
80
65
55
65
50
NOTE. These regulations, adopted by the Board of
Governors pursuant to the Securities Exchange Act of
1934, limit the amount of credit to purchase and carry
"margin securities" (as defined in the regulations) when
such value is collateralized by securities. Margin requirements on securities are the difference between the market
value (100 percent) and the maximum loan value of
collateral as prescribed by the Board. Regulation T was
Convertible
bonds
Short sales
Tonly 1
50
60
50
50
50
50
50
50
75
100
75
50
75
50
60
70
50
70
90
70
50
70
70
80
65
55
65
50
adopted effective October 15, 1934; Regulation U, effective May 1, 1936; and Regulation X, effective November 1,1971. The former Regulation G, which was adopted
effective March 11, 1968, was merged with Regulation U,
effective April 1, 1998.
1. From October 1, 1934, to October 31, 1937, the
requirement was the margin "customarily required" by
the brokers and dealers.
Statistical Tables 295
12. Principal Assets and Liabilities and Number of Insured Commercial Banks
in the United States, by Class of Bank, June 30, 2002 and 2001
Millions of dollars, except as noted
Member banks
Item
Total
Total
National
State
Nonmember
banks
2002
ASSETS
Loans and investments
Loans, gross
Net
Investments
U.S. Treasury and federal agency
securities
Other
Cash assets, total
4,798,152
3,594,011
3,591,278
1,204,142
3,755,257
2,852,608
2,850,558
902,649
2,673,168
2,056,938
2,055,165
616,231
1,082,089
795,670
795,393
286,418
1,042,895
741,402
740,720
301,493
248,538
955,604
263,009
153,103
749,546
215,087
78,284
537,946
154,757
74,819
211,600
60,330
95,435
206,058
47,922
3,754,435
54,619
605,321
3,094,494
605,538
2,862,152
44,810
450,257
2,367,085
486,215
2,024,281
31,320
325,710
1,667,251
345,079
837,871
13,490
124,547
699,834
141,135
892,282
9,809
155,064
727,409
119,323
7,944
3,049
2,101
948
4,895
LIABILITIES
Deposits, total
Interbank
Other transaction
Other nontransaction
Equity capital
Number of banks
2001
ASSETS
Loans and investments
Loans, gross
Net
Investments
U.S. Treasury and federal agency
securities
Other
Cash assets, total
4,561,478
3,523,938
3,521,844
1,037,540
3,527,620
2,775,703
2,774,486
751,917
2,508,999
2,022,579
2,021,670
486,420
1,018,621
753,124
752,816
265,497
1,033,858
748,235
747,358
285,623
233,187
804,353
257,196
148,577
603,340
210,439
79,672
406,748
151,083
68,905
196,592
59,356
84,610
201,013
46,757
3,529,783
55,952
607,288
2,866,543
546,344
2,645,449
47,276
457,860
2,140,313
432,167
1,887,121
33,538
332,383
1,521,200
302,733
758,327
13,738
125,477
619,113
129,434
884,334
8,676
149,428
726,230
114,178
8,152
3,146
2,172
974
5,006
LIABILITIES
Deposits, total
Interbank
Other transaction
Other nontransaction
Equity capital
Number of banks
NOTE. Data are the domestic assets and liabilities
(except for those components reported on a consolidated
basis only). Components may not sum to totals because of
rounding.
296
89th Annual Report, 2002
13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1918-2002 and Month-End 2002
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
U.S. Treasury and
federal agency securities
Total
Bought
outright1
Held
under
repurchase
agreement 2
Loans
Float 3
1918..
1919..
239
300
239
300
0
0
1,766
2,215
199
201
1920..
1921..
1922..
1923..
1924..
287
234
436
134
540
287
234
436
80
536
0
0
0
54
4
2,687
1,144
618
723
320
1925..
1926..
1927..
1928..
1929..
375
315
617
228
511
367
312
560
197
3
57
31
23
1930..
1931..
1932..
1933..
1934..
739
817
1,855
2,437
2,430
686
775
1,851
2,435
2,430
1935..
1936..
1937..
1938..
1939..
2,431
2,430
2,564
2,564
2,484
1940..
1941..
1942..
1943..
1944..
All
other 4
Other
Federal
Reserve
assets 5
Gold
stock 6
Total
Special
drawing
rights
certificate
account
Treasury
currency
outstanding 7
2,498
3,292
2,873
2,707
1,795
1,707
119
40
78
27
52
294
575
262
146
273
355
390
3,355
1,563
1,405
1,238
1,302
2,639
3,373
3,642
3,957
4,212
1,709
1,842
1,958
2,009
2,025
643
637
582
1,056
632
63
45
63
24
34
378
384
393
500
405
1,459
1,381
1,655
1,809
1,583
4,112
4,205
4,092
3,854
3,997
1,977
1,991
2,006
2,012
2,022
43
42
4
2
0
251
638
235
98
7
21
20
14
15
5
372
378
41
137
21
0
0
0
0
0
1,373
1,853
2,145
2,688
2,463
4,306
4,173
4,226
4,036
8,238
2,027
2,035
2,204
2,303
2,511
2,430
2,430
2,564
2,564
2,484
1
0
0
0
0
5
3
10
4
7
12
39
19
17
91
38
28
19
16
11
0
0
0
0
0
2,486
2,500
2,612
2,601
2,593
10,125
11,258
12,760
14,512
17,644
2,476
2,532
2,637
2,798
2,963
2,184
2,254
6,189
11,543
18,846
2,184
2,254
6,189
11,543
18,846
0
0
0
0
0
3
3
6
5
94
471
681
815
10
14
10
4
2,274
2,361
6,679
12,239
19,745
21,995
22,737
22,726
21,938
20,619
3,087
3,247
3,648
4,094
4,131
1945..
1946..
1947..
1948..
1949..
24,252
23,350
22,559
23,333
18,885
24,252
23,350
22,559
23,333
18,885
0
0
0
0
0
249
163
85
223
78
578
580
535
541
534
2
1
1
1
2
15,091
24,093
23,181
24,097
19,499
20,065
20,529
22,754
24,244
24,427
4,339
4,562
4,562
4,589
4,598
1950..
1951..
1952..
1953..
1954..
20,778
23,801
24,697
25,916
24,932
20,725
23,605
24,034
25,318
24,888
53
196
663
598
44
67
19
156
28
143
1,368
1,184
967
935
3
5
4
2
1
22,216
25,009
25,825
26,880
25,885
22,706
22,695
23,187
22,030
21,713
4,636
4,709
4,812
4,894
4,985
1955..
1956..
1957..
1958..
1959..
24,785
24,915
24,238
26,347
26,648
24,391
24,610
23,719
26,252
26,607
394
305
519
95
41
108
50
55
64
458
1,585
1,665
1,424
1,296
1,590
29
70
66
49
75
26,507
26,699
25,784
27,755
28,771
21,690
21,949
22,781
20,534
19,456
5,008
5,066
5,146
5,234
5,311
For notes see end of table.
Statistical Tables 297
13.—Continued
Factors absorbing reserve funds
Deposits, other
than reserves, with
Federal Reserve Banks
Cur-
Member bank
Other
Federal
Reserve
accounts 5
Re-
Other
Federal
Reserve
liabilities With
Federal
and
capital5 Reserve
Banks
reserves10
Reverse
repurchase
agreements8
Treasury
cash
holdings 9
4,951
5,091
0
0
288
385
51
51
96
73
25
28
118
208
0
0
0
0
1,636
1,890
0
0
5,325
4,403
4,530
4,757
4,760
0
0
0
0
0
218
214
225
213
211
57
96
11
38
51
5
12
3
4
19
18
15
26
19
20
298
285
276
275
258
0
0
0
0
0
0
0
0
0
0
1,781
1,753
1,934
1,898
2,220
0
0
0
0
0
4,817
4,808
4,716
4,686
4,578
0
0
0
0
0
203
201
208
202
216
16
17
18
23
29
8
46
5
6
6
21
19
21
21
24
272
293
301
348
393
0
0
0
0
0
0
0
0
0
0
2,212
2,194
2,487
2,389
2,355
4,603
5,360
5,388
5,519
5,536
0
0
0
0
0
211
222
272
284
3,029
19
54
8
3
121
6
79
19
4
20
22
31
24
128
169
375
354
355
360
241
0
0
0
0
0
0
0
0
0
0
5,882
0
0
0
0
226
160
235
242
256
253
0
544
244
142
923
634
29
6,543
6,550
6,856
7,598
2,566
2,376
3,619
2,706
2,409
261
263
260
251
0
0
0
0
0
8,732
11,160
15,410
20,499
25,307
0
0
0
0
0
2,213
2,215
2,193
2,303
2,375
368
867
799
579
440
1,360
1,204
599
586
485
356
394
284
291
256
339
402
28,515
28,952
28,868
28,224
27,600
0
0
0
0
0
2,287
2,272
1,336
1,325
1,312
977
393
870
821
862
508
392
642
767
446
314
569
547
750
27,741
29,206
30,433
30,781
30,509
0
0
0
0
0
1,293
1,270
1,270
761
796
668
247
389
346
563
895
526
550
423
490
31,158
31,790
31,834
32,193
32,591
0
0
0
0
0
767
775
761
683
391
394
441
481
358
504
402
322
356
272
345
rency
in
circulation
Treasury
1,123
Foreign
99
172
199
397
1,133
774
793
Other
quired
ciearing
balances
Currency
and
coin"
Ex-
Re-
quired12 cess12
1,585
1,822
51
68
0
1,884
2,161
0
99
0
14
59
0
0
0
0
0
2,256
2.250
2,424
2,430
2,428
-44
-56
63
-41
-73
2,471
1,961
2,509
2,729
4,096
0
0
0
0
0
2,375
1,994
1,933
1,870
2,282
96
-33
576
859
1,814
0
0
0
0
0
5,587
6,606
7,027
8,724
11,653
0
0
0
0
0
2,743
4,622
5,815
5,519
6,444
2,844
1,984
1,212
3,205
5,209
0
0
0
0
0
0
0
0
0
0
4,026
12,450
13,117
12,886
14,373
0
0
0
0
0
7,411
9,365
11,129
11,650
12,748
6,615
3,085
1,988
1,236
1,625
495
607
563
590
106
0
0
0
0
0
0
0
0
0
0
15,915
16,139
17,899
20,479
16,568
0
0
0
0
0
14,457
15,577
16,400
19,277
15,550
1,458
565
363
455
493
441
714
746
777
839
907
0
0
0
0
0
0
0
0
0
0
17,681
20,056
19,950
20,160
18,876
0
0
0
0
0
16,509
19,667
20,520
19,397
18,618
1,172
554
426
246
391
694
925
901
998
0
0
0
0
0
0
0
0
0
0
19,005
19,059
19,034
18,504
18,174
0
0
0
0
310
18,903
19,089
19,091
18,574
18,619
102
-30
-57
-70
1,122
841
1,654
0
562
1,499
1,202
1,018
389
-570
763
258
-135
298 89th Annual Report, 2002
13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1918-2002 and Month-End 2002—Continued
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
U.S. Treasury and
federal agency securities
Total
Bought
outright1
Held
under
repurchase
agreement2
Loans
Float*
All
other4
Other
Federal
Reserve
Gold
stock6
Total
Special
drawing
rights
certificate
account
Treasury
currency
outstand-
27,384
28,881
30,820
33,593
37,044
26,984
30,478
28,722
33,582
36,506
400
159
342
11
538
33
130
38
63
186
1,847
2,300
2,903
2,600
2,606
74
51
110
162
94
0
0
0
0
0
29,338
31,362
33,871
36,418
39,930
17,767
16,889
15,978
15,513
15,388
5,398
5,585
5,567
5,578
5,405
40,768
44,316
49,150
52,937
57,154
40,478
43,655
48,980
52,937
7,1545
62,142
70,804
71,230
80,495
85,714
62,142
69,481
71,119
80,395
84,760
94,124
104,093
111,274
118,591
126,167
92,789
100,062
108,922
117,374
124,507
130,592
140,348
148,837
160,795
169,627
128,038
136,863
144,544
159,203
167,612
290
661
170
0
0
0
1,323
111
100
954
1,335
4,031
2,352
1,217
1,660
2,554
3,485
4,293
1,592
2,015
137
173
141
186
183
335
39
1,981
1,258
299
211
25
265
1,174
1,454
1,809
1,601
717
918
3,577
2,248
2,495
2,576
3,443
3,440
4,261
4,343
3,974
3,099
2,001
3,688
2,601
3,810
6,432
6,767
4,467
1,762
2,735
1,605
833
187
193
164
58
64
57
261
106
68
999
1,126
991
954
587
704
776
195
1,480
418
0
0
0
0
0
2,743
1,123
1,068
1,260
1,152
3,195
3,312
3,182
2,442
4,543
5,613
8,739
9,230
9,890
8,728
12,347
43,340
47,177
52,031
56,624
64,584
67,918
76,515
78,551
86,072
92,208
102,461
110,892
118,745
131,327
140,705
146,383
153,136
63,659
172,464
186,384
13,733
13,159
11,982
10,367
10,367
10,732
10,132
10,410
11,567
11,652
11,599
11,598
11,718
11,671
11,172
11,160
11,151
11,148
11,121
11,096
400
400
400
400
400
500
1,200
1,250
1,300
1,800
2,518
3,318
4,618
4,618
4,618
5,575
6,317
6,784
6,795
6,852
7,147
7,710
8,313
8,716
9,253
10,218
10,810
11,331
11,831
13,083
13,427
13,687
13,786
15,732
16,418
191,248
221,459
231,420
247,489
235,417
186,025
205,454
226,459
240,628
233,300
5,223
16,005
4,961
6,861
2,117
3,060
1,565
3,815
2,170
481
1,261
811
1,286
1,093
0
0
0
0
0
15,302
17,475
15,837
18,803
39,631
210,598
241,760
251,883
269,748
276,622
11,090
11,084
11,078
11,060
11,059
4,718
5,018
5,018
5,018
8,518
17,075
17,567
18,177
18,799
19,628
259,785
288,429
308,517
349,866
378,746
241,431
272,531
300,423
336,654
368,156
18,354
15,898
8,094
13,212
10,590
190
218
675
94
223
2,566
1,026
3,350
963
740
0
0
0
0
0
39,880
34,524
30,278
33,394
33,441
302,421
324,197
342,820
384,317
413,150
11,058
11,059
11,056
11,053
11,051
10,018
10,018
8,018
8,018
8,018
20,402rr
21,014
21,447r
22,095 r<
22,994
394,693
414,715
455,260
482,854
618,784
555,208
601,935
668,916
380,831
393,132
431,420
452,478
478,144
511,833
551,685
629,416
13,862
21,583
23,840
30,376
140,640
43,375
50,250
39,500
135
85
2,035
17
233
110
34
40
231
5,297
561
1,009
407
795
