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'[Report
^<t_J 2007

Board of Governors of the Federal Reserve System

This publication is available from the Board of Governors of the Federal Reserve System,
Publications Fulfillment, Washington, DC 20551. It is also available on the Board's website,
at www.federalreserve.gov.

Letter of Transmittal

Board of Governors of the Federal Reserve System
Washington, D.C.
April 2008

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 ninety-fourth annual report of the
Board of Governors of the Federal Reserve System.
This report covers operations of the Board during calendar year 2007.
Sincerely,

Ben Bernanke
Chairman

Overview of the Federal Reserve
ety of System functions, including operating a nationwide payments system;
distributing the nation's currency and
coin; under authority delegated by the
• conducting the nation's monetary pol- Board of Governors, supervising and
icy by influencing monetary and credit regulating bank holding companies and
conditions in the economy
state-chartered banks that are members
• supervising and regulating banking in- of the System; serving as fiscal agents
stitutions, to ensure the safety and of the U.S. Treasury; and providing a
soundness of the nation's banking and variety of financial services for the Treafinancial system and to protect the sury, other government agencies, and
credit rights of consumers
other fiscal principals.
• maintaining the stability of the finanA major component of the Federal
cial system and containing systemic
Reserve System is the Federal Open
risk that may arise in financial markets
Market Committee (FOMC), which is
• providing financial services to deposi- made up of the members of the Board of
tory institutions, the U.S. government, Governors, the president of the Federal
and foreign official institutions
Reserve Bank of New York, and presiThe Federal Reserve is a federal sys- dents of four other Federal Reserve
tem composed of a central, governmen- Banks, who serve on a rotating basis.
tal agency—the Board of Governors— The FOMC establishes monetary policy
and twelve regional Federal Reserve and oversees open market operations,
Banks. The Board of Governors, located the Federal Reserve's main tool for inin Washington, D.C., is made up of fluencing overall monetary and credit
seven members appointed by the Presi- conditions. The FOMC sets the federal
dent of the United States and supported funds rate, but the Board has sole auby a staff of about 1,860. In addition thority over changes in reserve requireto conducting research, analysis, and ments and must approve any change in
policymaking related to domestic and the discount rate initiated by a Reserve
international financial and economic Bank.
matters, the Board plays a major role
Two other groups play roles in the
in the supervision and regulation of the functioning of the Federal Reserve: deU.S. banking system and administers pository institutions, through which
most of the nation's laws regarding con- monetary policy operates, and advisory
sumer credit protection. It also has broad councils, which make recommendations
oversight responsibility for the nation's to the Board and the Reserve Banks
payments system and the operations and regarding System responsibilities.
activities of the Federal Reserve Banks.
All federally chartered banks are, by
The Federal Reserve Banks, which law, members of the Federal Reserve
combine public and private elements, System. State-chartered banks may beare the operating arms of the central come members if they meet Board
banking system. They carry out a vari- requirements.
•

As the nation's central bank, the Federal
Reserve System has numerous, varied
responsibilities:

Contents
Monetary Policy and Economic Developments
3

OVERVIEW: MONETARY POLICY AND THE ECONOMIC OUTLOOK

7
8
16
19
22
22
25
27
28
39

RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
The Household Sector
The Business Sector
The Government Sector
National Saving
The External Sector
The Labor Market
Prices
Financial Markets
International Developments

MONETARY POLICY IN 2007 AND EARLY 2008

49 SUMMARY OF ECONOMIC PROJECTIONS
49 The Outlook
52 Risks to the Outlook
53 Diversity of Participants' Views
57 MONETARY POLICY REPORT OF JULY 2007
57 Monetary Policy and the Economic Outlook
62 Economic and Financial Developments in 2007

Federal Reserve Operations
85 BANKING SUPERVISION AND REGULATION
86 Scope of Responsibilities for Supervision and Regulation
86 Supervision for Safety and Soundness
95 Supervisory Policy
105 Supervisory Information Technology
106 Staff Development
107 Regulation of the U.S. Banking Structure
111 Enforcement of Other Laws and Regulations
111 Federal Reserve Membership
113
113
121
123
125

CONSUMER AND COMMUNITY AFFAIRS
Mortgage Credit
Credit Cards
Other Regulatory Actions
Other Supervisory Activities Related to Compliance with Consumer Protection
and Community Reinvestment Laws
138 Consumer Complaints
140 Responding to Community Economic Development Needs in Historically
Underserved Markets
143 Advice
from the Consumer Advisory Council

151 FEDERAL RESERVE BANKS
151
155
155
158
159
159
160
161
162
162
162
164

Developments in Federal Reserve Priced Services
Developments in Currency and Coin
Developments in Fiscal Agency and Government Depository Services
Electronic Access to Reserve Bank Services
Information Technology
Examinations of the Federal Reserve Banks
Income and Expenses
Holdings of Securities and Loans
Volume of Operations
Federal Reserve Law Enforcement
Federal Reserve Bank Premises
Pro Forma Financial Statements for Federal Reserve Priced Services

169 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE
AND RESULTS ACT
169 Strategic Plan, Performance Plan, and Performance Report
169 Mission
169 Goals and Objectives

Records
175 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS
175 Regulation A (Extensions of Credit by Federal Reserve Banks)
175 Regulation B (Equal Credit Opportunity), Regulation E (Electronic Fund Transfers),
Regulation M (Consumer Leasing), Regulation Z (Truth in Lending),
Regulation DD (Truth in Savings)
175 Regulation D (Reserve Requirements of Depository Institutions)
176 Regulation E (Electronic Fund Transfers)
176 Regulation H (Membership of State Banking Institutions in the Federal Reserve
System), Regulation K (International Banking Operations)
176 Regulation H (Membership of State Banking Institutions in the Federal Reserve
System), Regulation Y (Bank Holding Companies and Change in Bank Control)
177 Regulation L (Management Official Interlocks)
177 Regulation O (Loans to Executive Officers, Directors, and Principal Shareholders of
Member Banks)
177 Regulation R (Exceptions for Banks from the Definition of Broker in the Securities
Exchange Act of 1934)
178 Regulation V (Fair Credit Reporting)
178 Policy Statements and Other Actions
180 Discount Rates in 2007

183
184
197
205
213
222
230
241
259

MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS
Meeting Held on January 30-31, 2007
Meeting Held on March 20-21, 2007
Meeting Held on May 9, 2007
Meeting Held on June 27-28, 2007
Meeting Held on August 7, 2007
Meeting Held on September 18, 2007
Meeting Held on October 30-31, 2007
Meeting Held on December 11, 2007

271

LITIGATION

Federal Reserve System Organization
275

BOARD OF GOVERNORS

278

FEDERAL OPEN MARKET COMMITTEE

279 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS
279 Federal Advisory Council
280 Consumer Advisory Council
281 Thrift Institutions Advisory Council
282 FEDERAL RESERVE BANKS AND BRANCHES
282 Officers of the Banks and Branches
283 Conference of Chairmen
283 Conference of Presidents
284 Conference of First Vice Presidents
284 Directors of the Banks and Branches
301

MEMBERS OF THE BOARD OF GOVERNORS, 1913-2007

Statistical Tables
306
310
311
312
313
314

322
323
324
328
332
338
339
340

1. Federal Reserve Open Market Transactions, 2007
2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities,
December 31, 2005-2007
3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions,
December 31, 2007
4. Reserve Requirements of Depository Institutions, December 31, 2007
5. Banking Offices and Banks Affiliated with Bank Holding Companies
in the United States, December 31, 2006 and 2007
6. Reserves of Depository Institutions, Federal Reserve Bank Credit,
and Related Items
A. Year-End 1984-2007 and Month-End 2007
B. Year-End 1918-1983
7. Principal Assets and Liabilities of Insured Commercial Banks,
by Class of Bank, June 30, 2007 and 2006
8. Initial Margin Requirements under Regulations T, U, and X
9. Statement of Condition of the Federal Reserve Banks, by Bank,
December 31, 2007 and 2006
10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007
11. Income and Expenses of the Federal Reserve Banks, 1914-2007
12. Operations in Principal Departments of the Federal Reserve Banks, 2004-2007
13. Number and Annual Salaries of Officers and Employees of the Federal Reserve
Banks, December 31, 2007
14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve
Banks and Branches, December 31, 2007

Federal Reserve System Audits
343
345
357
375
376

AUDITS OF THE FEDERAL RESERVE SYSTEM
BOARD OF GOVERNORS FINANCIAL STATEMENTS
FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS
OFFICE OF INSPECTOR GENERAL ACTIVITIES
GOVERNMENT ACCOUNTABILITY OFFICE REVIEWS

378

MAPS OF THE FEDERAL RESERVE SYSTEM

383

INDEX

Monetary Policy and
Economic Developments

Parti

Overview:
Monetary Policy and the Economic Outlook
The U.S. economy has weakened considerably since last July, when the Federal Reserve Board submitted its previous Monetary Policy Report to the
Congress. Substantial strains have
emerged in financial markets here and
abroad, and housing-related activity has
continued to contract. Also, further increases in the prices of crude oil and
some other commodities have eroded
the real incomes of U.S. households and
added to business costs. Overall economic activity held up reasonably well
into the autumn despite these adverse
developments, but it decelerated sharply
in the fourth quarter. Moreover, the outlook for 2008 has become less favorable
since last summer, and considerable
downside risks to economic activity
have emerged. Headline consumer price
inflation picked up in 2007 as a result of
sizable increases in energy and food
prices, while core inflation (which excludes the direct effects of movements
in energy and food prices) was, on balance, a little lower than in 2006. Nonetheless, with inflation expectations anticipated to remain reasonably well

NOTE: The discussion here and in the next three
parts consists of the text, tables, and selected
charts from the Monetary Policy Report submitted
to the Congress on February 27, 2008, pursuant to
section 2B of the Federal Reserve Act. The complete set of charts is available on the Board's website, at www.federalreserve.gov/boarddocs/hh.
Other materials in this annual report related to
the conduct of monetary policy include the minutes of the 2007 meetings of the Federal Open
Market Committee (see the "Records" section) and
statistical tables 1-4 (at the back of this report).

anchored, energy and other commodity
prices expected to flatten out, and pressures on resources likely to ease, monetary policy makers generally have expected inflation to moderate somewhat
in 2008 and 2009. Under these circumstances, the Federal Reserve has eased
the stance of monetary policy substantially since July.
The turmoil in financial markets that
emerged last summer was triggered by a
sharp increase in delinquencies and defaults on subprime mortgages. That increase substantially impaired the functioning of the secondary markets for
subprime and nontraditional residential
mortgages, which in turn contributed to
a reduction in the availability of such
mortgages to households. Partly as a result of these developments as well as
continuing concerns about prospects for
house prices, the demand for housing
dropped further. In response to weak demand and high inventories of unsold
homes, homebuilders continued to cut
the pace of new construction in the second half of 2007, pushing the level of
single-family starts in the fourth quarter
more than 50 percent below the high
reached in the first quarter of 2006.
After midyear, as losses on subprime
mortgages and related structured investment products continued to mount, investors became increasingly skeptical
about the likely credit performance of
even highly rated securities backed by
such mortgages. The loss of confidence
reduced investors' overall willingness to
bear risk and caused them to reassess
the soundness of the structures of other

94th Annual Report, 2007
financial products. That reassessment
was accompanied by high volatility and
diminished liquidity in a number of financial markets here and abroad. The
pressures in financial markets were reinforced by banks' concerns about actual
and potential credit losses. In addition,
banks recognized that they might need
to take a large volume of assets onto
their balance sheets—including leveraged loans, some types of mortgages,
and assets relating to asset-backed commercial paper programs—given their existing commitments to customers and
the increased resistance of investors to
purchasing some securitized products. In
response to those unexpected strains,
banks became more conservative in deploying their liquidity and balance sheet
capacity, leading to tighter credit conditions for some businesses and households. The combination of a more
negative economic outlook and a reassessment of risk by investors precipitated a steep fall in Treasury yields, a
substantial widening of spreads on both
investment-grade and speculative-grade
corporate bonds, and a sizable net decline in equity prices.
Initially, the spillover from the problems in the housing and financial markets to other sectors of the economy was
limited. Indeed, in the third quarter, real
gross domestic product (GDP) rose at an
annual rate of nearly 5 percent, in part
because of solid gains in consumer
spending, business investment, and exports. In the fourth quarter, however,
real GDP increased only slightly, and
the economy seems to have entered
2008 with little momentum. In the labor
market, growth in private-sector payrolls slowed markedly in late 2007 and
January 2008. The sluggish pace of hiring, along with higher energy prices,
lower equity prices, and softening home
values, has weighed on consumer sentiment and spending of late. In addition,

indicators of business investment have
become less favorable recently. However, continued expansion of foreign
economic activity and a lower dollar
kept U.S. exports on a marked uptrend
through the second half of last year, providing some offset to the slowing in domestic demand.
Overall consumer price inflation, as
measured by the price index for personal consumption expenditures (PCE),
stepped up to 3V2 percent over the four
quarters of 2007 because of the sharp
increase in energy prices and the largest
rise in food prices in nearly two decades. Core PCE price inflation picked
up somewhat in the second half of last
year, but the increase came on the heels
of some unusually low readings in the
first half; core PCE price inflation over
2007 as a whole averaged slightly more
than 2 percent, a little less than in 2006.
The Federal Reserve has taken a number of steps since midsummer to address
strains in short-term funding markets
and to foster its macroeconomic objectives of maximum employment and
price stability. With regard to short-term
funding markets, the Federal Reserve's
initial actions when market turbulence
emerged in August included unusually
large open market operations as well as
adjustments to the discount rate and to
procedures for discount window borrowing and securities lending. As pressures intensified near the end of the year,
the Federal Reserve established a Term
Auction Facility to supply short-term
credit to sound banks against a wide variety of collateral; in addition, it entered
into currency swap arrangements with
two other central banks to increase the
availability of term dollar funds in their
jurisdictions. With regard to monetary
policy, the Federal Open Market Committee (FOMC) cut the target for the
federal funds rate 50 basis points at its
September meeting to address the poten-

Monetary Policy and the Economic Outlook
tial downside risks to the broader
economy from the ongoing disruptions
in financial markets. The Committee reduced the target 25 basis points at its
October meeting and did so again at the
December meeting. In the weeks following that meeting, the economic outlook
deteriorated further, and downside risks
to growth intensified; the FOMC cut an
additional 125 basis points from the target in January—75 basis points on January 22 and 50 basis points at its regularly
scheduled meeting on January 29-30.
Since the previous Monetary Policy
Report, the FOMC has announced new
communications procedures, which include publishing enhanced economic
projections on a timelier basis. The most
recent projections were released with the

minutes of the January FOMC meeting
and are reproduced in part 4 of this report. Economic activity was expected to
remain soft in the near term but to pick
up later this year—supported by monetary and fiscal stimulus—and to be expanding at a pace around or a bit above
its long-run trend by 2010. Total inflation was expected to be lower in 2008
than in 2007 and to edge down further in
2009. However, FOMC participants
(Board members and Reserve Bank
presidents) indicated that considerable
uncertainty surrounded the outlook for
economic growth and that they saw the
risks around that outlook as skewed to
the downside. In contrast, most participants saw the risks surrounding the forecasts for inflation as roughly balanced. •

Part 2

Recent Economic and Financial Developments
Although the U.S. economy had generally performed well in the first half of
2007, the economic landscape was subsequently reshaped by the emergence of
substantial strains in financial markets
in the United States and abroad, the intensifying downturn in the housing market, and higher prices for crude oil and
some other commodities. Rising delinquencies on subprime mortgages led to
large losses on related structured credit
products, sparking concerns about the
structures of other financial products
and reducing investors' appetite for risk.
The resulting dislocations generated unanticipated pressures on bank balance
sheets, and those pressures combined
with uncertainty about the size and distribution of credit losses to impair shortterm funding markets. Consequently, the
Federal Reserve and other central banks
intervened to support liquidity and functioning in those markets. Amid a deteriorating economic outlook, and with
downside risks increasing, Treasury
yields declined markedly, and the Federal Open Market Committee cut the
federal funds rate substantially. Meanwhile, risk spreads in a wide variety of
credit markets increased considerably,
and equity prices tumbled.
The financial turmoil did not appear
to leave much of a mark on overall economic activity in the third quarter. Real
GDP rose at an annual rate of nearly
5 percent, as solid gains in consumer
spending, business investment, and exports more than offset the continuing
drag from residential investment. In the
fourth quarter, however, economic activity decelerated significantly, and the

Change in Real GDP, 2001-07
Percent, annual rate

— 5

— 2
— 1

2001

2003

2005

2007

NOTE: Here and in subsequent figures, except as
noted, change for a given period is measured to its final
quarter from the final quarter of the preceding period.
SOURCE: Department of Commerce, Bureau of Economic Analysis.

economy seems to have entered 2008
with little forward momentum. In part
because of tighter credit conditions for
households and businesses, the housing
correction has deepened, and capital
spending has softened. In addition, a
number of factors, including steep increases in energy prices, lower equity
prices, and softening home values, have
started to weigh on consumer outlays. In
the labor market, private hiring slowed
sharply in late 2007 and January 2008.
The increase in the price index for total
personal consumption expenditures
(PCE) picked up to 3Vi percent in 2007
as a result of sizable increases in food
and energy prices. Core PCE inflation,
though uneven over the course of the
year, averaged a bit more than 2 percent
during 2007 as a whole, a little less than
the increase posted in 2006.

94th Annual Report, 2007

Change in the Chain-Type Price Index
for Personal Consumption Expenditures,

Private Housing Starts, 1994-2007

2 0 0 1 —07

Millions of units, annual rate

—

II
2003

1.2

Single-family

H Excluding food and energy

2001

1.6

—

• Total
4

Multifamily

—

2005

2007

SOURCE: Department of Commerce, Bureau of Economic Analysis.

The Household Sector
Residential Investment and Finance
Economic activity in the past two years
has been restrained by the ongoing contraction in the housing sector, and that
restraint intensified in the second half of
2007. Home sales and prices softened
significantly further, and homebuilders
curtailed new construction in response
to weak demand and elevated inventories. In all, the decline in residential investment reduced the annual growth rate
of real GDP in the second half of 2007
by more than 1 percentage point, and
the further drop in housing starts around
the turn of the year suggests that the
drag on the growth of real GDP remains
substantial in early 2008.
The downturn in housing activity followed a multi-year period of soaring
home sales and construction and rapidly
escalating home prices. The earlier
strength in housing reflected a number
of factors. One was a low level of global
real interest rates. Another was that

] I
1995

I i 1
1999
2003

I I i
2007

NOTE: The data are quarterly and extend through
2007 :Q4.
SOURCE: Department of Commerce, Bureau of the
Census.

many homebuyers apparently expected
that home prices would continue to rise
briskly into the indefinite future, thereby
adding a speculative element to the market. In addition, toward the end of the
boom, housing demand was supported
by an upsurge in nonprime mortgage
lending—in many cases fed by lax lending standards.1 By the middle of the decade, house prices had reached very
high levels in many parts of the United
States, and housing was becoming progressively less affordable. Declining affordability and waning optimism about
future house price appreciation apparently started to weigh on the demand for
housing, thereby causing sales to fall
and the supply of unsold homes to
ratchet up relative to the pace of sales.
1. Nonprime mortgages comprise subprime and
near-prime loans and accounted for about onefourth of all home-purchase mortgages in 2006.
Near-prime mortgages are generally less risky than
subprime mortgages but riskier than prime mortgages; they may require limited or no borrower
documentation, have nontraditional amortization
structures or high loan-to-value ratios, or be made
on investment properties.

Recent Economic and Financial Developments
for new homes, the constant-quality index of new home prices fell 2lA percent
over the four quarters of 2007. Moreover, many large homebuilders reportedly have been using not only price discounts but also nonprice incentives (for
S&P/Case-Shilleri
ten-city index
example, paying closing costs and including optional upgrades at no cost) in
an effort to bolster sales of new homes
and reduce inventories.
In all, the pace of sales of existing
homes fell 30 percent between mid-2005
and the fourth quarter of 2007, and sales
of new homes dropped by half. Builders
cut production in response to the downshift in demand; by the fourth quarter of
1 i I I i 1 II 1 1 M > 1 1 II
I li
2007, starts of single-family homes had
1989 1992 1995 1998 2001 2004 2007
fallen to an annual rate of just 826,000
NOTE: The data are quarterly and extend through
units—less than half the quarterly high
2007:Q4; changes are from one year earlier. For the
years preceding 1991, the repeat-transactions index
reached in early 2006. Nonetheless, the
includes appraisals
associated
with
mortgage
ongoing declines in sales prevented
refinancings; beginning in 1991, it includes purchase
transactions only. The S&P/Case-Shiller index reflects
builders from making much progress in
all arm's-length sales transactions in the metropolitan
paring their bloated inventories of
areas of Boston. Chicago, Denver, Las Vegas, Los
homes. In fact, although the number of
Angeles. Miami, New York, San Diego, San Francisco,
and Washington, D.C.
unsold new homes has decreased, on
SOURCE: For repeat transactions, Office of Federal
net, since the middle of 2006, inventoHousing Enterprise Oversight: for S&P/Case-Shiller,
ries have climbed sharply relative to
Chicago Mercantile Exchange.
sales. Measured relative to the average
Against this backdrop, prices began to pace of sales over the three months enddecelerate, further damping expectations ing in December, the months' supply of
of future price increases and exacerbat- unsold new homes at the end of December stood at nine months, more than
ing the downward pressure on demand.
House prices decelerated dramatically twice the upper end of the narrow range
in 2006 and softened further in 2007. In that had prevailed from 1997 to midmany areas of the nation, existing home 2005.
The contraction in housing demand
prices fell noticeably last year. For the
nation as a whole, the OFHEO price and construction was exacerbated in the
index declined in the second half of the second half of 2007 by the near eliminayear after rising modestly in the first tion of nonprime mortgage originations
half; that measure had risen 4 percent in and a tightening of lending standards on
2006 and about 9Vi percent in each of all types of mortgages. Indeed, large
the two years before that.2 In the market fractions of banks that responded to the
Federal Reserve's Senior Loan Officer
Opinion Survey on Bank Lending Prac2. The index is the seasonally adjusted
tices reported that they had tightened
purchase-only version of the repeat-transactions
lending standards over this period.
price index for existing single-family homes pubNonetheless, interest rates on prime conlished by the Office of Federal Housing Enterprise
Oversight.
forming mortgages have declined on

Change in Prices of Existing Single-Family
Houses, 1988-2007

94th Annual Report, 2007

net: Rates on conforming thirty-year
fixed-rate loans dropped from about
63/4 percent last summer to just above
6 percent at year-end. This year they
dipped as low as 5Vi percent but have
recently moved back up to about 6 percent, within the range that prevailed for
much of the 2003-05 period.3 Rates on
conforming adjustable-rate loans have
also fallen significantly over the past
several months and now stand at their
lowest level since the end of 2005. Offered rates on fixed-rate jumbo loans,
which ran up in the second half of 2007,
have recently declined somewhat, on
net.4 Even so, spreads between rates offered on these loans and conforming
loans remain unusually wide.
The softness in home prices has
played an important role in the ongoing
deterioration in the credit quality of
subprime mortgages. The deterioration
was rooted in poor underwriting
standards—and, in some cases, fraudulent and abusive lending practices—
which were based in part on the assumption that house prices would continue to
rise rapidly for some time to come.
Many borrowers with weak credit histories took out adjustable-rate mortgages
(subprime ARMs) with low initial rates;
of those loans originated in 2005 and
3. Conforming mortgages are those eligible for
purchase by Fannie Mae and Freddie Mac; they
must be equivalent in risk to a prime mortgage
with an 80 percent loan-to-value ratio, and they
cannot exceed the conforming loan limit. The Economic Stimulus Act of 2008, signed into law on
February 13, retroactively raised the conforming
loan limit for a first mortgage on a single-family
home in the contiguous United States from
$417,000 to 125 percent of the median house price
in an area, with an overall cap of $729,750. The
new conforming limit will be in effect through the
end of 2008.
4. Jumbo mortgages are those that exceed the
maximum size of a conforming loan; they are typically extended to borrowers with relatively strong
credit histories.

2006, a historically large fraction had
high loan-to-value ratios, which were
often boosted by the addition of an associated junior lien or "piggyback" mortgage. When house prices decelerated,
borrowers with high loan-to-value ratios
on their loans were unable to build equity in their homes, making refinancing
more difficult, and also faced the prospect of significantly higher mortgage
payments after the initial rates on the
loans reset.
Subprime ARMs account for about
7 percent of all first-lien mortgages outstanding. Delinquency rates on subprime
ARMs began to increase in 2006, and
by December 2007, more than one-fifth
of these loans were seriously delinquent
(that is, ninety days or more delinquent
or in foreclosure). Moreover, an increasing fraction of subprime ARMs in the
past few years have become seriously
delinquent soon after they were originated and often well before the initial
rate was due to reset.5 For subprime
ARMs originated in 2006, about 10 percent had defaulted in the first twelve
months, more than double the fraction
for mortgages originated in earlier years.
Furthermore, the path of the default rate
for subprime ARMs originated in 2007
has run even higher. For subprime mortgages with fixed interest rates, delinquency rates have moved up significantly in recent months, to the upper
end of their historical range.
For mortgages made to higher-quality
borrowers (prime and near-prime mortgages), performance weakened somewhat in 2007, but it generally remains
5. The initial low-rate period for most subprime
ARMs originated in the period from 2005 to 2007
was twenty-four months. Roughly l!/2 million
subprime ARMs are scheduled to undergo their
first rate reset in 2008. Even with the recent declines in market interest rates, a notable fraction of
those subprime ARMs are scheduled to reset to a
higher interest rate.

Recent Economic and Financial Developments
Mortgage Delinquency Rates, 2001-07
Percent

Subprime

—

/—

—

/ —
Adjustable rate *J /

-c :

Fixed rate

t i l l

—

I 1

Prime and near prime

—

4
Adjustable rate

Fixed rate

J—

2
0

1 1

Alt-A pools

8
6

Adjustable rate/

4
Fixed rate

0
1

1
1
2001

1
I
2003

1
2005

I
2007

NOTE: The data are monthly. For subprime, prime,
and near-prime mortgages, the data extend through
December 2007; for mortgages in alt-A pools, which are
a mix of prime, near-prime, and subprime mortgages,
the data extend through November 2007. For further
details on the loans included in alt-A pools, refer to text.
Delinquency rate is the percent of loans ninety days or
more past due or in foreclosure.
SOURCE: First American LoanPerformance.

fairly solid. Although the rate of serious
delinquency on ARMs has moved up,
that on fixed-rate loans has stayed low.
Serious delinquencies on jumbo mortgages—which often carry adjustable
rates—have crept up slightly from very
low levels.
The credit quality of loans that were
securitized in pools marketed as t4alt-A"

has declined considerably. Such loans
are typically made to higher-quality borrowers but have nontraditional amortization structures or other nonstandard features. Some of the loans are categorized
as prime or near prime and others as
subprime. The rate of serious delinquency on loans with adjustable rates in
alt-A pools currently stands at almost
6 percent, far above the rates of less
than 1 percent seen as recently as early
2006. The rate of serious delinquency
on fixed-rate alt-A loans has also increased in recent months.
The continued erosion in the quality
of mortgage credit has led to a rising
number of initial foreclosure filings; indeed, such filings were made at a record
pace in the third quarter of 2007. Foreclosures averaged about 360,000 per
quarter over the first three quarters of
2007, compared with a rate of about
235,000 in the corresponding quarters of
2006. As was the case in 2006, more
than half of the foreclosure filings in
2007 were subprime mortgages despite
the relatively smaller share of such loans
in total mortgages outstanding. In some
cases, falling prices may have tempted
more-speculative buyers with little or no
equity to walk away from their properties. Foreclosures have risen most in areas where home prices have been falling
after a period of rapid increase; foreclosures also have mounted in some regions where economic growth has been
below the national average.
Avoiding foreclosure—even if it involves granting concessions to the
borrower—can be an important lossmitigation strategy for financial institutions. To limit the number of delinquencies and foreclosures, financial
institutions can use a variety of approaches, including renegotiating the
timing and size of rate resets. A complication in implementing such approaches
is that the loans have often been pack-

94th Annual Report, 2007

aged and sold in securitized pools that
are owned by a dispersed group of investors, which makes the task of coordinating renegotiation among all affected
parties difficult. In part to address the
challenges in modifying securitized
loans, counselors, servicers, investors,
and other mortgage market participants
joined in a collaborative effort, called
the Hope Now Alliance, to facilitate
cross-industry solutions to the problem.6
Separately, the Federal Reserve has directly responded in a number of ways to
the problems with mortgage credit quality (described in the box entitled "The
Federal Reserve's Responses to the
Subprime Mortgage Crisis").
Most commercial banks responding to
the Federal Reserve's January 2008 Senior Loan Officer Opinion Survey indicated that loan-by-loan modifications
based on individual borrowers' circumstances were an important part of their
loss-mitigation strategies. Almost twothirds of respondents indicated that they
would consider refinancing the loans of
their troubled borrowers into other mortgage products at their banks. About onethird of respondents said that streamlined modifications of the sort proposed
by the Hope Now Alliance were important to their strategies for limiting losses.
All of the factors discussed above—
the drop in home sales, softer house
prices, and tighter lending standards (especially for subprime and alternative
mortgage products)—combined to reduce the growth of household mortgage

debt to an annual rate of about 7 V2 percent over the first three quarters of 2007,
down from MVA percent in 2006.
Growth likely slowed further in the
fourth quarter.
Consumer Spending and Household
Finance
Consumer spending held up reasonably
well in the second half of 2007, though
it moderated some in the fourth quarter.
Spending continued to be buoyed by
solid gains in aggregate wages and salaries as well as by the lagged effects of
the increases in household wealth in
2005 and 2006. However, other influences on spending have become less favorable. Job gains have slowed lately,
household wealth has been damped by
the softening in home prices as well as
by recent declines in equity values, and
consumers' purchasing power has been
sapped by sharply higher energy prices.
Moreover, consumer sentiment has
fallen appreciably, and although consumer credit has remained available to
Change in Real Income and Consumption,
2001-07
Percent, annual rate

• Disposable personal income
I I Personal consumption
expenditures

— 5

— 3
6. The Hope Now Alliance (www.hopenow.
com) aims to increase outreach efforts to contact
at-risk borrowers and to play an important role in
streamlining the process for refinancing and modifying subprime ARMs. The alliance will work to
expand the capacity of an existing national network to counsel borrowers and refer them to participating servicers, who have agreed to work toward cross-industry solutions to better serve the
homeowner.

— 2
— 1
i
2001

1
2003

2005

1
J_J
2007

SOURCE: Department of Commerce, Bureau of Economic Analysis.

Recent Economic and Financial Developments
most borrowers, credit standards for
many types of loans have been
tightened.
Real personal consumption expenditures (PCE) increased at an annual rate
of 23/4 percent in the third quarter, a little
above the average pace during the first
half of the year; in the fourth quarter,
PCE growth slowed to 2 percent. With
the notable exception of outlays for new
light motor vehicles (cars, sport-utility
vehicles, and pickup trucks)—which
were well maintained through yearend—the deceleration in spending in the
fourth quarter was widespread. PCE appears to have entered 2008 on a weak
trajectory, as sales of light vehicles
sagged in January and spending on other
goods was soft.
Growth in real disposable personal
income—that is, after-tax income adjusted for inflation—was sluggish in the
second half of 2007. Although aggregate wages and salaries rose fairly
briskly in nominal terms over that period, the purchasing power of the nominal gain was eroded by the energydriven upturn in consumer price
inflation in the fall. Indeed, for many
workers, increases in real wages over
2007 as a whole were modest, once
again falling short of the rise in aggregate labor productivity. For example, average hourly earnings, a measure of
wages for production or nonsupervisory
workers, increased only Vi percent over
the four quarters of 2007 after accounting for the rise in the overall PCE price
index. Moreover, for some workers, real
wages actually declined: Real average
hourly earnings in manufacturing edged
down about 3A percent last year, while
for retail trade—an industry that typically pays relatively low wages—this
measure of real wages fell about
2 percent.
On the whole, household balance
sheets remained in good shape in 2007,

although they weakened late in the year.
The aggregate net worth of households
rose modestly through the third quarter,
as increases in equity values more than
offset the effect of softening home
prices. However, preliminary data suggest that the value of household wealth
fell in the fourth quarter, and as a result
the ratio of household wealth to disposable income—a key influence on consumer spending—ended the year well
below its level at the end of 2006. Nonetheless, because changes in net worth
tend to influence consumption with a
lag, the increases in wealth during 2005
and 2006 likely helped sustain spending
in 2007. In the fourth quarter, the personal saving rate was just a shade above
zero, about in line with its average value
since 2005.
Overall household debt increased at
an annual rate of about 1XA percent
through the third quarter of 2007, a notable deceleration from the 10V4 percent
pace in 2006; household debt likely
slowed further in the fourth quarter. Because the growth of household debt
about matched the growth in nominal
disposable personal income through the
third quarter, and net changes in interest
rates on mortgage debt to that point
were small, the ratio of financial obligations to disposable personal income was
about flat.
Consumer (nonmortgage) borrowing
picked up a bit in 2007 to 5Vi percent,
perhaps reflecting some substitution of
consumer credit for mortgage debt. The
pickup in consumer debt was mostly attributable to faster growth in revolving
credit, a pattern consistent with the results of the Federal Reserve's Senior
Loan Officer Opinion Survey. Banks, on
net, reported easing lending standards
on credit cards over the first half of 2007
and reported little change in those standards on net over the second half of the
year. In contrast, significant fractions of

94th Annual Report 2007

The Federal Reserve's Responses to the Subprime Mortgage Crisis
The sharp increases in subprime mortgage
loan delinquencies and foreclosures over
the past year have created personal, economic, and social distress for many homeowners and communities. The Federal Reserve has taken a number of actions that
directly respond to these problems. Some
of the efforts are intended to help distressed
subprime borrowers and limit preventable
foreclosures, and others are aimed at reducing the likelihood of such problems in the
future.
Home losses through foreclosure can be
reduced if financial institutions work with
borrowers who are having difficulty meeting their mortgage payment obligations.
Foreclosure cannot always be avoided, but
in many cases prudent loss-mitigation techniques that preserve homeownership are
less costly to lenders than foreclosure. In
2007, the Federal Reserve and other banking agencies encouraged mortgage lenders
and mortgage servicers to pursue prudent
loan workouts through such measures as
modification of loans, deferral of payments, extension of loan maturities, capitalization of delinquent amounts, and conversion of adjustable-rate mortgages
(ARMs) into fixed-rate mortgages or fully
indexed, fully amortizing ARMs.1
The Federal Reserve has also collaborated with community groups to help
1. Board of Governors of the Federal Reserve System (2007), "Working with Mortgage Borrowers," Division of Banking Supervision and Regulation, Supervision and Regulation Letter SR 07-6 (April 17); and
"Statement on Loss Mitigation Strategies for Servicers
of Residential Mortgages," Supervision and Regulation
Letter SR 07-16 (September 5).

respondents in the second half of 2007
reported that they had tightened standards and terms on other consumer
loans, a change that may have contributed to a slowing in the growth of nonrevolving loans over the final months of
2007. Average interest rates on credit

homeowners avoid foreclosure. Staff
members throughout the Federal Reserve
System are working to identify localities
that are likely to experience the highest
rates of foreclosure; the resulting information is helping local groups to better
focus their borrower outreach efforts. In
addition, the Federal Reserve actively
supports NeighborWorks America, a national nonprofit organization that has
been helping thousands of mortgage borrowers facing current or potential distress. Federal Reserve staff members have
worked closely with this organization and
its local affiliates on an array of foreclosure prevention efforts, and a member of
the Federal Reserve Board serves on its
board of directors. Other contributions include efforts by Reserve Banks to convene workshops for stakeholders to develop community-based solutions to
mortgage delinquencies in their areas.
The Federal Reserve has taken important steps aimed at avoiding future problems in subprime mortgage markets while
still preserving responsible subprime
lending and sustainable homeownership.
In coordination with other federal supervisory agencies and the Conference of
State Bank Supervisors, the Federal Reserve issued principles-based guidance on
subprime mortgages last summer.2 The
guidance is designed to help ensure that
2. Board of Governors of the Federal Reserve System (2007). "Statement on Subprime Mortgage Lending," Division of Banking Supervision and Regulation, Supervision and Regulation Letter SR 07-12
(July 24).

cards generally moved down in the second half of the year, but by less than the
short-term market interest rates on
which they are often based. Interest rates
on new auto loans at banks and at auto
finance companies have also declined
some in recent months.

Recent Economic and Financial Developments

borrowers obtain adjustable-rate mortgages
that they can afford to repay and can refinance without prepayment penalty for a
reasonable period before the first interest
rate reset. The Federal Reserve issued similar guidance on nontraditional mortgages
in 2006.3
The Federal Reserve is working to help
safeguard borrowers in their interactions
with mortgage lenders. In support of this
effort, in December 2007 the Federal Reserve used its authority under the Home
Ownership and Equity Protection Act of
1994 to propose new rules that address unfair or deceptive mortgage lending practices. This proposal addresses abuses related to prepayment penalties, failure to
escrow for taxes and insurance, problems
related to stated-income and lowdocumentation lending, and failure to give
adequate consideration to a borrower's
ability to repay. The proposal includes
other protections as well, such as rules designed to curtail deceptive mortgage advertising and to ensure that consumers receive
mortgage disclosures at a time when the
information is likely to be the most useful
to them.
The Federal Reserve is also currently
undertaking a broad and rigorous review
of the Truth in Lending Act, including

extensive consumer testing of loan disclosure documents. After a similar comprehensive analysis of disclosures related
to credit card and other revolving credit
arrangements, the Board issued a proposal in May 2007 to require such disclosures to be clearer and easier to understand. Like the credit card review, the
review of mortgage disclosures will be
lengthy given the critical need for field
testing, but the process should ultimately
help more consumers make appropriate
choices when financing their homes.
Finally, strong uniform oversight of all
mortgage lenders is critical to avoiding
future problems in mortgage markets.
Regulatory oversight of the mortgage industry has become more challenging as
the breadth and depth of the market has
grown over the past decade and as the
role of nonbank mortgage lenders, particularly in the subprime market, has increased. In response, the Federal Reserve,
together with other federal and state
agencies, launched a pilot program last
summer focused on selected nondepository lenders with significant subprime
mortgage operations.4 The program will
review compliance with consumer protection regulations and impose corrective
or enforcement actions as warranted.

3. Board of Governors of the Federal Reserve System (2006), "Interagency Guidance on Nontraditional
Mortgage Product Risks." Division of Banking Supervision and Regulation, Supervision and Regulation Letter SR 06-15 (October 10).

4. The other agencies collaborating on the effort
are the Office of Thrift Supervision, the Federal
Trade Commission, the Conference of State Bank
Supervisors, and the American Association of Residential Mortgage Regulators.

Indicators of the credit quality of consumer loans suggest that it has weakened but generally remains sound. Over
the second half of the year, delinquency
rates on consumer loans at commercial
banks increased, but from relatively
moderate recent levels. Meanwhile, de

linquency rates at captive auto finance
companies increased somewhat but are
well below previous highs. Although
household bankruptcy filings remained
low relative to the levels seen before the
changes in bankruptcy law implemented
in late 2005, the bankruptcy rate rose

94th Annual Report, 2007

modestly over the first nine months of
2007.
The issuance of asset-backed securities (ABS) tied to credit card loans and
auto loans (consumer loan ABS) has remained robust. Spreads of yields on consumer loan ABS over comparablematurity swap rates have moved up
considerably since July; the rise pushed
spreads on two-year BBB-rated consumer loan ABS to almost double their
previous peaks in late 2002. Spreads on
two-year AAA-rated consumer loan
ABS jumped to between 60 basis points
and 100 basis points after having been
near zero for most of the decade, perhaps in part as a result of investors' general reassessment of the risk in structured credit products.

Change in Real Business Fixed Investment,
2001-07
Percent, annual rate

• Structures
• Equipment and software

JiH

Fixed Investment
Real business fixed investment (BFI)
rose at an annual rate of 8*/2 percent in
the second half of 2007, largely because
of a double-digit rise in expenditures on
nonresidential construction. Investment
in equipment and software (E&S),
which had accounted for virtually all of
the growth in real BFI from 2003 to
2005, has been erratic since early 2006
but, on balance, has decelerated noticeably. On the whole, the economic and
financial conditions that influence capital spending were fairly favorable in
mid-2007, but they subsequently worsened as the outlook for sales and profits
soured and as credit conditions for some
borrowers tightened. A bright spot, however, is that many firms still have ample
cash on hand to fund potential projects.
On average, real outlays on E&S rose
at an annual rate of 5 percent in the
second half of 2007; in the first half,
these outlays had risen just 2Vi percent,
in part because of a sharp downswing in

— 10
_L

High-tech equipment
and software
Other equipment excluding
transportation

— 40
20

FL ra PI n
U

The Business Sector

— 20

J
2001

2003

2005

L_J

2007

NOTE: High-tech equipment consists of computers
and peripheral equipment and communications
equipment.
SOURCE: Department of Commerce, Bureau of Economic Analysis.

outlays on motor vehicles.7 Real investment in high-technology performed well
in the second half, with further increases
in all major components (computers,
communications equipment, and software). Real outlays on equipment other
than high-tech and transportation (a
broad category that accounts for nearly
half of investment in E&S when measured in nominal terms) posted a solid
gain in the third quarter. However, those
7. The plunge in business outlays on motor vehicles in the first half was related to new Environmental Protection Agency emissions standards for
large trucks, which went into effect at the start of
2007. Many firms had accelerated their purchases
of such trucks into 2005 and 2006 so that they
could take delivery before the new standards went
into effect and thus avoid the higher costs associated with those standards. Outlays on motor vehicles rose modestly, on net, in the second half of
the year.

Recent Economic and Financial Developments

outlays edged down in the fourth quar- sued an aggressive strategy of producter, and the relatively slow pace of or- tion adjustments to keep dealer stocks
ders, along with the downbeat tone in reasonably well aligned with sales. In
recent surveys of business conditions, December 2007, days' supply of light
suggests that the softness in spending vehicles stood at a comfortable sixtyhas extended into early 2008.
four days—though it ticked up in JanuMeanwhile, real outlays on nonresi- ary because of the drop in sales noted
dential construction remained on a earlier. Apart from motor vehicles, real
strong uptrend. Some of the recent nonfarm inventory investment was a
strength likely represents a catch-up modest $10 billion (annual rate) in the
from the prolonged weakness in this sec- first half of 2007; it stayed around that
tor in the first half of the decade. With rate in the third quarter and appears to
the notable exception of the non-office have remained modest in the fourth
commercial sector—where spending has quarter as manufacturing firms adjusted
been about flat since mid-2007—all ma- production promptly in response to
jor types of building continued to ex- signs of softening demand. With only a
hibit considerable vigor in the second few exceptions—mostly related to the
half. In general, the nonfinancial funda- ongoing weakness in construction and
mentals affecting nonresidential con- motor vehicle production—book-value
struction remain favorable: Vacancy inventory-sales ratios in December
rates for office and industrial buildings seemed in line with historical trends.
have fallen appreciably over the past Moreover, businesses surveyed in Janufew years despite the addition of a good ary by the Institute for Supply Managedeal of available space; and, although ment reported that their customers were
the vacancy rate for retail buildings has generally satisfied with their current
moved up somewhat of late, it remains level of stocks.
well below its cyclical highs in 1991
and 2003. However, funding has report- Corporate Profits and Business
edly become more difficult to obtain in Finance
recent months, especially for speculative projects, and the slowing in aggre- Four-quarter growth in economic profits
gate output and employment is likely to for all U.S. corporations came in at
limit the demand for nonresidential about 2 percent in the third quarter of
space in coming quarters. Meanwhile, 2007, with the entire gain attributable to
real outlays for drilling and mining a large increase in receipts from foreign
structures have continued to rise in re- subsidiaries. The share of profits in the
sponse to high prices for petroleum and GDP of the nonfinancial sector peaked
in the third quarter of 2006, near its prenatural gas.
vious high reached in 1997, and has
since receded. For S&P 500 firms, operInventory Investment
ating earnings per share in the third
Although inventory imbalances had quarter came in about 6 percent below
8
cropped up in a number of industries in year-earlier levels. Data from about
late 2006, overhangs were largely eliminated in the first half of 2007, and firms
generally continued to keep a tight rein
on stocks in the second half. In the motor vehicle sector, manufacturers pur

8. The difference between economic profits and
S&P operating earnings in the third quarter is attributable primarily to numerous asset writedowns and capital losses, which are generally ex-

94th Annual Report, 2007

80 percent of those firms and analysts'
estimates for the rest indicate that operating earnings per share in the fourth
quarter fell more than 20 percent from
the fourth quarter of 2006. Earnings per
share among the group's financial firms
are estimated to have been negative, primarily because of asset write-downs; in
contrast, earnings per share of the nonfinancial firms appear to have increased
about 13 percent.
Nonfinancial business debt is estimated to have grown about 11 percent
in 2007, buoyed by robust merger and
acquisition activity. Net corporate bond
issuance was strong throughout the year,
although high-yield issuance declined
after midyear, as yields on such bonds
increased and spreads over yields on
Treasury securities of comparable maturity widened to levels not seen since late
2002. The amount of outstanding nonfinancial commercial paper was about
flat, on net, over 2007, held down
mostly by runoffs of lower-tier paper in
the second half of the year as the market
for such paper came under pressure. After an unprecedented amount of issuance of leveraged syndicated loans over
the first half of 2007, issuance declined
considerably in the second half of the
year, when demand by nonbank investors for those loans fell off. Commercial
and industrial (C&I) loans at banks expanded briskly in 2007 as underlying
demand for bank-intermediated business
credit seemed to remain solid and banks
took onto their balance sheets loans that
had been intended for syndication. In
the Senior Loan Officer Opinion Surveys taken in October 2007 and January
2008, considerable net fractions of
banks reported charging wider spreads
on C&I loans—the loan rate less the
eluded in the calculation of economic profits but
are included as an expense in operating earnings
per share of financial firms.

Selected Components of Net Financing
for Nonfinancial Corporate Businesses,
2003-07
Billions of dollars, annual rate

•

2003

Commercial paper
Bonds

2004

2005

2006

— 800

2007

NOTE: The data for the components except bonds are
seasonally adjusted. The data for 2007:Q4 are estimated.
SOURCE: Federal Reserve Board, flow of funds data.

bank's cost of funds—the first such
tightening in several years. Large fractions of banks also indicated that they
had tightened lending standards. Most
of the banks that tightened terms and
standards indicated that they had done
so in response to a less favorable or
more uncertain economic outlook and a
reduced tolerance for risk. A lesser
fraction—about one-fourth—cited concerns about the liquidity or capital position of their own banks as reasons for
tightening.
Gross equity issuance picked up in
2007 on an increase in the pace of seasoned offerings. Nonetheless, record
volumes of share repurchases and cashfinanced mergers and acquisitions
pushed net equity retirements even
higher in 2007 than in 2006.
The credit quality of nonfinancial corporations remained strong. The sixmonth trailing bond default rate stayed
near zero through January 2008. The delinquency rate on C&I loans at commercial banks at the end of 2007 remained
near the bottom of its historical range,
but it trended higher over the year.
Charge-offs on C&I loans at banks also
increased in 2007, particularly in the

Recent Economic and Financial Developments
fourth quarter. Rating downgrades of
corporate bonds were modest through
the fourth quarter, and over the year the
fraction of debt that was downgraded
roughly equaled the fraction that was
upgraded. For public firms, balance
sheet liquidity remained at a high level
through the third quarter of 2007, and
leverage stayed very low despite robust
borrowing and surging retirements of
equity.
Commercial real estate debt continued to expand briskly in 2007, reflecting
in part strong investment in nonresidential structures, but the overall pace tapered off some in the second half of the
year. As noted above, readings on some
market fundamentals for existing
structures—for example, vacancy rates
and rents—remained solid. Similarly,
the latest data for commercial mortgages
held by life insurance companies or by
issuers of commercial mortgage-backed
securities (CMBS)—mortgages that
mostly finance existing structures—
show little change in delinquency rates
in recent quarters.
In contrast, the delinquency rate on
commercial mortgages held by banks
about doubled over the course of 2007,
reaching almost 23/4 percent. The loan
performance problems were the most
striking for construction and land development loans—especially for those that
finance residential development—but
some increase in delinquency rates was
also apparent for loans backed by nonfarm, nonresidential properties and multifamily properties. In the most recent
Senior Loan Officer Opinion Survey,
large fractions of banks reported having
tightened standards and terms on commercial real estate loans. Among the
most common reasons cited by those
that tightened credit conditions were a
less favorable or more uncertain economic outlook, a worsening of commercial real estate market conditions in the

areas where the banks operate, and a
reduced tolerance for risk.
Moreover, despite the generally solid
performance of commercial mortgages
in securitized pools, spreads of yields on
BBB-rated CMBS over comparablematurity swap rates soared, and spreads
on AAA-rated tranches of those securities rose to unprecedented levels. The
widening of spreads reportedly reflected
heightened concerns regarding the underwriting standards for commercial
mortgages over the past few years and
likely also investors' general wariness
of structured finance products.
Issuance of CMBS in 2007 topped the
pace of 2006. It was fueled by leveraged
buyouts of real estate investment trusts
in the first half of the year, but issuance
slowed to a trickle over the final four
months of the year on tighter underwriting standards and the higher required
yields. Nonetheless, the still-steady
growth of commercial real estate debt
indicates that, thus far, borrowers have
found alternative funding sources for
projects.

The Government Sector
Federal Government
The deficit in the federal unified budget
stood at $162 billion in fiscal year 2007,
roughly $250 billion below the recent
high reached in fiscal 2004 and equal to
just 1 VA percent of nominal GDP. However, growth in revenues has slowed
since last summer, and growth in outlays has quickened. Given those developments, the deficit during the first four
months of fiscal 2008 (October 2007 to
January 2008) was larger than it had
been during the comparable period of
fiscal 2007. Over the remainder of fiscal
2008, a slow pace of economic activity
and the revenue loss associated with the

94th Annual Report, 2007

Economic Stimulus Act of 2008 are expected to boost the deficit.
Nominal federal receipts have decelerated sharply since posting double-digit
advances in fiscal years 2005 and 2006:
They rose less than 7 percent in fiscal
2007 and have slowed substantially further thus far in fiscal 2008. The deceleration has been most pronounced in
corporate receipts, which barely increased in fiscal 2007 after three years
of exceptional growth and have fallen
well below year-earlier levels so far in
fiscal 2008; the downturn has reflected
the recent softness in corporate profits.
In addition, growth in individual income
tax receipts has moderated from the
rapid rates seen around the middle of the
decade. Nonetheless, total receipts grew
faster than nominal GDP for the third
year in a row in fiscal 2007 and reached
183/4 percent of GDP, slightly above the
average of the past forty years.
Nominal federal outlays rose less than
3 percent in fiscal 2007 after having
Federal Receipts and Expenditures,
1987-2007

risen about IV2 percent in each of the
two preceding years. In large part, the
slowing in 2007 reflected a number of
transitory factors—most notably, the tapering off of expenditures for flood insurance and disaster relief related to the
2005 Gulf Coast hurricanes, which had
produced a noticeable bulge in spending
in fiscal 2006. So far in fiscal 2008,
sharp increases in outlays for defense
and net interest have helped push spending 8 percent above its year-earlier level.
As measured in the national income
and product accounts (NIPA), real federal expenditures on consumption and
gross investment—the part of federal
spending that is a direct component of
GDP—rose at an annual rate of 3 V2 percent, on average, in the second half of
calendar 2007 after having been unchanged in the first half. The step-up
was concentrated in real defense spending, which tends to be erratic from quarter to quarter and rose at an annual rate
of 4V2 percent in the second half, somewhat above its average pace over the
past three years.
Federal debt rose at an annual rate of
almost 5 percent over the four quarters

Percent of nominal GDP

Federal Government Debt Held
by the Public, 1960-2007

Expenditures
Receipts

— 22
Percent of nominal GDP

—
\
\

— 18

— 16
i I I I I I 11 1 1 1 I 1 I I
1987 1991 1995 1999

I 1
2003

2007

—

/""— 35

—
1967

NOTE: The receipts and expenditures data are on a
unified-budget basis and are for fiscal years (October
through September); GDP is for the four quarters ending
in Q3.
SOURCE: Office of Management and Budget.

—

— 20

1977

1987

— 30
— 25
— 20

Hll Mil!!
1997
2007

NOTE: The data for debt are as of year-end; the
observation for 2007 is an estimate. The corresponding
values for GDP are for Q4 at an annual rate. Excludes
securities held as investments of federal government
accounts.
SOURCE: Federal Reserve Board, flow of funds data.

Recent Economic and Financial Developments
of calendar year 2007, a bit faster than
the roughly 4 percent increase in 2006.
The ratio of federal debt held by the
public to nominal GDP remained in the
narrow range around 361/> percent seen
in recent years. The Treasury's decision
in May to discontinue auctions of threeyear nominal notes elicited little reaction in financial markets. The Treasury
also trimmed some auction sizes for a
few other coupon securities over the first
three quarters of the year as the narrower deficit reduced borrowing needs.
Data suggest that the proportion of
nominal coupon securities purchased at
Treasury auctions by foreign official institutions edged down over the second
half of 2007, but the proportion has
changed little, on net, since mid-2005.
State and Local Government
The fiscal condition of state and local
governments appears to have lost some
luster in 2007 after improving significantly between the early part of the decade and 2006. Indeed, for the state and
local sector as a whole, net saving as
measured in the NIPA, which is broadly
similar to the surplus in an operating
budget, fell from a recent high of
$25 billion in 2006 to roughly zero, on
average, during the first three quarters
of 2007. The downshift occurred as
revenue increases tailed off after a
period of hefty gains and as nominal
expenditures—especially on energy and
health care—rose sharply. Recent information from individual states points to a
good deal of unevenness in current budget conditions. Some states—especially
those in agricultural and energyproducing regions—continue to enjoy
strong fiscal positions. Others, however,
are reporting sizable shortfalls in revenues, in part because sales tax collections are being hit hard by the weakness
in purchases of housing-related items. In

these circumstances, some states may
have to cut spending or raise taxes to
satisfy their balanced-budget requirements. At the local level, property tax
receipts apparently were bolstered in
2007 by the earlier run-up in real estate
values, but the deceleration in house
prices will likely slow the rise in local
revenues down the road. Moreover,
many state and local governments expect to face significant structural imbalances in their budgets in coming years
as a result of the ongoing pressures from
Medic aid and the need to provide pensions and health care to their retired
employees.
According to the NIPA, real expenditures on consumption and gross investment by state and local governments
continued to expand briskly in the second half of 2007. Much of the strength
was in construction spending, which
picked up speed early last year after
having been essentially flat between
2002 and 2006. Meanwhile, real outlays
for current operations remained on the
moderate uptrend that has been evident
since 2006.
Boosted by spending on education
and industrial aid, borrowing for new
capital expenditures by state and local
governments was very strong in 2007.
Refundings in advance of retirements
were brisk in the early part of the year as
issuers locked in low interest rates, but
refundings subsided in the second half
as a result of higher volatility and reduced liquidity in the municipal bond
market. By contrast, short-term borrowing picked up a bit during the second
half of the year, possibly because of
some deterioration in state and local
budgets.
Municipal issuers are benefiting from
lower interest rates, as bond yields have
declined some since midyear. However,
investors reportedly have become increasingly concerned about the weaker

94th Annual Report, 2007

fiscal outlooks for many state and local
governments and the condition of municipal bond insurers. Partly as a result
of those developments, the ratio of an
index of municipal bond yields to the
yield on comparable-maturity Treasuries has climbed to the top end of its
historical range.
Some indicators of credit quality in
the municipal bond sector have begun
pointing to greater weakness in recent
months. Rating upgrades have slowed
while downgrades have risen. A substantial number of revenue bonds for
projects insured by a subsidiary of a major investment bank were downgraded
in October. In January another group of
bonds was downgraded because of the
downgrade of their insurer.

rise in the standard of living of U.S.
residents over time and hamper the ability of the nation to meet the retirement
needs of an aging population.
The External Sector
International Trade

The external sector provided significant
support to economic activity in the second half of last year. Net exports added
almost 1 percentage point to U.S. GDP
growth during that period, according to
the latest GDP release from the Bureau
of Economic Analysis, but data received
since then suggest a somewhat larger
positive contribution. The contribution
of net exports was supported by a robust
expansion—about 11 percent at an annual rate—of real exports of goods and
National Saving
services that was helped by still-solid
Total net national saving—that is, the growth of foreign economies and the efsaving of households, businesses, and fects of the past depreciation of the dolgovernments excluding depreciation lar. The broad-based rise in real exports
charges—was equal to about IV2 per- of goods included sizable increases for
cent of nominal GDP, on average, dur- automobiles, agricultural goods, and
ing the first three quarters of 2007. The capital goods, especially aircraft. Exdrain on national saving from the fed- ports of services rose in 2007 but at a
eral budget deficit was smaller than it
had been a few years earlier. However, Change in Real Imports and Exports
net business saving receded somewhat of Goods and Services, 1999-2007
from the relatively high levels of the
Percent
preceding few years, and personal sav• Imports
ing was very low for the third consecu—
• Exports
— 15
tive year.
Net national saving fell appreciably
as a percentage of GDP between the late
1990s and the early part of this decade;
— 5
—
that ratio has changed little since 2002
+
(apart from the third quarter of 2005,
which was marked by sizable hurricane—
— 5
related property losses). If not boosted
over the longer run, persistent low levels
— 10
—
of national saving will be associated
1
j
with either slower capital formation or
M i l l
1
1 1
U
2003
1999
2001
2005
2007
continued heavy borrowing from
abroad, either of which would retard the
SOURCE: Department of Commerce.

I 1Mil

Recent Economic and Financial Developments
slower pace than in the previous year.
The value of exports to China, India,
Russia, South America, and the members of OPEC rose quite substantially,
and gains for exports to Canada and
western Europe were also sizable. Exports to Mexico and Japan increased at a
somewhat slower pace.
A slowdown in real imports was also
a factor in the positive contribution of
net exports to the growth of real GDP
last year. The growth of real imports of
goods and services decreased to about
\Vi percent in 2007, down from a
33/4 percent rise in 2006, in part because
of a slowdown in U.S. domestic demand
and the depreciation of the dollar. Although real imports of capital goods
were strong, the growth of most other
major categories declined. Despite the
moderation in the growth of imports
overall, the value of goods (excluding
oil) imported from western Europe,
China, and Mexico still rose at solid
rates.
Given those movements in exports
and imports, along with somewhat
higher net investment income, the U.S.
current account deficit appears likely to
have shrunk in 2007 on an annual basis
for the first time since 2001. The current
account deficit narrowed from $811 billion in 2006 to an average of $753 billion at an annual rate, or around 5Vi percent of nominal GDP, in the first three
quarters of 2007 (the latest available
data). However, its largest component,
the trade deficit, widened in the fourth
quarter because of a steep increase in
the price of imported oil.
The price of crude oil soared on world
markets in 2007. The spot price of West
Texas intermediate increased from
around $60 per barrel at the end of 2006
to about $100 at present. The strong demand for oil was powered by the continued expansion of the world economy
through 2007, especially in the develop

Prices of Oil and of Nonfuel Commodities,

2003-08
January 2003 = 100

Dollars per barrel

260
240
220
200
180

—
—
—
—
—

160
140
120
100
80

*~/^^
— 50
—
J \P*
—
J
y
— 40
Nonfuel. .
— 30
— W ^ ._ /
commodities
20
——*S
—j 10
r1
1
I
1
i

— 100
V — 90

Oil
I\P

\*ljLs/r_/

—

2003 2004 2005 2006 2007 2008

NOTE: The data are monthly. The last observation for
the oil price is the average for February 1 through
February 21, 2008. The price of nonfuel commodities
extends through January 2008. The oil price is the spot
price of West Texas intermediate crude oil. The price of
nonfuel commodities is an index of forty-five
primary-commodity prices.
SOURCE: For oil, the Commodity Research Bureau;
for nonfuel commodities. International Monetary Fund.

ing countries. In addition, a number of
actual and potential disruptions to supply have contributed to the surge in oil
prices. OPEC members announced cuts
to oil production in late 2006. Despite
recent agreements that have reversed
some of these cuts, OPEC production
remains restrained. The growth of production has also been hampered by some
governments' moves to take control of
oil resources or raise their share of revenues. Geopolitical tensions in the
Middle East and instability in Nigeria
have contributed to concerns about oil
supply as well. The price of the fardated NYMEX oil futures contract (currently for delivery in 2016) now has
risen to nearly $95 per barrel and likely
reflects a belief by oil market participants that the balance of supply and demand will remain tight for some time to
come.
Broad indexes of non-oil commodities prices remain elevated. Although
they fell back slightly over the second
half of last year, prices have again risen
since the start of 2008. Prices of a num-

94th Annual Report, 2007

ber of metals, which surged in the spring
on strong global demand, retreated
somewhat during the latter half of 2007
as production increased and as users
substituted into other materials. However, more recently the prices of copper
and aluminum have moved back up.
Prices for food commodities continue to
rise steeply. Poor harvests in Australia
as well as in parts of Europe and Asia
led to higher wheat prices. The price of
soybeans also has risen sharply because
acreage has been shifted to corn production, in part to produce biofuel; in addition, the soybean harvest in China was
down sharply from last year.
Import price inflation increased in
2007, with the depreciation of the dollar
providing an important impetus; higher
oil and food prices also contributed.
Prices of imported goods rose about
8V2 percent in 2007, but excluding food,
oil, and natural gas, such prices rose
2V* percent; both rates were somewhat
higher than in the previous year.
The Financial Account
Although the current account deficit appears to have narrowed during 2007, it
remains sizable and continues to require
a significant inflow of financing from
abroad. As in the past, the deficit was
largely financed by foreign net acquisitions of U.S. securities.
The global financial turmoil that began in the summer left an imprint on the
components of the U.S. financial account. After acquiring record amounts
of U.S. securities in the first half of
2007, foreign private investors sold a
sizable net amount of non-Treasury U.S.
securities in the third quarter—the first
quarterly net sale of such securities in
more than fifteen years. In contrast, foreign private demand for U.S. Treasury
securities picked up sharply in the third
quarter as global investors shifted into

less-risky positions. On balance, flows
out of non-Treasuries and into U.S.
Treasuries nearly offset one another, and
total foreign private acquisitions of U.S.
securities recorded an unusually small
net inflow for the third quarter. Preliminary data for the fourth quarter indicate
renewed foreign acquisitions of U.S.
corporate securities, although at a notably weaker pace than in the first half of
the year. Foreign private demand for
U.S. Treasury securities has remained
strong.
As issuers of asset-backed commercial paper around the globe began to
encounter difficulties over the summer,
nonbank entities that had issued commercial paper in the United States and
lent the proceeds to foreign parents
sharply curtailed those activities. As a
result, those entities reduced their claims
on foreign parents, and net financial inflows from nonbank entities thus were
sizable in the third quarter. Foreign inflows through direct investment into the
United States surged in the third quarter,
as foreign parents injected additional equity capital into their U.S. affiliates.
Foreign official inflows slowed in
the third quarter, as Asian central
banks acquired debt securities issued
by government-sponsored enterprises
(GSEs) but on net sold U.S. Treasury
securities. Official inflows appear to
have strengthened again in the fourth
quarter, with a return to moderate purchases of U.S. Treasury securities, continued strong purchases of GSE-issued
debt securities, and a notable pickup in
acquisitions of both corporate equities
and corporate debt securities.
Net purchases of foreign securities by
U.S. residents, which represent a financial outflow, were maintained at a brisk
pace for 2007 as a whole. Outflows associated with U.S. direct investment
abroad remained strong.

Recent Economic and Financial Developments
The Labor Market
Employment and Unemployment
The demand for labor decelerated early
last year and has slowed further of late.
The average monthly gain in private
nonfarm payroll employment, which
slid from about 160,000 in 2006 to
80,000 over the first ten months of 2007,
was only 50,000 in November and December, and private employment was
nearly flat in January 2008. The civilian
unemployment rate, which had hovered
around 4Vi percent in the early part of
2007, drifted up about lA percentage
point from May to November; it rose
another lA percentage point, on net, over
the following two months and stood at
4.9 percent in January.
Employment in residential construction has been falling for about two years
and now stands 375,000 below the high
reached in early 2006. Jobs in related
financial industries have also decreased
lately. Payrolls in the manufacturing sector, which have been on a downtrend for
Net Change in Private Payroll Employment,
2001-08
Thousands of jobs, 3-month moving average

11
2002

2004

2006

2008

NOTE: Nonfarm business sector. The data are monthly
and extend through January 2008.
SOURCE: Department of Labor, Bureau of Labor
Statistics.

more than a quarter-century, have continued to shrink. Meanwhile, some
service-producing industries have maintained solid gains. In particular, hiring
by health and education institutions and
by food services and drinking establishments has remained strong, and job
gains at businesses providing professional and technical services have been
sizable as well.
The increase in joblessness since the
spring of 2007 has been widespread
across major demographic groups. In
January 2008, unemployment rates for
men and women aged 25 years and older
were both about VA percentage point
above the levels of last spring, and—as
typically occurs—rates for teenagers
and young adults showed larger increases. Among the major racial and
ethnic groups, unemployment rates for
blacks and Hispanics rose somewhat
more than did unemployment rates for
whites, a differential also typical of periods when labor market conditions
soften. An increase in the number of
unemployed who had lost their last jobs
(as opposed to those who had voluntarily left their jobs or were new entrants to
the labor force) accounted for about half
of the rise in the overall jobless rate
between the spring of 2007 and January
2008. The labor force participation rate
stood slightly above 66 percent in January; it has changed little, on net, over the
past couple of years after falling appreciably over the first half of the decade.
Most other recent indicators also
point to some softening of labor market
conditions. Initial claims for unemployment insurance, which had remained
relatively low through the fall, moved
up somewhat in the closing months of
2007; though erratic from week to week,
they appear to have risen further in early
2008. Meanwhile, private surveys suggest that firms have cut back on plans
for hiring in the near term. Households

94th Annual Report, 2007

have also become less upbeat about the
prospects for the labor market in the
year ahead.

Hourly compensation rose at a relatively moderate rate in 2007 despite a
pickup in overall consumer price inflation, a continued advance in labor productivity, and generally tight labor marProductivity and Labor
kets. The employment cost index (ECI)
Compensation
for private industry workers, which
measures both wages and the cost of
Output per hour in the nonfarm business
benefits, increased 3 percent in nominal
sector rose 2Vi percent in 2007 after avterms over the twelve months of 2007,
eraging just 1 Vi percent per year over
about in line with its pace in 2005 and
the preceding three years. Although esti2006. Within the ECI, wages and salamates of the underlying pace of producries increased VA percent in 2007, the
tivity growth are quite uncertain, the same as in 2006 but 3A percentage point
pickup in measured productivity growth above the increases in 2004 and 2005.
in 2007 suggests that the fundamental Meanwhile, increases in the cost of proforces supporting a solid underlying viding benefits have slowed markedly in
trend remain in place. Those forces in- recent years, in part because employer
clude the rapid pace of technological contributions for health insurance have
change as well as the ongoing efforts by decelerated. The increase in benefits
firms to use information technology to costs in 2007, which amounted to just
improve the efficiency of their opera- 2Vi percent, was also held down by a
tions. Increases in the amount of capital drop in employer contributions to
per worker also appear to be providing defined-benefit retirement plans in the
an impetus to productivity growth.
first quarter. The lower contributions appear to have been facilitated by several
factors, including a high level of emChange in Output per Hour, 1948-2007
ployer contributions over the preceding
Percent, annual rate
few years and the strong performance of
the stock market in 2006.
According to preliminary data, nomi— 5
nal compensation per hour in the nonfarm business sector—an alternative
measure of hourly compensation derived
from the compensation data in the
— 3
NIPA—rose 33/4 percent in 2007, somewhat faster than the ECI. In 2006, the
nonfarm business measure had risen
5 percent, with an apparent boost from a
high level of bonuses and stock option
exercises, which do not seem to have
been repeated in 2007.y The moderation
1948- 1974- 19962002 2004 2006
73
95
2000
in this measure last year, along with the

UlL

NOTE: Nonfarm business sector. Change for each
multiyear period is measured to the fourth quarter of the
final year of the period from the fourth quarter of the
year immediately preceding the period.
SOURCE: Department of Labor, Bureau of Labor
Statistics.

9. Income received from the exercise of stock
options is included in the measure of hourly
compensation in the nonfarm business sector but
not in the ECI. Income received from most types

Recent Economic and Financial Developments
step-up in measured productivity
growth, held the increase in unit labor
costs in 2007 to 1 percent. Unit labor
costs rose about 2Vi percent per year, on
average, from 2004 to 2006 after having
been nearly flat over the preceding three
years.

Prices
Headline consumer price inflation
slowed dramatically in the third quarter
of 2007, when energy prices hit a lull
after their first-half surge, but it moved
back up in the fourth quarter as energy
prices climbed again. Over the year as a
whole, the overall PCE chain-type price
index rose 3V2 percent, IV2 percentage
points more than in 2006. Core price
inflation excludes the direct effects of
increases in food and energy prices;
these increases were sharp last year.
Like headline inflation, core PCE inflation was uneven from quarter to quarter
in 2007; over the four quarters of the
year, it averaged a bit more than 2 percent. In 2006, the core index rose
2l/4 percent. Although data for PCE
prices in January 2008 are not yet available, information from the consumer
price index (CPI) and other sources suggests that both total and core inflation
remained on the high side early this year
after having firmed in the fourth quarter
of 2007.
The PCE price index for energy rose
nearly 20 percent over the four quarters
of 2007 after having fallen modestly in
2006. The retail price of gasoline was
up about 30 percent over the year as a
whole, driven higher by the upsurge in
the cost of crude oil. In 2008, gasoline
prices through mid-February were
around the high levels seen late last year.
Prices of natural gas rose sharply in
of bonuses is included in both measures of
compensation.

early 2007, but they receded over the
second half of the year as inventories
reached their highest levels since the
early 1990s. So far in 2008, natural gas
prices have risen notably as inventories
have fallen back into line with seasonal
norms. Consumer prices for electricity
rose sharply last fall, likely because of
last year's higher prices of fossil fuel
inputs to electricity generation.
Last year's increase in the PCE price
index for food and beverages, at 4V2 percent, was the largest in nearly two decades. Food prices accelerated in response to strong world demand and high
demand for corn for the production of
ethanol. Taken together, prices for
meats, poultry, fish, and eggs rose
5V2 percent, and prices of dairy products
were up at double-digit rates. Prices for
purchased meals and beverages, which
typically are influenced more by labor
and other business costs than by farm
prices, also recorded a sizable increase
last year. In commodity markets, grain
prices soared to near-record levels in
late 2007 as strong global demand outstripped available supply, and they have
moved somewhat higher since the turn
of the year. Meanwhile, spot prices of
livestock have declined of late; the decrease should provide some offset to the
upward pressure from grain prices and
thus help limit increases in consumer
food prices in coming months.
The pattern of core PCE inflation was
uneven during 2007. In the first half of
the year, core inflation was damped significantly by unusually soft prices for
apparel, prescription drugs, and nonmarket items (especially financial services
provided by banks without explicit
charge); all of these developments
proved transitory and were reversed
later in the year with little net effect on
core inflation over the year as a whole.
Meanwhile, the rate of increase in the
core CPI dropped from 23A percent in

94th Annual Report, 2007

2006 to 2!/4 percent in 2007; the main
reason for the sharper deceleration in
the core CPI than in the core PCE price
index is that housing costs, which rose
less rapidly in 2007 than they had in
2006, carry much greater weight in the
core CPI.
More fundamentally, the behavior of
core inflation in 2007 was shaped by
many of the same forces that were at
work in 2006. The December jump in
unemployment notwithstanding, resource utilization in labor and product
markets remained fairly high last year,
and increases in prices for energy and
other industrial commodities continued
to add to the cost of producing a wide
variety of goods and services. Higher
prices for non-oil imports also likely put
some upward pressure on core inflation.
Meanwhile, the news on inflation expectations has been mixed. Probably reflecting the higher rate of actual headline inflation, the median expectation for
year-ahead inflation in the Reuters/
University of Michigan Surveys of Consumers moved up from 3 percent in
early 2007 to between 3XA percent and
3V2 percent last spring; apart from a
downward blip in the autumn, it remained there through January 2008 and
spurted to 33A percent in the preliminary
estimate for February. In contrast, most
indicators suggest that expectations for
longer-run inflation have remained reasonably well contained. The preliminary
February result for median five- to tenyear inflation expectations in the Reuters/
University of Michigan survey, at
3.0 percent, was around the middle of
the narrow range that has prevailed for
the past few years. And according to the
Survey of Professional Forecasters, conducted by the Federal Reserve Bank of
Philadelphia, expectations of CPI inflation over the next ten years have remained around 2V2 percent, a level that
has been essentially unchanged since

Alternative Measures of Price Change,
2005-07
Percent
Price measure
Chain-type
Gross domestic product (GDP)
Excluding food and energy
Personal consumption expenditures
(PCE)
Excluding food and energy
Market-based PCE excluding food
and energy
Fixed-weight
Consumer price index
Excluding food and energy

2005 2006 2007
3.4
3.3

2.7
2.9

2.6
2.3

3.2
2.2

1.9
2.3

3.4
2.1

1.7

2.0

1.9

3.8
2.1

1.9
2.7

4.0
2.3

NOTE: Changes are based on quarterly averages of
seasonally adjusted data.
SOURCE: For chain-type measures, Department of
Commerce, Bureau of Economic Analysis; for fixedweight measures, Department of Labor, Bureau of Labor
Statistics.

1998. Meanwhile, ten-year inflation
compensation, as measured by the
spreads of yields on nominal Treasury
securities over those on their inflationprotected counterparts, has changed
little, on balance, since mid-2007.
Last year's sharp rise in energy prices
also left an imprint on the price index
for GDP, which rose a little more than
2V2 percent for the second year in a
row.10 Excluding food and energy
prices, the increase in GDP prices
slowed from 3 percent in 2006 to
2lA percent in 2007; significantly
smaller increases in construction prices
accounted for much of the deceleration.

Financial Markets
Domestic and international financial
markets experienced substantial strains
and volatility in 2007 that were sparked
by the ongoing deterioration of the
10. The effect of energy prices on GDP prices
was much smaller than that on PCE prices. The
reason is that much of the energy-price increase
was attributable to the higher price of imported
oil, which is excluded from GDP because it is not
part of domestic production.

Recent Economic and Financial Developments
subprime mortgage sector and emerging
worries about the near-term outlook for
U.S. economic growth. Substantial
losses on structured products related to
subprime mortgages caused market participants to reassess the risks associated
with a wide range of other structured
financial instruments. The result was a
drying up of markets for subprime and
nontraditional mortgage products as
well as a significant impairment of the
markets for asset-backed commercial
paper and leveraged syndicated loans.
Those dislocations generated unexpected balance sheet pressures at some
major financial institutions, and the
pressures in turn contributed to severe
strains in short-term bank funding markets. The Federal Reserve responded to
the financial turmoil and the risks to the
broader economy along two tracks: It
took a series of actions to support market liquidity and functioning (partly in
coordination with foreign central banks),
and it eased monetary policy in pursuit
of its macroeconomic objectives. As a
result of the downward revision to the
economic outlook and strained financial
conditions, yields on Treasury securities
fell, risk spreads widened significantly,
equity prices dropped, and volatility in
many financial markets increased.
Market Functioning and Financial
Stability
The ongoing erosion in the credit quality of subprime residential mortgages,
particularly adjustable-rate mortgages,
has exposed weaknesses in other financial markets and posed challenges to financial institutions. Over the first half of
2007, problems were mostly isolated
within the subprime mortgage markets.
However, around midyear, as credit
quality in that sector continued to
worsen and losses mounted, investors
began to retreat from structured credit

products and from risky assets more
generally. Strains began to emerge in the
leveraged syndicated loan market in late
June and then surfaced in the assetbacked commercial paper and term bank
funding markets in August. After a respite in late September and October, revelations of larger-than-expected losses
at several financial firms and a weaker
economic outlook contributed to yearend pressures in short-term funding
markets that exacerbated financial
strains and heightened market volatility.
Financial markets remained volatile
through mid-February, in part owing to
a further downgrading of the economic
outlook and problems at some financial
guarantors.
Signs of investor nervousness about
the mortgage situation first appeared in
December 2006 and then intensified in
late February 2007, at a time when
softer-than-expected U.S. economic data
were adding to market uncertainty. Over
this period, mortgage companies specializing in subprime products began to
experience considerable funding pressures, and many failed, because rising
delinquencies on recently originated
subprime mortgages required those
firms to repurchase the bad loans from
securitized pools. Financial markets
calmed in April, however, and liquidity
in major markets remained ample. In
June, rating agencies downgraded or put
under review for possible downgrade the
credit ratings of a large number of securities backed by subprime mortgages.
Shortly thereafter, a few hedge funds experienced serious difficulties as a result
of subprime-related investments.
Prices of indexes of credit default
swaps on residential mortgage-backed
securities backed by subprime mortgages—which had already weakened
over the first half of 2007 for the lowerrated tranches—dropped steeply in July
for both lower-rated and higher-rated

94th Annual Report, 2007

Gross Issuance of Securities Backed by
Alt-A and Subprime Mortgage Pools,
2002-08
Billions of dollars, annual rate

• Alt-A
n Subprime

"
—
—

2002

y
ill
2004

45
30
15
2006

2008

NOTE: Mortgages in alt-A pools are a mix of prime,
near-prime, and subprime mortgages; for further details
on alt-A pools, refer to text.
SOURCE: Inside MBS & ABS.

tranches. Subsequently, investor demand
for securities backed by subprime and
alt-A mortgage pools dwindled, and the
securitization market for those products
virtually shut down. Those developments amplified credit and funding pressures on mortgage companies specializing in subprime mortgages; with no
buyers for the mortgages they originated, more of those firms were forced
to close or drastically reduce their operations, and subprime originations slowed
to a crawl. Originations of alt-A
mortgages—which had held up over the
first half of the year—also dropped
sharply beginning in July. Interest rates
on jumbo loans increased, but institutions that had the capacity to hold such
loans on their balance sheets continued
to make them available to prime borrowers. In contrast, the market for conforming mortgages for prime borrowers was
affected relatively little. Indeed, the issuance of securities carrying guarantees
from Fannie Mae or Freddie Mac rose
somewhat in the second half of the year.
The unprecedented decline in the
value of highly rated tranches of
mortgage-related securities led investors
to doubt their own ability, and that of

the rating agencies, to evaluate many
other types of structured instruments.
The loss of confidence was reflected in
significantly higher spreads on the debt
of collateralized loan obligations
(CLOs), and the issuance of such debt
weakened noticeably over the summer.
Because CLOs had been the largest purchasers of leveraged syndicated loans,
the drop in issuance contributed to the
decline in leveraged lending. In the secondary market for such loans, trading
volumes were reportedly large, but bidasked spreads widened sharply and
prices, which had been high in the first
half of 2007, declined markedly. Implied spreads on an index of loan-only
credit default swaps (LCDX) spiked in
July and remained elevated in August.
Unable to distribute many leveraged
syndicated loans that they had reportedly underwritten—a problem apparently affecting about $250 billion of
such loans in the United States alone—
banks faced the prospect of bringing
those loans onto their balance sheets as
the underlying deals closed.
At the end of July, European assetbacked commercial paper (ABCP) and
short-term funding markets were roiled
by warnings of heavy losses associated
with commercial paper programs backed
by U.S. subprime mortgages. On August 9, a major European bank
announced that it had frozen redemptions for three of its investment funds,
citing its inability to value some of the
mortgage-related securities held by the
funds. After that announcement, liquidity problems and short-term funding
pressures intensified in Europe and
emerged in U.S. money markets. Partly
in response to those developments, the
Federal Reserve and other central banks
took steps to foster smoother functioning of short-term credit markets (refer
to the box entitled "The Federal

Recent Economic and Financial Developments
Reserve's Responses to Financial
Strains").
Spreads on U.S. ABCP widened considerably in mid-August, and the volume of ABCP outstanding began a precipitous decline as investors balked at
rolling over paper for more than a few
days. Outstanding European ABCP also
declined substantially, and the market
for Canadian ABCP not sponsored by
banks virtually collapsed.11 Structured
investment vehicles (SIVs) and singleseller ABCP conduits that were heavily
exposed to securities backed by subprime mortgages experienced the greatest difficulties. Unlike traditional ABCP
programs, SIVs had very little explicit
liquidity support from their sponsors. As
a result, investors became particularly
concerned about the ability of SIVs—
even those with little or no exposure to
residential mortgages—to make timely
payments, and demand for ABCP issued
by SIVs fell sharply. Over the next few
weeks, some U.S. issuers invoked their
right to extend the maturity of their paper. Others temporarily drew on their
bank-provided backup credit lines, and a
few issuers defaulted. The general uncertainty and lack of liquidity also led to
some decrease in demand for lower-tier
unsecured nonfinancial commercial
paper—especially at longer maturities—
and spreads in that segment of the market widened markedly in August as well.
Issuers of high-grade unsecured commercial paper were largely unaffected
by the turmoil and experienced little
disruption.
At the same time, term interbank
funding markets in the United States and
Europe came under pressure. Banks recognized that the difficulties in the markets for mortgages, syndicated loans,
11. In December, a group of investor representatives agreed in principle to restructure Canadian
nonbank ABCP into longer-term notes.

and commercial paper could lead to substantially larger-than-anticipated calls
on their funding capacity. Moreover,
creditors found they could not reliably
determine the size of their counterparties' potential exposures to those markets, and concerns about valuation practices added to the overall uncertainty. As
a result, banks became much less willing to provide funding to others, including other banks, especially for terms of
more than a few days. Spreads of term
federal funds rates and term Libor over
rates on comparable-maturity overnight
index swaps widened appreciably, and
the liquidity in these markets diminished
(for the definition of overnight index
swaps, refer to the accompanying figure). European banks also sought to secure term funding in their domestic currencies, and similar spreads were seen in
term euro and sterling Libor markets.
Liquidity in the foreign exchange swap
market was poor over this period, and
European firms found it more difficult
and costly to use the foreign exchange
swap market to swap term funds denominated in euros or other currencies
for funds denominated in dollars. Term
funding markets in the Japanese yen and
Australian dollar also came under pressure as foreign institutions attempted to
borrow in those currencies and swap the
funds into dollars or euros.
Against that backdrop, investors fled
to the relative safety of Treasury securities, particularly Treasury bills, during
mid-August. For example, inflows into
money market mutual funds investing
only in Treasury and agency securities
jumped in August. Surges of safe-haven
demand caused Treasury bill rates to
plunge at times, and the considerable
volatility in that market was likely exacerbated in September by a seasonal reduction in bill supply. Bid-asked spreads
in the Treasury bill market widened substantially in this period.