698
832
0
0
0
0
0
0
0
0
33,483 428,543
32,222 452,319
32,044 489,901
37,692 521,573
34,799 654,223
36,8% 593,009
36,885 639,552
38,574 708,363
11,050
11,048
11,047
11,046
11,048
11,046
11,045
11,039
10,168
9,718
9,200
9,200
6,200
2,200
2,200
2,200
24,003rr
24,966
25,543 '
26,270
28,013
31,219
33,195
34,497
Statistical Tables 299
13.—Continued
Factors absorbing reserve funds
Deposits, other
than reserves, with
Federal Reserve Banks
Cur-
Reverse
repurchase
agreements8
Treasury
cash
holdings 9
32,869
33,918
35,338
37,692
39,619
0
0
0
0
0
377
422
380
361
612
485
465
597
880
820
42,056
44,663
47,226
50,961
53,950
0
0
0
0
0
760
668
416
57,903
61,068
66,516
72,497
79,743
rency
in
circulation
Treasury
Member bank
Other
Other
Federal
Reserve
accounts 5
217
279
247
171
229
533
320
393
291
321
1,044
1,007
1,065
1,036
355
588
563
747
807
1,233
Foreign
941
Required
ripar
ciearing
balances
Other
Federal
Reserve
liabilities With
Federal
and
capital5 Reserve
Banks
18,988
18,988
20,071
20,677
21,663
637
96
645
471
574
0
0
0
0
0
0
0
0
0
0
1,919
18,447
19,779
21,092
21,818
22,085
4,163
4,310
4,631
4,921
5,187
22,848
24,321
25,905
27,439
28,173
-238
-232
-182
-700
-901
0
0
0
0
0
0
0
0
0
0
1,986
2,131
2,143
2,669
2,935
24,150
27,788
25,647
27,060
25,843
5,423
5,743
6,216
6,781
7,370
30,033 -460
32,496 1,035
98 1 3
32,044
35,268 -1,360
37,011 -3,798
0
0
0
0
0
2,968
3,063
3,292
4,275
4,957
26,052
25,158
26,870
31,152
29,792
8,036
8,628
9,421
10,538
11,429
35,197
35,461
37,615
42,694
44,217
0
117
436
27,456
25,111
26,053
20,413
20,693
13,654
15,576
16,666
17,821
675
40,558
42,145 -1,442
41,391 1,328
39,179 -945
211
1,312
0
0
0
0
0
431
460
345
317
185
1,156
2,020
1,855
2,542
2,113
148
294
325
251
418
1,419 1 4
1,275 1 4
86,547
93,717
103,811
114,645
125,600
0
0
0
0
483
460
392
240
494
7,285
10,393
7,114
4,196
4,075
353
352
379
368
429
1,090
1,357
1,187
1,256
1,412
0
0
0
0
136,829
144,774
154,908
171,935
183,796
0
0
0
0
0
441
443
429
479
513
3,062
4,301
5,033
3,661
5,316
411
505
328
191
253
617
781
0
0
0
0
0
1,013
1,126
4,671
5,261
4,990
5,392
5,952
197,488
211,995
230,205
247,649
260,456
0
0
0
0
0
550
447
454
395
450
9,351
7,588
5,313
8,656
6,217
480
287
244
347
589
0
0
0
0
0
1,490
1,812
1,687
1,605
1,618
5,940
6,088
7,129
7,683
8,486
27,141
46,295
40,097
37,742
36,713
286,963r
307,756'
334/701'
365,271r
403,843'
0
0
0
0
0
561
636
508
377
335
8,960
17,697
7,492
14,809
7,161
369
968
206
386
250
0
0
0
0
0
1,962
3,949
5,898
6,332
4,197
8,147
8,113
7,984
9,292
11,959
36,696
25,464
26,181
28,619
26,592
424,244'
450,648'
482,327'
517,484
628,359
593,694'
643,301'
687,418
0
0
0
0
0
0
0
270
249
225
85
109
450
425
367
5,979
7,742
5,444
6,086
28,402
5,149
6,645
4,420
386
167
457
167
71
216
61
136
0
0
0
0
0
0
0
0
5,167
6,601
6,665'
6,784
7,482'
6,332
8,534
10,533
12,342
13,829
15,500
16,354
17,256
17,962
17,083
18,977
24,444
17,923
24,173'
19,522
16,545'
12,713
8,944
12,004
21,091
1,041
917
1,027
548
1,298
242
1,706
372
397
876
932
892
900
1,605
1,261
1,382
820
1,152
Ex-
2,544
2,544
3,262
4,099
4,151
1,123
851
867
Re-
17,081
17,387
17,454
17,049
18,086
695
596
1,033
quired12 cess 12 ' 13
0
0
0
0
0
150
174
135
216
134
999
840
Currency
and
coin11
0
0
0
0
0
1,176
1,344
703
reserves10
-147
-773
-1,353
0
n.a.
n.a.
-1,103 1 5
-1,535
-1,265
-893
-2,835
n.a.
300 89th Annual Report, 2002
13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1918-2002 and Month-End 2002—Continued
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
Total
2002
Jan
Feb
Mar.
Gold
stock6
Special
drawing
rights
certificate
account
Treasury
currency
outstanding'
11,045
11,044
11,044
11,044
11,044
11,044
11,038
11,038
11,038
11,038
11,038
11,039
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
33,471
33,549
33,630
33,710
33,871
33,995
33,995
34,247
34,315
34,385
34,441
34,497
U.S. Treasury and
federal agency securities
598,886
602,143
. . . . 604,866
612,818
May'.'.'.'.'. 615,199
622,693
June
July . . . . 619,965
Aug
625,836
625,951
Sept
Oct
624,375
Nov
637,495
Dec
668,916
Bought
outright1
Held
under
repurchase
agreement2
561,386
567,644
575,366
581,318
587,199
590,693
600,465
602,836
604,201
607,875
608,995
629,416
37,500
34,499
29,500
31,500
28,000
32,000
19,500
23,000
21,750
16,500
28,500
39,500
Loans
Float3
All
other4
Other
Federal
Reserve
assets5
Total
19
68
20
72
124
184
186
330
177
80
59
40
4,272
-912
-339
0
0
0
0
0
0
0
0
0
0
0
0
37,744
35,404
37,571
38,605
36,674
39,188
39,712
37,887
38,246
39,171
37,031
38,574
640,921
636,702
642,117
651,415
651,379
661,986
659,047
664,083
664,043
662,937
674,368
708,363
-81
-618
-79
-815
31
-332
-690
-216
NOTE. For a description of figures and discussion of
their significance, see Banking and Monetary Statistics,
1941-1970 (Board of Governors of the Federal Reserve
System, 1976), pp. 507-23.
Components may not sum to totals because of
rounding.
. . . Not applicable.
r. Revised.
n.a. Not available.
1. In 1969 and thereafter, includes securities loaned—
fully guaranteed by U.S. government securities pledged
with Federal Reserve Banks—and excludes securities
sold and scheduled to be bought back under matched
sale-purchase transactions. On September 29, 1971, and
thereafter, includes federal agency issues bought outright.
2. On December 1, 1966, and thereafter, includes
federal agency obligations held under repurchase
agreements.
3. In 1960 and thereafter, figures reflect a minor
change in concept; see Federal Reserve Bulletin, vol. 47
(February 1961), p. 164.
4. Principally acceptances and, until August 21, 1959,
industrial loans, the authority for which expired on that
date.
5. For the period before April 16, 1969, includes the
total of Federal Reserve capital paid in, surplus, other
capital accounts, and other liabilities and accrued divi-
832
dends, less the sum of bank premises and other assets,
and is reported as "Other Federal Reserve accounts";
thereafter, "Other Federal Reserve assets" and "Other
Federal Reserve liabilities and capital" are shown
separately.
6. Before January 30, 1934, includes gold held in
Federal Reserve Banks and in circulation.
7. Includes currency and coin (other than gold) issued
directly by the Treasury. The largest components are
fractional and dollar coins. For details see "Currency and
Coin in Circulation," Treasury Bulletin.
8. Collateralized by U.S. Treasury securities.
9. Coin and paper currency held by the Treasury, as
well as any gold in excess of the gold certificates issued
to the Reserve Bank.
10. In November 1979 and thereafter, includes
reserves of member banks, Edge Act corporations, and
U.S. agencies and branches of foreign banks. On November 13, 1980, and thereafter, includes reserves of all
depository institutions.
In 1984 and thereafter, data on "Currency and coin"
and "Required" and "Excess" reserves changed from
daily to biweekly basis.
11. Between December 1, 1959, and November 23,
1960, part was allowed as reserves; thereafter, all was
allowed.
Statistical Tables 301
13.—Continued
Factors absorbing reserve funds
Deposits, other
than reserves, with
Federal Reserve Banks
Currency
circulation
631,141
638,325
641,873
645,495
653,796
657,900
661,144
664,116
660,082
663,370
673,822
687,418
Reverse
repurchase
agreements 8
Treasury
cash
holdings9
0
0
0
0
0
0
0
0
0
0
0
21,091
415
414
412
393
416
395
377
361
380
397
377
367
Member bank
Treasury
Foreign
Other
Other
Federal
Reserve
accounts5
13,688
5,752
5,692
5,387
5,883
8,116
6,242
4,874
7,879
5,878
4,928
4,420
162
89
256
111
128
%
164
86
150
89
78
136
286
254
181
287
207
212
236
194
221
233
253
1,152
0
0
0
0
0
0
0
0
0
0
0
0
12. Estimated through 1958. Before 1929, data were
available only on call dates (in 1920 and 1922 the call
date was December 29). Since September 12, 1968, the
amount has been based on close-of-business figures for
the reserve period two weeks before the report date.
13. For the week ending November 15, 1972, and
thereafter, includes $450 million of reserve deficiencies
on which Federal Reserve Banks are allowed to waive
penalties for a transition period in connection with bank
adaptation to Regulation J as amended, effective November 9,1972. Allowable deficiencies are as follows (beginning with first statement week of quarter, in millions):
1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84;
1974—Ql, $67; Q2, $58. The transition period ended
with the second quarter of 1974.
14. For the period before July 1973, includes certain
deposits of domestic nonmember banks and foreign-
Required
ing
balances
8,650
8,872
9,631
9,869
9,810
9,903
9,960
9,922
9,938
10,057
10,281
10,533
Other
Federal
Reserve
liabilities With
and Federal
capital5 Reserve
Banks
17,385
17,792
18,163
19,202
19,504
20,186
18,940
19,526
19,719
19,720
19,616
18,977
Currency
and
coin"
ReExquired12 cess12-13
15,909
11,997
12,784
17,626
8,751
12,421
9,219
12,489
13,226
10,816
12,692
12,004
owned banking institutions held with member banks and
redeposited in full with Federal Reserve Banks in connection with voluntary participation by nonmember institutions in the Federal Reserve System program of credit
restraint.
As of December 12, 1974, the amount of voluntary
nonmember bank and foreign-agency and branch deposits
at Federal Reserve Banks that are associated with marginal reserves are no longer reported. However, two
amounts are reported: (1) deposits voluntarily held as
reserves by agencies and branches of foreign banks operating in the United States and (2) eurodollar liabilities.
15. Adjusted to include waivers of penalties for reserve deficiencies, in accordance with change in Board
policy, effective November 19, 1975.
302 89th Annual Report, 2002
14. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the
United States, December 31, 2001 and 2002
Commercial banks'
Type of office
Member
Total
Nonmember
Total
Total
National
Statechartered
savings
banks
State
All banking offices
BANKS
Number, Dec. 31,2001 ..
Changes during 2002
New banks
Banks converted
into branches
Ceased banking
operation2
Other 3
Net change
Number, Dec. 31,2002 ..
8,454
8,033
3,056
2,089
967
4,977
421
83
81
33
29
4
48
2
-261
-253
-121
-70
-51
-132
-8
-47
0
-225
-36
2
-206
-19
28
-79
-10
-8
-59
-9
36
-20
-17
-26
-127
-11
-2
-19
8,229
7327
2,977
2,030
947
4,850
402
69,876
66,405
49,091
34,727
14364
17314
3,471
BRANCHES AND
ADDITIONAL OFFICES
Number, Dec. 31, 2001 ..
Changes during 2002
New branches
Branches converted
from banks
Discontinued2
Other3
Net change
1,989
1,879
1,300
909
391
579
110
261
-1,222
0
1,028
259
-1,137
70
1,071
148
-878
434
1,004
91
-542
577
1,035
57
-336
-143
-31
111
-259
-364
67
2
-85
-70
-43
Number, Dec. 31, 2002 ..
70,904
67,476
50,095
35,762
14,333
17,381
3,428
Banks affiliated with BHCs
BANKS
Number, Dec. 31, 2001 ..
6,526
6,408
2,583
1,752
831
3,825
118
Changes during 2002
BHC-affiliated
new banks
Banks converted
into branches
Ceased banking
operation2
Other3
Net change
165
157
49
30
19
108
8
-226
-220
-109
-61
-48
-111
-6
-42
0
-103
-33
1
-95
-18
24
-54
-10
-2
-43
-8
26
-11
-15
-23
-41
-9
-1
-8
Number, Dec. 31,2002 ..
6,423
6313
2,529
1,709
820
3,784
110
1. For purposes of this table, banks are entities that
are defined as banks in the Bank Holding Company Act
as amended and implemented in Federal Reserve Regulation Y. Generally, a bank is any institution that accepts
demand deposits and is engaged in the business of
making commercial loans or any institution that is
defined as an insured bank in section 3(h) of the FDIC
Act. Covers entities in the United States and its territories
and possessions (affiliated insular areas).
2. Institutions that no longer meet the Regulation Y
definition of bank.
3. Interclass changes and sales of branches.
Federal Reserve System Audits
305
Audits of the Federal Reserve System
The Board of Governors, the Federal
Reserve Banks, and the Federal Reserve
System as a whole are all subject to
several levels of audit and review. The
Board's financial statements, and its
compliance with laws and regulations
affecting those statements, are audited
annually by an outside auditor retained
by the Board's Office of Inspector General. The Office of Inspector General
also audits and investigates the Board's
programs and operations, as well as
those Board functions delegated to the
Reserve Banks.
The financial statements of the
Reserve Banks are also audited annually
by an independent outside auditor. In
addition, the Reserve Banks are subject
to annual examination by the Board.
As discussed in the chapter "Federal
Reserve Banks," the Board examination
includes a wide range of ongoing oversight activities conducted on and off
site by staff of the Board's Division of
Reserve Bank Operations and Payment
Systems.
Federal Reserve operations are also
subject to review by the General
Accounting Office.
•
307
Board of Governors Financial Statements
The financial statements of the Board for 2002 were audited by KPMG LLP,
independent auditors.
2001 M Street, N.W.
Washington, D.C. 20036
INDEPENDENT AUDITORS' REPORT
ON FINANCIAL STATEMENTS
To the Board of Governors of the
Federal Reserve System
We have audited the accompanying balance sheets of the Board of Governors of
the Federal Reserve System (the Board) as of December 31, 2002 and 2001, and
the related statements of revenues and expenses and changes in cumulative results
of operations and cash flows for the years then ended. These financial statements
are the responsibility of the Board's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America and Government Auditing Standards,
issued by the Comptroller General of the United States. Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of the Board at December 31, 2002 and
2001, and its results of operations and its cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.
In accordance with Government Auditing Standards, we have also issued our
reports dated March 28, 2003 on our consideration of the Board's internal control
over financial reporting and its compliance with laws and regulations. Those
reports are an integral part of an audit conducted in accordance with Government
Auditing Standards, and should be read in conjunction with this report in considering the results of our audit.
March 28, 2003
308
89th Annual Report, 2002
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
BALANCE SHEETS
As of December 31,
2002
2001
ASSETS
CURRENT ASSETS
Cash
Accounts receivable
Prepaid expenses and other assets
$ 8,635,164
871,626
801,031
$ 40,788,564
1,325,065
866,407
10,307,821
42,980,036
143,971,006
138,895,601
$154,278,827
$181,875,637
$ 11,450,099
8,102,710
11,873,527
50,546
442,066
$ 16,125,797
7,307,754
10,732,356
247,242
391,572
31,918,948
34,804,721
32,153
614,108
4,917,787
4,299,252
80,276
651,628
4,555,487
3,591,571
9,863,300
8,878,962
41,782,248
43,683,683
(21,560,581)
(9,831,147)
143,888,307
8,422,557
(8,798,686)
138,568,083
112,496,579
138,191,954
$154,278,827
$181,875,637
Total current assets
PROPERTY AND EQUIPMENT, NET (Note 5)
Total assets
LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS
CURRENT LIABILITIES
Accounts payable and accrued liabilities
Accrued payroll and related taxes
Accrued annual leave
Capital lease payable (current portion)
Unearned revenues and other liabilities
Total current liabilities
LONG-TERM LIABILITIES
Capital lease payable (non-current portion)
Accumulated retirement benefit obligation (Note 2)
Accumulated postretirement benefit obligation (Note 3)
Accumulated postemployment benefit obligation (Note 4)
Total long-term liabilities
Total liabilities
CUMULATIVE RESULTS OF OPERATIONS
Working capital
Unfunded long-term liabilities
Net investment in property and equipment
Total cumulative results of operations
Total liabilities and cumulative results of operations
See accompanying notes to financial statements.
Board of Governors Financial Statements 309
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
STATEMENTS OF REVENUES AND EXPENSES
AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS
For the years ended December 31,
2002
2001
BOARD OPERATING REVENUES
Assessments levied on Federal Reserve Banks for Board
operating expenses and capital expenditures
Other revenues (Note 6)
Total operating revenues
$205,110,800
9,039,417
$295,055,600
8,747,799
214,150,217
303,803,399
146,022,212
25,560,734
18,073,228
12,426,581
7,218,999
6,822,066
5,961,699
5,925,674
4,666,439
2,026,370
318,132
4,823,458
132,647,612
22,277,244
19,339,948
10,394,156
5,880,777
5,415,856
8,252,490
5,037,577
4,201,386
2,095,676
3,830,557
4,157,305
239,845,592
223,530,584
(25,695,375)
80,272,815
BOARD OPERATING EXPENSES
Salaries
Retirement and insurance contributions
Contractual services and professional fees
Depreciation and net losses on disposals
Utilities
Software
Postage and supplies
Travel
Repairs and maintenance
Printing and binding
Equipment and facilities rental
Other expenses (Note 6)
Total operating expenses
RESULTS OF OPERATIONS
ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES
Assessments levied on Federal Reserve Banks
for currency costs
Expenses for currency printing, issuance,
retirement, and shipping
429,568,393
338,537,426
429,568,393
338,537,426
0
0
CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES
TOTAL RESULTS OF OPERATIONS
(25,695,375)
80,272,815
CUMULATIVE RESULTS OF OPERATIONS, Beginning of year
138,191,954
57,919,139
$112,496,579
$138,191,954
CUMULATIVE RESULTS OF OPERATIONS, End of year
See accompanying notes to financial statements.
310 89th Annual Report, 2002
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
STATEMENTS OF CASH FLOWS
For the years ended December 31,
2002
2001
CASH FLOWS FROM OPERATING ACTIVITIES
RESULTS OF OPERATIONS
$(25,695,375)
$80,272,815
12,426,581
10,394,156
Adjustments to reconcile results of operations
to net cash provided by (used in) operating activities:
Depreciation and net losses on disposals
(Increase) decrease in assets:
Accounts receivable, prepaid expenses, and other assets
518,815
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities
Accrued payroll and related taxes
Accrued annual leave
Unearned revenues and other liabilities
Accumulated retirement benefit obligation
Accumulated postretirement benefit obligation
Accumulated postemployment benefit obligation
Net cash provided by (used in) operating activities
(24,805)
(4,675,698)
794,956
1,141,171
50,494
(37,520)
362,300
707,681
5,423,057
1,266,793
2,239,628
(1,652,588)
(43,154)
489,783
482,115
(14,406,595)
98,847,800
5,200
(17,507,186)
119,013
(80,886,996)
(17,501,986)
(80,767,983)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals
Capital expenditures
Net cash provided by (used in) investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Capital lease payable
Net cash provided by (used in) financing activities
(244,819)
(133,505)
(244,819)
(133,505)
NET INCREASE (DECREASE) IN CASH
(32,153,400)
17,946,312
CASH BALANCE, Beginning of year
40,788,564
22,842,252
$ 8,635,164
$40,788,564
CASH BALANCE, End of year
See accompanying notes to financial statements.
Board of Governors Financial Statements 311
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
NOTES TO FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 2002 AND 2001
(1) SIGNIFICANT ACCOUNTING POLICIES
Organization—The Federal Reserve System was established by Congress in 1913 and consists of the Board of
Governors (Board), the Federal Open Market Committee,
the twelve regional Federal Reserve Banks, the Federal
Advisory Council, and the private commercial banks that
are members of the System. The Board, unlike the
Reserve Banks, was established as a federal government
agency and is supported by Washington staff numbering
about 1,700, as it carries out its responsibilities in conjunction with other components of the Federal Reserve
System.
The Board is required by the Federal Reserve Act to
report its operations to the Speaker of the House of
Representatives. The Act also requires the Board each
year to order a financial audit of each Federal Reserve
Bank and to publish each week a statement of the financial condition of each such Reserve Bank and a consolidated statement for all of the Reserve Banks. Accordingly, the Board believes that the best financial disclosure
consistent with law is achieved by issuing separate financial statements for the Board and for the Reserve Banks.
Therefore, the accompanying financial statements include
only the operations and activities of the Board. A combined financial statement for the Federal Reserve Banks
are included in the Board's annual report to the Speaker
of the House of Representatives.
Basis of Accounting—The financial statements have
been prepared on the accrual basis of accounting.
Revenues—Assessments for operating expenses and
additions to property are based on expected cash needs.
Amounts over or under assessed due to differences
between actual and expected cash needs flow into
"Cumulative Results of Operations" during the year.
Issuance and Redemption of Federal Reserve Notes—
The Board incurs expenses and assesses the Federal
Reserve Banks for currency printing, issuance, retirement, and shipping of Federal Reserve Notes. These
assessments and expenses are separately reported in the
statements of revenues and expenses because they are not
Board operating transactions.
Property and Equipment—The Board's property, buildings and equipment are stated at cost less accumulated
depreciation. Depreciation is calculated on a straight-line
basis over the estimated useful lives of the assets, which
range from 3 to 10 years for furniture and equipment and
from 10 to 50 years for building equipment and structures. Upon the sale or other disposition of a depreciable
asset, the cost and related accumulated depreciation are
removed from the accounts and any gain or loss is
recognized.
Estimates—The preparation of financial statements in
conformity with accounting principles generally accepted
in the United States of America requires management to
make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates.
Reclassifications—Certain 2001 amounts have been
reclassified to conform with the 2002 presentation.
(2)
RETIREMENT BENEFITS
Substantially all of the Board's employees participate
in the Retirement Plan for Employees of the Federal
Reserve System (System Plan). The System Plan is a
multi-employer plan which covers employees of the Federal Reserve Banks, the Board, and the Plan Administrative Office.
Employees of the Board who entered on duty prior to
1984 are covered by a contributory defined benefits program under the System Plan. Employees of the Board
who entered on duty after 1983 are covered by a noncontributory defined benefits program under the System
Plan. Contributions to the System Plan are actuarially
determined and funded by participating employers at
amounts prescribed by the System Plan's administrator.
Based on actuarial calculations, it was determined that
employer funding contributions were not required for the
years 2002 and 2001, and the Board was not assessed
a contribution for these years. Excess Plan assets are
expected to continue to fund future years' contributions.
Because the plan is part of a multi-employer plan, information as to vested and nonvested benefits, as well as
plan assets, as it relates solely to the Board, is not readily
available.
A relatively small number of Board employees participate in the Civil Service Retirement System (CSRS) or
the Federal Employees' Retirement System (FERS). The
Board matches employee contributions to these plans.
These defined benefit plans are administered by the
Office of Personnel Management. The Board's contributions to these plans totaled $327,000 and $308,000 in
2002 and 2001, respectively. The Board has no liability
for future payments to retirees under these programs, and
it is not accountable for the assets of the plans.
Employees of the Board may also participate in the
Federal Reserve System's Thrift Plan. Under the Thrift
Plan, members may contribute up to a fixed percentage
of their salary. Board contributions are based upon a
fixed percentage of each member's basic contribution
and were $7,185,000 and $5,540,000 in 2002 and 2001,
respectively.
Effective January 1, 1996, Board employees covered
under the System Plan are also covered under a Benefits
Equalization Plan (BEP). Benefits paid under the BEP are
limited to those benefits that cannot be paid from the
System Plan due to limitations imposed by Sections 401(a)(17), 415(b) and 415(e) of the Internal Revenue Code of 1986. Pension costs attributed to the BEP
reduce the pension costs of the System Plan. Activity for
the BEP for 2002 and 2001 is summarized in the following table:
312 89th Annual Report, 2002
Change in benefit
obligation
Projected benefit
obligation at
beginning of year .. $
Service cost
Interest cost
Plan participants'
contributions
Plan amendments
Actuarial(gain)/loss . . . .
Benefits paid
Projected benefit
obligation at
endofyear
Change in plan assets
Fair value of plan assets
at beginning
of year
Actual return on plan
assets
Employer contributions .
Plan participants'
contributions
Benefits paid
Fair value of plan assets
at end of year
Reconciliation of funded
status at end of year
Funded status
Unrecognized net
actuarial (gain)/
loss
Unrecognized prior
service cost
Unrecognized net
transition (asset)/
obligation
Postretirement
benefit liability . . . .
$
The Board provides certain life insurance programs for
its active employees and retirees. Activity for 2002 and
2001 is summarized in the following table:
2,125
3,363
561
1,804
450
112
0
2,852
3,965
0
0
0
(241)
0
12,866
2,125
$_
$ (12,866)
$
(2,125)
(297,773)
(329,169)
(1,050,946)
(1,170,405)
850,071
747,477
$ (614,108)
7.00%
N/A
4.50%
10.00%
6.75%
N/A
4.25%
10.00%
$
3,363
561
0
$
450
112
0
(116,607)
(116,848)
(27,431)
(29,462)
102,594
$ (37,520)
102,594
$ (43,154)
2001
2002
Change in benefit
obligation
Benefit obligation at
beginning of year .. $5,868,425
Service cost
158,179
Interest cost
386,215
Plan participants'
contributions
0
Plan amendments
0
Actuarial (gain)/loss . . . .
(63,554)
Benefitspaid
(214,870)
Benefit obligation
atendofyear
$ 6,134,395
Change in plan assets
Fair value of plan
assets at beginning
of year
Actual return on
plan assets
Employer contributions
Plan participants'
contributions . . . .
Benefits paid
Fair value of plan
assets at end
of year
$
Weighted-average
assumptions as of
December 31
Discount rate
Expected asset return
Salary scale
Corridor
Components of net
periodic benefit cost
Service cost
Interest cost
Expected return
on plan assets . . .