94th Annual Report, 2007

The Federal Reserve's Responses to Financial Strains
In response to the serious financial strains
that emerged last August, the Federal Reserve has undertaken a number of measures
to foster the normal functioning of financial markets and thereby promote its dual
objectives of maximum employment and
price stability.
In mid-August, the Federal Reserve, as
well as several foreign central banks, took
actions designed to provide liquidity and
help stabilize markets. On August 9, the
European Central Bank (ECB) conducted
an unscheduled tender operation in response to sharply elevated demands for liquidity by European banks, an action it
repeated several more times in subsequent
weeks. On August 10, similar stresses
emerged in U.S. money markets, and the
Federal Reserve added substantial reserves
to meet heightened demand for funds from
banks.
Short-term markets remained under considerable pressure over subsequent days
despite the provision of ample liquidity in
overnight funding markets by the Federal
Reserve, the ECB, and the central banks of
other major industrialized countries. On
August 17, the Federal Reserve Board announced a narrowing of the spread between
the federal funds rate and the discount rate
from 100 basis points to 50 basis points
and changed discount window lending
practices to allow the provision of term
financing for as long as thirty days, renewable by the borrower. To ease pressures in
the Treasury market, the Federal Reserve
Bank of New York announced on August 21 some temporary changes to the
terms and conditions of the System Open
Market Account (SOMA) securities lending program.
The Federal Reserve's efforts achieved
some of the desired results. The provision
of increased liquidity generally succeeded

in keeping the federal funds rate from
rising above its intended level. (Indeed,
despite heightened demand for liquidity,
the effective federal funds rate was somewhat below the target for a time in August and early September, as efforts to
keep the rate near the target were hampered by technical factors and financial
market volatility.) After the September
meeting of the Federal Open Market
Committee, conditions in overnight funding markets improved further. The volume of loans to depository institutions
made through the discount window increased at times because of term loans to
a relatively small number of institutions,
but it remained generally moderate. Institutions may have been reluctant to use the
discount window, perhaps fearing that
their borrowing would become known
and would be seen by creditors and
counterparties as a sign of financial
weakness—the so-called stigma problem.
Nonetheless, collateral placed by banks
at the discount window in anticipation of
possible borrowing rose sharply during
August and September, which suggested
that some banks viewed the discount window as a potentially valuable option.
Pressures in financial markets ebbed
for a time in the fall but rose again later
in the year. On November 26, the Federal
Reserve Bank of New York announced
some additional modest, temporary
changes to the SOMA securities lending
program that were designed to further relax the limitations on borrowing particular Treasury securities and to improve the
functioning of the Treasury market. In
addition, the New York Reserve Bank
stated that the Open Market Trading Desk
planned to conduct a series of term repurchase agreements that would extend
over year-end and that it would provide

Recent Economic and Financial Developments

sufficient reserves to resist upward pressures on the federal funds rate around yearend. Then on December 12, the Federal
Reserve and several foreign central banks
announced a coordinated effort to facilitate
a return to more-normal pricing and functioning in term funding markets. As part of
that effort, the Federal Reserve announced
the creation of a temporary Term Auction
Facility (TAF) to provide secured term
funding to eligible depository institutions
through an auction mechanism beginning
in mid-December. The Federal Reserve
also established swap lines with the ECB
and the Swiss National Bank (SNB), which
provided dollar funds that those central
banks could lend in their jurisdictions. At
the same time, the Bank of England and the
Bank of Canada announced plans to conduct similar term funding operations in
their own currencies.
The Federal Reserve has conducted six
TAF auctions thus far, two of $20 billion in
December, two of $30 billion in January,
and two of $30 billion in February. The
auctions attracted a large number of bidders. The ratio of the dollar value of bids to
the amount offered (the bid-to-cover ratio)
at the two auctions in December was about
3. The auctions in January and February
were somewhat less oversubscribed, with
bid-to-cover ratios of roughly 2 on January
14, February 11, and February 25 and of
1 lA on January 28. The lower bid-to-cover
ratios in those auctions may have reflected
improved liquidity in term funding markets, the larger auction size, and, for the
January 28 auction, some uncertainty about
the monetary policy action that would
be taken at the January 29-30 FOMC
meeting.
The spread of the interest rate for the
auctioned funds over the minimum bid rate
(the overnight-index-swap rate correspond-

ing to the maturity of the credit being
auctioned) was about 50 basis points in
December but was lower in the January
and February auctions. The lower spread
apparently reflected some improvement
in banks* access to term funding after the
turn of the year. Although isolating the
impact of the TAF on financial markets is
not easy, a decline in spreads in term
funding markets since early December
provides some evidence that the TAF may
have had beneficial effects on financial
markets. The initial experience with the
TAF suggests that it may well be a useful
complement to the discount window in
some circumstances, and the Federal Reserve Board will consider making it a
permanent addition to the Federal Reserve's available instruments for providing liquidity to the banking system.
The swap arrangements with foreign
central banks allowed for up to $20 billion in currency swaps with the ECB and
up to $4 billion with the SNB. Drawing
upon these lines, the ECB auctioned $10
billion in dollar funds on December 17
and another $10 billion on December 20
in coordination with the Federal Reserve's TAF auctions. The SNB auctioned $4 billion in funds on December
17. The bid-to-cover ratios at the ECB
and SNB auctions in December ranged
between WA and 4lA\ the actions were
considered successful in helping to give
foreign financial institutions access to additional dollar funding. The December
loans were renewed by the ECB and SNB
at auctions in January, with bid-to-cover
ratios ranging from 1 lA to 2%. The ECB
and SNB have not conducted auctions in
February; ECB officials have indicated
that consideration would be given to reactivating dollar auctions if conditions appear to warrant such actions.

94th Annual Report, 2007

Financial conditions appeared to improve somewhat in late September and
October after the larger-than-expected
reduction of 50 basis points in the federal funds rate at the September FOMC
meeting and a few encouraging reports
on economic activity. Spreads in many
short-term funding markets partially reversed their August run-ups. Bid-asked
spreads in the interdealer market for
Treasury bills were a bit less elevated
than they had been in August. But the
Treasury bill market remained thin, and
yields were volatile at times. In the syndicated loan market, implied LCDX
spreads partly reversed their summer
surge, and some multibillion-dollar
deals were successfully placed in the
market. However, underwriting banks
were forced to take sizable discounts
from par value to induce investors to
purchase the loans, and they retained
significantly larger-than-intended portions of deals on their own balance
sheets. The improvements in market
functioning proved to be short lived, in
part because of a further worsening in
the outlook for the housing sector and
associated concerns about possible effects on financial institutions and the
economy.
The strains in financial markets intensified during November and December.
The syndicated loan market again
ground to a halt, and spreads on the
LCDX indexes moved up. The heightened uncertainties and ongoing financial
turmoil, along with the desire of financial institutions to show safe and liquid
assets on their year-end statements, generated significant year-end pressures in
short-term funding markets for the first
time in several years. Spreads on onemonth Libor and term federal funds shot
up in late November when their maturities crossed year-end. Similarly, spreads
on ABCP and lower-tier unsecured commercial paper widened further over the

period. Strong demand for safe assets
over year-end drove yields on shortdated Treasury bills maturing in early
2008 to low levels, and liquidity in that
market was impaired at times.
In mid-December, the Federal Reserve announced coordinated action
with a number of other central banks to
help facilitate a return to more-normal
pricing and functioning in term funding
markets. The efforts of the central banks,
combined with the passage of year-end,
appeared to help steady short-term financial markets in early 2008. So far
this year, commercial paper spreads—
both for ABCP and for lower-tier unsecured paper—and term bank funding
spreads have dropped, although they remain above the levels that prevailed before last August. In contrast, liquidity in
the Treasury bill market has been inconsistent. The subprime and alt-A mortgage markets remain essentially shuttered. Conditions in the market for
leveraged syndicated loans have worsened, and the forward calendar of committed deals remains substantial. Risk
spreads on corporate bonds widened significantly in January, and equity prices
dropped. Most recently, demand has
evaporated for auction-rate securities—
long-term debt (much of which is municipal bonds) with floating interest
rates that are reset at frequent, regular
auctions—and thereby imposed higher
rates on issuers and reduced liquidity for
current holders.
In January and February, problems at
several financial guarantors intensified
as rating agencies and investors became
more concerned that guarantors' exposures to collateralized debt obligations
that hold asset-backed securities (especially those backed by subprime residential mortgages) had imperiled the guarantors' AAA ratings. Indeed, the rating
agencies downgraded a few financial
guarantors and put some firms on watch

Recent Economic and Financial Developments
for possible downgrades; financial guarantors' equity prices declined, and credit
default swap spreads increased. A number of guarantors are undertaking efforts
to bolster their financial strength.
Financial guarantors have played an
important role in the markets for municipal bonds and for some structured finance products by providing insurance
against default. Those markets have already felt some effects from the stress at
the financial guarantors and could be
more substantially affected by any future downgrades. The direct exposures
of U.S. banks to losses from downgrades
of guarantors' ratings—through banks'
holdings of municipal bonds and credit
protection on structured products—
appear to be moderate relative to the
banks' capital. But some large banks
and broker-dealers could experience significant funding pressures from structured products tied to municipal bonds
that might return to their balance sheets
if guarantors are downgraded below
specified thresholds or if investors
choose to unwind their investments in
advance of potential downgrades.
Although U.S. financial markets and
institutions have encountered considerable difficulties over the past several
months, the financial system entered
that period with some distinct strengths.
In particular, most large financial institutions had strong capital positions, and
the financial infrastructure was robust.
Although some large financial institutions have experienced sizable losses,
the sector generally remains healthy. A
number of the firms that have reported
sizable write-downs of assets have been
able to raise additional capital. Market
infrastructure for clearing and settlement
performed well over the year, even when
volatility spiked and trading volumes
were very large.
Moreover, not all markets experienced significant impairment. For in

stance, the investment-grade corporate
bond market reportedly functioned well
over most of the period, and the unsecured high-grade commercial paper
market appeared little affected by the
difficulties encountered in other shortterm funding markets. The securitization of consumer loans and conforming
residential mortgages was robust. Despite a few notable failures, hedge funds
overall seemed to hold up fairly well,
and counterparties of failing hedge
funds did not sustain material losses.
Policy Expectations and Interest
Rates
The current target for the federal funds
rate, 3 percent, is substantially below
the level that investors expected at the
end of June 2007. Judging from futures
quotes at that time, market participants
expected the FOMC to shave at most
25 basis points from the federal funds
rate by February 2008 rather than the
225 basis points that has been realized.
Investors currently expect about 100 basis points of additional easing by the end
of 2008. Uncertainty about the path of
policy had been very low during the first
half of the year, but it increased appreciably over the summer and generally
has remained around its long-run historical average since then.
Although nominal Treasury yields
rose somewhat over the first half of last
year, rates subsequently fell sharply as
the outlook for the economy dimmed
and as market participants revised their
expectations for monetary policy accordingly. Treasury bill yields declined
to particularly low levels at times because of increased demand for safe and
liquid assets. On net, two-year yields
fell roughly 180 basis points in the second half of the year, and ten-year yields
shed about 100 basis points. Treasury
yields fell significantly more in early

94th Annual Report, 2007
Spreads of Corporate Bond Yields over
Comparable Off-the-Run Treasury Yields,
by Securities Rating, 1998-2008

Interest Rates on Selected Treasury
Securities, 2003-08
Percent

P e r c e n t a l - • .11 its

HA.

— Ten-year

w
Y

Two-year J\iyJ Three-month

—Kk jWSs/ J

1
2003

2004

2005

—

KL — ^
1 —3
1

2007

2008

NOTE: The data are daily and extend through February 21, 2008.
SOURCE: Department of the Treasury.

2008, especially for shorter-term securities, as policy expectations shifted down
in response to signs of further weakness
in the economic outlook. As of February 21, the two-year yield was about
2 percent, and the ten-year yield was
about 33/4 percent.
Yields on inflation-indexed Treasury
securities also declined considerably in
the second half of 2007 and into 2008.
The difference between the five-year
nominal Treasury yield and the fiveyear inflation-indexed Treasury yield—
five-year inflation compensation—
edged down over that period.
Meanwhile, the ten-year inflation compensation measure changed little. As
noted earlier, survey-based measures of
short-term inflation expectations rose
somewhat in 2007 and early 2008, presumably because of the increase in headline inflation. Survey measures of
longer-term
inflation
expectations
changed only slightly.
Yields on corporate bonds firmed a
bit over the first half of 2007, and
spreads of those yields over yields on
comparable-maturity Treasury securities
changed little, on net. Since June, yields
on AA-rated corporate bonds have decreased somewhat, on net, while those

— 4

— 2

1
2006

High-yield

_L
1998

1 1 1
2000

2002

2004

2006

2008

NOTE: The data are daily and extend through
February 21, 2008. The spreads shown are the yields on
ten-year bonds less the ten-year Treasury yield.
SOURCE: Derived from smoothed corporate yield
curves using Merrill Lynch bond data.

on BBB-rated bonds increased slightly;
spreads on AA-rated and BBB-rated
bonds have risen about 90 and 130 basis
points respectively. Moreover, yields on
speculative-grade securities have increased substantially over the same period, and their spreads have shot up almost 300 basis points.
Equity Markets
Broad equity indexes logged increases
of around 10 percent over the first half
of 2007 but then lost ground over the
second half; they ended the year with
Stock Price Indexes, 2005-08
January 3,2005 * 100

—

130

Wilshire 5OOoM/U

/TO

—

100

Dow Jones financial index 1

:>005

120

1
2006

2007

2008

NOTE: The data are daily and extend through February21.2OO8.
SOURCE: DOW Jones Indexes.

Recent Economic and Financial Developments
gains of 3 percent to 6 percent. The increase reflected continued strong profitability in many nonfinancial sectors,
particularly energy, basic materials, and
technology. By contrast, stock indexes
for the financial sector fell about 20 percent in 2007 as investors reacted to the
fallout from the problems in the
subprime mortgage sector. So far in
2008, growing concerns about the economic outlook, along with announcements of additional substantial losses at
some large financial firms, have precipitated a widespread drop in equity prices
that has pushed broad indexes down
about 8 percent.
The continued uncertainty surrounding the ultimate size and distribution of
losses from subprime-related and other
investment products, as well as the potential effects of the financial turmoil on
the broader economy, contributed to
higher volatility in equity markets and a
wider equity premium. The implied
volatility of the S&P 500, as calculated
from options prices, rose significantly in
the second half of 2007 and remains elevated. The ratio of twelve-monthforward expected earnings to equity
prices for S&P 500 firms increased over
the second half of 2007 and into 2008,
while the long-term real Treasury yield
decreased. The difference between these
two values—a measure of the premium
that investors require for holding equity
shares—has reached the high end of its
range over the past twenty years.
Flows into equity mutual funds were
heavy early in 2007 but slowed substantially after the first quarter. Indeed, equity funds that focused on domestic
holdings experienced consistent net outflows beginning in the spring. By contrast, inflows into foreign equity funds
held up through the end of 2007 despite
the weakness in many foreign stock
markets in the fourth quarter. Both domestic and foreign equity funds experi

enced large outflows in January as equity prices tumbled worldwide, but
flows appear to have stabilized in
February.
Debt and
Financial Intermediation
The total debt of the domestic nonfinancial sectors appears to have expanded
about 8 percent in 2007, a slightly
slower rate of growth than in 2006. The
slowing reflected a deceleration of
household debt that was only partially
offset by a considerable step-up in borrowing by businesses and governments.
Commercial
bank credit rose
10% percent last year, a pickup from the
93/4 percent gain in 2006.12 The acceleration of bank credit, as well as the
differences in growth rates across bank
asset classes, reflect in part the effects of
the financial market distress. As already
noted, commercial and industrial loans
surged in 2007 because of extremely
rapid growth in the second half of the
year that in part resulted from the inability of banks to syndicate leveraged
loans. At various times over the second
half of the year, banks' balance sheets
were boosted by extensions of credit to
nonbank financial institutions, a category that includes loans to ABCP programs that were no longer able to issue
commercial paper. Through the third
quarter of 2007, the growth of residential mortgages (excluding revolving
home equity loans) was fairly robust,
but the value of such loans on banks'
books contracted in the fourth quarter.
The reversal likely stemmed from a

12. The data for commercial bank balance
sheets are adjusted for some shifts of assets and
liabilities between commercial banks and nonbanks, including those resulting from mergers, acquisitions, changes in charter, and asset purchases
and sales.

94th Annual Report, 2007

stepped-up pace of securitization of conforming mortgages and a slowing of
new originations in response to the
weaker demand and the tightening of
lending standards reported in the Senior
Loan Officer Opinion Surveys covering
the second half of 2007. The growth of
revolving home equity loans picked up
in 2007, particularly late in the year;
because rates on such loans are generally tied to short-term market rates,
which declined over the second half of
2007, that form of financing may have
become relatively more attractive. Bank
consumer loans grew somewhat faster
in 2007 than in 2006, which is consistent with some substitution of nonmortgage credit for mortgage credit. To fund
the rapid expansion of their balance
sheets, commercial banks mainly turned
to a variety of managed liabilities, including large time deposits and advances from Federal Home Loan Banks.
Branches and agencies of foreign banks
also tapped their parent institutions for
funds. The growth of bank credit slowed
in January 2008, as declines in holdings
of securities and residential mortgages
partly offset continued growth in most
other loan categories.
Bank profits declined significantly in
2007 as fallout from the subprime mortgage crisis and related financial disruptions caused trading income to plunge
and loss provisions to more than double
from the previous year. Over the second
half of 2007, the return on assets and the
return on equity both dropped to levels
not seen since the early 1990s. Weak
profits or outright losses, along with significant balance sheet growth, also put
pressure on capital ratios at some of the
largest commercial banks. In response, a
number of banking organizations raised
significant amounts of new capital in the
second half of 2007 and early 2008.

Loan delinquency rates rose noticeably
for many loan categories, but especially
for residential mortgages, construction
and land development loans financing
residential projects, and other construction and land development loans.
Other types of financial institutions
also faced substantial challenges in
2007. As a result of exposures to
subprime loans, some thrift institutions
had significant losses. Several of the
major investment banks and their affiliates booked losses on mortgage-related
products and other exposures that were
large enough to lead some of them to
raise additional equity capital.
In the third quarter, Fannie Mae and
Freddie Mac each experienced sizable
losses on their mortgage portfolios and
on credit guarantees. In response, both
firms raised additional equity. The firms
also tightened underwriting standards
slightly and increased the fees that they
charge to purchase some types of loans.
All else equal, these changes would be
expected to increase borrower costs for
conforming loans.

The M2 Monetary Aggregate
M2 grew at a solid rate, on balance, in
2007 and the early part of 2008. Growth
was supported by declines in the opportunity cost of holding money relative to
other financial assets. The considerable
growth of money market mutual funds
also boosted M2 as investors sought the
relative safety of these liquid assets
amid the volatility in various financial
markets. The currency component of
M2 decelerated further in 2007 from its
already tepid pace in 2006; it actually
contracted from November through
January 2008, probably because of reduced demand from foreign sources.

Recent Economic and Financial Developments
International Developments
International Financial Markets
Global financial markets were calm over
the first half of 2007 except for a brief
period in late February when equity
markets were roiled in part by worries
about U.S. subprime mortgage lenders.
After midyear, as the global financial
turmoil began in earnest and the possibility of slowing growth weighed on investor sentiment, market volatility rose
substantially, and on net most major foreign stock markets fell. Despite the
rocky end to the year, most major equity
indexes in the advanced foreign economies, with the exception of Japan, finished higher on net in local-currency
terms compared with the beginning of
2007. However, indexes of the stock
prices of financial firms in those countries declined 10 percent to 30 percent.
The financial turbulence had less effect
on equity prices in emerging markets,
and most major emerging-market stock
indexes outperformed their counterparts
in the advanced economies. So far in
2008, stock markets in both advanced
and emerging-market economies are
down further as concerns about global
growth have increased.
Long-term bond yields in the advanced foreign economies rose over the
first half of 2007 but then reversed
course as investors reacted to signs in
many countries of deteriorating financial conditions, a softening economic
outlook, and expectations for a lower
future path of monetary policy rates. All
told, the net changes were not large;
long-term rates in Canada, the United
Kingdom, and Japan ended the year
20 to 30 basis points lower, on net, while
they were about 10 basis points higher
in the euro area than at the start of the
year. Yields on inflation-protected longterm securities followed a similar pat

tern; inflation compensation (the difference between yields on nominal
securities and those on inflationprotected securities) fell modestly in
Canada and rose slightly in the euro
area. Since the beginning of 2008, yields
on nominal securities in most economies have declined; yields on indexed
securities have fallen in the euro area
but have risen in Canada, the United
Kingdom, and Japan.
The Federal Reserve's broadest measure of the nominal trade-weighted foreign exchange value of the dollar has
declined about 8 percent on net since the
beginning of 2007. Over the same period, the major currencies index of the
dollar has moved down a bit more than
10 percent. The dollar has depreciated
about 9Vi percent against the yen and
slightly more than 10 percent versus the
euro. The dollar has depreciated roughly
U.S. Dollar Nominal Exchange Rate,
Broad Index, 2004-08
Week ending January 9,2004 = 100

—

1 I
2(X)4

J_
2005

2006

2007

2008

NOTE: The data, which are in foreign currency units
per dollar, are weekly. The last observation for each
series is the average for February 18 through February
21, 2008. The broad index is a weighted average of the
foreign exchange values of the U.S. dollar against the
currencies of a large group of the most important U.S.
trading partners. The index weights, which change over
time, are derived from U.S. export shares and from U.S.
and foreign import shares.
SOURCE: Federal Reserve Board.

94th Annual Report, 2007

13V2 percent against the Canadian dollar
and in November briefly touched its
lowest level in decades against that currency. The dollar has declined %Vi percent against the Chinese renminbi since
the beginning of 2007, and the pace of
depreciation accelerated late last year.

Advanced Foreign Economies
Economic activity in the major advanced foreign economies posted relatively strong growth over the first three
quarters of 2007, and labor markets
tightened. However, evidence of a slowdown has accumulated since the summer. Financial market strains appear to
be weighing on growth in the major
economies. Surveys of banks have revealed a tightening of credit standards
for both households and businesses.
Both consumer and business confidence
have slid since August, and readings
from surveys of economic activity have
declined. Retail sales have slowed, and
housing markets in a number of countries that until recently had been
robust—including Ireland, Spain, and
the United Kingdom—have softened.
According to initial releases, real GDP
growth for the fourth quarter slowed in a
number of countries. Although growth
in Japan rebounded in the fourth
quarter—pushed up by strong exports
and capital spending—household spending has been relatively weak, and the
construction sector has been depressed
by changes to regulations that have resulted in bottlenecks in reviewing building plans.
Headline rates of inflation have continued to rise in some economies,
mainly because of increasing food and
energy prices. The twelve-month change
in consumer prices in the euro area exceeded 3 percent in January, up from
less than 2 percent just a few months
earlier; core inflation (which excludes

the changes in the prices of energy and
unprocessed food) has moved up as
well. Canadian inflation climbed from
less than 1 percent late in 2006 to about
2Vi percent in the second half of 2007;
however, core inflation has slowed in
recent months, partly because of the
continued strength of the Canadian dollar. Although inflation in Japan was
close to zero for most of 2007, the rate
picked up to roughly 3A percent at the
end of the year, again mainly a result of
the rise in energy prices.
Faced with a weaker outlook for
growth but somewhat higher inflation,
major foreign central banks either have
cut official policy rates or have remained
on hold since late 2007—a change from
earlier market expectations of further
rate increases. The Bank of Canada and
the Bank of England lowered their targets for their respective overnight rates.
The European Central Bank and the
Bank of Japan have kept their policy
rates at 4 percent and 0.5 percent respectively. (Further discussion of actions by
foreign central banks is in the box entitled "The Federal Reserve's Responses
to Financial Strains.")

Emerging-Market Economies
The growth of output in the emergingmarket economies also slowed in the
second half of 2007 but was still strong.
In China, government policy measures
helped moderate the growth rate of real
GDP in the second half. To damp loan
growth, the government in 2007 repeatedly raised the reserve requirement ratio
and the benchmark rate at which banks
can lend to their customers. In addition,
the government directed banks to freeze
their level of lending over the final two
months of 2007 at the October level.
Chinese authorities also allowed the renminbi's rate of appreciation to step up in

Recent Economic and Financial Developments
late 2007, and the People's Bank of
China noted in its monetary policy report in November that it would be using
the exchange rate as a tool to fight
inflation.
Elsewhere in emerging Asia, growth
appears to have stepped down to a more
tempered pace in several countries in
the second half of the year, though generally from very strong levels in the first
half. One factor suppressing growth in
these export-dependent economies appears to be a softening of the rate of
activity in the rest of the world.
In Mexico, output growth was moderate in 2007 and followed roughly the
same pattern as in the United States.
The growth of economic activity exceeded 5 percent during the third quarter
but slowed to 3 percent in the fourth
quarter. In Brazil and other Latin American countries, growth was robust.

Increases in the prices of food and
fuel contributed to a rise in consumer
price inflation in many emerging-market
economies. Prices of edible oils and
grains were boosted by increased demand, higher energy prices, and unfavorable weather in several producing regions. Meat and dairy prices have also
increased as consumption of these products in developing countries has grown
rapidly and as the price of animal feed—
mostly grain—has risen. Inflation rose
during 2007 in many emerging Asian
economies, including China, where the
inflation rate for the twelve months ending in January reached just over 7 percent. Also, the pace of consumer price
inflation rose in the second half of the
year in Argentina, Chile, Mexico, and
Venezuela. The rise in inflation in Venezuela was compounded by stimulative
monetary and fiscal policies.
•

Part 3

Monetary Policy in 2007 and Early 2008
Throughout the first half of 2007, the
available information pointed to a generally favorable economic outlook despite
the ongoing correction in the housing
market. Indicators of consumer and
business spending were somewhat uneven, but their generally positive trajectories suggested that the housing market
developments were, as yet, having little
effect on the broader economy. Net exports, spurred in part by a falling dollar,
were providing support to economic
growth. Outside of the subprime mortgage sector, financial conditions in general were fairly accommodative. The
Federal Open Market Committee expected core inflation to moderate from
the somewhat elevated level that had
prevailed at the start of the year, but

high resource utilization had the potential to sustain upward pressure on inflation. As a result, during the first half of
the year, the Committee consistently
noted in its statement that its predominant policy concern was that inflation
would fail to moderate as expected.
However, in part owing to indications of
increasing weakness in the housing sector, the Committee emphasized in the
statements issued at the conclusion of its
March, May, and June meetings that its
future policy actions would depend on
the evolution of the outlook for both
inflation and economic growth.
When the Committee met on August 7, financial markets had been unusually volatile for a few weeks, and
credit conditions had become somewhat

Selected Interest Rates, 2005-08
Percent

Ten-year Treasury rate

— 1

2/2

5/3
3/22

8/9
6/30

11/1
9/20

2005

1/31
12/13

8/8

5/10
3/28

6/29

2006

5/9
8/7
10/25
1/31
10/31
1/30
9/20
12/12
3/21
6/28
9/18
12/11

2007

2008

NOTE: The data are daily and extend through February 21, 2008. The ten-year Treasury rate is the constantmaturity yield based on the most actively traded securities. The dates on the horizontal axis are those of regularly
scheduled FOMC meetings.
SOURCE: Department of the Treasury and the Federal Reserve.

94th Annual Report 2007

tighter for some households and businesses. Participants in FOMC meetings
(Board members and Reserve Bank
presidents) noted that adjustments in the
housing sector had the potential to prove
deeper and more prolonged than had
seemed likely earlier in the year, and a
further underperformance in the housing
area represented a significant downside
risk to the economic outlook. Nonetheless, incoming data indicated that economic growth had strengthened in the
second quarter, as a quicker pace of
business spending offset a slowdown in
consumer outlays. Participants believed
that the economy remained likely to expand at a moderate pace in coming quarters, supported in part by continued
growth in business investment and a robust global economy. Although core inflation had moved lower since the start
of the year, participants were still concerned about several factors—including
a continued high level of resource
utilization—that could augment inflation pressures. They believed that a sustained moderation in those pressures had
yet to be convincingly demonstrated. As
a result, the FOMC decided to leave the
target for the federal funds rate unchanged at 5VA percent and, despite somewhat greater downside risks to growth,
reiterated that the predominant policy
concern remained the risk that inflation
would fail to moderate as expected.
In the days following the August 7
FOMC meeting, financial conditions deteriorated rapidly as market participants
became concerned about counterparty
credit risk and their access to liquidity.
After an FOMC conference call on August 10 to review worsening strains in
money and credit markets, the Committee issued a statement indicating that the
Federal Reserve would provide reserves
as necessary through open market operations to promote trading in the federal
funds market at rates close to the

FOMC's target rate of 5lA percent. As
conditions deteriorated further, the Committee met again on August 16 by conference call to discuss the potential usefulness of various policy responses. The
following day, the Federal Reserve announced changes in discount window
policies to facilitate the orderly functioning of short-term credit markets.
Furthermore, the FOMC released a
statement indicating that the downside
risks to growth had increased appreciably and that the Committee was prepared to act as needed to mitigate adverse effects on the economy. (The box
entitled "The Federal Reserve's Responses to Financial Strains" provides
additional detail on the outcomes of
these conference calls and other measures taken by the Federal Reserve to
facilitate the orderly functioning of financial markets over the second half of
the year, including coordinated actions
with other central banks.)
At the time of the September FOMC
meeting, financial markets remained
volatile. Liquidity in short-term funding
markets was significantly impaired amid
heightened investor unease about exposures to subprime mortgages and to
structured credit products more broadly.
Credit generally remained available for
most businesses and households, but the
Committee noted that the tighter credit
conditions for other borrowers had the
potential to restrain economic growth.
Incoming economic data were mixed:
Consumer spending appeared to have
strengthened from its subdued secondquarter pace, but a further intensification of the housing contraction and
slowing employment growth suggested
a weaker economic outlook. Participants
noted that incoming data on core inflation continued to be favorable and that
the downwardly revised economic outlook implied some lessening of pressures on resources, but they remained

Monetary Policy in 2007 and Early 2008
concerned about possible upside risks to
inflation. To forestall some of the adverse macroeconomic effects that might
otherwise arise from the disruptions in
financial markets and to promote moderate growth over time, the FOMC lowered the target for the federal funds rate
50 basis points, to 43A percent. The
Committee also noted that recent developments had increased the uncertainty
surrounding the economic outlook and
stated that it would act as needed to
foster price stability and sustainable economic growth.
At the time of the October FOMC
meeting, the data indicated that economic growth had been solid in the third
quarter. A pickup in consumer spending
and continued expansion of business investment suggested that spillovers from
the turmoil in the housing and financial
markets had been limited to that point.
Although strains in financial markets
had eased somewhat on balance, tighter
credit conditions were thought likely to
slow the pace of economic expansion
over coming quarters. Furthermore, the
downturn in residential construction had
deepened, and available indicators
pointed to a further slowing in housing
activity in the near term. FOMC meeting participants noted that readings on
core inflation had improved somewhat
over the year and anticipated that some
of the moderation likely would be sustained. Nonetheless, participants expressed concern about the upside risks
to the outlook for inflation, stemming in
part from the effects of recent increases
in commodity prices and the significant
decline in the foreign exchange value of
the dollar. Against that backdrop, the
Committee decided to lower the target
for the federal funds rate 25 basis points,
to 4J/2 percent, and judged that the upside risks to inflation roughly balanced
the downside risks to growth.

Also at the October meeting, the
Committee continued its discussions regarding communication with the public.
Participants reached a consensus on increasing the frequency and expanding
the content of their periodic economic
projections. Under the new procedure,
which was announced on November 14,
the FOMC compiles and releases the
projections made by the Federal Reserve
Governors and Reserve Bank presidents
four times each year, at approximately
quarterly intervals, rather than twice
each year, as had been the practice since
1979. In addition, the projection horizon
has been extended from two years to
three years. FOMC meeting participants
provide projections for the increase in
the price index for total personal consumption expenditures (PCE) as well as
projections for real GDP growth, the unemployment rate, and core PCE price
inflation. Summaries of the projections
and an accompanying narrative are published along with the minutes of the
FOMC meeting at which they were discussed. Beginning with the present report, the projections made in January are
included in the February Monetary
Policy Report to the Congress, and the
projections made in June are included in
the July report.
In a conference call on December 6,
Board members and Reserve Bank
presidents reviewed conditions in domestic and foreign financial markets and
discussed two proposals aimed at improving market functioning. The first
proposal was for the establishment of a
temporary Term Auction Facility (TAF),
which would provide term funding
through an auction mechanism to eligible depository institutions against a
broader range of collateral than that used
for open market operations. The second
proposal was to set up a foreign exchange swap arrangement with the European Central Bank to address elevated

94th Annual Report, 2007

pressures in short-term dollar funding
markets. At the conclusion of the discussion, the Committee voted to direct the
Federal Reserve Bank of New York to
establish and maintain a reciprocal currency (swap) arrangement for the System Open Market Account with the European Central Bank.1 The Board of
Governors approved the TAF via notation vote on December 10.
At the Committee's meeting on December 11, participants noted that incoming information suggested economic
activity had decelerated significantly in
the fourth quarter. The housing contraction had steepened further, and participants agreed that the sector was weaker
than had been expected at the time of
the Committee's previous meeting.
Moreover, spillovers from housing to
other parts of the economy had begun to
emerge: Consumption spending appeared to be softening more than had
been anticipated, and employment gains
appeared to be slowing. Participants
noted that evidence of further deterioration in the credit quality of mortgages
and other loans to households appeared
to be spurring lenders to further tighten
the terms on new extensions of credit
for a widening range of credit products.
Financial market conditions had worsened significantly. The financial strains
were exacerbated by concerns related to
year-end pressures in short-term funding markets, and similar stresses were
evident in the financial markets of major
foreign economies. Although a surge in
energy prices pushed up headline consumer price inflation during September
and October, Committee members
agreed that the inflation situation had
changed little from the time of the previous meeting. In these circumstances, the
1. A swap arrangement with the Swiss National
Bank was approved by the Committee on December 11.

FOMC lowered the target for the federal
funds rate a further 25 basis points, to
4V4 percent, and, given the heightened
uncertainty, the Committee decided to
refrain from providing an explicit assessment of the balance of risks. The
Committee also indicated that it would
continue to assess the effects of financial and other developments on economic prospects and act as needed to
foster price stability and sustainable economic growth. In addition to that policy
move, the Federal Reserve and several
other central banks announced on December 12 the measures they were taking to address elevated pressures in
short-term funding markets. The Federal
Reserve announced the creation of the
TAF and the establishment of foreign
exchange swap lines with the European
Central Bank and the Swiss National
Bank.
In a conference call on January 9, the
Committee reviewed recent economic
data and financial market developments. The information, which included
weaker-than-expected data on home
sales and employment for December, as
well as a sharp decline in equity prices
since the beginning of the year, suggested that the downside risks to growth
had increased significantly since the
time of the December FOMC meeting.
Moreover, participants cited concerns
that the slowing of economic growth
could lead to a further tightening of financial conditions, which in turn could
reinforce the economic slowdown.
However, participants noted that core inflation had edged up in recent months
and believed that considerable uncertainty surrounded the inflation outlook.
Participants were generally of the view
that substantial additional policy easing
might well be necessary to support economic activity and reduce the downside
risks to growth, and they discussed the
possible timing of such actions.

Monetary Policy in 2007 and Early 2008
On January 21, the Committee held
another conference call. Participants in
the call noted that strains in some financial markets had intensified and that
incoming evidence had reinforced their
view that the outlook for economic
activity was weak. Participants observed that investors apparently were
becoming increasingly concerned about
the economic outlook and that these
developments could lead to an excessive pullback in credit availability.
Against that background, members
judged that a substantial easing in
policy was appropriate to foster moderate economic growth and reduce the
downside risks to economic activity.
The Committee decided to lower the
target for the federal funds rate 75 basis
points, to 3V2 percent, and stated that
appreciable downside risks to growth
remained. Although inflation was expected to edge lower over the course of
2008, participants underscored that this
assessment was conditioned upon inflation expectations remaining well anchored and stressed that the inflation
situation should continue to be monitored carefully.
The data reviewed at the regularly
scheduled FOMC meeting on January
29 and 30 confirmed a sharp deceleration in economic growth during the
fourth quarter of 2007 and continued
tightening of financial conditions. With
the contraction in the housing sector in-

tensifying and a range of financial markets remaining under pressure, participants generally expected economic
growth to remain weak in the first half
of 2008 before picking up strength in
the second half. However, the continuing weakness in home sales and house
prices, as well as the tightening of credit
conditions for households and businesses, were seen as posing downside
risks to the near-term outlook for economic growth. Moreover, many participants cited risks regarding the potential
for adverse feedback between the financial markets and the economy. Participants expressed some concern about the
disappointing inflation data received
over the latter part of 2007. Although
many expected that a leveling out of
prices for energy and other commodities, such as that embedded in futures
markets, and a period of below-trend
growth would contribute to some moderation in inflation pressures over time,
the Committee believed that it remained
necessary to monitor inflation developments carefully. Against that backdrop,
the FOMC decided to lower the target
for the federal funds rate 50 basis points,
to 3 percent. The Committee believed
that the policy action, combined with
those taken earlier, would help promote
moderate growth over time and mitigate
the risks to economic activity. However,
members judged that downside risks to
growth remained.
•

Part 4

Summary of Economic Projections
The following material appeared as
an addendum to the minutes of the
January 29-30, 2008, meeting of the
Federal Open Market Committee.
In conjunction with the January 2008
FOMC meeting, the members of the
Board of Governors and the presidents
of the Federal Reserve Banks, all of
whom participate in the deliberations of
the FOMC, provided projections for
economic growth, unemployment, and
inflation in 2008, 2009, and 2010. Projections were based on information
available through the conclusion of the
January meeting, on each participant's
assumptions regarding a range of factors
likely to affect economic outcomes, and
on his or her assessment of appropriate
monetary policy. "Appropriate monetary
policy" is defined as the future policy
that, based on current information, is
deemed most likely to foster outcomes
for economic activity and inflation that
best satisfy the participant's interpretation of the Federal Reserve's dual objectives of maximum employment and
price stability.
The projections, which are summarized in table 1 and chart 1, suggest that
FOMC participants expected that output
would grow at a pace appreciably below
its trend rate in 2008, owing primarily to
a deepening of the housing contraction
and a tightening in the availability of
household and business credit, and that
the unemployment rate would increase
somewhat. Given the substantial reductions in the target federal funds rate
through the January FOMC meeting as
well as the assumption of appropriate
policy going forward, output growth fur

ther ahead was projected to pick up to a
pace around or a bit above its long-run
trend by 2010. Inflation was expected to
decline in 2008 and 2009 from its recent
elevated levels as energy prices leveled
out and economic slack contained cost
and price increases. Most participants
judged that considerable uncertainty surrounded their projections for output
growth and viewed the risks to their
forecasts as weighted to the downside.
A majority of participants viewed the
risks to the inflation outlook as broadly
balanced, but a number of participants
saw the risks to inflation as skewed to
the upside.

The Outlook
The central tendency of participants'
projections for real GDP growth in
2008, at 1.3 to 2.0 percent, was considerably lower than the central tendency
of the projections provided in conjunction with the October FOMC meeting,
which was 1.8 to 2.5 percent. These
downward revisions to the 2008 outlook
stemmed from a number of factors, including a further intensification of the
housing market correction, tighter credit
conditions amid increased concerns
about credit quality and ongoing turmoil
in financial markets, and higher oil
prices. However, some participants
noted that a fiscal stimulus package
would likely provide a temporary boost
to domestic demand in the second half
of this year. Beyond 2008, a number of
factors were projected to buoy economic
growth, including a gradual turnaround
in housing markets, lower interest rates
associated with the substantial easing of

94th Annual Report, 2007

1. Economic Projections of Federal Reserve Governors and Reserve Bank Presidents
(Percent)
2008

2009

2010

Central Tendency1
Growth of real GDP
October projections
Unemployment rate
October projections
PCE inflation
October projections
Core PCE inflation
October projections

1.3 to 2.0
1.8 to 2.5
5.2 to 5.3
4.8 to 4.9
2.1 to 2.4
1.8 to 2.1
2.0 to 2.2
1.7 to 1.9

2.1 to 2.7
2.3 to 2.7
5.0 to 5.3
4.8 to 4.9
1.7 to 2.0
1.7 to 2.0
1.7 to 2.0
1.7 to 1.9

2.5 to 3.0
2.5 to 2.6
4.9 to 5.1
4.7 to 4.9
1.7 to 2.0
1.6 to 1.9
1.7 to 1.9
1.6 to 1.9

Range2
Growth of real GDP
October projections
Unemployment rate
October projections
PCE inflation
October projections
Core PCE inflation
October projections

1.0 to
1.6 to
5.0 to
4.6 to
2.0 to
1.7 to
1.9 to
1.7 to

1.8 to 3.2
2.0 to 2.8
4.9 to 5.7
4.6 to 5.0
1.7 to 2.3
1.5 to 2.2
1.7 to 2.2
1.5 to 2.0

2.2 to 3.2
2.2 to 2.7
4.7 to 5.4
4.6 to 5.0
1.5 to 2.0
1.5 to 2.0
1.4 to 2.0
1.5 to 2.0

2.2
2.6
5.5
5.0
2.8
2.3
2.3
2.0

NOTE: Projections of the growth of real GDP, of PCE
inflation, and of core PCE inflation are percent changes
from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE
inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures and the price index for personal consumption expenditures excluding food and energy. Projections for the
unemployment rate are for the average civilian unem-

ployment rate in the fourth quarter of the year indicated.
Each participant's projections are based on his or her
assessment of appropriate monetary policy.
1. The central tendency excludes the three highest and
three lowest projections for each variable in each year.
2. The range for a variable in a given year includes all
participants' projections, from lowest to highest, for that
variable in that year.

monetary policy to date and appropriate
adjustments to policy going forward,
and an anticipated reduction in financial
market strains. Real GDP was expected
to accelerate somewhat in 2009 and by
2010 to expand at or a little above participants' estimates of the rate of trend
growth.
With output growth running below
trend over the next year or so, most participants expected that the unemployment rate would edge higher. The central tendency of participants' projections
for the average rate of unemployment in
the fourth quarter of 2008 was 5.2 to
5.3 percent, above the 4.8 to 4.9 percent
unemployment rate forecasted in October and broadly suggestive of some
slack in labor markets. The unemployment rate was generally expected to
change relatively little in 2009 and then

to edge lower in 2010 as output growth
picks up, although in both years the unemployment rate was projected to be a
little higher than had been anticipated in
October.
The higher-than-expected rates of
overall and core inflation since October,
which were driven in part by the steep
run-up in oil prices, had caused participants to revise up somewhat their projections for inflation in the near term.
The central tendency of participants'
projections for core PCE inflation in
2008 was 2.0 to 2.2 percent, up from the
1.7 to 1.9 percent central tendency in
October. However, core inflation was
expected to moderate over the next two
years, reflecting muted pressures on resources and fairly well-anchored inflation expectations. Overall PCE inflation
was projected to decline from its current

Summary of Economic Projections

Chart 1: Central Tendencies and Ranges of Economic Projections

Real GDP growth

— 6
— 5
— 4

Central tendency of projections
— Range of projections
I
—

— 2
— 1
_|

Unemployment rate

— 7
— 6
t

— 5
— 4

2003

2004

2005

2006

PCE inflation

— 4
— 3
!

— 2
— 1

2003

2004

2005

2006

Core PCE inflation

— 3
— 2
— 1
_l

2003

2004

2005

Note: See notes to table 1 for variable definitions.

2006

94th Annual Report, 2007

elevated rate over the coming year,
largely reflecting the assumption that
energy and food prices would flatten
out. Thereafter, overall PCE inflation
was projected to move largely in step
with core PCE inflation.
Participants' projections for 2010
were importantly influenced by their
judgments about the measured rates of
inflation consistent with the Federal Reserve's dual mandate to promote maximum employment and price stability
and about the time frame over which
policy should aim to attain those rates
given current economic conditions.
Many participants judged that, given the
recent adverse shocks to both aggregate
demand and inflation, policy would be
able to foster only a gradual return of
key macroeconomic variables to their
longer-run sustainable or optimal levels.
Consequently, the rate of unemployment
was projected by some participants to
remain slightly above its longer-run sustainable level even in 2010, and inflation was judged likely still to be a bit
above levels that some participants
judged would be consistent with the
Federal Reserve's dual mandate.

Risks to the Outlook
Most participants viewed the risks to
their GDP projections as weighted to the
downside and the associated risks to
their projections of unemployment as
tilted to the upside. The possibility that
house prices could decline more steeply
than anticipated, further reducing households' wealth and access to credit, was
perceived as a significant risk to the central outlook for economic growth and
employment. In addition, despite some
recovery in money markets after the turn
of the year, financial market conditions
continued to be strained—stock prices
had declined sharply since the December meeting, concerns about further po

tential losses at major financial institutions had mounted amid worries about
the condition of financial guarantors,
and credit conditions had tightened in
general for both households and firms.
The potential for adverse interactions, in
which weaker economic activity could
lead to a worsening of financial conditions and a reduced availability of credit,
which in turn could further damp economic growth, was viewed as an especially worrisome possibility.
Regarding risks to the inflation outlook, several participants pointed to the
possibility that real activity could rebound less vigorously than projected,
leading to more downward pressure on
costs and prices than anticipated. However, participants also saw a number of
upside risks to inflation. In particular,
the pass-through of recent increases in
energy and commodity prices as well as
of past dollar depreciation to consumer
prices could be greater than expected. In
addition, participants recognized a risk
that inflation expectations could become
less firmly anchored if the current elevated rates of inflation persisted for
longer than anticipated or if the recent
substantial easing in monetary policy
was misinterpreted as reflecting less resolve among Committee members to
maintain low and stable inflation. On
balance, a larger number of participants
than in October viewed the risks to their
inflation forecasts as broadly balanced,
although several participants continued
to indicate that their inflation projections were skewed to the upside.
The ongoing financial market turbulence and tightening of credit conditions
had increased participants' uncertainty
about the outlook for economic activity.
Most participants judged that the uncertainty attending their January projections for real GDP growth and for the
unemployment rate was above typical
levels seen in the past. (Table 2 provides

Summary of Economic Projections
2. Average Historical Projection Error
Ranges (Percentage Points)

The dispersion of participants' projections for real GDP growth was markedly
wider than in the forecasts submitted in
2008
2009
2010
October, which in turn were consider±1.2
±1.4
±1.4
Real GDP1
ably more diverse than those submitted
±0.5
±0.8
±1.0
Unemployment rate2 .
Total consumer prices3
±1.0
±1.0
±0.9
in conjunction with the June FOMC
meeting and included in the Board's
NOTE: Error ranges shown are measured as plus or
Monetary Policy Report to the Congress
minus the root mean squared error of projections that
were released in the winter from 1986 through 2006 for
in July. Mirroring the increase in diverthe current and following two years by various private
sity of views on real GDP growth, the
and government forecasters. As described in the box
dispersion of participants' projections
"Forecast Uncertainty," under certain assumptions, there
is about a 70 percent probability that actual outcomes for
for the rate of unemployment also widreal GDP, unemployment, and consumer prices will be in
ened notably, particularly for 2009 and
ranges implied by the average size of projection errors
2010. The dispersion of projections for
made in the past. Further information is in David Reifschneider and Peter Tulip (2007), "Gauging the Unceroutput and employment seemed largely
tainty of the Economic Outlook from Historical Forecastto reflect differing assessments of the
ing Errors," Finance and Economics Discussion Series
#2007-60 (November).
effect of financial market conditions on
1. Projection is percent change, fourth quarter of the
real activity, the speed with which credit
previous year to fourth quarter of the year indicated.
conditions might improve, and the depth
2. Projection is the fourth quarter average of the civilian unemployment rate (percent).
and duration of the housing market con3. Measure is the overall consumer price index, the
traction. The dispersion of participants'
price measure that has been most widely used in governlonger-term projections was also afment and private economic forecasts. Projection is percent change, fourth quarter of the previous year to the
fected to some degree by differences in
fourth quarter of the year indicated. The slightly narrower
their judgments about the economy's
estimated width of the confidence interval for inflation in
trend growth rate and the unemployment
the third year compared with those for the second and
first years is likely the result of using a limited sample
rate that would be consistent over time
period for computing these statistics.
with maximum employment. Views also
differed about the pace at which output
an estimate of average ranges of forecast uncertainty for GDP growth, unem- and employment would recover toward
ployment, and inflation over the past those levels over the forecast horizon
twenty years.1) In contrast, the uncer- and beyond, given appropriate monetary
tainty attached to participants' inflation policy. The dispersion of the projections
projections was generally viewed as be- for PCE inflation in the near term partly
ing broadly in line with past experience, reflected different views on the extent to
although several participants judged that which recent increases in energy and
the degree of uncertainty about inflation other commodity prices would pass
through into higher consumer prices and
was higher than normal.
on the influence that inflation expectations would exert on inflation over the
Diversity of Participants' Views
short and medium run. Participants' inCharts 2(a) and 2(b) provide more detail flation projections further out were inon the diversity of participants' views. fluenced by their views of the rate of
inflation consistent with the Federal Reserve's dual objectives and the time it
1. The box "Forecast Uncertainty" at the end of
this summary discusses the sources and interpretawould take to achieve these goals given
tion of uncertainty in economic forecasts and excurrent economic conditions and approplains the approach used to assess the uncertainty
priate policy.
and risks attending participants' projections.

94th Annual Report, 2007

Chart 2(a): Distribution of Participants' Projections (Percent)
Unemployment rate

Real GDP

Number of participants

2008

2008
January projections
October projections

—

January projections
— October projections

— —

!~~l 1r
L
i

10
8

1
-'
I

i
|

2
1

1 "1
1 1
1

1
4.84.9

4.64.7

1
1
5.05.1

1
5.25.3

2009

1
5.6 5.7

Number of participants

Number of participai ts

1
5.4 5.5

_
-

1
i

-i h

1
1

8
6
4
2

liilisl i Ilillll-;
1
1
1
1
1
1
1
4.8 5.0 5.2 - 5.4 4.65.6 4.9
5.1
5.3
4.7
5.5
5.7

3.3

itlti!

Ninnber of participants

2010

•

1
1

1
1
1

1 1

2009

1 1

Number of participants

_ 2010

—

- |

ri
i

ill
i

i|l; |
1

1
1

1 1

—

T- - ' i ^

1
|

1
4.8 4.9

5.05.1

1
5.25.3

1
5.45.5

—

: 1

—

Sit.

1
4.6 4.7

1
5.65.7

Summary of Economic Projections

Chart 2(b): Distribution of Participants' Projections (Percent)
Core PCE inflation

PCE inflation
Number of participants

Nun her of participants

2008

2008
;::

January projections
October projections

—

1
1

,.:„: •,:,:, 1

1
1.71.8

1.92.0

2.12.2

2.32.4

2.5 2.6

2.7 2.8

1
1.31.4

1
1.51.6

1.71.8

2009

1
2.12.2

1
2.32.4

Number of participants

1
1.92.0

—

.: m

111
1

|
|

1.51.6

—

"
1

_ 2009

—

1I 1

|l
| iili 1
1
1

6
4

^
1

1
1.51.6

1
1.71.8

1
1.92.0

1
2.12.2

2.32.4

2.5 2.6

1
2.7 2.8

1.31.4

Number of participants

2010

-I »
1.71.8

1.92.0

2.1 2.2

2.3-

2.5-

2.4

2.6

2.72.8

- 2

i
1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

Number of participants
16

1.51.6

I|9H|

2010

94th Annual Report, 2007

Forecast Uncertainty
The economic projections provided by the
members of the Board of Governors and
the presidents of the Federal Reserve
Banks help shape monetary policy and can
aid public understanding of the basis for
policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic
forecasts are necessarily imperfect descriptions of the real world. And the future path
of the economy can be affected by myriad
unforeseen developments and events. Thus,
in setting the stance of monetary policy,
participants consider not only what appears
to be the most likely economic outcome as
embodied in their projections, but also the
range of alternative possibilities, the likelihood of their occurring, and the potential
costs to the economy should they occur.
Table 2 summarizes the average historical accuracy of a range of forecasts, including those reported in past Monetary Policy
Reports and those prepared by Federal Reserve Board staff in advance of meetings of
the Federal Open Market Committee. The
projection error ranges shown in the table
illustrate the considerable uncertainty associated with economic forecasts. For example, suppose a participant projects that
real GDP and total consumer prices will
rise steadily at annual rates of, respectively,
3 percent and 2 percent. If the uncertainty
attending those projections is similar to that
experienced in the past and the risks around
the projections are broadly balanced, the

numbers reported in table 2 might imply
a probability of about 70 percent that actual GDP would expand between 1.8 percent to 4.2 percent in the current year,
and 1.6 percent to 4.4 percent in the second and third years. The corresponding
70 percent confidence intervals for overall inflation would be 1 percent to 3 percent in the current and second years, and
1.1 percent to 2.9 percent in the third
year.
Because current conditions may differ
from those that prevailed on average over
history, participants provide judgments as
to whether the uncertainty attached to
their projections of each variable is
greater than, smaller than, or broadly
similar to typical levels of forecast uncertainty in the past as shown in table 2.
Participants also provide judgments as to
whether the risks to their projections are
weighted to the upside, downside, or are
broadly balanced. That is, participants
judge whether each variable is more
likely to be above or below their projections of the most likely outcome. These
judgments about the uncertainty and the
risks attending each participant's projections are distinct from the diversity of
participants' views about the most likely
outcomes. Forecast uncertainty is concerned with the risks associated with a
particular projection, rather than with divergences across a number of different
projections.

Monetary Policy Report of July 2007
homes; personal consumption expenditures (PCE) also slowed. Even so, the
available data point to solid gains overThe U.S. economy generally performed all in other components of final sales,
well in the first half of 2007. Activity and with manufacturing inventory imcontinued to increase moderately, on av- balances significantly reduced, growth
erage, over the period; businesses added in real GDP apparently sped up.
jobs at a steady pace; and the unemployJob growth in the first half of 2007
ment rate remained at 4Vi percent. Overwas driven by sizable increases in
all inflation, however, picked up as a
service-producing industries. In the
result of sizable increases in energy and
goods-producing sector, manufacturing
food prices. At the same time, core inemployment contracted, especially at
flation (which excludes the direct effects
firms closely tied to the construction inof movements in energy and food
dustry and at producers of motor veprices) held at about the same rate as in
hicles and parts. Employment in resi2006; this measure smoothes through
dential construction, which had turned
some of the volatility in the highdown in mid-2006, decreased only modfrequency data and thus is generally a
estly further over the first half of 2007
better gauge of underlying inflation
despite the substantial decline in hometrends.
building.
Although real gross domestic product
Real hourly compensation increased
appears to have expanded at about the over the year ending in the first quarter,
same average rate thus far this year as it the most recent period for which comdid in the second half of 2006, the pace plete data are available. In the second
of expansion has been uneven. In the quarter, however, gains in real compenfirst quarter, consumer expenditures and sation were probably curtailed by a
business fixed investment, taken to- steep, energy-driven rise in consumer
gether, posted a solid gain. However, prices. Employment continued to rise
homebuilding continued to contract, and apace in the first half of 2007 in the
manufacturing firms adjusted produc- face of moderate growth in output. As a
tion to address stock imbalances in that consequence, growth in labor prosector that had emerged over the course ductivity—which had slowed in 2006
of 2006. In the second quarter, housing from the rapid rate observed earlier in
activity declined further in response to the decade—appears to have remained
the continued softness in home sales and modest. The cooling of productivity
still-elevated inventories of unsold new growth in recent quarters likely reflects
cyclical or other temporary factors, but
the underlying pace of productivity
NOTE: The discussion in this chapter consists of
gains may also have slowed somewhat.
the text and tables from the Monetary Policy ReFinancial market conditions have conport submitted to the Congress on July 18, 2007;
tinued to be generally supportive of ecothe charts from that report (as well as earlier renomic expansion thus far in 2007,
ports) are available on the Board's web site, at
www.federalreserve.gov/boarddocs/hh.
though there was a notable repricing in

Monetary Policy and the
Economic Outlook

94th Annual Report, 2007

the subprime-mortgage sector. In recent
weeks, the deterioration in that sector
has been particularly marked, and markets for lower-quality corporate credits
have also experienced some strains.
Nonetheless, spreads on such corporate
credits have remained narrow on the
whole, and business borrowing has continued to be fairly brisk. On balance,
equity markets posted sizable gains
through mid-July, in part because of
continued robust corporate profits and
an upward revision to investors' outlook
for the economy. The improved outlook
led market participants to mark up their
anticipated path for the federal funds
rate, and intermediate- and long-term interest rates rose significantly. The foreign exchange value of the dollar has
declined moderately this year as the
pace of economic activity abroad has
strengthened.
Overall consumer price inflation, as
measured by the PCE price index,
picked up noticeably in the first half of
2007, largely because of a sharp increase in energy prices. After moving
down over the second half of 2006, the
prices households pay for energy subsequently turned up and by May were 14
percent (not at an annual rate) above
their level at the end of last year. Food
prices also contributed to the step-up in
overall inflation this year. The faster rate
of increase in overall prices has had only
a modest effect on inflation expectations: Surveys suggest that near-term inflation expectations have risen somewhat in recent months, but measures of
long-term inflation expectations have remained within the range of recent years.
The rate of increase in the core PCE
price index ticked down from 2.1 percent over the twelve months of 2006 to
an annual rate of 2.0 percent over the
first five months of 2007, primarily accounted for by more-favorable readings
between March and May. Although

higher energy prices this year added to
the cost of producing a wide variety of
goods and services that are included in
the core index, these effects were offset
by other factors—most notably, a slowdown in the rate of increase in shelter
costs from the very high rates seen in
2006.
The U.S. economy seems likely to
continue to expand at a moderate pace
in the second half of 2007 and in 2008.
The current contraction in residential
construction will likely restrain overall
activity for a while longer, but as stocks
of unsold new homes are brought down
to more comfortable levels, that restraint
should begin to abate. In addition, the
inventory correction that damped activity in the manufacturing sector around
the turn of the year appears largely to
have run its course. Thus, stock adjustment is unlikely to be a drag on production in coming quarters. Consumer
spending should also keep moving up.
Employment and real wages are on track
to rise further, and, although the difficulties in the subprime-mortgage market
have created severe financial problems
for some individuals and families, the
household sector is in good financial
shape overall. Businesses are also continuing to enjoy favorable financial conditions, which, along with a further expansion in business output, should
support moderate increases in business
investment. The positive outlook for
economic activity abroad bodes well for
U.S. exports.
Core inflation is expected to moderate a bit further over the next year and a
half. Longer-run inflation expectations
are contained, pressures on resource utilization should ease slightly in an environment of economic expansion at or
just below the rate of increase in the
nation's potential to produce, and some
of the other factors that boosted inflation in recent years have already receded

Monetary Policy Report of July 2007
or seem likely to do so. As noted, increases in shelter costs, which helped
push up core inflation in 2006, have
slowed appreciably this year. In addition, the paths for the prices of energy
and other commodities embedded in futures markets suggest that the impetus to
core inflation from these influences
should diminish. And although unit labor costs in the nonfarm business sector
have been rising, the average markup of
prices over unit labor costs is still high
by historical standards, an indication
that firms could potentially absorb
higher costs, at least for a time, through
a narrowing of profit margins.
Nonetheless, the possibility that the
expected moderation in inflation will
fail to materialize remains the predominant risk to the economic outlook. The
more-favorable readings on core inflation in recent months partly reflect some
factors that seem likely to prove transitory. Moreover, the economy appears to
be operating at a high level of resource
utilization, which has the potential to
sustain inflation pressures. In addition,
an upward impetus to costs could emanate from other sources, including
higher prices for energy and other commodities or a slower rate of increase in
structural productivity. Another concern
is that high rates of headline inflation, if
prolonged, could cause longer-run inflation expectations to rise and could thus
become another factor sustaining inflation pressures.
Significant risks also attend the outlook for real economic activity. On the
downside, the fall in housing construction could intensify or last longer than
expected. In addition, persistent weakness in the housing sector could spill
over to other sectors, especially consumption. But upside risks also exist.
For example, consumer spending appears to be rising less rapidly of late
after a period of large increases that

pushed the personal saving rate into
negative territory; increases in consumption could return to their earlier pace.
Exports could also boost aggregate demand more than anticipated, especially
if economic conditions abroad continue
to exceed expectations.
The Conduct of Monetary Policy
over the First Half of 2007
The Federal Open Market Committee
(FOMC) left the stance of monetary
policy unchanged over the first half of
2007. At the time of the January meeting, available economic information
pointed to a relatively favorable outlook
for both economic growth and inflation.
While manufacturing activity had softened, the housing sector had shown tentative signs of stabilizing, and consumer
spending remained strong. Readings on
core inflation had improved some from
the elevated levels reached in 2006, and
inflation expectations continued to be
stable. Nevertheless, the prevailing level
of inflation was uncomfortably high,
and elevated resource utilization had the
potential to sustain inflation pressures.
Against this backdrop, the Committee
decided to leave its target for the federal
funds rate unchanged at 5lA percent and
reiterated in its policy statement that
some inflation risks remained. The
Committee also explained that the extent and timing of any additional firming would depend on the evolution of
the outlook for both inflation and economic growth as implied by incoming
information.
When the Committee met in March,
data suggested that the ongoing weakness in the housing market had not
spilled over to consumption spending,
and the strains in the subprime-mortgage
market did not appear to be affecting the
availability of other types of household
or business credit. Although investment

94th Annual Report, 2007

spending had been soft, it was expected
to pick up, primarily because of strong
corporate balance sheets, continued high
profitability, and generally favorable financial conditions. Nevertheless, sluggish business spending and the deterioration in the subprime-mortgage market
suggested that downside risks to growth
had increased. At the same time, readings on core inflation had stayed somewhat elevated, and increases in the
prices of energy and non-energy commodities had boosted the risk that the
expected deceleration in inflation would
fail to occur. The FOMC decided to
leave its target for the federal funds rate
unchanged at 5lA percent and noted in
the accompanying statement that its predominant policy concern remained the
risk that inflation would fail to moderate
as expected. In light of the increased
uncertainty about the outlook for both
inflation and growth, the statement indicated that future policy adjustments
would depend on the evolution of the
outlook for both inflation and economic
growth as implied by incoming information—a characterization that has
been repeated in the two postmeeting
FOMC statements since then.
In May, the data in hand indicated
that the adjustment in the housing sector
was continuing and appeared likely to
persist for longer than previously anticipated. Moreover, growth in consumer
spending seemed to have slowed in the
early spring. Nonetheless, because the
problems in the subprime-mortgage
market apparently were contained and
business spending indicators suggested
improving prospects for investment, the
economy seemed likely to expand at a
moderate pace over coming quarters.
Despite more-favorable readings for
March, core inflation remained somewhat elevated from a longer perspective.
Inflation pressures were expected to
moderate over time, but the high level

of resource utilization had the potential
to sustain those pressures. As a result,
the FOMC decided to leave its target for
the federal funds rate unchanged at
5lA percent and repeated in the statement that its predominant policy concern remained the risk that inflation
would fail to moderate as expected.
At the June meeting, data appeared to
confirm that economic growth had
strengthened in the second quarter of
2007 despite the ongoing adjustment in
the housing sector. Business spending
on capital equipment, which had faltered around the turn of the year, firmed
somewhat in the spring, and nonresidential construction advanced briskly. In addition, the inventory correction that had
held down economic activity late last
year and early this year seemed to have
mostly run its course. Moreover, defense
spending and net exports appeared
poised to rebound after sagging in the
first quarter. These factors more than
offset a slowdown in the growth of consumer spending. Readings on core inflation remained favorable in April and
May. Nonetheless, a sustained moderation of inflation pressures had yet to be
convincingly demonstrated, and the high
level of resource utilization had the potential to sustain those pressures. Under
these circumstances, the Committee decided to leave its target for the federal
funds rate unchanged at 5lA percent. In
its policy statement, the Committee repeated that its predominant policy concern remained the risk that inflation
would fail to moderate as expected.
At their meetings over the first half of
2007, FOMC meeting participants continued the discussions they had formally
initiated last year regarding their communications with the public. The discussions included a review of the role of the
economic projections that are made
twice a year by the members of the
Board of Governors and the Reserve

Monetary Policy Report of July 2007
Bank presidents and which are included
in the Board's Monetary Policy Report
to the Congress. In addition, participants
exchanged views on the possible advantages and disadvantages of specifying a
numerical price objective for monetary
policy. They also discussed the appropriate role of meeting minutes and
policy statements. These discussions remain ongoing, as participants continue
to evaluate the best available means for
improving communication with the public in furtherance of the Committee's
dual mandate for both maximum employment and stable prices.
Economic Projections for 2007 and
2008
In conjunction with the FOMC meeting
at the end of June, the members of the
Board of Governors and the Reserve
Bank presidents, all of whom participate
in the deliberations of the FOMC, provided economic projections for 2007
and 2008 for this report. The central tendency of the FOMC participants' forecasts for the increase in real GDP is
2VA percent to 2Vz percent over the four
quarters of 2007 and 2T/2 percent to
23/4 percent in 2008. The civilian unemployment rate is expected to lie between
4Vi percent and 43A percent in the fourth
quarter of 2007 and to be at about the
top of that range in 2008. As for inflation, FOMC participants expect that the
increase in the price index for personal
consumption expenditures excluding
food and energy (core PCE inflation)
will total 2 percent to 2V4 percent over
the four quarters of 2007 and will drift
down to l3/4 percent to 2 percent in
2008.
Economic activity appears poised to
expand at a moderate rate in the second
half of 2007, and it should strengthen
gradually into 2008. The ongoing correction in the housing market seems

Economic Projections for 2007 and 2008
Percent

Indicator

Federal Reserve Governors
and
Reserve Bank presidents
Central
tendency

Range
2007
Change, fourth quarter
to fourth quarter1
Nominal GDP
Real GDP
PCE price index excluding
food and energy
Average level,
fourth quarter
Civilian unemployment
rate

41/2-51/2
2-2VA

4V2-5
21/4-21/2

2-21/4

2-2»/ 4

41/2-43/4

4i/2-43/4

2008
Change, fourth quarter
to fourth quarter1
Nominal GDP
Real GDP
PCE price index excluding
food and energy
Average level,
fourth quarter
Civilian unemployment
rate

41/2-51/2
2V2-3

4 3 /4-5
2V2-23/4

VA-2

P/4-2

4Vi-5

About 43A

1. Change from average for fourth quarter of previous
year to average for fourth quarter of year indicated.

likely to continue to weigh on the rate of
economic expansion over the near term.
But as that process runs its course, the
rate of growth of economic activity
should move up somewhat. The pace of
consumer spending may be restrained in
the near term as households continue to
adjust to the latest run-up in energy
prices and to softer house prices; still,
household balance sheets are generally
in good shape, and increases in employment and real wages over the next year
and a half should be sufficient to sustain
further gains in spending. Regarding
business investment, solid gains in real
outlays on equipment and software seem
likely in light of the anticipated expansion in business output, continuing

94th Annual Report, 2007

strong profits, and generally favorable
financial conditions. Opportunities to realize significant gains in efficiency by
investing in high-tech equipment should
provide ongoing support to equipment
spending as well. Investment in nonresidential buildings also seems to be expanding briskly. In addition, prospects
are favorable for continued increases in
demand for exports of U.S. goods and
services.
FOMC participants generally expect
core inflation to edge down a bit further
over the next year and a half. In assessing the apparent slowing of core inflation this spring, participants recognized
that the monthly price data are volatile
and that some of the recent improvement may prove to have been transitory.
Nonetheless, they believe that the current environment will be conducive to
some further moderation in underlying
price pressures. The participants' forecasts for real activity imply a slight easing over the next several quarters of the
tightness in labor and product markets.
And although core inflation is expected
to remain under some upward pressure
in the near term from the pass-through
of the increases to date in the prices of
energy and other commodities, those
cost pressures should subsequently
wane. Accordingly, with long-run inflation expectations contained, diminished
cost pressures should result in some
moderation in core inflation.

construction exerted significant restraint
on economic activity. The rise in real
GDP in the first quarter was also
damped by a downswing in inventory
investment, a dip in defense spending,
and an unusually sharp drop in net exports. The available information suggests that GDP growth rebounded in the
second quarter as the drag from inventory investment waned and as defense
expenditures and net exports snapped
back after their first-quarter declines. In
the labor market, hiring continued at a
steady pace throughout the first half, although job gains fell short of those recorded in 2006, and the unemployment
rate remained at 4Vi percent. Headline
consumer price inflation was boosted by
a reversal of the downturn in energy
prices in late 2006 and a step-up in retail
food prices, while core inflation was
little changed. Real hourly labor compensation increased over the year ending in the first quarter, although gains in
the second quarter were probably eroded
by the energy-driven pickup in overall
inflation. Conditions in financial markets have remained generally supportive
of economic expansion thus far this year
despite deteriorating conditions in the
subprime-mortgage sector. Investors
seemed to become more optimistic
about the outlook for the economy: Interest rates rose, credit spreads on corporate bonds stayed narrow on the whole,
and equity markets recorded sizable
gains.

Economic and Financial
Developments in 2007

The Household Sector

Real GDP increased at an annual rate of
2V4 percent in the second half of 2006,
and it appears to have risen at roughly
that pace, on average, over the first half
of 2007. Although consumer spending
and business fixed investment posted
moderate gains, on balance, during the
first half, the contraction in residential

Consumer Spending
After exhibiting considerable vigor in
late 2006, consumer spending slowed
somewhat over the first half of 2007.
Spending continued to be bolstered by
the strong labor market and the lagged
effects of earlier increases in household

Monetary Policy Report of July 2007
wealth. However, these positive influences were partly offset by the rise in
energy prices this year, which drained
consumers' purchasing power, and by
reduced home-price appreciation, which
limited recent gains in wealth for many
households. Surveys of consumer sentiment have remained in a favorable range
this year.
Real PCE rose at an annual rate of
4V4 percent in the first quarter. Spending
on light motor vehicles (cars, sportutility vehicles, and pickup trucks) got
off to a fast start this year, expenditures
on energy services were boosted by unusually cold weather in February, and
outlays for other goods and services
posted sizable gains after a steep run-up
in the fourth quarter. The available data
imply a much slower pace of spending
growth in the second quarter, as sales of
light motor vehicles softened and real
spending on goods other than motor vehicles turned lackluster.
Real disposable personal income
(DPI)—that is, after-tax income adjusted
for inflation—also started the year on a
strong note after a large increase in the
fourth quarter.1 Wages and salaries and
some other major categories of personal
income continued to rise appreciably in
nominal terms throughout the first half.
However, these gains were eroded in
real terms by the energy-related jump in
inflation in the spring, and, as a result,
real DPI rose at an annual rate of just
IV2 percent between the fourth quarter
1. According to the published data, real DPI
rose at an annual rate of 43A percent in the first
quarter. However, a substantial part of the increase
occurred because the Bureau of Economic Analysis (BEA) added $50 billion (annual rate) to its
estimate of first-quarter wages and salaries in response to information that bonus payments and
stock option exercises around the turn of the year
were unusually large. Because the BEA did not
assume that these payments carried forward into
April, real DPI fell sharply in that month.

of 2006 and May 2007, compared with
an increase of more than 3 percent over
the four quarters of 2006.
Even given the sharp deceleration in
residential real estate values, household
wealth has remained supportive of
spending growth. One reason is that the
surge in equity values in recent quarters
has allowed overall household wealth to
keep pace with nominal income despite
the softness in home prices. In addition,
because changes in net worth tend to
influence consumption with a lag of several quarters, the increases in wealth
during 2005 and 2006 are likely still
providing a good deal of impetus to
spending. These increases in wealth,
which have provided many households
with the resources and inclination to
raise their spending at a rate that exceeds income growth, have been a factor
pushing down the personal saving rate
over the past couple of years even as
interest rates have moved up. After fluctuating in the vicinity of 2 percent from
1999 to 2004, the saving rate subsequently dropped sharply, and it stood at
negative 1 lA percent, on average, in
April and May of 2007.
Residential Investment
Residential construction activity remained soft in the first half of 2007, as
builders continued to confront weak demand and an elevated inventory of unsold new homes. In the single-family
sector, new units were started at an average annual rate of 1.18 million between
January and May—more than 30 percent below the quarterly high reached in
the first quarter of 2006. Starts in the
multifamily sector averaged a little less
than 300,000 units during the first five
months of 2007, an amount at the lower
end of the range of the past nine years.
All told, the contraction in housing activity subtracted nearly 1 percentage

94th Annual Report, 2007

point from the change in real GDP in the
first quarter of 2007—almost as much
as in the second half of 2006—and the
drag likely remained substantial in the
second quarter.
The monthly data on home sales have
been erratic this year. But after smoothing through the ups and downs, the data
suggest that demand has softened further after falling at a double-digit rate
between mid-2005 and mid-2006 and
then holding reasonably steady in the
second half of last year. On average,
sales of existing homes over the three
months ending in May 2007 were AVi
percent below their average level in the
second half of last year, while sales of
new homes were down 10 percent over
that period. The further weakening of
housing demand this year likely reflects,
in part, tighter lending standards for
mortgages, and it occurred despite mortgage rates that were relatively low by
longer-run standards. The ongoing slippage in sales has made it more difficult
for homebuilders to make much of a
dent in their inventories of new homes
for sale. When evaluated relative to the
three-month average pace of sales, the
months' supply of unsold new homes in
May was more than 60 percent above
the high end of the relatively narrow
range it occupied from 1997 to 2005.
Moreover, these published figures probably understate the true inventory overhang in this sector to the extent that they
do not account for the surge in canceled
sales in the past year; such cancellations
return homes to unsold inventory but are
not incorporated in the official statistics.
The rate of house-price appreciation
slowed dramatically in 2006 after nearly
a decade of rapid increases, and prices
appear to have moved roughly sideways
in the first half of 2007. The purchaseonly version of the repeat-transactions
price index for existing single-family
homes published by the Office of Fed

eral Housing Enterprise Oversight,
which tracks sales prices of the same
houses over time, rose at an annual rate
of just 2 percent in the first quarter of
2007 (the latest available data) and was
up just 3 percent over the year ending in
the first quarter, compared with an increase of 10 percent over the preceding
year. For April and May combined, the
average price of existing single-family
homes sold—which does not control for
changes in the mix of houses sold but is
available on a more timely basis—was
about 1 percent below that of a year
earlier.
Household Finance
Household debt expanded at an annual
rate of 6 percent in the first quarter of
2007, somewhat below the pace of
83/4 percent posted in 2006. The deceleration was primarily the result of a significant step-down in the rise of mortgage debt, which reflected the sharp
slowing of house-price appreciation and
the slower pace of home sales. Consumer (nonmortgage) debt has remained
on a moderate uptrend this year.
Debt rose a little more slowly than
personal income in the first quarter, so
the financial obligations ratio for the
household sector inched down, though it
remained only a bit below its historical
high. Most households were able to
meet their debt service obligations, and
measures of household credit quality
were generally little changed. For example, delinquency rates on consumer
loans and prime mortgages—the two
main components of total household
debt—stayed low through the spring of
2007, as did those on subprime fixedrate mortgages. In addition, household
bankruptcy filings continued to be subdued in the first half of the year: They
ran near the average pace seen since
early 2006, after the bulge that accom-

Monetary Policy Report of July 2007
panied the implementation of the new
bankruptcy law in October 2005.
Some households, however, have experienced growing financial strains. Delinquency rates on subprime mortgages
with variable interest rates, which account for about 9 percent of all first-lien
mortgages outstanding, continued to
climb in the first five months of 2007
and reached a level more than double
the recent low for this series, which was
recorded in mid-2005. The rise in delinquencies has begun to show through to
new foreclosures. In the first quarter of
2007, an estimated 325,000 foreclosure
proceedings were initiated, up from an
average quarterly rate of 230,000 over
the preceding two years; about half of
the foreclosures this year were on
subprime mortgages. The decline in
credit quality in the subprime sector has
likely stemmed from a combination of
several factors, including the moderation in overall economic growth and
some regional economic weakness. In
addition, a substantial number of subprime borrowers with variable-rate
mortgages have faced an upward adjustment of the rates from their initial levels. When house prices were rising rapidly and rates on new loans were lower,
many of these borrowers qualified to refinance into another loan with morefavorable terms. With house prices having decelerated and rates having moved
higher, however, the scope for refinancing has been reduced. Moreover, investor owners may have been tempted to
walk away from properties with little or
no equity. Subprime mortgages originated in late 2005 and 2006 have shown
unusually high rates of early delinquency, suggesting that some lenders
unduly loosened underwriting standards
during that period.
In recent months, credit has become
less easily available in the subprimemortgage market, as investors in sub

prime-mortgage-backed securities reportedly have scrutinized the underlying
subprime loans more carefully and lenders have tightened underwriting standards. For example, more than half of
the respondents to the questions on
subprime residential mortgages in the
Federal Reserve's April 2007 Senior
Loan Officer Opinion Survey on Bank
Lending Practices indicated that they
had tightened credit standards on such
loans over the previous three months. In
June, the federal financial regulatory
agencies issued a final Statement on
Subprime Mortgage Lending to address
issues relating to certain adjustable-rate
mortgage products. Credit spreads on
the lower-rated tranches of new subprime securitizations have increased
sharply, on balance, this year, and issuance of subprime-mortgage-backed securities has moderated from its vigorous
pace of the past couple of years. However, despite the ongoing problems, the
subprime market has continued to function, and new loans are being made.
The Business Sector
Fixed Investment
After having risen sharply over much of
2006, real business fixed investment
(BFI) lost some steam in the fourth
quarter and posted a relatively meager
gain in the first quarter of 2007. The
slower rise in business output in recent
quarters has likely been a moderating
influence on business investment expenditures. But on the whole, economic and
financial conditions still appear to be
favorable for capital spending: Corporate profits remain robust, businesses
have ample liquid assets at their disposal, and conditions in financial markets remain supportive.
Much of the recent softness in BFI
was in spending on equipment and soft-

94th Annual Report, 2007

ware (E&S), which rose at an annual
rate of less than 2 percent in real terms
in the first quarter after having fallen
nearly 5 percent in the fourth quarter of
2006. Within the major components of
E&S, real spending on high-tech equipment expanded at an annual rate of more
than 20 percent in the first quarter of
2007 because of both a surge in outlays
on computers after the release of a major new operating system and a spurt in
investment in communications gear.
Aircraft purchases also posted a sizable
increase. However, spending on motor
vehicles tumbled, as many firms had accelerated their purchases of medium and
heavy trucks into 2005 and 2006 so that
they could take delivery before the Environmental Protection Agency's new
emissions standards for engines went
into effect this year. Elsewhere, real investment in equipment other than hightech and transportation goods dropped
at an annual rate of 10 percent in the
first quarter after a fall of nearly 5 percent in the previous quarter. The weakness in this category, which accounts for
roughly 40 percent of investment in
E&S when measured in nominal terms,
appears to have reflected, in part, appreciable declines in spending on equipment disproportionately used by the
construction and motor vehicle industries and was most pronounced around
the turn of the year.
Although the weakness in truck sales
apparently extended through midyear,
real E&S outlays apart from transportation equipment appear to have posted a
solid increase in the second quarter. Incoming information suggests that hightech spending continued to move up in
real terms—albeit not as fast as it did in
the first quarter. Moreover, shipments
and orders for equipment other than
high-tech and transportation items regained some lost ground.