Amortization of
prior service cost
Recognized actuarial
(gain)/loss
Amortization of net
transition (asset)/
obligation
Net periodic benefit
cost
(3) POSTRETIREMENT BENEFITS
2001
2002
Reconciliation of
funded status
at end of year
Funded status
Unrecognized net
actuarial
(gain)/loss
Unrecognized prior
service cost
Unrecognized net
transition
obligation
Prepaid/(accrued)
postretirement
benefit liability
Components of net
periodic cost
for year
Service cost
Interest cost
Amortization of prior
service cost
Amortization of
(gains)/losses ..
Total net periodic
cost
$
$
$ 4,255,290
133,550
345,753
0
95,993
1,037,839
0
$ 5,868,425
0
0
213,958
0
0
0
(213,958)
0
0
0
$
0
$(6,134,395)
$(5,868,425)
1,126,688
1,216,945
89,920
95,993
0
0
$(4,917,787)
$(4,555,487)
$
$
$
158,179
386,215
133,550
345,756
6,073
0
26,706
10,477
577,173
$
489,783
Board of Governors Financial Statements 313
The liability and costs for the postretirement benefit
plan were determined using discount rates of 6.75 percent
and 7.00 percent as of December 31, 2002 and 2001,
respectively. Unrecognized losses of $1,126,688 and
$1,216,945 as of December 31, 2002 and 2001, respectively, result from changes in the discount rate used to
measure the liabilities. Under Statement of Financial
Accounting Standards No. 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions, the
Board may have to record some of these unrecognized
losses in operations in future years. The assumed salary
trend rate for measuring the increase in postretirement
benefits related to life insurance was an average of
4.25 percent.
The above accumulated postretirement benefit obligation is related to the Board sponsored life insurance
programs. The Board has no liability for future payments
to employees who continue coverage under the federally
sponsored life and health programs upon retiring. Contributions for active employees participating in federally
sponsored health programs totaled $6,205,000 and
$5,364,000 in 2002 and 2001, respectively.
(4) POSTEMPLOYMENT BENEFIT PLAN
The Board provides disability and survivor income
benefits to eligible employees after employment but before retirement. Effective January 1, 1994, the Board
adopted Statement of Financial Accounting Standards
No. 112, Employers' Accounting for Postemployment
Benefits, which requires that employers providing
postemployment benefits to their employees accrue the
cost of such benefits. Prior to January 1994, postemployment benefit expenses were recognized on a pay-asyou-go basis.
Change in
benefit obligation
Benefit obligation
at beginning
of year
Service cost
Interest cost
Plan participants'
contributions
Plan amendments
Actuarial (gain)/loss . . .
Benefits paid
Benefit obligation at
end of year
Weighted-average
assumptions as of
December 31
Discount rate
Expected asset return ..
Salary scale
Corridor
2002
2001
$3,591,571
891,192
166,520
$3,109,456
755,135
115,142
0
0
(76,282)
(273,749)
$4,299,252
6.75%
N/A
4.25%
10.00%
0
0
(129,585)
(258,577)
$3,591,571
7.00%
N/A
4.50%
10.00%
(5) PROPERTY AND EQUIPMENT
The following is a summary of the components of the
Board's property, buildings and equipment, at cost, net
of accumulated depreciation.
As of December 31,
2002
2001
Land and
improvements . . .
Buildings
Furniture and
equipment
Software
Construction in
process
Less accumulated
depreciation
Property and
equipment, net...
$ 18,640,314
113,309,775
$ 18,640,314
104,403,830
37,044,828
9,830,112
54,301,936
9,215,280
9,467,020
188,292,049
6,901,864
193,463,224
(44,321,043)
(54,567,623)
$143,971,006
$138,895,601
Furniture and equipment includes $864,000 for capitalized leases as of December 31, 2002 and 2001, respectively. Accumulated depreciation includes $654,000 and
$510,000 for capitalized leases as of December 31, 2002
and 2001, respectively. The Board paid interest related to
these capital leases in the amount of $15,731 and $32,201
for 2002 and 2001, respectively.
The Board began the Eccles Building Infrastructure
Enhancement Project in July 1999. This $12.5 million
project, scheduled for nineteen phases over three and a
half years, includes asbestos removal, lighting and plumbing improvements, cabling and other enhancements. Multiple phases will be in process at the same time.
In 2001, the Board purchased land and building located
at 1709 New York Avenue, N.W., Washington, DC.
This purchase increased land and improvements by
$17,339,000 and buildings by $48,727,000 for 2001.
In 2002, fully depreciated furniture and equipment
totaling $22,350,000 was retired.
(6) OTHER REVENUES AND OTHER EXPENSES
The following are summaries of the components of
Other Revenues and Other Expenses.
As of December 31,
2002
2001
Other revenues
Data processing
revenue
Rent
Subscription
revenue
Reimbursable
services to
other agencies . . .
Board sponsored
conferences
National Information
Center
Miscellaneous
Total Other
Revenues
$4,830,600
1,996,893
$4,427,360
664,537
810,032
869,595
788,095
568,753
115,965
240,967
30,334
467,498
25,591
1,950,996
$9,039,417
$8,747,799
314 89th Annual Report, 2002
Other expenses
Tuition, registration,
and membership
fees
Subsidies and
contributions ...
Public transportation
subsidy
Meals and
representation ..
Contingency
operations
Security
investigations ...
Miscellaneous
Total Other
Expenses
(9) FEDERAL RESERVE BANKS
$1,642,013
$1,472,539
900,049
851,225
745,973
484,618
378,387
438,748
264,232
180,871
229,387
663,417
108,981
620,323
$4,823,458
$4,157,305
(7) COMMITMENTS
The Board has entered into several operating leases to
secure office, training and warehouse space for periods
ranging from one to ten years. Minimum future commitments under those leases having an initial or remaining
noncancelable lease term in excess of one year at December 31, 2002, are as follows:
$151,038
157,079
163,363
71,991
2003.
2004.
2005.
2006.
$543,471
Rental expenses under the operating leases were
$156,000 and $171,000 in 2002 and 2001, respectively.
(8) FEDERAL FINANCIAL INSTITUTIONS
EXAMINATION COUNCIL
The Board is one of the five member agencies of the
Federal Financial Institutions Examination Council (the
"Council"), and currently performs certain management
functions for the Council. Activity related to the Board
and Council for 2002 and 2001 is summarized in the
following table:
Board paid to the
Council:
Assessments for
operating expenses
of the Council
Total Board
paid to the
Council
Council paid to the
Board:
Data processing
related services
Administrative
services
Total Council
paid to the
Board
2002
2001
$ 300,000
$ 293,000
$ 300,000
$ 293,000
3,350,412
2,788,243
69,593
66,117
$3,420,005
$2,854,360
The Board performs certain transactions for the
Reserve Banks in conjunction with its responsibilities for
the Federal Reserve System, and the Federal Reserve
Banks provide certain administrative functions for the
Board. Activity related to the Board and Reserve Banks
for 2002 and 2001 is summarized in the following table:
Board paid to the
Reserve Banks:
Assessments for
employee benefits ..
Data processing and
communication . . . .
Contingency site
Total Board paid
to the Reserve
Banks
Reserve Banks paid
to the Board:
Assessments for
currency costs
Assessments for
operating expenses
of the Board
Data processing
Total Reserve Banks
paid to the
Board
$
$
2002
2001
2,014,839 $
1,859,752
2,154,087
264,232
2,469,052
180,871
4,433,158 $
4,509,675
$429,568,393 $338,537,426
205,110,800
1,281,759
295,055,600
1,499,559
$635,960,952 $635,092,585
Board of Governors Financial Statements 315
2001 M Street, N.W.
Washington, D.C. 20036
INDEPENDENT AUDITORS' REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
To the Board of Governors of the
Federal Reserve System
We have audited the financial statements of the Board of Governors of the
Federal Reserve System (the Board) as of and for the years ended December 31,
2002 and 2001, and have issued our report thereon dated March 28, 2003. We
conducted our audit in accordance with auditing standards generally accepted in the
United States of America and the standards applicable to financial audits contained
in Government Auditing Standards, issued by the Comptroller General of the
United States.
In planning and performing our 2002 audit, we considered the Board's internal
control over financial reporting by obtaining an understanding of the Board's
internal control, determining whether these internal controls had been placed in
operation, assessing control risk, and performing tests of controls in order to
determine our auditing procedures for the purpose of expressing our opinion on the
financial statements. The objective of our audit was not to provide assurance on
internal control. Consequently, we do not provide an opinion on internal control.
Our consideration of the internal control over financial reporting would not
necessarily disclose all matters in internal control over financial reporting that
might be material weaknesses under standards established by the American Institute of Certified Public Accountants. Material weaknesses are conditions in which
the design or operation of one or more of the internal control components does not
reduce to a relatively low level the risk that misstatements, in amounts that would
be material in relation to the financial statements being audited, may occur and not
be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control and its
operation that we consider to be material weaknesses as defined above.
This report is intended solely for the information and use of the Board and
management, the U.S. Office of Management and Budget, and the U.S. Congress,
and is not intended to be and should not be used by anyone other than these
specified parties.
LCP
March 28, 2003
316 89th Annual Report, 2002
2001 M Street, N.W.
Washington, D.C. 20036
INDEPENDENT AUDITORS' REPORT ON COMPLIANCE
WITH LAWS AND REGULATIONS
To the Board of Governors of the
Federal Reserve System
We have audited the financial statements of the Board of Governors of the
Federal Reserve System (the Board) as of and for the years ended December 31,
2002 and 2001, and have issued our report thereon dated March 28, 2003. We
conducted our audits in accordance with auditing standards generally accepted in
the United States of America and the standards applicable to financial audits
contained in Government Auditing Standards, issued by the Comptroller General of
the United States.
The management of the Board is responsible for complying with laws and
regulations applicable to the Board. As part of obtaining reasonable assurance
about whether the Board's 2002 financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws and
regulations, noncompliance with which could have a direct and material effect on
the determination of financial statement amounts. However, providing an opinion
on compliance with laws and regulations was not an objective of our audit and,
accordingly, we do not express such an opinion.
The results of our tests of compliance with the laws and regulations described in
the preceding paragraph disclosed no instances of noncompliance that are required
to be reported under Government Auditing Standards.
This report is intended solely for the information and use of the Board and
management, the U.S. Office of Management and Budget, and the U.S. Congress,
and is not intended to be and should not be used by anyone other than these
specified parties.
March 28, 2003
317
Federal Reserve Banks
Combined Financial Statements
The combined financial statements of the Federal Reserve Banks were audited by
PricewaterhouseCoopers LLP, independent accountants, for the years ended
December 31, 2002 and 2001.
Q
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Governors of The Federal Reserve System
and the Board of Directors of each of The Federal Reserve Banks:
We have audited the accompanying combined statements of condition of The
Federal Reserve Banks (the "Reserve Banks") as of December 31, 2002 and 2001,
and the related combined statements of income and changes in capital for the years
then ended, which have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of The Federal
Reserve System. These financial statements are the responsibility of the Reserve
Banks' management. Our responsibility is to express an opinion on the financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
As discussed in Note 3, the combined financial statements were prepared in
conformity with the accounting principles, policies, and practices established by
the Board of Governors of The Federal Reserve System. These principles, policies,
and practices, which were designed to meet the specialized accounting and reporting needs of The Federal Reserve System, are set forth in the Financial Accounting
Manual for Federal Reserve Banks and constitute a comprehensive basis of
accounting other than generally accepted accounting principles generally accepted
in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all
material respects, the combined financial position of the Reserve Banks as of
December 31, 2002 and 2001, and the combined results of their operations for the
years then ended, in comformity with the basis of accounting described in Note 3.
318
89th Annual Report, 2002
FEDERAL RESERVE BANKS
COMBINED STATEMENTS OF CONDITION
December 31, 2002 and 2001
(in millions)
ASSETS
Gold certificates
Special drawingrightscertificates
Coin
Items in process of collection
Loans to depository institutions
Securities purchased under agreements to resell (tri-party)
U.S. government and federal agency securities, net
Investments denominated in foreign currencies
Accrued interest receivable
Bank premises and equipment, net
Other assets
Total assets
2002
2001
$ 11,039
2,200
988
10,291
40
39,500
639,125
16,913
5,470
2,044
3,367
$730,977
$ 11,045
2,200
1,047
3,188
34
50,250
561,701
14,559
5,729
2,021
3,175
$654,949
$654,273
21,091
$611,757
. ..
22,541
4,420
444
9,459
838
915
236
714,217
17,478
6,645
287
2,490
498
882
227
640,264
8,380
8,380
16,760
$730,977
7,373
7,312
14,685
$654,949
LIABILITIES AND CAPITAL
LIABILITIES
Federal Reserve notes outstanding, net
Securities sold under agreements to repurchase
Deposits
Depository institutions
U.S. Treasury, general account
Other deposits
Deferred credit items
Interest on Federal Reserve notes due U.S. Treasury
Accrued benefit costs
Other liabilities
Total liabilities
CAPITAL
Capital paid-in
Surplus
Total capital
Total liabilities and capital
The accompanying notes are an integral part of these combined financial statements.
Federal Reserve Banks Combined Financial Statements 319
FEDERAL RESERVE BANKS
COMBINED STATEMENTS OF INCOME
for the years ended December 31, 2002 and 2001
(in millions)
Interest income
Interest on U.S. government and federal agency securities
Interest on investments denominated in foreign currencies
Interest on loans to depository institutions
Total interest income
Interest expense:
Interest expense on securities sold under agreements to repurchase
Net interest income
2002
2001
$25,525
272
2
25,799
$30,523
331
13
30,867
13
25,786
. ..
30,867
Other operating income
Income from services
Reimbursable services to government agencies
Foreign currency gains (losses), net
Government securities gains, net
Other income
Total other operating income
916
309
2,083
77
80
3,465
926
286
(1,435)
316
108
201
Operating expenses
Salaries and other benefits
Occupancy expense
Equipment expense
Assessments by Board of Governors
Other expenses
1,532
208
263
635
565
1,285
204
268
634
642
Total operating expenses
3,203
3,033
Net income prior to distribution
$26,048
$28,035
$
$
Distribution of net income
Dividends paid to member banks
Transferred to surplus
Payments to U.S. Treasury as interest on Federal Reserve notes
Total distribution
484
1,068
24,496
$26,048
The accompanying notes are an integral part of these combined financial statements.
428
518
27,089
$28,035
320
89th Annual Report, 2002
FEDERAL RESERVE BANKS
COMBINED STATEMENTS OF CHANGES IN CAPITAL
for the years ended December 31, 2002 and 2001
(in millions)
Capital
paid-in
Balance at January 1, 2001
(139 million shares)
Net income transferred to surplus
Net change in capital stock issued
(8 million shares)
Balance at December 31, 2001
(147 million shares)
Net income transferred to surplus
Net change in capital stock issued
(20 million shares)
Balance at December 31, 2002
(167 million shares)
$6,997
Surplus
Total
capital
$6,794
518
$13,791
518
376
$7,373
376
$7,312
1,068
1,007
1,007
$8,380
$14,685
1,068
$8,380
$16,760
The accompanying notes are an integral part of these combined financial statements.
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS
(1) STRUCTURE
The twelve Federal Reserve Banks (Reserve Banks) are
part of the Federal Reserve System (System) created by
Congress under the Federal Reserve Act of 1913 (Federal
Reserve Act) which established the central bank of the
United States. The Reserve Banks are chartered by the
federal government and possess a unique set of governmental, corporate, and central bank characteristics. Other
major elements of the System are the Board of Governors
of the Federal Reserve System (Board of Governors), the
Federal Open Market Committee (FOMC) and the Federal Advisory Council. The FOMC is composed of members of the Board of Governors, the president of the
Federal Reserve Bank of New York (FRBNY) and, on a
rotating basis, four other Reserve Bank presidents. Banks
that are members of the System include all national banks
and any state chartered bank that applies and is approved
for membership in the System.
Although the Reserve Banks are chartered as independent organizations overseen by the Board of Governors,
the Reserve Banks work jointly to carry out their statutory responsibilities. The majority of the assets, liabilities,
and income of the Reserve Banks is derived from central
bank activities and responsibilities with regard to monetary policy and currency. For this reason, the accompanying combined set of financial statements for the twelve
independent Reserve Banks is prepared with adjustments
to eliminate interdistrict accounts and transactions.
Board of Directors
The Reserve Banks serve twelve Federal Reserve Districts nationwide. In accordance with the Federal Reserve
Act, supervision and control of each Reserve Bank is
exercised by a Board of Directors. The Federal Reserve
Act specifies the composition of the Board of Directors
for each of the Reserve Banks. Each board is composed
of nine members serving three-year terms: three directors,
including those designated as Chairman and Deputy
Chairman, are appointed by the Board of Governors, and
six directors are elected by member banks. Of the six
elected by member banks, three represent the public and
three represent member banks. Member banks are divided
into three classes according to size. Member banks in
each class elect one director representing member banks
and one representing the public. In any election of directors, each member bank receives one vote, regardless of
the number of shares of Reserve Bank stock it holds.
(2) OPERATIONS AND SERVICES
The System performs a variety of services and operations.
Functions include: formulating and conducting monetary
policy; participating actively in the payments mechanism,
including large-dollar transfers of funds, automated clearinghouse (ACH) operations and check processing; distributing coin and currency; performing fiscal agency functions for the U.S. Treasury and certain federal agencies;
serving as the federal government's bank; providing
short-term loans to depository institutions; serving the
consumer and the community by providing educational
materials and information regarding consumer laws;
supervising bank holding companies, state member banks
and U.S. offices of foreign banking organizations; and
administering other regulations of the Board of Governors. The Board of Governors' operating costs are funded
through assessments on the Reserve Banks.
Federal Reserve Banks Combined Financial Statements 321
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
The FOMC establishes policy regarding open market
operations, oversees these operations, and issues authorizations and directives to the FRBNY for its execution of
transactions. Authorized transaction types include direct
purchase and sale of U.S. government and federal agency
securities, matched sale-purchase transactions, the purchase of securities under agreements to resell, the sale of
securities under agreements to repurchase, and the lending of U.S. government securities. FRBNY is also authorized by the FOMC to hold balances of and to execute
spot and forward foreign exchange (F/X) and securities
contracts in nine foreign currencies, maintain reciprocal
currency arrangements (F/X swaps) with various central
banks, and "warehouse" foreign currencies for the U.S.
Treasury and Exchange Stabilization Fund (ESF) through
the Reserve Banks.
(3) SIGNIFICANT ACCOUNTING POLICIES
Accounting principles for entities with the unique powers
and responsibilities of the nation's central bank have not
been formulated by the Financial Accounting Standards
Board. The Board of Governors has developed specialized accounting principles and practices that it believes
are appropriate for the significantly different nature and
function of a central bank as compared 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 of Governors. All Reserve
Banks are required to adopt and apply accounting policies
and practices that are consistent with the Financial
Accounting Manual.
These combined financial statements have been prepared in accordance with the Financial Accounting
Manual. Differences exist between the accounting principles and practices of the System and generally accepted
accounting principles in the United States of America
(GAAP). The primary differences are the presentation
of all security holdings at amortized cost, rather than at
the fair value presentation requirements of GAAP, and the
accounting for matched sale-purchase transactions as
separate sales and purchases, rather than secured borrowings with pledged collateral, as is generally required
by GAAP. In addition, the Board of Governors and the
Reserve Banks have elected not to present a Statement of
Cash Rows. The Statement of Cash Flows has not been
included, as the liquidity and cash position of the Reserve
Banks are not of primary concern to users of these
combined financial statements. Other information regarding the Reserve Banks' activities is provided in, or may
be derived from, the Statements of Condition, Income,
and Changes in Capital. Therefore, a Statement of Cash
Flows 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 of the combined financial statements
in conformity with the Financial Accounting Manual
requires management to make certain estimates and
assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at
the date of the combined financial statements, and the
reported amounts of income and expenses during the
reporting period. Actual results could differ from those
estimates. Certain amounts relating to the prior year have
been reclassified to conform to the current-year presentation. Unique accounts and significant accounting policies
are explained below.
(A) Gold Certificates
The Secretary of the Treasury is authorized to issue gold
certificates to the Reserve Banks to monetize 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 of the U.S.
Treasury. The U.S. Treasury may reacquire the gold certificates at any time and the Reserve Banks must deliver
them to the U.S. Treasury. At such time, the U.S. Treasury's account is charged and the Reserve Banks' gold
certificate account is lowered. The value of gold for
purposes of backing the gold certificates is set by law at
$42% a fine troy ounce.
(B) Special Drawing Rights Certificates
Special drawing rights (SDRs) are issued by the International Monetary Fund (Fund) to its members in proportion to each member's quota in the Fund at the time of
issuance. SDRs serve as a supplement to international
monetary reserves and may be transferred from one national monetary authority to another. Under the law providing for United States participation in the SDR system,
the Secretary of the U.S. Treasury is authorized to issue
SDR certificates, somewhat like gold certificates, to the
Reserve Banks. At such time, equivalent amounts in
dollars are credited to the account established for the U.S.
Treasury, and the Reserve Banks' SDR certificate account
is increased. The Reserve Banks are required to purchase
SDRs, at the direction of the US. Treasury, for the
purpose of financing SDR certificate acquisitions or for
financing exchange stabilization operations.
(C) Loans to Depository Institutions
The Depository Institutions Deregulation and Monetary
Control Act of 1980 provides that all depository institutions that maintain reservable transaction accounts or
nonpersonal time deposits, as defined in Regulation D
issued by the Board of Governors, have borrowing privileges at the discretion of 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 loans were ever
deemed to be uncollectible, an appropriate reserve would
be established. Interest is accrued using the applicable
discount rate established at least every fourteen days by
the Board of Directors of the Reserve Banks, subject to
review by the Board of Governors. Reserve Banks retain
the option to impose a surcharge above the basic rate in
certain circumstances.
322
89th Annual Report, 2002
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
(D) US. Government and Federal Agency Securities and
Investments Denominated in Foreign Currencies
The FOMC 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 market,
the FOMC authorizes and directs the FRBNY to execute
operations in foreign markets for major currencies in
order to counter disorderly conditions in exchange markets or to meet other needs specified by the FOMC in
carrying out the System's central bank responsibilities.
Such authorizations are reviewed and approved annually
by the FOMC.
In December 2002, matched sale-purchase (MSP)
transactions were replaced with securities sold under
agreements to repurchase. MSP transactions, accounted
for as separate sale and 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. Securities sold under agreements to repurchase are treated as secured borrowing transactions with
the associated interest expense recognized over the life of
the transaction.
In addition to the aforementioned matched salepurchase transactions and sales of securities under agreements to repurchase, the FRBNY engages in tri-party
purchases of securities under agreements to resell (triparty agreements). Tri-party agreements are conducted
with two custodial banks that manage the clearing and
settlement of collateral. Acceptable collateral under triparty repurchase agreements primarily includes U.S. Government and agency securities, pass-through mortgage
securities of GNMA, FHLMC, and FNMA, STRIP securities of the U.S. Government and "stripped" securities
of other government agencies. The tri-party agreements
are accounted for as financing transactions with the
associated interest income accrued over the life of the
agreements.
The FRBNY has sole authorization by the FOMC 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 clearing arrangements on
behalf of the System, in order to facilitate the effective
functioning of the domestic securities market. These
securities-lending transactions are fully collateralized by
other U.S. government securities. FOMC policy requires
FRBNY to take possession of collateral in excess of the
market values of the securities loaned. The market values
of the collateral and the securities loaned are monitored
by FRBNY on a daily basis, with additional collateral
obtained as necessary. The securities loaned continue to
be accounted for in the SOMA.
F/X 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 of a swap/warehousing transaction.
The FRBNY, on behalf of the Reserve Banks, main-
tains renewable, short-term F/X swap arrangements with
two authorized foreign central banks. The parties agree to
exchange their currencies up to a pre-arranged maximum
amount and for an agreed upon period of time (up to
twelve months), at an agreed upon interest rate. These
arrangements give the FOMC 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 currency. 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 maturity. The Bank will generally invest
the foreign currency received under an F/X swap in
interest-bearing instruments.
Warehousing is an arrangement under which the
FOMC agrees to exchange, at the request of the Treasury,
U.S. dollars for foreign currencies held by the Treasury
or ESF over a limited period of time. The purpose of the
warehousing facility is to supplement the U.S. dollar
resources of the Treasury and ESF for financing purchases of foreign currencies and related international
operations.
In connection with its foreign currency activities, the
FRBNY, on behalf of the Reserve Banks, may enter into
contracts which contain varying degrees of 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 limits, and performing daily monitoring procedures.
While the application of current market prices to the
securities currently held in the SOMA portfolio 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 of reserves available to the
banking system or on the prospects for future Reserve
Bank earnings or capital. Both the domestic and foreign
components of the SOMA portfolio from time to time
involve transactions that can result in gains or losses
when holdings are sold prior to maturity. Decisions
regarding the securities and foreign currencies transactions, including their purchase and sale, are motivated
by monetary policy objectives rather than profit. Accordingly, market values, earnings, and any gains or losses
resulting from the sale of such currencies and securities
are incidental to the open market operations and do not
motivate its activities or policy decisions.
U.S. government and federal agency securities and
investments denominated in foreign currencies comprising the SOMA are recorded at cost, on a settlement-date
basis, and adjusted for amortization of premiums or accretion of discounts on a straight-line basis. Interest income
is accrued on a straight-line basis and is reported as
"Interest on U.S. government and federal agency securities" or "Interest on investments denominated in foreign
currencies," as appropriate. Income earned on securities
lending transactions is reported as a component of "Other
income." Gains and losses resulting from sales of securities are determined by specific issues based on average
cost. Gains and losses on the sales of U.S. government
Federal Reserve Banks Combined Financial Statements 323
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
and federal agency securities are reported as "Government securities gains, net." Foreign-currencydenominated assets are revalued daily 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 counterparty, and warehousing arrangements are
revalued daily, with the unrealized gain or loss reported
as a component of "Other assets" or "Other liabilities,"
as appropriate.
(E) Bank Premises, Equipment, and Software
Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is calculated on a
straight-line basis over estimated useful lives of assets
ranging from 2 to 50 years. New assets, major 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. Costs incurred for software, either developed
internally or acquired for internal use, during the application stage are capitalized based on the cost of direct
services and materials associated with designing, coding,
installing, or testing software.
(F) Federal Reserve Notes
Federal Reserve notes are the circulating currency of the
United States. These notes are issued through the various
Federal Reserve agents (the Chairman of the Board of
Directors of each Reserve Bank) to the Reserve Banks
upon deposit with such agents of certain classes of collateral security, typically U.S. government securities. These
notes are identified as issued to a specific Reserve Bank.
The Federal Reserve Act provides that the collateral
security tendered by the Reserve Bank to the Federal
Reserve agent must be equal to the sum of the notes
applied for by such Reserve Bank. In accordance with the
Federal Reserve Act, gold certificates, special drawing
rights certificates, U.S. government and federal agency
securities, securities purchased under agreements to
resell, loans to depository institutions, and investments
denominated in foreign currencies are pledged as collateral for Federal Reserve notes. The collateral value is
equal to the book value of the collateral tendered, with the
exception of securities whose collateral value is equal to
the par value of the securities tendered and securities
purchased under agreements to resell, which are valued at
the contract amount. The par value of securities pledged
for securities sold under agreements to repurchase is
similarly deducted. The Board of Governors may, at any
time, call upon a Reserve Bank for additional security
to adequately collateralize the Federal Reserve notes. To
satisfy the obligation to provide sufficient collateral for
outstanding Federal Reserve notes, the Reserve Banks
have entered into an agreement that provides that certain
assets of the Reserve Banks are jointly pledged as collateral for the Federal Reserve notes of all Reserve Banks.
In the event that this collateral is insufficient, the Federal
Reserve Act provides that Federal Reserve notes become
a first and paramount lien on all the assets of the Reserve
Banks. Finally, as obligations of the United States, Federal Reserve notes are backed by the full faith and credit
of the United States government.
The "Federal Reserve notes outstanding, net" account
represents Federal Reserve notes outstanding reduced by
the Reserve Banks' currency holdings of $104,983 million and $139,783 million at December 31, 2002 and
2001, respectively.