Nonresidential construction activity
turned up steeply in 2006 after having
been stagnant for several years, and it
continued to exhibit considerable
strength in early 2007. Outlays for office, retail, and industrial buildings are
all running well above year-earlier levels, and—given that vacancy rates have
moved down over the past couple of
years—prospects for further gains in
coming quarters are good. One exception to the recent strength in this sector
is the drilling and mining category, in
which real outlays fell in the first quarter after three years of sizable gains. The
recent softening in this category of investment may reflect, in part, reported
shortages of specialty equipment and
skilled labor.
Inventory Investment
Inventory investment slowed markedly
in the fourth quarter of 2006 as firms
acted to stem rising inventory imbalances, and it turned negative in the first
quarter of 2007. The downswing in inventory investment shaved about 1 pcicentage point from the change in real
GDP in both the fourth and first quarters, and it appears to have brought
stocks into better alignment with sales.
Some of the inventory correction was in
the motor vehicle sector, in which high
gasoline prices have been causing demand to shift to more-fuel-efficient
models—a trend that, by the middle of
2006, had left dealers with bloated inventories of light trucks and sport-utility
vehicles. Facing little prospect of significantly stronger sales of those vehicles in the near term, the manufacturers instituted sharp cuts in production
starting in the second half of last year.
The production cuts, which in the first
quarter of 2007 brought assemblies of
light vehicles to their lowest level in
more than a decade, helped clear out

Monetary Policy Report of July 2007

dealers' lots and thus set the stage for a double-digit gains in 2006; nonetheless,
step-up in assemblies in the second before-tax profits measured as a share of
quarter. The automakers have scheduled sector GDP were nearly 13 percent,
a further rise in assemblies in the third close to the high levels posted last year.
Fueled in part by continued heavy
quarter, in part to get a good start on
producing the new, more-fuel-efficient merger and acquisition activity, nonfimodels that will be introduced to the nancial business debt expanded at an annual rate of 9 percent in the first quarter
public in coming months.
Excluding motor vehicles, inventories of this year, only a bit slower than in
appeared to be well aligned with sales 2006, and data in hand suggest a robust
through much of 2006, but they too pace of expansion again in the second
started to look excessive as the growth quarter. Net bond issuance has been
of aggregate demand slowed in the latter solid so far in 2007, and commercial
part of the year. The emerging imbal- and industrial lending by banks has reances, some—though not all—of which mained strong. Although lower-quality
appear to have been at firms that supply corporate credit markets experienced
the construction and motor vehicle in- some strains, generally narrow credit
dustries, prompted production adjust- spreads have encouraged corporate bond
ments that reduced non-auto inventory issuance, and the growth of business
investment to a very modest rate in the loans has been spurred by banks' acfirst quarter. According to the limited commodative lending posture. Consideravailable information, the pace of real able net fractions of respondents to the
stockbuilding appears to have remained April 2007 Senior Loan Officer Opinion
low in April and May, and, for the most Survey indicated that they had eased
part, inventories seem to have moved some terms—especially spreads of loan
back into rough alignment with sales. In rates over their costs of funds, costs of
fact, businesses surveyed in June by the credit lines, and loan covenants—on
Institute for Supply Management re- commercial and industrial loans over the
ported that their customers were mostly previous three months. Banks pointed to
comfortable with their current stock lev- more-aggressive competition from other
els, whereas earlier in the year an el- banks or nonbank lenders and to inevated number of respondents had char- creased liquidity in the secondary maracterized these inventory positions as ket for these loans as the most important
reasons for having eased business lendtoo high.
ing terms. Commercial paper outstanding was flat in the first quarter but inCorporate Profits and Business
creased somewhat in the second quarter.
Finance
Gross public issuance of equity by
In the first quarter of 2007, growth in nonfinancial corporations has continued
corporate profitability slowed from last to be moderate so far this year, but priyear's pace, but the level of profitability vate equity issuance has apparently reremained high. Earnings per share for mained strong, as leveraged buyout acS&P 500 firms decelerated but still tivity has continued to climb. However,
came in nearly 10 percent above their given the elevated levels of share repuryear-earlier level. In the national income chases and equity retirements from cashaccounts, profits of nonfinancial corpo- financed mergers and acquisitions in the
rations in the first quarter were little first quarter, net equity issuance continchanged from year-earlier levels after ued to be deeply negative.

94th Annual Report, 2007

Despite some deceleration in profits,
the credit quality of nonfinancial firms
has generally continued to be robust.
The six-month trailing bond default rate
has stayed near zero this year, and the
delinquency rate on commercial and industrial loans at banks remained extremely low in the first quarter. For public firms, balance sheet liquidity was
still high in the first quarter, whereas
corporate leverage stayed near historical
lows despite the large net retirement of
equity. In addition, net interest payments
relative to cash flow continued to be
near the low end of the range seen over
the past two decades.
Commercial real estate debt expanded
briskly in the first quarter of 2007,
albeit not quite so rapidly as in 2006, a
pattern consistent with the net tightening of credit standards on commercial
real estate loans reported in the Senior
Loan Officer Opinion Survey. Spreads
on BBB-rated commercial-mortgagebacked securities (CMBS) soared in late
February and have varied within an elevated range since then. The increase
reportedly came in response to a reduction in investor interest in collateralized
debt obligations, sponsors of which traditionally have purchased many of these
securities, and to plans by the rating
agencies to increase the level of credit
support required for such securities.
However, because rents on commercial
properties have been increasing and vacancy rates have remained moderate,
credit quality has generally continued to
be good. Delinquency rates on commercial mortgages held by life insurance
companies and on those backing CMBS
have stayed near the bottom of their recent ranges this year. The delinquency
rate on commercial mortgages held by
banks edged up further in the first quarter in response to a deterioration in the
performance of loans for multifamily
properties and for construction and land

development; nevertheless, this delinquency rate remained low by historical
standards.
The Government Sector
Federal Government
The deficit in the federal unified budget
narrowed further during the past year:
Receipts continued to rise at a fairly
rapid rate, while growth in outlays was
relatively subdued. Over the twelve
months ending in June, the unified budget recorded a deficit of $163 billion,
$113 billion less than during the comparable period ending in June 2006. When
measured relative to nominal GDP, the
deficit has decreased steadily from a recent fiscal year high of 3.6 percent in
2004 to a little more than 1 percent during the past twelve months.
Nominal federal receipts during the
twelve months ending in June were
8 percent higher than during the same
period a year earlier. This increase was
considerably smaller than the doubledigit advances recorded in fiscal 2005
and fiscal 2006. Nonetheless, it was
faster than the increase in income and
pushed up the ratio of receipts to GDP
to nearly 19 percent. Individual income
tax receipts continued to outpace the rise
in taxable personal income as measured
in the national income and product accounts (NIPA), likely a result, at least in
part, of larger capital gains realizations
(which are excluded from NIPA income), the effect of some taxpayers
moving into higher tax brackets as their
real incomes increased, and perhaps a
further shift in the distribution of income toward high-income households,
which typically face higher tax rates.
Corporate receipts, after rising at an annual rate of nearly 40 percent, on average, over the three years ending in fiscal
2006, rose 15 percent during the year

Monetary Policy Report of July 2007
ending in June, a rate more in line with
the increase in corporate profits.
Nominal federal outlays increased
less than 3 percent during the twelve
months ending in June and edged down
to 20 percent of nominal GDP, around
the lower end of the narrow range that
has prevailed since 2003. In large part,
the deceleration in outlays reflected the
tapering off of the temporary bulge in
expenditures for flood insurance and disaster relief associated with the 2005
hurricanes. Meanwhile, spending on
health programs continued to rise
briskly, only in part because of the net
increment to spending from the Medicare Part D prescription drug program,
which started in January 2006. Defense
spending was up 5 percent over the period, an increase somewhat below those
recorded in fiscal years 2005 and 2006.
Total federal outlays were also boosted
by a sizable rise in net interest payments
as interest rates moved higher, although
the increase in debt service costs was
significantly smaller than that of a year
earlier.
As measured in the NIPA, real federal
expenditures on consumption and gross
investment—the part of federal spending that is a direct component of GDP—
fell at an annual rate of nearly 4 percent
in the first quarter, as a drop in defense
spending more than offset a moderate
increase in nondefense purchases. Defense expenditures tend to be erratic
from quarter to quarter, and the firstquarter dip followed a large increase in
the fourth quarter. Defense spending appears to have turned back up in the second quarter, and, given currently enacted
appropriations, it is likely to increase
further in coming quarters.
All else being equal, the significant
narrowing of the unified budget deficit
over the past few years raises national
saving. However, the positive effect on
national saving of the smaller federal

deficit has been largely offset by a
downward drift in nonfederal saving.
Although business saving has increased
substantially over this period, personal
saving has dropped sharply. Accordingly, total national saving (that is, federal plus nonfederal) has recovered only
a little from the exceptionally low levels
reached between 2003 and 2005; measured net of estimated depreciation, it
has fluctuated between Wi percent and
2Vi percent of GDP since the start of
2006. If not boosted over the longer run,
persistent low levels of saving will be
associated with either slower capital formation or continued heavy borrowing
from abroad, either of which would retard the rise in the standard of living of
U.S. residents over time and hamper the
ability of the nation to meet the retirement needs of an aging population.
Federal Borrowing
Federal debt rose at an annual rate of
63/4 percent in the first quarter of 2007, a
bit slower than in the corresponding
quarter of last year. As of the end of the
first quarter, the ratio of federal debt
held by the public to nominal GDP was
about 36 percent, a level little changed
from that in recent quarters.
The improvement in the budget position of the federal government has led
the Treasury to scale back issuance of
marketable coupon securities. As part of
its reduction in issuance, the Treasury
announced in May that it was discontinuing auctions of three-year nominal
notes. This move had been widely anticipated and elicited little reaction in
financial markets.
Overall, foreign purchases of Treasury securities appear to have increased
further this year, thereby bringing the
share of these securities held by foreign
investors to a new high of almost 45 percent at the end of the first quarter. The

94th Annual Report, 2007

proportion of nominal coupon securities
purchased at auctions by foreign investors moved up in late 2006 and has
stayed elevated thus far this year, albeit
well off the peak reached in 2004. Balance of payments data point to sizable
net purchases by foreign private investors between January and March,
whereas such investors sold Treasury securities, on net, in 2006. In contrast, net
purchases by foreign official investors
have declined somewhat this year. Custody holdings at the Federal Reserve
Bank of New York on behalf of foreign
official and international accounts have
only edged up since the end of 2006.
State and Local Government
On the whole, state and local governments continue to enjoy strong fiscal positions as a consequence of several years
of robust revenue inflows and a period
of appreciable restraint on spending after these governments' fiscal difficulties
earlier in the decade. Accordingly, over
the past year or so, states and localities
in the aggregate have been able both to
raise expenditures and to maintain
healthy balances in their reserve funds.
However, revenue flows in many states
appear to have slowed a bit of late, a
pattern similar to the one that has
emerged at the federal level. For local
governments, property tax receipts are
still being bolstered by the earlier run-up
in real estate values, but the deceleration
in house prices over the past year will
likely slow the rise in local revenues
down the road. Moreover, many state
and local governments expect to face
significant structural imbalances in their
budgets in coming years as a result of
the ongoing pressures from Medicaid
and the need to provide pensions and
health care to an increasing number of
retired state and local government
employees.

According to the NIPA, real expenditures on consumption and gross investment by state and local governments
rose at an annual rate of nearly 4 percent
in the first quarter, and they apparently
posted a further increase in the second
quarter. Much of the strength in the first
half of 2007 was in construction spending, which has been climbing since the
start of 2006, in part because of very
rapid increases in outlays on highways.
Hiring by states and localities also exhibited considerable vigor during the
first half of 2007, both in the education
sector and elsewhere; on average, state
and local government employment rose
30,000 per month over the six months
ending in June, compared with an average monthly increase of 22,000 over the
preceding ten years.
State and Local Government
Borrowing
Borrowing by state and local governments has been strong thus far in 2007,
largely because refundings in advance
of retirements have been elevated as interest rates have remained relatively
low. In contrast, issuance of short-term
debt has been moderate—a development
consistent with the strong budgets of
state and local governments. The credit
quality of municipal bonds has remained
solid on the whole, as the number of
bond-rating upgrades has outpaced the
number of downgrades thus far this year.
The ratio of yields on municipal bonds
to those on comparable-maturity Treasury securities has stayed at the low end
of its range of the past decade.
The External Sector
In 2006, U.S. real net exports made a
positive contribution to the full year's
economic growth for the first time since
1995. The contribution of net exports
moved into negative territory again,

Monetary? Policy Report of July 2007
however, in the first quarter of this year,
as imports rebounded and exports
slowed from their exceptional pace late
last year. Data for April and May point
to a resurgence of exports and a moderation of imports in the second quarter.
The U.S. nominal current account
deficit widened a bit in the first quarter
of 2007 to $770 billion at an annual rate,
or about 53A percent of nominal GDP,
from $752 billion in the fourth quarter
of 2006. The larger deficit was due to an
increase in net unilateral transfers
abroad. Although the first-quarter trade
balance deteriorated in real terms, increases in export prices outpaced those
in import prices, thereby leaving the
nominal trade balance unchanged. Despite the large negative U.S. net international investment position, the U.S. balance on investment income remained
positive and also was about unchanged
in the first quarter.
International Trade
Despite continued solid foreign economic expansion and persisting stimulus from earlier declines in the dollar,
the growth of real exports of goods and
services slowed to an annual rate of less
than 1 percent in the first quarter from
its exceptionally strong pace of more
than 10 percent in the fourth quarter.
The slowdown was particularly evident
in sales of capital goods—especially aircraft and computers—and industrial
supplies, which fell in the first quarter
after rising robustly in late 2006. Also
contributing to the slowdown, real exports of services rose only 2 percent in
the first quarter after increasing more
than 16 percent in the fourth quarter.
Available data for nominal exports in
April and May suggest that real export
growth moved up in the second quarter,
as increases in exports of services, automobiles, industrial supplies, and con

sumer goods more than offset a further
contraction in exports of capital goods.
Prices of exported goods rose at an
annual rate of 4 percent in the first quarter of 2007, up from the pace of about
2Vi percent seen in the second half of
2006. Prices of non-agricultural industrial supplies, which had been reduced
in the fourth quarter by lower oil prices,
were pushed up in the first quarter by
higher prices for metals and renewed
increases in oil prices. In addition, agricultural prices—especially those of
corn, soybeans, and wheat—have risen
briskly over the past several quarters, in
part because of the direct and indirect
effects of the increased demand for ethanol. Monthly data on trade prices in the
second quarter point to further increases
in export prices on the strength of additional run-ups in the prices of nonagricultural industrial supplies, most notably metals.
After falling at an annual rate of
2Vi percent in the fourth quarter, real
imports of goods and services rose at a
5Vi percent rate in the first quarter. A
sharp increase in oil imports, after a
fourth-quarter decline, was the most important contributor to the swing, but imports of computers, semiconductors, and
natural gas also accelerated. Imports of
other goods continued to be weak, likely
a result, in part, of slower U.S. growth;
imports of autos and industrial supplies,
in particular, contracted sharply. The
growth of real imports of services
dropped from 6VA percent in the fourth
quarter to 23A percent in the first quarter.
Data for April and May imply some
slowing of overall real imports in the
second quarter. In particular, imports of
oil and computers displayed noteworthy
decelerations.
Prices of imported goods excluding
oil and natural gas rose at an annual rate
of about 1 Vi percent in the first quarter
of 2007, as prices of both finished and

94th Annual Report, 2007

material-intensive
goods
recorded
higher rates of increase. Monthly trade
price data suggest that import prices accelerated in the second quarter, partly
because of higher metals prices, which
have fluctuated widely in recent months
but are up substantially, on balance, so
far in 2007. More generally, prices of
industrial supplies have been rising
briskly, a movement that may reflect, in
part, a response to the depreciation of
the dollar in recent months. No such
effect of the dollar's decline is readily
apparent in the prices of finished goods.
Oil prices fell at the beginning of
2007, as unusually mild temperatures reduced oil demand and OPEC members
appeared less likely to implement fully
production cuts agreed to at the end of
2006. The spot price of West Texas intermediate (WTI) crude oil, the U.S.
benchmark, fell from an average of
$62 per barrel in December to $54 per
barrel in January. Oil prices then rose
gradually as it became apparent that
OPEC, led by Saudi Arabia, indeed
would restrain oil production further. Oil
prices also have been supported by solid
growth in demand, particularly in developing countries, and by long-running
concerns about supply disruptions. Ongoing violence has depressed oil production in Iraq and Nigeria; the Nigerian
outage recently worsened to about onefourth of the country's estimated capacity. Since the start of the year, concerns
have also intensified about a possible
future disruption of oil exports from
Iran. The spot price of WTI averaged
$72 per barrel in the first half of July.
Despite its elevated level by historical
standards, the spot price of WTI has not
increased as much in recent months as
have the prices of other grades of crude
oil because of high inventories of WTI
in the central United States arising from
interruptions for maintenance and unplanned outages at refineries. Since

early March, the spot price of Brent
crude oil, the European benchmark, has
risen about $5 per barrel more than has
the spot price of WTI; the price of Brent
averaged $76 per barrel in the first half
of July.
The Financial Account
The U.S. nominal current account deficit
continued to be financed primarily by
foreign purchases of U.S. debt securities. Driven by purchases of U.S. government securities by Asian central
banks, foreign official inflows moved up
noticeably in the first quarter. Although
demand for U.S. Treasury securities by
foreign official investors eased, it was
more than offset by increased official
purchases of bonds and mortgagebacked securities issued by governmentsponsored enterprises (GSEs). Preliminary data indicate that official inflows
remained strong through April.
Foreign private purchases of U.S. securities maintained the extraordinary
pace set in 2006. Demand for U.S. Treasury bonds extended its fourth-quarter
strength, while demand for equities
picked up from an already robust level;
purchases of corporate bonds moderated
slightly, and, on net, private foreigners
sold debt issued by GSEs. Foreign direct
investment flows into the United States
weakened significantly; the rate of inflows in the first quarter was roughly
half that in 2006.
Net purchases of foreign securities by
U.S. residents, which represent a financial outflow, remained strong in the first
quarter of this year. Net acquisitions of
bonds continued at the brisk pace recorded in the second half of 2006, while
purchases of foreign stocks, although
slowing slightly, remained elevated.
Outflows associated with U.S. direct investment abroad strengthened to a nearrecord rate.

Monetary Policy Report of July 2007

The Labor Market
Employment and Unemployment
The demand for labor has been increasing at a moderate rate this year, somewhat less quickly than in 2006. After
having averaged 190,000 per month in
2006, gains in payroll employment averaged 145,000 per month in the first half
of 2007. The civilian unemployment
rate has changed little since last fall and
stood at 4.5 percent in June.
As was the case in 2006, job growth
in the first half of 2007 was driven by
solid gains in service-producing industries. In particular, hiring at health, education, and eating and drinking establishments remained on strong uptrends,
and job gains at businesses providing
professional and technical services were
sizable. However, employment in the financial activities and administrative
support sectors softened after two years
of strong advances. In the goodsproducing sector, manufacturing employment, which has been on a secular
downtrend for more than a quartercentury, declined again over the first
half of 2007. The decline this year reflected cutbacks at firms closely tied to
the construction industry and at producers of motor vehicles and parts, as well
as the ongoing downtrend in payrolls at
manufacturers of apparel and textiles.
Employment in residential construction,
which had fallen in 2006 after two years
of substantial increases, declined just
modestly, on net, over the first half of
2007 despite the substantial contraction
in housing activity.
Other labor market indicators have
mostly remained positive. Initial claims
for unemployment insurance have
stayed relatively low in recent months.
In addition, readings from private surveys of hiring plans have remained in a
favorable range despite recent declines,

and the job openings rate has held at a
high level. According to the Conference
Board, households' assessments of job
availability cooled a bit in the spring
after having improved somewhat earlier
in the year; even so, the June value for
this indicator was still relatively
positive.
After hovering around 43A percent
during the first three quarters of 2006,
the unemployment rate fell to 4V2 percent in the fourth quarter, and it remained in that neighborhood through
June. The labor force participation rate
has continued to be buoyed by the favorable job market, and it stood at 66.1 percent in June, within the narrow range
that has prevailed since 2005. Despite
the recent flatness, the participation rate
has fallen appreciably since the start of
the decade; the downtrend has largely
reflected longer-run demographic forces
that include a leveling off in the participation rate of women and an increase in
the proportion of the workforce in older
age groups, which have lower average
participation rates than do younger age
groups.
Productivity and Labor Compensation
Gains in labor productivity have slowed
lately. According to currently published
data, output per hour in the nonfarm
business sector rose just 1 percent over
the year ending in the first quarter of
2007, down from the pace of 2 percent
per year recorded over the preceding
two years (and down from much larger
increases in the first half of the decade).
The slowing in productivity was associated with the deceleration in output and
thus was probably, at least in part, a
temporary cyclical phenomenon. Indeed, the fundamental forces that in recent years have supported a solid uptrend in underlying productivity—the
driver of real wage gains over time—

94th Annual Report, 2007

remain in place. They include the rapid
pace of technological change and firms'
ongoing efforts to use information technology to improve the efficiency of their
operations. Increases in the amount of
capital, especially high-tech capital,
available to each worker also appear to
be providing considerable impetus to
productivity growth.
Broad measures of hourly compensation have been bounced around in recent
years by the lumpiness of bonus payments, stock option exercises, and sharp
swings in employer benefit costs. However, on balance, the evidence points to
some pickup recently in the underlying
pace of compensation gains, a development consistent with the tight labor market. The employment cost index (ECI)
for private industry workers, which
measures both wages and the cost of
benefits, increased 3V4 percent in nominal terms between March 2006 and
March 2007, compared with an increase
of 2Vi percent over the preceding twelve
months. Adjusted for inflation, as measured by the increase in the overall PCE
price index, the ECI rose nearly 1 percent over the year ending in March after
having fallen nearly Vi percent over the
preceding year. Data on hourly compensation in the second quarter are not yet
available, but a sharp rise in overall consumer prices during that period probably offset much—if not all—of the
nominal gains that were realized.
The step-up in the rate of increase in
the ECI over the past year was concentrated in its wage and salary component,
which rose V/i percent over the year
ending in March, 1 lA percentage points
more than the increase over the yearearlier period. Meanwhile, increases in
the cost of providing benefits have
slowed dramatically of late, in part because premiums for health insurance
have stopped rising at double-digit rates.
The increase in benefit costs over the

year ending in March, which amounted
to just 2lA percent, was also held down
by a sharp drop in employer contributions to retirement plans. The lower contributions appear to have reflected several factors, including the strong
performance of the stock market in 2006
and a high level of employer contributions over the past several years; taken
together, these factors significantly
boosted the funding levels of definedbenefit plans.
According to preliminary data, compensation per hour in the nonfarm business (NFB) sector—an alternative measure of hourly compensation derived
from the data in the NIPA—rose
3!/4 percent over the year ending in the
first quarter of 2007, the same rise as in
the ECI. Over the year ending in the
first quarter of 2006, NFB hourly compensation had risen 53/4 percent, in part
because of an apparent surge in the
value of stock option exercises (which
are excluded from the ECI) early last
year. Largely reflecting the slower
growth in NFB hourly compensation,
unit labor costs rose 2lA percent over
the year ending in the first quarter of
2007 after increasing ?>Vi percent over
the preceding four quarters.

Prices
Headline inflation picked up again in
the first half of 2007, as energy prices
surged after having eased late last year
and increases in food prices quickened.
The PCE chain-type price index increased at an annual rate of 4.4 percent
between December 2006 and May 2007
after rising 2.2 percent over the twelve
months of 2006. Core PCE prices—
which exclude the direct effects of
movements in food and energy prices—
rose at an annual rate of 2.0 percent over
the first five months of the year, 0.1 per-

Monetary Policy Report of July 2007
Alternative Measures of Price Change,
2006-07
Percent
Price measure
Chain-type (Ql to Ql)
Gross domestic product (GDP) ..
Excluding food and energy ...
Gross domestic purchases
Personal consumption
expenditures (PCE)
Excluding food and energy ...
Market-based PCE excluding
food and energy
Fixed-weight (Q2 to Q2)
Consumer price index
Excluding food and energy ...

2006

2007

3.1
2.9
3.5

2.8
2.7
2.5

3.0
2.0

2.2
2.3

1.6

2.1

4.0
2.4

2.6
2.3

NOTE: Changes are based on quarterly averages of seasonally adjusted data. For the consumer price index, the
2007:Q2 value is calculated as the average for April and
May compared with the average for the second quarter of
2006 and is expressed at an annual rate.
SOURCE: For chain-type measures, Department of
Commerce, Bureau of Economic Analysis; for fixedweight measures. Department of Labor, Bureau of Labor
Statistics.

centage point less than the increase over
the twelve months of 2006.
Energy prices, which had fallen substantially in the fourth quarter of 2006,
decreased further in January in response
to declines in the price of crude oil, unseasonably mild temperatures in North
America and Europe, and historically
high inventories of petroleum products
and natural gas. However, energy prices
shot up from February to May, and the
rise brought the net increase in the PCE
price index for energy over the first five
months of the year to 14 percent (not at
an annual rate). The increase was especially large for gasoline, the price of
which was boosted not only by higher
prices for crude oil beginning in late
winter but also by numerous refinery
shutdowns, reflecting both planned
maintenance and unplanned disruptions.
Retail gasoline prices have fallen some
since May as refiners have made some
progress in bringing output closer to seasonal norms, but they are still about
$0.70 per gallon above the levels of late
December.

Food prices have also picked up this
year, in part because of the jump in the
price of corn, which is now in demand
not only as a feedstuff and food but also
as an input to the production of ethanol.
Between December 2006 and May
2007, the PCE price index for food and
beverages increased at an annual rate of
nearly 6 percent. The higher cost of corn
was partly responsible for a IOV2 percent rise over the period in prices for
meats, poultry, fish, and eggs. The index
for fruits and vegetables also posted a
double-digit increase, mainly because a
severe freeze in California in January
destroyed a substantial portion of the
citrus crop and set back the harvest of
many other fruits and vegetables. Prices
for food consumed away from home,
which typically are influenced more by
labor and other business costs than by
farm prices, rose at an annual rate of
4 percent over the first five months of
the year.
The edging down of core PCE inflation this year largely reflected some
waning of the sizable increases in shelter costs that were recorded in 2006.
Core PCE inflation in the most recent
few months was also held down significantly by transitory factors—most notably, a sharp drop in the price of apparel.
In addition, the retail price of tobacco,
which, like apparel, tends to be volatile
from month to month, flattened out after
a steep increase earlier in the year.
Meanwhile, the rate of increase in the
core consumer price index (CPI) has
dropped from 2.6 percent in 2006 to an
annual rate of 2.1 percent so far this
year; the main reason for the sharper
deceleration in the core CPI than in core
PCE prices is that housing costs receive
a much greater weight in this index than
they do in the core PCE measure.
More fundamentally, the behavior of
core inflation so far this year has been
shaped by many of the same forces that

94th Annual Report, 2007

were at work in 2006. Resource utilization in labor and product markets remains fairly high. And although last autumn's drop in energy prices may have
offered some temporary relief, the resurgence in prices for energy and other
commodities is likely putting some upward pressure on core inflation. Regarding inflation expectations, the Reuters/
University of Michigan Surveys of
Consumers (Reuters/Michigan) suggest
that the median expectation for yearahead inflation has moved up in response to the energy-driven pickup in
headline inflation: It rose from 3.0 percent in the first three months of the year
to 3.3 percent in April and remained at
about this level through early July. However, longer-run inflation expectations
appear to have remained contained. In
fact, according to the Reuters/Michigan
surveys, the median five- to ten-year expectation, at 3.1 percent in early July,
has stayed within the narrow range that
has prevailed for the past two years. According to the Survey of Professional
Forecasters, conducted by the Federal
Reserve Bank of Philadelphia, expectations of inflation over the next ten years
remained around 2j/2 percent in the first
half of 2007, a level that has been
essentially unchanged since 1998. Inflation compensation as measured by the
spreads of yields on nominal Treasury
securities over those on their inflationprotected counterparts has also stayed
within its range of recent years.
Broader, NIPA-based measures of inflation, which are available only through
the first quarter of this year, slowed relative to the pace of the past couple of
years. The latest data show a rise in the
price index for GDP less food and energy of 23/4 percent over the year ending
in the first quarter, down lA percentage
point from the year-earlier figure. Although core PCE inflation picked up
slightly during the past four quarters,

prices for some other components of
final demand, especially construction,
decelerated.
U.S. Financial Markets
U.S. financial markets have functioned
well thus far in 2007 despite episodes of
heightened volatility. As the year
opened, financial market quotes put considerable weight on the expectation of
an easing of monetary policy sometime
soon. By the spring, however, investors
apparently had become more optimistic
about the economic outlook and, as a
result, had concluded that less Federal
Reserve easing would be forthcoming
than they had anticipated earlier. In line
with the upward shift in policy expectations, two-year Treasury yields rose
about 10 basis points, on balance,
through mid-July; ten-year yields increased 40 basis points. Supported by
solid corporate profits and the more upbeat economic outlook, equity prices advanced roughly 10 percent on net. Despite some widening in recent weeks,
risk spreads on corporate credits generally remained narrow, reflecting strong
and liquid corporate balance sheets.
Measures of investors' uncertainty about
prospects for a number of financial asset
prices widened somewhat, on balance,
from low levels.
Market Functioning and Financial
Stability
In late February and early March, financial market volatility increased sharply
amid a pullback from riskier assets that
was reportedly spurred by a variety of
factors, including a sharp dip in the Chinese equity market, mounting concerns
about conditions in the subprimemortgage sector, and some softer-thanexpected U.S. economic data. During the
period, spreads on indexes of subprimemortgage credit default swaps (CDS)

Monetary Policy Report of July 2007
spiked; equity markets in the United
States and abroad declined; Treasury
yields dropped across maturities;
spreads of riskier fixed-income instruments over comparable Treasuries widened somewhat; and measures of market
uncertainty, including implied volatilities derived from options prices, moved
up sharply. Despite some capacityrelated technical difficulties in equity
markets on February 27, financial markets generally handled the volatility
well. Liquidity in the Treasury market
continued to be good, as record-high
trading volumes were accompanied by
bid-ask spreads within ranges of the
past few years. Market sentiment subsequently improved—apparently a result,
in part, of reduced anxiety about spillovers to broader markets of the problems in the subprime-mortgage sector—
and financial markets gradually stabilized. Many asset prices reversed their
earlier declines, and measures of uncertainty moved lower.
Strains in financial markets increased
again late in the spring, prompted
largely by renewed concerns about the
subprime-mortgage sector. A considerable widening in spreads on indexes of
subprime-mortgage CDS contributed to,
and was likely reinforced by, troubles at
a few small and medium-si zed hedge
funds that had taken positions designed
to profit from an improvement in
subprime credit quality. These pressures
intensified as a result of actual and anticipated downgrades of some securities
backed by subprime mortgages. Investors' uncertainty about a range of asset
prices increased, and lower-quality corporate credit spreads widened, reportedly reflecting, in part, heightened uncertainty about the valuation of
structured credit products, which are an
important source of funding in the
subprime-mortgage market and in other
financing markets. These pressures have

been contained, though: In spite of the
recent rise, spreads on lower-quality
corporate credits remain near the low
end of their historical ranges, and, although investors recently have balked at
some aggressively structured deals, financing activity in bond and other credit
markets continues at a fairly brisk pace.
Market participants do not appear to
have pulled back from risk-taking more
generally, in that equity prices have
moved higher in recent weeks, and Treasury bid-ask spreads have stayed within
normal ranges despite elevated trading
volumes.
The effects on financial institutions of
this year's difficulties in the subprimemortgage sector have depended on the
institutions' exposure to the sector.
Several mortgage lenders—particularly
monoline subprime lenders—experienced substantial losses, as they had to
repurchase larger-than-expected volumes of previously securitized loans because of so-called early payment defaults. Consequently, a number of these
lenders have gone out of business since
the beginning of the year. Large investment banks active in the securitization
of subprime mortgages suffered modest
hits to their earnings, and their CDS
spreads are considerably higher than at
the beginning of the year. To date, most
large depository institutions appear to
have been less affected by the subprime
difficulties, in part because of their
greater diversification and generally
limited subprime lending activity. CDS
spreads for these institutions have
moved up only a little, on the whole,
thus far in 2007.
Interest Rates
Since the beginning of the year, investors appear to have become more optimistic, on balance, about the outlook for
economic activity and consequently

94th Annual Report, 2007

have raised their expected path for the
federal funds rate. Judging from futures
markets, market participants currently
anticipate that the rate will decline about
25 basis points through the end of 2008;
at the end of last year, market participants had expected about 75 basis points
of easing over the same period. Investors also have apparently become more
certain about the path for the federal
funds rate: Implied volatilities derived
from options on Eurodollar futures over
the next year have moved down, on net,
this year and remain near historical
lows. Estimated probability distributions
for the target federal funds rate between
six and twelve months ahead were
somewhat skewed toward lower rates
through mid-July.
Reflecting the reduced odds placed on
policy easing, yields on two-year nominal Treasury securities increased about
10 basis points over the year through
mid-July. Ten-year Treasury yields rose
40 basis points over the same period. A
portion of the increase in longer-term
yields appears to be attributable to a
widening of term premiums, although
estimated term premiums remain relatively low by historical standards.
Yields on inflation-indexed Treasury
securities moved nearly in line with
those on their nominal counterparts,
thereby leaving inflation compensation
only a little higher.
In the corporate bond market, yields
on investment- and speculative-grade
securities rose about as much, on balance, as those on comparable-maturity
Treasury securities through mid-July,
and so risk spreads on such instruments
are little changed on the year. The narrow spreads on corporate bonds appear
to reflect investors' positive outlook for
business credit quality over the medium
term. The term structure of forward risk
spreads for corporate bonds supports
this view, as forward spreads for the

next few years are low while spreads
further out the curve are more in line
with historical norms.
Equity Markets
Broad equity indexes increased between
%Vi percent and 12 percent, on net,
through mid-July. Stock prices were
boosted by solid first-quarter earnings
that generally met or exceeded investors' expectations and by the more upbeat economic outlook. Share prices
rose for a wide range of industries, although basic materials and energy firms
outperformed the broader market because of strong global demand for commodities. The spread between the
twelve-month forward earnings-price
ratio for the S&P 500 and a real longrun Treasury yield—a rough gauge of
the equity risk premium—narrowed a bit
and now stands close to the middle of its
range of the past few years. After a spike
in connection with the period of unsettled conditions in financial markets in
late February and early March, the implied volatility of the S&P 500 calculated from options prices fell back, but it
picked up again recently in response to
renewed concerns about the subprimemortgage market.
Debt and Financial Intermediation by
Banks
The total debt of the domestic nonfinancial sectors expanded at an annual rate
of 11A percent in the first quarter of
2007, a somewhat slower pace than in
2006. The deceleration in borrowing
was mainly accounted for by a slowdown in household debt, particularly
mortgage debt. In contrast, borrowing
by nonfinancial businesses remained robust in the first quarter. Preliminary data
for the second quarter suggest slightly
slower growth in total domestic nonfinancial sector debt. The step-down in

Monetary Policy Report of July 2007
growth is particularly noticeable in the
federal government sector, in which
strong receipts this tax season held down
borrowing. However, the recent data
suggest somewhat faster growth in nonfinancial business debt in the second
quarter, a pickup fueled by heavy
merger and acquisition activity.
Commercial bank credit increased at
an annual rate of about 6V2 percent in
the first half of 2007. However, adjusted
to remove the effects of a conversion of
a bank to a thrift institution, bank credit
expanded at an annual rate of about
8l/4 percent over the same period, somewhat slower than in 2006.
Excluding this bank-to-thrift conversion, total loans grew briskly in the first
half of the year, with most bank loan
types expanding vigorously. Rapid
growth in commercial and industrial
loans was supported by the continued
robust merger and acquisition activity.
Growth in commercial real estate loans
was also strong even though construction and land development loans, a portion of which is used to fund residential
development, decelerated sharply. Despite the ongoing adjustment in the
housing market, residential real estate
loans on banks' books (adjusted for the
bank-to-thrift conversion noted earlier)
expanded at a strong pace. But home
equity loans grew only modestly. Because rates on these loans are generally
tied to short-term market interest rates,
the flattening of the yield curve last year
made them a relatively more expensive
source of credit. Consumer loans held
by banks picked up in the first quarter,
but they slowed in the second quarter.
Commercial bank profitability declined somewhat in the first quarter of
2007 but remained solid. The net interest margin of the industry continued to
narrow, a likely result of ongoing competitive pressures and the flat yield
curve. Bank profitability was also re

strained by growth in non-interest expenses and a modest increase in provisions for loan losses. Credit quality
stayed strong overall: Delinquency and
charge-off rates remained generally low,
although delinquency rates on residential and commercial real estate loans
moved up further from last year's levels.
The M2 Monetary Aggregate
M2 expanded at an annual rate of about
IV2 percent over the first half of 2007.
The increase evidently outstripped
growth in nominal GDP by a substantial
margin and exceeded the rate that would
have been expected on the basis of the
aggregate's previous relationship with
income and interest rates. M2 rose at an
annual rate of 8 percent in the first quarter before slowing to a pace of 63A percent in the second quarter. Liquid deposits, by far the largest component of M2,
have followed a similar pattern this year.
Small time deposits and retail money
market funds both grew rapidly last
year, as the rates paid on them moved up
with short-term market interest rates.
However, these components have decelerated this year because market rates
have changed relatively little. Currency
growth has remained modest in 2007,
apparently a result of weak demand for
U.S. dollars overseas.

International Developments
Foreign economic growth remained
strong in the first quarter of 2007, supported by increased domestic demand in
many key countries. Most recent indicators point to continued strength in foreign economies in the second quarter as
well. Canada, the euro area, Japan, and
the United Kingdom all posted abovetrend growth rates in the first quarter.
Although the expansion of the Japanese
economy moderated somewhat in the
first quarter, growth remained brisk rela-

94th Annual Report, 2007

tive to the average pace seen in recent
years. Output accelerated in emerging
Asia, led by China, and growth in
Mexico appears to be picking up again
after a lull in the first quarter.
Rising energy prices boosted consumer prices in many regions of the
world last year, and, in some cases, substantial increases in food prices also
contributed to inflation pressures. Broad
measures of price inflation have continued to rise in many foreign economies
this year, as economic growth has remained strong, and core inflation has
moved up noticeably in a number of
these economies. In response, monetary
policy has been tightened in many major
industrial countries as well as in some
emerging-market economies. Longerterm foreign interest rates have also
risen.
Global financial markets were calm at
the beginning of 2007, and volatilities
for many asset prices were at, or close
to, record lows. Toward the end of February, conditions changed, as international investors scaled back their exposure to risky positions—particularly
those funded in yen—in response to a
sharp drop in Chinese stock prices and
concerns about the U.S. economy. As a
result, equity prices in most industrial
and emerging economies fell over the
course of several days, while the yen
appreciated sharply against most other
currencies.
More-placid conditions returned in
early March, and by early June share
prices around the world had posted solid
gains, reaching multiyear highs or even
record highs in many countries. In particular, Chinese stock prices resumed
their steep climb, although the rise was
interrupted by occasional additional periods of heightened volatility. These episodes had no apparent disruptive effects
on other global financial markets.

Most major global equity indexes experienced another increase in volatility
during June and July amid concerns
about the U.S. subprime-mortgage market, but they were little changed, on net,
over this period. On balance, equity indexes in the major foreign industrial
countries have increased between 5 percent and 12 percent in local-currency
terms since the beginning of 2007. The
Shanghai composite index is up more
than 45 percent this year after a remarkable increase of about 130 percent last
year. Leading equity indexes in other
emerging Asian economies and in Latin
America have also posted sizable gains
in the range of 10 percent to 35 percent
so far this year.
As in the United States, long-term
bond yields in Canada, the euro area,
and Japan rose significantly, on balance,
in the first half of 2007; increases on
ten-year nominal sovereign debt ranged
from 25 to 70 basis points. Starting in
early February, yields declined in global
markets for several weeks amid growing
concerns about the outlook for the U.S.
economy. Since then, market participants seem to have become more optimistic about prospects for both U.S. and
foreign economic growth, and yields
have more than reversed the declines.
Yields on inflation-protected long-term
securities also rose during the first half
of 2007 in the major industrial countries, but, with the exception of those in
the euro area, they did not rise quite as
much as nominal yields did, implying
some modest increases in inflation compensation.
Our broadest measure of the nominal
trade-weighted foreign exchange value
of the dollar has declined about 3Vi percent, on net, since the beginning of
2007. Over the same period, the major
currencies index of the dollar has moved
down more, about 4x/2 percent. On a bilateral basis, the dollar has depreciated

Monetary Policy Report of July 2007
10 percent against the Canadian dollar
and roughly 3Vi percent against the euro
and sterling; in contrast, it has appreciated about 2l/z percent against the yen.
The bulk of the change against the Canadian dollar occurred in the second
quarter after better-than-expected news
about economic activity and expectations of monetary policy tightening in
Canada. The U.S. dollar has depreciated
3 percent, on net, against the Chinese
renminbi since the beginning of 2007;
the pace of change in the renminbidollar rate has accelerated somewhat
over the past two and a half months.
Industrial Economies
The major foreign industrial economies
experienced above-trend growth in the
first quarter of this year. In Canada, real
GDP grew at an annual rate of 33A percent after rising nearly 2 percent during
2006; inventory accumulation figured
prominently in the faster growth. In the
United Kingdom, real GDP increased at
an annual rate of 23/4 percent in the first
quarter. Robust expansions in both
countries have been accompanied by increases in inflation rates, which in recent months have hovered at or above
those countries' inflation targets of
2 percent. Although the pickup in headline inflation partly reflected higher energy prices, core inflation has also
trended up in recent months in both
Canada and the United Kingdom. In the
midst of elevated inflation and increasing rates of resource utilization, monetary policy was tightened three times
this year in the United Kingdom (by
25 basis points each time) after two increases in the policy rate last year. The
Bank of Canada also recently raised its
policy rate 25 basis points. Market participants expect that both countries' central banks will raise their policy rates
further.

Growth of real GDP in the euro area
moved down to 23A percent in the first
quarter after posting growth of 3lA percent over the four quarters of 2006. Although export growth moderated from
its strong performance of 2006, recovery of domestic demand appears to have
taken firmer hold, as investment accelerated in the first quarter. Private consumption in Germany had been muted
earlier this year, partly because of a hike
in the value-added tax at the start of the
year, but lately retail sales in Germany
and the euro area more broadly have
picked up, on balance, from their January lows. Survey indicators of consumer
and business sentiment also point to
relatively strong growth in the euro area
during the second quarter. Overall consumer price inflation has remained just
below the European Central Bank's
2 percent ceiling since the fall of last
year, while core inflation has risen to
about 2 percent from around 1 Vi percent
last year. To combat potential inflation
pressures, the Bank continued to tighten
monetary policy during the first half of
this year, implementing two more increases of 25 basis points in its policy
rates.
Japanese economic growth moderated
in the first quarter of this year to a stillbrisk annual rate of 3lA percent. Household consumption rose at a robust rate
of about 3 percent, and real exports increased almost 14 percent. Investment
growth slowed, although recent surveys
report that businesses are optimistic
about the outlook. The labor market in
Japan improved further in the first five
months of the year: The unemployment
rate fell below 4 percent, and the ratio of
job offers to applicants remained elevated. Despite the strong growth of
output and improved labor markets, consumer prices were about unchanged on a
twelve-month basis in May; the GDP
deflator has continued to fall, though,

94th Annual Report, 2007

during the period. Core consumer prices
have shown small twelve-month declines over the past several months, and
wages have declined relative to their
year-earlier levels.
Emerging-Market Economies
Economic activity in China accelerated
in the first quarter of 2007 and appears
to have remained robust in the second
quarter. Growth was supported by a
surge in exports and a pickup in fixed
investment, which had slowed somewhat in the second half of 2006. The
strength of exports has resulted in a ballooning of the Chinese trade surplus.
Since late 2006, inflation in China has
increased—reaching a rate of V/i percent over the twelve months ending in
May—largely because of higher food
prices. Continuing rapid growth of aggregate demand and liquidity pressures
from the accumulation of foreign exchange reserves have raised concerns
about broader, more-sustained upward
pressures on inflation. Chinese authorities have tightened monetary policy
through several increases in banks' reserve requirements and two increases in
interest rates so far this year; they have
also continued to use sterilization operations to partially offset the effect of the
reserve accumulation on the money
supply.
Elsewhere in emerging Asia, real
GDP surged in India and the Philippines
in the first quarter and remained strong
in Malaysia and Singapore. Growth was
generally supported by domestic demand in all four economies. Growth
held steady in South Korea, as stronger
domestic demand was partially offset by
a drag from net exports. Incoming data
point to strength in the region in the
second quarter. Outside of China, infla

tionary pressures in several emerging
Asian economies have eased somewhat
this year because of the unwinding of
previous increases in food prices and, in
some cases, the effect of currency appreciations. During the past year, political
tensions in Thailand and uncertainty
about the government's policy on capital controls have periodically disrupted
markets and economic activity.
In a continuation of the deceleration
that started about the middle of last year,
Mexican output rose a scant Vz percent
in the first quarter; manufacturing (particularly in the automobile sector) was
restrained by the moderation in the U.S.
economic expansion, and construction
slowed sharply. Recent data on industrial production, however, suggest that
growth may have rebounded in the second quarter. Mexican headline consumer
price inflation continues to hover at the
upper limit of the Bank of Mexico's target range of 2 percent to 4 percent. Monetary policy was tightened in Mexico in
April for the first time since March
2005.
In Brazil, the growth of real GDP
moderated to about 3 percent in the first
quarter, as the appreciation of the Brazilian real weighed on the external sector.
The strong real has also helped keep
inflation in check despite fairly strong
economic growth and a lowering of the
policy interest rate. Economic growth in
Argentina moved down in the first quarter, in part because of a contraction in
exports, and reported data suggest that
inflation has continued to decline.
Growth in Venezuela appears to have
slowed sharply so far in 2007 after three
years of double-digit performances,
driven by expansionary fiscal policy
funded by high petroleum revenues. Venezuelan twelve-month inflation picked
up to nearly 20 percent in June.
•

Federal Reserve Operations

Banking Supervision and Regulation
The Federal Reserve has supervisory
and regulatory authority over a variety
of financial institutions and activities. It
plays an important role as umbrella supervisor of bank holding companies, including financial holding companies.
And it is the primary federal supervisor
of state banks that are members of the
Federal Reserve System.
Two thousand seven was a challenging year for bank holding companies
(BHCs) and state member banks. BHC
asset quality and earnings deteriorated
over the second half of the year, mainly
because of the effects of developments
in the residential housing market. Nonperforming assets increased notably as
the quality of mortgages, home equity
lines of credit, and loans to real estate
developers weakened. Nevertheless,
BHCs reported net income exceeding
$90 billion for the full year. A sharp
increase in subprime mortgage delinquencies adversely affected the securitization market. Liquidity and capital
were strained as some BHCs brought
certain off-balance-sheet exposures onto
their books. Several institutions also recognized significant valuation writedowns on assets affected by market conditions. Despite these pressures, BHCs
continued to maintain regulatory capital
ratios in excess of minimum regulatory
requirements.
Most state member banks entered
2007 after a sustained period of strong
earnings performance, partly mitigating
developments in the market. Although
net income and return on assets fell late
in the year, reflecting asset write-downs
and higher loan-loss provisions, these
measures of profitability have been at

historically high levels since the mid1990s, helping to provide banks with a
substantial base of capital. Risk-based
capital ratios declined modestly over the
year, but at year-end more than 99 percent of all commercial banks continued
to report capital ratios consistent with a
"well capitalized" designation under
prompt corrective action standards. Although credit quality indicators also
worsened during the year, overall loan
quality measures remained relatively
sound by historical standards.
In 2007 the banking industry saw
bank failures for the first time in three
years as three insured institutions—two
state nonmember banks and one thrift
institution with assets totaling approximately $2.6 billion—were closed.
Banking supervisors focused in 2007
on credit risk issues related to subprime
lending activities. During the course of
the year the federal financial regulatory
agencies—the Federal Reserve, Federal
Deposit Insurance Corporation (FDIC),
National Credit Union Administration
(NCUA), Office of the Comptroller of
the Currency (OCC), and Office of
Thrift Supervision (OTS)—issued guidance encouraging supervised institutions
to work constructively with homeowners unable to continue meeting their
mortgage payments. The agencies also
released a statement emphasizing the
need to maintain prudent underwriting
standards and to provide clear and balanced information to consumers so that
institutions and consumers can assess
the risks arising from certain adjustablerate mortgage (ARM) products that offer discounted or low introductory rates.
The Federal Reserve also joined with

94th Annual Report, 2007

the FDIC, NCUA, OCC, OTS, and the
Conference of State Bank Supervisors
to issue a statement encouraging federally regulated financial institutions and
state-supervised entities that service securitized residential mortgages to review
their authority under pooling and servicing agreements so as to identify borrowers at risk of default and pursue
appropriate loss-mitigation strategies
designed to preserve sustainable home
ownership.
Federal Reserve staff continued to
work with the other federal banking
agencies in 2007 to prepare for U.S.
implementation of the Basel II capital
accord.1 In November the Board of Governors approved final rules implementing new risk-based capital requirements
for large, internationally active banking
organizations (the Basel II advanced approaches framework) and joined the
OCC, FDIC, and OTS in publishing
those rules in December.

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 1999 Gramm-Leach-Bliley
Act, and state-chartered commercial
banks that are members of the Federal
Reserve System. In overseeing these or1. The Basel II capital accord, an international
agreement formally titled "International Convergence of Capital Measurement and Capital Standards: A Revised Framework," was developed by
the Basel Committee on Banking Supervision,
which is made up of representatives of the central
banks or other supervisory authorities of thirteen
countries. The original document was issued in
2004; the original version and an updated version
issued in November 2005 are available on the
website of the Bank for International Settlements
(www.bis.org).

ganizations, the Federal Reserve seeks
primarily to promote their safe and
sound operation, including their compliance with laws and regulations.
The Federal Reserve also has responsibility for supervising the operations of
all Edge Act and agreement corporations, the international operations of
state member banks and U.S. bank holding companies, and the U.S. operations
of foreign banking organizations.
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
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 the other federal banking
agencies, state agencies, functional
regulators, and the bank regulatory
agencies of other nations.

Supervision for
Safety and Soundness
To promote the safety and soundness of
banking organizations, the Federal
Reserve conducts on-site examinations
and inspections and off-site surveillance
and monitoring. It also takes enforcement and other supervisory actions as
necessary.

Examinations and Inspections
The Federal Reserve conducts examinations of state member banks, the U.S.
branches and agencies of foreign banks,

Banking Supervision and Regulation

State Member Banks and Bank Holding Companies, 2003-2007
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 System1 . . .
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
Off site
By state banking agency
Financial holding companies
Domestic
Foreign

2007

2006

2005

2004

2003

878
1,519
694
479
215

901
1,405
761
500
261

907
1,318
783
563
220

919
1,275
809
581
228

935
1,912
822
581
241

459
13,281
492
476
438
38
16

448
12,179
566
557
500
57
9

394
10,261
501
496
457
39
5

355
8,429
500
491
440
51
9

365
8,295
454
446
399
47
8

4,611
974
3,186
3,007
120
2,887
179

4,654
947
3,449
3,257
112
3,145
192

4,760
890
3,420
3,233
170
3,063
187

4,796
852
3,703
3,526
186
3,340
177

4,787
847
3,453
3,324
183
3,141
129

597
43

599
44

591
38

600
36

612
32

1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.

and Edge Act and agreement corporations. In a process distinct from examinations, it conducts inspections of bank
holding companies and their nonbank
subsidiaries. Whether an examination or
an inspection is being conducted, the review of operations entails (1) an assessment of the quality of the processes in
place to identify, measure, monitor, and
control risks; (2) an assessment of the
quality of the organization'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, asset quality, earnings, and
liquidity; and (5) a review for compliance with applicable laws and regulations. The table provides information on
examinations and inspections conducted

by the Federal Reserve during the past
five years.
Inspections of bank holding companies, including financial holding companies, are built around a rating system
introduced in 2005 that reflects the recent shift in supervisory practices for
these organizations away from a historical analysis of financial condition toward a more dynamic, forward looking
assessment of risk-management practices and financial factors. Under the
system, known as RFI but more fully
termed RFI/C(D), holding companies
are assigned a composite rating (C) that
is based on assessments of three components: Risk Management (R), Financial
Condition (F), and the potential Impact
(I) of the parent company and its nondepository subsidiaries on the subsidiary

94th Annual Report, 2007

depository institution.2 The fourth component, Depository Institution (D), is intended to mirror the primary regulator's
rating of the subsidiary depository
institution.
In managing the supervisory process,
the Federal Reserve takes a risk-focused
approach that directs resources to
(1) those business activities posing the
greatest risk to banking organizations
and (2) the organizations' management
processes for identifying, measuring,
monitoring, and controlling risks. The
key features of the supervision program
for large complex banking organizations
(LCBOs) 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; (2) maintaining continual supervision of these
organizations so that the Federal Reserve's assessment of each organization's condition is current; (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 Federal Reserve System's central
point of contact for the organization, has
responsibility for only one LCBO, and
is supported by specialists capable of
evaluating the risks of LCBO business
activities and functions); and (4) promoting Systemwide and interagency
information-sharing through automated
systems.
For other banking organizations, the
risk-focused supervision program provides that examination procedures are

2. Each of the first two components has four
subcomponents: Risk Management—Board and
Senior Management Oversight; Policies, Procedures, and Limits; Risk Monitoring and Management Information Systems; and Internal Controls.
Financial Condition—Capital; Asset Quality;
Earnings; and Liquidity.

tailored to each banking organization's
size, complexity, and risk profile. As
with the LCBOs, examinations entail
both off-site and on-site work, including
planning, pre-examination visits, detailed documentation, and examination
reports tailored to the scope and findings of the examination.
State Member Banks
At the end of 2007, 878 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 14 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,
although certain well-capitalized, wellmanaged organizations having total assets of less than $500 million may be
examined once every eighteen months.3
The Federal Reserve conducted 479 exams of state member banks in 2007.

3. The total assets threshold for this group of
well-capitalized, well-managed organizations was
increased during the year. The Financial Services
Regulatory Relief Act of 2006, which became effective in October 2006, authorized the federal
banking agencies to raise the threshold from $250
million to $500 million, and final rules incorporating the change into existing regulations were issued on September 21, 2007.

Banking Supervision and Regulation
Bank Holding Companies
At year-end 2007, a total of 5,793 U.S.
bank holding companies were in operation, of which 5,070 were top-tier bank
holding companies. These organizations
controlled 6,038 insured commercial
banks and held approximately 96 percent of all insured commercial bank assets in the United States.
Federal Reserve guidelines call for
annual inspections of large bank holding
companies and complex smaller companies. In judging the financial condition
of the subsidiary banks owned by holding 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 supervisory burden on banking organizations. Noncomplex bank
holding companies with consolidated assets of $1 billion or less are subject to a
special supervisory program that permits a more flexible approach.4 In 2007,
the Federal Reserve conducted 476 inspections of large bank holding companies and 3,007 inspections of small, noncomplex bank holding companies.
Financial Holding Companies
Under the Gramm-Leach-Bliley Act,
bank holding companies that meet certain capital, managerial, and other requirements may elect to become financial holding companies and thereby
engage in a wider range of financial activities, including full-scope securities
underwriting, merchant banking, and insurance underwriting and sales. The
4. The special supervisory program was
implemented in 1997 and modified in 2002. See
SR letter 02-01 for a discussion of the factors
considered in determining whether a bank holding
company is complex or noncomplex (www.
federalreserve.gov/boarddocs/srletters/).

statute streamlines the Federal Reserve's
supervision of all bank holding companies, including financial holding companies, and sets forth parameters for the
supervisory relationship between the
Federal Reserve and other regulators.
The statute also 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 firms).
As of year-end 2007, 597 domestic
bank holding companies and 43 foreign
banking organizations had financial
holding company status. Of the domestic financial holding companies, 33 had
consolidated assets of $15 billion or
more; 136, between $1 billion and
$15 billion; 93, between $500 million
and $1 billion; and 335, less than
$500 million.
International Activities
The Federal Reserve supervises the foreign branches and overseas investments
of member banks, Edge Act and agreement corporations, and bank holding
companies and also the investments by
bank holding companies in export trading companies. In addition, it supervises
the activities that foreign banking
organizations conduct through entities
in the United States, including branches,
agencies, representative offices, and
subsidiaries.
Foreign Operations of
U.S. Banking Organizations
In supervising the international operations of state member banks, Edge Act
and agreement corporations, and bank
holding companies, the Federal Reserve
generally conducts its examinations or
inspections at the U.S. head offices of
these organizations where the ultimate
responsibility for the foreign offices lies.

94th Annual Report, 2007

Examiners also visit the overseas offices
of U.S. banks to obtain financial and
operating information and, in some instances, to evaluate the organizations'
efforts to implement corrective measures
or to test their adherence to safe and
sound banking practices. Examinations
abroad are conducted with the cooperation of the supervisory authorities of the
countries in which they take place; for
national banks, the examinations are coordinated with the OCC.
At the end of 2007, 55 member banks
were operating 619 branches in foreign
countries and overseas areas of the
United States; 33 national banks were
operating 567 of these branches, and 22
state member banks were operating the
remaining 52. In addition, 17 nonmember banks were operating 23 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.
Sections 25 and 25A of the Federal
Reserve Act grant Edge Act and agreement corporations permission to 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 in

vestments that are broader than those
permissible for member banks.
At year-end 2007, 67 banking organizations, operating 12 branches, were
chartered as Edge Act or agreement corporations. 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, bank holding
companies, and certain nonbanking
companies. Foreign banks continue to
be significant participants in the U.S.
banking system.
As of year-end 2007, 172 foreign
banks from 53 countries were operating
211 state-licensed branches and agencies, of which 8 were insured by the
FDIC, and 47 OCC-licensed branches
and agencies, of which 4 were insured
by the FDIC. These foreign banks also
owned 9 Edge Act and agreement corporations and 2 commercial lending
companies; in addition, they held a controlling interest in 62 U.S. commercial
banks. Altogether, the U.S. offices of
these foreign banks at the end of 2007
controlled approximately 18 percent of
U.S. commercial banking assets. These
172 foreign banks also operated 91 representative offices; an additional 49 foreign banks operated in the United States
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 ev-

Banking Supervision and Regulation
ery twelve months, but the period may
be extended to eighteen months if the
branch or agency meets certain criteria.
In cooperation with the other federal
and state banking agencies, the Federal
Reserve conducts a joint program for
supervising the U.S. operations of foreign banking organizations. The program has two main parts. One part involves examination of those foreign
banking organizations that have multiple
U.S. operations and is intended to ensure
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, 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 357 examinations in 2007.
Compliance with
Regulatory Requirements
The Federal Reserve examines supervised institutions for compliance with a
broad range of legal requirements, including anti-money-laundering and consumer protection laws and regulations,
and other laws pertaining to certain
banking and financial activities. Most
compliance supervision is conducted under the oversight of the Division of
Banking Supervision and Regulation,
but consumer compliance supervision is
conducted under the oversight of the Division of Community and Consumer Affairs. The two divisions coordinate their
efforts with each other and also with the
Board's Legal Division to ensure consistent and comprehensive Federal Reserve

supervision for compliance with legal
requirements.
Anti-Money-Laundering
Examinations
With regard to anti-money-laundering
requirements, U.S. Department of the
Treasury regulations (31 CFR 103)
implementing the Bank Secrecy Act
(BSA) generally require banks and other
types of financial institutions to file certain reports and maintain certain records
that are useful in criminal or regulatory
proceedings. The BSA and separate
Board regulations require banking organizations supervised by the Board to file
reports on suspicious activity related to
possible violations of federal law, including money laundering, terrorism financing, and other financial crimes. In
addition, BSA and Board regulations require that banks develop written programs on BSA/anti-money-laundering
compliance and that the programs be
formally approved by bank boards of
directors. An institution's compliance
program must (1) establish a system of
internal controls to ensure compliance
with the BSA, (2) provide for independent compliance testing, (3) identify individuals responsible for coordinating
and monitoring day-to-day compliance,
and (4) provide training for personnel as
appropriate.
The Federal Reserve is responsible
for examining its supervised institutions
for compliance with various antimoney-laundering laws and regulations.
During examinations of state member
banks and U.S. branches and agencies of
foreign banks and, when appropriate, inspections of bank holding companies,
examiners review the institution's compliance with the BSA and determine
whether adequate procedures and controls to guard against money laundering
and terrorism financing are in place.

94th Annual Report, 2007

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.
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
banking organizations as well as certain
independent data centers that provide information technology services to these
organizations. All safety and soundness
examinations include a risk-focused review of information technology risk
management activities. During 2007, the
Federal Reserve was the lead agency in
2 cooperative, interagency examinations
of large, multiregional data processing
servicers.
Fiduciary Activities
The Federal Reserve has supervisory responsibility for state member commercial banks and depository trust companies that together reported, at the end of
2007, $39 trillion of assets in various
fiduciary or custodial capacities. Additionally, state member nondepository
trust companies supervised by the Federal Reserve reported $40 trillion of assets held in a fiduciary or custodial capacity. During on-site examinations of
fiduciary activities, an organization's
compliance with laws, regulations, and
general fiduciary principles and its po

tential conflicts of interest are reviewed;
its management and operations, including its asset- and account-management,
risk-management, and audit and control
procedures, are also evaluated. In 2007,
Federal Reserve examiners conducted
98 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
an organization's operations and its
compliance with relevant securities
regulations. During 2007, the Federal
Reserve conducted on-site examinations
at 18 of the 68 state member banks and
bank holding companies that were registered as transfer agents and 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
Treasury regulations governing dealing
and brokering in government securities.
Thirty state member banks and 6 state
branches of foreign banks have notified
the Board that they are government securities dealers or brokers not exempt
from Treasury's regulations. During
2007, the Federal Reserve conducted
7 examinations of broker-dealer activi-

Banking Supervision and Regulation
ties in government securities at these organizations. 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 that state member
banks and bank holding companies that
act as municipal securities dealers comply with the Securities Act Amendments
of 1975. Municipal securities dealers are
examined pursuant to the Municipal Securities Rulemaking Board's rule G-16
at least once every two calendar years.
Of the 22 entities that dealt in municipal
securities during 2007, 7 were examined
during the year.
Securities Credit Lenders
Under the Securities Exchange Act of
1934, the Board is responsible for regulating credit in certain transactions involving the purchase or carrying of
securities. As part of its general examination program, the Federal Reserve examines the banks under its jurisdiction
for compliance with the Board's Regulation U (Credit by Banks and Persons
other than Brokers or Dealers for the
Purpose of Purchasing or Carrying Margin Stock). In addition, the Federal Reserve maintains a registry of persons
other than banks, brokers, and dealers
who extend credit subject to Regulation
U. The Federal Reserve may conduct
specialized examinations of these lenders if they are not already subject to
supervision by the Farm Credit Administration (FCA), the NCUA, or the OTS.
At the end of 2007, 621 lenders other
than banks, brokers, or dealers were registered with the Federal Reserve. Other
federal regulators supervised 200 of
these lenders, and the remaining 421
were subject to limited Federal Reserve
supervision. On the basis of regulatory
requirements and annual reports, the

Federal Reserve exempted 246 lenders
from its on-site inspection program.
Nonexempt lenders are subject to either
biennial or triennial inspection. Sixtyeight inspections were conducted during
the year.
Business Continuity
In 2007, the Federal Reserve continued
its efforts to strengthen the resilience of
the U.S. financial system in the event of
unexpected disruptions. The Federal Reserve, the OCC, and the Securities and
Exchange Commission (SEC) continued
joint supervisory assessments of the activities of core clearing and settlement
firms and significant market participants
in implementing and maintaining sound
business resiliency and continuity practices as outlined in "Interagency Paper
on Sound Practices to Strengthen the
Resilience of the U.S. Financial System." The Federal Reserve and the other
Federal Financial Institutions Examination Council (FFIEC) agencies continued to coordinate their efforts to ensure
a consistent supervisory approach for
business continuity practices.5
Enforcement Actions
The Federal Reserve has enforcement
authority over the banking organizations
it supervises and their affiliated parties.
Enforcement actions may be taken to
address unsafe and unsound practices or
violations of any law or regulation. Formal enforcement actions include ceaseand-desist orders, written agreements,
removal and prohibition orders, and
civil money penalties. In 2007, the Federal Reserve completed 34 formal enforcement actions. Civil money penalties totaling $20,255,290 were assessed.
5. The FFIEC member agencies are the Federal
Reserve Board, the FDIC, the NCUA, the OCC,
and the OTS.

94th Annual Report, 2007

As directed by statute, all civil money
penalties are remitted to either the Treasury or the Federal Emergency Management Agency. Enforcement orders,
which are issued by the Board, and written agreements, which are executed by
the Reserve Banks, are made public
and are posted on the Board's website
(www.federalreserve.gov/boarddocs/
enforcement).
In addition to taking these formal enforcement actions, the Reserve Banks
completed 67 informal enforcement actions in 2007. Informal enforcement actions include memoranda of understanding and board of directors resolutions.
Information about these actions is not
available to the public.
Surveillance and
Off-Site Monitoring
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. Such
monitoring and analysis helps direct examination resources to institutions that
have higher risk profiles. Screening systems also assist in the planning of examinations by identifying companies
that are engaging in new or complex
activities.
The primary off-site monitoring tool
used by the Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SRSABR). Drawing primarily on the
financial data that banks report on their
Reports of Condition and Income (Call
Reports), SR-SABR uses econometric
techniques to identify banks that report
financial characteristics weaker than
those of other banks assigned similar
supervisory ratings. To supplement the
SR-SABR screening, the Federal Reserve also monitors various market data,

including equity prices, debt spreads,
agency ratings, and measures of expected default frequency, to gauge market perceptions of the risk in banking
organizations. In addition, the Federal
Reserve prepares quarterly Bank Holding Company Performance Reports
(BHCPRs) for use in monitoring and inspecting supervised banking organizations. The BHCPRs, which are compiled
from data provided by large bank holding companies in quarterly regulatory
reports (FR Y-9C and FR Y-9LP), contain, for individual companies, financial
statistics and comparisons with peer
companies. BHCPRs are made available
to the public on the National Information Center (NIC) website, which can be
accessed at www.ffiec.gov.
During 2007, three major upgrades to
the web-based Performance Report Information and Surveillance Monitoring
(PRISM) application were completed.
PRISM is a querying tool used by Federal Reserve analysts to access and display financial, surveillance, and examination data. In the analytical module,
users can customize the presentation of
institutional financial information drawn
from Call Reports, Uniform Bank Performance Reports, FR Y-9 statements,
BHCPRs, and other regulatory reports.
In the surveillance module, users can
generate reports summarizing the results
of surveillance screening for banks and
bank holding companies. The upgrades
made more regulatory data available for
querying, gave users the ability to display commercial real estate guidance
data, and provided a way to access structure information for all institutions in
NIC.
The Federal Reserve works through
the FFIEC Task Force on Surveillance
Systems to coordinate surveillance activities with the other federal banking
agencies.

Banking Supervision and Regulation
International Training
and Technical Assistance
In 2007, the Federal Reserve continued
to provide technical assistance on bank
supervisory matters to foreign central
banks and supervisory authorities. Technical assistance involves visits by Federal Reserve staff members to foreign
authorities as well as consultations with
foreign supervisors who visit the Board
or the Reserve Banks. Technical assistance in 2007 was concentrated in Latin
America, Asia, and former Soviet bloc
countries. The Federal Reserve, along
with the OCC, the FDIC, and the Treasury, was also an active participant in
the Middle East and North Africa Financial Regulators' Training Initiative,
which is part of the U.S. government's
Middle East Partnership Initiative.
During the year the Federal Reserve
offered training courses exclusively for
foreign supervisory authorities, both in
the United States and in a number of
foreign jurisdictions. 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
(Basel Committee), and the Financial
Stability Institute.
The Federal Reserve is also an associate member of the Association of Supervisors of Banks of the Americas
(ASBA), an umbrella group of bank supervisors from countries in the Western
Hemisphere. The group, headquartered
in Mexico, promotes communication
and cooperation among bank supervisors in the region; coordinates training
programs throughout the region, with
the help of national banking supervisors
and international agencies; and aims to
help members develop banking laws,
regulations, and supervisory practices

that conform to international best practices. The Federal Reserve contributes
significantly to ASBA's organizational
management and to its training and technical assistance activities.

Supervisory Policy
The Federal Reserve's supervisory
policy function is responsible for developing guidance for examiners and banking organizations as well as regulations
for banking organizations under the Federal Reserve's supervision. Staff members participate in supervisory and regulatory forums, provide support for the
work of the FFIEC, and participate in
international forums such as the Basel
Committee, the Joint Forum, and
the International Accounting Standards
Board.
Capital Adequacy Standards
Risk-Based Capital Standards for
Certain Internationally Active
Banking Organizations
On December 7, 2007, the Federal Reserve, OCC, FDIC, and OTS published
final rules implementing new risk-based
capital requirements for large, internationally active banking organizations
(the Basel II advanced approaches
framework). The advanced approaches
framework is broadly consistent with international approaches to implementation of Basel II and includes a number
of prudential safeguards, such as the requirement that banking organizations
satisfactorily complete a four-quarter
parallel run period before operating under the Basel II framework, and the use
of transitional capital floors. It retains
the long-standing minimum risk-based
capital requirement of 4 percent tier 1
capital and 8 percent total qualifying
capital and the tier 1 leverage ratio.

94th Annual Report 2007

New Capital Adequacy Framework for UJS, Banking Organizations
Aligning regulatory capital requirements with risk and fostering good risk measurement and management practices for our largest and most complex banking
organizations will, I believe, contribute to safer and sounder banks and a more
resilient financial system.
Randall S. Kroszner, Member, Board of Governors
November 2007

On December 7, 2007, the US. banking
agencies published a new risk-based capital adequacy framework.1 The new
framework—known as the advanced approaches framework—is designed to align
more closely the amount of capital U.S.
banking organizations are required to hold
as a cushion against potential losses with
the risks to which they are exposed. Effective April 2008, large, internationally active U.S. banking organizations will be
required to transition to the advanced
approaches framework to calculate the
amount of capital they must hold relative
to their risk profile; other banking organizations may choose to use the new framework.2 The advanced approaches framework for U.S. banking organizations is
based on the revised international capital
accord known as Basel II, which was

1. The U.S. banking agencies are the Federal
Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.
2. Banking organizations with at least
$250 billion of consolidated total assets or at
least $10 billion of foreign exposure are required
to use the advanced approaches and to meet the
rule's rigorous qualification requirements; other
banking organizations may opt into the advanced
approaches framework, provided they also meet
its requirements.

Banking organizations subject to the
framework are expected to meet certain
public disclosure requirements designed
to foster transparency and market discipline. In addition, the prompt corrective

adopted in 2006 by international banking
authorities working through the Basel
Committee on Banking Supervision.
The need for a new capital adequacy
framework arose from continuing rapid
and extensive evolution and innovation in
the financial marketplace, which has substantially reduced the effectiveness of the
existing risk-based capital rules (the
Basel I-based rules) for large, internationally active banking organizations. The
Basel II-based rules are more sensitive to
risk and are tailored to the different kinds
of risk to which banking organizations are
exposed. Basel II regulatory capital requirements will vary from organization to
organization in line with the organization's actual risk profile, so that a banking
organization exposed to greater risk will
have higher requirements than one exposed to less risk.
Both the international and the U.S.
frameworks encompass three elements, or
pillars: minimum risk-based capital requirements (pillar 1); supervisory review
of capital adequacy (pillar 2); and market
discipline through enhanced public disclosure (pillar 3).
Pillar 1 addresses calculation of regulatory capital requirements in relation to certain risk exposures. To calculate their minimum requirements in relation to the credit
risk arising from wholesale and retail

action rules for banks that are not adequately capitalized remain in effect.
(For more information, see the box
"New Capital Adequacy Framework for
U.S. Banking Organizations.")

Banking Supervision and Regulation

exposures, U.S. banking organizations will
use an internal ratings-based approach, inserting their own internal estimates of key
credit risk parameters into formulas provided by supervisors. They will calculate
their minimum requirements in relation to
operational risk using advanced measurement approaches, which rely on the institutions* internal risk-measurement and capital calculation processes. The advanced
approaches framework also specifies separate methodologies for calculating capital
requirements in relation to securitization
and equity exposures.
Compared with the Basel I-based rules,
banking organizations under Basel II-based
rules will be required to take greater account of their off-balance-sheet activities in
calculating their capital requirements. The
new framework also provides a more-risksensitive regulatory capital approach to
capital markets activities and transactions,
such as repurchase agreements, securities
borrowing and lending, margin loans, and
over-the-counter derivatives. The enhanced
risk sensitivity of the advanced approaches
framework should provide incentives for
lending to creditworthy counterparties and
using effective credit-risk mitigation techniques, such as requiring collateral.
The advanced approaches build on the
risk-measurement and risk-management
approaches already being used by sophisticated banking organizations and are designed to evolve over time as these organizations refine and enhance their internal
practices. As a result, these approaches are
better able than the Basel 1-based rules to
be adapted to innovations in banking and
financial markets and to capture the risks
arising from new products and activities.
This increased adaptability and flexibility
suggests that the relationship between

Revisions to the
Market Risk Capital Rule
During 2007, the Federal Reserve, OCC,
FDIC, and OTS considered public com

the risk-based regulatory measure of capital adequacy and a banking organization's
actual risk exposures and its day-to-day
risk management will be stronger and
more consistent.
Pillars 2 and 3 are also essential elements of the advanced approaches framework. Under pillar 2, banking organizations are required to have an internal
process for ensuring that they are holding
enough capital to support their overall risk
profile (including those risks not captured
or not fully addressed under pillar 1), particularly during economic downturns and
periods of financial stress. These internal
processes will be subject to rigorous supervisory review.
Pillar 3 addresses banking organizations' communication with market participants about their risks, the associated levels of capital, and the manner in which
they are meeting the requirements of the
advanced approaches framework. The
public disclosures called for under pillar 3
are expected to increase the transparency
of banking organizations' activities and
exposures, giving market participants useful information about banking organizations' risk profiles and their ability to
manage risk.
Adoption of the advanced approaches
framework is an important milestone for
the U.S. banking agencies, but effective
implementation in the coming years will
be just as important. Implementation of
the Basel II-based rules, and the associated improvements in risk management,
will not be a one-time event, but rather an
ongoing process. The agencies will observe carefully how the advanced approaches work in practice, assessing their
advantages and limitations, to ensure that
they are operating as intended.

ments on a September 2006 notice of
proposed rulemaking that presented revisions to the market risk capital rule
used by the Federal Reserve, OCC, and

94th Annual Report, 2007

FDIC since 1997 for banking organizations having significant exposure to
market risk. Under the existing market
risk capital rule, certain banking organizations are required to calculate a capital requirement for the general market
risk of their covered positions and the
specific risk of their covered debt and
equity positions. The proposed revisions
would enhance the rule's risk sensitivity, require banking organizations that
model specific risk to reflect any incremental default risk of traded positions,
and require public disclosure of certain
qualitative and quantitative market risk
information. The agencies expect to finalize this rule in the first half of 2008.
In July 2007, the Federal Reserve issued a letter reminding supervised banking organizations that the application of
the fair value option to securities may
subject the organization to the market
risk capital rule. The letter directed
those organizations to contact their Reserve Bank to discuss their plans to address the rule's requirements.
Risk-Based Capital Standards
for Banking Organizations
Not Subject to Basel II
During 2007, the Federal Reserve, OCC,
FDIC, and OTS considered public comments on a notice of proposed rulemaking (NPR) issued in December 2006
proposing modifications to the current
Basel I-based capital rules. The proposed rules would provide an option to
those banking organizations that are not
required to adopt Basel II and do not
wish to voluntarily follow the advanced
approaches. This option is known as the
Basel I-A proposal.
In response to comments calling for
an option to adopt the standardized approach under Basel II, the agencies revised the Basel I-A proposal and intend
to issue a new NPR setting forth a pro

posed standardized Basel II capital rule
in the first half of 2008.
Other Capital Issues
Board staff conduct supervisory analyses of innovative capital instruments and
novel transactions to determine whether
such instruments qualify for inclusion in
tier 1 capital.6 Much of this work in
2007 involved evaluating enhanced
forms of trust preferred securities and
mandatory convertible securities.
Staff members also identify and address supervisory concerns related to supervised banking organizations' capital
issuances and work with the Reserve
Banks to evaluate the overall composition of banking organizations' capital.
In this work, the staff often must review
the funding strategies proposed in applications for acquisitions and other transactions submitted to the Federal Reserve
by banking organizations.
Accounting Policy
The supervisory policy function is also
responsible for monitoring major domestic and international proposals, standards, and other developments affecting
the banking industry in the areas of
accounting, auditing, internal controls
over financial reporting, financial
disclosure, and supervisory financial
reporting. Federal Reserve staff
members interact with key constituents
in the accounting and auditing professions, including regulators, standardsetters, accounting firms, accounting
and banking industry trade groups, and
the banking industry, and issue
supervisory guidance as appropriate.

6. Tier 1 capital comprises common stockholders' equity and qualifying forms of preferred
stock, less required deductions such as goodwill
and certain intangible assets.

Banking Supervision and Regulation
Domestic Accounting
The Federal Reserve continues to
closely monitor domestic and international accounting standard-setting related to the use of fair value accounting.
In previous comment letters to the Financial Accounting Standards Board
(FASB), the Federal Reserve has raised
concerns about the reliability of reported
financial results based on fair value
measurements, especially when financial instruments are illiquid. In May
2007, Federal Reserve staff issued a
comment letter to the FASB regarding
its "Invitation to Comment on Valuation Guidance for Financial Reporting"
that strongly supported efforts to consider the need for additional valuation
guidance.
The FASB's Statement of Financial
Accounting Standards No. 159, The Fair
Value Option for Financial Assets and
Financial Liabilities, issued in February
2007, allows most financial assets and
financial liabilities to be reported at fair
value. As part of its continued focus on
the use of fair value accounting at banking organizations, and in light of the
potential increased use of fair value accounting for loans, the Federal Reserve
staff conducted a study of fair value
measurements of commercial loan values. The study was intended to provide
additional insight into valuation methodologies used and related control frameworks for loans at a number of large,
internationally active banking organizations. The study report, issued in June
2007, summarizes commercial loan fair
value measurement practices at these
organizations.
Federal Reserve staff participated in a
number of SEC and FASB efforts to address current accounting issues. A senior Federal Reserve representative is
an official observer on the SEC Advisory Committee on Improvements to Fi-

nancial Reporting, which was established to examine the U.S. financial
reporting system with the goals of reducing unnecessary complexity and
making information more useful and understandable for investors. Federal Reserve staff also participated in FASB efforts to improve financial reporting,
including roundtable discussions on
modifications of securitized subprime
mortgage loans and the joint FASBInternational Accounting Standards
Board (IASB) project on Financial
Statement Presentation.
Bank Secrecy Act and
Anti-Money Laundering
In 2007, the FFIEC again updated the
Bank Secrecy Act/Anti-Money Laundering Examination Manual (originally
issued in 2005) to further clarify supervisory expectations, incorporate new
regulatory issuances, and respond to industry requests for additional guidance.
Significant revisions included updates to
the chapters on customer due diligence,
suspicious activity reporting, foreign
correspondent accounts, electronic
banking, and trade finance. The manual
provides current and consistent riskbased guidance to help banking
organizations comply with the BSA and
safeguard operations from money
laundering and terrorism financing.
Also during the year, the FFIEC agencies issued "Interagency Statement on
Enforcement of Bank Secrecy Act/AntiMoney Laundering Requirements" setting forth their interpretation of the requirement in the Federal Deposit
Insurance Act relating to supervisory actions to address certain BSA compliance
issues. The statement provides greater
consistency among the agencies on certain BSA enforcement decisions and describes considerations that affect those
decisions.

100 94th Annual Report, 2007
The Federal Reserve and other federal banking agencies continued during
2007 to share information with the Financial Crimes Enforcement Network
(FinCEN) under the interagency memorandum of understanding (MOU) that
was finalized in 2004, and with the
Treasury's Office of Foreign Assets
Control (OFAC) under the interagency
MOU that was finalized in 2006.
The Federal Reserve continues to participate in efforts to promote transparency and address risks faced by financial institutions that act as intermediaries
in international funds transfers. The
Federal Reserve, other U.S. banking
agencies, and the Treasury have supported private-sector efforts to address
the anti-money-laundering and sanctions
concerns of banks that have international operations. In addition, the Federal Reserve participates in the AntiMoney Laundering and Countering the
Financing of Terrorism Expert Group, a
subcommittee of the Basel Committee's
International Liaison Group.
International Guidance on
Supervisory Policies
As a member of the Basel Committee,
the Federal Reserve participates in efforts to advance sound supervisory policies for internationally active banking
organizations and to improve the stability of the international banking system.
In 2007, the Federal Reserve participated in ongoing cooperative work on
implementation of Basel II and on development of international supervisory
guidance, particularly in the area of
funding liquidity risk management.
The Federal Reserve also continued
to participate in Basel Committee working groups addressing issues not fully
resolved in the Basel II framework. One
effort is a look at eligible capital instruments across jurisdictions with the goal

of developing a definition of capital.
The Federal Reserve also participated in
a workshop addressing supervisory and
industry expectations with regard to
implementation of pillar 2 of Basel II
(supervisory review).
Risk Management
The Federal Reserve contributed to supervisory policy papers, reports, and
recommendations issued by the Basel
Committee during 2007 that were
generally aimed at improving the
supervision of banking organizations'
risk-management practices.7 Two of
these were
• "Principles for Home-Host Supervisory Cooperation and Allocation
Mechanisms in the Context of Advanced Measurement Approaches,"
consultative document published in
February and final document published in November
• "Guidelines for Computing Capital
for Incremental Default Risk in the
Trading Book," consultative document published in October
The Federal Reserve contributed to efforts begun in January 2007 to look at
liquidity regulation across jurisdictions
and to review the 2000 Basel Committee paper "Sound Practices for Managing Liquidity in Banking Organisations"
with a view toward updating the paper.
Joint Forum
In 2007, the Federal Reserve continued
to participate in the Joint Forum—a
group established under the aegis of the
Basel Committee to address issues related to the banking, securities, and insurance sectors, including the regulation
7. Papers issued by the Basel Committee can
be accessed via the Bank for International Settlements website at www.bis.org.

Banking Supervision and Regulation
of financial conglomerates. The Joint
Forum is made up of representatives of
the Basel Committee, the International
Organization of Securities Commissions, and the International Association
of Insurance Supervisors. The Federal
Reserve contributed to the development
of supervisory policy papers, reports,
and recommendations issued by the
Joint Forum during 2007, including
work on risk concentrations, credit risk
transfer, customer suitability, and implementation of principles for the supervision of financial conglomerates.8 The
Federal Reserve also participated in
Joint Forum-sponsored informationsharing on pandemic planning and other
business continuity initiatives.
International Accounting
The Federal Reserve participates in the
Basel Committee's Accounting Task
Force (ATF), which represents the Basel
Committee at international meetings on
accounting, auditing, and disclosure issues affecting global banking organizations. During 2007, Federal Reserve
staff contributed to the development of
numerous Basel Committee comment
letters related to accounting and auditing matters that were submitted to the
IASB and the International Auditing and
Assurance Standards Board (IAASB).
The Basel Committee in May 2007
issued a comment letter to the IASB on
its discussion paper "Fair Value Measurements." The paper was prepared by
the IASB as part of its efforts to develop
a standard for fair value measurements
similar to the FASB Statement of Financial Accounting Standards No. 157, Fair
Value Measurements, issued in September 2006. In its letter, the Basel Committee emphasized the importance of sound

101

guidance on fair value measurement,
particularly as part of the joint FASBIASB program on convergence between
International Financial Reporting Standards and U.S. generally accepted accounting principles (GAAP).
In 2007 the Basel Committee also issued a series of comment letters to the
IAASB related to the international standards on auditing (ISAs) that are being
revised as part of the IAASB's Clarity
Project. The Clarity Project is part of an
effort by the IAASB to increase consistency in the application of auditing standards around the world and to improve
the clarity of the ISAs. The revised ISAs
cover such audit areas as planning the
audit, auditing different types of financial statements, audit evidence, related
parties, going concern, fair value measurements, internal audit, and the auditor's report.
Credit Risk Management
The Federal Reserve works with the
other federal banking agencies to develop guidance on the management of
credit risk.
Working with Mortgage Borrowers
In April 2007 the Federal Reserve,
FDIC, NCUA, OCC, and OTS issued
staff guidance to encourage supervised
institutions to work constructively with
homeowners who are financially unable
to continue meeting their mortgage payments. The agencies reminded institutions that prudent workout arrangements
that are consistent with safe and sound
lending practices are generally in the
long-term best interest of both the financial institution and the borrower.
Subprime Mortgage Lending

8. Papers issued by the Joint Forum can be
accessed via the Bank for International Settlements website at www.bis.org.

In June the Federal Reserve, FDIC,
NCUA, OCC, and OTS issued "State-

102 94th Annual Report, 2007
ment on Subprime Mortgage Lending"
to address issues and questions related
to certain adjustable-rate mortgage
(ARM) products marketed to subprime
borrowers. The statement emphasizes
the need for prudent underwriting standards and clear and balanced consumer
information, so that institutions and consumers can assess the risks arising from
certain ARM products that have discounted or low introductory rates. It describes the prudent safety and soundness
and consumer protection standards that
institutions should follow to ensure that
borrowers obtain loans they can afford
to repay. These standards include qualifying borrowers on a fully indexed, fully
amortized basis and guidelines on the
use of risk-layering features, including
an expectation that stated income and
reduced documentation would be accepted only if there are documented factors that clearly minimize the need for
verification of the borrower's repayment
capacity. Consumer protection standards
include clear and balanced product disclosures for customers and limits on prepayment penalties so that customers
have a reasonable period to refinance
without penalty, typically at least sixty
days before expiration of the initial fixed
interest rate period.
Statement on
Loss-Mitigation Strategies
In September the Federal Reserve,
FDIC, NCUA, OCC, OTS, and Conference of State Bank Supervisors issued a
statement encouraging federally regulated financial institutions and statesupervised entities that service securitized residential mortgages to review
their authority under pooling and servicing agreements to identify borrowers at
risk of default and to pursue appropriate
loss-mitigation strategies designed to
preserve sustainable home ownership.

The statement outlines the steps a servicer may take when there is an increased risk of default, including identifying borrowers at heightened risk of
delinquency or default, contacting borrowers to assess their ability to repay,
and determining whether default is reasonably foreseeable. The statement goes
on to explain possible loss-mitigation
techniques that a servicer may pursue
with a borrower, recognizing that the
servicer must consider the documents
governing the securitization trust to determine its authority to restructure loans
that are delinquent or are at risk of imminent default.
Pandemic Planning
In December, the FFIEC agencies published guidance on planning for the purpose of minimizing the potential adverse
effects of an influenza pandemic. The
guidance emphasizes the importance of
(1) a preventive program to reduce the
likelihood that the institution's operations will be significantly affected by a
pandemic, (2) a documented strategy
that scales the response to the particular
stages of an outbreak, (3) a comprehensive framework of facilities, systems, or
procedures needed to continue critical
operations, (4) a testing program, and
(5) an oversight program. In September
and October, the Federal Reserve participated with the other FFIEC agencies
in a Treasury-sponsored, industrywide
business continuity exercise to test the
financial sector's ability to respond to a
pandemic crisis. The Federal Reserve
helped develop the after-exercise report,
which was published in January 2008.
Banks' Securities Activities
In September, the Federal Reserve and
the SEC adopted joint final rules defining the scope of securities activities a

Banking Supervision and Regulation
bank may conduct without registering
with the SEC as a securities broker. The
Gramm-Leach-Bliley Act eliminated the
blanket "broker" exception for banks
that had been contained in section
3(a)(4) of the Securities Exchange Act
of 1934, but it granted exceptions designed to allow banks to continue to engage in securities transactions for customers in connection with their normal
trust, fiduciary, custodial, and other
banking operations. The rules implement the most important "broker" exceptions for trust and fiduciary activities, custodial and deposit "sweep"
functions, and third-party networking
arrangements.
Economic Growth and Regulatory
Paperwork Reduction Act of 1996
The Economic Growth and Regulatory
Paperwork Reduction Act of 1996
(EGRPRA) requires that the federal
banking agencies review their regulations every ten years to identify and
eliminate any unnecessary requirements
imposed on insured depository institutions. (In addition, the Board periodically reviews each of its regulations.)
During 2007, the Federal Reserve, OCC,
FDIC, and OTS completed the required
review and issued a joint report to
Congress, which is available on the
EGRPRA website at www.egrpra.gov.

Regulatory Reports
The supervisory policy function is responsible for developing, coordinating,
and implementing regulatory reporting
requirements for various financial reporting forms filed by domestic and foreign financial institutions subject to Federal Reserve supervision. Federal
Reserve staff' members interact with appropriate federal and state supervisors,
including foreign bank supervisors as

103

needed, to recommend and implement
appropriate and timely revisions to the
reporting forms and the attendant
instructions.
Bank Holding Company
Regulatory Reports
The Federal Reserve requires that U.S.
bank holding companies periodically
submit reports providing financial and
structure information. The information
is essential in supervising the companies
and in formulating regulations and supervisory policies. It is also used in responding to requests from Congress and
the public for information about bank
holding companies and their nonbank
subsidiaries. Foreign banking organizations also are required to periodically
submit reports to the Federal Reserve.
Reports in the FR Y-9 series—
FR Y-9C, FR Y-9LP, and FR Y-9SP—
provide standardized financial statements for bank holding companies on
both a consolidated and a parent-only
basis. The reports are used to detect
emerging financial problems, to review
performance and conduct pre-inspection
analysis, to monitor and evaluate risk
profiles and capital adequacy, to evaluate proposals for bank holding company
mergers and acquisitions, and to analyze
the holding company's overall financial
condition. Nonbank subsidiary reports—
FR Y-l 1, FR 2314, and FR Y-7N—help
the Federal Reserve determine the condition of bank holding companies that
are engaged in nonbank activities and
also aid in monitoring the number, nature, and condition of the companies'
nonbank subsidiaries.
In March, several revisions to the
FR Y-9C report were approved for
implementation during 2007: (1) collection of certain data on the sources of fair
value measurements from all institutions
that choose, under GAAP, to apply a fair

104 94th Annual Report, 2007
value option to one or more financial
instruments and one or more classes of
servicing assets and liabilities, and from
certain institutions that report trading assets and liabilities; (2) collection of information on the cumulative change in
the fair value of liabilities accounted for
under the fair value option that is attributable to changes in the bank holding
company's own creditworthiness, for
purposes of determining regulatory capital; (3) collection of certain data on oneto four-family residential mortgage
loans that have terms allowing for negative amortization; and (4) revision of instructions for reporting time deposits
and brokered deposits.
Effective March 2007, four new items
were added to the quarterly FR Y-11
and FR2314 reporting forms to facilitate monitoring of the extension of negatively amortizing residential mortgage
loans. Also, a new section concerning
notes to the financial statements was
added to the FR 2314.
Effective June 2007, reporting forms
used to collect information on changes
in organizational structure and the status
of a foreign branch (FR Y-10,
FRY-10F, FR Y-10S, and FR 2058)
were combined into one event-generated
form called the FR Y-10. Also, a supplemental form was created (FR Y-10E) to
collect additional structure information
that the Federal Reserve deems to be
critical and is needed in an expedited
manner in order to meet new legislative
requirements, answer congressional inquiries, or respond to market events.
Effective December 2007, a requirement that an institution verify its list of
domestic branches was added to the
FR Y-6.
In November, the Federal Reserve
proposed a number of revisions to the
FR Y-9 for the 2008 reporting period
comparable to those proposed for the
bank Consolidated Reports of Condition

and Income (Call Report) as described
in the next section. In addition, the Federal Reserve proposed to collect certain
data on the FR Y-9LP, FR Y-9SP,
FRY-11, FR 2314, FR Y-7, and
FR 2886b forms from all institutions
that choose to apply a fair value option
to financial instruments and servicing
assets and liabilities, and also proposed
to collect other information on sources
of income for supervisory purposes.
Commercial Bank
Regulatory Financial Reports
As the federal supervisor of state member banks, the Federal Reserve, along
with the other banking agencies through
the FFIEC, requires banks to submit
quarterly Call Reports. Call Reports are
the primary source of data for the supervision and regulation of banks and the
ongoing assessment of the overall
soundness of the nation's banking system. 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 2007 reporting period, the
FFIEC implemented various revisions to
the Call Report to address new safety
and soundness considerations and to facilitate supervision. Among these revisions were changes related to the reporting of data for deposit insurance
assessments; changes to provide for the
reporting of data on nontraditional mortgage products; and changes to provide
for the reporting of data related to certain financial instruments measured at
fair value.
In September, the FFIEC proposed a
number of revisions to the Call Report
for the 2008 reporting period. The pro-

Banking Supervision and Regulation
posed revisions include collecting additional information related to one- to
four-family residential mortgage loans;
modifying the definition of trading account in response to the creation of a
fair value option in generally accepted
accounting principles; revising certain
schedules to enhance the reporting of
information available under the fair
value option; revising the instructions
for reporting daily average deposit data
by newly insured institutions to conform
with the FDIC's assessment regulations;
and clarifying the instructions for reporting credit derivatives data in the riskbased capital schedule.
In 2007, Federal Reserve staff led a
review of the Call Report by the federal
banking agencies to determine which
data requirements are no longer necessary or appropriate. The review, required by the Financial Regulatory Relief Act of 2006 to be conducted every
five years, documented the safety and
soundness and other public policy uses
of each Call Report item and will serve
as a reference for future changes to the
Call Report.

Supervisory Information
Technology
Information technology supporting Federal Reserve supervisory activities is
managed within the System supervisory
information technology (SSIT) function
in the Board's Division of Banking Supervision and Regulation. SSIT works
through assigned staff at the Board and
the Reserve Banks, as well as through
System committees, to ensure that key
staff members throughout the System
participate in identifying requirements
and setting priorities for information
technology initiatives.
In 2007, the SSIT function worked on
several strategic projects and initiatives:
(1) alignment of technology investments

105

with business needs; (2) identification
and implementation of improvements to
make technology more accessible to
staff working in the field; (3) strengthening of compliance with data-privacy
regulations; (4) identification of opportunities to converge and streamline IT
applications, including key administrative systems, to provide consistent and
seamless information; (5) evaluation and
implementation of collaboration and
analysis technologies (such as communities of practice and business intelligence tools) to integrate supervisory and
management information systems that
support both office-based and field staff;
(6) with the other federal regulatory
agencies, modernization of the Shared
National Credit system; and (7) enhancement of the information security
framework for the supervisory function,
improving both overall security and
compliance with best-practices and
regulatory requirements (security enhancements included the encryption of
data on all laptop computers and distribution of encrypted portable drives). In
addition, new, advanced security measures were pilot-tested prior to expected
implementation in 2008.
National Information Center
The National Information Center (NIC)
is the Federal Reserve's comprehensive
repository for supervisory, financial, and
banking structure data and supervisory
documents. NIC includes data on banking structure throughout the United
States; the National Examination Database (NED), which enables supervisory
personnel as well as federal and state
banking authorities to access NIC data;
the Banking Organization National
Desktop (BOND), an application that facilitates secure, real-time electronic
information-sharing and collaboration
among federal and state banking regula-

106 94th Annual Report, 2007
tors for the supervision of banking organizations; and the Central Document and
Text Repository (CDTR), which contains documents supporting the supervisory processes.
Within the NIC, the supporting systems have been modified over time to
extend their useful lives and improve
business workflow efficiency. During
2007 work continued on upgrading the
entire NIC infrastructure in order to provide easier access to information, a consistent Federal Reserve enterprise information layer, a comprehensive metadata
repository, and uniform security across
the Federal Reserve. Implementation is
expected to be phased in beginning midyear 2008, with a completion target of
2010. Also in 2007, the NED system
was modified to enhance the collection
and reporting of Bank Secrecy Act information. In addition, the BOND and
CDTR systems were enhanced to provide the document storage facility for
the new national Federal Reserve Consumer Help call center. Key summary
documentation regarding consumer
complaints and inquiries is posted into
the CDTR and made available to System staff and staff at the other federal
banking agencies via the BOND system.
The BOND and CDTR systems were
also enhanced to provide an automated,
electronic means for passing examination and inspection reports to the records
management system of the Board's Office of the Secretary. This new electronic process has allowed the Reserve
Banks to discontinue the long-standing
practice of sending hard-copy reports to
the Board for records management purposes.
Finally, during 2007 the Federal Reserve continued to work closely with
other federal and state banking
agencies—including federal agency
chief information officers, FFIEC task
forces and subgroups, and the Confer

ence of State Bank Supervisors—on a
variety of technology-related initiatives
and projects supporting the supervision
business function.

Staff Development
The System Staff Development Program
trains staff members at the Board, the
Reserve Banks, and state banking departments. Training is offered at the basic, intermediate, and advanced levels in
several disciplines within bank supervision: safety and soundness, information
technology, foreign banking organizations, and consumer affairs. Classes are
conducted in Washington, D.C., as well
as at Reserve Banks and other locations.
The Federal Reserve also participates in
training offered by the FFIEC and by
certain other regulatory agencies. The
System's involvement includes developing and implementing basic and advanced training in relation to various
emerging issues as well as in specialized
areas such as international banking, information technology, anti-money laundering, capital markets, payment systems risk, and real estate appraisal (see
table).
In 2007, the Federal Reserve trained
2,588 students in Federal Reserve System schools, 894 in schools sponsored
by the FFIEC, and 26 in other schools,
for a total of 3,508. The number of training days in 2007 totaled 16,791.
The System provides scholarship assistance to the states for training their
examiners in Federal Reserve and
FFIEC schools. Through this program,
659 state examiners were trained—347
in Federal Reserve courses, 309 in
FFIEC programs, and 3 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 two specialty areas, safety and sound-

Banking Supervision and Regulation

107

Training Programs for Banking Supervision and Regulation, 2007
Number of sessions conducted
Program
Total

Regional

9
9
3
17
9
15

8
8
1
17
9
15

Other schools
Credit risk analysis
Examination management
Real estate lending seminar
Senior forum for current banking and regulatory issues
Basel II corporate activities
Basel II operational risk
Basel II retail activities

7
6
2
1
1
2
2

7
5
1
1
1
1
2

Principles of fiduciary supervision
Commercial lending essentials for consumer affairs
Consumer compliance examinations I
Consumer compliance examinations II
CRA examination techniques
CA risk-focused examination techniques
Fair lending examination techniques

1
2
2
2
2
2

1
1
0
2
2
2
2

1
8
2
6
4
2
4
7
21

0
0

0
0
0

71
1

1
1

Schools or seminars conducted by the Federal Reserve
Core schools
Banking and supervision elements
Financial analysis and risk management
Bank management
Report writing
Team dynamics and negotiation
Conducting meetings with management

Foreign banking organizations seminar
Information systems continuing education
Asset liability management (ALMl)
Fundamentals of interest rate risk management .
Technology risk integration
Trading risk management
Leadership and influence
Fundamentals of fraud
Information technology seminars1
Self-study or online learning2
Orientation (core and specialty)
Self-study programs 1, 2, and 3
Self-study modules
Other agencies conducting courses3
Federal Financial Institutions Examination Council
The Options Institute
1. Held at the IT Lab at the Chicago Federal Reserve
Bank.

ness or consumer affairs. In 2007, 161
examiners passed the first proficiency
examination and 73 passed the second
proficiency examination, 53 examiners
in safety and soundness and 20 in
consumer affairs. An information
technology specialty is also offered; it
requires passing a proficiency examination and an examination administered
by an information technology industry
association.

2. Self-study programs do not involve group sessions.
3. Open to Federal Reserve employees.

Regulation of the
U.S. Banking Structure
The Federal Reserve administers several
federal statutes that apply to bank holding companies, financial holding companies, member banks, and foreign
banking organizations—the Bank Holding Company Act, the Bank Merger Act,
the Change in Bank Control Act, the
Federal Reserve Act, and the Interna-

108 94th Annual Report, 2007
tional Banking Act. In administering
these statutes, the Federal Reserve acts
on a variety of proposals that directly or
indirectly affect the structure of the U.S.
banking system at the local, regional,
and national levels; the international operations of domestic banking organizations; or the U.S. banking operations of
foreign banks. The proposals concern
bank holding company formations and
acquisitions, bank mergers, and other
transactions involving bank or nonbank
firms. In 2007, the Federal Reserve acted
on 1,365 proposals, which represented
2,661 individual applications filed under
the five administered statutes.
Bank Holding Company Act
Under the Bank Holding Company Act,
a corporation or similar legal entity 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 the nonbanking 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 may
consider 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 Federal Reserve information deemed
necessary to ensure compliance with ap

plicable 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. In
2007, the Federal Reserve acted on 603
applications and notices filed by bank
holding companies to acquire a bank or
a nonbank firm, or to otherwise expand
their activities.
Bank holding companies generally
may engage in only those nonbanking
activities that the Board has previously
determined to be closely related to banking under section 4(c)(8) of the Bank
Holding Company Act. Since 1996, the
act has provided an expedited prior notice procedure for certain permissible
nonbank activities and for acquisitions
of small banks and nonbank entities.
Since that time the act has also 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.
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 2007, the
Federal Reserve reviewed 11 stock repurchase proposals by bank holding
companies.
The Federal Reserve also reviews
elections from bank holding companies
seeking financial holding company status under the authority granted by the
Gramm-Leach-Bliley Act. Bank holding
companies seeking financial holding
company status must file a written dec-

Banking Supervision and Regulation
laration with the Federal Reserve. In
2007, 37 domestic financial holding
company declarations and 2 foreign
bank declarations were approved.
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. The Federal Reserve has primary jurisdiction if the institution surviving the merger is a state member
bank. 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 organizations,
the convenience and needs of the community(ies) to be served, and the competitive effects of the proposed merger.
The Federal Reserve also must consider
the views of the U.S. Department of Justice regarding the competitive aspects of
any proposed bank merger involving unaffiliated insured depository institutions.
In 2007, the Federal Reserve approved
68 merger applications under the act.
Change in Bank Control Act
The Change in Bank Control Act requires individuals and certain other parties that seek 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 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 fu

109

ture prospects of the institution to be
acquired; the effect of the proposed
change on competition in any relevant
market; the completeness of the information submitted by the acquiring person; and whether the proposed change
would have an adverse effect on the federal deposit insurance fund. A proposed
transaction should not jeopardize the
stability of the institution or the interests
of depositors. During its review of a proposed transaction, the Federal Reserve
may contact other regulatory or law enforcement agencies for information
about relevant individuals.
In 2007, the Federal Reserve
approved 106 changes in control of state
member banks and bank holding
companies.
Federal Reserve Act
Under the Federal Reserve Act, a member bank may be required to seek Federal Reserve approval before expanding
its operations domestically or internationally. 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, among other things, 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
2007, the Federal Reserve acted on new
and merger-related branch proposals for
1,520 domestic branches and granted
prior approval for the establishment of
20 new foreign branches.
State member banks must also obtain
Federal Reserve approval to establish fi-

110 94th Annual Report, 2007
nancial 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 2007,
no financial subsidiary applications
were filed.

Overseas Investments by
U.S. Banking Organizations
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 Federal Reserve, large and other significant investments require prior approval. In 2007, the Federal Reserve approved 69 proposals for overseas
investments by U.S. banking organizations, many of which represented investments through an Edge Act or agreement corporation.
International Banking Act
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.

operations; the managerial resources of
the foreign bank; whether the homecountry 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 Federal
Reserve, 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 2007, the Federal Reserve approved 18 applications by foreign banks to establish branches, agencies, or representative offices in the
United States.
Public Notice of
Federal Reserve Decisions
Certain decisions by the Federal Reserve
that involve an acquisition by 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 made known to the
public 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. The H.2 release also
contains announcements of applications
and notices received by the Federal Reserve upon which action has not yet
been taken. For each pending applica-

Banking Supervision and Regulation
tion and notice, the related H.2 contains
the deadline for comments. The Board's
website (www.federalreserve.gov) provides information on orders and announcements as well as a guide for U.S.
and foreign banking organizations that
wish to submit applications or notices to
the Federal Reserve.

Enforcement of
Other Laws and Regulations
The Federal Reserve's enforcement responsibilities also extend to the disclosure of financial information by state
member banks and the use of credit to
purchase and carry securities.
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
SEC. At the end of 2007, 12 state member banks were registered with the
Board under the Securities Exchange
Act of 1934.

111

the credit is used to purchase 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.
Several regulatory agencies enforce
the Board's securities credit regulations.
The SEC, the Financial Industry Regulatory Authority (formed through the combination of the National Association of
Securities Dealers and the regulation,
enforcement, and arbitration functions
of the New York Stock Exchange), and
the Chicago Board Options Exchange
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
FCA, the NCUA, and the OTS examine
lenders under their respective jurisdictions; and the Federal Reserve examines
other Regulation U lenders.

Securities Credit

Federal Reserve Membership

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

At the end of 2007, 2,489 banks were
members of the Federal Reserve System
and were operating 55,603 branches.
These banks accounted for 36 percent of
all commercial banks in the United
States and for 71 percent of all commercial banking offices.
•

113

Consumer and Community Affairs
Among the Federal Reserve's responsibilities in the areas of consumer and
community affairs are
• writing and interpreting regulations to
implement federal laws that protect
and inform consumers;
• supervising state member banks to ensure compliance with the regulations;
• investigating complaints from the
public about state member banks'
compliance with regulations;
• promoting community development
in historically underserved markets;
and
• conducting research and promoting
consumer education.
These responsibilities are carried out by
the members of the Board of Governors,
the Board's Division of Consumer and
Community Affairs, and the consumer
and community affairs staff of the Federal Reserve Banks.
The Federal Reserve System's various consumer protection and community development roles were the subject
of great interest in 2007. Consumer protection concerns moved to the forefront
of public dialogue as lawmakers, regulators, the media, and consumers scrutinized various practices being used in the
financial services marketplace, particularly in the markets for subprime mortgages and credit cards. Intense examination of the policies and practices at issue
has revealed the complexity of the current financial services marketplace. Deregulation and technological and financial innovation over the last two decades
fueled the growth of this market, in

creasing competition and consumer
choice. However, the number and types
of consumer financing products and providers now available means consumers
have to become more vigilant and wellinformed as they shop for financial
products and manage their personal finances. The Federal Reserve has strategically used its regulatory and supervisory authorities to address consumer
protection issues in today's complex
consumer financial services marketplace
and to promote consumer education and
community development.

Mortgage Credit
Homeownership has long been a highly
valued goal of both policymakers and
consumers. In response to the demand
for home loans, the mortgage industry
has introduced innovative and creative
loan products into the consumer financial services market. As a result, consumers' access to home mortgage credit
has expanded considerably over the last
decade. Market opportunities and technological advancements have contributed to the growth of the mortgage industry. As the mortgage market grew,
some lenders employed nontraditional
underwriting and risk-layering strategies
in order to capture new market segments, particularly consumers who may
not have been able to qualify for
credit under more-traditional mortgageunderwriting criteria. Although innovation in the mortgage market has made
access to mortgage credit possible for
increasing numbers of households, loan
products have become increasingly
complex—and underwriting standards

114 94th Annual Report, 2007

An Overview of the Subprime Mortgage Market
At $ 11 trillion, the depth and breadth of
the U.S. home mortgage market is unique.
Its sheer capacity has enabled many
families to become homeowners, facilitating a long-standing goal of consumers and
policymakers. Over the past two decades,
the mortgage industry has expanded as a
result of financial innovation, technological advancements, and deregulation. Lenders have been able to provide more
consumers with access to mortgage credit.
In particular, advances in credit scoring
technology and risk-based pricing strategies opened up the mortgage market to
consumers considered to be higher-risk
because of their limited or negative credit
histories, income limitations, or other
financial issues. Lenders charged these
borrowers, known as subprime borrowers,
higher rates to reflect the higher level of
risk they presented. The subprime
mortgage market began to expand markedly in the mid-1990s and peaked in 2006.
The growth of the subprime mortgage
market was fueled by expansive developments across the financial industry that
significantly changed every aspect of the
mortgage industry, from how mortgages
were marketed and underwritten to how
they were funded. The use of credit scoring models to price for risk enabled lenders to more efficiently evaluate a
consumer's creditworthiness, reducing
transaction costs for lenders. In addition,
changes to and the ongoing growth of the
secondary mortgage market increased the

have loosened in recent years, particularly in the subprime market. (See related box "An Overview of the
Subprime Mortgage Market.")
Aware of the changing conditions in
the mortgage market, the Federal Reserve Board has responded to the consumer protection and supervisory concerns of nontraditional and subprime

ability of lenders to sell many mortgages
to "securitizers" that pooled large numbers
of mortgages and sold the rights to the
resulting cash flows to investors. Previously, lenders tended to hold mortgages on
their books until the loans were repaid.
The increasingly popular "originate-todistribute" lending model gave lenders
(and mortgage borrowers) greater access to
capital markets and allowed risk to be
shared more widely. Increased access to
mortgage credit was further fueled by the
rise of both mortgage brokers who
expanded the sales and distribution channels of mortgage lending and independent
mortgage originators not directly affiliated
with a federally supervised depository
institution.
The expanding field of nonbank
mortgage lenders was particularly notable
in the subprime mortgage market. Data
from 2006 reported under the Home
Mortgage Disclosure Act indicate that
45 percent of high-cost first mortgages
were originated by independent mortgage
companies, institutions that are not
regulated by the federal banking agencies
and that typically sell nearly all of the
mortgages they originate. These nondepository institutions fund mortgage lending through the capital markets rather than
customer deposits, the traditional source of
loan funding for banks.
All of these mortgage market developments increased the supply of mortgage
credit, which in turn likely contributed to

mortgage loans. 1 In recent years and
throughout 2007, Federal Reserve staff
have undertaken various initiatives to
(1) scrutinize potentially risky practices
within the mortgage industry and (2) ad1. See the testimony of Chairman Ben S. Bernanke, September 20.2007 (www.federalreserve.gov/
newsevents/testimony/bernanke20070920a.htm).

Consumer and Community Affairs

the rise in the national homeownership rate
from 64 percent in 1994 to about 68 percent in 2007. But the broadening of access
to mortgage credit also had negative aspects. Given their weaker credit histories
and financial conditions, subprime borrowers tend to default on their loans more frequently than prime borrowers. A higher incidence of weaker underwriting standards
and risk-layering practices, such as failing
to document income and lending nearly to
the full value of the home, further increased
a subprime borrower's vulnerability for
default.
In 2007, the problems in the subprime
market, deceleration of the housing market,
decreased house-price appreciation, and the
weakening of the overall economy contributed to a significant number of subprime
mortgage defaults. As a result, the subprime mortgage market experienced significant setbacks: several independent
mortgage lenders declared bankruptcy, and
some large financial organizations experienced multimillion dollar losses in their
portfolios. For consumers, the consequences of defaulting on a mortgage can be
severe, such as the loss of accumulated
home equity, reduced access to credit, and
foreclosure. And the negative effects can
spread beyond subprime customers. Clusters of foreclosures in one community can
cause the value of nearby properties to decline and lead to an increase in vacant and
abandoned properties, thereby inflicting
economic harm on entire neighborhoods.

dress issues through regulatory, supervisory, or community engagement
activities.

115

As the subprime mortgage crisis expanded throughout the last quarter of 2007,
the Federal Reserve actively used its
policy, supervisory, and regulatory tools to
respond to the needs of markets, lenders,
consumers, and communities. These activities were discussed in detail by Federal
Reserve Board governors and other officials who testified before Congress
throughout the year, offering lawmakers
and the public an in-depth discussion about
the issues and actions undertaken by the
Federal Reserve in response to concerns
about the subprime market.1 In addition,
staff at Federal Reserve Banks across the
country worked with regulators, government officials, lenders, servicers, consumer
advocates, and community leaders to improve their understanding of the complex
issues that contribute to, as well as the effects of, widespread mortgage delinquencies and foreclosures. (For a detailed discussion of the Federal Reserve's efforts,
see the "Mortgage Credit" section of this
chapter.) The Federal Reserve has a strong
interest in supporting consumers and communities. Its activities during 2007 have
laid the foundation for continued efforts to
help stabilize the mortgage industry and
assist consumers to make sound financial
decisions.

1. See www.federalreserve.gov/newsevents/
testimony/2007testimony.htm)

Regulatory Actions

of the hearing was to gather information
on how the Board might use its rulemaking authority to curb abusive lending
practices in the home mortgage market,
particularly the subprime sector.2 The

In June, the Board held a public hearing
under the Home Ownership and Equity
Protection Act (HOEPA). The purpose

2. In 1994, HOEPA was enacted in response to
reports of predatory home equity lending practices
in underserved markets. HOEPA amended the

116 94th Annual Report, 2007
meeting, moderated by Governor Randall Kroszner, was the last in a series of
five hearings held under HOEPA; the
other four hearings were held throughout the nation during the summer of
2006.3 Representatives from the financial services industry, consumer and
community groups, and state agencies
participated in the June hearing and
shared their perspectives on certain
lending practices, such as prepayment
penalties, the underwriting of "stated income" loans, and the failure to provide
escrow accounts for taxes and insurance.4 Representatives from the financial services industry acknowledged that
some recent lending practices merited
concern, but these participants urged the
Board to address most of the concerns
by issuing supervisory guidance rather
than regulations under HOEPA. They
suggested that recent supervisory guidance on nontraditional mortgages and
subprime lending, as well as corrective
measures initiated within the mortgage
market, had reduced the need for new
regulations. Industry participants said
that if the Board issues regulations, they
must be clear enough to eliminate uncertainty and avoid unduly restricting
credit. To help consumers avoid abusive
lending practices, industry representaTruth in Lending Act by imposing additional disclosure requirements and other limits on certain
high-cost, home-secured loans. Under HOEPA, the
Board is authorized to issue rules that prohibit
certain acts or practices in connection with home
mortgage loans. HOEPA also directs the Board to
periodically hold public hearings to examine the
home equity lending market and the adequacy of
existing regulatory and legislative provisions for
protecting the interests of consumers, particularly
low-income consumers.
3. For Governor Kroszner's opening comments, see www.federalreserve.gov/newsevents/
speech/kroszner20070614a.htm.
4. For a list of panelists and the agenda, see
www.federalreserve.gov/newsevents/press/bcreg/
20070612a.htm.

tives supported improving the disclosures provided to consumers during the
mortgage process.
Conversely, consumer advocates and
state and local officials urged the Board
to adopt robust regulations under
HOEPA. They acknowledged a useful
role for supervisory guidance but contended that recent problems in the mortgage market indicated a need for stronger requirements that can be enforced
through civil actions—actions that
would only be possible under regulations, not supervisory guidance. Consumer advocates and others welcomed
efforts to improve mortgage disclosures
but insisted that disclosures alone would
not prevent abusive loans. They argued
that independent mortgage lenders are
not subject to the federal regulators' guidance, and enforcement of the existing
laws governing these entities is limited.
In addition to the series of hearings,
the Board received information and advice from its Consumer Advisory Council (see "Advice from the Consumer Advisory Council") and from outreach
meetings to gain insight into industry
practices. These efforts informed the
Board's release of proposed amendments to Regulation Z (Truth in Lending) at a public meeting in December.5
The goals of these proposed amendments are to
• protect consumers in the mortgage
market from unfair, abusive, or deceptive lending and servicing practices,
while preserving responsible lending
and sustainable homeownership;
• ensure that advertisements for mortgage loans provide accurate and balanced information and do not contain
misleading or deceptive representations; and
5. See www.federalreserve.gov/newsevents/
press/bcreg/20071218a.htm.

Consumer and Community Affairs
• provide additional consumer protections on "higher-priced mortgages,"
mortgages whose annual percentage
rate (APR) exceeds the yield on comparable Treasury securities by at least
three percentage points for first-lien
loans, or five percentage points for
subordinate-lien loans.
The proposed rules are comprehensive
both in their reach and aim: they would
apply to all mortgage lenders, not just
depository institutions, and they seek to
improve transparency and enhance consumer protection in mortgage lending.
The proposal directly addresses those
practices raising the most significant
concerns. For higher-priced loans, the
proposed rule would prohibit lenders
from engaging in a pattern or practice of
making mortgage loans on the basis of
collateral alone, without considering a
borrower's ability to repay the loan; require lenders to verify the income or
assets they rely upon in making the loan;
and require lenders to establish escrow
accounts for taxes and insurance. Prepayment penalties would be permitted
on higher-cost loans only under certain
conditions. For higher-cost loans and
most other mortgage loans secured by a
principal dwelling, the proposed rules
would prohibit lenders from paying
yield-spread premiums to brokers, unless a written agreement between the
consumer and broker disclosed the broker's total compensation and other important information; prohibit lenders and
brokers from coercing appraisers to misstate a home's value; and require that
servicers credit loan payments on the
date of receipt and refrain from charging
consumers multiple late fees.
With respect to the marketing of
home loans, the proposed rules would
require lenders to disclose applicable
rates or payments in advertisements as
prominently as advertised teaser rates.

117

For closed-end loans, the proposed rules
would prohibit seven misleading or deceptive advertising practices, for example, using the term "fixed" to describe a rate that is not fixed. The public
comment period ends in early April
2008.
Supervisory Activities
Throughout 2007, concerns about the
mortgage industry continued to grow.
The Board undertook various supervisory activities in collaboration with
other agencies to provide guidance to
lenders and support to consumers. A
comprehensive overview of the Federal
Reserve Board's ongoing efforts to address supervisory concerns in the
subprime mortgage market was outlined
in congressional testimony delivered in
March by the director of the Division of
Consumer and Community Affairs.6 In
April, the federal financial regulatory
agencies jointly issued the "Statement
on Working with Mortgage Borrowers"
that encouraged institutions to work
constructively with residential borrowers who are, or who are reasonably expected to be, unable to make payments
on their home loans.7 The statement emphasizes that loan-workout arrangements are generally in the long-term best
interest of both financial institutions and
borrowers, provided the arrangement is
consistent with safe and sound lending
practices. The statement cites examples
of constructive workout arrangements;
for instance, an institution might modify
a borrower's loan terms or move a borrower from a variable-rate to a fixed6. See the testimony of Sandra F. Braunstein,
March 27, 2007 (www.federalreserve.gov/
newsevents/testimony/braunstein20070327a.htm).
7. See
www.federalreserve.gov/newsevents/
press/bcreg/20070417a.htm (press release) and
www .federalreserve .gov/boarddocs/srletters/2007/
sr0706.htm (Consumer Affairs letter).

118 94th Annual Report, 2007
rate loan. In addition, bank and thrift
programs that transition low- or
moderate-income homeowners from
higher-cost loans to lower-cost loans in
a safe and sound manner may receive
favorable consideration under the Community Reinvestment Act.8
In May, the federal bank, thrift, and
credit union regulatory agencies issued
final illustrations of the information on
nontraditional mortgage products that
lenders should provide to consumers.
The sample illustrations are intended to
help institutions implement consumer
protections in the "Interagency Guidance on Nontraditional Mortgage Product Risks" that the agencies adopted in
October 2006.9 The consumer protections described in the guidance aim to
ensure that consumers receive clear and
balanced information about nontraditional mortgages—before they choose a
mortgage product or select a payment
option for an existing mortgage. Accordingly, the illustrations consist of a
narrative explanation of nontraditional
mortgage products, a chart comparing interest-only and payment-option
adjustable-rate mortgages (ARMs) with
a traditional fixed-rate loan, and a table
showing the impact of various payment
options on the loan balance of a
payment-option ARM (such a table
could be included in monthly loan statements). Institutions are not required to
use the sample illustrations, but the
guidance sets forth information that
lenders should provide to consumers to
allow them to evaluate a nontraditional
mortgage loan.
The federal financial regulatory agencies jointly issued additional guidance
8. For more information, see Q&A § .22(a)-l
(Interagency Questions and Answers Regarding
Community Reinvestment, July 11, 2001).
9. See www.federalreserve.gov/newsevents/
press/bcreg/20070531b.htm.

titled the "Statement on Subprime Mortgage Lending" in June.10 This guidance
describes prudent safety-and-soundness
and consumer protection standards that
institutions should follow when originating certain ARMs that are typically offered to subprime borrowers. These
ARMs offer low initial payments that
are based on a short-term fixed introductory rate that is significantly discounted
from the fully indexed rate (the sum of
the current index and the margin). The
statement emphasizes the importance of
evaluating a borrower's repayment capacity and ability to make payments under the fully indexed rate, assuming a
fully amortizing repayment schedule.
The guidance also stresses the need for
institutions to consider a borrower's total monthly housing-related payments
(that is, principal, interest, taxes, and insurance) when assessing the borrower's
repayment capacity, using the borrower's debt-to-income ratio. Finally, the
guidance instructs lenders to provide
consumers with clear and balanced information on the benefits and risks of
this type of ARM.
In September, the federal financial
regulatory agencies and the Conference
of State Banking Supervisors issued the
"Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages."11 The guidance encourages servicers of residential mortgages to pursue
strategies to mitigate their losses and
seek to preserve homeownership among
their borrowers. The statement outlines
steps that servicers may pursue to determine if a borrower is at an increased risk
10. See www.federalreserve.gov/newsevents/
press/bcreg/20070629a.htm (press release) and
ww w .federalreserve .gov/boarddocs/srletters/2007/
srO712.htm (Consumer Affairs letter).
11. See www.federalreserve.gov/newsevents/
press/bcreg/20070904a.htm (press release) and
www.federalreserve.gov/boarddocs/srletters/2007/
srO716.htm (Consumer Affairs letter).

Consumer and Community Affairs
of mortgage default. Steps include identifying borrowers who have a heightened risk of delinquency, contacting
those borrowers to assess their ability to
repay, and determining whether default
is reasonably foreseeable. The guidance
also presents many possible lossmitigation techniques that a servicer
may initiate with a troubled borrower.
In addition to issuing industry guidance, the Board entered a multiagency
partnership to conduct targeted consumer compliance reviews of selected
nondepository lenders that have significant subprime mortgage operations.12
The joint effort, announced in July, is
the first time multiple agencies have collaborated to plan and conduct consumer
compliance reviews of independent
mortgage lenders and nondepository
subsidiaries of bank and thrift holding
companies, as well as mortgage brokers
doing business with, or working for,
these entities.
The agencies involved—the Federal
Reserve, the Office of Thrift Supervision (OTS), the Federal Trade Commission (FTC), state agencies represented
by the Conference of State Bank Supervisors, and the American Association of
Residential Mortgage Regulators—have
begun developing plans for the targeted
consumer compliance reviews. Federal
Reserve System examiners, assisted by
representatives from the FTC and the
states, will lead reviews of entities supervised by the Federal Reserve System.
At the same time, state regulators will
conduct a coordinated review of an independent state-licensed subprime lender
and associated mortgage brokers, and
the OTS will conduct a review of a selected mortgage subsidiary of a thrift
holding company. These reviews will
evaluate the companies' underwriting
12. See www.federalreserve.gov/newsevents/
press/bcreg/20070717a.htm.

119

standards, as well as senior management's oversight of the risk-management practices the companies used to
ensure compliance with state and federal consumer protection regulations and
laws, including the Home Mortgage
Disclosure Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the
Real Estate Settlement Procedures Act,
the Federal Trade Commission Act, and
the Home Ownership and Equity Protection Act. The agencies will share information about the reviews and investigations; take supervisory action, as
appropriate; collaborate on lessons
learned; and seek ways to better cooperate in ensuring effective and consistent
reviews of these institutions. By jointly
developing and applying a coordinated
review program, the regulatory agencies
will be better positioned to evaluate and
more consistently assess subprime mortgage practices across a broad range of
mortgage lenders and other participants
within the industry. On-site reviews are
scheduled to begin in February 2008.
Community Outreach Efforts
To augment the Board's regulatory and
supervisory activities, System community affairs staff engaged in numerous
efforts to address the personal, economic, and social distress of homeowners and communities that have been
negatively affected by the sharp increases in subprime mortgage loan delinquencies and foreclosures. Community affairs analysts and outreach
specialists used their long-standing networks of industry and community relationships to convene local community
and business leaders, investors, lenders,
servicers, rating agency representatives,
government officials, consumer and
community groups, and others across
the country. To complement these discussions, System research staff collected

120 94th Annual Report, 2007
and analyzed data on real estate and
subprime mortgage conditions and on
the impact of homeowner counseling
programs. The Federal Reserve Bank of
Philadelphia began collecting data for a
longitudinal study of the effectiveness
of homeownership counseling. In a
similar but smaller-scale study, the Dallas Reserve Bank began measuring the
impact of a local mortgage assistance
program. The New York Reserve Bank
collected zip code-level data on the incidence of Alt-A and subprime mortgage products in its District. Several
other researchers focused on loan workouts and modifications throughout the
country. Other key initiatives for the research functions included providing regional foreclosure projections and indepth analyses of the incidence of
defaults within a particular region.
The Board and the Reserve Banks
hosted a number of events, conferences,
and meetings on foreclosure-related
matters in 2007. Many events focused
on encouraging lenders and servicers to
develop systematic loss-mitigation techniques and to promote coordinated outreach to distressed borrowers. In the
twelfth District, the San Francisco Reserve Bank and its partners conducted a
series of six forums to explore foreclosure issues and identify strategies for
preserving homeownership among minorities and low-income borrowers.13
The Federal Reserve Bank of Chicago
sponsored symposiums in Chicago, Indianapolis, and Detroit that featured discussions on the regional impact of foreclosures. The Cleveland Reserve Bank
cosponsored a conference on vacant and
abandoned properties, and the Federal
Reserve Bank of Minneapolis hosted
several events in the Twin Cities area
focused on mortgage broker licensing,
13. See www.sf.frb.org/community/issues/assets/
preservation/index.html.

the need to modernize the foreclosure
system, and the differences in state foreclosure laws. The Reserve Banks also
organized several public workshops and
participated in outreach events to highlight innovative intervention programs.
For example, the San Francisco and Dallas Reserve Banks cosponsored a series
of mortgage-streamlining workshops to
leverage participants' broader knowledge of community development subjects and apply this knowledge to homeownership initiatives for
Native
Americans.
During the past year, Board and System staff strengthened partnerships with
two prominent national homeownership
preservation organizations, NeighborWorks America and the Hope Now Alliance. Both groups have mobilized their
national networks of affiliates and partners in order to advance efforts to
streamline the mortgage-refinancing
process and modify subprime mortgages. In 2007, Governor Kroszner continued to serve on the NeighborWorks
America board of directors. Members of
the Board's staff remain involved with
that organization's Center for Homeownership Education and Counseling,
which establishes education standards
for counseling intermediaries. System
community affairs staff collaborated
with NeighborWorks America by participating in several foreclosureprevention training workshops for homeownership counselors; staff also helped
promote the 1-888-995-HOPE hotline
that links borrowers in financial distress
with mortgage counseling. The Atlanta
Reserve Bank produced an educational
DVD in partnership with NeighborWorks America that addressed the growing foreclosure challenges in its region.
Several Reserve Banks also supported
the Hope Now Alliance, a collaboration
of counselors, servicers, investors, and
other mortgage market participants. Sys-

Consumer and Community Affairs
tern community affairs staff worked with
local Hope Now partners and community stakeholders to identify crossindustry technology solutions that would
enable servicers and counselors to contact at-risk borrowers and better serve
homeowners.
Substantial consumer protection and
community development concerns continue to be raised about mortgage lending practices. The Federal Reserve will
continue its regulatory, supervisory, and
community development efforts to seek
ways to protect and support consumers'
interests in mortgage credit. The Federal
Reserve will also work collaboratively
with a broad spectrum of partners to develop strategies and programs that will
help troubled homeowners address their
mortgage credit difficulties.14

Credit Cards
The credit card market is another area of
consumer finance that has grown rapidly, spurred by technological advances,
new products, and other innovations. Increasingly, electronic payments are accepted for a wide range of transactions,
and consumers now use credit cards to
facilitate everyday purchases, such as
groceries, gasoline, and even a cup of
coffee. In 2007, the total level of revolving debt held by consumers increased by
nearly 8 percent from 2006, to nearly
$944 billion.
Competition in the credit card market
has intensified over the last decade. As a
result, lenders have undertaken aggressive marketing and product development
campaigns and also pursued strategies
to rely more on fee-based income. (Pre14. See the testimony of Governor Randall S.
Kroszner, December 6, 2007 (www.federalreserve.
gov/newsevents/testimony/kroszner20071206a.htm),
and October 24, 2007 (www.federalreserve.gov/
newsevents/testimony/kroszner20071024a.htm).

121

viously, lenders had relied almost solely
on interest from their customers' account balances for revenue.) These industry developments have significantly
elevated concerns about consumer protection; the transparency of credit card
pricing; and the adequacy of consumer
disclosures in credit card marketing materials, contracts, and periodic statements.15
Credit card disclosures are intended
to provide consumers with the information they need to shop for the product
that best meets their needs and to enable
them to make well-informed decisions
regarding usage of their cards. However,
as credit products became more complex, the Board recognized the need to
evaluate its existing regulations governing the content and presentation of information on credit card disclosures. This
undertaking required an in-depth understanding of the credit card industry, consumers' information needs, and the way
consumers shop for credit cards. Before
engaging in rule-writing, the Board undertook extensive consumer testing.
Working with a consultant, the Board
developed a testing methodology that involved several stages. First, two sets of
focus-group meetings were held with
credit card customers. The focus groups
offered insight on
• what credit terms consumers usually
consider when shopping for a credit
card,
• what information consumers find useful when they receive a new card in
the mail, and
• what information consumers find useful on periodic statements.

15. See the testimony of Governor Frederic S.
Mishkin, June 7, 2007 (www.federalreserve.gov/
newsevents/testimony/mishkin20070607a.htm).

122 94th Annual Report, 2007
The second stage of the consumer testing focused on current credit card disclosures. In one-on-one interviews,
credit card customers were presented
with mock disclosures. Participants were
asked to evaluate the information presented, and an interviewer asked them
follow-up questions in order to evaluate
the usability of the disclosures and consumers' understanding of them.
Feedback from the second stage was
used to develop revised sample disclosures for the third phase of testing.
These sample disclosures were tested
and refined during multiple interviews
with consumers. This process allowed
staff to learn more about what information consumers read on current credit
card disclosures; to observe how easily
consumers can find various pieces of
information in these disclosures; and to
test consumers' understanding of the terminology used in the disclosures.
The consumer testing process provided important insights into the way
consumers shop for credit cards and the
information they need to make informed
decisions. In particular, staff found that
consumers tend to notice numbers rather
than narrative text. Consumers frequently reviewed the summary table of
rates and terms that they receive with
credit card solicitations but paid little
attention to densely worded accountopening disclosures and change-interms notifications. Likewise, on periodic statements, consumers generally
focused on numbers, such as fee and
interest charge information. The Board
took these findings into account as it
began drafting proposed amendments to
Regulation Z.
Proposed Amendments
to Regulation Z
In May, the Board issued for public
comment proposed Regulation Z amend

ments. The proposal is intended to improve the effectiveness of the disclosures consumers receive in connection
with credit card accounts and other revolving credit plans; specifically, the
proposal seeks to ensure that such information is provided in a timely manner
and in a form that is readily understandable. The proposed amendments would
require changes to the format, timing,
and content requirements of the five
main types of open-end credit disclosures: (1) credit and charge card application and solicitation disclosures; (2) account-opening disclosures; (3) periodicstatement disclosures; (4) change-interms notices; and (5) advertising
provisions. The proposed amendments
largely reflect the results of the consumer testing described above.
The proposal generated a great deal
of interest, yielding more than 2,500
comments during the comment period
that ended in October. A large number
of these comments were submitted by
individual consumers. Additional insights were provided by consumer advocates and industry representatives serving on the Board's Consumer Advisory
Council. (See "Advice from the Consumer Advisory Council.")
Applications and Solicitations
The proposal contains changes to make
the disclosures provided with credit and
charge card applications and solicitations more meaningful and easier for
consumers to use. Proposed changes include adopting new format requirements
for the summary table, including rules
regarding type size and the use of boldface type for certain key terms; placement of information; and use of crossreferences. The proposed rules address a
number of issues regarding the penalties
credit and charge card companies may
charge customers. For example, applications and solicitations would have to

Consumer and Community Affairs
state how long penalty rates may be in
effect, provide a modified disclosure
about variable rates, describe the effect
of creditors' payment-allocation practices, and reference consumer education
materials on the Board's website.
Account-Opening Disclosures
The proposal contains revisions to make
the cost disclosures provided to consumers at account opening more conspicuous and easier to read. The proposed
changes would require that certain key
terms be disclosed in a summary table at
account opening; this table would summarize the key information consumers
need to make informed decisions about
how they use credit cards. The proposed
changes would also adopt a different approach to disclosing fees, in order to
make it easier for consumers to identify
the costs associated with using the card.
Periodic-Statement Disclosures
The proposal contains revisions to make
the disclosures on periodic statements
more understandable, primarily by
changing the format requirements for
these disclosures—for example, by
grouping fees, interest charges, and
transactions together by type. Other format changes include itemizing the interest charges for different types of transactions, such as purchases and cash
advances, and providing aggregate totals of fees and interest for the month
and year-to-date. In addition, creditors
would have to disclose to consumers the
effect of making only the minimum
required payments on their account
balances.
Change in Consumer's Interest Rate
and Other Account Terms
The proposal expands the circumstances
under which consumers will receive
written notice of changes in the terms

123

(for example, an increase in the interest
rate) applicable to their accounts, and it
increases the amount of time these notices must be sent before the change becomes effective. Generally, the proposed
rules would increase advance notice before a changed term can be imposed
from 15 to 45 days, to better allow consumers to obtain alternative financing or
change their account usage. The proposed rules would also require a creditor
to provide 45 days' prior notice before
increasing a rate as a result of a consumer's delinquency or default.
Advertising Provisions
The proposal revises the rules governing
the advertising of open-end credit, to
help consumers better understand the
credit terms being offered. Under the
proposed revisions, advertisements that
state a minimum monthly payment on a
plan offered to finance the purchase of
goods or services would be required to
disclose, in equal prominence to the
minimum payment, the time period required to pay off the balance and the
total of payments if only minimum payments were made. Furthermore, advertisements would be able to refer to a rate
as "fixed" only if the advertisement
specified the time period for which the
rate was fixed and that the rate would
not increase for any reason during that
time. If a time period is not specified,
the term "fixed" may be used only if the
rate will not increase for any reason
while the plan is open.

Other Regulatory Actions
In addition to proposed rules related to
mortgages and credit cards, the Board
issued regulatory amendments in 2007
related to the electronic delivery of
consumer disclosures, electronic fund

124 94th Annual Report, 2007
transfers, and the privacy of financial
information.

Electronic Disclosures
In November, the Board published
amendments to five consumer financial
services and fair lending regulations
(Regulations B, E, M, Z, and DD). The
amendments clarify the requirements for
providing consumer disclosures in electronic form under the Electronic Signatures in Global and National Commerce
Act (the E-Sign Act). Enacted in 2000,
the E-Sign Act provides that electronic
documents and electronic signatures
have the same validity as paper documents and handwritten signatures. The
E-Sign Act also contains special rules
for the use of electronic disclosures in
consumer transactions. Under the act,
consumer disclosures that are required
by other laws or regulations to be provided in writing may be provided in
electronic form if the consumer affirmatively consents after receiving the notice
specified in the statute and if certain
other conditions are met.
In March 2001, the Board published
interim final rules under Regulations B,
E, M, Z, and DD that established uniform standards for the timing and delivery of electronic disclosures, consistent
with the requirements of the E-Sign Act.
The Board later lifted the mandatory
compliance date for these rules. As a
result, institutions could provide disclosures electronically pursuant to the
E-Sign Act but were not required to
comply with the 2001 interim rules.
In November, the Board withdrew
certain portions of the 2001 interim rules
from the Code of Federal Regulations in
order to reduce confusion about their
status and simplify the regulations. The
Board also withdrew other provisions of
the 2001 interim rules that might have
imposed undue burdens on electronic

banking and commerce and that were
unnecessary for consumer protection.
The November final rules also included
guidance on the use of electronic disclosures, including provisions to clarify the
circumstances under which consumers
conducting transactions online may obtain electronic disclosures without regard to the consent requirements of the
E-Sign Act. The mandatory compliance
date for the final rules is October 1,
2008.16
Regulation E
The Electronic Fund Transfer Act
(EFTA) provides a basic framework of
rights, liabilities, and responsibilities for
participants in electronic fund transfer
systems. The EFTA is implemented by
the Board's Regulation E (12 CFR 205).
In July, the Board published a final rule
that exempts transactions of $15 or less
from Regulation E's requirement that receipts be made available to consumers
for transactions initiated at an electronic
terminal. For this purpose, electronic
terminals include automated teller machines and point-of-sale terminals. This
exception is intended to facilitate the
ability of consumers to use debit cards
in retail settings where it may not be
practical or cost-effective to provide receipts. The rule was effective August 6,
2007.17
Fair Credit Reporting Act
In November, the Board published two
final rules under Regulation V to implement provisions of the Fair and Accurate Credit Transactions Act of 2003
(the FACT Act), which amended the

16. See www.federalreserve.gov/newsevents/
press/bcreg/20071101 a.htm.
17. See www.federalreserve.gov/newsevents/
press/bcreg/20070628a.htm.

Consumer and Community Affairs
Fair Credit Reporting Act (FCRA).
First, the Board published final rules to
implement the affiliate-marketing-notice
and opt-out requirements of section 214
of the FACT Act. The final rules give
consumers the ability to limit the use of
certain information for marketing purposes by affiliates of companies with
which consumers have done business.
The final rules also incorporate certain
statutory exceptions to the notice and
opt-out requirement, including exceptions for when an affiliate has a preexisting business relationship with a
consumer or when the marketing is in
response to a consumer-initiated communication. The mandatory compliance
date for the final rule is October 1, 2008.
The affiliate-marketing rules were developed on an interagency basis with the
other federal banking agencies, the Federal Trade Commission (FTC), and the
Securities and Exchange Commission.18
Second, the Board published final
rules to implement the identity theft "red
flag" provisions of section 114 of the
FACT Act and the address-discrepancy
provisions of section 315 of the act. The
final rules require financial institutions
and creditors to develop and implement
an identity theft protection program that
is designed to detect, prevent, and mitigate identity theft. The final rules also
require users of consumer reports to (1)
adopt reasonable policies and procedures for verifying the identity of a consumer upon receipt of a notice of address discrepancy from a consumer
reporting agency and (2) reconcile the
discrepancy when the user opens an account despite the discrepancy and regularly furnishes information to the consumer reporting agency. The mandatory
compliance date for the final rule is November 1, 2008. The rules for identity
18. See www.federalreserve.gov/newsevents/
press/bcreg/20071025a.htm.

125

theft red flags and address discrepancies
were developed on an interagency basis
with the other federal banking agencies
and the FTC.19
In December, the Board published
proposed rules to implement the provisions of section 312 of the FACT Act,
which apply to those who furnish information to consumer reporting agencies
(furnishers). That section requires the
Board to issue guidelines to ensure the
accuracy and integrity of information
being furnished to consumer reporting
agencies. Section 312 also requires the
Board to issue rules identifying the circumstances under which furnishers must
investigate disputes about the accuracy
of information contained in consumer
reports based on a direct request from a
consumer. The comment period for the
proposal will close in February 2008.
The furnisher accuracy-and-integrity
guidelines and the direct-dispute rules
were developed on an interagency basis
with the other federal banking agencies
and the FTC.20

Other Supervisory Activities
Related to Compliance with
Consumer Protection and
Community Reinvestment Laws
The Division of Consumer and Community Affairs supports and oversees the
supervisory efforts of the Reserve Banks
to ensure that consumer protection laws
and regulations are fully and fairly enforced. (See "Mortgage Credit" earlier
in this chapter for a description of the
division's supervisory activities related
to mortgage lending.) Division staff
members provide guidance and expertise to the Reserve Banks on consumer
19. See www.federalreserve.gov/newsevents/
press/bcreg/20071031 a.htm.
20. See www.federalreserve.gov/newsevents/
press/bcreg/20071129a.htm.

126 94th Annual Report, 2007
protection regulations, examination and
enforcement techniques, examiner training, and emerging issues. Routinely,
staff members develop and update examination policies, procedures, and
guidelines; review Reserve Bank supervisory reports and work products; and
participate in interagency activities that
promote uniformity in examination principles and standards.
Examinations are the System's primary means of enforcing compliance
with consumer protection laws. During
the 2007 reporting period,21 the Reserve
Banks conducted 324 consumer compliance examinations—312 of state member banks and 12 of foreign banking
organizations.22

are enforced consistently and rigorously
throughout
the Federal
Reserve
System.23
The Federal Reserve enforces the
ECOA and the provisions of the Fair
Housing Act that apply to lending institutions. The ECOA prohibits creditors
from discriminating against any applicant, in any aspect of a credit transaction, on the basis of race, color, religion,
national origin, sex, marital status, or
age. In addition, creditors may not discriminate against an applicant because
the applicant receives income from a
public assistance program or has exercised, in good faith, any right under the
Consumer Credit Protection Act. The
Fair Housing Act prohibits discrimination in residential real estate-related
transactions, including the making and
Fair Lending
purchasing of mortgage loans, on the
The Federal Reserve is committed to en- basis of race, color, religion, national
suring that the institutions it supervises origin, handicap, familial status, or sex.
comply fully with the federal fair lendPursuant to the ECOA, if the Board
ing laws—the Equal Credit Opportunity
has reason to believe that a creditor has
Act (ECOA) and the Fair Housing Act.
engaged in a pattern or practice of disFair lending reviews are conducted
crimination in violation of the ECOA,
regularly within the supervisory cycle.
the matter will be referred to the DepartAdditionally, examiners may conduct
fair lending reviews outside of the usual ment of Justice (DOJ) The DOJ reviews
supervisory cycle, if warranted. When the referral and decides if further invesexaminers find evidence of potential dis- tigation is warranted. A DOJ investigacrimination, they work closely with the tion may result in a public civil enforcedivision's Fair Lending Enforcement ment action or settlement. The DOJ may
Section, which brings additional legal decide instead to return the matter to the
and statistical expertise to the examina- Federal Reserve for administrative ention and ensures that fair lending laws forcement. When a matter is returned to
the Federal Reserve, staff ensures that
the institution corrects the problems and
21. The 2007 reporting period for examination
makes amends to the victims.
data was July 1, 2006, through June 30, 2007.
During 2007, the Board referred the
22. The foreign banking organizations examfollowing eight matters to the DOJ:
ined by the Federal Reserve are organizations op-

erating under section 25 or 25A 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.

23. See the testimony of Sandra F. Braunstein,
director, Division of Consumer and Community
Affairs, July 25, 2007 (www.federalreserve.gov/
newsevents/testimony/braunstein20070725a.htm).

Consumer and Community Affairs
• Two referrals involved ethnic and
racial discrimination in mortgage
pricing by nationwide lenders. These
referrals are discussed in more detail
below. (See "Evaluating PricingDiscrimination
Risk
by
Analyzing HMDA Data and Other
Information.")
• One referral involved racial discrimination in the pricing of automobile
loans. The institution purchased loans
in which auto dealers had charged
higher interest rates, through the use
of markups, that were based on the
race of the borrowers. This pricing
was permitted by the lender, who received a share of the markups.
• One referral involved an institution
with two loan policies that were found
to be discriminatory. One policy prohibited lending on Native American
lands. The other policy restricted
lending on row houses, which resulted
in discrimination against African
Americans.
• Four referrals involved discrimination
against unmarried people. In one matter, an institution combined incomes
for married applicants, but not for coapplicants who were unmarried, when
underwriting consumer loans. In another matter, an institution only permitted spousal co-applicants for consumer loans. The institution also
improperly required non-applicant
spouses to sign mortgage notes. The
remaining two referrals involved improper spousal guarantees.
If a fair lending violation does not
constitute a pattern or practice that is
referred to the DOJ, the Federal Reserve
acts on its own to ensure that the bank
remedies it. Most lenders readily agree
to correct fair lending violations. In fact,
lenders often take corrective steps as

127

soon as they become aware of a problem. Thus, the Federal Reserve generally uses informal supervisory tools
(such as memoranda of understanding
between the bank's board of directors
and the Reserve Bank) or board resolutions to ensure that violations are corrected. If necessary to protect consumers, however, the Board can and does
bring public enforcement actions.
Evaluating Pricing-Discrimination Risk
by Analyzing HMDA Data and
Other Information
The two previously mentioned referrals
involving mortgage-pricing discrimination resulted from a process of targeted
pricing reviews that the Federal Reserve
initiated when Home Mortgage Disclosure Act (HMDA) pricing data first became available in 2005. (See "Reporting
on Home Mortgage Disclosure Act
Data.") Board staff developed, and continue to refine, HMDA screens that
identify institutions that may warrant
further review on the basis of an analysis of HMDA pricing data. Because
HMDA data lack many factors that
lenders routinely use to make credit
decisions and set loan prices, such as
information about a borrower's creditworthiness and loan-to-value ratios,
HMDA data alone cannot be used to
determine whether a lender discriminates. Thus, the Federal Reserve
staff analyzes HMDA data in conjunction with other supervisory information
to evaluate a lender's risk for engaging
in discrimination.
For the 2006 HMDA pricing data—
the most recent year for which the data
are publicly available—Federal Reserve
examiners performed
a pricingdiscrimination risk assessment for each
institution that was identified through
the HMDA screening process. These
risk assessments incorporated not just

128 94th Annual Report, 2007
the institution's HMDA data but also
the strength of the institution's fair lending compliance program; past supervisory experience with the institution;
consumer complaints against the institution; and the presence of fair lending
risk factors, such as discretionary pricing. On the basis of these comprehensive assessments, Federal Reserve staff
determined which institutions would receive a targeted pricing review. Depending on the examination schedule, the targeted pricing review could occur as part
of the institution's next examination or
outside the usual supervisory cycle.
Even if an institution is not identified
through HMDA screening, examiners
may still conclude that the institution is
at risk for engaging in pricing discrimination and may perform a pricing review. The Federal Reserve supervises
many institutions that are not required to
report data under HMDA. Also, many
of the HMDA-reporting institutions supervised by the Federal Reserve originate few higher-priced loans and, therefore, report very little pricing data. For
these institutions, examiners analyze
other available information to assess
pricing-discrimination risk and, when
appropriate, perform a pricing review.
During a targeted pricing review, staff
analyze additional information, including potential pricing factors that are not
available in the HMDA data, to determine whether any pricing disparity by
race or ethnicity is fully attributable to
legitimate factors, or whether any portion of the pricing disparity may be attributable to illegal discrimination. To
perform these reviews, staff use analytical techniques that account for the increasing complexity of the mortgage
market. Two industry changes in
particular—the proliferation of product
offerings and the increased use of riskbased pricing—have increased the complexity of fair lending reviews. It is not

uncommon for a lender to offer many
different products, each with its own
pricing based on the borrower's credit
risk.
To effectively detect discrimination in
the expanding range of products and
credit-risk categories, the Federal Reserve increasingly uses statistical techniques. When performing a pricing review, staff typically obtain extensive
proprietary loan-level data on all mortgage loans originated by the lender, including prime loans (that is, not just the
higher-priced loans reported under
HMDA). To determine how to analyze
these data, the Federal Reserve studies
the lender's specific business model,
pricing policies, and product offerings.
On the basis of the review of the lender's policies, staff determine which factors from the lender's data should be
considered. A statistical model is then
developed that takes those factors into
account and is then tailored to that specific lender. Typically, a test for discrimination in particular geographic
markets, such as metropolitan statistical
areas (MSAs), is performed. Looking at
specific markets is important, as relatively small unexplained pricing disparities at the national level can mask much
larger disparities in individual markets.
On the basis of the results of pricing
reviews conducted, Federal Reserve
staff had reason to believe that two nationwide lenders had engaged in a pattern or practice of discrimination and
referred these cases to the DOJ. After
accounting for legitimate factors reflected in the lenders' specific pricing
policies, staff found that minorities still
paid more for their mortgages than nonHispanic white borrowers in multiple
MSAs. The first referral involved two of
the fair lending risk factors that the
agencies have identified and used for
some time: (1) broad discretion in pricing by loan officers or brokers and (2) fi-

Consumer and Community Affairs
nancial incentives for loan officers or
brokers to charge borrowers higher
prices. The lending institution gave its
loan officers discretion to charge overages and underages, that is, to set loan
prices higher or lower than its standard
rates. The institution also paid loan officers more if they charged overages.
The Federal Reserve found evidence
that, in multiple MSAs, African American and Hispanic borrowers paid higher
overages than comparable non-Hispanic
whites.
The second referral involved loans
originated through mortgage brokers at
which the institution also permitted pricing discretion. In multiple MSAs, African Americans and Hispanics paid
higher annual percentage rates than
comparable non-Hispanic whites. Pricing discretion and financial incentives to
charge borrowers more do not always
result in fair lending violations; however, these referrals underscore that it is
critical for lenders that permit these
practices to have clear policies about
their use and to monitor their use
effectively.
Reporting on Home Mortgage
Disclosure Act Data
The Home Mortgage Disclosure Act
(HMDA), enacted by Congress in 1975,
requires most mortgage lenders located
in metropolitan areas to collect data
about their housing-related lending activity, report the data annually to the
government, and make the data publicly
available. In 1989, Congress expanded
the data required by HMDA to include
information about loan applications that
did not result in a loan origination, as
well as information about the race, sex,
and income of applicants and borrowers.
In response to the growth of the
subprime loan market, the Federal Reserve updated Regulation C (HMDA's

129

implementing regulation) in 2002. The
revisions, which became effective in
2004, require lenders to collect price information for loans they originated in
the higher-priced segment of the homeloan market. When applicable, lenders
report the number of percentage points
by which a loan's annual percentage rate
exceeds the threshold that defines
"higher-priced loans." The threshold is
3 percentage points or more above the
yield on comparable Treasury securities
for first-lien loans, and 5 percentage
points or more above that yield for
junior-lien loans. The HMDA data collected in 2004 and released to the public
in 2005 provided the first publicly available loan-level data about loan prices.
The FFIEC released the 2006 HMDA
data to the public in September 2007.
A December 2007 article published
by Federal Reserve staff in the Federal
Reserve Bulletin uses the 2006 data to
describe the market for higher-priced
loans and patterns of lending across loan
products, geographic markets, and borrowers and neighborhoods of different
races and incomes.24 The article also
analyzed several of the items included
in the HMDA data in order to determine
their usefulness in predicting mortgageloan delinquency across metropolitanarea counties. The analysis resulted in
several findings, including that the incidence of higher-priced lending and the
share of non-owner-occupied loans in a
county were both related to higher levels of default in the future.
As in 2004 and 2005, most reporting
institutions reported extending few if
any higher-priced loans in 2006; 61 percent of the lenders originated less than
24. Robert B. Avery, Kenneth P. Brevoort, and
Glenn B. Canner, "The 2006 HMDA Data,"
Federal Reserve Bulletin, December 2007
(www.federalreserve.gov/pubs/bulletin/2007/pdf/
hmdaO6final.pdf).

130 94th Annual Report, 2007
10 higher-priced loans that year. The
data also indicate that relatively few
lenders accounted for most of the
higher-priced loan originations in 2006.
Of the nearly 8,900 home lenders reporting HMDA data, 928 of them made 100
or more higher-priced loans. The 10
home lenders that had the largest volume of higher-priced loans accounted
for about 38 percent of all such loans in
2006. Also as in 2004 and 2005, the
majority of all loan originations were
not higher priced in 2006; however, the
incidence of higher-priced lending did
increase from 26.2 percent in 2005 to
28.7 percent in 2006. Some of the increase in the incidence of higher-priced
lending is attributed to changes in the
interest rate environment from 2005 to
2006, as well as to changes in borrower
profiles and lender practices.
Loan pricing is a complex process
that may reflect a wide variety of factors
about the level of risk a particular loan
or borrower presents to the lender. As a
result, the prevalence of higher-priced
lending varies widely. First, the incidence of higher-priced lending varies by
product type. For example, manufactured-home loans show the greatest
incidence of higher-priced lending
(more than half of these loans are higher
priced), because these loans are considered higher risk. In addition, first-lien
mortgages are generally less risky than
comparable junior-lien loans, and the
pricing for these loans reflects their risk
profiles: 25.3 percent of first-lien conventional home purchase loans were reported as higher-priced in 2006, compared with 45.7 percent of comparable
junior-lien loans.
Second, higher-priced lending varies
widely by geography. As in 2004 and
2005, many of the metropolitan areas
that reported the greatest incidence of
higher-priced lending were in the south

ern region of the country. Several metropolitan areas on the West Coast also had
an elevated incidence of higher-priced
lending in 2006. In many metropolitan
areas in the South, Southwest, and West,
30 percent to 40 percent of the homebuyers who obtained conventional loans
in 2006 received higher-priced loans.
Third, the incidence of higher-priced
lending varies greatly among borrowers
of different races and ethnicities. In
2006, as in 2004 and 2005, African
Americans and Hispanics were much
more likely than non-Hispanic whites
and Asians to receive higher-priced
loans. For example, in 2006, 54 percent
of African American borrowers, and
47 percent of Hispanic borrowers, received higher-priced conventional home
purchase loans, compared with 18 percent of non-Hispanic white and 17 percent of Asian borrowers. Because
HMDA data lack information about
credit risk and other legitimate pricing
factors, it is not possible to determine
from HMDA data alone whether the observed pricing disparities and market
segmentation reflect discrimination.
When analyzed in conjunction with other
fair lending risk factors and supervisory
information, however, the HMDA data
can facilitate fair lending supervision
and enforcement. (See "Fair Lending.")

Examinations and Activities
Related to the Community
Reinvestment Act
The Community Reinvestment Act
(CRA) requires that the Federal Reserve
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 operations. To carry out
this mandate, the Federal Reserve

Consumer and Community Affairs
• examines state member banks to assess their compliance with the CRA,25
• analyzes applications for mergers and
acquisitions by state member banks
and bank holding companies in relation to CRA performance, and26
• disseminates information on community development techniques to bankers and the public through community
affairs offices at the Reserve Banks.
The Federal Reserve assesses and rates
the performance of state member banks
under the CRA in the course of examinations conducted by staff at the twelve
Reserve Banks. During the 2007 reporting period, the Reserve Banks conducted 271 CRA examinations of banks:
33 were rated Outstanding, 237 were
rated Satisfactory, none was rated Needs
to Improve, and one was rated Substantial Noncompliance.27
Consumer Alert on Solicitations
for CRA Programs
In February, the Board, the Federal Deposit Insurance Corporation, the Office
of the Comptroller of the Currency, and
the Office of Thrift Supervision jointly
released a consumer alert about CRArelated solicitations from lenders.28 This
alert cautioned the public about loan solicitations or other offers from lenders or
mortgage brokers that offer consumers
cash as part of a "Community Reinvestment Act (CRA) Program." The agen25. See the testimony of Sandra F. Braunstein,
director, Division of Consumer and Community
Affairs, October 24, 2007 (www.federalreserve.gov/
newsevents/testimony/braunstein20071024a.htm).
26. See the testimony of Sandra F. Braunstein,
director, Division of Consumer and Community
Affairs, May 21, 2007 (www.federalreserve.gov/
ne wse vents/testimony/braunstein20070521 a.htm).
27. The 2007 reporting period for examination
data was July 1, 2006, through June 30, 2007.
28. See www.federalreserve.gov/newsevents/
press/other/20070216a.htm.