At December 31, 2002, all gold certificates, all special
drawing rights certificates, and $644,458 million of
domestic securities and securities purchased under agreements to resell were pledged as collateral. At December 31, 2002, no loans or investments denominated in
foreign currencies were pledged as collateral.
(G) Capital Paid-in
The Federal Reserve Act requires that each member bank
subscribe to the capital stock of the Reserve Bank in an
amount equal to 6 percent of the capital and surplus of the
member bank. As a member bank's capital and surplus
changes, its holdings of the Reserve Bank's stock must be
adjusted. Member banks are those state-chartered banks
that apply and are approved for membership in the System and all national banks. Currently, only one-half of the
subscription is paid-in and the remainder is subject to
call. These shares are nonvoting with a par value of $100.
They may not be transferred or hypothecated. By law,
each member bank is entitled to receive an annual dividend of 6 percent on the paid-in capital stock. This
cumulative dividend is paid semiannually. A member
bank is liable for Reserve Bank liabilities up to twice the
par value of stock subscribed by it.
(H) Surplus
The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount of capital paid-in as of
December 31. This amount is intended to provide additional capital and reduce the possibility that the Reserve
Banks would be required to call on member banks for
additional capital. Pursuant to Section 16 of the Federal
Reserve Act, Reserve Banks are required by the Board of
Governors to transfer to the U.S. Treasury excess earnings, after providing for the costs of operations, payment
of dividends, and reservation of an amount necessary to
equate surplus with capital paid-in. Surplus was not
equated to capital at December 31, 2001 at one Reserve
Bank where the amount of additional surplus required
exceeded the Bank's net income.
In the event of losses, or a substantial increase in
capital, a Reserve Bank will suspend its payments to the
U.S. Treasury until such losses or increases in capital are
recovered through subsequent earnings. Weekly payments to the U.S. Treasury may vary significantly.
(I) Income and Costs Related to Treasury Services
Reserve Banks are required by the Federal Reserve Act
to serve as fiscal agents and depositories of the United
States. By statute, the Department of the Treasury is
permitted, but not required, to pay for these services.
324 89th Annual Report, 2002
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
(J) Taxes
The Reserve Banks are exempt from federal, state, and
local taxes, except for taxes on real property, which are
reported as a component of "Occupancy expense."
(4) U.S. GOVERNMENT AND FEDERAL AGENCY
SECURITIES
Securities bought outright are held in the SOMA at the
FRBNY.
Total securities held in the SOMA at December 31,
2002 and 2001, that were bought outright, were as follows (in millions):
2002
Par value
Federal agency
U.S. government
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total
$
2001
10
$
10
226,682
297,893
104,832
629,417
182,074
265,941
103,660
551,685
10,762
(1,054)
$639,125
11,302
(1,286)
$561,701
The maturity distribution of U.S. government and federal agency securities bought outright and securities purchased under agreements to resell, which were held in
the SOMA at December 31, 2002, was as follows (in
millions):
U.S.
Maturities of
securities held
government
securities
(Par)
Within 15 days .. . $ 27,444
16 days to 90 days . 154,225
91 days to 1 year . . 141,840
Over 1 year to
5 years
. 172,758
Federal
agency
obligations
(Par)
$. . .
10
172,758
Over 5 years to
10years . . . . .
Over 10 y e a r s . . . . .
53,300
79,840
Total.... $629,407
Maturities of
securities held
Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total
Total
$ 27,444
154,225
141,850
$10
53,300
79,840
$629,417
Repurchase
agreements
(Contract amount)
$25,500
14,000
• ••
_1_L_L_
$39,500
Securities purchased under agreements to resell at
December 31, 2002 and 2001 were $39,500 million and
$50,250 million, respectively, and consisted entirely of
agreements through third party custodial arrangements.
As mentioned in footnote 3, in December 2002, the
FRBNY replaced MSP transactions with securities sold
under agreements to repurchase. At December 31, 2002,
securities sold under agreements to repurchase with a
contract amount of $21,091 million and a par value of
$21,098 million were outstanding. At December 31,2001,
MSP transactions involving U.S. government securities
with a par value of $23,188 million were outstanding.
Securities sold under agreements to repurchase and MSP
transactions are generally overnight arrangements.
At December 31, 2002 and 2001, U.S. government
securities with par values of $1,841 million and
$7,345 million, respectively, were loaned from the
SOMA.
(5) INVESTMENTS DENOMINATED IN
FOREIGN CURRENCIES
The FRBNY, on behalf of the Reserve Banks, holds
foreign currency deposits with foreign central banks and
the Bank for International Settlements, and invests in
foreign government debt instruments. Foreign government debt instruments held include both securities bought
outright and securities held under agreements to resell.
These investments are guaranteed as to principal and
interest by the foreign governments.
Total investments denominated in foreign currencies,
valued at current exchange rates at December 31, were as
follows (in millions):
European Union Euro
Foreign currency deposits
Government debt instruments
including agreements
to resell
Japanese Yen
Foreign currency deposits
Government debt instruments
including agreements
toresell
Accrued interest
Total
2002
2001
$ 5,580
$ 4,593
3,298
2,695
1,789
1,891
6,164
5,315
82
65
$16,913
$14,559
Federal Reserve Banks Combined Financial Statements 325
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
The maturity distribution of investments denominated
in foreign currencies at December 31, 2002, was as
follows (in millions):
Maturities of Investments Denominated
in Foreign Currencies
Within 1 year
Over 1 year to 5 years
Over 5 years to 10 years
$15,611
904
398
Total
$16,913
At December 31, 2002 and 2001, there were no open
foreign exchange contracts or outstanding F/X swaps.
At December 31,2002 and 2001, the warehousing facility was $5,000 million, with a zero balance outstanding.
(6) BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31 is as follows (in millions):
2002
Bank premises and equipment
Land
Buildings
Building machinery and
equipment
Construction in progress
Furniture and equipment
Accumulated depreciation
Bank premises and
equipment, net
345
51
1,362
329
32
1,365
Thereafter .
3,481
3,405
Amount representing interest . . .
(1,437)
(1,384)
$2,044
$2,021
2001
$15
_(12)
$21
(14)
$J[
$J7
Certain of the Reserve Banks lease unused space to
outside tenants. Those leases have terms ranging from 1
to 13 years. Rental income from such leases totaled
$21 million and $20 million for the years ended December 31, 2002 and 2001, respectively. Future minimum
lease payments under noncancelable agreements in existence at December 31, 2002, were (in millions):
Thereafter
Total
2003
2004
2005
2006
2007
$ 201
1,478
2002
2003
2004
2005
2006
2007
Future minimum rental payments under noncancelable
operating leases, net of sublease rentals, with terms
of one year or more, at December 31, 2002, were (in
millions):
$ 209
1,514
Bank premises and equipment at December 31 include
the following amounts for leases that have been capitalized (in millions):
Capitalized leases, net
At December 31,2002, the Reserve Banks were obligated
under noncancelable leases for premises and equipment
with terms ranging from 1 to approximately 21 years.
These leases provide for increased rentals based upon
increases in real estate taxes, operating costs, or selected
price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data processing and
office equipment (including taxes, insurance and maintenance when included in rent), net of sublease rentals, was
$70 million and $69 million for the years ended December 31, 2002 and 2001, respectively. Certain of the
Reserve Banks' leases have options to renew.
2001
Depreciation expense was $187 million and $186 million for the years ended December 31, 2002 and 2001,
respectively.
Bank premises and equipment
Accumulated depreciation
(7) COMMITMENTS AND CONTINGENCIES
$17
15
12
9
6
21
$80
Operating
Capital
$ 11.0
10.2
8.8
7.4
6.6
$130.8
$174.8
$ 6.3
6.2
.4
.4
$13.3
(1.1)
$12.2
At December 31,2002, the Reserve Banks had contractual commitments through the year 2007 totaling
$119.7 million for the maintenance of currency machines
and check-processing-related services, $118.7 million of
which has not been recognized. Two Reserve Banks
contract for these services on behalf of the System.
Three Reserve Banks have additional contractural commitments through the year 2007 for software maintenance, architectural services, and check transportation
services. At December 31, 2002, these contractual commitments totaled $160.8 million, $143.7 million of which
has not been recognized.
The Reserve Banks are involved in certain legal actions
and claims arising in the ordinary course of business.
Although it is difficult to predict the ultimate outcome of
these actions, in management's opinion, based on discussions with counsel, the aforementioned litigation and
claims will be resolved without material adverse effect
on the financial position or results of operations of the
Reserve Banks.
(8) RETIREMENT AND THRIFT PLANS
Retirement Plans
The Reserve Banks currently offer two defined benefit
retirement plans to their employees, based on length of
service and level of compensation. Substantially all of
the Reserve Banks', Board of Governors', and the Plan
Administrative Office's employees participate in the
326
89th Annual Report, 2002
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
Retirement Plan for Employees of the Federal Reserve
System (System Plan) and the Benefit Equalization
Retirement Plans offered by each individual Reserve
Bank (BEP) and certain Bank officers participate in a
Supplemental Employee Retirement Plan (SERP).
The System Plan is a multi-employer plan with contributions fully funded by participating employers. Certain
Board employees not covered by the Social Security Act
also contribute to the plan. No separate accounting is
maintained of assets contributed by the participating
employers. FRBNY acts as a sponsor of this Plan. The
prepaid pension cost includes amounts related to employees participating in the plans from the 12 Reserve Banks,
the Board of Governors, and the Plan Administrative
Office.
Following is a reconciliation of the beginning and
ending balances of the System Plan benefit obligation (in
millions):
2002
2001
Estimated actuarial present value
of projected benefit
obligation at January 1
$3,091
$2,810
Service cost—benefits earned
during the period
104
85
Interest cost on projected
benefit obligation
226
207
Actuarial loss
126
125
Contributions by plan participants ..
3
3
Benefits paid
(170)
(139)
Plan amendments
143 _ j _ ^ _
Estimated actuarial present value
of projected benefit
obligation at December 31 . . . . $3,523
$3,091
The weighted-average assumptions used in developing
the pension benefit obligation for the System Plan are as
follows:
Discount rate
Expected long-term rate of
return on plan assets
Rate of compensation increase
2002
2001
6.75%
7.00%
9.00%
4.25%
9.00%
4.50%
The components of net periodic pension benefit credit
for the System Plan as of December 31 are shown below
(in millions):
Service cost—benefits earned
during the period
Interest cost on projected
benefit obligation
Amortization of initial net
transition obligation
Amortization of prior service
cost
Recognized net (gain)
Expected return on plan assets
Net periodic pension benefit (credit).
2002
2001
$ 104
$ 85
226
207
(45)
(514)
27
16
(44)
(550)
$(157)
$(331)
Net periodic pension benefit (credit) is reported as a
component of "Salaries and other benefits."
The Reserve Banks' projected benefit obligation and
net pension costs for the BEP at December 31, 2002 and
2001, and for the SERP at December 31, 2002, and for
the years then ended, are not material.
Thrift Plan
Following is a reconciliation of the beginning and
ending balances of the System Plan assets, the funded
status, and the prepaid pension benefit costs (in millions):
2002
2001
Estimated fair value of plan
assets at January 1
$5,795
Actual return on plan assets
(631)
Contributions by plan participants ..
3
Benefits paid
(170)
$6,176
(245)
3
(139)
Estimated fair value of plan
assets at December 31
$4,997
$5,795
Funded status
$1,474
Unrecognized prior service cost . . . .
223
Unrecognized net actuarial
loss/(gain)
1,042
$2,703
107
Prepaid pension benefit costs
2,739
(228)
2,582
Prepaid pension benefit costs are reported as a component
of "Other assets."
Employees of the Reserve Banks may also participate in
the defined contribution Thrift Plan for Employees of the
Federal Reserve System (Thrift Plan). The Reserve
Banks' Thrift Plan contributions totaled $63 million and
$50 million for the years ended December 31, 2002 and
2001, respectively, and are reported as a component of
"Salaries and other benefits."
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
AND POSTEMPLOYMENT BENEFITS
Postretirement Benefits Other Than Pensions
In addition to the Reserve Banks' retirement plans,
employees who have met certain age and length of service requirements are eligible for both medical benefits
and life insurance coverage during retirement.
The Reserve Banks fund benefits payable under the
medical and life insurance plans as due and, accordingly,
have no plan assets. Net postretirement benefit costs are
actuarially determined using a January 1 measurement
date.
Federal Reserve Banks Combined Financial Statements 327
NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED
Following is a reconciliation of beginning and ending
balances of the benefit obligation (in millions):
2002
One percentage
point increase
Effect o n
2001
aggregate
of service and
interest cost
components of
net
periodic
postretirement
^ benefit costs
$ 9
Effect o n
accumulated
postretirement
benefit obligation . . . 94
Accumulated postretirement benefit
obligation at January 1
$674
$644
Service cost—benefits earned during
theperiod
17
16
Interest cost of accumulated
benefit obligation
47
47
Actuarial loss
49
54
Contributions by plan participants
4
4
Benefits paid
(37) (31)
Plan amendments, curtailments,
and special termination benefits . . . (12)
(60)
Accumulated postretirement benefit
obligation at December 31
$742
$674
=
=
Following is a reconciliation of the beginning and ending
balances of the plan assets, the unfunded postretirement
benefit obligation and the accrued postretirement benefit
costs (in millions):
2002
Fair value of plan assets at January 1 . . . $
Contributions by the employer
33
Contributions by plan participants
4
Benefits paid
(37)
Fair value of plan assets at
December31
$• • .
One percentage
point decrease
$ (8)
(81)
The following is a summary of the components of net
periodic postretirement benefit costs for the years ended
December 31 (in millions):
2002 2001
Servic e
k
me
cost-benefits earned during
$17
$16
^nod
accumulated benefit
obligation
47
47
Amortization of prior service cost
(14)
(9)
Recognized net actuarial loss/(gain)
2
(1)
Net periodic postretirement benefit costs . . $52
$53
v
F
=
=
Interest cost o f
2001
$
27
4
(31)
Net periodic postretirement benefit costs are reported as a
component of "Salaries and other benefits."