131

cies had received numerous consumer
complaints and inquiries about this type
of solicitation, and the alert warned that
the solicitation appears to be a deceptive
effort to encourage consumers to apply
for a mortgage loan secured by their
home. A statement that the agencies do
not sponsor or endorse such programs
and that the CRA does not require such
programs was also included in the alert,
along with a warning for consumers to
be suspicious about conducting business
with lenders who make deceptive
claims.
Proposed Interagency Questions
and Answers on the CRA
In July, the federal bank and thrift regulatory agencies released for comment a
series of new and revised interagency
questions and answers on CRA. The
agencies are proposing new questions
and answers, as well as making substantive and technical revisions to the existing material. Some of the proposed revisions are intended to encourage
institutions to work with homeowners
who are unable to make their mortgage
payments; the questions and answers
emphasize that institutions can receive
CRA consideration for foreclosureprevention programs for low- and
moderate-income homeowners, consistent with the April 2007 interagency
"Statement on Working with Mortgage
Borrowers."29 In addition, several technical changes are being proposed to
clarify, update, and improve the readability of existing guidance. A few of
the more substantive changes include
• allowing CRA consideration for investments made by banks to minorityor women-owned financial institutions when that investment benefits
29. See www.federalreserve.gov/newsevents/
press/bcreg/20070417a.htm.

132 94th Annual Report, 2007
the minority or women-owned financial institution's local community,
even if the investment does not benefit the bank's own assessment area;
• providing flexibility to certain intermediate small banks in the evaluation
of their home mortgage, small business, and small farm loans; and
• clarifying that an institution that
makes a loan or investment in a national or regional community development fund should be able to demonstrate that the fund will benefit the
institution's assessment area(s) or the
broader statewide or regional area that
includes the bank's assessment area(s)
as contemplated by the regulation,
provided the fund meets certain definition and geographic requirements.

• An application by Huntington Baneshares, Inc., Columbus, Ohio, to acquire Sky Financial Group, Inc.,
Bowling Green, Ohio, was approved
in June.
• An application by Wells Fargo &
Company, San Francisco, California,
to acquire Greater Bay Bancorp, East
Palo Alto, California, was approved
in August.

The public submitted comments on nine
applications, including those mentioned
above. Many of the commenters referenced pricing information on residential
mortgage loans and concerns that minority applicants were more likely than
nonminority applicants to receive
higher-priced mortgages. These concerns were largely based on observaAnalysis of Applications for
tions of lenders' 2005 and 2006 HMDA
Mergers and Acquisitions
pricing data. Other issues raised by comin Relation to the CRA
menters involved minority applicants
During 2007, the Board considered ap- being denied mortgage loans more freplications for several significant bank- quently than nonminority applicants; poing mergers. The Board approved two tentially predatory lending practices by
applications by Bank of America Corpo- subprime and payday lenders; the potenration, Charlotte, North Carolina, the tial adverse effects of branch closings;
second largest depository institution in and lenders' failure to address the
the United States. The company's acqui- convenience and needs of low- and
sition of U.S. Trust Corporation, New moderate-income communities. In addiYork, New York, was approved by the tion, the Board also received comments
Board in March and its application to about the adverse effects of increased
acquire ABN AMRO North America foreclosures, especially in low- and
Holding Company, Chicago, Illinois, moderate-income communities.
The Board considered forty-two
was approved in September. The merger
applications with outstanding issues inof two historic bank holding companies,
The Bank of New York, New York, New volving compliance with consumer proYork, and Mellon Financial Corporation, tection statutes and regulations, includ30
Pittsburgh, Pennsylvania, was approved ing fair lending laws, and the CRA.
by the Board in June. Several other sig- Thirty-seven of those applications were
approved and five were withdrawn,
nificant applications are listed below.
including one with an adverse CRA
• An application by PNC Financial Ser- rating.
vices Group, Inc., Pittsburgh, Pennsylvania, to acquire Mercantile Bankshares
Corporation,
Baltimore,
30. The forty-two applications do not include
Maryland, was approved in February. the nine protested applications.

Consumer and Community Affairs

Initiatives for Minority-Owned
Financial Institutions

133

Bank Examiner Guidance
and Training

The Federal Reserve is committed to en- Examiner Guidance on Unfair and
suring the provision of financial services Deceptive Acts and Practices
to all consumers and communities. One
of the many ways the Board achieves Periodically, the Board issues guidance
this goal is by promoting the safety and on consumer protection laws and regulasoundness of all the institutions subject tions to Reserve Bank examiners. Some
to System supervision, including those guidance is developed and updated in
that are minority owned. Through its concert with the other federal financial
regulatory, supervisory, and community institution regulatory agencies, and
development functions, the Board con- some is issued solely by the Board. In
sistently addresses the unique challenges 2007, the Board issued examination proand needs of minority-owned banks. At cedures designed to help examiners dethe same time, the Board holds these termine whether specific acts or pracinstitutions to the supervisory standards tices conducted by state-chartered banks
that are applied to all state member are unfair or deceptive. These procebanks. The Board views this strategy as dures incorporate general guidance prointegral to its efforts to promote a safe, vided in the March 11, 2004, "Statement
sound, and competitive banking system on Unfair or Deceptive Acts or Practices
(UDAP) by State-Chartered Banks" isthat also protects consumer interests.
To enhance its support of minority- sued jointly by the Board and the Fedowned institutions, the Federal Reserve eral Deposit Insurance Corporation. The
has been developing an innovative and Board's guidance helps examiners anacomprehensive training and technical lyze potential UDAP issues during a
assistance program for minority-owned consumer compliance examination or a
depository institutions. Designed to ad- complaint investigation.
dress issues that might inhibit or limit
the financial and operating performance Training for Bank Examiners
of minority-owned institutions, the program includes outreach and technical as- Ensuring that financial institutions comsistance for institution directors. It also ply with laws that protect consumers and
fosters relationship-building between in- encourage community reinvestment is
stitutions and supervisory staff, and an important part of the bank examinaraises supervisory awareness of the tion and supervision process. As the
unique challenges faced by minority- number and complexity of consumer fiowned institutions. The program is nancial transactions grow, training for
scheduled to be fully operational in staff that review and examine the organizations under the Federal Reserve's su2008.31
pervisory responsibility becomes even
more important. The consumer compliance examiner training curriculum con31. See the speech by Governor Randall S.
Kroszner, August 1, 2007 (www.federalreserve.gov/
sists of six courses focused on various
newsevents/speech/kroszner20070801a.htm). See
consumer protection laws, regulations,
also the testimony of Sandra F. Braunstein, direcand examination concepts. In 2007,
tor, Division of Consumer and Community Afthese courses were offered in eleven sesfairs, October 30, 2007 (www.federalreserve.gov/
sions to more than 193 consumer comnewsevents/testimony/braunstein20071030a.htm).

134 94th Annual Report, 2007
pliance examiners and System staff
members.
Board and Reserve Bank staff regularly review the core curriculum for examiner training, updating subject matter
and adding new elements as appropriate.
During 2007, staff conducted a curriculum review of the Introduction to Consumer Compliance Examinations I
(CA I) course to incorporate technical
changes in policy and laws, along with
changes in instructional delivery techniques. This course, designed for assistant examiners, focuses on the (1) consumer laws and regulations that govern
operations and non-real estate lending
and (2) regulations affecting deposit and
non-real estate lending operations. The
course emphasizes examination techniques and procedures that demonstrate
the practical application of these laws
and regulations.
When appropriate, courses are delivered via alternative methods, such as the
Internet or other distance-learning technologies. The CA I course uses a
combination of instructional methods:
(1) classroom instruction focused on
case studies and (2) specially developed
computer-based instruction that includes
interactive self-check exercises.
In addition to providing core training,
the examiner curriculum emphasizes the
importance of continuing professional
development. Opportunities for continuing development include special projects
and assignments, self-study programs,
rotational assignments, the opportunity
to instruct at System schools, mentoring
programs, and an annual senior examiner forum.

determined to have special flood hazards. Under the Federal Reserve's Regulation H, which implements the act, state
member banks are generally prohibited
from making, extending, increasing, or
renewing any such loan unless the building or mobile home and any personal
property securing the loan are covered
by flood insurance for the term of the
loan. Moreover, the act requires the
Board and other federal financial institution regulatory agencies to impose civil
money penalties when it finds a pattern
or practice of violations of the regulation. The civil money penalties are payable to the Federal Emergency Management Agency for deposit into the
National Flood Mitigation Fund.
During 2007, the Board imposed civil
money penalties against eight state
member banks. The penalties, which
were assessed via consent orders, totaled $246,050.
Agency Reports on Compliance
with Consumer Protection Laws
The Board reports annually on compliance with consumer protection laws by
entities supervised by federal agencies.
This section summarizes data collected
from the twelve Federal Reserve Banks
and the FFIEC member agencies (collectively, the FFIEC agencies), as well
as other federal enforcement agencies.32
Regulation B
(Equal Credit Opportunity)
The FFIEC agencies reported that
85 percent of the institutions examined
during the 2007 reporting period were in
compliance with Regulation B, com-

Flood Insurance
The National Flood Insurance Act imposes certain requirements on loans secured by buildings or mobile homes located in, or to be located in, areas

32. Because the agencies use different methods
to compile the data, the information presented here
supports only general conclusions. The 2007 reporting period was July 1, 2006, through June 30,
2007.

Consumer and Community Affairs
pared with 87 percent for the 2006 reporting period. The most frequently
cited violations involved
• the failure to properly collect information for monitoring purposes, including the race, ethnicity, sex, marital
status, and age of applicants seeking
credit primarily for the purchase or
refinancing of a principal residence
• the improper collection of information on an applicant's race, color, religion, national origin, or sex when not
permitted by regulation
• the improper requirement of the signature of an applicant's spouse or
other person, other than a joint applicant, when the applicant qualified under the creditor's standards of creditworthiness for the amount and terms
of the credit requested
• the failure to provide a written notice
of denial or other adverse action to a
credit applicant that contains the specific reason for the adverse action,
along with other required information
During this reporting period, the OTS
issued two supervisory agreements and
one cease-and-desist order to a savings
association for alleged violations of the
Equal Credit Opportunity Act (ECOA)
and Regulation B, as well as other consumer regulations. The other FFIEC
agencies did not issue any formal enforcement actions specific to Regulation
B during the reporting period.
The other agencies that enforce the
ECOA—the Farm Credit Administration
(FCA), the Department of Transportation, the Securities and Exchange Commission (SEC), the Small Business Administration, and the Grain Inspection,
Packers and Stockyards Administration
of the Department of Agriculture—
reported substantial compliance among

135

the entities they supervise. The FCA's
examination activities revealed Regulation B violations involving the improper
collection of government monitoring
information.
Regulation E
(Electronic Fund Transfers)
The FFIEC agencies reported that approximately 94 percent of the institutions examined during the 2007 reporting period were in compliance with
Regulation E, compared with 95 percent
in the 2006 reporting period. The most
frequently cited violations involved the
failure to take one or more of the following actions:
• determine whether an error occurred,
within ten business days of receiving
a notice of error from a consumer
• give the consumer provisional credit
for the amount of an alleged error
when an investigation into the alleged
error cannot be completed within ten
business days
• provide initial disclosures that contain
required information, including limitations on the types of transfers permitted and error-resolution procedures, at the time a consumer
contracts for an electronic fund transfer service
• when a determination is made that no
error has occurred, provide a written
explanation and note the consumer's
right to request documentation supporting the institution's findings
The FFIEC agencies did not issue any
formal enforcement actions relating to
Regulation E during the period.
The Federal Trade Commission
(FTC) settled charges against one corporation that falsely marketed products and

136 94th Annual Report, 2007
debited consumer accounts without obtaining consumers' authorization for
preauthorized electronic fund transfers,
in violation of Regulation E. The FTC
also continued litigation against a group
of defendants for allegedly enrolling
consumers in a program and automatically billing them for charges without
obtaining authorization for the recurring
debits.
Regulation M (Consumer Leasing)
The FFIEC agencies reported that more
than 99 percent of the institutions examined during the 2007 reporting period
were in compliance with Regulation M,
which equals the level of compliance for
the 2006 reporting period. The FFIEC
agencies did not issue any formal enforcement actions relating to Regulation
M during the period.
Regulation P (Privacy of Consumer
Financial Information)
The FFIEC agencies reported that
97 percent of the institutions examined
during the 2007 reporting period were in
compliance with Regulation P, compared with 98 percent for the 2006 reporting period. The most frequently
cited violations involved the failure to
take one or more of the following
actions:
• provide a clear and conspicuous annual privacy notice to customers
• disclose the institution's informationsharing practices in initial, annual,
and revised privacy notices
• provide customers with a clear and
conspicuous initial privacy notice that
accurately reflects the institution's
privacy policies and practices, not
later than when the customer relationship is established

The FFIEC agencies did not issue any
formal enforcement actions relating to
Regulation P during the reporting
period.
Regulation Z (Truth in Lending)
The FFIEC agencies reported that
82 percent of the institutions examined
during the 2007 reporting period were in
compliance with Regulation Z, compared with 85 percent for the 2006 reporting period. The most frequently
cited violations involved the failure to
take one or more of the following
actions:
• accurately disclose the finance charge
in closed-end credit transactions
• accurately disclose the amount
financed, by subtracting any prepaid
finance charge from the amount
financed
• accurately disclose the payment
schedule, including the number,
amounts, and timing of payments
scheduled to repay the obligation
• ensure that disclosures reflect the
terms of the legal obligation between
the parties
In addition, 185 banks supervised by the
Federal Reserve, FDIC, OCC, and OTS
were required, under the Interagency
Enforcement Policy on Regulation Z, to
reimburse a total of approximately
$2.75 million to consumers for understating the annual percentage rate or the
finance charge in their consumer loan
disclosures.
The OTS issued two supervisory
agreements and two cease-and-desist orders for violations of a number of consumer regulations, including Regulation
Z, during the reporting period. The other
FFIEC agencies did not issue any formal enforcement actions specific to

Consumer and Community Affairs
Regulation Z during the reporting
period.
The Department of Transportation
continued to prosecute one air carrier
for its improper handling of credit card
refund requests and other Federal Aviation Act violations.
The FCA identified creditors that
were using incorrect templates, resulting
in violations of Regulation Z. While all
required disclosures were made, the format of the disclosures was not consistent with regulatory requirements.
The FTC continued litigation in federal district court against a mortgage
broker for alleged violations of Regulation Z; the alleged violations involved
the broker's advertisements and financecharge disclosures.

137

that are not subject to next-day
availability
• follow procedures when invoking the
exception for large-dollar deposits
• provide required information when
placing an exception hold on an
account
• make funds from local and certain
other checks available for withdrawal
within the times prescribed by
regulation
The OTS issued one supervisory agreement for violations of a number of consumer regulations, which included
Regulation CC. The other FFIEC agencies did not issue any formal enforcement actions specific to Regulation CC
during the reporting period.

Regulation AA (Unfair or Deceptive
Acts or Practices)

Regulation DD (Truth in Savings)

The FFIEC agencies reported that more
than 99 percent of the institutions examined during the 2007 reporting period
were in compliance with Regulation
AA, which equals the level of compliance for the 2006 reporting period. No
formal enforcement actions relating to
Regulation AA were issued during the
reporting period.

The FFIEC agencies reported that
88 percent of institutions examined during the 2007 reporting period were in
compliance with Regulation DD,
compared with 91 percent for the 2006
reporting period. The most frequently
cited violations involved the failure to
take one or more of the following
actions:

Regulation CC (Availability of Funds
and Collection of Checks)
The FFIEC agencies reported that
90 percent of institutions examined during the 2007 reporting period were in
compliance with Regulation CC, compared with 92 percent for the 2006 reporting period. The most frequently
cited violations involved the failure to
take one or more of the following
actions:
• make available on the next business
day the lesser of $100 or the aggregate amount of checks deposited

• provide a statement that fees could
reduce the earnings on an account,
when the term "annual percentage
yield" is used in an advertisement
• use the term "annual percentage
yield" if an advertisement states a rate
of return
• provide initial account disclosures
containing all required information
• provide adequate subsequent account
disclosures for time accounts that
have maturities greater than one year
The OTS issued one supervisory agreement and one cease-and-desist order for

138 94th Annual Report, 2007
violations of a number of consumer
regulations, including Regulation DD.
The other FFIEC agencies did not issue
any formal enforcement actions specific
to Regulation DD during the reporting
period.

Consumer Complaints
The Federal Reserve investigates complaints against state member banks and
forwards those that involve other creditors and businesses to the appropriate
enforcement agency. Each Reserve
Bank investigates complaints against
state member banks in its District. In
2007, the Federal Reserve received
1,540 consumer complaints concerning
regulated practices by state member banks.
In November, the Federal Reserve
System launched Federal Reserve Consumer Help (FRCH), an initiative that
consolidates and streamlines the Federal
Reserve's process for handling consumer complaints and inquiries. FRCH
improves consumers' access to the Federal Reserve by providing a convenient,
one-stop website and a toll-free number
where consumers can get assistance with
their banking problems or questions.
(See related box "The Federal Reserve
Consumer Help Center.")
Under the direction of the Federal Financial Institutions Examination Council (FFIEC), an interagency working
group was formed in late 2007 to explore ways to improve consumers' experiences with contacting a banking
agency and with submitting a complaint
or inquiry to the appropriate regulator. A
third-party contractor may be used to
examine best practices and recommend
improvements to the process consumers
use to file a complaint or inquiry with
one of the FFIEC agencies.33
33. FFIEC agencies represented on the working
group are the Federal Reserve Board, the Office of

Complaints Against State Member
Banks
The majority (61 percent) of complaints
about regulated practices involved credit
cards. The most common credit card
problem fell into the complaint category
called "other rates/terms/fees" (35 percent), followed by problems with
billing-error resolution (19 percent) and
banks' providing inaccurate account information (8 percent).34
Complaints about checking accounts
were the next largest category (19 percent) of complaints about regulated
practices. The most common checking
account concerns were insufficientfunds or overdraft charges and procedures (30 percent), funds availability
(14 percent), and disputed withdrawals
of funds by banks (13 percent).
Real estate-related complaints made
up 5 percent of complaints involving
regulated practices.35 Of those, only
4 percent (or three complaints) concerned adjustable-rate mortgages. The
most common real estate-related loan
problems concerned escrow accounts
(15 percent); other rates, terms, or fees
(11 percent); and errors or delays in
crediting loan payments (10 percent). Of
all complaints involving regulated practices, 13 (0.8 percent) alleged discrimination on a basis prohibited by law
(race, color, religion, national origin,
the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift
Supervision, and the National Credit Union Administration. Representatives from the Conference
of State Bank Supervisors are also participating.
34. Includes complaints about interest rates,
terms, or fees other than late fees, overlimit fees,
prepayment fees, fees related to credit insurance,
or the calculation of the finance charge.
35. Includes adjustable-rate mortgages; residential construction loans, open-end home equity
lines of credit, home improvement loans, home
purchase loans, home refinance or closed-end
loans; and reverse mortgages.

Consumer and Community Affairs

139

Consumer Complaints against State
Member Banks That Involve Regulated
Practices, by Classification, 2007

sex, marital status, handicap, 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).
Complaint investigations determined
that banks had handled customers' accounts in accordance with Federal Reserve regulations in the majority (96 percent) of the complaints reviewed.
Investigations for the remaining 4 percent determined that the bank had violated a consumer protection regulation.
The most common violations involved
credit cards and checking accounts. (See
tables.)

Number

Classification
Regulation A A (Unfair or Deceptive
Acts or Practices)
Regulation B (Equal Credit Opportunity)
Regulation C (Home Mortgage Disclosure)...
Regulation E (Electronic Fund Transfers)
Regulation H (Bank Sales of Insurance)
Regulation M (Consumer Leasing)
Regulation P (Privacy of Consumer
Financial Information)
Regulation Q (Payment of Interest)
Regulation Z (Truth in Lending)
Regulation BB (Community Reinvestment)...
Regulation CC (Expedited Funds
Availability)
Regulation DD (Truth in Savings)
Regulations T, U, and X
Regulation V (Fair and Accurate
Credit Transactions)
Fair Credit Reporting Act
Fair Debt Collection Practices Act
Fair Housing Act
Flood Insurance
Homeownership Counseling
HOPA (Homeowners Protection Act)
Real Estate Settlement Procedures Act
Right to Financial Privacy Act

Unregulated Practices
As required by section 18(f) of the Federal Trade Commission Act, the Board
continued to monitor complaints about
banking practices that are not subject to
existing regulations and to focus on
those that concern possible unfair or deceptive practices. In 2007, the Board received more than 2,000 complaints
against state member banks that involved unregulated practices. The product categories that contained the most
complaints were credit cards and checking accounts. In those categories, con-

85
62
1
98
2
3
35
3
761
6
123
124
0
13
138
64
1
2
1
15
2
1,540

Total

sumers most frequently complained
about fraud, forgery, or theft (216 complaints); problems with opening or closing an account (196 complaints); issues
involving insufficient-funds or overdraft
charges and procedures (190 complaints); and certain credit card interest
rates, terms, and fees (129 complaints).

Complaints against State Member Banks That Involve Regulated Practices, 2007
All complaints

Complaints involving violations

Subject of complaint
Number

Discrimination alleged
Real estate loans
Credit cards
Other loans . ..

Nondiscrimination complaints, total1
Credit cards
Checking accounts
Real estate loans

Number

1,540

Total

Percent
100

0
0
0

39
13
0

13
1
8
4
1,527'
939
295
80

.1
.5
.3
61
19
5

1. Only the top three product categories of nondiscrimination complaints are listed here.

Percent

.8
0

140

94th Annual Report, 2007

The Federal Reserve Consumer Help Center:
A New Resource for Expert, Immediate Help
Credit cards, mortgages, and electronic
funds transfers are just a few of the
services and products consumers use to
conduct their financial business. The use
of these products and services has become
widespread, and it can be easy to lose sight
of their complexity—until a consumer has
a question or something goes wrong.
Consumers often need help navigating the
maze of terminology, regulations, and policies that governs financial products,
services, and institutions. For more than 30
years, the Federal Reserve System has
provided professional help to consumers
who have complaints against a financial
institution. In 2007, the Federal Reserve
launched the Federal Reserve Consumer
Help (FRCH) center, a centralized
consumer complaint center that improves
consumers' access to information and
services. The FRCH website (www.
federalreserveconsumerhelp.gov) provides
comprehensive information on consumer
financial issues, as well as contact information. Consumers can use the site to
research their issue, or they may contact
the Federal Reserve to ask a question or
file a complaint via e-mail, a toll-free
number, fax, or mail.

Complaint Referrals to HUD
In 2007, the Federal Reserve received
one housing-related discrimination complaint and forwarded it to HUD in accordance with a memorandum of understanding between HUD and the federal
bank regulatory agencies regarding
complaints alleging a violation of the
Fair Housing Act. The Federal Reserve's investigation of this complaint
revealed no evidence of illegal credit
discrimination.

Consumer complaints are an important
source of information for the Federal
Reserve Board. Regardless of their
outcome, complaints often identify areas
of concern that the Board considers when
writing regulations or guidance for bank
examiners. Complaints can also reveal
emerging consumer-protection issues and
trends in banking practices. The Federal
Reserve established its program for receiving consumer complaints and inquiries in
1976. Drawing on the resources of the
Federal Reserve System*s twelve Reserve
Bank Districts, the program answers
consumers' questions, investigates complaints against state member banks
(those institutions under the Federal
Reserve's supervisory authority), or refers
consumers to the appropriate agency for a
response. In addition, the Board responds
to issues raised by congressional representatives on behalf of their constituents. Over the last decade, the
consumer financial services marketplace
has dramatically changed. Technological
developments and increased access to
technology have also changed both the
way institutions operate and how consumers want to communicate with financial

Responding to Community
Economic Development Needs in
Historically Underserved
Markets
The mission of the community affairs
function within the Federal Reserve System is to promote community economic
development and fair access to credit for
low- and moderate-income communities
and populations. As a decentralized
function, the Community Affairs Offices
(CAOs) at each of the twelve Reserve

Consumer and Community Affairs

institutions and others. In 2007, the Federal
Reserve responded to these forces by
launching FRCH, while continuing to tap
staff expertise and knowledge of regional
banking markets.
The Federal Reserve is committed to
providing superior service to consumers.
The call center is staffed by highly trained
professionals; 80 percent of incoming calls
or e-mail inquiries are answered by a
representative within 60 seconds or less.
Complaints against banking institutions
supervised by the Federal Reserve continue
to be investigated by the Reserve Bank
responsible for examining the institution in
question. This approach ensures that
complaints are investigated by examiners
who are knowledgeable about an institution and its regional banking market—and
who can leverage the bank-supervisor
relationship to resolve an issue. If a
consumer has a complaint against an
institution not supervised by the Federal
Reserve, FRCH can seamlessly connect
him or her with the appropriate agency.
FRCH tracks ail incoming questions and
requests for assistance, by issue and
volume. Data will be shared with the other
federal banking regulatory agencies. The
Federal Reserve and other agencies

Banks design activities in response to
the needs of communities in the Districts they serve, with oversight from
Board staff. The CAOs focus on providing information and promoting awareness of investment opportunities to
financial institutions, government agencies, and organizations that serve lowand moderate-income communities and
populations. Similarly, the Board's CAO
promotes and coordinates Systemwide

141

analyze the data so that they can identify
shared issues, develop best practices for
customer service and complaint investigation, and develop consumer education
materials. Such collaboration is critical to
addressing consumer protection issues in
the broader financial services marketplace
and developing consumer information
materials to educate consumers about
trends in banking products and their rights.
In addition, FRCH is establishing a
mechanism for tracking customer satisfaction, that is, whether consumers feel the
center helped them with their financial
services issues.
Early reviews of available data on
FRCH call volume and website visits
indicate that consumers are contacting the
the Federal Reserve in record numbers.
The Federal Reserve is dedicated to
providing superior access to consumers
who need assistance and will continue to
monitor the performance of FRCH, with
the goal of identifying further opportunities to help consumers exercise their rights
and work through their financial services
challenges. The Federal Reserve plans to
launch a Spanish-language version of the
website in the first quarter of 2008.

high-priority efforts; in particular, Board
community affairs staff focus on issues
that have public policy implications. 36
In 2007, disruptions in the housing
market made collaboration among the
financial
services community, the
Board, and the Reserve Banks impera-

36. See www.federalreserve.gov/communitydev/
default.htm.

142 94th Annual Report, 2007
tive. The CAOs worked diligently to
identify solutions that would help mitigate the adverse consequences of the increasing numbers of mortgage defaults
and foreclosures in many Districts. (See
"Mortgage Credit.") System staff also
continued work on a number of important topics: improving the sustainability
and financial capacity of community development organizations, creating assetbuilding opportunities for low- and
moderate-income populations, and developing programs to promote community development and consumer education. Activities included conducting
research, sponsoring conferences and
seminars, publishing newsletters and articles, and supporting the dissemination
of information to both general and targeted audiences.

System Collaborative Efforts
The Reserve Banks and the Board continued their work on two substantial collaborative efforts over the past year. The
first effort, an initiative undertaken by
System Community Affairs staff and the
Brookings Institution, analyzes and
compares communities that have high
concentrations of poverty. Using sixteen
case studies from selected communities,
the project employs both quantitative
and qualitative analyses to explore the
dynamics of the communities, their residents, their economies, and programs
that are helping or hindering a community's integration into the economic
mainstream. The data generated by this
ongoing initiative help Reserve Banks,
local financial institutions, business
leaders, service providers, and philanthropic organizations better understand
their regional economies and the capital
and credit needs of the communities
they serve.
The second major collaborative effort
in 2007 was the Community Affairs

System Research Conference, "Financing Community Development: Learning
from the Past, Looking to the Future,"
cosponsored by the Board and the Federal Reserve Bank of Philadelphia. The
conference brought together a diverse
audience from academia, financial institutions, community organizations, foundations, and the government. Approximately 400 participants learned about
and discussed original studies on the opportunities and obstacles to helping lowand moderate-income communities and
people build wealth by using home
loans, small business loans, or other financial services. System community affairs staff were actively involved in the
planning and execution of the conference: staff reviewed papers, developed
the agenda, presented research, and
served as moderators and participants in
formal discussion groups. The Board's
Community Affairs officer delivered a
keynote address during the conference,
and Chairman Ben Bernanke provided
remarks on the history, evolution, and
new challenges of the Community Reinvestment Act.37
Identifying Strategies to Enhance
Access to Community
Development Financing and
Asset-Building
In 2007, Community Affairs staff from
around the System continued working
on several initiatives to not only enhance access to affordable credit in currently underserved markets but also to
provide information and promote awareness of investment opportunities to financial institutions, government agencies, and organizations. The St. Louis
Reserve Bank hosted "Exploring Innovation: A Conference on Community
37. See www.federalreserve.gov/newsevents/
speech/bernanke20070330a.htm.

Consumer and Community Affairs
Development Finance" to explore how
organizational creativity, learning, and
innovation can improve community
development projects, increase their
access to capital, and help projects
achieve scale and sustainability. The
San Francisco Reserve Bank's Center
for Community Investments hosted two
conferences focused on community
development investment. One conference, which was cosponsored with the
Board, focused on the availability of rural venture capital; the other, cosponsored with the New York Reserve Bank,
discussed issues related to the creation
of a secondary market for community
development loans. Other Reserve
Banks hosted symposiums on this topic
as well, such as the Federal Reserve
Bank of Richmond's Community Development Financial Institution (CDFI)
workshops that gathered community development lenders, local bankers, and
representatives from the CDFI Fund to
discuss capitalizing and certifying potential CDFIs. The Federal Reserve
Bank of Boston and the Aspen Institute,
a national research and leadership development organization, cohosted a conference on socially responsible investment
and the role of subsidy dollars in public
investment. In a related initiative, the
Boston Reserve Bank collaborated with
the Massachusetts Small Business Assistance Advisory Council on the launch
of a loan program for small businesses.
Asset-building and financial education remained major areas of focus for
the Community Affairs Offices in 2007.
System staff continued to collaborate
with constituent organizations on efforts
to provide advisory services and conduct outreach to low- and moderateincome communities. The Federal Reserve Bank of Atlanta worked with the
Federal Deposit Insurance Corporation
to create MoneySmart curriculum modules on low-income investment. The

143

Kansas City Reserve Bank cosponsored
a major conference on entrepreneurship
with the Association for Enterprise Opportunity. Together with the San Francisco and Minneapolis Reserve Banks,
the Kansas City Reserve Bank also continued work on several Indian country
initiatives focused on improving the financial literacy and housing options of
Native Americans. The three Banks continued to promote the adoption of uniform commercial codes to facilitate
tribes' efforts to borrow from offreservation partners or other tribes. The
Federal Reserve Bank of Dallas engaged
in efforts to promote financial education
in the workplace, including sponsorship
of a highly successful seminar for human resource professionals attended by
approximately 80 employers, who in
turn represented 380,000 employees.
The Richmond Reserve Bank released
two issues of its journal MarketWise,
one which featured an article on the
earned-income tax credit (EITC). The
New York Reserve Bank cosponsored a
conference with the New York City Office of Financial Empowerment that promoted the EITC. As a result of the conference, a statewide coalition of EITC
practitioners was created, and several
statewide asset-building strategies for
low- and moderate-income communities
were adopted.

Advice from the
Consumer Advisory Council
The Board's Consumer Advisory
Council—whose members represent
consumer and community organizations,
the financial services industry, academic
institutions, and state agencies—advises
the Board of Governors on matters concerning laws and regulations that the
Board administers and on other issues
related to consumer financial services.
Council meetings are held three times a

144 94th Annual Report, 2007
year, in March, June, and October, and
are open to the public. (For a list of
members of the council, see the section
"Federal Reserve System Organization.") Among other issues, council discussions in 2007 focused on two significant topics:
• various issues related to mortgage
lending, specifically the Board's rulemaking authority under the Home
Ownership and Equity Protection Act
(HOEPA) to address concerns about
abusive lending practices in the home
mortgage market, and concerns about
foreclosures and the subprime lending
market
• proposed amendments to Regulation
Z that would revise the disclosure requirements for credit card accounts
and other open-end (revolving) credit
plans that are not secured by a borrower's home
Mortgage Lending Issues
HOEPA
In its June and October meetings, the
council addressed several issues related
to the Board's rulemaking authority under HOEPA: whether the Board should
issue rules or guidance, the possibility
of prohibiting or restricting certain loan
terms or practices in subprime loans, the
definition of "subprime," and the role
and timing of the disclosures provided
to consumers during the loan-making
process.
Several consumer representatives
strongly supported issuing rules under
HOEPA rather than guidance. Consumer
representatives expressed the view that
guidance puts supervised institutions at
a competitive disadvantage to other
mortgage lenders that do not have to
comply with guidance. Rules, however,
would apply to all mortgage lenders, not

just federally supervised institutions.
Consumer representatives noted that
rules would also provide consumers
with a private right of action. Several
members stated that rulemaking may be
appropriate for areas in which the Board
can establish clear, bright lines for regulatory supervision but that guidance is
the best way to ensure that institutions
have appropriate flexibility to meet consumers' needs.
In considering whether proposed rules
on mortgage lending should apply to the
subprime mortgage market, council
members generally urged the Board to
define "subprime" not by borrower characteristics but according to the type of
loan or its terms, such as a loan's annual
percentage rate. An industry member
endorsed the definition of "subprime"
that the Board used in earlier guidance
and cautioned against using Home Mortgage Disclosure Act (HMDA) standards
as a pricing criterion for subprime loans,
because the HMDA standards may not
capture all subprime loans.
Several members urged the Board to
ban prepayment penalties, particularly
for subprime loans. They expressed concerns that, for subprime borrowers, prepayment penalties are not balanced by
lower interest rates and often prevent
borrowers from graduating into prime
loans. Other members acknowledged
problems with using prepayment penalties in the subprime market but said the
penalties can be a useful tool and yield
lower interest rates for consumers.
These members urged the Board to
regulate prepayment penalties to ensure
that borrowers receive a choice about
whether to have a prepayment penalty,
which may result in a lower interest rate
for them. A consumer representative
suggested that prepayment penalties for
adjustable-rate mortgages should expire
60 days before the first interest-rate reset on such a loan.

Consumer and Community Affairs
Council members generally agreed
that it is a sound underwriting practice
to require borrowers to make monthly
payments to escrow accounts for taxes
and insurance, as loans that include escrow payments generally perform better.
There was also consensus on the importance of clearly disclosing whether an
advertised payment amount includes a
borrower's taxes and insurance. Recognizing the financial vulnerability of
subprime borrowers, members generally
agreed that the Board should mandate
that escrow accounts be established for
subprime loans. Some members suggested that escrow accounts should not
be required for borrowers who take out
prime loans. Members had a variety of
views about initially mandated escrow
accounts that borrowers could later opt
out of. Both consumer and industry representatives generally agreed that any
opt-out decision should not be made at
loan closing and that clear disclosure of
any escrow requirement and opt-out provision is paramount.
Several council members commented
on the need for stated-income loans, especially in immigrant communities and
for borrowers who engage in cash transactions or are otherwise not connected
with mainstream financial institutions.
The members emphasized the importance of sound, responsible underwriting for stated-income loans and urged
that lenders be given flexibility to use
nontraditional, third-party forms of income documentation. Some members
highlighted the importance of providing
borrowers with clear disclosures for
stated-income loans to ensure that these
borrowers are aware they may not be
receiving the lowest rate for which they
qualify.
Council members generally agreed
that the Board should require lenders to
ensure borrowers' ability to repay a loan
for a reasonable term by underwriting

145

the loan to the fully indexed rate. Some
members commented that such a standard would also benefit investors by giving them greater assurance about the
quality of the loans they are purchasing.
Members disagreed about the length of
time for which ability to repay should be
considered. Some industry representatives cautioned that setting too strict a
standard could inappropriately restrict
access to credit.
Members agreed on the importance of
providing consumers with simplified,
plain-language disclosures for mortgage
products. Several members identified
key terms that should be clearly and
concisely disclosed. Some members expressed concern, however, that simplified disclosures may not sufficiently inform borrowers about the more complex
or exotic mortgage products being offered; they suggested such products may
require a different type of disclosure.
Some members supported a requirement
that Truth in Lending Act (TILA) disclosures be provided earlier in the loanmaking process for nonpurchase mortgage loans. They also emphasized that
TILA disclosures should accurately reflect the terms of the transaction.
In a discussion of yield-spread premiums (YSPs), several members stated
that many consumers do not know about
YSPs or understand how they work.
Members agreed on the importance of
providing borrowers with transparent
YSP disclosures. Several consumer representatives expressed concern about
abusive practices related to YSPs; for
example, a consumer may receive a
higher interest rate because his or her
mortgage broker has an agreement to
receive a YSP from a certain lender, or
some lenders may combine YSPs and
discount points, resulting in higher fees
for borrowers. An industry member expressed the view that banning YSPs
would hurt small broker businesses by

146 94th Annual Report, 2007
eliminating a key source of their compensation and would put small loan
originators at a competitive disadvantage to large lenders, thereby leaving
consumers with fewer choices in the
marketplace.

adjustable-rate mortgage loans and (2)
these products may pose an elevated risk
to financial institutions. Most members
supported the guidance. Several members voiced approval for the provision
recommending that lenders underwrite a
loan at its fully indexed rate. They were
also supportive of the recommendation
Foreclosures and
that a loan's underwriting include an esSubprime Lending Issues
crow component for taxes and insurAt its March meeting, the council dis- ance. Some members supported extendcussed the recent increase in home fore- ing the principles of the guidance to
closures in a number of markets across prime mortgage lending, but others
the country. Several members described noted possible difficulties to segmenting
the impact of defaults and foreclosures the mortgage market in this way. Sevon their communities: large concentra- eral members shared concerns that aptions of abandoned and vacant proper- plying the guidance to prime loans
ties and the associated need to enhance might reduce the variety of loan prodpolicing efforts and other city services, a ucts available to consumers. Members
rise in homelessness, decreasing prop- representing the financial services inerty values, and declining tax revenues dustry questioned whether the guidance
for local governments. Some members might lead to the creation of a loannoted a disproportionate concentration suitability standard, that is, a requireof foreclosures in communities that are ment that lenders gauge the suitability
predominately Latino or African Ameri- of a loan product for certain borrowers.
can; members also shared concerns Industry members generally thought
about foreclosure "rescue" scams and such a standard could limit the array of
the "flipping" of previously foreclosed loan products available to consumers.
homes, and they stressed the importance Several members emphasized the need
of having community-based organiza- for a new Federal Housing Administrations coordinate and manage rescue tion loan product that could meet the
funds for homeowners facing foreclo- needs of subprime borrowers.
sure. Members discussed possible ways
to assist households facing default or
foreclosure. Several consumer represen- Credit Cards
tatives described the difficulty credit
counselors face when they try to contact In May, the Board issued proposed
servicers on behalf of borrowers. Mem- amendments to Regulation Z, which
bers also noted the challenges associ- implements the Truth in Lending Act,
ated with restructuring mortgages that that would affect the content, format,
have been securitized.
and timing of credit card disclosures.
Members commented on the proposed The council's discussions in June and
statement on subprime mortgage lend- October focused on several dimensions
ing issued by the federal financial regu- of the proposal: the summary table, or
latory agencies in March. The proposal "Schumer box," for application and soaddressed concerns that (1) subprime licitation disclosures; account-opening
borrowers may not fully understand the disclosures; periodic statements; and
risks and consequences of products like change-in-terms notices.

Consumer and Community Affairs
Several members commended the
Board for proposed revisions to the
Schumer box. By highlighting key information on credit card terms, the revisions would facilitate consumers' ability
to compare different credit cards, members said. Several consumer representatives urged the Board to include a "typical APR" in the Schumer box. This APR
would include the fees that consumers
typically pay during a billing cycle and
could alert them to the potential costs of
using the credit card. A typical APR
would also allow consumers to compare
the fees different cards charge. Several
industry members objected to the idea
of a typical APR, however, expressing
concerns that such a rate would be misleading and unhelpful, as many fees are
not necessarily incurred by every consumer. Industry representatives supported the disclosure of fees in dollar
amounts rather than as a percentage of
the balance, noting that the Board's consumer testing found that consumers
more readily understand dollar amounts
than percentages. Several consumer representatives commended the Board for
proposing a disclosure to inform consumers about the amount of available
credit if the account-opening fees are
25 percent or more of the credit limit, as
is sometimes the case with subprime
credit cards.
For account-opening disclosures,
members generally supported the
Board's proposal to require a summary
table similar to the Schumer box. They
noted that a summary would make it
easy for consumers to compare the actual account terms with those they were
originally offered. Some industry and
consumer representatives disagreed
about the proposal to allow the verbal
disclosure of some fees at the time a
consumer incurs a charge, instead of relying on account-opening disclosures to
disclose all fees.

147

Members generally approved of the
new format for periodic statements, particularly the clear grouping of fees and
the year-to-date totals for interest
charges and fees. They noted the importance of highlighting the late-payment
notice by requiring its placement on the
front of the statement and emphasized
the importance of clearly disclosing day
and time deadlines for payments (that is,
the cutoff before late-payment charges
apply). Several consumer representatives stated that the effective APR disclosure should be retained because it
more accurately accounts for the total
cost of credit. Industry representatives,
however, expressed their preference for
eliminating the effective APR disclosure
on the basis that, even with the change
in labeling, the figure is confusing to
consumers. The industry members stated
that the proposed year-to-date totals for
interest and fees represent the most
meaningful disclosure to consumers of
the total cost. Several members commended the Board on its use of consumer testing to develop the credit card
disclosures and urged the Board to continue using both qualitative and quantitative testing as it determines how best
to communicate complicated financial
terms to consumers.
For change-in-terms notices, several
consumer representatives expressed
support for requiring 45 days' advance
notice for rate increases triggered by a
consumer's default or delinquency.
They emphasized that advance notice
will give consumers the opportunity to
pursue other credit options. Industry
representatives disagreed with providing a 45-day advance notice of increased rates when the increase is
prompted by consumer default. They
noted that default pricing is properly
disclosed to consumers at account opening and that the triggering of a default
rate by a consumer's action does not

148 94th Annual Report, 2007
constitute a change in terms. Industry
representatives expressed support for
45 days' advance notice of charges or
changes in terms that have not been
previously disclosed. Several industry
representatives opposed having an optout when a rate increase is prompted by
default or delinquency, but they supported a consumer's right to opt out in
other cases.
The council also discussed credit card
issuers' practice of offering a 0 percent
APR for consumers' balance transfers
from other credit cards and a higher
APR for purchases. Typically, issuers
then typically allocate consumers' payments to balances that have the lowest
APR—allowing high-APR balances to
remain high. Several consumer representatives urged the Board to prohibit
policies that apply all payments to the
lowest-rate balance first, noting that
many consumers do not understand how
such low-APR products work. Several
industry representatives expressed the
view that such payment-allocation methods are appropriate business practices
and that consumers benefit from lowAPR cards because they receive an
interest-free loan for a certain period
of time. Industry representatives did
acknowledge the need for better
disclosures.
There was consensus among council
members on what they consider to be
best practices for due dates on credit
card payments: if creditors do not receive mail or post payments on weekends or holidays, then payments that arrive on those days should be posted on
the next business day and should be
credited as on time if the due date fell
on that weekend or holiday. Similarly, a
payment that has a weekend or holiday
due date should be credited as on time if
it is received on the next business day.

Other Issues
At their March meeting, council members discussed additional topics, including model privacy notices, proposed
amendments to Regulation E, and several aspects of Regulation CC.
To comply with their disclosure obligations on the sharing of consumer information under the Gramm-LeachBliley Act, financial institutions may
use the model privacy form developed
jointly by the federal financial regulatory agencies and the Federal Trade
Commission. Members generally commended the agencies for the proposed
form, noting that the prototype was a
marked improvement over current privacy notices because it is clearer and
easier to navigate—and thus makes it
easier for consumers to compare different privacy policies. Some industry representatives expressed concerns that the
form did not sufficiently address additional notice and opt-out requirements
that may exist under state laws; they
urged the agencies to preempt state privacy law requirements. Institutions may
not use the form if they lack confidence
that doing so would satisfy their obligations under state laws, industry representatives said.
The council provided feedback on
proposed amendments to Regulation E,
which implements the Electronic Fund
Transfer Act, that would eliminate the
receipt requirement at point-of-sale and
other electronic terminals for debit card
transactions of $15 or less. Members acknowledged that consumers increasingly
use credit and debit cards for smalldollar transactions but disagreed about
whether receiving a receipt helps consumers manage their finances. Industry
members generally expressed the view
that consumers receive minimal benefit

Consumer and Community' Affairs
from receipts for small-dollar transactions. They noted that consumers would
continue to receive information about
each of their transactions on periodic
statements. Several consumer representatives opposed the Board's proposal,
stating that receipts are an important tool
to help consumers accurately track their
transactions, obtain reimbursements,
and provide documentation in a dispute.
Several industry representatives expressed concern that the costs associated
with providing terminal receipts for
debit card transactions are burdensome
and impede industry efforts to create
cashless payment options in certain retail settings. Consumer representatives
generally regarded the proposed $15
threshold as too high. Industry representatives, however, suggested that the
threshold should be increased to $25,
consistent with current credit card rules
that waive requirements for authorization by signature or personal identification number for transactions less than
this amount.
Members discussed several aspects of
Regulation CC, which governs the availability of funds deposited in checking

149

accounts and the collection and return of
checks. They focused particularly on
scams involving fraudulent checks and
on the exception-hold practices that financial institutions can use to protect
themselves and their customers from
these scams. Members expressed concern that the brief hold periods permitted under Regulation CC for certain
checks may impede financial institutions' ability to conduct appropriate due
diligence. Several industry representatives emphasized the importance of cooperation
and
information-sharing
among financial institutions when an institution has concerns that a check may
be fraudulent. Some members suggested
that enhanced enforcement to require a
paying institution to return a check item
promptly could be helpful in this process. Others recommended that the federal financial regulatory agencies standardize and coordinate fraudulent-check
alerts rather than issue separate alerts.
Members highlighted the importance of
education to increase awareness of
fraudulent-check issues among both
financial institution employees and
consumers.
•

151

Federal Reserve Banks
In addition to contributing to setting national monetary policy and supervising
and regulating banks and other financial
entities (discussed in preceding chapters), the Federal Reserve Banks provide
payment services to depository and certain other institutions, distribute the nation's currency and coin, and serve as
fiscal agents and depositories for the
United States.

Developments in
Federal Reserve Priced Services
The Federal Reserve Banks provide a
range of payment and related services to
depository institutions, including collecting checks, operating an automated
clearinghouse service, transferring funds
and securities, and providing a multilateral settlement service. The Reserve
Banks charge fees for providing these
"priced services."
The Monetary Control Act of 1980
requires that the Federal Reserve establish fees for priced services provided to
depository institutions so as to recover,
over the long run, all direct and indirect
costs actually incurred as well as the
imputed costs that would have been incurred, including financing costs, taxes,
and certain other expenses, and the return on equity (profit) that would have
been earned if a private business firm
had provided the services.1 The imputed
costs and imputed profit are collectively
referred to as the private-sector adjust1. Financial data reported throughout this
chapter—revenue, other income, cost, income before taxes, and net income—can be linked to the
pro forma financial statements at the end of this
chapter.

ment factor (PSAF).2 Over the past ten
years, the Reserve Banks have recovered 99.1 percent of their priced services
costs, including the PSAF (table).3
In 2007, the Reserve Banks recovered
101.9 percent of total costs of
$993.7 million, including the PSAF.4
Revenue from priced services amounted
to $878.4 million, other income was
$133.8 million, and costs were
$913.3 million, resulting in net income
from priced services of $98.9 million.

2. 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 (FDIC). Board of Governors assets and costs that are related to priced
services are allocated to priced services; in the pro
forma financial statements at the end of this chapter, Board assets are part of long-term assets, and
Board expenses are included in operating expenses.
3. Effective December 31, 2006, the Reserve
Banks implemented the Financial Accounting
Standards Board's Statement of Financial Accounting Standards (SFAS) No. 158, Employers1
Accounting for Defined Benefit Pension and Other
Postretirement Plans, which has resulted in the
recognition of a $237.9 million reduction in equity
related to the priced services' benefit plans
through 2007. Including this reduction in equity,
which represents a decline in economic value, results in cost recovery of 96.7 percent for the tenyear period. For details on how implementing
SFAS No. 158 affected the pro forma financial
statements, refer to notes 2, 3, and 5 at the end of
this chapter.
4. 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 FDIC assessment), imputed income
taxes, and the targeted return on equity.

152 94th Annual Report 2007
Priced Services Cost Recovery, 1998-2007
Millions of dollars except as noted

Year

Revenue from
servicesl

Operating
expenses and
imputed costs2

1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

839.8
867.6
922.8
960.4
918.3
881.7
914.6
994.7
1,031.2
1,012.3

743.2
775.7
818.2
901.9
891.7
931.3
842.6
834.7
875.5
913.3

1998-2007

9,343.4

8,528.0

Targeted return
on equity

Total
costs

Cost recovery
(percent) 3 ' 4

66.8
57.2
98.4
109.2
92.5
104.7
112.4
103.0
72.0
80.4

809.9
832.9
916.6
1,011.1
984.3
1,036.1
955.0
937.7
947.5
993.7

103.7
104.2
100.7
95.0
93.3
85.1
95.8
106.1
108.8
101.9

896.6

9,424.8

99.1

NOTE: Here and elsewhere in this chapter, totals and
percentages may not reflect components shown because
of rounding.
1. For the ten-year period, includes revenue from services of $8,816.8 million and other income and expense
(net) of $526.6 million.
2. For the ten-year period, includes operating expenses

of $7,938.1 million, imputed costs of $227.2 million, and
imputed income taxes of $362.8 million.
3. Revenue from services divided by total costs.
4. For the ten-year period, cost recovery is 96.7 percent, including the net reduction in equity related to
FAS 158 reported by the priced services in 2007.

Commercial Check-Collection
Service

9.8 percent from 2006 (table). The decline in Reserve Bank check volume is
consistent with nationwide trends away
from the use of checks and toward
greater use of electronic payment methods.5 Of all the checks presented by the
Reserve Banks to paying banks in 2007,
42.2 percent were deposited and 24.6
percent were presented using Check 21
products, compared with 14.0 percent
and 4.3 percent, respectively, in 2006.6
By the end of 2007, this growth resulted
in 57.5 percent of the Reserve Bank

In 2007, the Reserve Banks recovered
100.7 percent of the total costs of their
commercial check-collection service, including the PSAF. The Reserve Banks'
operating expenses and imputed costs
totaled $743.3 million, of which $26.1
million was attributable to the transportation of commercial checks between
Reserve Bank check-processing centers.
Revenue amounted to $705.0 million, of
which $23.1 million was attributable to
estimated revenues derived from the
transportation of commercial checks between Reserve Bank check-processing
centers, and other income was
$106.9 million. The resulting net income
was $68.6 million. Check-service revenue in 2007 decreased $40.0 million
from 2006, largely because of a drop in
paper-check fee revenue; this drop was
partially offset by an increase in Check
21 fee revenue.
The Reserve Banks handled 10.0 billion checks in 2007, a decrease of

5. The Federal Reserve System's retail payments research suggests that the number of checks
written in the United States has been declining
since the mid-1990s. For details, see Federal Reserve System, "The 2007 Federal Reserve Payments Study: Noncash Payment Trends in the
United States, 2003-2006" (December 2007).
(www.frbservices.org/files/communications/pdf/
research/2007_pay ments_study.pdf)6. The Reserve Banks also offer non-Check 21
electronic-presentment
products.
In
2007,
19.2 percent of the Reserve Banks' deposit volume was presented to paying banks using these
products.

Federal Reserve Banks

153

Activity in Federal Reserve Priced Services, 2005-2007
Thousands of items
Percent change
Service

2006

2007

2005
2006 to 2007

Commercial check
Commercial ACH
Funds transfer
Multilateral settlement
Securities transfer

10,001,289
9,363.429
137,555
505
10,110

11,083,122
8,230,782
136,399
470
9,053

12,227,718
7,338,950
135,227
440
9,235

2005 to 2006

-9.8
13.8
0.9
7.4
11.7

-9.4
12.2
0.9
6.8
-2.0

NOTE: Activity in commercial check is the total number of commercial checks collected, including processed
and fine-sort items; in commercial ACH, the total number
of commercial items processed; in funds transfer and

securities transfer, the number of transactions originated
online and offline; and in multilateral settlement, the
number of settlement entries processed.

check deposits and 39.0 percent of Reserve Bank check presentments being
made through Check 21 products.
In 2007, the Reserve Banks continued
efforts to reduce check-service operating costs in response to the ongoing decline in check volume. These efforts included the consolidation of some checkprocessing sites. Check processing at
Nashville has now been consolidated to
Atlanta; San Francisco operations to Los
Angeles; and Helena (Montana) operations to Denver. As part of a longerrange strategy, the Reserve Banks have
selected Philadelphia, Cleveland, Atlanta, and Dallas as regional checkprocessing sites, which will provide a
full range of check-processing services.
The transition to this new structure is
expected to begin in 2008. The Reserve
Banks will continue to review their
check infrastructure regularly to respond
to further changes within the nation's
payments system and to meet statutory
requirements for long-term cost
recovery.

The Reserve Banks' operating expenses
and imputed costs totaled $85.9 million.
Revenue from ACH operations totaled
$88.3 million and other income totaled
$13.7 million, resulting in net income of
$16.0 million. The Banks processed
9.4 billion commercial ACH transactions, an increase of 13.8 percent from
2006.
In 2007, nationwide ACH volumes
continued to grow at double-digit rates.
This growth is largely attributable to
volume increases associated with electronic check conversion applications—
including checks converted at lockbox
locations or at the point of purchase.
ACH rule changes that took effect in
early 2007 permitted checks to be converted in processing centers or back offices, spurring further growth in the volume of ACH check conversions.

Commercial Automated
Clearinghouse Services
In 2007, the Reserve Banks recovered
107.6 percent of the total costs of their
commercial automated clearinghouse
(ACH) services, including the PSAF.

Fedwire Funds and
National Settlement Services
In 2007, the Reserve Banks recovered
107.3 percent of the costs of their Fedwire Funds and National Settlement Services, including the PSAF. The Reserve
Banks' operating expenses and imputed
costs totaled $63.1 million in 2007. Revenue from these operations totaled
$64.4 million and other income

154 94th Annual Report, 2007
amounted to $10.1 million, resulting in
net income of $11.4 million.
Fedwire Funds Service
The Fedwire Funds Service allows participants to use their reserve or clearing
balances at the Reserve Banks to transfer funds to other participants. In 2007,
the number of Fedwire funds transfers
originated by depository institutions increased 0.9 percent from 2006, to approximately 137.6 million. The average
daily value of Fedwire funds transfers in
2007 was $2.7 trillion.
National Settlement Service
The National Settlement Service is a
multilateral settlement system that allows participants in private-sector clearing arrangements to exchange and settle
transactions on a net basis using reserve
or clearing balances. In 2007, the service processed settlement files for approximately fifty-four local and national
private arrangements, primarily check
clearinghouse associations. The Reserve
Banks processed slightly more than
17,000 files that contained almost
505,000 settlement entries for these arrangements in 2007.
Fedwire Securities Service
In 2007, the Reserve Banks recovered
103.7 percent of the total costs of their
Fedwire Securities Service, including
the PSAF. The Reserve Banks' operating expenses and imputed costs for providing this service totaled $21.0 million
in 2007. Revenue from the service totaled $20.6 million, and other income
totaled $3.2 million, resulting in net income of $2.9 million.
The Fedwire Securities Service allows participants to electronically transfer securities issued by the U.S. Treasury, federal government agencies,

government-sponsored enterprises, and
certain international organizations to
other participants in the service.7 In
2007, the number of non-Treasury securities transfers processed by the service
increased 11.7 percent from 2006, to approximately 10.1 million.
In 2007, the Board published an assessment of the compliance of the Fedwire Securities Service with the Recommendations for Securities Settlement
Systems that are included in the Federal
Reserve Policy on Payments System
Risk.8 The Fedwire Securities Service
mostly complied with the recommendations' applicable standards.9 Both the
Fedwire Funds Service and the Fedwire
Securities Service assessments will be
reviewed periodically to ensure that they
remain accurate.
Float
The Federal Reserve had daily average
credit float of $604.9 million in 2007,

7. The expenses, revenues, volumes, and fees
reported here are for transfers of securities issued
by federal government agencies, governmentsponsored enterprises, and certain international organizations. The Reserve Banks provide Treasury
securities services in their role as the US. Treasury's fiscal agent. These services are not considered priced services. For details, see the section
"Debt Services" later in this chapter.
8. The Recommendations are a set of nineteen
minimum standards, developed by the Committee
on Payment and Settlement Systems (CPSS) and
the Technical Committee of the International Organization of Securities Commissions (IOSCO), to
address legal, presettlement, settlement, operational, and custody risks, among other issues, in
securities settlement systems. See www.
federalreserve.gov/paymentsystems/fedwiresecsvs/
fedwiresecsvs.pdf.
9. In 2006, the Board published an assessment
of the compliance of the Fedwire Funds Service
with the Core Principles for Systemically ImportantPaymentSystems.Seewww.federalreserve.gov/
paymentsystems/coreprinciples/coreprinciples.pdf.

Federal Reserve Banks 155
the Reserve Banks' Currency Technology Office to develop more-secure designs for the $5 Federal Reserve note.
The Reserve Banks issued the redeDevelopments in
signed $5 note in March 2008.
Currency and Coin
Board staff worked with the Reserve
Banks and the United States Mint to
The Federal Reserve Banks issue the nation's currency (in the form of Federal implement the distribution strategy for
Reserve notes) and distribute coin the Presidential $1 Coin Program. Conthrough depository institutions. The Re- sistent with the requirements of the
serve Banks also receive currency and Presidential $1 Coin Act, the Federal
coin from circulation through these in- Reserve and the Mint conducted addistitutions. The Reserve Banks received tional outreach to depository institutions
38.0 billion Federal Reserve notes from and coin users to gauge demand for the
circulation in 2007, a 0.8 percent de- coins and to anticipate and eliminate obcrease from 2006, and made payments stacles to the efficient circulation of $1
of 38.5 billion notes into circulation in coins.
The Reserve Banks began implement2007, a 1.5 percent decrease from 2006.
ing a program to extend to 2017 the
They received 63.3 billion coins from
circulation in 2007, a 5.9 percent in- useful life of the System's BPS 3000
crease from 2006, and made payments high-speed currency-processing maof 75.7 billion coins into circulation, a chines. The program will replace the operating systems of the current equip2.2 percent increase from 2006.
ment but retain the machines' frames,
In July, the Reserve Banks implenote-transport mechanisms, and large
mented the fee component of the Fedmechanical parts. Software problems
eral Reserve currency recirculation
and development delays have extended
policy. The intent of the policy is to
the schedule for completion of the proreduce the overuse of Federal Reserve
gram to the fourth quarter of 2009.
currency-processing services by deposiThe Reserve Banks selected a vendor
tory institutions. Under the policy, the
to design software to replace the current
Reserve Banks assess fees to institutions
that, within a one-week period, deposit standard cash application. The multiyear
fit $10 or $20 notes and reorder cur- project will begin in 2008; the target
rency of the same denomination, above implementation date for the new autoa de minimis amount, within the same mation system is 2010.
Reserve Bank office's service area. At the
end of the first two billing quarters, the Developments in
Reserve Banks had collected $5.5 million Fiscal Agency and
in recirculation fees from institutions.
Government Depository Services
Board staff worked with the Treasury
Department, the U.S. Secret Service, and As fiscal agents and depositories for the
federal government, the Federal Reserve
Banks provide services related to the
10. Credit float occurs when the Reserve Banks
federal debt, help the Treasury collect
present items for collection to the paying bank
funds owed to the federal government,
prior to providing credit to the depositing bank,
process electronic and check payments
and debit float occurs when the Reserve Banks
for the Treasury, maintain the Treacredit the depositing bank prior to presenting items
sury's bank account, and invest excess
for collection to the paying bank.

compared with credit float of $85.9 million in 2006.10

156 94th Annual Report 2007
Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services,
2005-2007
Thousands of dollars
Agency and service

2007

2006

2005

74,149.2
8,687.7
41,372.0
3,558.7
724.5
128,492.1

73,931.4
7,535.2
23,594.9
3,853.1
1,578.7
110,493.2

86,503.2
6,055.8
17,553.5
2,575.5
1,806.5
114,494.5

DEPARTMENT OF THE TREASURY

Bureau of the Public Debt
Treasury retail securities
Treasury securities safekeeping and transfer
Treasury auction
Computer infrastructure development and support
Other services
Total
Financial Management Service
Payment services
Government check processing
Automated clearinghouse
Fedwire funds transfers
Other payment programs
Collection services
Tax and other revenue collections
Other collection programs
Cash-management services
Computer infrastructure development and support
Other services
Total

17,522.7
6,050.3
116.8
81,636.9

20,918.6
5,823.1
123.1
69,696.8

20,988.0
5,709.5
109.4
49,366.0

38,254.5
12,483.6
46,093.6
70,999.9
7,507.2
280,665.7

37,095.5
14,122.6
48,320.2
67,046.4
7,414.8
270,561.2

39,736.0
14,354.2
40,496.7
67,703.3
2,332.2
240,795.4

Other Treasury
Total
Total, Treasury

17.997.1
427,154.9

16,786.3
397,840.7

15,726.7
371,016.6

2,706.0

2,929.8

2,642.4

8,913.2

9,334.4

7,647.8

OTHER FEDERAL AGENCIES

Department of Agriculture
Food coupons
United States Postal Service
Postal money orders
Other agencies
Other services
Total, other agencies

19,412.0
31,031.1

15,977.1
28,241.4

14,870.2
25,160.4

Total reimbursable expenses

458,186.0

426.082.1

396,177.0

Treasury balances. The Reserve Banks
also provide limited fiscal agency and
depository services to other entities.
The total cost of providing fiscal
agency and depository services to the
Treasury and other entities in 2007
amounted to $458.2 million, compared
with $426.1 million in 2006 (table).
Treasury-related costs were $427.2 million in 2007, compared with $397.8 million in 2006, an increase of 7.4 percent.
The cost of providing services to other
entities was $31.0 million, compared
with $28.2 million in 2006. In 2007, as
in 2006, the Treasury and other entities

reimbursed the Reserve Banks for the
costs of providing these services.

Debt Services
The Reserve Banks auction, provide
safekeeping for, and transfer Treasury
securities. Reserve Bank operating expenses for these activities totaled $50.1
million in 2007, compared with $31.1
million in 2006. The Banks processed
104,000 commercial tenders for Treasury securities in 2007 through the Fedwire Securities Service, compared with
148,000 in 2006. They originated

Federal Reserve Banks
13.7 million transfers of Treasury securities in 2007, a 6.4 percent increase
from 2006. The Reserve Banks are developing a new Treasury auction application and infrastructure that will
provide increased functionality and security. The application will be operational in early 2008.
The Reserve Banks also operate computer applications and provide customer
service and back-office support for the
Treasury's retail securities programs.
Reserve Bank operating expenses for
these activities were $74.1 million in
2007, compared with $73.9 million in
2006. The Reserve Banks operate
Legacy Treasury Direct, a program that
allows investors to purchase and hold
Treasury securities directly with the
Treasury through the Reserve Banks instead of through a broker. The program
held $70.3 billion (par value) of Treasury securities as of December 31. Because the program was designed for investors who plan to hold their securities
to maturity, it does not provide transfer
services. Investors may, however, sell
their securities for a fee through Sell
Direct, a program operated by one of the
Reserve Banks. Approximately 13,000
securities worth $642.4 million were
sold through Sell Direct in 2007, compared with 13,000 securities worth
$678.9 million in 2006. The Banks
printed and mailed more than 25.1 million savings bonds in 2007, a 13.2 percent decrease from 2006. They issued
more than 4.2 million Series I (inflationindexed) bonds and 20.6 million Series
EE bonds.
Payments Services
The Reserve Banks process both electronic and check payments for the Treasury. Reserve Bank operating expenses
for processing government payments
and for payments-related programs to

157

taled $105.3 million in 2007, compared
with $96.6 million in 2006. The Banks
processed 1,027 million ACH payments
for the Treasury, an increase of 3.6 percent from 2007, and more than 618,000
Fed wire funds transfers. They also processed 214 million government checks,
a decline of 3.6 percent from 2006. The
proportion of government checks being
processed as paper checks has been declining as an increasing number of
checks are being presented by depository institutions in image form. Of all
the government checks processed by the
Banks in 2007, 54 percent of the checks
were presented as paper and 46 percent
were presented as images, compared
with 87 percent and 13 percent, respectively, in 2006. In addition, the Banks
issued more than 131,000 fiscal agency
checks, a decrease of 22.6 percent from
2006.
Collection Services
The Reserve Banks support several
Treasury programs to collect funds
owed the federal government. Reserve
Bank operating expenses related to these
programs totaled $50.7 million in 2007,
compared with $51.2 million in 2006.
The Banks operate the Federal Reserve
Electronic Tax Application (FR-ETA) as
an adjunct to the Treasury's Electronic
Federal Tax Payment System (EFTPS).
EFTPS allows businesses and individual
taxpayers to pay their taxes electronically. It uses the automated clearinghouse (ACH) to collect funds, so tax
payments must be scheduled at least one
day in advance. Some business taxpayers, however, do not know their tax liability until the tax due date. FR-ETA
allows these taxpayers to use EFTPS by
providing a same-day electronic federal
tax payment alternative. FR-ETA collected $519.8 billion for the Treasury in

158 94th Annual Report, 2007
2007, compared with $456.3 billion in
2006.
In addition, the Reserve Banks operate Pay.gov, a Treasury program that allows members of the public to use the
Internet to pay for goods and services
offered by the federal government. They
also operate the Treasury's Paper Check
Conversion and Electronic Check Processing programs, whereby checks written to government agencies are converted into ACH transactions at the
point of sale or at lockbox locations. In
2007, the Reserve Banks originated
more than 10.1 million ACH transactions through these programs, a significant increase from 2006 due to growth
in the electronic check processing
program.
Treasury Cash-Management
Services
The Treasury maintains its bank account
at the Reserve Banks and invests the
funds it does not need for current payments with qualified depository institutions through the Treasury Tax and Loan
(TT&L) program, which the Reserve
Banks operate. Reserve Bank operating
expenses related to this program and
other cash-management initiatives totaled $46.1 million in 2007, compared
with $48.3 million in 2006. The investments either are callable on demand or
are for a set term. In 2007, the Reserve
Banks placed a total of $308.4 billion in
immediately callable investments, which
includes funds invested through retained
tax deposits and direct, special direct,
and dynamic investments, and $687 billion in term investments. The rate for
term investments is set by auction; the
Reserve Banks held 126 such auctions
in 2007, roughly the same number of
auctions as in 2006. In 2007, the Treasury's income from the TT&L program
was $1.15 billion. The Treasury pro

vides the Repurchase Agreement Program on a limited basis, which allows
the Treasury to place a portion of its
excess operating funds directly with
TT&L depositaries through a repurchase
transaction for a set period at an
agreed-on interest rate. In 2007, the Reserve Banks placed a total of $499 billion of investments through repurchase
agreements.
In 2007, the Treasury announced the
Collections and Cash Management
Modernization (CCMM) initiative,
which is a multiyear effort to streamline,
modernize, and improve the process and
systems supporting the Treasury's collections and cash-management programs. Several Federal Reserve Banks
have been selected to work on the
CCMM initiative.
Services Provided to Other Entities
The Reserve Banks provide fiscal
agency and depository services to other
domestic and international entities when
required to do so by the Secretary of the
Treasury or when required or permitted
to do so by federal statute. The majority
of the work is securities-related.

Electronic Access to
Reserve Bank Services
In 2007, the Federal Reserve Banks continued to migrate their computer interface customers to FedLine Direct and
FedLine Command. This migration,
typically for high-volume depository institutions, comes after the Reserve
Banks completed the FedLine Advantage migration, typically for low- to
moderate-volume depository institutions, in 2006. FedLine Direct is an
internet-protocol-based
computer-tocomputer electronic access channel used
to access critical payment services, such
as Fedwire Funds, Fedwire Securities,

Federal Reserve Banks
National Settlement, and FedACH Services. FedLine Command is a lowercost internet-protocol-based computerto-computer electronic access channel
for file delivery services, including the
FedACH Service. The Reserve Banks
began the migration to FedLine Direct
and FedLine Command in 2006 and expect to complete the conversion in 2008.

Information Technology
In 2007, the Federal Reserve Banks enhanced their information technology
(IT) governance framework to better
align IT management authority and accountability with the business models
used in the System. A System chief information officer (CIO) position and two
advisory councils were established. The
Business Technology Council represents
the technology needs of the Federal Reserve's business lines, and the Technology Services Council represents the
Federal Reserve's IT providers. The
CIO leads System efforts to develop and
implement the Federal Reserve's overall
IT strategy at the Reserve Banks, manages national information-security risk,
and analyzes and coordinates the System's IT investments.
The System continued to develop the
National Information Security Assurance function as a central point of governance for enterprise-level information
security. Associated roles and responsibilities within the function were clarified. Efforts to improve the function will
continue as the Federal Reserve's information security environment continues
to evolve.
To address the business implications
of reduced demand for mainframe services, Federal Reserve Information
Technology in mid-2007 implemented a
multiyear strategic plan for mainframe
technologies. These technologies are no
longer considered strategic, and the Sys

159

tem has decided not to make any further
significant investments in the mainframe
platform. System business owners are
looking at alternative platforms for webbased access to applications and data,
partly because of concerns about the
continued availability of technical resources to support mainframe platforms.
In 2007, the Federal Reserve continued to implement the Information Security Architecture Framework (ISAF), a
large program scheduled to be completed in 2008. ISAF is intended to respond to the continuing and increasingly
sophisticated security threats facing information technology systems and to
improve information security at all
points in the Federal Reserve by raising
the level of enterprise-wide assurance.
Major accomplishments in 2007 include
improving the separation of sensitive infrastructure, limiting access to sensitive
desktop functions, and strengthening
desktop-access protections.

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 performs its own reviews and engages a public accounting firm. The
public accounting firm performs an annual audit of the combined financial
statements of the Reserve Banks (see
the section "Federal Reserve Banks
Combined Financial Statements") and
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) to assess their internal controls
over financial reporting, including the
safeguarding of assets. The Reserve
Banks have further enhanced their as-

160 94th Annual Report, 2007
sessments under the COSO framework
to strengthen the key control assertion
process and in 2007 met the requirements of the Sarbanes-Oxley Act of
2002. Within this framework, management of each Reserve Bank provides an
assertion letter to its board of directors
annually confirming adherence to
COSO standards, and a public accounting firm confirms management's assertion and issues an attestation report to
each Bank's board of directors and to
the Board of Governors.
In 2007, the Board engaged Deloitte
& Touche LLP (D&T) for the audits of
the individual and combined financial
statements of the Reserve Banks. Previously, PricewaterhouseCoopers LLP performed the audits. Fees for D&T's services totaled $4.7 million. To ensure
auditor independence, the Board requires
that D&T be independent in all matters
relating to the audit. Specifically, D&T
may not perform services for the Reserve Banks or others that would place it
in a position of auditing its own work,
making management decisions on behalf
of Reserve Banks, or in any other way
impairing its audit independence. In
2007, the Reserve Banks did not engage
D&T for nonaudit services.
The Board's annual examination of
the Reserve Banks includes a wide range
of off-site and on-site oversight activities conducted primarily by the Division
of Reserve Bank Operations and Payment Systems. Division personnel monitor the activities of each Reserve Bank
on an ongoing basis and conduct on-site
reviews based on the division's riskassessment methodology. The examinations also include assessing the efficiency and effectiveness of the internal
audit function. To assess compliance
with the policies established by the Federal Reserve's Federal Open Market
Committee (FOMC), the division also
reviews 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, D&T
audits the schedule of participated asset
and liability accounts and the related
schedule of participated income accounts at year-end. The FOMC receives
the external audit reports and the report
on the division's examination.

Income and Expenses
The accompanying table summarizes the
income, expenses, and distributions of
net earnings of the Federal Reserve
Banks for 2006 and 2007. Income in
2007 was $42,576 million, compared
with $38,410 million in 2006.
Expenses totaled $4,382 million
($3,270 million in operating expenses,
$240 million in earnings credits granted
to depository institutions, $296 million
in assessments for expenditures by the
Board of Governors, and $576 million
for the cost of new currency). Revenue
from priced services was $878.4 million. Net additions to and deductions
from current net income showed a net
profit of $198 million. The profit was
due primarily to unrealized gains on assets denominated in foreign currencies
revalued to reflect current market exchange rates offset, in part, by interest
expense on reverse repurchase agreements. Statutory dividends paid to member banks totaled $992 million,
$121 million more than in 2006; 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 $34,598 million in 2007,
up from $29,052 million in 2006; the
payments equal net income after the de-

Federal Reserve Banks 161
Income, Expenses, and Distribution of Net Earnings
of the Federal Reserve Banks, 2007 and 2006
Millions of dollars

2007

2006

Current income
Current expenses
Operating expenses1
Earnings credits granted

42,576
3,510
3,270
240

38,410
3,264
2,987
276

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
Change in funded status of benefit plans2

39,066
198
872
296
576
324

35,147
-159
793
301
492

Net income before payments to Treasury
Dividends paid
Transferred to (from) surplus and change in accumulated
other comprehensive income

38,716
992

34,195
871

3,126

4,272

34,598

29,052

Item

Payments to Treasury

...

1. Includes a net periodic pension expense of
$110 million in 2007 and $53 million in 2006.
2. Subsequent to the adoption of SFAS 158 in 2006,
the Reserve Banks began to recognize the change in

funded status of benefit plans as an element of other
comprehensive income.
3. Interest on Federal Reserve notes.
. . . Not applicable.

duction of dividends paid and of the
amount necessary to equate the Reserve
Banks' surplus to paid-in capital.
In the "Statistical Tables" section of
this report, table 10 details the income
and expenses of each Reserve Bank for
2007 and table 11 shows a condensed
statement for each Bank for the years
1914 through 2007; table 9 is a statement of condition for each Bank, and
table 13 gives the number and annual
salaries of officers and employees for
each Bank. A detailed account of the
assessments and expenditures of the
Board of Governors appears in the section "Board of Governors Financial
Statements."

lion, an increase of $28,243 million
from 2006 (table). U.S. government securities holdings increased $26,124 million, and loans increased $1,297 million.
In December 2007, the Federal Reserve
established a Term Auction Facility
(TAF) under which the Reserve Banks
conduct auctions for a fixed amount of
funds for a fixed term, with the interest
rate determined by the auction process,
subject to a minimum bid rate. All advances under the TAF must be fully collateralized. In 2007, average daily holdings of Term Auction Credit (TAC) under
the TAF amounted to $822 million.
The average rate of interest earned on
the Reserve Banks' holdings of government securities increased to 4.95 percent, from 4.63 percent in 2006, and the
average rate of interest earned on loans
decreased to 2.18 percent, from
5.36 percent. The average interest rate
on TAC was 4.66 percent.

Holdings of Securities and Loans
The Federal Reserve Banks' average
daily holdings of securities and loans
during 2007 amounted to $816,115 mil-

162 94th Annual Report, 2007
Securities and Loans of the Federal Reserve Banks, 2005-2007
Millions of dollars except as noted

Item and year

Average daily holdings4
2005 5
20065
2007
Earnings b
2005
2006
2007
Average interest rate (percent)
2005 5
20065
2007 ..
.

Term
Auction
Credit3

Total

U.S.
government
securities1

Loans 2

753,748
787,872
816,115

753,549
787,648
813,772

199
224
1,521

822

28,966
36,464
40,369

28,959
36,452
40,298

7
12
33

3.84
4.63
4.95

3.52
5.36
2.18

4.66

1. Includes federal agency obligations.
2. Does not include indebtedness assumed by the Federal Deposit Insurance Corporation.
3. Reflects temporary Term Auction Facility activity
beginning in 2007.
4. Based on holdings at opening of business.

5. Amounts in bold are restatements due to changes in
previously reported data.
6. Earnings have not been netted with the interest expense on securities sold under agreements to repurchase.
. . . Not applicable.

Volume of Operations

law enforcement officers (FRLEOs).
The 240-hour program covers a variety
of topics related to the mission of an
FRLEO. The Federal Reserve was
granted federal law enforcement authority by the USA Patriot Act to protect
and safeguard Board and Federal Reserve Bank premises, grounds, property,
personnel, and operations.

Table 12 in the "Statistical Tables" section shows the volume of operations in
the principal departments of the Federal
Reserve Banks for the years 2004
through 2007.

Federal Reserve
Law Enforcement
In November, the Federal Reserve System became the eleventh federal law enforcement agency to be awarded accreditation from the Federal Law
Enforcement Training Accreditation
board of directors for its Basic Law Enforcement Course (BLEC). The primary
benefit of accreditation is increased public confidence in the integrity, professionalism, and accountability of the law
enforcement agencies. Accreditation is
considered a "best practice" for federal
law enforcement agencies and signifies
compliance with 63 stringent standards.
All law enforcement candidates complete the Federal Reserve's BLEC prior
to their designation as Federal Reserve

Federal Reserve Bank Premises
In 2007, construction was largely completed on the Kansas City Bank's new
headquarters building and the San Francisco Bank's new Seattle Branch building. The multiyear renovation program
at the New York Bank's headquarters
building continued. The St. Louis Bank
continued a long-term facility redevelopment program that includes the ongoing construction of an addition to the
Bank's headquarters building.
Security enhancement programs continued at several facilities. Construction
of security improvements to the Richmond Bank's headquarters building is

Federal Reserve Banks
ongoing. The Philadelphia Bank completed the purchase of property behind
its headquarters building for the construction of a remote vehicle-screening
facility and is developing the facility's
design. Design development of a similar
screening facility for the Dallas Bank
also continued.
During 2007, the Board approved the

163

final design of a new parking garage to
be constructed adjacent to the Richmond
Bank's headquarters building. Efforts to
sell the St. Louis Bank's Little Rock
Branch building continued.
Table 14 in the "Statistical Tables"
section of this report details the acquisition costs and net book value of the Federal Reserve Banks and Branches.
•

164 94th Annual Report, 2007

Pro Forma Financial Statements for Federal Reserve Priced Services
Pro Forma Balance Sheet for Priced Services, December 31, 2007 and 2006
Millions of dollars

Short-term assets (Note 1)
Imputed reserve requirements
on clearing balances
Imputed investments
Receivables
Materials and supplies
Prepaid expenses
Items in process of collection
Total short-term assets
Long-term assets (Note 2)
Premises
Furniture and equipment
Leases, leasehold improvements, and
long-term prepayments
Prepaid pension costs
Deferred tax asset
Total long-term assets

Long-term liabilities
Long-term debt
Postretirement/postemployment
benefits obligation
Total long-term liabilities

11,518.9

9,088.0
453.5
130.2

424.9
127.9

64.2
484.6
109.4

83.3
453.0
130.0
1,242.0

1,219.0

10,330.0

12,737.9

8,015.6
3,592.5
0.0
100.4

7,641.1
1,685.1
0.0
102.4

11,708.4

9,428.5
0.0

0.0

392.6

385.0

Total liabilities
Equity (including accumulated other
comprehensive loss of
$237.9 million and
$306.1 million at
December 31, 2007 and
2006, respectively)
Total liabilities and equity (Note 3) . . .
NOTE: Components may not sum to totals because of
rounding. Amounts in bold are restated due to changes in
previously reported data.

821.7
7,207.5
73.6
0.9
24.2
3,391.0

755.7
6,465.7
66.7
1.8
28.5
1,769.6

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

2006

2007

Item

385.0

392.6

9,813.5

12,101.0

516.5

636.9

10,330.0

12,737.9

The accompanying notes are an integral part of these
pro forma priced services financial statements.

Federal Reserve Banks

165

Pro Forma Income Statement for Federal Reserve Priced Services, 2007 and 2006
Millions of dollars
Item
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 6)
Net income
MEMO: Targeted return on equity (Note 6)

2006

2007

908.4
803.5
104.8

878.4
888.2
-9.8
-32.0
0.0
11.6
0.0

-4.9
0.0
10.8
0.0

-20.4

5.9
98.9

10.6
362.3
-228.5

NOTE: Components may not sum to totals because of
rounding.

383.6
-260.8

133.8
144.5
45.5
98.9
80.4

122.8
221.8
66.1
155.7
72.0

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, 2007
Millions of dollars

Item

Total

Commercial
check
collection

Revenue from services
(Note 4)

878.4

705.0

88.3

64.4

20.6

Operating expenses
(Note 5)

888 2

733 6

78 3

56 9

19 3

Income from operations

-9.8

-28.6

10.0

7.5

1.3

Imputed costs (Note 6)

-20.4

-21.8

0.2

0.9

0.3

Income from operations
after imputed costs

Commercial
ACH

Fedwire
funds

Fedwire
securities

106

-6 7

Other income and expenses,
net (Note 7)

133.8

106.9

13.7

10.1

3.2

Income before income taxes

4.2

144.5

100.2

23.4

16.6

Imputed income taxes
(Note 6)

45 5

31 6

1 3

Net income

98 9

68 6

160

11 4

MEMO: Targeted return on
equity (Note 6)

80.4

63.2

8.8

6.3

2.0

101.9

100.7

107.6

107.3

103.7

MEMO: Cost recovery (percent)
(Note 8)

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.

166 94th Annual Report, 2007
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
a portfolio of investments, shown as imputed investments.
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

Long-term assets consist of long-term assets used solely
in priced services, the priced-service 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 December 31, 2006, the Reserve Banks
implemented the Financial Accounting Standard Board's
Statement of Financial Accounting Standards (SFAS) No.
158, Employers' Accounting for Defined Benefit Pension
and Other Postretirement Plans, which requires an employer to record the funded status of its benefit plans on
its balance sheet. This resulted in a reduction to the prepaid pension asset related to priced services and the recognition of an associated deferred tax asset with an offsetting adjustment, net of tax, to accumulated other
comprehensive income (AOCI) (see Note 3).
(3) LIABILITIES AND EQUITY

Under the matched-book capital structure for assets,
short-term assets are financed with short-term payables
and core clearing balances. Long-term assets are financed

with long-term liabilities and clearing balances. As a result, no short- or long-term debt is imputed. Other shortterm liabilities include clearing balances maintained at
Reserve Banks and deposit balances arising from float.
Other long-term liabilities consist of accrued postemployment, postretirement, and nonqualified pension
benefits costs and obligations on capital leases.
In order to reflect the funded status of its benefit plans
as required by SFAS No. 158, the Reserve Banks recognized the deferred items related to these plans, which
include prior service costs and actuarial gains or losses,
on the balance sheet. In 2007, this resulted in a decrease
to the benefits obligation related to the priced services
with an offsetting adjustment, net of tax, to AOCI, which
is included in equity.
Equity is imputed at 5 percent of total assets.
(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 (see Note 7).
(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 $6.7 million in 2007 and $7.5 million
in 2006.
Effective January 1, 1987, the Reserve Banks implemented SFAS No. 87, Employers' Accounting for Pensions. Accordingly, the Reserve Banks recognized operating expenses for the qualified pension plan of
$21.3 million in 2007 and $11.5 million in 2006. Operating expenses also include the nonqualified pension expense of $3.1 million in 2007 and $3.2 million in 2006.
The implementation of SFAS No. 158 does not change
the systematic approach required by generally accepted
accounting principles to recognize the expenses associated with the Reserve Banks' benefit plans in the income
statement.
The income statement by service reflects revenue, operating expenses, imputed costs, and cost recovery. Certain corporate overhead costs not closely related to any
particular priced service are allocated to priced services
based on an expense-ratio method. Corporate overhead
was allocated among the priced services during 2007 and
2006 as follows (in millions):
2007

2006

Check
ACH
Fedwire funds
Fedwire securities

34.7
4.3
3.0
1.7

30.6
4.1
2.8
1.5

Total

43.7

39.0

Federal Reserve Banks
(6) IMPUTED COSTS

Imputed costs consist of income taxes, return on equity,
interest on debt, sales taxes, the FDIC assessment, and
interest on float. Many imputed costs are derived from the
private-sector adjustment factor (PSAF) model. The cost
of debt and the effective tax rate are derived from bank
holding company data, which serves as the proxy for the
financial data of a representative private-sector firm, and
are used to impute debt and income taxes in the PSAF
model. The after-tax rate of return on equity is based on
the returns of the equity market as a whole and is used to
impute the profit that would have been earned had the
services been provided by a private-sector firm.
Interest is imputed on the debt assumed necessary to
finance priced-service assets; however, no debt was imputed in 2007 or 2006.
Effective in 2007, the Reserve Bank priced services
imputed a one-time FDIC assessment credit of $16.6 million. In 2007, the credit fully offset the imputed $4.0
million assessment, resulting in a remaining credit of
$12.6 million. The remaining credit can be used to offset
up to 90 percent of the assessment in the future.
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 the Check,
Fedwire Funds, National Settlement Service, ACH, and
Fedwire Securities services.
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 service to the total expenses, less the total shipping expenses, for all services.
The following shows the daily average recovery of
actual float by the Reserve Banks for 2007 in millions of
dollars:
Total float
Unrecovered float
Float subject to recovery

-603.3
24.1
-627.4

Sources of recovery of float
Income on clearing balances
As-of adjustments
Direct charges
Per-item fees

-62.7
-1.6
267.3
-833.6

167

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 CIPC, 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 reserve or clearing balances or by
billing institutions directly. Float recovered through direct
charges and per-item 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 2007.
(7) OTHER INCOME AND EXPENSES

Other income and expenses consist of investment income
on clearing balances and the cost of earnings credits.
Investment income on clearing balances for 2007 and
2006 represents the average coupon-equivalent yield on
three-month Treasury bills plus a constant spread, based
on the return on a portfolio of investments. The return is
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 a discounted average coupon-equivalent yield on
three-month Treasury bills to the required portion of the
clearing balances, adjusted for the net effect of reserve
requirements on clearing balances.
(8) COST RECOVERY

Annual cost recovery is the ratio of revenue to the sum of
operating expenses, imputed costs, imputed income taxes,
and targeted return on equity.

169

The Board of Governors and the
Government Performance and Results Act
The Government Performance and Results Act (GPRA) of 1993 requires that
federal agencies, in consultation with
Congress and outside stakeholders, prepare a strategic plan covering a multiyear period and submit an annual performance plan and performance report.
Although the Federal Reserve is not
covered by the GPRA, the Board of
Governors voluntarily complies with the
spirit of the act.

Strategic Plan, Performance
Plan, and Performance Report
The Board's strategic plan articulates
the Board's mission, sets forth major
goals, outlines strategies for achieving
those goals, and discusses the environment and other factors that could affect
their achievement. It also addresses issues that cross agency jurisdictional
lines, identifies key quantitative performance measures, and discusses performance evaluation. The most recent strategic plan covers the period 2006-09.
Both the performance plan and the
performance report are prepared every
two years. The performance plan includes specific targets for some of the
performance measures identified in the
strategic plan and describes the operational processes and resources needed to
meet those targets. It also discusses data
validation and results verification. The
most recent performance plan covers the
period 2006-07.
The performance report discusses the
Board's performance in relation to its
goals. The report covering the period
2006-07 will be completed in 2008. Pre

liminary analysis indicates that the
Board generally met its goals for 200607.
All of these documents are available
on the Board's web site, at www.
federalreserve.gov/boarddocs/rptcongress.
The Board's mission statement and a
summary of the Federal Reserve's goals
and objectives, as set forth in the most
recently released strategic and performance plans, are listed below. Updated
documents will be posted on the website
as they are completed.

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 six 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
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.

170 94th Annual Report, 2007
• 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 U.S. 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
• Promote overall financial stability,
manage and contain systemic risk, and
identify emerging financial problems
early so that crises can be averted.
• Provide a safe, sound, competitive,
and accessible banking system
through comprehensive and effective
supervision of U.S. banks, bank and
financial holding companies, foreign
banking organizations, and related
entities. At the same time, remain
sensitive to the burden on supervised
institutions.
• Provide a dynamic work environment
that is challenging and rewarding. Enhance efficiency and effectiveness,
while remaining sensitive to the burden on supervised institutions, by addressing the supervision function's
procedures, technology, resource allocation, and staffing issues.

• Promote compliance by domestic and
foreign banking organizations supervised by the Federal Reserve with
applicable laws, rules, regulations,
policies, and guidelines through a
comprehensive and effective supervision program.
Goal
To effectively implement federal laws
designed to inform and protect the consumer, to encourage community development, and to promote access to banking services in historically underserved
markets
Objectives
• Take a leadership role in shaping the
national dialogue on consumer protection in financial services, address the
rapidly emerging issues that affect
today's consumers, strengthen consumer compliance supervision programs when required, and remain sensitive to the burden on supervised
institutions.
• Promote, develop, and strengthen effective communications and collaborations within the Board, the Federal
Reserve Banks, and other agencies
and organizations.
• Increase public understanding of consumer protection and community development and the Board's role in
these areas through increased outreach
and by developing programs that
address the information needs of
consumers and the financial services
industry.
• Develop a staff that is highly skilled,
professional, innovative, and diverse;
provide career development opportunities to improve retention; and
recruit highly qualified and skilled
employees.
• Promote an efficient and effective
work environment by aligning busi-

Government Performance and Results Act
ness functions with appropriate work
processes and implementing solutions
for work products and processes that
can be handled more efficiently
through automation.

171

cient and reliable operations, effective
performance, and sound project management and should assist the Board
in the effective discharge of its oversight responsibilities.

Goal

To foster the integrity, efficiency, and
accessibility of U.S. payment and settlement systems

To foster the integrity, efficiency, and
effectiveness of the Board's programs

Objectives
• Develop sound, effective policies and
regulations that foster payment system integrity, efficiency, and accessibility. Support and assist the Board in
overseeing U.S. dollar payment and
securities settlement systems by assessing their risks and risk management approaches against relevant
policy objectives and standards.
• Conduct research and analysis that
contributes to policy development and
increases the Board's and others'
understanding of payment system
dynamics and risk.
Goal
To provide high-quality oversight of
Reserve Banks
Objective
• Produce high-quality assessments and
oversight of Federal Reserve System
strategies, projects, and operations, including adoption of technology to the
business and operational needs of the
Federal Reserve. The oversight process should help Federal Reserve
management foster and strengthen
sound internal control systems, effi-

Objectives
• Oversee a planning and budget process that clearly identifies the Board's
mission, results in concise plans for
the effective accomplishment of operations, transmits to the staff the information needed to attain objectives
efficiently, and allows the public to
measure our accomplishments.
• Develop appropriate policies, oversight mechanisms, and measurement
criteria to ensure that the recruiting,
training, and retention of staff meet
Board needs.
• Establish, encourage, and enforce a
climate of fair and equitable treatment
for all employees regardless of race,
creed, color, national origin, age, or
sex.
• Provide financial management support
needed for sound business decisions.
• Provide cost-effective and secure information resource management services to Board divisions and analyze
information technology issues for the
Board, Reserve Banks, other financial
regulatory institutions, and other nations' central banks.
• Efficiently provide safe, modern, and
secure facilities and necessary support
for activities conducive to efficient
and effective Board operations.
•

Records

175

Record of Policy Actions
of the Board of Governors
Regulation A
Extensions of Credit by
Federal Reserve Banks

Regulation DD
Truth in Savings
[Docket Nos. R-1281 through R-1285]

[Docket No. R-1304]
On December 10, 2007, the Board approved amendments establishing a temporary term auction facility (TAF), with
the intention of permitting depository institutions to obtain credit from the Federal Reserve on a secured basis at rates
that meet the market demand for credit
of relatively short terms. The TAF allows depository institutions to obtain advances from their local Federal Reserve
Banks at interest rates determined
through auctions. The amendments are
effective December 12, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation B
Equal Credit Opportunity
Regulation E
Electronic Fund Transfers
Regulation M
Consumer Leasing
Regulation Z
Truth in Lending
NOTE: Full texts of the policy actions are available via the online version of the Annual Report,
from the "Reading Rooms" on the Board's FOIA
web page, and on request from the Board's Freedom of Information Office.

On October 23, 2007, the Board approved amendments to the requirements
in several regulations and official staff
commentaries for electronic disclosures
to consumers concerning consumer financial services and fair lending. The
amendments simplify and clarify the requirements by withdrawing unnecessary
or unduly burdensome provisions in the
interim final rules approved in March
2001 and by providing guidance on using electronic disclosures. The amendments are effective December 10, 2007,
and compliance is mandatory by October 1, 2008.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
On December 11, 2007, technical
amendments were approved, under delegated authority, to clarify certain
amendments to the official staff commentaries to Regulations B and Z that
were approved by the Board on October
23. The technical amendments are effective January 14, 2008, and compliance
is mandatory by October 1, 2008.

Regulation D
Reserve Requirements of
Depository Institutions
[Docket No. R-1262]
On April 2, 2007, the Board approved
revisions to its 1980 interpretation of the

176 94th Annual Report, 2007
regulation, which sets forth criteria for
the exemption of bankers' banks from
reserve requirements. The revisions allow the Board to make case-by-case determinations as to whether a bankers'
bank may, to a limited extent, have as
customers certain entities that are not
specified in the interpretation without
losing its exemption. The revised interpretation is effective May 7, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
[Docket No. R-1297]
On September 24, 2007, the Board approved amendments to reflect the annual indexing of the reserve requirement
exemption amount and the low reserve
tranche. For 2008, the reserve requirement exemption amount is $9.3 million,
an increase from $8.5 million in 2007,
and the low reserve tranche is $43.9 million, a decrease from $45.8 million in
2007. The Board also adjusted the nonexempt deposit cutoff level ($216.2 million for 2008) and the reduced reporting
limit ($1,211 billion for 2008), which
are used to determine the frequency of
reporting by depository institutions.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation E
Electronic Fund Transfers

amendments are effective August 6,
2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation H
Membership of
State Banking Institutions
in the Federal Reserve System
Regulation K
International Banking Operations
[Docket No. R-1279]
On September 14, 2007, the Board, acting with the other federal bank and thrift
regulatory agencies, approved final rules
to extend, from twelve to eighteen
months, the on-site examination cycle
for certain state member banks and U.S.
offices of foreign banks. The extended
schedule applies to (1) insured institutions that have up to $500 million in
total assets, are well capitalized and well
managed, and receive a composite
CAMELS rating of 1 or 2 and (2) U.S.
branches and agencies of foreign banks
that have up to $500 million in total
assets and meet comparable criteria. The
final rules, which implement the Financial Services Regulatory Relief Act of
2006 and related legislation, are identical to interim final rules approved by the
Board on March 16, 2007, and are effective September 25, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

[Docket No. R-1270]
On June 25, 2007, the Board approved
amendments to the regulation and official staff commentary to exempt electronic fund transfers of $15 or less from
the requirement to make paper receipts
available to consumers for transactions
initiated at electronic terminals. The

Regulation H
Membership of
State Banking Institutions
in the Federal Reserve System
Regulation Y
Bank Holding Companies
and Change in Bank Control

Record of Policy Actions of the Board of Governors 177
[Docket No. R-1261]
On November 2, 2007, the Board, acting
with the other federal bank and thrift
regulatory agencies, approved a new
risk-based capital adequacy framework
for banking organizations (which include thrifts), popularly known as Basel II. The new framework requires
some banking organizations, and permits other qualifying banking organizations, to calculate their regulatory capital requirements using an internal
ratings-based approach for credit risk
and advanced measurement approaches
for operational risks. Basel II, which
modernizes the Basel Capital Accord of
1988, consists of three components, or
pillars: minimum regulatory capital requirements (pillar 1), supervisory review
of capital adequacy (pillar 2), and market discipline through enhanced disclosure (pillar 3). The final rules set forth
the qualifying criteria and applicable
risk-based capital requirements for
banking organizations operating under
the new framework. They are effective
April 1,2008.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
Regulation L
Management Official Interlocks
[Docket No. R-1272]
On July 9, 2007, the Board, acting with
the other federal bank and thrift regulatory agencies, approved a final rule to
permit management interlocks between
unaffiliated depository institutions that
have offices in the same relevant metropolitan statistical area if one of the institutions has less than $50 million (previously $20 million) in total assets. The
final rule, which implements provisions
of the Financial Services Regulatory Re

lief Act of 2006, is identical to an interim final rule approved in December
2006 and is effective July 16, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation O
Loans to Executive Officers,
Directors, and Principal
Shareholders of Member Banks
[Docket No. R-1271]
On May 23, 2007, the Board approved a
final rule to eliminate certain reporting
requirements that have not contributed
significantly to effective monitoring or
to prevention of insider lending abuse.
The final rule, which implements provisions of the Financial Services Regulatory Relief Act of 2006, is identical to
an interim final rule approved in December 2006 and is effective July 2, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation R
Exceptions for Banks from the
Definition of Broker in the
Securities Exchange Act of 1934
[Docket No. R-1274]
On September 24, 2007, the Board, acting with the Securities and Exchange
Commission (SEC), approved a single
set of joint final rules to implement certain exceptions for banks from the definition of broker under section 3(a)(4) of
the Securities Exchange Act of 1934
(Exchange Act), as amended by the socalled push-out provisions of the
Gramm-Leach-Bliley Act of 1999. The
final rules help define the scope of securities activities that banks may conduct
in providing banking services to their

178 94th Annual Report, 2007
customers without registering with the
SEC as a securities broker or complying
with the SEC's rules. Some portions of
the final rules are effective September
28, 2007; the remaining portions are effective December 3, 2007. However,
banks are exempt from complying with
the final rules and the broker exceptions
in section 3(a)(4)(B) of the Exchange
Act until the first day of their first fiscal
year that begins after September 30,
2008.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Regulation V
Fair Credit Reporting
[Docket No. R-1203]
On October 17, 2007, the Board, acting
with the other federal financial institutions regulatory agencies, approved final rules requiring that a financial institution provide notice and a reasonable
opportunity to opt out before using information from an affiliate to market its
own products and services to a consumer. The final rules, which implement
the affiliate-marketing provisions of the
Fair and Accurate Credit Transactions
Act of 2003, are effective January 1,
2008, and compliance is mandatory by
October 1, 2008.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
[Docket No. R-1255]
On October 23, 2007, the Board, acting
with the other federal financial institutions regulatory agencies and the Federal Trade Commission, approved final
rules requiring financial institutions and
creditors that open or hold certain accounts to develop and implement a writ

ten identity theft prevention program
that includes reasonable policies and
procedures for detecting, preventing,
and mitigating identity theft. The final
rules provide guidelines for developing
and implementing those programs and
examples of "red flags" signaling possible identity theft. In addition, the final
rules require (1) debit and credit card
issuers to assess the validity of changeof-address notifications under certain
circumstances and (2) users of consumer
reports to establish and maintain reasonable policies and procedures regarding
notifications of address discrepancies
they receive from consumer reporting
agencies. The final rules and guidelines,
which implement provisions of the Fair
and Accurate Credit Transactions Act of
2003, are effective January 1, 2008, and
compliance is mandatory by November 1, 2008.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Policy Statements
and Other Actions
Policy on Payments System Risk
[Docket No. OP-1259]
On January 11, 2007, the Board approved revisions to part 1 of its Policy
on Payments System Risk to address
risk management in payments and settlement systems. The revisions establish an
expectation that payments and settlement systems under the Board's authority that are systemically important will
publicly disclose self-assessments of
their compliance with the relevant principles or minimum standards set forth in
the policy. Self-assessments should be
updated after any material change and
should be reviewed at least every two
years. In addition, the revisions incorpo-

Record of Policy Actions of the Board of Governors
rate the Recommendations for Central
Counterparties, which were developed
jointly by international committees of
central banks and securities commissions, as the Board's minimum standards for central counterparties. The revisions also clarify the purpose of and
revise the scope of part 1 relating to
central counterparties. The revisions are
effective January 19, 2007, and the initial self-assessments are expected to be
completed and published by December
31,2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Bies, Warsh, Kroszner, and Mishkin.
Illustrations of
Consumer Information for
Nontraditional Mortgage Products
[Docket No. OP-1267]
On May 25, 2007, the Board, acting with
the other federal financial institutions
regulatory agencies, approved final illustrations of consumer information for
nontraditional mortgage products to assist financial institutions in implementing the consumer protection provisions
of the Interagency Guidance on Nontraditional Mortgage Product Risks issued
in October 2006. Financial institutions
may use the illustrations as provided,
change their format, or tailor the information to specific transactions or products. The illustrations are effective
June 8, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Statement on
Subprime Mortgage Lending
[Docket No. OP-1278]
On June 27, 2007, the Board, acting
with the other federal financial institu

179

tions regulatory agencies, approved interagency guidance intended to clarify
how financial institutions may offer certain adjustable-rate mortgages in a manner that is safe and sound and also allows for clear disclosure of the risks
assumed by the borrower. The guidance
is effective July 10, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Statement on Loss Mitigation
Strategies for Servicers of
Residential Mortgages
On August 29, 2007, the Board, acting
with the other federal financial institutions regulatory agencies and the Conference of State Bank Supervisors, approved guidance to encourage federally
regulated and state-regulated financial
institutions and state-supervised servicers of residential mortgages to pursue
strategies to mitigate losses while preserving home ownership to the extent
possible and appropriate.
Votes for this action: Chairman Bernanke
and Governors Warsh, Kroszner, and
Mishkin. Absent and not voting: Vice
Chairman Kohn.
Permissible Complementary
Activities for
Financial Holding Companies
On September 6, 2007, the Board determined under the Gramm-Leach-Bliley
Act of 1999 that, subject to certain
limitations, disease management and
mail-order pharmacy services are complementary activities permissible for financial holding companies. To qualify,
an activity must complement a financial
activity and not pose a substantial risk to
the safety or soundness of depository
institutions or the financial system generally. The Board concluded that disease
management and mail-order pharmacy

180 94th Annual Report, 2007
services complement the financial activity of underwriting and selling health
insurance and do not pose a substantial
risk. The determination is effective September 7, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
On December 3, 2007, the Board similarly determined that, subject to certain
limitations, energy management activities are permissible activities for financial holding companies because they
complement the financial activities of
engaging as principal in commodity derivatives activities and providing advisory services for derivatives transactions
and do not pose a substantial risk. The
determination is effective December 4,
2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.
Permissible Financial Activities for
Financial Holding Companies
On October 10, 2007, the Board determined under the Gramm-Leach-Bliley
Act of 1999 and after consultation with
the Secretary of the Treasury that, subject to certain limitations, the acquisition, management, and operation in the
United Kingdom of certain third-party
defined benefit pension plans are financial activities permissible for financial
holding companies. The determination
is effective October 12, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin.

Discount Rates in 2007
Under the Federal Reserve Act, the
boards of directors of the Federal Reserve Banks must establish rates on dis

count window loans to depository institutions at least every fourteen days,
subject to review and determination by
the Board of Governors.

Primary Credit
Primary credit, the Federal Reserve's
main lending program, is extended at a
rate above the federal funds rate target
set by the Federal Open Market Committee (FOMC). It is typically made
available with minimal administration
for very short terms as a backup source
of liquidity to depository institutions
that, in the judgment of the lending Federal Reserve Bank, are in generally
sound financial condition.
During 2007, acting on recommendations of the Reserve Bank boards of directors, the Board approved four reductions in the primary credit rate, bringing
the rate from 6!/4 percent to 43A percent.
The first of these reductions came on
August 17 in response to the emergence
of severe financial market strains in previous weeks. The Board approved a
temporary narrowing of the spread of
the primary credit rate over the FOMC's
target rate to 50 basis points, from 100 basis points, and announced a temporary
change to the Reserve Banks' discount
window lending practices to allow the
provision of term financing for as long
as thirty days, renewable by the borrower. These changes remained in effect
at the end of 2007. In the remaining
three instances, the Board reached its
determinations on the primary credit rate
in conjunction with the FOMC's decisions to lower the target federal funds
rate by a cumulative 1 percentage point,
from 5V4 percent to 4J/4 percent. Monetary policy developments are reviewed
more fully in other parts of this report
(see the section "Monetary Policy and
Economic Developments" and the minutes of FOMC meetings held in 2007).

Record of Policy Actions of the Board of Governors
Secondary and Seasonal Credit
Secondary credit is available in appropriate circumstances to depository institutions that do not qualify for primary
credit. The secondary credit rate is set at
a spread above the primary credit rate.
Throughout 2007, the spread was set at
50 basis points.
Seasonal credit is available to smaller
depository institutions to meet liquidity
needs that arise from regular swings in
their loans and deposits. The rate on seasonal credit is calculated every two
weeks as an average of selected moneymarket yields, typically resulting in a
rate close to the federal funds rate target.
At year-end, the secondary and seasonal credit rates were 5V4 percent and
4.70 percent, respectively.
Term Auction Facility Credit
In December, the Federal Reserve established a temporary Term Auction Facility (TAF). Under the TAF, the Federal
Reserve auctions term funds to depository institutions that are in generally
sound financial condition and are eligible to borrow under the primary credit
program. The amount of each auction is
determined in advance by the Federal
Reserve, and the interest rate on TAF
credit is determined by the bidding process as the rate at which all bids can be
fulfilled, up to the maximum auction
amount and subject to a minimum bid
rate. The Federal Reserve conducted
two TAF auctions in 2007—on December 17 and December 20; the resulting
rates were 4.65 percent and 4.67 percent, respectively.
Votes on Discount Rate Changes
About every two weeks during 2007, the
Board approved proposals by the twelve
Reserve Banks to maintain the formulas
for computing the secondary and sea

181

sonal credit rates. In December, the
Board approved proposals by the twelve
Reserve Banks to establish the auction
method by which the TAF credit rate is
set. Details on the four actions by the
Board to approve changes in the primary credit rate are provided below.
August 16, 2007. The Board approved
actions taken by the directors of the Federal Reserve Banks of New York and
San Francisco to lower the rate on discounts and advances under the primary
credit program by Vi percentage point,
to 53/4 percent, effective August 17,
2007. The Board also approved an identical action subsequently taken by the
directors of the Federal Reserve Banks
of Boston, Philadelphia, Cleveland,
Richmond, Atlanta, Chicago, Minneapolis, Kansas City, and Dallas, effective
August 17, 2007, and the Federal Reserve Bank of St. Louis, effective August 20, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin. Votes
against this action: None.
September 18, 2007. Effective this date,
the Board approved actions taken by the
directors of the Federal Reserve Banks
of Boston, New York, Cleveland, Minneapolis, Kansas City, and San Francisco to lower the rate on discounts and
advances under the primary credit program by Vi percentage point, to 5]A percent. The same change was approved for
the Federal Reserve Bank of St. Louis,
effective September 19, 2007. The
Board also approved an identical action
subsequently taken by the directors of
the Federal Reserve Banks of Richmond, Atlanta, and Dallas, effective
September 19, 2007, and the Federal Reserve Banks of Philadelphia and Chicago, effective September 20, 2007.
Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors

182 94th Annual Report, 2007
Warsh, Kroszner, and Mishkin. Votes
against this action: None.
October 31, 2007. Effective this date,
the Board approved actions taken by the
directors of the Federal Reserve Banks
of New York, Richmond, Atlanta, Chicago, and San Francisco to lower the
rate on discounts and advances under
the primary credit program by V* percentage point, to 5 percent. The same
change was approved for the Federal
Reserve Bank of St. Louis, effective November 1, 2007. The Board also approved an identical action subsequently
taken by the directors of the Federal Reserve Banks of Boston, Philadelphia,
Cleveland, Minneapolis, Kansas City,
and Dallas effective November 1, 2007.

December 11, 2007. Effective this date,
the Board approved actions taken by the
directors of the Federal Reserve Banks
of New York, Philadelphia, Cleveland,
Richmond, Atlanta, and Chicago to
lower the rate on discounts and advances
under the primary credit program by
l
A percentage point, to 43A percent. The
same change was approved for the Federal Reserve Bank of St. Louis, effective
December 12, 2007. The Board also approved identical actions subsequently
taken by the directors of the Federal Reserve Banks of San Francisco, effective
December 11, 2007; Boston, Minneapolis, and Dallas, effective December 12,
2007; and Kansas City, effective December 13, 2007.

Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin. Votes
against this action: None.

Votes for this action: Chairman Bernanke,
Vice Chairman Kohn, and Governors
Warsh, Kroszner, and Mishkin. Votes
against this action: None.
•

183

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 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 summary
of the information and discussions that
led to the decisions. In addition, four
times a year, starting with the October
2007 Committee meeting, a Summary
of Economic Projections is published as
an addendum to the minutes. The descriptions of economic and financial
conditions in the minutes and the Summary of Economic Projections are based
solely on the information that was available to the Committee at the time of the
meetings.
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 instructions from the
Federal Open Market Committee that
take the form of an Authorization for
Domestic Open Market Operations and
a Domestic Policy Directive. (A new
Domestic Policy Directive is adopted at
each regularly scheduled meeting.) In
the foreign currency area, the Federal
Reserve Bank of New York operates
under an Authorization for Foreign Currency Operations, a Foreign Currency
Directive, and Procedural Instructions
with Respect to Foreign Currency Operations.1 Changes in the instruments
during the year are reported in the minutes for the individual meetings.

1. As of January 1, 2007, the Federal Reserve
Bank of New York was operating under the
Domestic Policy Directive approved at the December 12, 2006, Committee meeting. The other
policy instruments (the Authorization for Domestic Open Market Operations, the Authorization for
Foreign Currency Operations, the Foreign Currency Directive, and Procedural Instructions with
Respect to Foreign Currency Operations) in effect
as of January 1, 2007, were approved at the January 31, 2006, meeting.

184 94th Annual Report, 2007
Meeting Held on
January 30-31, 2007
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 30, 2007 at 2:00 p.m.,
and continued on Wednesday, January
31, 2007 at 9:00 a.m.
Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Ms. Bies
Mr. Hoenig
Mr. Kohn
Mr. Kroszner
Ms. Minehan
Mr. Mishkin
Mr. Moskow
Mr. Poole
Mr. Warsh
Mr. Fisher, Ms. Pianalto, and Messrs.
Plosser and Stern, Alternate Members of the Federal Open Market
Committee
Mr. Lacker and Ms. Yellen, Presidents
of the Federal Reserve Banks of
Richmond and San Francisco, respectively
Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta
Mr. Reinhart, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist

Ms. Liang and Mr. Struckmeyer, Associate Directors, Division of Research and Statistics, Board of
Governors
Messrs. Gagnon, Reifschneider, and
Wascher, Deputy Associate Directors, Divisions of International Finance, Research and Statistics, and
Research and Statistics, respectively, Board of Governors
Messrs. Dale and Orphanides, Senior
Advisers, Division of Monetary
Affairs, Board of Governors
Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors
Ms. Kole2 and Mr. Lebow,2 Section
Chiefs, Divisions of International
Finance, and Research and Statistics, respectively, Board of Governors
Messrs. Doyle,2 Schindler,3 and Wood,2
Senior Economists, Division of International Finance, Board of Governors
Messrs. Engen3 and Tetlow,2 Senior
Economists, Division of Research
and Statistics, Board of Governors
Ms. Weinbach, Senior Economist, Division of Monetary Affairs, Board of
Governors
Ms. Roush,3 Economist, Division of
Monetary Affairs, Board of Governors
Mr. Hambley,2 Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Gross, Special Assistant to the
Board, Office of Board Members,
Board of Governors

Messrs. Connors, Evans, Fuhrer, Kamin, Madigan, Rasche, Sellon,
Slifman, Tracy, and Wilcox, Associate Economists
Mr. Dudley, Manager, System Open
Market Account
Messrs. Clouse and English, Associate
Directors, Division of Monetary
Affairs, Board of Governors

2. Attended portion of the meeting relating to
the role of economic forecasts in policy communications.
3. Attended portion of the meeting relating to
the economic outlook and monetary policy discussion.

Minutes of FOMC Meetings, January
Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Messrs. Judd and Rosenblum, Executive Vice Presidents, Federal Reserve Banks of San Francisco and
Dallas
Mses. Mester and Mosser and Messrs.
Sniderman and Weinberg, Senior
Vice Presidents, Federal Reserve
Banks of Philadelphia, New York,
Cleveland, and Richmond, respectively
Mr. Cunningham, Vice President, Federal Reserve Bank of Atlanta
Mr. Weber, Senior Research Officer,
Federal Reserve Bank of Minneapolis
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 a term beginning January
30, 2007 had been received and that
these individuals had executed their
oaths of office.
The elected members and alternate
members were as follows:

185

W. Fisher, President of the Federal Reserve Bank of Dallas, as alternate.
Thomas M. Hoenig, President of the Federal
Reserve Bank of Kansas City, with
Gary H. Stern, President of the Federal
Reserve Bank of Minneapolis, as alternate.
By unanimous vote, the following officers of the Federal Open Market Committee were selected to serve until the
selection of their successors at the first
regularly scheduled meeting of the
Committee in 2008, 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:
Ben S. Bernanke
Timothy F. Geithner
Vincent R. Reinhart
Deborah J. Danker
Michelle A. Smith
David W. Skidmore
Scott G. Alvarez
Thomas C. Baxter, Jr.
Karen H. Johnson
David J. Stockton

Chairman
Vice Chairman
Secretary and
Economist
Deputy Secretary
Assistant Secretary
Assistant Secretary
General Counsel
Deputy General
Counsel
Economist
Economist

Thomas A. Connors, Charles L. Evans, Jeffrey C. Fuhrer, Steven B. Kamin, Brian
Timothy F. Geithner, President of the FedF. Madigan, Robert H. Rasche, Gordon
eral Reserve Bank of New York, with
H. Sellon, Lawrence Slifman, Joseph S.
Christine M. Cumming, First Vice
Tracy, and David W. Wilcox, Associate
President of the Federal Reserve Bank
Economists
of New York, as alternate.
By unanimous vote, the Committee
Cathy E. Minehan, President of the Federal amended its Rules of Organization by
Reserve Bank of Boston, with Charles
I. Plosser, President of the Federal Re- making a provision for a backup to the
serve Bank of Philadelphia, as alter- Manager of the System Open Market
nate.
Account should he/she be unable to
Michael H. Moskow, President of the Fed- serve, and it made several technical
eral Reserve Bank of Chicago, with changes to its Program for Security of
Sandra Pianalto, President of the Fed- FOMC Information.
eral Reserve Bank of Cleveland, as alBy unanimous vote, the Federal Reternate.
serve Bank of New York was selected to
William Poole, President of the Federal Re- execute transactions for the System
serve Bank of St. Louis, with Richard Open Market Account.

186 94th Annual Report, 2007
By unanimous vote, William C. Dudley 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.4
By unanimous vote, the Committee
approved the Authorization for domestic Open Market Operations with an
amendment to paragraph l(b) that brings
the language for repurchase agreements
into conformity with the authorization's
existing language for outright purchases
and reverse repurchase agreements. Accordingly, the Authorization for Domestic Open Market Operations was
adopted, effective January 30, 2007, as
shown below.
Authorization for Domestic Open
Market Operations
(Amended January 30, 2007)
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;
4. Secretary's note: Advice subsequently was
received that the selection of Mr. Dudley as Manager was satisfactory to the board of directors of
the Federal Reserve Bank of New York.

(b) To buy U.S. Government securities,
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 System Open
Market Account 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.
(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 i:>
dealers at rates that shall be determined by
competitive bidding. The Federal R^e r ve
Bank of New York shall set a minimum
lending fee consistent with the objectives of
the program and 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 and accounts maintained at the Federal
Reserve Bank of New York as fiscal agent of
the United States pursuant to Section 15 of
the Federal Reserve Act, the Federal Open
Market Committee authorizes and directs

Minutes of FOMC Meetings, January 187
the Federal Reserve Bank of New York (a)
for System Open Market Account, to sell
U.S. Government securities to such 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 such foreign,
international, and fiscal agency accounts
maintained at the Bank. Transactions undertaken with such accounts under the provisions of this paragraph may provide for a
service fee when appropriate.

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:

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.

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.

By unanimous vote, the Authorization for Foreign Currency Operations
was reaffirmed in the form shown
below.
Authorization for Foreign Currency
Operations
(Reaffirmed January 30, 2007)
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

Canadian dollars
Danish kroner
Euro
Pounds sterling
Japanese yen

Mexican pesos
Norwegian kroner
Swedish kronor
Swiss francs

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

188 94th Annual Report, 2007
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 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 non-market exchange rates.
4. It shall be the normal practice to
arrange with foreign central banks for the
coordination of foreign currency transactions. In making 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.
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). Such investments may include buying
or selling outright obligations of, or fully
guaranteed as to principal and interest by, a

foreign government or agency thereof; buying such securities under agreements for
repurchase of such securities; selling such
securities under agreements for the resale of
such securities; and holding various time
and other deposit accounts at foreign institutions. In addition, 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.
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 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.

Minutes of FOMC Meetings, January
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 3G(1) of the Board of Governors'
Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks
dated January 1, 1944.
By unanimous vote, the Foreign Currency Directive was reaffirmed in the
form shown below.

Foreign Currency Directive
(Reaffirmed January 30, 2007)
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
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.
3. Transactions may also be undertaken:
A. To adjust System balances in light of
probable future needs for currencies.
B. To provide means for meeting System and Treasury commitments in particular
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 Interna

189

tional Monetary Fund regarding exchange
arrangements under IMF Article IV.
By unanimous vote, the Procedural
Instructions with Respect to Foreign
Currency Operations were reaffirmed in
the form shown below.

Procedural Instructions
with Respect to
Foreign Currency Operations
(Reaffirmed January 30, 2007)
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 I.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.

190 94th Annual Report, 2007
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.
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 federal agency obligations
during the period since the previous
meeting. By unanimous vote, the Committee ratified these transactions.
The information reviewed at the January meeting, which included the advance data on the national income and
product accounts for the fourth quarter,
showed that economic expansion had
picked up in the fourth quarter of 2006,
but was uneven across sectors. Considerable vigor in consumer spending late
last year boosted economic growth in
the fourth quarter, supported by further
increases in employment and income. A
surge in net exports and a pickup in
defense spending also raised output
growth last quarter, but these factors

were expected to prove largely transitory. The decline in residential construction continued to weigh on overall activity, but some indications of stabilization
in the demand for homes had emerged.
Outlays for business fixed investment
softened in the fourth quarter. Although
a spike in energy prices lifted total consumer price inflation in December, readings on core inflation had edged lower
in recent months.
The labor market exhibited continued
strength through year-end. Nonfarm
payrolls rose robustly again in December, driven by further gains in the
service-producing sectors. Employment
in the manufacturing and construction
industries declined further, but by less
than in the previous several months. Aggregate hours of private production or
nonsupervisory workers edged up further. The unemployment rate held steady
at 4.5 percent.
Industrial production firmed in December after having softened in the preceding three months. Output of manufacturing industries rose noticeably in
December after being flat in November;
the increase was associated with sizable
gains in the production of semiconductors, computers, and commercial aircraft. Motor vehicle output turned up in
November and December, but remained
low compared with earlier in the year as
vehicle makers continued their efforts to
pare inventories. After contracting in
November, output in the mining sector
increased in December, boosted by a rise
in the production of crude oil. In contrast, unseasonably warm weather
caused a sharp cutback in the output of
utilities in December.
Real consumer spending rose briskly
in November and December, buoyed by
sizable increases in outlays for non-auto
consumer goods. Spending on services,
in contrast, appeared to be expanding
only moderately toward year-end, as

Minutes of FOMC Meetings, January
warmer-than-usual temperatures led to a
drop in real outlays for energy services
in November and probably damped expenditures in that category again in December. Real disposable income posted
solid gains in October and November
and likely rose further in December, reflecting increases in wages and salaries
and further declines in energy prices.
Although house-price appreciation appeared to have slowed further since the
end of the third quarter, robust gains in
equity prices likely resulted in a small
rise in the ratio of household wealth to
disposable income last quarter. Readings on consumer sentiment moved up
at the end of last year and held steady in
early 2007.
Residential construction activity remained quite weak late last year, but
home sales showed some tentative signs
of stabilization. Single-family housing
starts declined modestly in December,
reversing about half of November's
gain. However, new permit issuance
edged up in December after having
moved down steadily for nearly a year.
Construction in the multifamily sector,
which accounts for a much smaller share
of new home construction, rose sharply
in December to the upper end of the
range that has prevailed over the past
decade. Sales of existing single-family
homes held steady in November and
rose in December, while sales of new
homes inched up in both months. Inventories of unsold homes remained considerable although they ticked down in December for the second straight month.
The most timely indicators of home
prices, which are not adjusted for
changes in quality or the mix of homes
sold, pointed to small declines.
After having risen at a solid average
pace in the first three quarters of last
year, real investment in equipment and
software fell in the fourth quarter. Business outlays on transportation equip

191

ment, a volatile spending category,
dropped considerably. Sales of light vehicles to business customers declined to
their lowest level in two years, which
more than offset a surge in sales of medium and heavy trucks ahead of stricter
regulations on truck engine emissions
that went into effect this year. Spending
on high-tech capital goods moderated.
Outside of the transportation and hightech sectors, real spending declined last
quarter. That weakness appeared to be
concentrated in equipment related to
construction and motor vehicle manufacturing. Nonresidential construction
activity decelerated late last quarter;
however, indicators of future expenditures in this sector remained firm, with
office and industrial vacancy rates somewhat below their historical averages.
Overall, prospects for business spending
continued to be supported by robust
corporate cash flow and a low cost of
capital.
Business inventories remained elevated in the fourth quarter. In November, the book-value ratio of inventories
to sales for the manufacturing and trade
sectors (excluding motor vehicles) stood
near its highest level since early 2005.
Although relatively high ratios of inventories to sales appeared to be associated
in part with developments in the homebuilding and motor vehicle sectors,
some indications of inventory imbalances in other sectors had recently become evident.
The U.S. international trade deficit
narrowed again in October, primarily reflecting declines in both the price and
volume of imported oil. In addition, imports of non-oil industrial supplies, capital goods, and automotive products fell,
offsetting small increases in imports of
consumer goods, food, and services. In
November, the trade deficit edged down
further—to its smallest level since mid2005—as export growth outpaced a

192 94th Annual Report, 2007
modest increase in non-oil imports, and
oil imports remained flat.
Economic activity in the advanced
foreign economies appeared to have accelerated in the fourth quarter, supported
by a broad-based firming of domestic
demand and strong employment gains.
In the euro area, consumer sentiment
was lifted by lower unemployment, and
economic growth continued at a solid
pace. After contracting in the third quarter, consumption spending in Japan apparently rebounded last quarter, providing significant support to economic
activity. The expansion in the United
Kingdom's economy strengthened,
likely reflecting a pickup in consumption growth. Output growth in Canada
seemed to have firmed but likely remained below trend. Recent economic
data for the emerging-market economies
pointed to some moderation in the pace
of growth in the fourth quarter. In China,
the most recent evidence suggested that
growth had remained strong.
While large fluctuations in energy
prices continued to cause swings in
overall consumer price inflation in recent months, readings on core inflation
improved. Overall consumer prices were
flat in November, but turned up in December because of a surge in retail energy prices that month. Still, the rise in
the price index for personal consumption expenditures over the twelve
months ending in December was estimated to have been noticeably less than
that of the year-earlier period. Prices for
personal consumption expenditures
other than those for food and energy
were estimated to have increased
slightly faster over the twelve months of
2006 than they did a year earlier. However, the three-month change in core
prices in December likely was down
considerably from its peak in May. Yearover-year increases in average hourly
earnings late last year continued to run

ahead of those a year earlier. However,
hourly compensation of private industry
workers, as measured by the employment cost index, rose at a moderate rate
in the three months ending in December,
a touch below the pace registered in the
previous quarter. Survey measures of
households' year-ahead inflation expectations held steady through January at
levels that were below those reported in
the second and third quarters of last
year, and respondents' longer-term inflation expectations had been unchanged
since ticking down in the middle of
2006.
At its December meeting, the Federal
Open Market Committee (FOMC) decided to maintain its target for the federal funds rate at 5lA percent. The Committee's accompanying statement noted
that economic growth had slowed over
the course of the year, partly reflecting a
substantial cooling of the housing market. Although recent indicators had been
mixed, the economy seemed likely to
expand at a moderate pace on balance
over coming quarters. Readings on core
inflation had been elevated, and the high
level of resource utilization had the potential to sustain inflation pressures.
However, inflation pressures seemed
likely to moderate over time, reflecting
reduced impetus from energy prices,
contained inflation expectations, and the
cumulative effects of monetary policy
actions and other factors restraining aggregate demand. Nonetheless, the Committee judged that some inflation risks
remained. The extent and timing of any
additional firming that may be needed to
address these risks would depend on the
evolution of the outlook for both inflation and economic growth, as implied
by incoming information.
The FOMC's decision at the December meeting to leave its target for the
federal funds rate unchanged and to retain the language in the statement re-

Minutes of FOMC Meetings, January
garding the risks to inflation appeared to
match investors' expectations. However,
the characterization of recent economic
growth was reportedly interpreted by
market participants as suggesting a
slight softening in the Committee's outlook for the expansion. As a result, the
expected path of the federal funds rate
beyond the near term edged down. The
subsequent release of the minutes from
the meeting elicited little market reaction. Investors' outlook for economic
activity firmed over the intermeeting period, as economic data releases came in
stronger than expected and oil prices declined notably. As a result, investors
markedly reduced the extent of policy
easing anticipated over coming quarters,
and yields on nominal and inflationindexed Treasury coupon securities rose.
Measures of inflation compensation
were little changed on net. Spreads of
investment-grade corporate bond yields
over those of comparable-maturity Treasury securities moved down a bit, while
those of speculative-grade issues declined significantly more. Broad equity
indexes edged higher. The foreign exchange value of the dollar against other
major currencies rose, on balance, particularly versus the yen.
Debt of the domestic nonfinancial
sectors was estimated to have expanded
in the fourth quarter at a pace that was
close to that registered over the first
three quarters of the year. A pickup in
merger-related borrowing appeared to
boost business debt growth last quarter,
and a sharp rise in the issuance of bonds
and commercial paper more than offset
a moderation in bank loans. In the
household sector, the ongoing deceleration in house prices further restrained
the growth of home mortgage debt. M2
continued to expand briskly in December and January, primarily reflecting
strength in its liquid deposit component.

193

In its forecast prepared ahead of the
meeting, the staff had revised up its estimate of growth of aggregate economic
activity in the fourth quarter. Nonetheless, real GDP in the second half of last
year was still projected to have increased at a pace that was a bit below
the economy's long-run potential, primarily because of the ongoing adjustment in the housing sector and the lower
level of motor vehicle production. Looking ahead, the staff expected the rate of
increase in real GDP to be little changed
in 2007 relative to the projected pace for
the second half of 2006. However, with
the contraction in housing activity expected to abate this year, the pace of
economic growth was anticipated to
edge back up to a level that was close to
the staffs estimate of potential output
growth by the end of 2007 and to remain
in that same range throughout 2008. In
light of developments in futures markets, the paths of both energy and import prices were projected to be lower
than was previously thought. Against
this background and with the rate of increase of shelter prices slowing down,
the staff expected core inflation to edge
down in 2007 and 2008. The advance
data on the national income and product
accounts for the fourth quarter that were
released on the morning of the second
day of the FOMC meeting showed
stronger-than-expected net exports and
a larger-than-anticipated accumulation
of inventories. The staff interpreted this
information as suggesting some upward
revision to its estimate of output growth
in the fourth quarter and perhaps a slight
downward revision to its forecast for the
current quarter.
In their discussion of the economic
situation and outlook, meeting participants noted that the economic information received since the last meeting
pointed to a somewhat more favorable
outlook regarding both inflation and

194 94th Annual Report, 2007
economic growth than they had earlier
anticipated. Incoming data suggesting a
leveling out in housing demand and
strength in consumer spending outside
the housing sector supported the view
that the expansion remained resilient despite the appreciable decline in housing
activity and recent weakness in the
manufacturing sector. Over the next several quarters, economic activity would
likely advance at a pace at or modestly
below the economy's trend rate of
growth. Thereafter, growth was likely to
return to around its trend rate, which
several participants viewed as likely to
be higher than the staff's estimate. Favorable readings on core inflation and
lower energy prices had also improved
the odds that inflation pressures would
diminish. However, it was noted that the
prevailing level of inflation was uncomfortably high, and resource utilization
was elevated. The upside risks to inflation remained the Committee's predominant concern.
In preparation for the Federal Reserve's semiannual report to the Congress on the economy and monetary
policy, the members of the Board of
Governors and the presidents of the Federal Reserve Banks submitted individual
projections of the growth of nominal and
real GDP, the rate of unemployment, and
core consumer price inflation for the
years 2007 and 2008, conditioned on
their views of the appropriate path for
monetary policy. The projections of the
growth of nominal GDP were in the
range of 43/4 to 5Vi percent for both
years, with a central tendency of 5 to
5V2 percent for 2007 and 43/4 to 5lA percent for 2008. Projections of the rate of
expansion in real GDP for 2007 were in
the 2lA to 3J/4 percent range, with a central tendency of 2Vi to 3 percent; for
2008 the forecasts were in the slightly
higher range of 2lh to 3V4 percent, with
a central tendency of 23A to 3 percent.

These rates of growth were associated
with a civilian unemployment rate in the
range of AVi to 43/4 percent in the fourth
quarter of 2007 and AV2 to 5 percent in
the fourth quarter of 2008; the central
tendency of these projections was AV2 to
43/4 percent for both years. The rate of
inflation, as measured by the core PCE
price index, was projected to edge down
from a range of 2 to 2lA percent in 2007,
with the central tendency being the
same, to a range of 1 Vi to 2lA percent in
2008, centered on l3/4 to 2 percent.
In their discussion of the major sectors of the economy, participants noted
that the housing market showed tentative signs of stabilization in most regions. Anecdotal reports presented a
mixed picture, with fairly firm home
sales in some areas but continuing decline in others. But aggregate data indicated that home sales, which had been
essentially flat since mid-year, had risen
a bit during the fourth quarter. Mortgage
applications for home purchases had
risen from their low levels of last summer. Sentiment among homebuilders reportedly had improved in the past few
months, and the inventory of new homes
for sale had fallen. Nonetheless, participants noted that inventories remained elevated and needed to be worked down
before growth in this sector resumed.
Unseasonably warm weather so far this
winter complicated the interpretation of
recent data, but participants were optimistic that the risk of a much larger
contraction in housing had diminished
and that the drag on growth from the
housing sector would ease later this
year.
Participants saw continued gains in
employment and incomes and lower energy prices as sustaining solid growth in
consumer spending. Contacts reported
healthy holiday sales in many regions,
particularly late in the Christmas season.
In addition, the growth of gift cards was

Minutes of FOMC Meetings, January
mentioned as a factor that likely boosted
retail sales in January. To date, weakness in the housing market had not appeared to have spilled over to aggregate
consumption, although some such effect
could not be ruled out as the growth in
households' home equity slowed. The
recent strength of consumption spending, together with favorable readings
from consumer sentiment surveys, suggested that households were optimistic
about prospects for employment and income. Indeed, the possibility that the
personal saving rate would fail to rise as
in the staff forecast was cited by some
participants as posing a significant upside risk to the outlook.
Meeting participants noted that continued gains in nonresidential construction spending were offsetting some of
the weakness on the residential side.
Further advances in nonresidential investment were likely. Office vacancy
rates were reported as declining in some
areas. However, the recent decrease in
energy prices had already led to a reduction in drilling activity and was likely to
reduce some investment in alternative
fuels. Participants noted that business
fixed investment overall continued to be
weaker than anticipated, suggesting
some caution on the part of businesses
in expanding capacity. Nonetheless, participants expected that, going forward,
favorable financial conditions, strong
corporate balance sheets, high profitability, and growth in sales would support a
firming of investment spending.
Net exports were unexpectedly strong
in the fourth quarter. In part, this development could be attributed to a temporary reduction in petroleum imports as
a result of the unseasonably warm
weather. Although imports were likely
to pick up again, global economic
growth, which had been strong of late,
was expected to continue to provide ongoing support for growth in exports.

195

The more favorable budget positions
of the state and local governments were
seen as permitting additional spending
by such governmental units and hence
as an additional source of stimulus to
the economy. Strong federal tax receipts
suggested that personal incomes were
expanding vigorously.
Participants reported some continuing
softness in manufacturing, primarily in
industries related to housing or automobiles. The recent slackness in manufacturing activity appeared to be largely an
inventory correction, which participants
expected would be completed this year.
Participants noted that the tone of contacts in the industrial sector was generally more positive than at the time of the
December meeting, and some survey information pointed to expectations of a
rebound in manufacturing activity later
this year. However, the recent declines
in energy prices were likely to restrain
energy extraction as well as activity in
associated energy-producing sectors.
Many participants observed that labor
markets remained relatively taut, with
significant wage pressures being reported in some occupations. In addition
to the continuing shortages of skilled
workers in technical and professional
fields, recent reports suggested a scarcity of less skilled and unskilled workers in some areas of the country. One
participant observed that some of the
sluggishness in manufacturing job
growth could be due to difficulties in
hiring rather than indicating weakness
in demand. So far, aggregate measures
of labor compensation were showing
only moderate increases, but looking
ahead, the possibility that labor costs
might rise more rapidly as a result of the
tightness in labor market was seen as an
upside risk to inflation.
All meeting participants expressed
some concern about the outlook for inflation. To be sure, incoming data had

196 94th Annual Report, 2007
suggested some improvement in core inflation, and a further gradual decline
was seen as the most likely outcome,
fostered in part by the continued stability of inflation expectations. However,
participants did not yet see a downtrend
in core inflation as definitively established. Although lower energy prices,
declining core import prices, and a deceleration in owners' equivalent rent
were expected to contribute to slower
core inflation in coming months, the
effects of some of these factors on inflation could well be temporary. The influence of more enduring factors, importantly including pressures in labor
and product markets and the behavior of
inflation expectations, would primarily
determine the extent of more persistent
progress. In light of the apparent
underlying strength in aggregate demand, risks around the desired path of a
further gradual decline in core inflation
remained mainly to the upside.
Participants emphasized that a failure of
inflation to moderate as expected could
impair the long-term performance of the
economy.
In the Committee's discussion of
monetary policy for the intermeeting period, all members favored keeping the
target federal funds rate at 5VA percent at
this meeting. The confluence of betterthan-expected news on economic activity and inflation suggested somewhat
smaller downside risks to economic
growth as well as improved prospects
for core inflation. Recent developments
were seen as supporting the Committee's view that maintaining the current
target was likely to foster moderate economic growth and to further the gradual
reduction of core inflation from its elevated level over the past year. Nonetheless, Committee members saw continued risks to the economic outlook. The
ongoing contraction in the housing

sector and the potential for spillovers to
other sectors remained notable downside risks to economic activity, although
those risks had diminished somewhat,
and continuing strength in consumption
suggested upside risks as well. All members agreed that the predominant concern remained the risk that inflation
would fail to moderate as desired.
In light of the recent economic data
and anecdotal information, the Committee agreed that the statement to be released after the meeting should acknowledge evidence of somewhat firmer
economic growth and tentative signs of
stabilization in the housing market.
They further agreed that the statement
should reiterate that the economy
seemed likely to expand at a moderate
pace over coming quarters. The statement would also note the modest improvement in readings on core inflation
and the Committee's view that inflation
pressures seemed likely to moderate
over time. The members discussed
whether the balance of risks language in
its recent statements still was the best
way to represent the views of the Committee and decided that a change was
not warranted at this time. All members
agreed that the statement should continue to stress that some inflation risks
remained and note that additional policy
firming was possible.
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 andfinancialconditions 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

Minutes of FOMC Meetings, March 197
markets consistent with maintaining the
federal funds rate at an average of around
5lA percent.

mously approved the minutes of the
FOMC meeting held on December 12,
2006.
By notation vote completed on JanuThe vote encompassed approval of
the text below for inclusion in the state- ary 5, 2007, the Committee unanimously
selected William C. Dudley to serve at
ment to be released at 2:15 p.m.:
the pleasure of the Committee as ManThe Committee judges that some inflation
risks remain. The extent and timing of any ager, System Open Market Account, on
additional firming that may be needed to the understanding that his selection was
address these risks will depend on the evolu- subject to being satisfactory to the Fedtion of the outlook for both inflation and eral Reserve Bank of New York.
economic growth, as implied by incoming
Secretary's note: Advice subseinformation.
quently was received that the selection
Votes for this action: Messrs. Bernanke of Mr. Dudley as Manager was satisfacand Geithner, Ms. Bies, Messrs. Hoe- tory to the board of directors of the Fednig, Kohn, and Kroszner, Ms. Minehan,
Messrs. Mishkin, Moskow, Poole, and eral Reserve Bank of New York.
Warsh. Votes against this action: None.
Vincent R. Reinhart
Secretary
The Committee then moved on to a
discussion of the role of economic projections in policy communications. Meeting Held on
Meeting participants reviewed the ob- March 20-21, 2007
jectives, advantages, and disadvantages
of potential changes to the production A meeting of the Federal Open Market
and communication of policymakers' Committee was held in the offices of the
forecasts of key economic variables. Board of Governors of the Federal ReThey expressed support for continuing serve System in Washington, D.C., on
to report summaries of their individual Tuesday, March 20, 2007 at 2:30 p.m.,
forecasts, which they now make twice a and continued on Wednesday, March 21,
year and which are included in the Mon- 2007 at 9:00 a.m.
etary Policy Report. Participants agreed Present:
to explore whether changes to current
Mr. Bernanke, Chairman
practices might facilitate improved comMr. Geithner, Vice Chairman
Mr. Hoeni^
munication internally among themselves
Mr. Kohn
during the policy debate and externally
Mr. Kroszner
by providing the public with additional
Ms. Minehan
context for understanding the CommitMr. Mishkin
tee's policy decisions. No decisions on
Mr. Moskow
Mr. Poole
any such changes were made at this
Mr. Warsh
meeting, and a further discussion of
communications topics was planned for
Ms. Cumming, Mr. Fisher, Ms. Pianthe next FOMC meeting, confirmed for
alto, and Messrs. Plosser and
Stern, Alternate Members of the
March 20-21, 2007.
Federal Open Market Committee
The meeting adjourned at 2:45 p.m.
Notation Votes
By notation vote completed on December 29, 2006, the Committee unani

Messrs. Lacker and Lockhart, and Ms.
Yellen, Presidents of the Federal
Reserve Banks of Richmond, Atlanta, and San Francisco, respectively

198

94th Annual Report, 2007
Mr. Reinhart, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist

Mr. Gross, Special Assistant to the
Board, Office of Board Members,
Board of Governors

Messrs. Connors, Evans, Fuhrer, Kamin, Madigan, Rasche, Slifman,
and Wilcox, Associate Economists

Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors

Mr. Dudley, Manager, System Open
Market Account

Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors

Messrs. Clouse and English,5 Associate
Directors, Division of Monetary
Affairs, Board of Governors
Mr. Struckmeyer, Associate Director,
Division of Research and Statistics, Board of Governors
Mr. Reifschneider, Deputy Associate
Director, Division of Research and
Statistics, Board of Governors
Messrs. Dale6 and Oliner, Senior Advisers, Divisions of Monetary Affairs
and Research and Statistics, respectively. Board of Governors
Mr. Hambley,6 Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Affairs, Board of Governors
Mr. Small,5 Project Manager, Division
of Monetary Affairs, Board of
Governors
Mr. Kiley6 and Ms. Kole,6 Section
Chiefs, Divisions of International
Finance and Research and Statistics, respectively, Board of Governors
Mr. Doyle,6 Ms. Mauskopf,6 and Mr.
Wood,6 Senior Economists, Divisions of International Finance, Research and Statistics, and International Finance, respectively, Board
of Governors
5. Attended Wednesday's session.
6. Attended portion of the meeting relating to
the discussion of communications issues.

Ms. Roush, Economist, Division of
Monetary Affairs, Board of Governors

Mr. Rosenblum, Executive Vice President, Federal Reserve Bank of
Dallas
Mr. Hakkio, Ms. Mester, Messrs.
Rolnick, Rudebusch, and Sniderman, Senior Vice Presidents, Federal Reserve Banks of Kansas City,
Philadelphia, Minneapolis, San
Francisco, and Cleveland, respectively
Messrs. Cunningham and Hilton, Vice
Presidents, Federal Reserve Banks
of Atlanta and New York, respectively
Ms. Sbordone, Research Officer, Federal Reserve Bank of New York
Mr. Hetzel, Senior Economist, Federal
Reserve Bank of Richmond
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 federal agency obligations
during the period since the previous
meeting. By unanimous vote, the Committee ratified these transactions.
The information reviewed at the
March meeting indicated that the
economy appeared to be expanding at a

Minutes of FOMC Meetings, March 199
modest pace in the first quarter. Declines in residential construction activity
continued to weigh on overall activity,
and business investment had softened
considerably over the preceding several
months, especially in equipment used in
the construction and motor vehicle industries. However, consumer spending
had increased appreciably in the early
part of the year, and labor demand continued to expand, albeit at a somewhat
slower pace than last year. Meanwhile,
the twelve-month increase in core consumer prices remained elevated relative
to its pace one year earlier.
Employment gains moderated in early
2007. In February, employment in the
construction industry contracted considerably, in part because of severe winter
storms; manufacturing employment also
declined, but hiring in service-producing
sectors remained solid. A decline in the
average workweek led to a contraction
in aggregate hours. At the same time,
the unemployment rate edged down
from 4.6 percent in January to 4.5 percent in February.
Industrial production rose strongly in
February and was revised up for both
December and January. In February,
production was boosted by a rebound in
motor vehicle assemblies and by a temporary surge in output at utilities that
reflected a swing from unseasonably
warm temperatures in January to colder
weather in February. Production rose at
a solid pace in all major high-tech categories. Output of materials and defense
and space equipment expanded as well.
In contrast, production of consumer
goods and business equipment changed
little, while output of construction supplies declined.
Real consumer spending appeared on
track to rise at a robust pace in the first
quarter, buoyed in part by a weatherrelated surge in spending on energy services and by a jump in sales of light

motor vehicles. Outside of these areas,
however, real consumer spending moderated. The determinants of household
spending were mixed. Disposable personal income was estimated to have
risen sharply in January, but the increase
was partly the result of special factors,
such as pay raises for federal and military personnel and cost-of-living adjustments to Social Security payments.
Meanwhile, readings on consumer sentiment, which had been favorable in recent months, edged down in early
March. The boost to consumer spending
from earlier gains in wealth was likely
being muted by the lagged effects of the
upward trend in borrowing costs. In addition, recent declines in equity prices
and slowing house price appreciation
pointed to a modest reduction in households' wealth-to-income ratio in the first
quarter.
Housing starts declined in January,
extending the downward trend that had
been in place since early 2006, but
bounced back in February. However, adjusted permit issuance in the singlefamily sector continued to step down,
suggesting that builders were still slowing the pace of new construction to work
off elevated inventories. The inventory
of new homes for sale remained high,
although cuts in residential construction
in the last few months had reduced the
number of unsold homes. As at the time
of the January meeting, available data
suggested that housing demand was stabilizing. Sales of both new and existing
single-family homes in recent months
were, on balance, in line with the pace
seen since mid-2006. However, a tightening of standards for subprime borrowers in recent weeks seemed likely to
restrain home sales. House price appreciation had slowed further, with some
measures showing outright declines in
home values.

200 94th Annual Report, 2007
Business fixed investment had been
sluggish in recent months. Real spending on equipment and software fell in
the fourth quarter, and nominal orders
for and shipments of nondefense capital
goods excluding aircraft posted widespread declines in January, with transportation equipment showing a very
large drop. Business purchases of light
vehicles remained low, and new orders
for and deliveries of medium and heavy
trucks plunged in the last few months
after a surge in 2006. Investment in
goods and services other than transportation and high-tech equipment softened
more than fundamentals had suggested.
Declines in spending for capital equipment that is used heavily in the construction and motor vehicle industries
accounted for an outsized share of the
drop in orders and shipments at manufacturers outside high-tech and transportation in January. Investment in categories such as industrial equipment;
electromedical, measuring, and controlling devices; and other electrical equipment also softened. In contrast, computer imports surged in January,
suggesting rising domestic purchases,
and computer sales appeared to have
picked up in February. The ample cash
reserves held by firms and ongoing reductions in the user cost of high-tech
capital goods remained supportive of investment going forward.
Businesses accumulated inventories
of items other than motor vehicles at a
slower pace in January than in the previous two quarters. Even so, the ratio of
inventories to sales for manufacturing
and trade excluding motor vehicles remained elevated. In addition, purchasing managers at manufacturing firms, on
net, continued to view their customers'
inventory levels as too high.
The U.S. international trade deficit
narrowed considerably in the fourth
quarter. Exports rose, partly reflecting a

robust increase in deliveries of civilian
aircraft to foreign buyers, while imports
were pushed down by a fall in the volume and price of imported oil. In January, the trade deficit was little changed.
Economic activity in the advanced
foreign economies accelerated in the
fourth quarter. In Japan, private consumption rebounded strongly, and private investment and net exports continued to boost growth. The pace of
economic expansion in the euro area
picked up as investment and exports
rose. Growth in the United Kingdom
firmed because of brisk investment
spending and a rebound in consumption
growth. In contrast, output in Canada
decelerated in the fourth quarter as inventory accumulation turned down
sharply. Recent data for the emergingmarket economies pointed to continued
strength in activity, although there were
signs that growth was moderating in
some countries. Growth remained solid
in China but decelerated in several other
Asian economies and Mexico.
In January, the overall PCE price index rose moderately as a decline in energy prices helped to offset a jump in
food prices. Meanwhile, the PCE price
index excluding food and energy rose at
a faster pace than in the previous two
months. Increases in consumer energy
prices and higher prices for fruits and
vegetables in February reflected a period of unusually cold weather and contributed to an acceleration in that
month's CPI. Excluding food and energy, core CPI inflation slowed slightly
in February but remained elevated. In
recent months, prices had risen across a
broad range of core goods. On a twelvemonth-change basis, core CPI inflation
in February was considerably above its
pace a year earlier, largely because of a
sharp acceleration in shelter rents over
the past year. Average hourly earnings
also rose at a noticeably faster pace dur-

Minutes of FOMC Meetings, March 201
ing the year ending in February than
during the preceding twelve-month period. Surveys indicated that households'
expectations of inflation over the next
year were little changed in February
while households' and professional forecasters' longer-term inflation expectations edged lower.
At its January meeting, the Federal
Open Market Committee maintained its
target for the federal funds rate at
5x/4 percent. The Committee's accompanying statement noted that recent indicators had suggested somewhat firmer
economic growth and that some tentative signs of stabilization had appeared
in the housing market. Overall, the
economy seemed likely to expand at a
moderate pace over coming quarters.
Readings on core inflation had improved
in recent months, and inflation pressures
seemed likely to moderate over time,
but the high level of resource utilization
had the potential to sustain inflation
pressures. The Committee judged that
some inflation risks remained. The extent and timing of any additional firming that might be needed to address
these risks would depend on the evolution of the outlook for both inflation and
economic growth, as implied by incoming information.
The FOMC's decision at its January
meeting was in accord with market expectations, but the accompanying statement reportedly was read as a sign that
the Committee was more sanguine about
inflation prospects than in December,
and the expected path for monetary
policy beyond 2007 edged lower. Policy
expectations declined a bit more in the
wake of the Chairman's semiannual
monetary policy testimony, which apparently reinforced investors' beliefs
that the FOMC anticipated gradually diminishing inflation pressures. Economic
data releases were somewhat weaker
than expected on balance over the first

few weeks of the intermeeting period,
and policy expectations moved appreciably lower on net by mid-February.
Financial market volatility increased
sharply in the second half of the intermeeting period amid an apparent pullback from risk-taking that was reportedly spurred by mixed news on domestic
economic activity, mounting concerns
about the subprime mortgage sector, and
significant declines in foreign equity
prices. On net over the intermeeting period, investors tilted their anticipated
path for monetary policy beyond mid2007 down substantially, and yields on
two- and ten-year nominal Treasury securities fell 30 to 40 basis points. Yields
on inflation-indexed Treasury securities
generally declined somewhat less than
their nominal counterparts, leaving inflation compensation slightly lower
across the term structure. Broad stock
price indexes dropped several percent
on net over the period. Yields on
investment-grade corporate bonds fell
about in line with those on Treasury securities of comparable maturity. In contrast, yields on speculative-grade bonds
declined only modestly, leaving risk
spreads noticeably wider, albeit still narrow by historical standards.
Domestic nonfinancial sector debt appeared to be continuing to rise at a relatively brisk rate in the first quarter. Despite the recent volatility in financial
markets, funding in the bond and syndicated loan markets appeared to remain
readily available. However, borrowing
by nonfinancial corporations was estimated to be moderating somewhat in the
first quarter, with a step-down in bond
issuance associated with merger and acquisition activity. Indicators pointed to a
continuing deceleration in house prices
this quarter, and home mortgage borrowing probably continued to slow. M2
increased more moderately in February
than at the end of 2006 as the expansion

202 94th Annual Report, 2007
of liquid deposits slowed from its outsized fourth-quarter rate.
In its forecast prepared for this meeting, the staff marked down the projected
increase in real GDP in the first quarter
in response to weaker-than-expected incoming data on business equipment
spending and federal defense purchases.
The recent increase in oil prices and decline in equity prices, along with increased strains in the subprime mortgage sector, were expected to exert some
drag on real activity over the remainder
of the year. Even so, real GDP growth
was expected to pick up to a rate a little
below that of the economy's long-run
potential for the remainder of 2007, as
declines in residential construction activity lessened, and to remain at a similar rate in 2008. The increase in energy
prices over the intermeeting period led
the staff to revise up its forecast for
headline PCE inflation during the first
half of this year, but the staff continued
to expect that core PCE inflation would
edge down over the remainder of this
year and next.
In their discussion of the economic
situation and outlook, meeting participants agreed that, while recent economic
data had been mixed, the economy was
likely to expand at a moderate pace in
coming quarters. Although the housing
sector adjustment continued, accumulating data suggested that the demand for
homes was leveling out. Business fixed
investment had been soft in recent
months, but financing conditions and
other fundamentals remained favorable
for a pickup in capital spending. Moreover, continuing gains in personal income could be expected to support
growth in consumer spending. Thus economic growth likely would increase in
coming quarters to a pace close to or
modestly below the economy's trend
growth rate. However, additional evidence of sluggish business investment

and recent developments in the
subprime mortgage market suggested
that the downside risks relative to the
expectation of moderate growth had increased in the weeks since the January
FOMC meeting. At the same time, the
prevailing level of inflation remained
uncomfortably high, and the latest information cast some doubt on whether core
inflation was on the expected downward
path. Most participants continued to expect that core inflation would slow
gradually, but the recent readings on inflation and productivity growth, along
with higher energy prices, had increased
the odds that inflation would fail to
moderate as expected; that risk remained
the Committee's predominant concern.
Participants reported signs of stabilization in housing demand in most regions of the country. At the national
level, sales of new and existing homes,
while fluctuating in recent months, did
not display declining trends. The inventory of new homes for sale reportedly
had fallen further from its recently elevated level. Participants noted, however, that such inventories likely would
need to be worked down appreciably
more before growth in housing construction would resume. The increase in delinquencies on subprime adjustable-rate
mortgage loans and the ensuing increase
in interest rates and tightening of credit
standards in the subprime mortgage
market likely would constrain home purchases by some borrowers, perhaps retarding the recovery in the housing sector. However, there was no sign of
spillovers from the subprime market to
the overall mortgage market; indeed, interest rates on prime mortgage loans had
declined somewhat in recent weeks,
along with yields on U.S. Treasury securities. Moreover, home-buying attitudes
had improved and continuing job growth
could be expected to support home
sales.

Minutes of FOMC Meetings, March 203
Business fixed investment spending
had been surprisingly weak of late,
given strong corporate balance sheets,
high profitability, anticipated growth in
sales, and favorable financial conditions.
Participants continued to expect these
fundamentals to support a firming of investment spending going forward, and
they saw no indication that recent market volatility had prompted a reduction
in the availability of financing for business investment. Also, declining office
vacancy rates in some areas were spurring gains in nonresidential construction
activity, and further advances in commercial construction were seen as likely.
Energy prices were high enough to encourage continued investment in alternative fuels. However, the relatively slow
pace of investment in recent months
might be signaling that business executives had become less certain about the
outlook, and perhaps that they expected
quite modest gains in sales. Participants
agreed that the possibility of persistently
sluggish investment spending was an
important downside risk to the outlook
for economic growth.
Growth in consumer spending would
likely continue to be supported by gains
in employment and incomes. Meeting
participants noted that weakness in the
housing market had not spilled over to
aggregate consumption—though the
flattening out in house prices likely
would contribute to an increase in the
personal saving rate—and turmoil in the
subprime mortgage market did not appear to be generating any diminution in
the availability of other types of household credit. The recent increase in oil
prices and the reduction in household
net worth resulting from the small net
declines in equity prices during the intermeeting period warranted a modest
downward adjustment in projected
growth of consumer spending. Even so,
the possibility that the personal saving

rate would fail to rise as projected in the
staff forecast remained an upside risk to
the outlook.
Growth in federal as well as state and
local government spending probably
would remain a source of stimulus to the
economy. Moreover, continued expansion in domestic demand in our major
trading partners could be expected to
sustain solid growth in U.S. exports.
Many participants again reported softness in manufacturing, primarily but not
exclusively in industries related to housing or automobiles. However, a number
of firms outside of the housing sector—
including auto companies—appeared to
have made progress in reducing inventories to more comfortable levels,
and contacts in the industrial sector
were generally optimistic about future
growth. Such attitudes were consistent
with national and regional surveys that
pointed to a rebound in manufacturing
activity later this year.
Anecdotal and statistical evidence
suggested that labor markets remained
relatively tight. Business contacts continued to report shortages of skilled
workers in technical and professional
fields, with significant wage pressures
in some occupations, as well as a scarcity of less skilled and unskilled workers in some areas of the country. So far,
aggregate measures of labor compensation were showing only moderate increases, but, looking ahead, the possibility that labor costs might rise more
rapidly was seen as an upside risk to
inflation. It was noted, however, that increases in compensation that exceeded
productivity gains might be absorbed to
some extent by a narrowing of firms'
high profit margins. Participants expected that productivity growth would
pick up as firms slowed hiring to a pace
more in line with output growth but acknowledged that the improvement might

204 94th Annual Report, 2007
be limited, particularly if business investment spending were to remain soft.
Most participants continued to expect
a gradual decline in core inflation over
the next year or two, fostered by stable
inflation expectations, a likely deceleration in shelter costs, and a slight easing
of pressures on resources. Nonetheless,
all meeting participants expressed concern about the risks to this outlook. The
latest readings on core inflation were
higher than expected, and it was difficult to discern whether the apparent
downward trend in core inflation during
the past few quarters was continuing.
Also, the recent increases in prices for
energy and some non-energy imports
likely would boost overall inflation in
the near term and might put upward
pressure on prices of some core goods
and services. Moreover, rates of resource utilization that were near the high
end of historical experience suggested a
possibility that inflation pressures could
build. Participants agreed that risks
around the expected and desired path of
a gradual decline in core inflation remained mainly to the upside; some
noted that upside risks to inflation appeared to have increased slightly in recent months.
In the Committee's discussion of
monetary policy for the period between
its March and May meetings, all members favored keeping the target federal
funds rate at 5lA percent. Recent developments were seen as supporting the
Committee's view that maintaining the
current target was likely to foster moderate economic growth and to further the
gradual reduction of core inflation from
its elevated level. Nonetheless, the combination of generally weaker-thanexpected economic indicators and uncomfortably high readings on inflation
suggested increased downside risks to
economic growth and greater uncer

tainty that the expected gradual decline
in core inflation would materialize.
In light of the recent economic data
and anecdotal information, the Committee agreed that the statement to be released after the meeting should note that
economic indicators had been mixed,
that the adjustment in the housing market was ongoing, and that the economy
seemed likely to expand at a moderate
pace over coming quarters. Members
agreed the statement also should indicate that inflation pressures seemed
likely to moderate over time, but that
recent readings on core inflation had
been somewhat elevated and the high
level of resource utilization had the potential to sustain inflation pressures. A
persistence of inflation at recent rates
could eventually have adverse consequences for economic performance. All
members agreed the statement should
indicate that the Committee's predominant policy concern remains the risk that
inflation will fail to moderate as expected. The Committee agreed that further policy firming might prove necessary to foster lower inflation, but in light
of the increased uncertainty about the
outlook for both growth and inflation,
the Committee also agreed that the statement should no longer cite only the possibility of further firming. Instead, the
statement should indicate that future
policy adjustments will depend on the
evolution of the outlook for both inflation and economic growth, as implied
by incoming 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 andfinancialconditions that

Minutes of FOMC Meetings, May 205
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
5lA percent.

It was agreed that the next meeting of
the Committee would be held on
Wednesday, May 9, 2007.
The meeting adjourned at 1:30 p.m.

The vote encompassed approval of
the text below for inclusion in the statement to be released at 2:15 p.m.:

By notation vote completed on February
20, 2007, the Committee unanimously
approved the minutes of the FOMC
meeting held on January 30-31, 2007.

In these circumstances, the Committee's
predominant policy concern remains the risk
that inflation will fail to moderate as
expected. Future policy adjustments will
depend on the evolution of the outlook for
both inflation and economic growth, as
implied by incoming information.
Votes for this action: Messrs. Bernanke,
Geithner, Hoenig, Kohn, and Kroszner,
Ms. Minehan, Messrs. Mishkin, Moskow, Poole, and Warsh. Votes against
this action: None.

Notation Vote

Vincent R. Reinhart
Secretary
Meeting Held on
May 9, 2007
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, May 9, 2007 at 8:30 a.m.