$. • .
Postemployment Benefits
Unfunded postretirement benefit
obligation
$742
Unrecognized prior service cost
141
Unrecognized net actuarial gain/(loss) . . J 9 3 )
Accrued postretirement benefit costs . . . $790
$674
146
J48)
$772
The Reserve Banks offer benefits to former or inactive
employees. Postemployment benefit costs are actuarially
d e t e r m i n e d md
i n c l u d e m e c o s t o f m e d i c a l md
dental
insurance, survivor income, disability benefits, and those
workers' compensation expenses self-insured by indiAccrued postretirement benefit costs are reported as a
v i d u a l R ese rve Banks. Costs were projected using the
component of "Accrued benefit costs."
s a m e d i SCO unt rate and health care trend rates as were
At December 31, 2002 and 2001, the weighted-average
u s e d f o r projecting postretirement costs. The accrued
discount rate assumptions used in developing the postpostemployment benefit costs recognized by the Reserve
retirement benefit obligation were 6.75 percent and B a n k s a t December 31, 2002 and 2001, were $121 mil7.00 percent, respectively.
l i o n and $110 million, respectively. This cost is included
For measurement purposes, a 9.00 percent annual rate
a s a component of "Accrued benefit costs." Net periodic
of increase in the cost of covered health care benefits was
postemployment benefit costs included in 2002 and 2001
assumed for 2003. Ultimately, the health care cost trend
operating expenses were $26 million and $21 million,
rate is expected to decrease gradually to 5.00 percent by
respectively.
2008, 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
trendI rates would have the following effects for the year
ended December 31.2002 (in millions):
( 1 0 ) SUBSE
<*>ENT EVENT
~n~~ , „
, ., ,
_
'
H 2 0 0 3 ' * e S y. s t e m d £ l d e d t 0 reslIuctu" l t s
h
c h <
coIlectl n
ons
^
? . "^f
- ™ " restructuring plans
m de
f
• * » * » » ' « «"» c h e c k management structure,
reducing staff, decreasing the number of check-processing
locations and increasing processing capacity in other locations. The restructuring, which is expected to begin in
2003 and conclude by the end of 2004, will result in the
Reserve Banks discontinuing check operations in thirteen
offices, increasing check processing capacity in nine
offices, and consolidating check adjustment functions in
twelve offices. At this time, the Reserve Banks have not
developed detailed estimates of the cost of the restucturing plan in the aggregate or for the individual Reserve
Banks affected.
T
to
T
328
Office ofInspector General Activities
The Board's Office of Inspector General
(OIG) functions in accordance with the
Inspector General Act of 1978, as
amended. In addition to retaining an
independent auditor each year to audit
the Board's financial statements, the
OIG plans and conducts audits and
investigations of the Board's programs
and operations and its delegated functions at the Federal Reserve Banks. The
OIG also reviews existing and proposed
legislation and regulations for economy
and efficiency. It recommends policies,
and it supervises and conducts activities
that promote economy and efficiency
and that prevent and detect waste, fraud,
and abuse in Board and Board-delegated
programs and operations as well as in
activities administered or financed by
the Board. The OIG keeps the Congress
and the Chairman of the Board of
Governors fully informed about serious
abuses and deficiencies and about the
status of any corrective actions.
During 2002, the OIG completed
eleven audits, reviews, and other assessments (table) and conducted a number
of follow-up reviews to evaluate action
taken on earlier recommendations. The
OIG also closed twenty-seven investigations and performed numerous legislative and regulatory reviews.
Completed OIG Audits, Reviews, and Assessments, 2002
Report title
Report number
Month issued
Audit of Board's Government Travel Card Program
Audit of the FFIEC's Financial Statements (Years Ended 2000 and 2001) ..
Bond Life Cycle Assessment
Audit of the Board's Financial Statements (Years Ended 2000 and 2001)...
Audit of the Board's Use of and Controls over Purchase Cards
Review of the Eccles Building Project—Phase 3
Board's Recruiting Process Assessment
Review of Integrating Support Services into the Management Division
Business Process Review of the Board's Publications Program—Phase 3 . . .
Audit of the Board's Information Security Program
Report on the Failure of the Oakwood Deposit Bank Company
AOOll
A0115
R0103
A0115BD
A0109
R0202
R0203
R0204
R0201
A0205
A0202
January
February
February
March
May
May
May
June
June
September
October
329
General Accounting Office Reviews
Under the Federal Banking Agency
Audit Act (Public Law 95-320), most of
the operations of the Federal Reserve
System are under the purview of the
General Accounting Office (GAO). In
2002, the GAO completed four reports
on selected aspects of Federal Reserve
operations (table). Seven projects concerning the Federal Reserve were in
various stages of completion at yearend (table). The reports are available
directly from the GAO.
Completed GAO Reports Relating to the Federal Reserve System, 2002
Report title
Payment Systems: Central Bank Roles Vary, but Goals Are the Same
Federal Reserve Banks: Areas for Improvement in Computer Controls
Federal Reserve System: The Surplus Account
Federal Reserve System: Update on GAO's 1996 Recommendations
Report number
GAO-02-303
GAO-02-832R
GAO-02-939
GAO-02-774
Date issued
2-25-02
7-30-02
9-18-02
9-25-02
Active GAO Projects Relating to the Federal Reserve System, Year-End 2002
Subject of project
Supervisory and regulatory policies regarding cyber-threats
Business continuity planning and security issues for Fedwire
Risk assessment, security, and controls for the pay.gov system
Federal Reserve's relationship with U.S. Mint and BEP
Prevention and identification of illegal tying
Role investment banks play in design and marketing various types of financial transactions
Progress with implementing information technology enterprise architectures
Date initiated
5-24-02
5-30-02
7-30-02
7-30-02
9-24-02
10-25-02
10-29-02
Maps of the
Federal Reserve System
332 89th Annual Report, 2002
The Federal Reserve System
1
BOSTON
INNEAPOLiS |
7
_
o
• N E W YORK
CHICAGO
CLEVELAND
I SAM FRANCISCO
PHILADELPHIA
4
lCAN$ASfclTY|
JBT
°
RICHMOND
ST. LOUIS
11
5
8
6 •
DALLAS
ATLANTA
HAWAII fi
LEGEND
Both pages
• Federal Reserve Bank city
Q Board of Governors of the Federal
Reserve System, Washington, D.C.
Facing page
• Federal Reserve Branch city
— Branch boundary
NOTE
The Federal Reserve officially identifies
Districts by number and by Reserve
Bank city (shown on both pages) and by
letter (shown on the facing page).
In the 12th District, the Seattle
Branch serves Alaska, and the San Francisco Bank serves Hawaii.
The System serves commonwealths
and territories as follows: The New York
Bank serves the Commonwealth of
Puerto Rico and the U.S. Virgin Islands;
the San Francisco Bank serves American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands.
The maps show the boundaries within
the System as of year-end 2002.
Maps of the Federal Reserve System
1-A
ME
2-B
3-C
4-D
5-E
Pittsburgh
333
Balti
PA
•Charlotte
Buffalo
BOSTON
NEW YORK
PHILADELPHIA
7-G
ATLANTA
RICHMOND
CLEVELAND
8-H
CHICAGO
ST. LOUIS
MINNEAPOLIS
12-L
•Los Angeles
SAN FRANCISCO
Index
337
Index
Accrued interest receivable, guidance,
108
Agreement corporations, 103, 104, 153,
155
Applications, processing of, 120
Assets and liabilities
Banks, insured commercial, by class,
295
Board of Governors, 308
Federal Reserve Banks, 272-75
Nonperforming assets, 93
ATMs (See Automated teller machines)
Auditors' reports, 307, 315, 316, 317
Automated clearinghouse services, Federal
Reserve Banks, 128, 291
Automated screening systems, 103
Automated teller machines, use of, 81
Availability of Funds and Collection of
Checks (See Regulations: CC)
Balance sheets
Board of Governors, 308-14
Federal Reserve Banks, combined,
317-27
Federal Reserve priced services, 138-41
Bank holding companies
Capital standards, 106, 154
Financial reports, 111
Inspections and examinations of, 95-97,
100, 103, 104"
International lending, 155
Stock repurchases by, 120
Bank Holding Companies and Change in
Bank Control (See Regulations: Y)
Bank Holding Company Act, 115
Bank Holding Company Performance
Reports, 103
Bank Merger Act, 118
Bank Secrecy Act, 121
Banking industry, structuring, 115-20
Banking organizations, U.S.
Capital standards, 106, 109
Examinations and inspections of, 95-101
Financial reporting, transparency, 111
Foreign operations, 104
Internal controls, 111
Operating efficiency, 94
Banking organizations, U.S.—Continued
Overseas investments, 119
Parallel-owned, 157
Risk-focused supervision of, 101-103
Banks, U.S.
Number, 295, 302
Operating efficiency, 94
Basel Committee on Banking Supervision,
109
Board of Governors (See also Federal
Reserve System)
Audit of, 307-16
Consumer Advisory Council, 84, 246
Federal Advisory Council, 245
FFIEC activities, 107, 112-14
Financial statements, 307-16
Government Performance and Results
Act, 143-45
Inspector General, Office of, audits and
reviews, 328
Law enforcement authority, 156
Members and officers, lists, 241-43,
267-70
Policy actions, 151-59
Public notice of decisions, 120
Thrift Institutions Advisory Council, 247
Borrowers of Securities Credit (See
Regulations: X)
Business loans, demand for, 93
Business spending, investment, and
finance, 14-20, 48-51
Business-continuity plans, Federal Reserve
Banks, 125
Business-continuity risk profile, 108
CAESAR (See Complaint Analysis
Evaluation System and Reports)
Call Reports, 113
Capital
Accounts, Federal Reserve Banks,
272-75, 318
Changes in, Federal Reserve Banks, 320
Flows, 23, 54
Standards, 94, 106, 109, 154
Car loans, interest rates, 59
Cash flows, Board of Governors, 310
Cash services, Federal Reserve Banks, 130
338
89th Annual Report, 2002
Chain-type price index, 58
Change in Bank Control Act, 118
Check collection and processing, Federal
Reserve Banks, 126-28, 291
Citigroup, Inc., merger application, 70
Civil money penalties, 101
Commercial Lending Essentials for
Consumer Affairs, examiner training,
74
Commercial, banks, number of, 295, 302
Community affairs, 69-91
Community banks, risk-focused supervision
of, 102
Community development
Indian Country, 88
Small businesses, 90
Underserved markets, 86
Community Reinvestment Act
Compliance examinations, 69-71
Mergers and acquisitions, applications
for, 70
Review of, 72
Community Reinvestment Act Examination
Techniques, examiner training, 74
Complaint Analysis Evaluation System and
Reports, 82
Compliance examinations, 71-75, 75-79
Consumer
Affairs, 69-91
Complaints, 82-84
Leasing (See Regulations: M)
Privacy protection, 86
Protection laws, compliance with, 75-79
Spending, 12, 46
Consumer Advisory Council, 84-86, 246
Consumer Compliance Examinations I
and II, examiner training, 73
Coooperatieve Centrale RaiffeisenBoerenleenbank, B.A., merger
application, 70
Corporate profits, 16-20, 49-51
Country risk, management of, 106
Courses, consumer compliance examiners,
73
Credit by Banks for the Purpose of
Purchasing or Carrying Margin Stocks
(See Regulations: U)
Credit card lending, guidance, 107
Credit, primary and secondary, 159
Currency and coin, operations and
developments in, 131, 291, 296, 298,
300, 318
Current account (See Trade, Foreign)
Debit card and direct deposit use, 81
Debt and financial intermediation, 31, 61
Depository institutions
Discount window credit, 151
Electronic access, 134
Interest rates on loans from Reserve
Banks, 292
Mortgage lending, 74
Reserve requirements, 153, 293
Reserves held, 296-301
Services to, by Federal Reserve Banks,
126-31
Depository services to U.S. Treasury, by
Federal Reserve Banks, 133
Deposits
Federal Reserve Banks, 272-75, 297,
299, 301
Insured commercial banks, 295
Direct bill payment, 81
Direct deposit, 81
Directors, Federal Reserve Banks and
Branches, list, 250-66
Disclosure statements and requirements, 74,
121
Discount rate (See also Interest rates),
157-59
Discount window credit, 33, 60, 151, 159
Earnings, banking industry, 93
Economic projections, 8, 44
Economies, foreign, 34-39, 62-65
Economy, U.S.