The Committee then returned to the
topic of improving policy communica- Present:
Mr. Bernanke, Chairman
tions. Participants expressed a range of
Mr. Geithner, Vice Chairman
views on the possible advantages and
Mr. Hoenig
disadvantages of specifying a numerical
Mr. Kohn
price objective for monetary policy and
Mr. Kroszner
on technical aspects of a quantification.
Ms. Minehan
Mr. Mishkin
Participants emphasized that any such
Mr. Moskow
move would need to be consistent with
Mr. Poole
the Committee's statutory objectives for
Mr. Warsh
promoting maximum employment as
Mr. Fisher, Ms. Pianalto, and Messrs.
well as price stability. The Committee
Plosser and Stern, Alternate Memmade no decisions on this issue. Particibers of the Federal Open Market
pants also discussed the communicaCommittee
tions role of the economic projections
Messrs. Lacker and Lockhart, and Ms.
that are made periodically by the memYellen, Presidents of the Federal
bers of the Board of Governors and the
Reserve Banks of Richmond, AtReserve Bank presidents. A number of
lanta, and San Francisco, respectively
substantive and practical issues would
still need to be evaluated before the
Mr. Reinhart, Secretary and Economist
Committee could make decisions about
Ms. Danker, Deputy Secretary
an enhanced role for projections in exMs. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
plaining policy. The Committee planned
Mr. Alvarez, General Counsel
to continue its review of communication
Mr. Baxter, Deputy General Counsel
issues at the FOMC meeting in June
Ms. Johnson, Economist
2007.
Mr. Stockton, Economist

206 94th Annual Report 2007
Messrs. Connors, Evans, Kamin, Madigan, Rasche, Slifman, Tracy, and
Wilcox, Associate Economists
Mr. Dudley, Manager, System Open
Market Account
Messrs. Clouse and English, Associate
Directors, Division of Monetary
Affairs, Board of Governors
Ms. Liang and Mr. Struckmeyer, Associate Directors, Division of Research and Statistics, Board of
Governors
Messrs. Leahy and Wascher, Deputy
Associate Directors, Divisions of
International Finance and Research and Statistics, respectively
Mr. Dale, Senior Adviser, Division of
Monetary Affairs
Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors
Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Mr. Carlson, Economist, Division of
Monetary Affairs, Board of Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Ms. Green, First Vice President, Federal Reserve Bank of Richmond
Mr. Rosenblum, Executive Vice President, Federal Reserve Bank of
Dallas
Mr. Hakkio, Ms. Perelmuter, Messrs.
Rolnick, Rudebusch, Sniderman,
and Weinberg, Senior Vice Presidents, Federal Reserve Banks of
Kansas City, New York, Minneapolis, San Francisco, Cleveland,
and Richmond, respectively
Messrs. Dotsey, Tallman, and Tootell,
Vice Presidents, Federal Reserve

Banks of Philadelphia, Atlanta,
and Boston, respectively
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 federal agency obligations
during the period since the previous
meeting. By unanimous vote, the Committee ratified these transactions.
By unanimous vote, the Committee
extended for one year beginning in midDecember 2007 the reciprocal currency
("swap") arrangements with the Bank of
Canada and the Banco de Mexico. The
arrangement with the Bank of Canada is
in the amount of $2 billion equivalent
and that with the Banco de Mexico is in
the amount of $3 billion equivalent.
Both arrangements are associated with
the Federal Reserve's participation in
the North American Framework Agreement of 1994. The vote to renew the
System's participation in the swap arrangements maturing in December was
taken at this meeting because of the provision that each party must provide six
months' prior notice of an intention to
terminate its participation.
The information reviewed at the May
meeting suggested that economic activity had expanded at a below-trend pace
in recent months. Gains in payroll employment had moderated, and the unemployment rate appeared to have stabilized after a period of decline. Housing
construction remained under pressure
from weak demand and large inventories of unsold homes, and consumer
spending appeared to have slowed in recent months. Business fixed investment

Minutes of FOMC Meetings, May 207
remained subdued. Manufacturing pro- and light trucks moved up in the first
duction, however, showed signs of quarter, but eased a bit in April. Real
strengthening after a period of consider- spending on goods other than motor veable softness. Rising energy prices hicles, which had shown exceptional
pushed up total PCE price inflation in vigor late last year, was broadly flat beMarch, while the twelve-month increase tween December and March. However,
in core PCE prices was just slightly outlays on non-energy services were reabove its year-earlier pace.
ported to have posted solid gains, espeThe average monthly increase in pay- cially in March. Real disposable perroll employment through the first four sonal income rose smartly in the first
months of this year was well below the quarter. Wages and salaries increased
relatively strong pace recorded in the solidly, on average, and the Bureau of
fourth quarter of 2006. In April, the con- Economic Analysis estimated that instruction industry continued to shed come in January was boosted by unusujobs, manufacturing employment de- ally large bonus payments and stock opclined further, and retailers reduced hir- tion exercises. The household wealth-toing after a large gain in March. The un- income ratio likely ticked down in the
employment rate stood at 4.5 percent in first quarter, as the stock market rose
April, similar to its average in the first only a little and house prices remained
quarter, and the labor force participation soft. However, given the surge in stock
prices in April, much of the lost ground
rate moved down.
Industrial production increased at a had probably since been made up.
modest annual rate of 1.4 percent in the
Residential construction activity refirst quarter, with the monthly pattern mained soft as builders attempted to
reflecting fluctuations in the output of work off elevated inventories of unsold
utilities, which was influenced impor- new homes. Single-family housing starts
tantly by swings in weather conditions. moved up in March, almost certainly
Manufacturing output declined, on net, boosted by unusually warm and dry
over the six months ending in February weather; single-family permit issuance
as a result of inventory-related adjust- also increased. Although existing home
ments in a number of industries. How- sales declined in March, the level of
ever, factory production turned up in sales was only slightly below the steady
March. The output of high-tech indus- pace that had prevailed in the second
tries rose briskly; the production of con- half of 2006. By contrast, new home
sumer goods increased; and the output sales fell sharply in the first two months
of business equipment, construction sup- of the year and had recovered only a bit
plies, and materials picked up. The lim- in March. All told, recent readings on
ited information available on industrial home sales suggested that housing deproduction for April suggested that out- mand had weakened further. Houseput had been boosted by the scheduled price appreciation continued to slow,
pickup in motor vehicle assemblies.
and some measures were again showing
Real consumer expenditures in- declines in home values.
creased at a brisk pace in the first quarReal spending on equipment and softter, although monthly gains in spending ware rose modestly in the first quarter
slowed over the course of the quarter, in after having fallen in the fourth quarter
part because of swings in weather- of 2006. Spending on high-tech equiprelated outlays on energy goods and en- ment, boosted by a surge in outlays on
ergy services. Retail sales of both autos computers, posted a substantial increase

208 94th Annual Report, 2007
in the first quarter. In addition, purchases of communications equipment—
which tend to be volatile quarter to
quarter—rebounded strongly after a
fourth-quarter dip. By contrast, spending on transportation equipment declined significantly: Although domestic
spending on aircraft jumped after three
weak quarters, purchases of medium and
heavy trucks dropped sharply, largely as
a consequence of a pull-forward of truck
purchases in the latter part of last year in
anticipation of the tighter emissions
standards that took effect in January.
Business investment in equipment other
than high-tech and transportation
dropped in the first quarter, although the
weakness in this broad category appeared to have been especially pronounced around the turn of the year and
to have lessened somewhat over the
course of the quarter. Robust corporate
cash reserves and continuing declines in
the user cost of high-tech goods remained supportive of equipment and
software spending going forward. Real
outlays for nonresidential construction
regained some momentum in the first
quarter of this year after having hit a lull
in late 2006.
Real nonfarm inventory investment
excluding motor vehicles increased at a
slower pace in the first quarter of 2007
than in the previous quarter. The downshift in inventory investment had helped
to reduce the apparent overhangs that
had emerged in late 2006. In the motor
vehicle sector, the sharp decline in the
pace of assemblies over the past few
quarters appeared to have brought inventories back into line with sales. In
April, surveys indicated that the net
number of firms who viewed their customers' inventory levels as too high had
dropped back from elevated readings
over the previous two quarters.
The U.S. international trade deficit
narrowed in February, reflecting a steep

drop in imports, which more than offset
a sizable decline in exports. Within imports, the value of oil imports plunged,
reflecting decreases in both prices and
quantities, and imports of industrial supplies, capital goods, and automotive
parts also fell. The lion's share of the
February decline in exports was of capital goods. Smaller decreases occurred in
exports of industrial supplies, consumer
goods, and services.
Economic activity in advanced foreign economies appeared to have grown
at a steady rate in the first part of the
year. Canada's growth seemed to have
rebounded from a disappointing fourth
quarter. Renewed household demand in
Japan pointed to further strong growth
in the first quarter, while investment demand seemed to be underpinning growth
in the United Kingdom. Although euroarea exports had slowed from the rapid
pace set in the fourth quarter and the
hike in the German value-added tax
likely depressed consumption, overall
economic conditions remained solid.
Economic activity in the emerging market countries appeared to have continued to advance at a robust pace in the
first quarter. Surging growth in China
was a highlight of the strong performance of most countries in Asia. In
Latin America, indicators pointed to further lackluster growth in Mexico and
some weakening in Argentina, but in
other countries, especially Brazil, conditions appeared more positive.
The total PCE price index rose substantially in both February and March.
The advance in February was distributed across a broad range of categories,
while the March increase was driven
largely by a jump in the index for energy. Core PCE prices were unchanged
in March after an upswing in February.
Smoothing through the high-frequency
movements, the twelve-month change in
the core PCE price index in March was

Minutes of FOMC Meetings, May 209
just a touch higher than the increase
over the year-earlier period. Accelerations in the costs of housing and medical
services were major contributors to both
core CPI and core PCE inflation over
the past year. Household surveys conducted in April indicated that the median expectation for year-ahead inflation had moved up, consistent with the
recent pickup in headline CPI inflation.
Median expectations of longer-term inflation had edged higher but were still in
the narrow range seen over the past few
years. Average hourly earnings for production or nonsupervisory workers,
which had accelerated noticeably over
the past couple of years, posted moderate increases in March and April.
At its March meeting, the Federal
Open Market Committee (FOMC) maintained its target for the federal funds rate
at 5V4 percent. The Committee's accompanying statement noted that recent economic indicators had been mixed and
that the adjustment in the housing sector
was ongoing. Nevertheless, the economy seemed likely to expand at a moderate pace over coming quarters. Recent
readings on core inflation had been
somewhat elevated. Although inflation
pressures seemed likely to moderate
over time, the high level of resource utilization had the potential to sustain those
pressures. The Committee's predominant policy concern remained the risk
that inflation would fail to moderate as
expected. Future policy adjustments
would depend on the evolution of the
outlook for both inflation and economic
growth, as implied by incoming information.
Market participants had largely anticipated the FOMC's decision at its March
meeting to leave the target federal funds
rate unchanged. Nevertheless, the expected path for monetary policy moved
lower on the announcement, as investors
apparently interpreted the accompany

ing statement as suggesting that the
Committee's economic outlook had become somewhat more balanced. However, subsequent FOMC communications—including the Chairman's
testimony before the Joint Economic
Committee, speeches by various FOMC
members, and the minutes from the
March meeting—were generally seen as
emphasizing the Committee's concern
about upside risks to inflation. Over the
intermeeting period, yields on nominal
Treasury securities edged up at all maturities. Measures of inflation compensation based on inflation-indexed Treasury
securities were little changed despite a
significant rise in oil prices. Yields on
investment-grade corporate bonds rose
in line with those on comparablematurity Treasury securities, leaving
their spreads little changed at fairly low
levels. Spreads on speculative-grade
corporate bonds narrowed. Equity prices
climbed steeply amid solid earnings reports and improved sentiment, more
than reversing the declines in the previous intermeeting period. The foreign exchange value of the dollar against other
major currencies moved lower, on
balance.
Gross bond issuance by nonfinancial
businesses slowed from its torrid firstquarter pace in April, but acquisitionrelated financing continued to fuel
the issuance of both investment- and
speculative-grade corporate bonds.
Commercial paper outstanding declined,
but bank lending accelerated. In the
household sector, the rise in home mortgage debt likely slowed a bit further in
the first quarter, as home-price appreciation appeared to have remained sluggish. Consumer credit continued to expand at a moderate pace early in the
year. M2 accelerated during March and
April, primarily reflecting faster growth
in liquid deposits, which were likely
boosted in April by tax-related flows.

210 94th Annual Report, 2007
In its forecast prepared for this meeting, the staff expected the pace of economic activity to pick up from weak
first-quarter growth to a rate a little below that of the economy's long-run potential for the remainder of this year and
to increase at a pace broadly in line with
potential output in 2008. The projected
gradual acceleration in economic activity largely reflected the expected waning of the drag from residential investment, although recent readings on sales
and inventories of new homes had been
interpreted by the staff as suggesting that
the ongoing contraction in residential investment would continue for longer than
previously expected. In response to data
received over the past year, the staff had
marked down slightly its estimate of
structural productivity growth and
nudged up its estimate for the increase
in labor supply—leaving its estimate of
the overall growth of potential GDP
broadly unchanged. The increases in energy and other commodity prices over
the intermeeting period had led the staff
to revise up its forecast for headline
PCE inflation during the first half of the
year. Nonetheless, the staff continued to
expect core inflation to edge lower over
the course of the next two years.
In their discussion of the economic
situation and outlook, participants noted
that their assessments of the mediumterm prospects for economic growth and
inflation had not changed materially
from the previous meeting. The pace of
economic expansion had slowed in the
first part of this year, but the recent subpar performance probably exaggerated
the weakness of underlying demand, and
the rate of economic growth was expected to pick up in coming quarters.
Meeting participants anticipated that
real GDP would advance at a pace a
little below the economy's trend rate of
growth through the remainder of this
year and then pick up to a rate broadly

in line with the economy's trend rate in
2008. Most participants continued to
expect core inflation to slow gradually,
although considerable uncertainty surrounded that judgment and the Committee's predominant concern remained
the risk that inflation would fail to
moderate as expected.
The incoming data on new home sales
and inventories suggested that the ongoing adjustment in the housing market
would probably persist for longer than
previously anticipated. In particular, the
demand for new homes appeared to have
weakened further in recent months, and
the stock of unsold homes relative to
sales had increased sharply. That said,
participants also noted that sales of existing homes appeared to have held up
somewhat better since the beginning of
the year. Moreover, the turmoil in the
subprime market evidently had not
spread to the rest of the mortgage market; indeed, mortgage rates available to
prime borrowers remained well below
their levels of last summer. Nevertheless, most participants agreed that, although the level of inventories of unsold
homes that homebuilders desired was
uncertain, the correction of the housing
sector was likely to continue to weigh
heavily on economic activity through
most of this year—somewhat longer
than previously expected.
Growth in consumer spending appeared to have slowed over the past few
months. Real spending on goods had
flattened out, and contacts in both the
retail sector and the consumer credit sector reported a softening in the expansion
of demand. In contrast to the rapid gains
of recent years, meeting participants expected household expenditure to grow at
a more moderate pace in coming quarters. Consumption was likely to be supported by continued advances in employment and incomes, as well as gains
in stock prices; but the recent increases

Minutes of FOMC Meetings, May 211
in gasoline prices probably would damp
households' spending power in the near
term, and the effect of the anticipated
leveling out in home-price appreciation
on household wealth was expected to
contribute to a gradual increase in the
personal saving rate over the medium
run. Participants remained concerned
that the housing market correction could
have a more pronounced impact on consumer spending than currently expected,
especially if house prices were to decline significantly.
The growth of business fixed investment seemed most likely to move higher
in coming quarters, supported by strong
corporate balance sheets and profits, favorable financial conditions, and a
gradual strengthening in business output. The downside risks to business
capital spending appeared to have diminished somewhat since the previous
meeting. In particular, participants took
note of the upturn in orders and shipments of capital goods, and of more upbeat surveys of business conditions.
However, participants cautioned against
drawing too much comfort from the
most recent few data observations, and
recognized that the current sluggishness
of equipment outlays could persist for
longer than currently anticipated, especially if financial market conditions became less supportive. Participants were
also encouraged that, outside of the construction sector, the correction of inventories to more comfortable levels appeared well advanced, thus reducing the
possibility that going forward this adjustment process could trigger shortfalls
in business spending and output.
Economic activity in the rest of the
world continued to advance briskly. Participants noted that strong foreign expansion should help to underpin demand
for U.S. exports, but expressed some
concern that the strength of global demand could contribute to price pressures

at home. Prices of non-energy commodities, especially metals, had moved
up markedly since the previous meeting.
Moreover, inflationary pressures in a
number of overseas economies appeared
to have increased of late, perhaps partly
in response to heightened levels of capacity utilization in those countries, and
this development had the potential to
add to the prices of U.S. imports. In that
regard, several participants noted that
the decline in the foreign exchange
value of the dollar over the intermeeting
period could reinforce the upward pressure on import prices.
Participants discussed how best to
reconcile the slowdown in output
growth over the past year with the relatively strong performance of the labor
market. This apparent tension could
partly reflect measurement issues; in
particular, participants noted that the
more-rapid gains in estimates of gross
domestic income over this period might
better capture the pace of activity than
the modest advances in measured GDP.
Aside from measurement problems, a
possible explanation was that these differing trends largely related to the
lagged adjustment of employment to the
slowing pace of expansion. In that regard, several participants observed that
the recent moderation in economic
growth had been concentrated in the
construction sector, but that measured
employment in construction had not yet
declined by a corresponding amount.
This suggested that increases in overall
employment in coming quarters may
possibly be held down by notable declines in construction employment as the
adjustment of the labor force in that sector played out. A slowing in employment could then occur in conjunction
with a strengthening in productivity
growth. Alternatively, some of the recent weakness in measured productivity
growth could reflect a decline in the un-

212 94th Annual Report, 2007
derlying trend in productivity and so
might persist. Although this explanation
might help account for some of the
downshift in measured productivity
growth, participants agreed that there
appeared to be little other evidence
pointing to a significant slowing of advances in structural productivity. In the
context of this discussion, many participants commented that their view of potential output growth was somewhat
more optimistic than that of the staff.
Labor markets appeared to remain
relatively tight. Unemployment continued around the low levels seen since last
fall, and many business contacts reported difficulties in recruiting suitably
qualified workers, especially for certain
types of professional and skilled positions. However, several participants observed that aggregate measures of labor
compensation had so far increased only
modestly, perhaps suggesting that the labor market might be less stretched than
it appeared. Moreover, even if wages
and salaries did accelerate, the resulting
cost pressures might be absorbed by a
narrowing in firms' profit margins from
current elevated levels, rather than being
passed on in the form of higher prices.
On the other hand, some participants reported that their business contacts appeared very resistant to any squeeze in
profit margins. All told, for most participants, the apparent tightness of the labor
market remained a significant source of
upside risk to inflation.
Nearly all participants viewed core inflation as remaining uncomfortably high
and stressed the importance of further
moderation. Although readings on core
inflation in March had been more favorable, this followed several months of elevated inflation data and price pressures
were not yet viewed as convincingly on
a downward trend. Most participants expected core inflation to moderate gradually, fostered in part by stable inflation

expectations and a likely deceleration in
shelter costs. Some participants also expected the anticipated slight easing of
pressures on resources to help nudge inflation lower, although others felt that
small movements in resource utilization
were unlikely to have discernible effects
on inflation. All participants agreed that
the risks around the anticipated moderation in inflation were to the upside; and
some noted that a failure of inflation to
moderate could entail significant costs
particularly if it led to an upward drift in
inflation expectations.
In the Committee's discussion of
monetary policy for the intermeeting period, all members favored keeping the
target federal funds rate at 5lA percent.
Recent developments were seen as supporting the Committee's view that maintaining the current target rate was likely
to foster moderate economic growth and
a gradual ebbing in core inflation. Members continued to view the risks to economic activity as weighted to the downside, although with turmoil in the
subprime market appearing to have remained relatively well contained and
business spending indicators suggesting
a more encouraging outlook, these
downside risks were judged to have diminished slightly. Members agreed that
considerable uncertainty attended the
prospects for inflation, and the risk that
inflation would fail to moderate as desired remained the Committee's predominant concern.
In light of the recent economic data
and anecdotal information, the Committee agreed that the statement to be released after the meeting should acknowledge that economic growth had
slowed in the first part of the year. The
Committee thought that the statement
should reiterate the view that the adjustment in the housing market was ongoing, but that nevertheless the economy
seemed likely to expand at a moderate

Minutes of FOMC Meetings, June 213
pace over coming quarters. While readings on core inflation were lower in
March, members felt that it was appropriate to emphasize that core inflation
remained somewhat elevated. The Committee agreed that the statement should
continue to note that their predominant
policy concern was the risk that inflation would fail to moderate as expected,
and that future policy adjustments would
depend on the evolution of the outlook
for both inflation and economic growth.
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 meeting adjourned at 1:15 p.m.
Notation Vote
By notation vote completed on April 10,
2007, the Committee unanimously approved the minutes of the FOMC meeting held on March 20-21, 2007.
Vincent R. Reinhart
Secretary
Meeting Held on
June 27-28, 2007
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, June 27, 2007 at 2:00 p.m.
and continued on Thursday, June 28,
2007 at 9:00 a.m.

The Federal Open Market Committee
seeks monetary andfinancialconditions that
will foster price stability and promote sus- Present:
Mr. Bernanke, Chairman
tainable growth in output. To further its
Mr. Geithner, Vice Chairman
long-run objectives, the Committee in the
Mr. Hoenig
immediate future seeks conditions in reserve
Mr. Kohn
markets consistent with maintaining the fedMr. Kroszner
eral funds rate at an average of around
Ms. Minehan
5V4 percent.
Mr. Mishkin
The vote encompassed approval of
the text below for inclusion in the statement to be released at 2:15 p.m.:
In these circumstances, the Committee's
predominant policy concern remains the risk
that inflation will fail to moderate as expected. Future policy adjustments will
depend on the evolution of the outlook for
both inflation and economic growth, as
implied by incoming information.
Votes for this action: Messrs. Bernanke,
Geithner, Hoenig, Kohn, and Kroszner,
Ms. Minehan, Messrs. Mishkin, Moskow, Poole, and Warsh. Votes against
this action: None.
Meeting participants briefly discussed
the next steps in their review of communication issues and agreed to consider
them at the next FOMC meeting, confirmed for June 27-28, 2007.

Mr. Moskow
Mr. Poole
Mr. Warsh
Mr. Fisher, Ms. Pianalto, and Messrs.
Plosser and Stern, Alternate Members of the Federal Open Market
Committee
Messrs. Lacker and Lockhart, and Ms.
Yellen, Presidents of the Federal
Reserve Banks of Richmond, Atlanta, and San Francisco, respectively
Mr. Reinhart, Secretary and Economist
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Messrs. Connors, Evans, Fuhrer, Madigan, Rasche, Sellon, Slifman, and
Wilcox, Associate Economists

214 94th Annual Report, 2007
Mr. Dudley, Manager, System Open
Market Account
Messrs. Clouse and English, Associate
Directors, Division of Monetary
Affairs, Board of Governors
Ms. Liang and Mr. Struckmeyer, Associate Directors, Division of Research and Statistics, Board of
Governors
Messrs. Leahy and Wascher, Deputy
Associate Directors, Divisions of
International Finance and Research and Statistics, respectively,
Board of Governors
Mr. Dale, Senior Adviser, Division of
Monetary Affairs, Board of Governors
Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Gross,7 Special Assistant to the
Board, Office of Board Members,
Board of Governors
Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors
Mr. Ahmed8 and Ms. Kusko,8 Senior
Economists, Divisions of International Finance and Research and
Statistics, respectively, Board of
Governors
Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Ms. Beechey and Mr. Natalucci,8
Economists, Division of Monetary
Affairs, Board of Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Mr. Moore, First Vice President, Federal Reserve Bank of Cleveland

7. Attended portion of the meeting relating to
monetary policy communications.
8. Attended portion of the meeting relating to
the economic outlook and monetary policy discussion.

Mr. Rosenblum, Executive Vice President, Federal Reserve Bank of
Dallas
Ms. Mester, Messrs. Sniderman, Weinberg, and Williams, Senior Vice
Presidents, Federal Reserve Banks
of Philadelphia, Cleveland, Richmond, and San Francisco, respectively
Ms. McLaughlin and Mr. Tallman, Vice
Presidents, Federal Reserve Banks
of New York and Atlanta, respectively
Ms. McConnell, Assistant Vice President, Federal Reserve Bank of
New York
Mr. Weber, Senior Research Officer,
Federal Reserve Bank of Minneapolis
The information reviewed at the June
meeting suggested that the expansion of
economic activity rebounded in the second quarter from its subpar pace in the
first quarter. Upswings in net exports
and inventory investment were expected
to contribute importantly to the rise in
real GDP. Consumer spending appeared
to have slowed from its rapid pace earlier in the year, while business fixed investment continued to rise at a modest
rate. Residential construction remained
weak as builders worked further to clear
high inventories of unsold homes. Sharp
increases in energy prices drove up
overall inflation in April and appeared
to have done so again in May; core
inflation seemed to have remained
subdued.
Employment continued to rise at a
moderate pace; the average monthly increase in payroll employment in April
and May was a little below that of the
first quarter. In May, employment was
boosted by strong hiring in the service
sector, but the manufacturing and retail
sectors continued to shed jobs. Larger
payrolls and a slightly longer average
workweek in May led to an increase in

Minutes of FOMC Meetings, June 215
aggregate hours; the unemployment rate construction activity. In May, singlefamily housing starts declined, and adheld steady at 4.5 percent.
Industrial production increased mod- justed permit issuance for the singleestly in April and May after having been family sector stepped down further,
little changed in the first quarter when indicating that builders were intending
some manufacturers restrained produc- to slow further the pace of new contion to cope with a buildup in invento- struction. The monthly readings on sales
ries. Manufacturing output edged up in of new and existing homes through May
recent months, reflecting increases in had fluctuated around levels lower than
the output of light motor vehicles, other the average over the second half of
consumer durable goods, construction 2006. Some, though not all, of this
supplies, and durable materials. The pro- weakening in home sales was likely reduction of high-tech industries also rose, lated to the tightening of lending stanalbeit at a relatively sluggish pace com- dards for nonprime borrowers that bepared with the brisk expansion seen gan in February. Even though the
around the turn of the year. Capacity inventory of new homes for sale ticked
utilization in the manufacturing sector down in May, the months' supply in
in May was close to its long-run average May remained noticeably above its level
and slightly below its level one year in late 2006. According to OFHEO's
purchase-only price index for existing
earlier.
The pace of real consumer spending homes, house-price appreciation continappeared to have slowed somewhat in ued to slow in the first quarter.
the second quarter after substantial inOutlays for nonresidential construccreases late last year and early this year. tion appeared to have remained robust
The deceleration primarily reflected a early in the second quarter. Business
flattening out of outlays for goods in spending on equipment and software in
recent months; spending on services recent months appeared to be about uncontinued to rise at a solid pace for the changed from the first quarter, although
quarter as a whole, although the monthly the softness was largely confined to outpattern was affected by weather-related lays for transportation equipment. Shipswings in outlays on energy services. ments and orders for items other than
The determinants of household spend- transportation moved up markedly in
ing were broadly supportive. Real dis- March and April after weakness in earposable personal income rose at a mod- lier months, and, even with the small
erate pace, on average, in the first four declines in May, the data pointed to a
months of the year, boosted not only by healthy rise in outlays in the second
ongoing gains in wages and salaries, but quarter. In particular, real spending on
also by unusually large bonus payments equipment other than high-tech and
and stock option exercises in the first transportation seemed to be rebounding
quarter. Although the household wealth- after sizable declines over the previous
to-income ratio ticked down in the first two quarters. After a surge in outlays on
quarter with the stock market up only a computers in the first quarter, spending
little and house prices remaining soft, on high-tech equipment appeared to be
the increase in stock prices in the second rising at a more modest pace in April
quarter likely made up much of the lost and May. In contrast, spending on transground.
portation equipment declined signifiElevated inventories of unsold new cantly. Purchases of medium and heavy
homes continued to weigh on residential trucks dropped further in May, continu

216 94th Annual Report, 2007
ing to reflect the payback from sales that
were pulled forward into 2005 and 2006
in anticipation of tighter emissions standards that took effect in January. New
orders for trucks picked up in May, albeit from very low levels. Shipments
data indicated that spending on aircraft
dropped back from the elevated level in
the first quarter. The downtrend in the
cost of capital was likely curtailed in
recent weeks by the rise in corporate
bond rates. Nonetheless, firms retained
ample cash in reserve to finance investment.
Real nonfarm inventory investment
excluding motor vehicles slowed appreciably in the first quarter of 2007, as
firms in most industries appeared to
have made considerable progress in addressing the inventory overhangs that
developed in 2006. The adjustment apparently continued into the second quarter, as the ratio of inventories to sales for
manufacturing and trade excluding motor vehicles ticked down further in April
after a March decline. Inventories of
light motor vehicles, which were pared
down to more comfortable levels during
the first quarter, continued to edge lower
through May. Indeed, the inventory adjustment reached the point that, for the
third month in a row, the May survey of
purchasing managers indicated that, on
net, more firms viewed their customers'
inventory levels as too low rather than
too high.
After no change between the fourth
quarter and first quarter, the U.S. international trade deficit narrowed in April
from its March level. The recent narrowing reflected a steep decline in many
categories of goods imports and a modest increase in exports, especially of agricultural products. Nominal imports of
petroleum were flat in April after surging in March despite steady increases in
the price of imported oil.

Economic activity in advanced foreign economies appeared to have grown
at a solid rate in the first quarter. Economic growth in Canada rebounded
sharply from a disappointing fourth
quarter, and growth picked up in the
United Kingdom, owing primarily to a
robust expansion in the service sector. In
the euro area, export growth in the first
quarter slowed from its rapid fourthquarter pace, and the hike in the German
value-added tax likely temporarily
depressed first-quarter consumption
growth. Consumer spending showed
signs of recovering in recent months,
and overall, economic conditions in the
euro area remained solid. In Japan, recent data suggested that growth in the
second quarter had moderated from the
vigorous first-quarter pace, with public
spending and net exports likely sources
of weakness. Recent data indicated that
economic activity in emerging-market
economies remained strong. Growth in
China and India appeared to have moderated somewhat from the very high
rates of the first quarter. In Latin
America, indicators for Mexico suggested some recovery from the marked
slowdown of the previous few quarters,
while growth in Argentina and Brazil
appeared to pick up as well.
Headline consumer price inflation
stepped up in recent months, driven by
large increases in the index for energy.
However, readings on core inflation had
declined. Core PCE prices rose 0.1 percent in April and were estimated to have
posted a similar, modest increase in
May. The recent readings had been held
down, in part, by declines in volatile
categories such as apparel and tobacco
products that were likely to prove transitory; the rent components had also decelerated. The twelve-month change in
core PCE prices in May was expected to
be lower than the increase over the yearearlier period; however, over that longer

Minutes of FOMC Meetings, June 217
period, the decline in core PCE inflation
was almost entirely the result of a slowing in its nonmarket component. Household surveys conducted in early June
indicated that the median expectation for
year-ahead inflation increased further,
consistent with the energy-driven acceleration in overall consumer prices in recent months. After edging higher in
April and May, median expectations of
longer-term inflation fell back in June
and remained in the narrow range seen
over the past two years. The twelvemonth change in average hourly earnings for production or nonsupervisory
workers edged lower in recent months.
At its May meeting, the Federal Open
Market Committee (FOMC) maintained
its target for the federal funds rate at
5V4 percent. The Committee's accompanying statement noted that economic
growth slowed in the first part of the
year and that the adjustment in the housing sector was ongoing. Nevertheless,
the economy seemed likely to expand at
a moderate pace over coming quarters.
Core inflation remained somewhat elevated. Although inflation pressures
seemed likely to moderate over time, the
high level of resource utilization had the
potential to sustain those pressures. The
Committee's predominant policy concern remained the risk that inflation
would fail to moderate as expected. Future policy adjustments would depend
on the evolution of the outlook for both
inflation and economic growth, as implied by incoming information.
Market participants had largely anticipated the FOMC's decision at its May
meeting to leave the target federal funds
rate unchanged, but some market participants were reportedly surprised by
the retention of the assessment that inflation was "somewhat elevated." The
publication of the minutes of the May
meeting elicited little market response.
Over the intermeeting period, however,

investors seemed to reappraise their beliefs that the economic expansion would
slow and that monetary policy easing
would be forthcoming. This reappraisal
seemed to be based in part on the release
of some economic data in the United
States and abroad that were more favorable than expected. As a result, the expected path of the federal funds rate over
the coming year was marked up sharply
in financial markets. Yields on nominal
Treasury securities at all maturities also
rose over the intermeeting period, with
the most pronounced gains in forward
rates three to five years ahead. Measures
of long-horizon inflation compensation
based on inflation-indexed Treasury securities edged slightly higher. Yields on
investment-grade corporate bonds rose
in line with those on comparablematurity Treasury securities, leaving
their spreads little changed. In contrast,
spreads on speculative-grade corporate
bonds narrowed. Equity prices were
volatile at times during the intermeeting
period, but broad stock price indexes advanced modestly, on net, as favorable
news on the economy and announcements of mergers and acquisitions outweighed the drag of higher bond yields.
The foreign exchange value of the dollar
against other major currencies was little
changed, on balance.
Gross bond issuance by nonfinancial
businesses surged in May from the already robust pace of earlier in the year.
Acquisition-related financing continued
to support corporate bond issuance, but
a significant share of recent issues was
reportedly designated for capital expenditures. Commercial paper outstanding
was unchanged in May, but bank lending maintained a strong pace. In the
household sector, mortgage debt expanded at a slower pace in the first quarter, reflecting the slowdown in homeprice appreciation over the past year and
the lower pace of home sales. Interest

218 94th Annual Report 2007
rates available to prime borrowers on
both fixed-rate and variable-rate mortgages increased along with other market
interest rates. Consumer credit continued to expand at a moderate pace in the
first quarter. After rising at a particularly
rapid rate in the first quarter, M2 increased at a more moderate pace in
April and May.
In preparation for this meeting, the
staff reduced its estimate of the increase
in real GDP in the first quarter and
marked up its forecast of the rebound in
economic activity in the second quarter,
in large part because of a more substantial swing in inventory investment than
previously expected. The revisions,
however, left the projection of economic
growth over the first half of the year
unchanged. As was the case in May,
economic activity was expected to increase at a rate a little below that of the
economy's long-run potential for the remainder of the year and to rise at a pace
broadly in line with potential output
growth in 2008. The projected gradual
acceleration in economic activity in
coming quarters largely reflected the expected waning of the drag from residential investment and improvements in the
pace of business fixed investment. Increases in energy and food prices over
the intermeeting period led the staff to
revise up its forecast for headline PCE
inflation during the second quarter, but
its projection of core PCE inflation was
revised down. Although some of the recent slowing in readings on core PCE
inflation was likely due to transitory factors, the staff took some signal from the
data and trimmed its forecast for core
PCE inflation slightly in coming quarters. Over the next several quarters, total
PCE inflation was projected to moderate
to a pace close to core PCE inflation.
In their discussion of the economic
situation and outlook, participants noted
that economic activity appeared to have

expanded at a moderate pace on balance
over the first half of the year. In view of
incoming data and anecdotal information, participants continued to anticipate
moderate economic growth in coming
quarters, with growth rising gradually to
a pace close to that of potential output.
Participants interpreted the most recent
information on business spending, business sentiment, and the labor market as
suggesting that the risks to growth were
more balanced than at the time of the
May meeting, despite the ongoing adjustment in the housing sector and the
significant recent increases in longerterm interest rates. Participants generally expected that inflation would probably edge lower over the next two years,
reflecting the waning of temporary factors that had boosted prices last year and
a slight easing of pressures on resources.
Recent data on core consumer prices
were encouraging in this regard, but participants were wary of drawing any firm
conclusions about future trends from a
few monthly readings that could reflect
transitory influences and remained concerned about forces that could contribute to inflation pressures. Against this
backdrop, participants agreed that the
risk that inflation would fail to moderate
as expected remained their predominant
concern.
In preparation for the Federal Reserve's semiannual report to the Congress on the economy and monetary
policy, the members of the Board of
Governors and the presidents of the Federal Reserve Banks submitted individual
projections of the growth of nominal and
real GDP, the rate of unemployment, and
core consumer price inflation for the
years 2007 and 2008, conditioned on
their views of the appropriate path for
monetary policy. The projections for the
growth of nominal GDP were in the
range of AVi to 5Vi percent, with a central tendency of AVi to 5 percent for

Minutes of FOMC Meetings, June 219
2007; for 2008, the projections for
nominal GDP growth ranged between
4Vi to 5Vi with a central tendency of
43/4 to 5 percent. Projections for the rate
of expansion in real GDP in 2007 were
in a range from 2 to 23A percent in 2007,
with a central tendency of 2!/4 to
2x/2 percent; for 2008, the projections
ranged between 2Vi to 3 percent, with a
central tendency of 2Vi to 23A percent.
These rates of growth were associated
with civilian unemployment rates in the
range of 4Vi to 43A percent in the fourth
quarter of 2007 and 4V2 to 5 percent in
the fourth quarter of 2008; the central
tendency of these projections was 4Vi to
43/4 percent in 2007 and about 43/4 percent in 2008. Projections for the rate of
inflation, as measured by the core PCE
price index, in 2007 were in a range of
2 to 2lA percent in 2007 and P/4 to
2 percent in 2008. The central tendencies of these projections in 2007 and
2008 were identical to the ranges for
those years.
Participants generally agreed that the
housing sector was likely to remain a
drag on growth for some time yet and
represented the most significant downside risk to the economic outlook. Although starts of single-family homes had
moved up, on balance, over recent
months, permits for new construction
continued to decline. A number of participants noted that inventories of new
homes for sale remained quite elevated.
Housing activity was seen as likely to
continue to contract for several more
quarters. Participants also identified a
number of downside risks associated
with their outlook for residential construction. The recent increase in interest
rates for prime mortgages could further
dampen the demand for housing. Moreover, a number of participants pointed to
rising mortgage delinquency rates and
related difficulties in the subprime mortgage market as factors that could crimp

the availability of mortgage credit and
the demand for housing.
Spillovers from the strains in the
housing market to consumption spending had apparently been quite limited to
date. To be sure, personal consumption
expenditures appeared to be rising more
slowly in recent months than earlier in
the year, but that development was probably, at least in part, a result of the rise
in gasoline prices, which was not expected to be extended. Participants generally anticipated moderate gains in consumption spending over coming months,
supported by the strong labor market
and solid growth in personal income.
Still, the advance in spending was expected to fall short of income growth,
and the saving rate was anticipated to
trend higher over coming quarters from
the unusually low levels of recent years.
Some participants noted a risk that the
saving rate could rise more than currently foreseen, particularly if household
wealth were depressed by a further softening in house prices or by a less buoyant equity market that might accompany
a potential slowing in the growth of corporate earnings. Several participants
noted that higher interest rates and a potential tightening in credit availability
might also be factors that could contribute to a rise in the personal saving rate.
At the same time, participants recognized that consumption growth had held
up to date and saw a risk that the saving
rate could fail to rise as much as currently expected, particularly if equity
markets continued to register significant
gains.
A number of participants remarked
that the recent data on business spending were more encouraging than those
available at the time of the May meeting. In particular, orders and shipments
for nondefense capital goods had
stepped up, on balance, from March
through May, and survey indicators of

220 94th Annual Report 2007
business conditions had improved of
late. Strength in foreign demand for U.S.
goods and services was another factor
that seemed likely to contribute to the
firming of business spending. Participants noted that inventories appeared to
be better aligned with sales, boding well
for a resumption of inventory accumulation and a pickup in manufacturing activity. At the same time, some recognized the possibility that downside risks
to investment spending persisted.
Longer-term interest rates and the cost
of credit generally had moved higher of
late, the growth of business profits
seemed to be moderating, and measured
productivity growth had been slower.
Although credit market conditions
seemed to remain generally quite accommodative, in the days just prior to
the meeting, the availability of credit to
some highly leveraged and other lowerrated borrowers appeared to be tightening a bit and investors seemed to reevaluate the risks associated with
investments in complex and illiquid financial instruments.
Strength in spending abroad and the
decline in the exchange value of the dollar were seen as factors boosting U.S.
exports. The rise in global interest rates
was cited as evidence of increasing global demand, and some participants
pointed to strength of aggregate demand
worldwide and its potential effect on the
prices of imports and globally traded
commodities as contributing to upside
risks to U.S. inflation.
Most participants judged labor market conditions to remain rather tight,
particularly for the most skilled workers. The continued tautness of labor
markets was something of a puzzle in
light of below-trend economic growth
over recent quarters, and this development seemed to be connected with
slower productivity growth lately. In
their discussion of this issue, partici

pants noted that employment data for
2006 could ultimately be revised down,
resulting in a corresponding upward revision to productivity. Some participants
also pointed to evidence of lags in employment adjustments, particularly in
the construction industry, as a factor depressing productivity in recent quarters.
These observations suggested that the
recent decline in productivity growth
might prove smaller than now estimated
and largely transitory. Still, some decline in the pace of trend productivity
growth could not be ruled out—a development that could have implications for
business costs and price pressures. Some
participants further noted that the level
of the unemployment rate consistent
with stable inflation could be lower than
previously thought—a possibility that
would help to explain the absence of
outsized wage pressures in the current
environment.
The incoming data on core consumer
prices were viewed as favorable, but
were not seen as convincing evidence
that the recent moderation of core inflation would be sustained. Participants
noted that monthly data on consumer
prices are noisy, and recent readings on
core inflation seemed to have been depressed by transitory factors. Moreover,
a number of forces could sustain inflation pressures, including the generally
high level of resource utilization, elevated energy and commodity prices,
the decline in the exchange value of the
dollar over recent quarters, and slower
productivity growth. In addition, while
core consumer price inflation had moderated of late, total consumer price inflation had moved substantially higher,
boosted by rising energy and food
prices. While total inflation was expected to slow toward the pace of core
inflation over time, a number of participants noted that recent elevated readings
posed some risk of a deterioration in

Minutes of FOMC Meetings, June 221
inflation expectations. On this point,
several participants cited the uptick in
forward measures of inflation compensation over the intermeeting period derived from Treasury inflation-indexed
securities. However, a portion of this increase might be attributed to technical
factors, and survey measures of longterm inflation expectations had held
steady over recent weeks. Nonetheless,
several participants emphasized that
holding long-run inflation expectations
at or below current levels would likely
be necessary for core inflation to moderate as expected over coming quarters.
In their discussion of monetary policy
for the intermeeting period, members
generally regarded the risks to economic
growth as more balanced than at the
time of the May meeting. Although the
housing market remained a key source
of uncertainty about the outlook, members thought it most likely that the overall economy would expand at a moderate pace over coming quarters. Members
generally anticipated that core inflation
would remain relatively subdued but
concurred that a sustained moderation in
inflation had not yet been convincingly
demonstrated. In these circumstances,
members agreed that maintaining the
target federal funds rate at 5lA percent
for this meeting was appropriate and that
future policy adjustments would depend
on the outlook for economic growth and
inflation, as implied by incoming information.
In light of the recent economic data
and anecdotal information, the Committee agreed that the statement to be released after the meeting should indicate
that the economy seemed to be expanding at a moderate pace over the first half
of the year. Members agreed that while
measures of core inflation had improved
lately, the statement should indicate that
a sustained moderation of inflation remained in question and that high levels

of resource utilization had the potential
to fuel inflation pressures. Against this
backdrop, members judged that the risk
that inflation would fail to moderate as
expected remained their predominant
concern.
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
5lA percent.
The vote encompassed approval of
the text below for inclusion in the statement to be released at 2:15 p.m.:
In these circumstances, the Committee's
predominant policy concern remains the risk
that inflation will fail to moderate as expected. Future policy adjustments will
depend on the evolution of the outlook for
both inflation and economic growth, as
implied by incoming information.
Votes for this action: Messrs. Bernanke,
Geithner, Hoenig, Kohn, and Kroszner,
Ms. Minehan, Messrs. Mishkin, Moskow, Poole, and Warsh. Votes against
this action: None.
The Committee then again took up
the topic of monetary policy communications. The discussion at this meeting
focused on several key elements of the
Committee's communications vehicles:
the statement released after each FOMC
meeting; the minutes of FOMC meetings; and the projections of FOMC participants that are summarized in the Federal Reserve's semiannual monetary
policy reports to the Congress. The

222

94th Annual Report, 2007

Committee made no decisions at this
meeting, and it was understood that the
subcommittee on communications issues would review the Committee's discussions to date on these matters.
It was agreed that the next meeting of
the Committee would be held on Tuesday, August 7, 2007.
The meeting adjourned at 2:20 p.m.

Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Messrs. Connors, Evans, Fuhrer, Kamin, Rasche, Sellon, Slifman,
Tracy, and Wilcox, Associate
Economists
Mr. Dudley, Manager, System Open
Market Account

Notation Vote
By notation vote completed on May 29,
2007, the Committee unanimously approved the minutes of the FOMC meeting held on May 9, 2007.
Vincent R. Reinhart
Secretary
Meeting Held on
August 7, 2007
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 7, 2007 at 8:30 a.m.
Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Mr. Hoenig
Mr. Kohn
Mr. Kroszner
Mr. Mishkin
Mr. Moskow
Mr. Poole
Mr. Rosengren
Mr. Warsh
Ms. Cumming, Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and
Stern, Alternate Members of the
Federal Open Market Committee
Messrs. Lacker and Lockhart, and Ms.
Yeilen, Presidents of the Federal
Reserve Banks of Richmond, Atlanta, and San Francisco, respectively
Mr. Madigan, Secretary and Economist
Ms. Danker, Deputy Secretary

Mr. Struckmeyer, Deputy Staff Director, Office of Staff Director for
Management, Board of Governors
Messrs. Clouse and English, Senior Associate Directors, Division of
Monetary Affairs, Board of Governors
Ms. Liang and Mr. Reifschneider, Associate Directors, Division of Research and Statistics, Board of
Governors
Messrs. Dale and Reinhart, Senior Advisers, Division of Monetary Affairs, Board of Governors
Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Affairs, Board of Governors
Ms. Dykes, Project Manager, Division
of Monetary Affairs, Board of
Governors
Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Mr. Driscoll, Economist, Division of
Monetary Affairs, Board of Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Mr. Connolly, First Vice President, Federal Reserve Bank of Boston
Messrs. Judd and Rosenblum, Executive Vice Presidents, Federal Re-

Minutes of FOMC Meetings, August 223
serve Banks of San Francisco and
Dallas, respectively

moderate pace during the first half of
the year despite the ongoing drag from
Ms. Mosser and Mr. Sniderman, Senior the housing sector. While the growth of
Vice Presidents, Federal Reserve consumer spending slowed in the secBanks of New York and Cleve- ond quarter from its rapid pace in prior
land, respectively
quarters, wages and salaries increased
Mr. Cunningham, Vice President, Fed- solidly and household sentiment appeared supportive of further gains in
eral Reserve Bank of Atlanta
spending. Business fixed investment
Mr. Chatterjee, Senior Economic Adpicked up in the second quarter after
viser, Federal Reserve Bank of
little net change in the preceding two
Philadelphia
quarters. Inventories generally appeared
Mr. Hetzel, Senior Economist, Federal to be well aligned with sales at midyear.
Reserve Bank of Richmond
Overall inflation receded in June beMr. Weber, Senior Research Officer, cause of a decline in energy prices,
Federal Reserve Bank of Minne- while the core personal consumption exapolis
penditure (PCE) price index rose a bit
In the agenda for this meeting, it was less than its average pace over the past
reported that advices of the election of year.
Eric S. Rosengren as a member of the
Private nonfarm payroll employment
Federal Open Market Committee had continued to increase at a healthy pace;
been received and that he had executed the rise in July was about equal to the
his oath of office.
average increase over the first half of
By unanimous vote, the Federal Open the year. Solid hiring in the service secMarket Committee selected Brian F. tor was partly offset by declines in conMadigan to serve as Secretary and struction and manufacturing employEconomist until the selection of a suc- ment. Most of the drop in construction
cessor at the first regularly scheduled employment occurred in jobs typically
meeting of the Committee in 2008.
associated with nonresidential construcThe Manager of the System Open tion. Both the average workweek and
Market Account reported on recent de- aggregate hours ticked down in July.
velopments in foreign exchange mar- The unemployment rate edged up to
kets. There were no open market opera- 4.6 percent; it had remained between
tions in foreign currencies for the 4.4 percent and 4.6 percent since SepSystem's account in the period since the tember 2006.
previous meeting. The Manager also reIndustrial production picked up in the
ported on developments in domestic fi- second quarter after little net change
nancial markets and on System open over the preceding two quarters. The inmarket operations in government securi- crease was largely attributable to a
ties and federal agency obligations dur- smaller drag from inventory liquidation
ing the period since the previous meet- and a modest improvement in net exing. By unanimous vote, the Committee ports. Manufacturing production rose
ratified these transactions.
solidly in the second quarter because of
The information reviewed at the Au- substantial increases in the output of
gust meeting suggested that economic light motor vehicles, other durable conactivity picked up in the second quarter sumer goods, business equipment, confrom the slow pace in the first quarter. struction supplies, and materials. ProOn average, the economy expanded at a duction in high-tech industries rose

224 94th Annual Report, 2007
relatively modestly in comparison to its
longer-run growth.
The growth of real consumer spending slowed considerably in the second
quarter after substantial increases earlier
in the year. The deceleration primarily
reflected sharply slower growth in outlays for goods as purchases of motor
vehicles decreased noticeably. Although
a spike in energy prices eroded real income growth in the second quarter, there
were solid gains in wages and salaries.
Despite continued softness in house
prices, household wealth moved markedly higher in the second quarter, mostly
reflecting rising equity prices.
Demand for housing in the second
quarter was restrained by higher interest
rates and by tightening credit conditions
in the subprime mortgage market. Sales
of new and existing homes in the second
quarter were down substantially from
their average levels in the second half of
2006. In June, single-family housing
starts held steady at their May rate, although adjusted permit issuance slipped
further. The combination of decreased
sales and unchanged production left inventories of new homes for sale still elevated. House-price appreciation continued to slow, with some measures again
showing declines in home values.
Outlays for nonresidential construction rose rapidly in the second quarter.
Business spending on equipment and
software, other than transportation
equipment, posted a solid increase after
being flat, on net, in the preceding two
quarters. The rise was led by a rebound
in purchases of industrial machinery.
Expenditures for computers, software,
and communications equipment grew
moderately in the second quarter after a
brisk first-quarter increase. Spending on
transportation equipment again declined
sharply. The drop was largely a continuation of the payback from exceptionally
strong purchases of heavy trucks in 2005

and 2006 in anticipation of tighter emissions standards on diesel engines. New
orders for medium and heavy trucks
edged up in the second quarter, though
they remained at low levels, suggesting
that the downturn in business spending
on motor vehicles may be ending.
Real nonfarm inventory investment
was a roughly neutral influence on real
GDP growth in the second quarter after
having held down the growth rate by an
average of 1 percentage point in the previous two quarters. Businesses made
considerable progress in reducing the
apparent inventory overhangs that had
emerged at the end of 2006. In the motor vehicle sector, low rates of assemblies in the first half of this year left
inventories of domestic light vehicles at
the end of the second quarter fairly well
aligned with sales; however, inventories
rose again in July as production accelerated and sales remained weak. More
broadly, the number of purchasing managers who viewed their customers' inventory levels as too high in July only
slightly exceeded the number who saw
them as too low.
The U.S. international trade deficit
widened in May, as a rise in imports
more than offset an increase in exports.
Within imports, most categories of
goods recorded an increase, as did services. The value of oil imports rose
sharply, boosted by a jump in the price
of imported oil. The increase in exports
was largely attributable to capital goods,
including aircraft, computers and semiconductors, and industrial supplies.
Economic activity in advanced foreign economies expanded somewhat
less rapidly in the second quarter than in
the prior quarter, but nonetheless appeared to have grown faster than trend,
reflecting upbeat business and consumer
confidence as well as favorable labor
market conditions. Although many of
those economies recently experienced

Minutes of FOMC Meetings, August
sharp declines in equity prices and widening credit spreads amid deepening
concerns about credit quality, these developments occurred too late in the intermeeting period to have any apparent
effect on incoming data. In Japan, survey evidence suggested that its economy
expanded moderately. Survey evidence
indicated high levels of economic sentiment and strong capital spending plans
among large manufacturers. In the euro
area, survey measures of business and
consumer confidence remained near
record highs in July, and labor market
conditions generally continued to improve in May and June. In the United
Kingdom, real GDP growth rose in the
second quarter, an increase driven
mainly by robust expansion in the service sector. Canada's growth seemed to
continue to pick up from its disappointing rate posted in much of last year.
Recent data indicated that economic
activity in emerging-market economies
remained generally strong. The Chinese
economy continued to expand at a rapid
pace, and activity elsewhere in emerging Asia appeared to have accelerated.
In Latin America, Mexican indicators
pointed to a weaker-than-expected rebound in the second quarter, whereas
Brazil and Argentina appeared to have
experienced solid growth. While equity
prices fell and bond spreads widened in
several emerging-market economies,
particularly in Latin America, there was
no evidence that this increased volatility
had yet weighed on economic activity.
U.S. headline consumer price inflation slowed in June as energy prices flattened out after a rapid increase over the
preceding three months. Core PCE
prices rose 0.1 percent in June, as a decline in the price index for core goods
nearly offset a rise in the index for core
services. The readings on core PCE
price inflation in recent months had been
held down, in part, by declines in prices

225

of some categories of goods, such as
apparel, that tend to be volatile on a
monthly basis. Household surveys conducted in early July indicated that the
median expectation for inflation over the
next year remained unchanged from
June's elevated level despite declines in
gasoline prices in both months. Median
expectations of longer-term inflation
ticked up and were near the top of the
narrow range that had prevailed over the
past few years. The employment cost
index rose somewhat faster in the second quarter than over the preceding
three months, and the twelve-month
change was slightly higher than that of a
year ago.
At its June meeting, the Federal Open
Market Committee (FOMC) maintained
its target for the federal funds rate at
5VA percent. The statement announcing
the policy decision noted that economic
growth appeared to have been moderate
during the first half of the year, despite
the ongoing adjustment in the housing
sector. The economy seemed likely to
continue to expand at a moderate pace
over coming quarters. Readings on core
inflation had improved modestly in recent months. However, a sustained moderation in inflation pressures had yet to
be convincingly demonstrated. Moreover, the high level of resource utilization had the potential to sustain those
pressures. The Committee's predominant policy concern remained the risk
that inflation would fail to moderate as
expected. Future policy adjustments
would depend on the evolution of the
outlook for both inflation and economic
growth, as implied by incoming information.
Market participants had largely anticipated the FOMC's decision at its June
meeting to leave the target for the federal funds rate unchanged, although the
accompanying statement expressed
greater concern about inflation than in-

226 94th Annual Report, 2007
vestors reportedly had foreseen and
caused the expected path for the federal
funds rate to edge higher. Expectations
for a policy easing diminished somewhat more in the wake of favorable economic news early in the period. Subsequently, the semiannual Monetary
Policy Report to the Congress and the
accompanying testimony, which reported lower projections for real GDP
growth than investors apparently expected, appeared to prompt a downward
shift in investors' expected path for the
federal funds rate. Later in the intermeeting period, growing apprehension
that turmoil in markets for subprime
mortgages and some low-rated corporate debt might have adverse effects on
economic growth led investors to mark
down their expectations for the future
path of policy considerably further. At
the same time, measures of long-horizon
inflation compensation based on
inflation-indexed Treasury securities
edged down.
Financial market conditions were
volatile during the intermeeting period,
particularly over the last few weeks of
the interval. Yields on nominal Treasury
securities fell on balance, possibly reflecting an increased preference by investors for safe assets as well as revisions in policy expectations. Conditions
in markets for subprime mortgages and
related instruments, including segments
of the asset-backed commercial paper
market, deteriorated sharply toward the
end of the period. Credit conditions for
speculative-grade corporate borrowers
tightened substantially, as investors
pulled back from higher-risk assets.
Spreads on speculative-grade bonds increased to near their highest levels in the
past four years. A number of high-yield
bond and leveraged loan deals intended
to finance leveraged buyouts were delayed or restructured, though other highyield bonds were issued. In contrast,

credit conditions for investment-grade
businesses and prime households were
relatively little affected by the market
turbulence. Issuance of investmentgrade bonds continued. Yields on
investment-grade corporate issues rose
relative to yields on Treasury securities,
but because yields on Treasuries declined, yields on investment-grade
bonds were about unchanged on net.
Nonfinancial commercial paper outstanding posted a modest gain in July,
while the pace of bank lending to businesses picked up from an already solid
clip. Mortgage loans and consumer
credit appeared to remain readily available to households with strong balance
sheets, although late in the period some
evidence pointed to diminishing availability of jumbo mortgages.
Broad stock price indexes declined
substantially, on net, over the intermeeting period despite generally solid
second-quarter earnings reports. Share
prices of financial firms fell especially
sharply, reportedly a reflection, in part,
of concerns about exposures to sub
prime mortgages and about the effect of
a potential slowdown in merger activity
on operating profits. The foreign exchange value of the dollar against other
major currencies fell, on balance.
Growth of home mortgage debt likely
slowed again in the second quarter,
mainly reflecting the decline in homeprice appreciation over the past year and
the drop in home sales. Overall consumer credit expanded moderately
through the year ending in May. The
debt of nonfinancial businesses expanded at a robust pace in the second
quarter but slowed in July. After rising
at a rapid pace in the first half of the
year, M2 grew at a more moderate rate
in July.
In preparation for this meeting, the
staff lowered somewhat its forecast of
real GDP growth in the second half of

Minutes of FOMC Meetings, August 227
2007 and in 2008. The reduction was in
part due to the annual revision of national income and product accounts
(NIPA), which revealed somewhat less
rapid growth in output and productivity
during the past three years than previously reported and led the staff to trim
its estimates of the growth rates of structural productivity and potential GDP;
the reduction also reflected less accommodative financial conditions and the
softer tone of some near-term indicators.
The near-parallel revisions to the forecasts for potential and actual GDP left
the staff's projections for resource utilization about unchanged. Although part
of the recent favorable monthly readings
on core PCE price changes was expected
to be transitory, the staff revised down
slightly its forecast for core PCE price
inflation in the second half of 2007;
however, in light of slower growth in
structural productivity and prospects of
somewhat greater pressure from import
prices, the staff left its projection for
core PCE inflation unchanged for 2008.
Overall PCE inflation was expected to
slow in the second half of 2007 from the
elevated pace of the first half, as the
effects of the sizable increases in food
and energy prices earlier this year
abated, and then to move down a bit
further in 2008.
In their discussion of the economic
situation and outlook, meeting participants indicated that they still saw moderate economic expansion in coming
quarters as the most likely outcome but
that the downside risks to growth had
increased. Participants reported that economic expansion had continued at a
moderate pace in many regions of the
country despite further weakness in the
housing sector. Going forward, most
participants anticipated that growth in
aggregate demand would be supported
by rising employment, incomes, and exports, with the result that growth in ac

tual output probably would remain close
to growth of potential GDP despite the
ongoing adjustment in the housing sector. Several mentioned that the revisions
to the NIPA pointed to a modest downward adjustment in projected growth of
actual and potential GDP, but thought
that potential output growth was likely
to be a bit higher than forecast by the
staff. However, recent spending indicators had been mixed, and credit conditions had become tighter, suggesting
greater downside risks to growth. Participants generally expected that core inflation would edge lower over the next
two years, reflecting a slight easing of
pressures on resources, well-anchored
inflation expectations, and the waning
of temporary factors that had boosted
prices last year and early this year. Participants anticipated that total inflation
would slow as well, particularly if market expectations of a modest decline in
energy prices in coming quarters were
to prove correct. But they were concerned that the high level of resource
utilization and slower productivity
growth could augment inflation pressures. Against this backdrop, the Committee agreed that the risk that inflation
would fail to moderate as expected remained its predominant policy concern.
Participants agreed that the housing
sector was apt to remain a drag on
growth for some time and represented a
significant downside risk to the economic outlook. Indeed, developments in
mortgage markets during the intermeeting period suggested that the adjustment
in the housing sector could well prove to
be both deeper and more prolonged than
had seemed likely earlier this year. Participants noted that investors had become much more uncertain about the
likely future cash flows from subprime
and certain other nontraditional mortgages, and thus about the valuation of
securities backed by such mortgages.

228 94th Annual Report, 2007
Consequently, the markets for securities
backed by subprime and other nontraditional mortgages had become illiquid, and originations of new subprime
mortgages had dropped sharply. While
these markets were expected to recover
over time, it was anticipated that credit
standards for these types of mortgages
would be tighter, and interest rates
higher relative to rates on conforming
mortgages, in the future than in recent
years. However, participants also observed that mortgage loans remained
readily available to most potential borrowers, and that interest rates on conforming, conventional mortgage loans
had declined in recent weeks, providing
some support to the housing sector.
Participants thought that consumer
expenditures likely would expand at a
moderate pace in coming quarters, supported by solid gains in employment and
real income. Though growth in consumer spending had slowed in the second quarter, the slowing likely reflected
temporary factors in part, including
some payback from unusually strong
growth in prior quarters and the surge in
gasoline prices. Several participants
noted the risks that house prices could
decline significantly and that credit standards for home equity loans could be
tightened substantially as factors that
could weigh on consumer spending.
However, the sizable upward revision—
from negative to positive—in estimates
of the personal saving rate during the
past three years suggested somewhat
less need for households to rebuild their
savings.
Participants expected that business investment would be supported by solid
fundamentals, including high profits,
strong business balance sheets, and
moderate growth in output. Recent financial market developments were
thought unlikely to have an appreciable
adverse effect on capital spending. Al

though lenders recently appeared to be
less willing to extend credit for financial
restructuring, the supply of credit to finance real investment did not appear
significantly diminished. Funding had
become more costly and difficult to obtain for riskier corporate borrowers, but
there had been little net change in the
cost of credit for investment-grade businesses. Also, businesses in the aggregate continued to have sufficient internally generated funds to finance the
expected level of real investment. Nonetheless, participants recognized that conditions in corporate credit markets could
change rapidly, and that adverse effects
on business spending were possible.
Moreover, heightened asset market volatility and the associated increase in uncertainty, if they were to persist for long,
could lead businesses to pare capital
spending plans. Still, participants judged
that continued growth of investment outlays going forward was the most likely
outcome.
Rapid economic growth abroad and
the decline in the foreign exchange
value of the dollar in recent quarters
were seen as likely to boost U.S. exports
and thus support the economic expansion. Some participants also anticipated
that growth in government purchases of
goods and services would support continued growth in output.
The data on core inflation received
during the intermeeting period were favorable, but meeting participants believed that the readings for the past few
months likely had been damped by transitory factors and did not provide reliable evidence that the recent level would
be sustained. Still, participants thought
that a slight decrease in pressures on
resources and the stability of inflation
expectations likely would foster over
time a gradual moderation in core inflation. Participants anticipated that total
inflation would slow as well, particu-

Minutes of FOMC Meetings, August
larly if market expectations for a modest
decline in energy prices in coming quarters were to prove correct. Participants
remained concerned about factors that
could augment inflation pressures, including the continuing high level of resource utilization and slower trend
growth in productivity. Some also
pointed to the strength of aggregate demand worldwide and the depreciation of
the dollar, and their potential effects on
the prices of imports and globally traded
commodities, as contributing to upside
risks to U.S. inflation. Several participants noted significant increases in
wages in their Districts, particularly in
the service sector, but it was also observed that overall gains in labor compensation had remained moderate, suggesting that sustainable rates of resource
utilization could be slightly higher than
typically estimated. On balance, participants continued to agree that risks to the
outlook for sustained moderation in inflation pressures remained tilted to the
upside.
In their discussion of monetary policy
for the intermeeting period, Committee
members again agreed that maintaining
the existing stance of policy at this
meeting was likely to be consistent with
the overall economy expanding at a
moderate pace over coming quarters and
inflation pressures moderating over
time. The expansion would be supported
by solid job gains and rising real incomes that would bolster consumption,
and by increasing foreign demand for
goods and services produced in the
United States. The ongoing adjustment
in housing markets likely would exert a
restraining influence on overall growth
for several more quarters and remained
a key source of uncertainty about the
outlook. The recent strains in financial
markets posed additional downside risks
to economic growth. Members expected
a return to more normal market condi

229

tions, but recognized that the process
likely would take some time, particularly in markets related to subprime
mortgages. However, a further deterioration in financial conditions could not be
ruled out and, to the extent such a development could have an adverse effect on
growth prospects, might require a policy
response. Policymakers would need to
watch the situation carefully. For the
present, however, given expectations
that the most likely outcome for the
economy was continued moderate
growth, the upside risks to inflation remained the most significant policy concern. In these circumstances, members
agreed that maintaining the target federal funds rate at 5lA percent at this
meeting was appropriate.
In light of the recent economic data,
anecdotal information, and financial
market developments, the Committee
agreed that the statement to be released
after the meeting should indicate that
economic growth was moderate during
the first half of the year and that the
economy seemed likely to continue to
expand moderately in coming quarters,
supported by solid growth in employment and incomes and by robust economic growth abroad. Members also
agreed that the statement should incorporate their view that downside risks to
growth had increased somewhat, and
should mention volatile financial markets, tighter credit conditions for some
households and businesses, and the ongoing correction in the housing market.
In addition, the Committee agreed that
the statement should again note that
readings on core inflation had improved
modestly in recent months but did not
yet convincingly demonstrate a sustained moderation of inflation pressures,
and that the high level of resource utilization had the potential to sustain inflation pressures. Against this backdrop,
members judged that the risk that infla-

230 94th Annual Report, 2007
tion would fail to moderate as expected
continued to outweigh other policy
concerns.
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
5lA percent.
The vote encompassed approval of
the text below for inclusion in the statement to be released at 2:15 p.m.:
Although the downside risks to growth
have increased somewhat, the Committee's
predominant policy concern remains the risk
that inflation will fail to moderate as
expected. Future policy adjustments will
depend on the outlook for both inflation and
economic growth, as implied by incoming
information.
Votes for this action: Messrs. Bernanke,
Geithner, Hoenig, Kohn, Kroszner,
Mishkin, Moskow, Poole, Rosengren,
and Warsh. Votes against this action:
None.
It was agreed that the next meeting of
the Committee would be held on Tuesday, September 18, 2007.
The meeting adjourned at 1:25 p.m.

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 18, 2007 at 8:30
a.m.
Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Mr. Evans
Mr. Hoenig
Mr. Kohn
Mr. Kroszner
Mr. Mishkin
Mr. Poole
Mr. Rosengren
Mr. Warsh
Mr. Fisher, Ms. Pianalto, and Messrs.
Plosser and Stern, Alternate Members of the Federal Open Market
Committee
Messrs. Lacker and Lockhart, and Ms.
Yellen, Presidents of the Federal
Reserve Banks of Richmond, Atlanta, and San Francisco, respectively
Mr. Madigan, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Messrs. Clouse, Connors, Fuhrer, Kamin, Rasche, Slifman, and Wilcox,
Associate Economists
Mr. Dudley, Manager, System Open
Market Account

Notation Vote
By notation vote completed on July 18,
2007, the Committee unanimously approved the minutes of the FOMC meeting held on June 27-28, 2007.

Meeting Held on
September 18, 2007

Brian F. Madigan
Secretary

Ms. J. Johnson,9 Secretary, Office of
the Secretary, Board of Governors

9. Attended portion of the meeting relating to
the discussion of approaches to stabilizing money
markets.

Minutes of FOMC Meetings, September 231
Mr. Frierson,9 Deputy Secretary, Office
of the Secretary, Board of Governors
Ms. Bailey9 and Mr. Roberts,9 Deputy
Directors, Division of Banking Supervision and Regulation, Board of
Governors
Mr. English, Senior Associate Director,
Division of Monetary Affairs,
Board of Governors
Ms. Liang and Mr. Reifschneider, Associate Directors, Division of Research and Statistics, Board of
Governors
Mr. Wright, Deputy Associate Director,
Division of Monetary Affairs,
Board of Governors
Mr. G. Evans,9 Assistant Director, Division of Reserve Bank Operations
and Payment Systems, Board of
Governors
Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors
Mr. Oliner, Senior Adviser, Division of
Research and Statistics, Board of
Governors
Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Affairs, Board of Governors
Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors
Mr. Natalucci, Senior Economist, Division of Monetary Affairs, Board of
Governors
Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Ms. Beattie,9 Assistant to the Secretary,
Office of the Secretary, Board of
Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Ms. Holcomb, First Vice President,
Federal Reserve Bank of Dallas

Messrs. Judd, Rosenblum, and Sniderman, Executive Vice Presidents,
Federal Reserve Banks of San
Francisco, Dallas, and Cleveland,
respectively
Messrs. Dzina and Hakkio, Mses.
Krieger9 and Mester, and Messrs.
Rolnick and Weinberg, Senior
Vice Presidents, Federal Reserve
Banks of New York, Kansas City,
New York, Philadelphia, Minneapolis, and Richmond, respectively
Messrs. Krane, Peach, and Robertson,
Vice Presidents, Federal Reserve
Banks of Chicago, New York, and
Atlanta, respectively
In the agenda for this meeting, it was
reported that advices of the election of
Charles L. Evans as a member of the
Federal Open Market Committee had
been received and that he had executed
his oath of office.
By unanimous vote, the Federal Open
Market Committee selected James A.
Clouse and Daniel G. Sullivan to serve
as Associate Economists until the selection of their successors at the first regularly scheduled meeting of the Committee in 2008.
The Manager of the System Open
Market Account (SOMA) 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 operations in government securities and federal agency obligations during the period since the
previous meeting. By unanimous vote,
the Committee ratified these transactions.
The information reviewed at the September meeting suggested that economic
activity advanced at a moderate rate
early in the third quarter. After expand-

232 94th Annual Report 2007
ing at a robust pace in July, retail sales
rose at a somewhat slower rate in August. Orders and shipments of capital
goods posted solid gains in July. However, residential investment weakened
further, even before the recent disruptions in mortgage markets. In addition,
private payrolls posted only a small gain
in August, and manufacturing production decreased after gains in the previous two months. Meanwhile, core inflation rose a bit from the low rates
observed in the spring but remained
moderate through July.
Private nonfarm payroll employment
rose only modestly in August, and the
levels of employment in June and July
were revised down. The weakness in
employment was spread fairly widely
across industries. Residential construction and manufacturing posted noticeable declines in jobs, employment in
wholesale trade and transportation was
little changed, and hiring at business services was well below recent trends. Both
the average workweek and aggregate
hours were unchanged in August. The
unemployment rate held steady at
4.6 percent, 0.1 percentage point above
its second-quarter level and equal to its
2006 average.
After posting solid gains in June and
July, total industrial production edged
up only a bit in August. This increase
was attributable to a surge in electricity
generation, as temperatures swung from
mild in July to very warm in August.
After large gains in the preceding two
months, manufacturing output declined
in August, held down by a decrease in
the production of motor vehicles and
parts. High-tech output rose only modestly in August, but production gains in
June and July were revised up considerably.
Consumer spending appeared to have
strengthened early in the summer from
its subdued second-quarter pace. Al

though auto sales were weak in July,
real outlays for other goods rose briskly.
At the same time, spending on services
was up moderately despite a drop in outlays for energy associated with relatively cool weather in the eastern part of
the United States. In August, consumption appeared to have posted another
solid gain. Although nominal retail sales
outside the motor vehicle sector were
about flat (abstracting from a drop in
nominal sales at gasoline stations associated with falling gas prices), vehicle
sales stepped up and warmer weather
likely caused an increase in energy usage. Real disposable income rose further
in July, as wages and salaries posted a
strong gain and energy prices came
down. However, household wealth
likely was providing a diminishing impetus to the pace of spending, reflecting
recent declines in stock market wealth
and an apparent further deceleration in
house prices. Readings on consumer
sentiment turned down in August after
having risen in July, and the Reuters/
Michigan index remained near its
relatively low August level in early
September.
The housing sector remained exceptionally weak. Home sales had dropped
considerably this year: Sales of new and
existing single-family homes in July
were down substantially from their averages over the second half of last year.
Demand was restrained by deteriorating
conditions in the subprime mortgage
market and by an increase in rates for
thirty-year fixed-rate conforming mortgages. In the nonconforming mortgage
market, the availability of financing to
borrowers recently appeared to have
been crimped even further. Most
forward-looking indicators of housing
demand, including an index of pending
home sales, pointed to a further deterioration in sales in the near term. Singlefamily starts slid in July to their lowest

Minutes of FOMC Meetings, September 233
reading since 1996, and adjusted permit exceeded the number who saw them as
issuance continued on a downward tra- too high.
The U.S. international trade deficit
jectory. Although single-family housing
starts had come down substantially from narrowed slightly in July, as exports intheir peak, the drop had lagged the de- creased more than imports. Sharp incline in demand, and as a result, inven- creases in exports of both aircraft and
tories of new homes had risen consider- automobiles contributed importantly to
ably. In the multifamily sector, starts in the overall gain. Exports of agricultural
July were in line with readings thus far products and consumer goods were also
this year and at the low end of the fairly strong. In contrast, exports of industrial
narrow range seen since 1997. Mean- supplies and semiconductors exhibited
while, house prices generally continued declines. The value of imported goods
and services was boosted by a large into decelerate.
crease in imports of automotive prodOrders and shipments of capital goods
posted a strong gain early in the third ucts. Higher imports of capital goods
quarter. In particular, orders and ship- excluding aircraft, computers, and semiments of equipment outside the high- conductors and of oil also contributed to
the overall gain in imports.
tech and transportation sector registered
Economic growth slowed in the seca robust increase in July, and data on
ond quarter in most advanced foreign
computer production and shipments of
high-tech goods pointed to solid in- economies, except the United Kingdom.
The step-down was most pronounced in
creases in business demand for highJapan, where GDP contracted, but was
tech. In contrast, indicators of spending
also substantial in the euro area, where
for transportation equipment were
total domestic demand rose only
mixed. Aircraft shipments in July and
slightly. Although growth remained ropublic information on Boeing's deliverbust in Canada, data late in the quarter,
ies suggested that domestic spending on including retail sales, indicated a more
aircraft was retreating somewhat in the significant weakening in activity. This
current quarter. While fleet sales of light softness appeared to have continued into
vehicles appeared to have moved up in the third quarter in some economies. In
July and August, sales of medium and July, indicators for Europe generally
heavy trucks remained below the moderated, on balance, from their
second-quarter average. More generally, second-quarter levels; those for Canada
surveys of business conditions sug- and Japan, however, slowed more notagested that increases in business activity bly. Most of the readings available on
were somewhat slower in August than economic developments after August 9,
in the second quarter.
when financial turmoil intensified, were
Book-value data for the manufactur- measures of confidence. They dropped,
ing and trade sectors excluding motor on average, but otherwise were consisvehicles and parts suggested that inven- tent with the indicators reported for July.
tory accumulation stepped down noticeData through July suggested that ecoably in July from the second-quarter nomic activity in emerging-market
pace. Inventories of light motor vehicles countries remained robust. Output in the
rose again in July and August. The num- Asian economies soared in the second
ber of manufacturing purchasing manag- quarter, and several countries posted
ers who viewed their customers' inven- growth at or near double-digit rates. In
tory levels as too low in August slightly Latin America, output in Mexico and

234 94th Annual Report, 2007
Venezuela rebounded sharply from earlier weakness. Indicators for China in
July pointed to only a modest slowing of
output growth from its torrid pace in the
first half of the year. The scant data for
August received thus far provided little
indication that the turmoil in financial
markets had a significant negative impact on real economic activity in
emerging-market economies.
After rapid price increases earlier this
year, U.S. headline consumer price inflation was moderate in both June and July.
Although food prices continued their
string of sizable increases, energy prices
fell in June and July and gasoline prices
appear to have dropped further in August. Core PCE prices rose 0.2 percent
in June and 0.1 percent in July. On a
twelve-month-change basis, core PCE
inflation in July was below the comparable rate twelve months earlier. Stepdowns in price inflation for prescription
drugs, motor vehicles, and nonmarket
services accounted for nearly all of the
deceleration in core PCE prices. Although owners' equivalent rent decelerated over the past year, this change was
largely offset by an acceleration in tenants' rent and lodging away from home.
Household surveys indicated that the
median expectation for year-ahead inflation declined in August and edged down
further in early September to a level
only slightly above the reading at the
turn of the year; the median expectation
of longer-term inflation in early September remained in the range seen over the
past couple of years. The producer price
index for core intermediate materials
rose only modestly in July. Compensation per hour decelerated in the second
quarter. Nonetheless, the increase over
the four quarters ending in the second
quarter was noticeably above the increase in the preceding four quarters and
well above the rise in the employment
cost index over the same period.

At its August meeting, the FOMC decided to maintain its target for the federal funds rate at 5lA percent. In the
statement, the Committee acknowledged
that financial markets had been volatile
in recent weeks, credit conditions had
become tighter for some households and
businesses, and the housing correction
was ongoing. The Committee reiterated
its view that the economy seemed likely
to continue to expand at a moderate pace
over coming quarters, supported by
solid growth in employment and incomes and a robust global economy.
Readings on core inflation had improved
modestly in recent months. However, a
sustained moderation in inflation pressures had yet to be convincingly demonstrated. Moreover, the high level of resource utilization had the potential to
sustain these pressures. Although the
downside risks to growth had increased
somewhat, the Committee repeated that
its predominant policy concern remained the risk that inflation would fail
to moderate as expected. Future policy
adjustments would depend on the outlook for both inflation and economic
growth, as implied by incoming information. The FOMC's policy decision
and the accompanying statement were
about in line with market expectations,
and reactions in financial markets were
muted.
In the days after the August FOMC
meeting, financial market participants
appeared to become more concerned
about liquidity and counterparty credit
risk. Unsecured bank funding markets
showed signs of stress, including volatility in overnight lending rates, elevated
term rates, and illiquidity in term funding markets. On August 10, the Federal
Reserve issued a statement announcing
that it was providing liquidity to facilitate the orderly functioning of financial
markets. The Federal Reserve indicated
that it would provide reserves as neces-

Minutes of FOMC Meetings, September 235
Short-term financial markets came
sary through open market operations to
promote trading in the federal funds under pressure over the intermeeting pemarket at rates close to the target rate of riod amid heightened investor unease
514 percent. The Federal Reserve also about exposures to subprime mortgages
noted that the discount window was and to structured credit products more
generally. Rates on asset-backed comavailable as a source of funding.
On August 17, the FOMC issued a mercial paper and on low-rated unsestatement noting that financial market cured commercial paper soared, and
conditions had deteriorated and that some issuers, particularly asset-backed
tighter credit conditions and increased commercial paper programs with investuncertainty had the potential to restrain ments in subprime mortgages, found it
economic growth going forward. The difficult to roll over maturing paper.
FOMC judged that the downside risks to These developments led several progrowth had increased appreciably, indi- grams to draw on backup lines, exercise
cated that it was monitoring the situa- options to extend the maturity of outtion, and stated that it was prepared to standing paper, or even default. As a
act as needed to mitigate the adverse result, asset-backed commercial paper
effects on the economy arising from the outstanding contracted substantially. Indisruptions in financial markets. Simul- vestors sought the safety and liquidity of
taneously, the Federal Reserve Board Treasury securities, and yields on Treaannounced that, to promote the restora- sury bills dropped sharply for a period;
tion of orderly conditions in financial trading conditions in the bill market
markets, it had approved a 50 basis point were impaired at times. Meanwhile,
reduction in the primary credit rate to banks took measures to conserve their
53/4 percent. The Board also announced liquidity and were cautious about couna change to the Reserve Banks' usual terparties' exposures to asset-backed
practices to allow the provision of term commercial paper. Term interbank fundfinancing for as long as thirty days, re- ing markets were significantly impaired,
newable by the borrower. In addition, with rates rising well above expected
the Board noted that the Federal Re- future overnight rates and traders reportserve would continue to accept a broad ing a substantial drop in the availability
range of collateral for discount window of term funding. Pressures eased a bit in
loans, including home mortgages and re- mid-September, but short-term financial
lated assets, while maintaining existing markets remained strained.
Conditions in corporate credit marcollateral margins. On August 21, the
Federal Reserve Bank of New York an- kets were mixed. Investment- and
corporate
bond
nounced some temporary changes to the speculative-grade
terms and conditions of the SOMA se- spreads edged up; they were near their
curities lending program, including a re- highest levels in four years, although
duction in the minimum fee. The effec- they remained far below the peaks seen
tive federal funds rate was somewhat in mid-2002. Investment-grade bond isbelow the target rate for a time over the suance was strong in August as yields
intermeeting period, as efforts to keep declined, but issuance of speculativethe funds rate near the target were ham- grade bonds was scant. Speculativepered by technical factors and financial grade bond deals and leveraged loans
market volatility. In the days leading up slated to finance leveraged buyouts conto the FOMC meeting, however, the tinued to be delayed or restructured.
Bank lending to businesses surged in
funds rate traded closer to the target.