Business sector, 14-20, 48-51
Debt, 31, 61
Equity markets, 29-31, 59
Financial account, 23, 54
Financial markets, 27-34, 58-62
Government sector, 20, 51-53
Household sector, 12-14, 46-48
Interest rates, 28, 58
Labor market, 23-25, 55
Monetary aggregates, 32, 62
Monetary policy, 3-9, 41-45
Prices, 25-27, 56-58
Trade and current account, 22, 53
Edge Act corporations, 103, 104, 153, 155
Electronic access to Federal Reserve
services, 134
Electronic Fund Transfer Act, economic
effects of, 81
Index 339
Electronic Fund Transfers (See
Regulations: E)
Emerging-market economies (See
Economies, Foreign)
Employment, 23, 55
Employment cost index, 25, 56
Enforcement actions, Federal Reserve
System, 101
Equal Credit Opportunity (See Regulations:
B)
Equity markets, 29, 59, 156
Examinations and inspections
Bank holding companies, 95-97
Compliance with consumer protection
laws, 69-79
Fair lending, 71
Federal Reserve Banks, 134
Financial holding companies, 97
International banking activities, 103-105
Specialized
Fiduciary activities, 100
Government and municipal securities
dealers and brokers, 100
Information technology activities, 97,
100
Securities clearing agencies, 100
Securities credit lenders, 100
Transfer agents, 100
State member banks, 71, 95, 104
Supervisory policy, 105-14
U.S. banking organizations, foreign
operations, 104
Extensions of Credit by Federal Reserve
Banks (See Regulations: A)
Fair Lending Examination Techniques,
examiner training, 74
Fair lending examinations, 71
Federal Advisory Council, 245
Federal agency securities and obligations
Depository institution holdings, 295
Federal Reserve Banks, 272-75, 280,
282-85, 296, 298, 300
Federal Reserve open market operations,
225, 278
Federal Financial Institutions Examination
Council, activities, 103, 112-14
Federal funds rate, 4, 6, 7, 43, 44
Federal Open Market Committee
Authorizations, 161, 163, 168, 170
Directives, 171, 180, 189, 196, 204, 212,
219, 228, 235
FOMC—Continued
Disclosure policy, 180, 189
Guidelines and procedural instructions,
163, 165, 169, 172
Meetings, minutes of, 166, 180, 189,
197, 205, 213, 220, 229
Members and officers, list, 244
Notation votes, 220
Federal Reserve Act, 98, 155
Federal Reserve Banks
Assessments by Board of Governors,
284, 286-89
Audits of, 134, 305, 317-27
Branches
Directors, list, 250-66
Officers, list, 248
Premises, 136
Vice presidents in charge, list, 248
Business-continuity plans, 125
Checks handled, 291
Condition statements, 272-75, 318
Conferences of chairmen, presidents, and
first vice presidents, 249
Consumer and community affairs, 69-91
Currency and coin, operations and
developments in, 131, 291, 318
Deposits, 272-75
Directors, list, 250-66
Discount rate, 157-59, 292
Discount window programs, revisions,
151
Examinations of, 134
Financial statements, combined, 317-27
Float, credit outstanding, 131, 296, 298,
300
Holdings of loans and securities, 136,
137, 272-75, 296-301
Income and expenses, 132, 135, 138-41,
282-85, 286-89, 319
Information technology, 134
Initiatives, 125
Law enforcement authority, 156
Officers and employees, number and
salaries, 281
Officers, list, 248
Operations, volume, 291
Payments to the U.S. Treasury, 287, 289
Premises, 136, 272-75, 290, 318
Priced services, 126-31, 282
Salaries of officers and employees, 281
Securities and loans, holdings of, 136,
137, 272-75, 296-301
340 89th Annual Report, 2002
Federal Reserve Banks—Continued
Services
Automated clearinghouse, 128, 291
Cash, 130
Check collection, 126-28
Depository, 131, 133
Fedwire Funds, 128, 291
Fedwire Securities, 130
Fiscal agency, 131
Float associated with, 131
Food coupon, 291
National Settlement, 128, 130
Noncash collection, 130
Special cash, 130
Federal Reserve notes, interest on, 287,
289
Federal Reserve System (See also Board of
Governors)
Applications and proposals, 120
Decisions, public notice of, 120
Enforcement actions and civil money
penalties, 101
Examinations and inspections, 95-101
Examiner training, 73, 115
Intraday credit, 98
Maps, 332
Membership, 123
Supervision and regulation
responsibilities, 93-123
Technical assistance and training, 105
Federal sector, 20, 52
Federal tax payments, 133
Fedwire, 129, 130
FFIEC (See Federal Financial Institutions
Examination Council)
Fiduciary activities, supervision of, 100
Finance, business and household, 13, 16,
47,49
Financial
Education for consumers, 87
Holding companies, 97
Institutions, credit extensions to, 60
Markets, 4-9, 27-34, 42-44, 58-62
Reports, bank holding companies, 111
Statements
Board of Governors, 307-16
Disclosures of, 121
Federal Reserve Banks, combined,
317-27
Federal Reserve priced services,
138-41
Subsidiaries and Regulation W, 99
Fiscal agency services, Federal Reserve
Banks, 131
Float, Federal Reserve, 131, 296, 298, 300
Rood insurance, compliance with
Regulation H, 72
Food coupon services, Federal Reserve
Banks, 134, 291
Foreign
Banking organizations
Regulation W, 98
U.S. activities, examination of, 104
U.S. agencies and branches of, reserve
requirements, 153
Currency income, Federal Reserve
Banks, 282
Currency operations
Authorization for the conduct of, 163,
170
Procedural instructions for, 165, 172
Economic developments, 34-39, 62-65
Trade, 22, 53
Funds transfers, Federal Reserve Banks,
291
G-fund, 52
Garn-St Germain Depository Institutions
Act of 1982, 153
General Accounting Office, 329
Gold certificate account of Reserve Banks
and gold stock, 272-75, 296, 298,
300, 318
Government Performance and Results Act
of 1993, 143-45
Government Securities Investment Fund
(G-fund), 52
Government, federal
Depository services to, 133
Fiscal agency services to, 131-33
Receipts, spending, and debt, 20, 51-53
Securities dealers and brokers,
examination of, 100
Government, state and local, 21, 53
Gramm-Leach-Bliley Act of 1999, 86, 98,
110, 154, 237
Home Mortgage Disclosure (See
Regulations: C)
Home Mortgage Disclosure Act
Data collection, changes in procedures,
79,85
Data on loan transactions, 74
Index 341
Home Ownership and Equity Protection
Act, examination procedures, 72
Home Ownership Counseling Act,
examination procedures, 72
Homeowners Protection Act, examination
procedures, 72
Host-state loan-to-deposit ratios, updated,
73
Household sector, 12-14, 46-48
Housing and Urban Development,
Department of, complaint referrals, 84
Identity theft, 86
Immigrant communities, banking for, 89
Income and expenses
Board of Governors, 309
Federal Reserve Banks, 132-34, 135,
282-85, 286-89, 319
Federal Reserve priced services, 126-31,
138-41, 282
Inflation, 25-27, 56-58
Information technology
Federal Reserve examination of, 97, 100
Interagency examination program, 113
Services to depository institutions, 134
Supervisory Information Technology
(SIT), 114
Inspector General, Office of, audits and
reviews, 328
Insured commercial banks, assets and
liabilities, 295
Interest rates (See also Discount rate and
Federal funds rate), 28, 58, 93, 292
International
Banking activities, 155
Banking activities, supervision of,
103-105
Economic developments, 34-39, 62-65
International Accounting Standards Board,
110
International Banking Act, applications
under, 119
International Banking Operations (Reg. K),
155
International Lending Supervision Act of
1983, 155
Interstate bank branches, 154
Intraday credit, 98
Investments
Business, 14-16, 48, 49
Equity, regulatory capital treatment of,
106
Investments—Continued
Federal Reserve Banks, 272-75
Inventory, 16, 49
Overseas, by U.S. banking organizations,
119
Residential, 13, 47
Joint Forum, 110
Justice, Department of, Board referrals to,
71
Labor market, 23-25, 55
Labor productivity, 24, 55
Large, complex banking organizations,
supervision of, 102
Law enforcement authority, Federal
Reserve Board and Banks, 156
Legislation, federal, 147
Litigation involving the Board of
Governors
Albrecht, 237
Artis, 237
Caesar, 237
Community Bank Trust, 237
Fraternal Order of Police, 238
Howe, 238
Laredo National Bancshares, Inc., 237
Radfar, 237
Sedgwick, 237
Trans Union LLC, 237
Loans
Federal Reserve Banks
Holdings of and earnings on, 136,
137, 272-75, 296, 298, 300
Interest rates for depository
institutions, 292
Insured commercial banks, 295
Purchases and Regulation W, 99
State member bank executive officers,
123
Maps, Federal Reserve System, 332
Margin stocks and requirements, 121, 294
Margin stocks, interest, 93
Member banks (See also State member
banks)
Applications by, 120
Assets and liabilities, 295
Number of, 295, 302
Reserves, 297, 299, 301
Transactions with affiliates, 155
342 89th Annual Report, 2002
Members and officers, Board of Governors,
2 4 1 ^ 3 , 267-70
Membership of State Banking Institutions
in the Federal Reserve System (See
Regulations: H)
Mergers and acquisitions under CRA, 70
Monetary aggregates (Ml, M2, M3), 32, 62
Monetary Control Act of 1980, 153
Monetary policy, 3-9, 41-45
Monetary policy reports to the Congress
February 2003, 3-9, 11-39
July 2002, 41-65
Money laundering, 121
Municipal securities dealers and brokers,
examination of, 100
National Flood Insurance Act of 1968, 72
National Information Center (NIC), 114
Native Americans, community
development, 88
Noncash collection services, Federal
Reserve Banks, 130
Nonmember banks, 295, 302
Notes, Federal Reserve
Interest, 287, 289
Operations, 131, 291, 318
Oil prices, 23, 54
Open market operations
Alternative assets, use, 228
Authorization for conduct of, 161, 163,
168
Guidelines for the Conduct of System
Open Market Operations in Federal
Agency Issues, 163
Volume of transactions, 276-79
Overseas investments, U.S. banking
organizations, 119
Parallel-owned banking organizations,
157
Payments system, risk, 157
Point-of-sale transactions, 81
Policy statements and actions, 105-110,
151-59
Postal money order services, Federal
Reserve Banks, 134
Preferred stock, hedging of, guidance, 107
Premises, Federal Reserve Banks, 136,
272-75, 290, 318
Priced services, Federal Reserve Banks,
126-41, 282
Prices
Consumer, 25-27, 56, 58
Energy, 25, 56
Equity, 29-31, 59
Gasoline, 26, 56
Privacy of Consumer Financial Information
(See Regulations: P)
Privacy, consumer rights, 86
Profit and loss, Federal Reserve Banks, 284
Profits, corporate, 16-20, 49-51
Real Estate Settlement Procedures Act
(RESPA), examiner review and
guidance, 72, 86
Regional banking organizations,
supervision of, 101
Regulations
A, Extensions of Credit by Federal
Reserve Banks, 60, 151, 159
B, Equal Credit Opportunity, 76
C, Home Mortgage Disclosure, 79, 85,
151, 152
D, Reserve Requirements of Depository
Institutions, 151, 153
E, Electronic Fund Transfers, 76, 81
H, Membership of State Banking
Institutions in the Federal Reserve
System, 154
K, International Banking Operations, 155
M, Consumer Leasing, 77
P, Privacy of Consumer Financial
Information, 77
T, Credit by Brokers and Dealers, 294
U, Credit by Banks for the Purpose of
Purchasing or Carrying Margin
Stocks, 294
W, Transactions between Member Banks
and Their Affiliates, 98, 155
X, Borrowers of Securities Credit, 294
Y, Bank Holding Companies and Change
in Bank Control, 154
Z, Truth in Lending, 77, 80
AA, Unfair or Deceptive Acts or
Practices, 78
CC, Availability of Funds and Collection
of Checks, 78
DD, Truth in Savings, 79
Reports of Condition and Income, 113
Reserve requirements, 293
Reserve Requirements of Depository
Institutions (See Regulations: D)
Index 343
Reserves of depository institutions,
296-301
Revenue and income
Board of Governors, 309
Federal Reserve Banks, 135, 282-85,
286-89, 319
Federal Reserve priced services, 125-41,
282
Non-interest, 93
Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994, 154
Risk-based capital standards, final rule
amending, 106
Risk-focused supervision program, 101
Risk management, supervisory policy, 109
Royal Bank of Canada, merger application,
70
Rules
Regulatory capital treatment of equity
investments, 106
Risk-based capital standards, 106
Salaries, Federal Reserve Bank officers
and employees, 281
Sarbanes-Oxley Act, 111
Savings bonds, 133
Securities (See also Treasury securities)
Clearing agencies, examination of, 100
Credit for purchasing or carrying, 121,
294
Credit lenders, examination of, 100
Dealers and brokers, supervision of, 100
Firms, claims on, 106, 154
Government and municipal, 100
Holdings by Federal Reserve Banks,
136, 137, 280, 318
Marketable, 131
State member banks, 154
Securities Act Amendments of 1975,
compliance with, 100
Securitization, guidance on, 107
Settlement services, Federal Reserve
Banks, 130
Small businesses, community development,
90
SOMA (See System Open Market Account)
Sound Practices for the Management and
Supervision of Operational Risk,
policy paper, 109
Special cash services, Federal Reserve
Banks, 130
Special drawing rights certificate account,
272-75, 296, 298, 300, 318
State and local government sector, 21, 53
State banks, number, 302
State member banks (See also Member
banks)
Capital standards, 154
Claims on securities firms, 154
Community Reinvestment Act,
compliance with, 69
Complaints against, 82, 83, 84
Credit to executive officers, 123
Examinations of, 69, 71-74, 95, 100,
103
Financial disclosure by, 121
Foreign operations of, 104
International activities of, 103-105, 155
Number, 295, 302
Securities clearing agencies, 100
Transfer agents, 100
State-chartered banks, number, 302
Statistical loan sampling, guidance on, 107
Stock repurchases, bank holding
companies, 120
Supervision and regulation responsibilities,
Federal Reserve System, 94-123
Supervisory Guidance in Dealing with
Weak Banks, report, 109
Supervisory Information Technology (SIT),
114
Supervisory policies, guidance, 105-114
System Open Market Account (SOMA),
holdings and operations, 163, 169
Technical assistance by, Federal Reserve
System, 105
Terrorism Risk Insurance Act of 2002, 147
Thrift Institutions Advisory Council, 247
Trade, foreign, 22, 53
Training, Federal Reserve examiners, 73,
115
Training, foreign supervisory authorities,
105
Transactions between Member Banks and
Their Affiliates (See Regulations: W)
Transfer agents, supervision of, 100
Transparency in financial reporting, 111
Treasury securities
Depository institution holdings, by class
of bank, 295
Federal Reserve Banks, holdings,
272-75, 280, 282-85, 296, 298, 300
344 89th Annual Report, 2002
Treasury securities—Continued
Open market transactions, 276-79
Repurchase agreements, 272-75, 278,
Truth in Savings (See Regulations: DD)
Unemployment, 23, 55
980 OQfx 9Q8 ^00
T
n o n
!;
* **u ,o
i
Treasury, U.S. Department of the (See also
Treasury securities), 287, 289
Currency outstanding, 296, 298, 300
Truth in Lending (See Regulations: Z)
Truth in Lending Act, examination
procedures, 72
FRB1/1-600O-0403
Unfair or Deceptive Acts or Practices (See
Regulations- AA^
Regulations. AA)
USA
PATRIOT Act, 122, 156
West Texas intermediate, prices, 23, 54
@FedFRASER