236 94th Annual Report, 2007
August, apparently because some banks
funded leveraged loans that they had intended to syndicate to institutional investors and perhaps because some firms
substituted bank credit for commercial
paper. Although markets for nonconforming mortgages were impaired over
the intermeeting period, the supply of
conforming mortgages seemed to have
been largely unaffected by recent developments. Broad stock price indexes
were volatile but about unchanged, on
net, over the intermeeting period. The
foreign exchange value of the dollar
against other major currencies fell, on
balance.
Investors appeared to mark down significantly their expected path for the
federal funds rate during the intermeeting period, evidently in response to the
strains in money and credit markets and
a few key data releases, including
weaker-than-expected reports on housing activity and employment. Yields on
nominal Treasury securities fell appreciably across the term structure. TIPSbased inflation compensation at the fiveyear horizon was about unchanged,
while inflation compensation at longer
horizons crept higher.
Growth of nonfinancial domestic debt
was estimated to have slowed a little in
the third quarter from the average pace
in the first half of the year. The deceleration in total nonfinancial debt reflected a
projected slowdown in borrowing across
all major sectors of the economy
excluding the federal government.
Although it decelerated in the third
quarter, business-sector debt continued
to advance at a solid pace, boosted by a
surge in business loans. In the household sector, mortgage borrowing was
estimated to have slowed notably, as
mortgage interest rates moved up, nonconforming mortgages became harder to
obtain, and as home sales slowed and
house prices decelerated. M2 increased

at a brisk pace in August. The rise was
led by a surge in liquid deposits and in
retail money funds as investors adjusted
their portfolios in response to the turmoil in financial markets.
In preparation for this meeting, the
staff continued to estimate that real GDP
increased at a moderate rate in the third
quarter. However, the staff marked down
the fourth-quarter forecast, reflecting a
judgment that the recent financial turbulence would impose restraint on economic activity in coming months, particularly in the housing sector. The staff
also trimmed its forecast of real GDP
growth in 2008 and anticipated a modest
increase in unemployment. Softer demand for homes amid a reduction in the
availability of mortgage credit would
likely curtail construction activity
through the middle of next year. Moreover, lower housing wealth, slower gains
in employment and income, and reduced
confidence seemed likely to restrain
consumer spending in 2008. Despite the
recent difficulties in some corporate
credit markets, financial conditions confronting most nonfinancial businesses
did not appear to have tightened appreciably to date. But going forward, the
staff anticipated that businesses would
scale back their capital spending a touch
in response to financing conditions that
were likely to become a little less accommodative and to more modest gains
in sales. With credit markets expected to
largely recover over coming quarters,
growth of real GDP was projected to
firm in 2009 to a pace a bit above the
rate of growth of its potential. Incoming
data on consumer price inflation that
were slightly to the low side of the previous forecast, in combination with the
easing of pressures on resource utilization in the current forecast, led the staff
to trim slightly its forecast for core PCE
inflation. Headline PCE inflation, which
was boosted by sizable increases in en-

Minutes of FOMC Meetings, September 237
ergy and food prices earlier in the year, the recent deterioration in various term
was expected to slow in 2008 and 2009. funding markets, might well lead banks
In their discussion of the economic to tighten the availability of credit to
situation and outlook, meeting partici- households and firms. Tighter credit
pants focused on the potential for recent conditions were likely to weigh particucredit market developments to restrain larly on residential investment and to a
aggregate demand in coming quarters. lesser extent on other components of agThe disruptions to the market for non- gregate demand in coming quarters.
conforming mortgages were likely to re- Meeting participants also noted that fiduce further the demand for housing, nancial market conditions, while seemand recent financial developments could ing to have improved somewhat in the
well lead to a more general tightening of most recent days, were still fragile and
credit availability. Moreover, some re- that further adverse credit market develcent data and anecdotal information opments could well increase the downpointed to a possible nascent slowdown side risks to the economy. Even after
in the pace of expansion. Given the un- market volatility subsided and the recent
usual nature of the current financial strains eased, risk spreads probably
shock, participants regarded the outlook would be wider and credit terms tighter
for economic activity as characterized than they had been a few months ago.
by particularly high uncertainty, with the Although these developments would
risks to growth skewed to the downside. likely be consistent with longer-term fiSome participants cited concerns that a nancial stability, they were likely to exweaker economy could lead to a further ert some restraint on aggregate demand.
In their discussion of individual sectightening of financial conditions, which
in turn could reinforce the economic tors of the economy, participants noted
slowdown. But participants also noted that recent data suggested greater weakthat the resilience of the economy in the ness in the housing market than had preface of a number of previous periods of viously been expected. Furthermore, refinancial market disruptions left open cent financial developments had the
the possibility that the macroeconomic potential to deepen further and prolong
effects of the financial market turbu- the downturn in the housing market, as
subprime mortgages remained essenlence would prove limited.
Although financial markets were ex- tially unavailable, little activity was evipected to stabilize over time, partici- dent in the markets for other nonprime
pants judged that credit markets were mortgages, and prime jumbo mortgage
likely to restrain economic growth in the borrowers faced higher rates and tighter
period ahead. Given existing commit- lending standards. The faster pace of
ments to customers and the increased foreclosures as subprime mortgage rates
resistance of investors to purchasing reset was also seen as posing a downsome securitized products, banks might side risk to the housing market. Noneneed to take a large volume of assets theless, participants observed that cononto their balance sheets over coming forming mortgages remained readily
weeks, including leveraged loans, asset- available to creditworthy borrowers and
backed commercial paper, and some that rates on these mortgages had detypes of mortgages. Banks' concerns clined in recent weeks. Moreover, condiabout the implications of rapid growth tions in the jumbo mortgage market
in their balance sheets for their capital were expected to improve gradually
ratios and for their liquidity, as well as over time.

238 94th Annual Report, 2007
Although employment probably was
not as weak as the most recent monthly
data had suggested, trend growth in jobs
had fallen off even prior to the recent
financial market strains, and participants
judged that some further slowing of employment growth was likely. Indeed, financial services firms had already announced layoffs, largely reflecting
mortgage market developments, the demand for temporary workers appeared
to have softened, and the most recent
weakening in construction employment
was likely to continue for a while. Moreover, if declines in house prices were to
damp consumption, that could feed back
on employment and income, exerting
additional restraint on the demand for
housing. Nonetheless, to date, initial
claims for unemployment insurance did
not indicate a substantial and widespread weakening in labor demand, and
labor markets across the country generally remained fairly tight, with several
participants citing continued reports of
shortages of labor from their contacts in
some sectors.
Participants thought that the most
likely prospect was for consumer
expenditures to continue to expand at a
moderate pace on average over coming
quarters, supported by growth in employment and income. However, some
participants saw indications of a possible weakening of consumer spending.
Sales of automobiles and building materials had flagged of late, and survey
measures suggested that consumer confidence had been adversely affected by
the recent financial market developments. Also, a further tightening of
terms for home equity lines of credit and
second mortgages seemed possible,
which could weigh on consumer spending, especially for consumer durables.
Participants reported that recent financial market developments generally
appeared to have had limited effects to

date on business capital spending plans
and expected that business investment
was likely to remain healthy in coming
quarters. The access of investment-grade
corporate borrowers to credit so far remained unimpeded, and rates on
investment-grade bonds had declined in
recent weeks. Moreover, participants
noted that many capital expenditures
were internally financed, making them
less sensitive to credit market conditions. Nonetheless, the pace of financing
for lower-rated firms—including issuance of both speculative-grade bonds
and leveraged loans—had slowed
sharply over the summer. Participants
also noted that standards and terms for
commercial real estate credit reportedly
had tightened, and that credit availability for homebuilders could be trimmed
going forward. In addition, contacts indicated that business executives in parts
of the country had apparently become
somewhat more cautious and that some
were delaying investment outlays in
view of heightened economic and financial uncertainty.
Some participants noted that foreign
demand remained robust and net exports
appeared strong. Port utilization rates reportedly remained high. Participants discussed the turbulence in foreign financial markets and noted that unusually
high precautionary demand for dollardenominated term funding in Europe
had added to strains in U.S. interbank
markets and contributed to a wide
spread between libor and federal funds
rates.
Participants made only modest revisions to their outlook for inflation in the
period since the Committee's last regular meeting. Still, they recognized that
incoming data on core inflation continued to be favorable, and they generally
were a little more confident that the decline in inflation earlier this year would
be sustained. Inflation expectations

Minutes of FOMC Meetings, September 239
seemed to be contained, and the less With economic growth likely to run berobust economic outlook implied some- low its potential for a while and with
what less pressure on resources going incoming inflation data to the favorable
forward. Participants nonetheless re- side, the easing of policy seemed unmained concerned about possible upside likely to affect adversely the outlook for
risks to inflation. Higher benefit costs, inflation.
rising unit labor costs more generally,
The Committee agreed that the statereduced markups, and levels of resource ment to be released after the meeting
utilization both in the United States and should indicate that the outlook for ecoabroad that remained relatively high nomic growth had shifted appreciably
were all cited as factors that could con- since the Committee's last regular meettribute to inflationary pressures. Infla- ing but that the 50 basis point easing in
tion risks could be heightened if the policy should help to promote moderate
dollar were to continue to depreciate growth over time. They also agreed that
significantly.
the inflation situation seemed to have
In the Committee's discussion of improved slightly and judged that it was
policy for the intermeeting period, all no longer appropriate to indicate that a
members favored an easing of the stance sustained moderation in inflation presof monetary policy. Members empha- sures had yet to be shown. Nonetheless,
sized that because of the recent sharp all agreed that some inflation risks rechange in credit market conditions, the mained and that the statement should
incoming data in many cases were of indicate that the Committee would conlimited value in assessing the likely evo- tinue to monitor inflation developments
lution of economic activity and prices, carefully. Given the heightened unceron which the Committee's policy deci- tainty about the economic outlook, the
sion must be based. Members judged Committee decided to refrain from prothat a lowering of the target funds rate viding an explicit assessment of the balwas appropriate to help offset the effects ance of risks, as such a characterization
of tighter financial conditions on the could give the mistaken impression that
economic outlook. Without such policy the Committee was more certain about
action, members saw a risk that tighten- the economic outlook than was in fact
ing credit conditions and an intensifying the case. Future actions would depend
housing correction would lead to sig- on how economic prospects were afnificant broader weakness in output and fected by evolving market developments
employment. Similarly, the impaired and by other factors.
functioning of financial markets might
At the conclusion of the discussion,
persist for some time or possibly the Committee voted to authorize and
worsen, with negative implications for direct the Federal Reserve Bank of New
economic activity. In order to help fore- York, until it was instructed otherwise,
stall some of the adverse effects on the to execute transactions in the System
economy that might otherwise arise, all
Account in accordance with the followmembers agreed that a rate cut of 50 baing domestic policy directive:
sis points at this meeting was the most
The Federal Open Market Committee
prudent course of action. Such a measure should not interfere with an adjust- seeks monetary and financial conditions that
will foster price stability and promote susment to more realistic pricing of risk or tainable growth in output. To further its
with the gains and losses that implied long-run objectives, the Committee in the
for participants in financial markets. immediate future seeks conditions in reserve

240 94th Annual Report, 2007
markets consistent with reducing the federal ened in the days since its last meeting.
funds rate to an average of around 43A per- Participants discussed the condition of
cent.
domestic and foreign financial markets,
The vote encompassed approval of the Open Market Desk's approach to
the text below for inclusion in the state- open market operations, possible adjustments to the discount rate, and the statement to be released at 2:15 p.m.:
Developments in financial markets since ment to be issued immediately after the
the Committee's last regular meeting have conference call.
increased the uncertainty surrounding the
On August 16, 2007, the Committee
economic outlook. The Committee will con- again met by conference call. With fitinue to assess the effects of these and other nancial market conditions having detedevelopments on economic prospects and
will act as needed to foster price stability riorated further, meeting participants
discussed the potential usefulness of
and sustainable economic growth.
Votes for this action: Messrs. Bernanke, various policy responses. The discusGeithner, Evans, Hoenig, Kohn, sion focused primarily on changes assoKroszner, Mishkin, Poole, Rosengren, ciated with the discount window that
and Warsh. Votes against this action: would be directed at improving the funcNone.
tioning of the money markets. Most parThe Committee then resumed its dis- ticipants expressed strong support for
cussion of monetary policy communica- taking such steps, although some contion issues. Subsequently, in a joint ses- cern was noted about the likely
sion of the Federal Open Market effectiveness of these measures and one
Committee and the Board of Governors, participant also questioned their apBoard members and Reserve Bank propriateness. In light of the risks posed
presidents discussed additional policy to the economic outlook by the tighter
options to address strains in money mar- credit conditions and the increased
kets. No decisions were made in this uncertainty in financial markets, the
session, but it was agreed that policy- Committee felt that the downside risks
makers should continue to consider such to growth had increased appreciably, but
options carefully.
that a change in the federal funds rate
It was agreed that the next meeting of target was not yet warranted. However,
the Committee would be held on the situation bore close watching.
Tuesday-Wednesday, October 30-31,
At the conclusion of the discussion,
2007.
the Committee voted to approve the text
The meeting adjourned at 3:55 p.m.
below to be released the following
morning:
Notation Vote
Financial market conditions have deteriorated, and tighter credit conditions and
By notation vote completed on August increased uncertainty have the potential to
27, 2007, the Committee unanimously restrain economic growth going forward. In
approved the minutes of the FOMC these circumstances, although recent data
suggest that the economy has continued to
meeting held on August 7, 2007.
expand at a moderate pace, the Federal Open
Market Committee judges that the downside
Conference Calls
risks to growth have increased appreciably.
The Committee is monitoring the situation
On August 10, 2007, the Committee re- and is prepared to act as needed to mitigate
viewed developments in money and the adverse effects on the economy arising
credit markets, where strains had wors- from the disruptions in financial markets.

Minutes of FOMC Meetings, October 241
Votes for: Messrs. Bernanke, Geithner,
Fisher, Hoenig, Kohn, Kroszner, Mishkin, Moskow, Rosengren, and Warsh.
Votes against: None. Mr. Fisher voted
as alternate member.

Mr. Dudley, Manager, System Open
Market Account

Brian F. Madigan
Secretary

Mr. English, Senior Associate Director,
Division of Monetary Affairs,
Board of Governors

Meeting Held on
October 30-31, 2007
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, October 30, 2007 at 2:00 p.m.
and continued on Wednesday, October
31, 2007 at 9:00 a.m.
Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Mr. Evans
Mr. Hoenig
Mr. Kohn
Mr. Kroszner
Mr. Mishkin
Mr. Poole
Mr. Rosengren
Mr. Warsh
Ms. Cumming, Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and
Stern, Alternate Members of the
Federal Open Market Committee
Messrs. Lacker and Lockhart, and Ms.
Yellen, Presidents of the Federal
Reserve Banks of Richmond, Atlanta, and San Francisco, respectively
Mr. Madigan, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Mr. Baxter, Deputy General Counsel
Mr. Sheets, Economist
Mr. Stockton, Economist
Messrs. Clouse, Connors, Fuhrer, Kami n, Rasche, Slifman, Sullivan,
and Wilcox, Associate Economists

Mr. Struckmeyer, Deputy Staff Director, Office of Staff Director for
Management

Messrs. Reifschneider10 and Wascher,
Associate Directors, Division of
Research and Statistics, Board of
Governors
Mr. Wright, Deputy Associate Director,
Division of Monetary Affairs,
Board of Governors
Mr. Zakrajsek, Assistant Director, Division of Monetary Affairs, Board of
Governors
Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors
Ms. K. Johnson, Senior Adviser, Division of International Finance,
Board of Governors
Mr. Oliner, Senior Adviser, Division of
Research and Statistics, Board of
Governors
Mr. Dale,10 Senior Adviser, Division of
Monetary Affairs, Board of Governors
Mr. Gross,10 Special Assistant to the
Board, Office of Board Members,
Board of Governors
Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors
Messrs. Kumasaka11 and Luecke,12 Senior Financial Analysts, Division
of Monetary Affairs, Board of
Governors
Ms. Judson, Economist, Division of
Monetary Affairs, Board of Governors
10. Attended portion of meeting relating to the
discussion of communication issues.
11. Attended Tuesday session.
12. Attended Wednesday session.

242 94th Annual Report 2007
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Mr. Lyon, First Vice President, Federal
Reserve Bank of Minneapolis
Messrs. Judd and Sniderman, Executive
Vice Presidents, Federal Reserve
Banks of San Francisco and Cleveland, respectively
Mr. Altig and Ms. Mester, Senior Vice
Presidents, Federal Reserve Banks
of Atlanta and Philadelphia, respectively
Mr. Hakkio, Special Adviser, Federal
Reserve Bank of Kansas City
Messrs. Hilton, Koenig, and Potter,
Vice Presidents, Federal Reserve
Banks of New York, Dallas, and
New York, respectively
Mr. Weber, Senior Research Officer,
Federal Reserve Bank of Minneapolis
Mr. Hetzel, Senior Economist, Federal
Reserve Bank of Richmond
By unanimous vote, the Federal Open
Market Committee selected D. Nathan
Sheets to serve as Economist until the
selection of his successor at the first
regularly scheduled meeting of the
Committee in 2008.
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 operations in government securities and federal agency obligations during the period since the previous meeting. By unanimous vote, the Committee
ratified these transactions.
The information provided to the Committee on the first day of the meeting,
prior to the release of the advance esti

mates of the third-quarter national income and product accounts, indicated
that economic activity expanded at a
solid pace in the third quarter. Consumer
spending rose more strongly after a tepid
increase in the second quarter, and the
pace of expansion of business outlays
for equipment and structures remained
reasonably solid. Manufacturing posted
a sizable gain for the third quarter as a
whole. In contrast, the slump in residential investment intensified during the
third quarter, at least partly because of
ongoing disruptions in the markets for
nonconforming mortgages. The average
monthly gain in private employment
also slowed significantly. Headline inflation eased during the third quarter,
reflecting a decline in energy prices;
core inflation continued to be moderate.
Employment increased more slowly
in the third quarter than in the first half
of the year. Private payroll employment
registered a considerably smaller average monthly gain; employment in residential construction, manufacturing, and
industries related to mortgage lending
continued to decline, but most serviceproducing industries added jobs at a
moderate pace. With gains in employment smaller and the workweek flat, the
growth of aggregate hours of private
production or nonsupervisory workers
stepped down from its second-quarter
pace. The labor force participation rate
was unchanged, on average, in the third
quarter, and the unemployment rate
ticked up to 4.7 percent in September.
Industrial production changed little in
August and September after having
posted solid advances in June and July.
Manufacturing output expanded in the
third quarter overall at about the same
pace as in the second quarter but declined modestly on net in August and
September. During those two months,
production was damped by declines in
the output of motor vehicles and parts.

Minutes of FOMC Meetings, October 243
In addition, output of construction supplies and products fell, likely reflecting
the ongoing decline in residential investment. Meanwhile, production in the
high-tech sector rose at a moderate rate.
Consumer spending was well maintained in August and September. Motor
vehicle sales improved, and real spending on other goods posted solid gains in
both months. Real outlays on consumer
services were strong in August because
of a weather-induced jump in energy
services. Solid increases in nominal
wages and salaries and lower headline
inflation led to robust gains in real income over the summer. However, other
factors affecting consumer spending
were mixed. Short-term interest rates
dropped and stock prices rose, on balance, after August. By contrast, house
prices continued to decelerate, standards
on consumer and mortgage credit tightened after midsummer, and the turmoil
in financial markets that started in the
summer likely exerted some restraint on
consumer spending. Moreover, measures of consumer confidence had declined in recent months.
The housing downturn deepened as
sales of new and existing single-family
homes continued to fall. Deterioration in
nonprime mortgage markets as well as
higher mortgage interest rates and
tighter lending conditions for prime
jumbo loans since earlier in the year appeared to be restraining housing demand. Forward-looking indicators, including an index of pending home sales
and adjusted single-family permit issuance, continued to point to a further
slowing in housing activity over the near
term. Single-family housing starts declined significantly over August and
September. Nonetheless, with singlefamily home sales continuing to sag, inventories of unsold homes remained
quite elevated. In the multifamily sector,
starts declined sharply in September;

however, the third-quarter reading remained within the fairly narrow range
observed over the past decade.
Orders and shipments of nondefense
capital goods excluding aircraft rose on
average over August and September. In
the high-tech category, orders and shipments of computers and peripherals
posted robust gains over the same period. Shipments of communication
equipment also rose in August and September, but orders were little changed
on balance over the same period. Outside the technology sector, shipments of
nondefense capital goods excluding aircraft increased at a solid rate over August and September but orders declined
in August and were flat in September.
Sales of medium and heavy trucks leveled off in the third quarter after a sharp
drop in the first half of the year. Domestic outlays for aircraft likely stepped
down somewhat in the third quarter.
Nonresidential building activity remained vigorous through August after
having posted very strong gains in the
second quarter; anecdotal evidence
through early October indicated that the
recent turbulence in commercial credit
markets had done little to slow the pace
of commercial construction. More generally, surveys of business conditions
continued to point to further near-term
gains in spending, although reports from
business contacts indicated that some
firms had marked down their capital
spending plans.
Data on the book value of business
inventories through August suggested
that real nonfarm inventory investment
excluding motor vehicles moved down
in the third quarter after having risen at
a moderate pace in the second quarter.
The ratio of book-value inventories to
sales in the manufacturing and trade sector excluding motor vehicles, which was
available through August, remained well
below the elevated values seen around

244 94th Annual Report, 2007
the turn of the year. Purchasing managers, on average, viewed the level of their
customers' inventories as about right in
September.
The U.S. international trade deficit
narrowed in August as exports increased
and imports decreased. Goods exports
were boosted by a jump in exports of
agricultural products and of gold, which
more than offset a decline in exports of
other goods. Exports of automotive
products fell back sharply after a surge
in July. Exports of capital goods contracted slightly, led by a drop in aircraft
exports. Exports of semiconductors declined, while exports of computers were
about flat. On the import side, the decline was concentrated in goods; service
imports were flat. Higher imports of oil
and of capital goods, particularly computers and semiconductors, were more
than offset by lower imports of automotive products, consumer goods, and industrial supplies excluding oil.
Indicators of economic activity in the
third quarter for advanced foreign
economies were solid on balance. In the
euro area, production and sales picked
up in the third quarter from their secondquarter levels. However, recent survey
data, including the purchasing managers' index for the service sector in the
euro area, pointed to a possible slowing
in the pace of growth. Likewise, notwithstanding a strong preliminary estimate of third-quarter GDP growth in the
United Kingdom, more recent surveys
pointed to some softening. Recent Canadian data were mixed, with relatively
strong employment growth and some
weakness in retail sales. In contrast, Japan's retail sales and exports rebounded
in August, and the October Tankan survey seemed to suggest that the second
quarter's sharp contraction in investment was temporary.
In emerging-market economies, recent information, mostly through Au

gust, gave no signs that the turmoil in
financial markets was having a significant negative effect on real economic
activity. In emerging Asia, activity appeared to have remained robust, although growth slowed from its elevated
second-quarter pace. Economic indicators for Mexico pointed to moderate
growth in the third quarter. In South
America, activity was strong, boosted
by high prices for commodities and, in
Argentina and Venezuela, by expansionary macroeconomic policies. Food
prices continued to be a major source of
inflationary pressures in emergingmarket economies, and Chinese authorities took several steps aimed at quelling
rising prices.
After having risen rapidly in the first
half of the year, headline consumer
prices decelerated considerably over the
summer, largely because of a fall in energy prices. Over September and October, gasoline prices appeared to have
risen only moderately despite a jump in
crude oil costs. Consumer food prices
posted further sizable increases in August and September and continued to
run well above the change in core prices.
Core consumer price inflation remained
moderate in August and September and,
on a twelve-month change basis, was
down noticeably from a year earlier.
Core goods prices fell over the year ending in September after having risen little
over the preceding year; noticeable decelerations occurred in the prices of apparel, prescription drugs, and motor vehicles. In addition, increases in owners'
equivalent rent slowed noticeably, while
rent inflation remained about the same
as a year earlier. The producer price index for core intermediate materials
edged up in September. The twelvemonth change in that index stepped
down considerably from last year, in
part because of softer prices for a
variety
of
energy-intensive
and

Minutes of FOMC Meetings, October 245
construction-related items. Household
surveys indicated that median yearahead inflation expectations inched
down in September and October to
about the level observed in the first
quarter, and longer-term inflation expectations slipped to their lowest level in
two years. Average hourly earnings
posted a moderate increase over the
twelve months ending in September.
At its September meeting, the FOMC
lowered its target for the federal funds
rate 50 basis points, to 43A percent. The
Board of Governors also approved a
50 basis point decrease in the discount
rate, to 5lA percent, leaving the gap between the federal funds rate target and
the discount rate at 50 basis points. The
Committee's statement noted that, while
economic growth had been moderate
during the first half of the year, the tightening of credit conditions had the potential to intensify the housing correction
and to restrain economic growth more
generally. The Committee indicated that
its action was intended to help forestall
some of the adverse effects on the
broader economy that could otherwise
arise from the disruptions in financial
markets and to promote moderate
growth over time. Readings on core inflation had improved modestly during
the year, but the Committee judged that
some inflation risks remained, and the
Committee planned to continue to monitor inflation developments carefully. The
Committee further noted that developments in financial markets since the last
regular FOMC meeting had increased the
uncertainty surrounding the economic
outlook. Accordingly, the Committee
would continue to assess the effects of
these and other developments on
economic prospects and remained ready
to act as needed to foster price stability
and sustainable economic growth.
The expected path for monetary
policy as inferred from futures markets

declined in the wake of the September
policy action, as many investors were
surprised by the magnitude of the reduction in the target rate. Over the intermeeting period, many investors came to
expect that the Committee would reduce
the target federal funds rate at its October meeting; in addition, the anticipated
policy path further ahead moved down a
bit more, on net, over the remainder of
the intermeeting period, apparently in
response to heightened concerns among
investors about economic growth.
Early in the intermeeting period, the
functioning of short-term funding markets improved somewhat, but conditions
in these markets remained strained. The
effective federal funds rate was very
close to the target, on average, but the
average absolute daily deviation of the
effective rate from the target and the
intraday standard deviation remained elevated. Credit spreads declined in the
commercial paper and term interbank
funding markets but stayed well above
longer-term norms. Liquidity in the
Treasury bill market was poor at times.
Corporate bond spreads narrowed somewhat, leaving private yields a little
lower. Nonfinancial bond issuance was
robust; speculative-grade offerings increased markedly. The credit quality of
most households remained strong, but
delinquency rates on subprime mortgages climbed further. Securitization of
nonconforming mortgages remained
limited, and spreads on jumbo mortgages relative to conforming mortgages
stayed high. Two-year Treasury yields
declined roughly in line with the lower
expected policy path, while yields on
ten-year Treasuries were little changed,
on net. TIPS-based inflation compensation was about unchanged on balance
over the intermeeting period despite a
sharp rise in spot oil prices. Stock prices
jumped early in the intermeeting period
in response to the cut in the target fed-

246 94th Annual Report, 2007
eral funds rate and some favorable economic news but later dropped back,
leaving broad indexes up only a bit on
net. The foreign exchange value of the
dollar against other major currencies declined notably.
Debt of the domestic nonfinancial
sectors was estimated to have expanded
slightly more quickly in the third quarter
than in the previous quarter. Despite evidence that bank lending standards and
terms had tightened over the previous
three months, business debt was still rising strongly, reflecting a continued
surge in commercial and industrial
(C&I) lending by banks and robust issuance of investment-grade bonds. The expansion of business loans was apparently due in part to financings for
leveraged buyouts that underwriters
could not syndicate to institutional investors. Household mortgage borrowing
was estimated to have decelerated again
in the third quarter. M2 increased significantly more slowly in September and
October than the rapid pace observed in
August, when the financial market turmoil apparently drove investors to the
safety of M2 assets. Inflows to retail
money market funds and small time deposits were especially strong in September and October; small time deposits
were apparently boosted by the attractive rates that banks were offering in
order to help fund their expanding loan
portfolios.
In the forecast prepared for this meeting, which was formulated prior to the
release of the advance estimates of the
third-quarter national income and product accounts, the staff revised up its estimate of aggregate economic activity in
the third quarter from its forecast presented at the September meeting in light
of available indicators that suggested
that consumer spending, business investment, and exports were stronger than
previously expected. Nonetheless, the

staff expected real GDP growth to be
considerably slower in the fourth quarter, reflecting steepening declines in
residential construction, reductions in
the pace of motor vehicle production,
and a smaller contribution from net exports. Looking forward, the staff expected residential investment to remain
weak in 2008 with modest declines in
house prices. In addition, the staff continued to expect the stress in credit markets and the appreciably higher oil
prices indicated by futures markets to
restrain spending by businesses and consumers, although the lower foreign exchange value of the dollar suggested
some boost to net exports. On balance,
real GDP growth for 2008 was projected
to slow to a pace a bit below that of its
potential, and unemployment was expected to creep up slightly. For 2009,
the forecast called for real output growth
to step up to a pace slightly above potential as the drags on economic activity
exerted by the contraction in residential
investment and financial strains were
expected to abate. The staff's forecast
for core PCE inflation was little changed
from that presented at the September
meeting because favorable incoming
figures on core PCE inflation were offset by expectations for some limited
feed-through into retail prices of recent
increases in energy prices and for
slightly less easing in resource utilization. The forecast for headline inflation
was in the same range as that for core
inflation in 2008 and 2009, reflecting
expectations that energy prices would
level off and then turn down and that
increases in food prices would slow to a
pace more in line with core inflation.
The advance data on the national income and product accounts for the third
quarter, which were released on the
morning of the second day of the FOMC
meeting, indicated a stronger increase in
real GDP than the staff had forecast,

Minutes of FOMC Meetings, October 247
mostly because inventory investment
was estimated to be higher than projected by the staff. The staff interpreted
this information as suggesting some upward revision to its estimate of output
growth in the third quarter, a small
downward revision to its forecast of
growth in the current quarter, and no
significant change to its forecast for
coming quarters.
In conjunction with the FOMC meeting in October, all meeting participants
(Federal Reserve Board members and
Reserve Bank presidents) provided annual projections for economic growth,
unemployment, and inflation for the period 2007 through 2010. The projections
are described in the Summary of Economic Projections, which is attached as
an addendum to these minutes.
In their discussion of the economic
outlook and situation, and in the projections that they had submitted for this
meeting, participants noted that economic activity had expanded at a somewhat faster pace in the third quarter than
previously anticipated and that there was
scant evidence of negative spillovers
from the ongoing housing correction to
other sectors of the economy. Conditions in financial markets had improved
since the September FOMC meeting,
but functioning in a number of markets
remained strained. Even with some further easing of monetary policy, participants expected economic growth to slow
over the next few quarters, reflecting
continued sharp declines in the housing
sector and tighter lending standards and
terms across a broad range of credit
products. The slowing of growth was
likely to produce a modest increase in
the unemployment rate from its recent
levels, leading to the emergence of a
little slack in labor markets. Looking
further ahead, participants noted that
economic growth should increase gradually to around its trend rate by 2009 as

weakness in the housing sector abated
and stresses in financial markets subsided. With aggregate demand showing
somewhat greater than expected strength
in the third quarter and little evidence of
significant spillovers from the housing
sector to other components of spending,
participants viewed the downside risks
to growth as somewhat smaller than at
the time of the September meeting, but
those risks were still seen as significant.
Participants generally expected that inflation would edge down over the next
few years, a projection consistent with
the recent string of encouraging releases
on core consumer prices, futures prices
pointing to a flattening of energy costs,
and the anticipated easing of pressures
on resources. Nonetheless, some upside
risks to inflation remained, reflecting in
part the potential feed-through to inflation expectations of increases in energy
and import prices.
Financial market functioning was
judged to have improved somewhat
since the previous FOMC meeting, but
the situation in a number of markets remained strained, and credit market conditions were thought likely to weigh on
economic growth over coming quarters.
In light of some improvement in the
commercial paper and leveraged loan
markets over the intermeeting period,
participants were somewhat less concerned that banks would not have sufficient balance-sheet capacity to absorb
large volumes of assets. Conditions in
corporate credit markets also had improved in recent weeks, and most businesses were apparently having little difficulty raising external funds, as
evidenced by strong issuance of
investment-grade corporate bonds, a
pickup in speculative-grade issuance,
and surging C&I loans. Markets for nonconforming mortgages, by contrast, remained disrupted. Meeting participants
also mentioned that while financial

248 94th Annual Report, 2007
market conditions had improved, the
functioning of some markets remained
somewhat impaired. Indeed, several
participants noted some relapse in
financial conditions late in the intermeeting period. Moreover, unusual pressures in funding markets persisted.
Participants generally viewed financial
markets as still fragile and were
concerned that an adverse shock—such
as a sharp deterioration in credit quality
or disclosure of unusually large and
unanticipated losses—could further dent
investor confidence and significantly
increase the downside risks to the
economy. Participants were also concerned about a potential scenario in
which unexpected economic weakness
could cause a further tightening of credit
conditions that could in turn reinforce
weakness in aggregate demand.
In their discussion of individual sectors of the economy, participants noted
that the recent declines in housing
activity—while substantial—had largely
been anticipated. Nonetheless, the potential for significant further weakening
in housing activity and home prices
represented a downside risk to the
economic outlook. Most participants
pointed to the deterioration in nonprime mortgage markets as well as
higher interest rates and tighter credit
standards for prime nonconforming
mortgages as factors that had exacerbated the deterioration in housing markets, and they noted that these developments could further limit the availability
of mortgage credit and depress the demand for housing. Some participants
also pointed to downside risks to the
housing market stemming from the large
volume of substantial upward interestrate resets that were likely on subprime
mortgages in coming quarters, which
could lead to a faster pace of foreclosures in the near term, thereby intensify

ing the downward pressure on house
prices.
Participants generally agreed that the
available data suggested that consumer
spending had been well maintained over
the past several months and that spillovers from the strains in the housing
market had apparently been quite limited to date. Nevertheless, a number of
participants cited notable declines in
survey measures of consumer confidence since the onset of financial turbulence in midsummer, along with sharply
higher oil prices, declines in house
prices, and tighter underwriting standards for home equity loans and some
types of consumer loans, as factors
likely to restrain consumer spending going forward. Moreover, anecdotal reports by business contacts suggested a
softening in retail sales in some regions
of the country. Participants expressed a
concern that larger-than-expected declines in house prices could further sap
consumer confidence as well as net
worth, causing a pullback in consumer
spending. All told, however, participants
envisioned that the most likely scenario
was for consumer spending to continue
to advance at a moderate rate in coming
quarters, supported by the generally
strong labor market and further gains in
real personal income.
Meeting participants noted that capital expenditures had grown at a solid
pace in recent months and that the financial turmoil generally appeared to have
had a limited effect on business capital
spending plans to date. Nevertheless,
business sentiment appeared to have
eroded somewhat amid heightened economic and financial uncertainty, potentially restraining investment outlays in
some industries. However, participants
noted that conditions in corporate bond
markets had improved since the September FOMC meeting, and that credit
availability generally appeared to be

Minutes of FOMC Meetings, October 249
ample, albeit on somewhat tighter terms.
Participants judged that moderate
growth of investment outlays going forward was the most likely outcome. A
number of participants saw downside
risk to the outlook for nonresidential
building activity, reflecting elevated
spreads on commercial-mortgagebacked securities and a further tightening of banks' lending standards for
commercial real estate loans.
Data on economic growth outside the
United States indicated that the global
expansion, though likely to slow somewhat in coming quarters, was nevertheless on a firm footing. The continued
strength of global growth and the recent
decline in the foreign exchange value of
the dollar were seen as likely to support
U.S. exports going forward.
Readings on core inflation received
during the intermeeting period continued to be generally favorable, and meeting participants agreed that the recent
moderation in core inflation would
likely be sustained. The slower pace of
economic expansion anticipated for the
next few quarters would help ease inflationary pressures. Nonetheless, participants expressed concern about the upside risks to the outlook for inflation.
The recent increases in the prices of energy and other commodities, along with
the significant decline in the foreign exchange value of the dollar, were cited as
factors that could exert upward pressure
on prices of some core goods and services in the near term. Increases in unit
labor costs also could add to inflationary
pressures. Moreover, participants expressed concern that some measures of
inflation compensation calculated from
TIPS securities had risen this year, although they viewed inflation expectations generally as remaining contained.
Participants were concerned that if headline inflation remained above core measures for a sustained period, then longer

term inflation expectations could move
higher, a development that could lead to
greater inflation pressures over the
longer term and be costly to reverse.
In the Committee's discussion of
policy for the intermeeting period, members discussed the relative merits of lowering the target federal funds rate 25 basis points, to 4V2 percent, at this meeting
or awaiting additional information on
prospects for economic activity and inflation before assessing whether a further adjustment in the stance of monetary policy was necessary. Many
members noted that this policy decision
was a close call. However, on balance,
nearly all members supported a 25 basis
point reduction in the target federal
funds rate. The stance of monetary
policy appeared still to be somewhat restrictive, partly because of the effects of
tighter credit conditions on aggregate
demand. Moreover, most members saw
substantial downside risks to the economic outlook and judged that a rate
reduction at this meeting would provide
valuable additional insurance against an
unexpectedly severe weakening in economic activity. Many members were
concerned about the still-sensitive state
of financial markets and thought that an
easing of policy would help to support
improvements in market functioning,
thereby mitigating some of the downside risks to economic growth. With real
GDP likely to expand below its potential over coming quarters, recent price
trends favorable, and inflation expectations appearing reasonably well anchored, the easing of policy at this meeting seemed unlikely to affect adversely
the outlook for inflation. A number of
members noted that the recent policy
moves could readily be reversed if circumstances evolved in a manner that
would warrant such action.
The Committee agreed that the statement to be released at this meeting

250 94th Annual Report, 2007
should indicate that economic growth
was solid in the third quarter and that
strains in financial markets had eased
somewhat on balance. Members also
agreed that economic growth seemed
likely to slow over coming quarters, but
that the easing action taken at the
meeting—combined with the 50 basis
point cut in the target federal funds rate
at the September meeting—should help
to promote moderate growth over time,
although some downside risks to growth
would remain. Members felt that it was
appropriate to underscore the upside
risks to inflation stemming from the recent increases in the prices of energy
and other commodities, even though recent readings on core inflation had been
favorable. While the Committee saw uncertainty regarding the economic outlook as still elevated, it judged that, after
this action, the upside risks to inflation
roughly balanced the downside risks to
growth.
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:

eased somewhat on balance. However, the
pace of economic expansion will likely slow
in the near term, partly reflecting the intensification of the housing correction. Today's
action, combined with the policy action
taken in September, should help forestall
some of the adverse effects on the broader
economy that might otherwise arise from the
disruptions infinancialmarkets and promote
moderate growth over time.
Readings on core inflation have improved
modestly this year, but recent increases in
energy and commodity prices, among other
factors, may put renewed upward pressure
on inflation. In this context, the Committee
judges that some inflation risks remain, and
it will continue to monitor inflation developments carefully.
The Committee judges that, after this
action, the upside risks to inflation roughly
balance the downside risks to growth. The
Committee will continue to assess the effects
offinancialand other developments on economic prospects and will act as needed to
foster price stability and sustainable economic growth.

Votes for this action: Messrs. Bernanke,
Geithner, Evans, Kohn, Kroszner, Mishkin, Poole, Rosengren, and Warsh.
Votes against this action: Mr. Hoenig.
Mr. Hoenig dissented because he believed that policy should remain unchanged at this meeting. Projections for
the U.S. and global economies suggested
that growth was likely to proceed at a
The Federal Open Market Committee reasonable pace over the outlook period.
seeks monetary and financial conditions that To better assure that outcome, the
will foster price stability and promote sus- FOMC had moved rates down signifitainable growth in output. To further its cantly at its September meeting. At this
long-run objectives, the Committee in the meeting, inflation risks appeared elimmediate future seeks conditions in reserve
markets consistent with reducing the federal evated and Mr. Hoenig felt that the tarfunds rate to an average of around 41/2 per- get federal funds rate was currently
close to neutral. In these circumstances,
cent.
The vote encompassed approval of he judged that policy needed to be
the statement below to be released at slightly firm to better hold inflation in
check. Going forward, if the data sug2:15 p.m.:
gested the Committee needed to ease
The Federal Open Market Committee further, it could do so. He also recogdecided today to lower its target for the Fed- nized that liquidity remains a near-term
eral funds rate 25 basis points to AVi percent.
Economic growth was solid in the third challenge and that the Federal Reserve
quarter, and strains in financial markets have would be prepared to act if needed. Mr.

Minutes of FOMC Meetings, October 251
Hoenig saw the risks to both economic
growth and inflation to be elevated and
preferred to wait, watch, and be ready to
act depending on how events developed.
The Committee then resumed its discussion of an enhanced role for the economic projections that are made periodically by the members of the Board of
Governors and the Reserve Bank presidents. At this meeting, participants
reached a consensus on increasing the
frequency and expanding the content of
the projections that in the past have been
released to the public in summary form
twice a year. They agreed to publish
with the minutes a summary of participants' economic projections made for
this meeting and to release a press statement describing the plan for the future.
The release of more frequent forecasts

covering longer time spans and accompanied by explanations of those forecasts was seen as providing the public
with more context for understanding the
Committee's monetary policy decisions.
It was agreed that the next meeting of
the Committee would be held on Tuesday, December 11,2007.
The meeting adjourned at 12:00 noon.

Summary of Economic
Projections

The projections, which are summarized in table 1 and chart 1, suggest that
FOMC participants expected that, in the
near term, output will grow at a pace
somewhat below its trend rate and the
unemployment rate will edge higher,
owing primarily to weakness in housing
markets and to the tightening in the
availability of credit resulting from recent strains in financial markets. Further
ahead, output was projected to expand at
a pace close to its long-run trend. Total
inflation was expected to be lower in
2008 than in 2007, and then to edge
down further in subsequent years.

In conjunction with the October 2007
FOMC meeting, the members of the
Board of Governors and the presidents
of the Federal Reserve Banks, all of
whom participate in the deliberations of
the FOMC, provided projections for
economic growth, unemployment, and
inflation in 2007, 2008, 2009, and 2010.
Projections were based on information
available through the conclusion of the
October meeting, on each participant's
assumptions regarding a range of factors
likely to affect economic outcomes, and
his or her assessment of appropriate
monetary policy. "Appropriate monetary
policy" is defined as the future policy
most likely to foster outcomes for
economic activity and inflation that best
satisfy the participant's interpretation of
the Federal Reserve's dual objectives
of maximum employment and price
stability.

Notation Vote
By notation vote completed on October
5, 2007, the Committee unanimously approved the minutes of the FOMC meeting held on September 18, 2007 and of
the conference calls on August 10, 2007
and August 16, 2007.
Brian F. Madigan
Secretary

The Outlook
Data available at the time of the October
FOMC meeting indicated that economic
growth had been solid during the second
and third quarters, and evidence that the
contraction in the housing sector had begun to spill over substantially to other
sectors of the economy remained scant.
Consequently, despite the recent finan-

252 94th Annual Report, 2007
1. Economic Projections of Federal Reserve Governors and Reserve Bank Presidents1
2007

Central Tendencies
Real GDP Growth ..
June Projections ..
Unemployment Rate
June Projections ..
PCE Inflation
Core PCE Inflation ..
June Projections ..
Ranges
Real GDP Growth ..
June Projections ..
Unemployment Rate
June Projections ..
PCE Inflation
Core PCE Inflation ..
June Projections ..

2.4 to 2.5
V/4 tO Vh
4.7 to 4.8
4Vi to 43A
2.9 to 3.0
1.8 to 1.9

2008

2009

2010

1.8 to 2.5

2.3 to 2.7

2.5 to 2.6

4.8 to 4.9

4.7 to 4.9

1.7 to 2.0
1.7 to 1.9

1.6 to 1.9
1.6 to 1.9

2.0 to 2.8

2.2 to 2.7

4.6 to 5.0

1.5 to 2.2
1.5 to 2.0

1.5 to 2.0
1.5 to 2.0

V/2 tO 23/4

4.8 to 4.9
about 43/4

1.8 to 2.1
1.7 to 1.9

2 to 2V4

P/4 tO 2

2.2 to 2.7
4.7 to 4.8

1.6 to 2.6
V/2 to 3
4.6 to 5.0

4Vi to 43M

4*/2 to 5

2.7 to 3.2
1.8 to 2.1

1.7 to 2.3
1.7 to 2.0
PA to 2

2 to 23/4

2 to 2V4

1. Projections of real GDP growth, PCE inflation, and
core PCE inflation are fourth-quarter-to-fourth-quarter
growth rates, that is, percentage changes from the fourth
quarter of the prior year to the fourth quarter of the
indicated year. PCE inflation and core PCE inflation are
the percentage rates of change in the price index for
personal consumption expenditures and the price index
for personal consumption expenditures excluding food
and energy, respectively. Projections for the unemploy-

ment rate are for the average civilian unemployment rate
in the fourth quarter of each year. Each participant's projections are based on his or her assessment of appropriate
monetary policy. The range for each variable in a given
year includes all participants' projections, from lowest to
highest, for that variable in the given year; the central
tendencies exclude the three highest and three lowest
projections for each variable in each year.

cial market turmoil, the central tendency
of participants' projections for real GDP
growth in 2007, at 2.4 to 2.5 percent,
was little changed from the central tendency of the projections provided in
conjunction with the June FOMC meeting and included in the Board's Monetary Policy Report to the Congress in
July. However, the central tendency of
participants' projections for real GDP
growth in 2008 was revised down to 1.8
to 2.5 percent, notably below the 2l/i to
23/4 percent central tendency in June.
These revisions to the 2008 outlook
since June stemmed from a number of
factors, including the tightened terms
and reduced availability of subprime and
jumbo mortgages, weaker-than-expected
housing data, and rising oil prices. Partly
in response to declining housing wealth,
the personal saving rate was expected to
rise over the next few years, contributing to restraint on the growth of personal consumption expenditures. How-

ever, net exports were expected to
provide some support to growth. The
subpar economic growth projected in the
near term was not anticipated to persist.
Growth was expected to pick up as the
adjustment in housing markets ran its
course, financial markets gradually resumed more-normal functioning, and as
the monetary policy easing at the September and October FOMC meetings
provided support to aggregate demand.
Economic activity was projected to expand at a pace broadly in line with participants' estimates of the rate of expansion of the economy's productive
potential in 2009 and to continue at
much the same pace in 2010. Participants read last summer's benchmark revisions to the national income and product accounts as suggesting a somewhat
slower rate of trend growth than previously thought.
Most participants expected that, with
output growth running somewhat below

Minutes of FOMC Meetings, October 253
1. Central Tendencies and Ranges of Economic Projections*
Real GDP Growth
H i Central tendency of projections
Z1Z Range of projections

Unemployment Rate

PCE Inflation

Core PCE Inflation

Percent

^—
2002

2003

— •

=£
==

—

2004

* See notes to table 1 for variable definitions.

trend over the next year or so, the unemployment rate would increase modestly.
The central tendency of participants'
projections for the average rate of unemployment in the fourth quarter of 2008
was 4.8 to 4.9 percent, slightly above
the 43/4 percent unemployment rate forecasted in June; these projections suggested the emergence of a little slack in

labor markets. The central tendency of
participants' projections was for the unemployment rate to stabilize in 2009 and
to fall back a bit in 2010 as output and
employment growth pick up.
Overall inflation was expected to
edge down over the next few years, fostered by an assumed flattening of energy
prices about in line with futures markets

254 94th Annual Report, 2007
quotes, a modest easing of pressures on conditions, which could in turn slow the
resource utilization, and fairly well an- economy further. The potential for a
chored inflation expectations. Partici- more severe contraction in the housing
pants' projections for core inflation this sector and a substantial decline in house
year and next were marked down from prices was also perceived as a risk to the
those provided at the time of the June central outlook for economic growth.
FOMC meeting, partly in light of recent But participants also noted that in recent
generally favorable core inflation data decades, the U.S. economy had proved
that pointed to some reduction in under- quite resilient to episodes of financial
lying inflation pressures. The central distress, suggesting that the adverse eftendency of projections for core PCE fects of financial developments on ecoinflation in 2007 was 1.8 to 1.9 percent, nomic activity outside of the housing
down from 2 to 2VA percent in June. The sector could prove to be more modest
central tendency of core inflation projec- than anticipated.
tions for 2008 was 1.7 to 1.9 percent.
Participants were more persuaded
Participants' projections for PCE infla- than they had been in June that the detion in 2009 and 2010 were importantly cline in core inflation readings this year
influenced by their judgments about the represented a sustained albeit modest
measured rates of inflation consistent step-down rather than the effect of tranwith the Federal Reserve's dual man- sitory influences. Nonetheless, particidate to promote maximum employment pants saw some upside risks to their inand price stability and about the time flation projections. Recent increases in
frame over which policy should aim to energy and commodity prices and the
attain those rates given current eco- pass-through of dollar depreciation into
nomic conditions. The central tendency import prices would raise inflation over
of participants' projections for both core the medium term. That increase could
and total inflation in 2010 ranged from lead to an upward drift in inflation ex1.6 to 1.9 percent.
pectations that would add to price pressures and could be costly to reverse.
Risks to the Outlook
The possibility that financial market
Most participants viewed the risks to turbulence could have larger-thantheir GDP projections as weighted to the anticipated adverse effects on household
downside and the associated risks to and business spending heightened partheir projections of unemployment as ticipants' uncertainty about the outlook
tilted to the upside. Financial market for economic activity. Most participants
conditions had deteriorated sharply in judged that the uncertainty attending
August, and although there had been their October projections for real GDP
some signs of improvement since then, growth was above typical levels seen in
markets remained strained. The possi- the past. (Table 2 provides an estimate
bilities that markets could relapse or that of average ranges of forecast uncertainty
current tighter credit conditions could for GDP growth, unemployment, and inexert unexpectedly large restraint on flation over the past twenty years.13) In
household and business spending were
viewed as downside risks to economic
13. The box "Forecast Uncertainty" at the end
activity. Participants were concerned
about the possibility for adverse feed- of this summary discusses the sources and interpretation of uncertainty in economic forecasts and
backs in which economic weakness explains the approach used to assess the uncercould lead to further tightening in credit tainty and risks attending participants' projections.

Minutes of FOMC Meetings, October 255
tions for real GDP growth in 2008 was
markedly wider than in June. The dispersion of participants' projections for
2007 2008 2009 2010
growth next year seemed largely to re2
±0.6 ±1.3 ±1.4 ±1.4
Real GDP
flect differing assessments of the likely
±0.2 ±0.6 ±0.9 ±1.1
Unemployment rate3
Total consumer prices2 ... ±0.3 ±1.0 ±1.0 ±1.0
depth and duration of the correction in
the housing market, the effect of finan1. "Average historical projection error ranges" for the
cial market disruptions on real activity
years 2007 through 2010 are measured as plus or minus
the root mean squared error of projections that were reoutside of the housing sector, and the
leased in the autumn from 1986 through 2006 for the
speed with which financial markets will
current and following three years hy various private and
government forecasters. As described in the forecast unreturn to more normal functioning. The
certainty box, under certain assumptions, there is about a
dispersion of participants' projections
70 percent probability that actual outcomes for real activfor the rate of unemployment over the
ity, unemployment, and inflation will fall in ranges implied by the average size of projection errors made in the
next year or so had changed little. Parpast. For further information, see David Reifschneider
ticipants' longer-term projections for
and Peter Tulip, "Gauging the Uncertainty of the Ecoreal GDP growth and for the rate of
nomic Outlook from Historical Forecast Errors," Federal
Reserve Board Financial and Economics Discussion Seunemployment were more heavily influries #2007-60 (November 2007).
enced by their views about, respectively,
2. Overall consumer price index, as this is the price
measure that has been most widely used in government
the economy's trend growth rate and the
and private economic forecasts. Percent change, fourth
unemployment rate that would be conquarter of year relative to fourth quarter of preceding
sistent over time with maximum emyear.
3. Percent, fourth-quarter average.
ployment. The dispersion of the projections for PCE inflation in the near term
contrast, the uncertainty attached to par- partly reflected different weights atticipants' inflation projections was gen- tached to the various factors expected to
erally viewed as being broadly in line foster a moderation of inflation. Some
with past experience, although several participants judged that the anticipated
participants judged that the degree of modest easing in resource pressures was
uncertainty about total inflation was unlikely to have a marked effect on inhigher than usual, reflecting the possi- flation. Similarly, views differed about
bility that the recent volatility in food the influence that inflation expectations
and energy prices might persist.
would exert on inflation over the short
and medium run. Participants' projecDiversity of Participants' Views
tions further out were also influenced by
Charts 2(a) and 2(b) provide more detail their views about the rate of inflation
on the diversity of participants' views. consistent with the Federal Reserve's
The dispersion of participants' projec- dual mandate.
2. Average Historical Projection Error
Ranges1

256 94th Annual Report, 2007
2(a). Distribution of Participants' Projections (percent)*
Unemployment Rate

Real GDP
2007

2007
Number of Participants

Number of Participants

1
1
1

June Projections

1
1

October Projections

]

June Projections

October Projeclio

•

16
12

8
4

1 ill

2008

2008
Number of Participants

Number of Participants

T--H

I
1 mm•::;-;••:-:•••

1.6-1.7

1.8-1.9

2.0-2.1 2.2-2.3

2.4-2.5 2.6-2.7

2.8-2.9 3.0-3.1

2009

4.44.5

4.64.7

~ ——-.—I
4.8-4.9

5.0-5.1

5.2-5.3

2009
Number of Participants

i i
4.44.5

2010

4.6-4.7

4.84.9

5.0-5.1

5.2-5.3

2010
Number of Participants

Number of Participants

.
4.44.5

_
4.6-4.7

4.8-4.9

5.0-5.1

5.2-5.3

* See notes to table 1 for variable definitions. Those participants' June projections that were provided in quarter points have been rounded to the nearest tenth for the
construction of these histograms.

Minutes of FOMC Meetings, October 257
2(b). Distribution of Participants' Projections (percent)*
PCE Inflation

Core PCE Inflation

2007

2007
Number of Participants

Number of Participants

October Projections

1
6

June Projections

October Projections

1
2

12
i

4
1.71.8

1.92.0

1.3-1.4

2.12.2

2008

liii

•111!

0
1.51.6

1.5-1.6

1.7-1.8

1.9-2.0

2008
Number of Participants

Number of Participants

II
1.3-1.4

2009

1.5-1.6

1.7-1.8

1.9-2.0

2009
Number of Participants

Number of Participants

I
1.3-1.4

2010

1.5-1.6

1.7-1.8

1.9-2.0

2.1-2.2

2.3-2.4

2010
Number of Participants

Number of Participants

16
12

•
1.51.6

4
0
1.7-

1.9-

2.1-

2.3-

2.5-

2.7-

2.9-

3.1-

1.3-1.4

1.5-1.6

1.7-1.8

1.9-2.0

2.1-2.2

2.3-2.4

• See notes to table 1 for variable definitions. Those participants' June projections that were provided in quarter points have been rounded to the nearest tenth for the
construction of these histograms.

258 94th Annual Report, 2007

numbers reported in table 2 might imply
a probability of about 70 percent that actual GDP would expand 2.4 percent to
3.6 percent in the current year, 1.7 percent to 4.3 percent next year, and 1.6
percent to 4.4 percent in the third and
fourth years. The corresponding 70 percent confidence intervals for overall inflation would be 1.7 percent to 2.3 percent in the current year and 1.0 percent to
3.0 percent in the second, third, and
fourth years.
Because current conditions may differ
from those that prevailed on average over
history, participants provide judgments as
to whether the uncertainty attached to
their projections of each variable is
greater than, smaller than, or broadly
similar to typical levels of forecast uncertainty in the past as shown in table 2.
Participants also provide judgments as to
whether the risks to their projections are
weighted to the upside, downside, or are
broadly balanced. That is, participants
judge whether each variable is more
likely to be above or below their projections of the most likely outcome. These
judgments about the uncertainty and the
risks attending each participant's projections are distinct from the diversity of
participants' views about the most likely
outcomes. Forecast uncertainty is concerned with the risks associated with a
particular projection, rather than with divergences across a number of different
projections.

Minutes of FOMC Meetings, December

259

Meeting Held on
December 11, 2007

Ms. Liang and Mr. Wascher, Associate
Directors, Division of Research
and Statistics, Board of Governors

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 11, 2007, at 8:00
a.m.

Mr. Blanchard, Assistant to the Board,
Office of Board Members, Board
of Governors

Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Mr. Evans
Mr. Hoenig
Mr. Kohn
Mr. Kroszner
Mr. Mishkin
Mr. Poole
Mr. Rosengren
Mr. Warsh

Mr. Small, Project Manager, Division
of Monetary Affairs, Board of
Governors

Ms. Cumming, Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and
Stern, Alternate Members of the
Federal Open Market Committee
Messrs. Lacker and Lockhart, and Ms.
Yellen, Presidents of the Federal
Reserve Banks of Richmond,
Atlanta, and San Francisco,
respectively
Mr. Madigan, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Mr. Baxter, Deputy General Counsel
Mr. Sheets, Economist
Mr. Stockton, Economist
Messrs. Clouse, Connors, Fuhrer, Kamin, Rasche, Sellon, Slifman, Sullivan, and Wilcox, Associate
Economists
Mr. Dudley, Manager, System Open
Market Account
Mr. Struckmeyer, Deputy Staff Director, Office of Staff Director for
Management
Mr. English, Senior Associate Director,
Division of Monetary Affairs,
Board of Governors

Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Affairs, Board of Governors

Mr. Luecke, Senior Financial Analyst,
Division of Monetary Affairs,
Board of Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of Governors
Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta
Mr. Rosenblum, Executive Vice President, Federal Reserve Bank of
Dallas
Mr. Altig, Ms. Perelmuter, Messrs.
Rolnick, Weinberg, and Williams,
Senior Vice Presidents, Federal
Reserve Banks of Atlanta, New
York, Minneapolis, Richmond, and
San Francisco, respectively
Messrs. Bryan and Yi, Vice Presidents,
Federal Reserve Banks of Cleveland and Philadelphia, respectively
Mr. McCarthy, Research Officer, Federal Reserve Bank of New York
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 operations in government securities and federal agency obligations during the period since the previous meeting. By unanimous vote, the Committee
ratified these transactions.

260 94th Annual Report, 2007
The Committee approved a foreign
currency swap arrangement with the
Swiss National Bank that paralleled the
arrangement with the European Central
Bank approved during the Committee's
conference call on December 6, 2007.
With Mr. Poole dissenting, the Committee voted to direct the Federal Reserve
Bank of New York to establish and
maintain a reciprocal currency (swap)
arrangement for the System Open Market Account with the Swiss National
Bank in an amount not to exceed $4 billion. The Committee authorized associated draws of up to the full amount of
$4 billion, and the arrangement itself
was authorized for a period of up to 180
days unless extended by the FOMC. Mr.
Poole dissented because he viewed the
swap agreement as unnecessary in light
of the size of the Swiss National Bank's
dollar-denominated foreign exchange
reserves.
The information reviewed at the December meeting indicated that, after the
robust gains of the summer, economic
activity decelerated significantly in the
fourth quarter. Consumption growth
slowed, and survey measures of sentiment dropped further. Many readings
from the business sector were also
softer: Industrial production fell in October, as did orders and shipments of capital goods. Employment gains stepped
down during the four months ending in
November from their pace earlier in the
year. Headline consumer price inflation
moved higher in September and October
as energy prices increased significantly;
core inflation also rose but remained
moderate.
The slowing in private employment
gains was due in large part to the ongoing weakness in the housing market.
Employment in residential construction
posted its fourth month of sizable declines in November, and employment in
housing-related sectors such as finance,

real estate, and building-material and
garden-supply retailers continued to
trend down. Elsewhere, factory jobs declined again, while employment in most
service-producing industries continued
to move up. Aggregate hours of production or nonsupervisory workers edged
up in October and November. Some indicators from the household survey also
suggested softening in the labor market,
but the unemployment rate held steady
at 4.7 percent through November.
Industrial production fell in October
after small increases in the previous two
months. The index for motor vehicles
and parts fell for the third consecutive
month, and the index for construction
supplies moved down for the fourth
straight month. Materials output also declined in October, with production likely
curbed by weak demand from the construction and motor vehicle sectors. Production in high-tech industries, however,
increased modestly, and commercial aircraft production registered another solid
gain. In November, output appeared to
have edged up in manufacturing sectors
(with the exception of the motor vehicles sector) for which weekly physical
product data were available.
After posting notable gains in the
summer, real consumer spending was
nearly flat in September and October.
Spending on goods excluding motor vehicles was little changed on net over that
period. Spending on services edged
down, reflecting an extraordinarily large
drop in securities commissions in September. The most recent readings on
weekly chain store sales as well as industry reports and surveys suggested
subdued gains in November and an uneven start to the holiday shopping season. Sales of light motor vehicles in November remained close to the pace that
had prevailed since the second quarter.
Real disposable income was about unchanged in September and October. The

Minutes of FOMC Meetings, December 261
Reuters/University of Michigan index of
consumer sentiment ticked down further
in early December as respondents took a
more pessimistic view of the outlook for
their personal finances and for business
conditions in the year ahead.
In the housing market, new home
sales were below their third-quarter
pace, and sales of existing homes were
flat in October following sharp declines
in August and September. These
declines likely were exacerbated by the
deterioration in nonprime mortgage
markets and by the higher interest rates
and tighter lending conditions for jumbo
loans. Single-family housing starts
stepped down again in October after
substantial declines in the JuneSeptember period. Yet, because of sagging sales, builders made only limited
progress in paring down their substantial inventories. Single-family permit issuance continued along the steep downward trajectory that had begun two years
earlier, which pointed toward further
slowing in homebuilding over the near
term. Multifamily starts rebounded in
October from an unusually low reading
in September, and the level of multifamily starts was near the midpoint of the
range in which this series had fluctuated
over the past ten years.
Real spending on equipment and software posted a solid increase in the third
quarter. In October, however, orders and
shipments of nondefense capital goods
excluding aircraft declined, suggesting
that some deceleration in spending was
under way in the fourth quarter. The October decline in orders and shipments
was led by weakness in the high-tech
sector: Shipments of computers and peripheral equipment declined while the
industrial production index for computers was flat; orders and shipments for
communications equipment plunged.
Some of that weakness may have been
attributable to temporary production dis

ruptions stemming from the wildfires in
Southern California; cutbacks in demand from large financial institutions
affected by market turmoil may have
contributed as well. In the transportation
equipment category, purchases of medium and heavy trucks changed little,
and orders data suggested that sales
would remain near their current levels in
the coming months. Orders for equipment outside high-tech and transportation rose in October, but shipments were
about flat, pointing to a weaker fourth
quarter for business spending after two
quarters of brisk increases. Some prominent surveys of business conditions remained consistent with modest gains in
spending on equipment and software
during the fourth quarter, but other surveys were less sanguine. In addition, although the cost of capital was little
changed for borrowers in the
investment-grade corporate bond market, costs for borrowers in the high-yield
corporate bond market were up significantly. In the third quarter, corporate
cash flows appeared to have dropped
off, leaving firms with diminished
internally generated funds for financing
investment. Data available through
October suggested that nonresidential
building activity remained vigorous.
Real nonfarm inventory investment
excluding motor vehicles increased
slightly faster in the third quarter than in
the second quarter. Outside of motor vehicles, the ratio of book-value inventories to sales had ticked up slightly in
September but remained near the low
end of its range in recent years. Bookvalue estimates of the inventory investment of manufacturers—the only inventory data available beyond the third
quarter—were up in October at about
the third-quarter pace.
The U.S. international trade deficit
narrowed slightly in September as an
increase in exports more than offset

262 94th Annual Report, 2007
higher imports. The September gain in
exports primarily reflected higher exports of goods; services exports recorded moderate growth. Exports of agricultural products exhibited particularly
robust growth, with both higher prices
and greater volumes. Exports of industrial supplies and consumer goods also
moved up smartly in September. Automotive products exports, in contrast,
were flat, and capital goods exports fell,
led by a decline in aircraft. The increase
in imports primarily reflected higher imports of capital goods, with imports of
computers showing particularly strong
growth. Imports of automotive products,
consumer goods, and services also increased. Imports of petroleum, however,
were flat, and imports of industrial supplies fell.
Output growth in the advanced foreign economies picked up in the third
quarter. In Japan, real output rebounded,
led by exports. In the euro area, GDP
growth returned to a solid pace in the
third quarter on the back of a strong
recovery in investment. In Canada and
the United Kingdom, output growth
moderated but remained robust, as vigorous domestic demand was partly offset by rapid growth of imports. Indicators of fourth-quarter activity in the
advanced foreign economies were less
robust on net. Confidence indicators had
deteriorated in most major economies in
the wake of the financial turmoil and
remained relatively weak. In November,
the euro-area and U.K. purchasing managers indexes for services were well below their level over the first half of the
year; nevertheless they pointed to moderate expansion. Labor market conditions generally remained relatively
strong in recent months. Incoming data
on emerging-market economies were
positive on balance. Overall, growth in
emerging Asia moderated somewhat in
the third quarter from its double-digit

pace in the second quarter, but remained
strong. Economic growth was also solid
in Latin America, largely reflecting
stronger-than-expected
activity
in
Mexico.
In the United States, headline consumer price inflation increased in September and October from its low rates in
the summer as the surge in crude oil
prices began to be reflected in retail energy prices. In addition, though the rise
in food prices in October was slower
than in August and September, it remained above that of core consumer
prices. Excluding food and energy, inflation was moderate, although it was up
from its low rates in the spring. The
pickup in core consumer inflation over
this period reflected an acceleration in
some prices that were unusually soft last
spring, such as those for apparel, prescription drugs, and medical services, as
well as nonmarket prices. On a twelvemonth-change basis, core consumer
price inflation was down noticeably
from a year earlier. In October, the producer price index for core intermediate
materials moved up only slightly for a
second month, and the twelve-month increase in these prices was considerably
below that of the year-earlier period.
This pattern reflected, in part, a deceleration in the prices of a wide variety of
construction materials, such as cement
and gypsum, and in the prices of some
metal products. In response to rising energy prices, household survey measures
of expectations for year-ahead inflation
picked up in November and then edged
higher in December. Households'
longer-term inflation expectations also
edged up in both November and December. Average hourly earnings increased
faster in November than in the previous
two months. Over the twelve months
that ended in November, however, this
wage measure rose a bit more slowly
than over the previous twelve months.

Minutes of FOMC Meetings, December 263
expected path for policy. During the intermeeting period, the release of the
FOMC minutes and associated summary
of economic projections, as well as various data releases, elicited only modest
market reaction. In contrast, markets
were buffeted by concerns about the potential adverse effects on credit availability and economic growth of sizable
losses at large financial institutions and
of financial market strains in general.
Market participants marked down their
expected path for policy substantially,
and by the time of the December meeting, investors were virtually certain of a
rate cut. Two-year Treasury yields fell
on net over the intermeeting period by
an amount about in line with revisions
to policy expectations. Ten-year Treasury yields also declined, but less than
shorter-term yields. The steepening of
the yield curve was due mostly to
sharply lower short- and intermediateterm forward rates, consistent with investors' apparently more pessimistic
outlook for economic growth. TIPS
yields fell less than their nominal counterparts, implying modest declines in inflation compensation both at the fiveyear and longer horizons.
After showing some signs of improvement in late September and October, conditions in financial markets
worsened over the intermeeting period.
Heightened worries about counterparty
credit risk, balance sheet constraints,
and liquidity pressures affected interbank funding markets and commercial
paper markets, where spreads over riskfree rates rose to levels that were, in
some cases, higher than those seen in
The Committee's action at its Octo- August. Strains in those markets were
ber meeting was largely expected by exacerbated by concerns related to yearmarket participants, although the assess- end pressures. In longer-term corporment that the upside risks to inflation ate markets, both investment- and
balanced the downside risks to growth speculative-grade credit spreads widwas not fully anticipated and apparently ened considerably; issuance slowed but
led investors to revise up slightly the remained strong. In housing finance,

At its October meeting, the FOMC
lowered its target for the federal funds
rate 25 basis points, to 4Vi percent. The
Board of Governors also approved a
25 basis point decrease in the discount
rate, to 5 percent, leaving the gap between the federal funds rate target and
the discount rate at 50 basis points. The
Committee's statement noted that, while
economic growth was solid in the third
quarter and strains in financial markets
had eased somewhat on balance, the
pace of economic expansion would
likely slow in the near term, partly reflecting the intensification of the housing correction. The Committee indicated
that its action, combined with the policy
action taken in September, should help
forestall some of the adverse effects on
the broader economy that might otherwise arise from the disruptions in financial markets and should promote moderate growth over time. Readings on core
inflation had improved modestly during
the year, but the statement noted that
recent increases in energy and commodity prices, among other factors, may put
renewed upward pressure on inflation.
In this context, the Committee judged
that some inflation risks remained and
indicated that it would continue to monitor inflation developments carefully. The
Committee also judged that, after this
action, the upside risks to inflation
roughly balanced the downside risks to
growth. The Committee said that it
would continue to assess the effects of
financial and other developments on
economic prospects and would act as
needed to foster price stability and sustainable economic growth.

264 94th Annual Report, 2007
subprime mortgage markets stayed virtually shut, and spreads on jumbo loans
apparently widened further. Spreads on
conforming mortgage products also
widened after reports of losses and
reduced capital ratios at the housingrelated government-sponsored enterprises. Broad-based equity indexes were
volatile and ended the period down noticeably. Financial stocks were especially hard hit, dropping substantially
more than the broad indexes. Similar
stresses were evident in the financial
markets of major foreign economies.
The trade-weighted foreign exchange
value of the dollar against major currencies moved up, on balance, over the intermeeting period.
Debt in the domestic nonfinancial
sector was estimated to be increasing
somewhat more slowly in the fourth
quarter than in the third quarter. Nonfinancial business debt continued to expand strongly, supported by solid bond
issuance and by a small rebound in the
issuance of commercial paper. Bank
loans outstanding also continued to rise
rapidly. Household mortgage debt was
expected to expand at a reduced rate in
the fourth quarter, reflecting softer home
prices and declining home sales, as well
as a tightening in credit conditions for
some borrowers. Nonmortgage consumer credit in the fourth quarter appeared to be expanding at a moderate
pace. In November, M2 growth picked
up slightly from its October rate. While
liquid deposits continued to grow
slowly, heightened demand for safety
and liquidity appeared to boost holdings
of retail money market mutual funds.
Small time deposits continued to expand, likely in part due to high rates
offered by some depository institutions
to attract retail deposits. Currency outstanding was about flat in November.
In the forecast prepared for this meeting, the staff revised down its estimate

of growth in aggregate economic activity in the fourth quarter. Although thirdquarter real GDP was revised up
sharply, most available indicators of activity in the fourth quarter were more
downbeat than had previously been expected. Faster inventory investment contributed importantly to the upward revision to third-quarter real GDP, but part
of that upswing was expected to be unwound in the fourth quarter. The available data for domestic final sales also
suggested a weaker fourth quarter than
had been anticipated. In particular, real
personal consumption expenditures had
been about unchanged in September and
October, and the contraction in singlefamily construction had intensified. Providing a bit of an offset to these factors,
however, was further improvement in
the external sector. The staff also
marked down its projection for the rise
in real GDP over the remainder of the
forecast period. Real GDP was anticipated to increase at a rate noticeably
below its potential in 2008. Conditions
in financial markets had deteriorated
over the intermeeting period and were
expected to impose more restraint on
residential construction as well as consumer and business spending in 2008
than previously expected. In addition,
compared with the previous forecast,
higher oil prices and lower real income
were expected to weigh on the pace of
real activity throughout 2008 and 2009.
By 2009, however, the staff projected
that the drag from those factors would
lessen and that an improvement in mortgage credit availability would lead to a
gradual recovery in the housing market.
Accordingly, economic activity was expected to increase at its potential rate in
2009. The external sector was projected
to continue to support domestic economic activity throughout the forecast
period. Reflecting upward revisions to
previously published data, the forecast

Minutes of FOMC Meetings, December 265
for core PCE price inflation for 2007
was a bit higher than in the preceding
forecast; core inflation was projected to
hold steady during 2008 as the indirect
effects of higher energy prices on prices
of core consumer goods and services
were offset by the slight easing of resource pressures and the expected deceleration in the prices of nonfuel imported
goods. The forecast for headline PCE
inflation anticipated that retail energy
prices would rise sharply in the first
quarter of 2008 and that food price inflation would outpace core price inflation
in the beginning of the year. As pressures from these sources lessened over
the remainder of 2008 and in 2009, both
core and headline price inflation were
projected to edge down, and headline
inflation was expected to moderate to a
pace slightly below core inflation.
In their discussion of the economic
situation and outlook, participants generally noted that incoming information
pointed to a somewhat weaker outlook
for spending than at the time of the October meeting. The decline in housing
had steepened, and consumer outlays
appeared to be softening more than anticipated, perhaps indicating some spillover from the housing correction to
other components of spending. These
developments, together with renewed
strains in financial markets, suggested
that growth in late 2007 and during 2008
was likely to be somewhat more sluggish than participants had indicated in
their October projections. Still, looking
further ahead, participants continued to
expect that, aided by an easing in the
stance of monetary policy, economic
growth would gradually recover as
weakness in the housing sector abated
and financial conditions improved, allowing the economy to expand at about
its trend rate in 2009. Participants
thought that recent increases in energy
prices likely would boost headline infla

tion temporarily, but with futures prices
pointing to a gradual decline in oil prices
and with pressures on resource utilization seen as likely to ease a bit, most
participants continued to anticipate
some moderation in core and especially
headline inflation over the next few
years.
Participants discussed in detail the resurgence of stresses in financial markets
in November. The renewed stresses reflected evidence that the performance of
mortgage-related assets was deteriorating further, potentially increasing the
losses that were being borne in part by a
number of major financial firms, including money-center banks, housing-related
government-sponsored enterprises, investment banks, and financial guarantors. Moreover, participants recognized
that some lenders might be exposed to
additional losses: Delinquency rates on
credit card loans, auto loans, and other
forms of consumer credit, while still
moderate, had increased somewhat, particularly in areas hard hit by house price
declines and mortgage defaults. Past and
prospective losses appeared to be spurring lenders to tighten further the terms
on new extensions of credit, not just in
the troubled markets for nonconforming
mortgages but, in some cases, for other
forms of credit as well. In addition, participants noted that some intermediaries
were facing balance sheet pressures and
could become constrained by concerns
about rating-agency or regulatory capital requirements. Among other factors,
banks were experiencing unanticipated
growth in loans as a result of continuing
illiquidity in the market for leveraged
loans, persisting problems in the commercial paper market that had sparked
draws on back-up lines of credit, and
more recently, consolidation of assets of
off-balance-sheet affiliates onto banks'
balance sheets.

266 94th Annual Report, 2007
Concerns about credit risk and the
pressures on banks' balance sheet capacity appeared to be contributing to diminished liquidity in interbank markets and
to a pronounced widening in term
spreads for periods extending through
year-end. A number of participants
noted some potential for the Federal Reserve's new Term Auction Facility and
accompanying actions by other central
banks to ameliorate pressures in term
funding markets. Participants recognized, however, that uncertainties about
values of mortgage-related assets and related losses, and consequently strains in
financial markets, could persist for quite
some time.
Some participants cited more-positive
aspects of recent financial developments. A number of large financial
intermediaries had been able to raise
substantial amounts of new capital.
Moreover, credit losses and asset writedowns at regional and community banks
had generally been modest; these institutions typically were not facing balance
sheet pressures and reportedly had not
tightened lending standards appreciably,
except for those on real estate loans.
And, although spreads on corporate
bonds had widened over the intermeeting period, especially for speculativegrade issues, the cost of credit to most
nonfinancial firms remained relatively
low; nonfinancial firms outside of the
real estate and construction sectors generally reported that credit conditions,
while somewhat tighter, were not restricting planned investment spending;
and consumer credit remained readily
available for most households. Nonetheless, participants agreed that heightened
financial stress posed increased downside risks to growth and made the outlook for the economy considerably more
uncertain.
Participants noted the marked deceleration in consumer spending in the na

tional data. Real personal consumption
expenditures had shown essentially no
growth in September and October, suggesting that tighter credit conditions,
higher gasoline prices, and the continuing housing correction might be restraining growth in real consumer spending.
Retailers reported weaker results in
many regions of the country, but in
some, retailers saw solid growth. Job
growth rebounded somewhat in October
and November, and participants expected continuing gains in employment
and income to support rising consumer
spending, though they anticipated
slower growth of jobs, income, and
spending than in recent years. However,
consumer confidence recently had
dropped by a sizable amount, leading
some participants to voice concerns that
household spending might increase less
than currently anticipated.
Recent data and anecdotal information indicated that the housing sector
was weaker than participants had expected at the time of the Committee's
previous meeting. In light of elevated
inventories of unsold homes and the
higher cost and reduced availability of
nonconforming mortgage loans, participants agreed that the housing correction
was likely to be both deeper and more
prolonged than they had anticipated in
October. Moreover, rising foreclosures
and the resulting increase in the supply
of homes for sale could put additional
downward pressure on prices, leading to
a greater decline in household wealth
and potentially to further disruptions in
the financial markets.
Indicators of capital investment for
the nation as a whole suggested solid
but appreciably less rapid growth in
business fixed investment during the
fourth quarter than the third. Participants
reported that firms in some regions and
industries had indicated they would
scale back capital spending, while con-

Minutes of FOMC Meetings, December 267
tacts in other parts of the country or
industries reported no such change.
Similarly, business sentiment had deteriorated in many parts of the country,
but in other areas firms remained cautiously optimistic. Anecdotal evidence
generally suggested that inventories
were not out of line with desired levels.
Even so, participants expected that inventory accumulation would slow from
its elevated third-quarter pace. Several
participants remarked that, unlike residential real estate, commercial and industrial real estate activity remained
solid in their Districts. But participants
also noted the deterioration in the secondary market for commercial real estate loans and the possible effects of that
development, should it persist, on building activity.
The available data showed strong
growth abroad and solid gains in U.S.
exports. Participants noted that rising
foreign demand was benefiting U.S. producers of manufactured goods and agricultural products, in particular. Exports
were unlikely to continue growing at the
robust rate reported for the third quarter,
but participants anticipated that the combination of the weaker dollar and stillstrong, though perhaps less-rapid,
growth abroad would mean continued
firm growth in U.S. exports. Several participants observed, however, that strong
growth in foreign economies and U.S.
exports might not persist if global financial conditions were to deteriorate
further.
Recent readings on inflation generally were seen as slightly less favorable
than in earlier months, partly due to upward revisions to previously published
data. Moreover, earlier increases in energy and food prices likely would imply
higher headline inflation in the next few
months, and past declines in the dollar
would put upward pressure on import
prices. Some participants said that

higher input costs and rising prices of
imports were leading more firms to seek
price increases for goods and services.
However, few business contacts had reported unusually large wage increases.
Downward revisions to earlier compensation data, along with the latest readings on compensation and productivity,
indicated only moderate pressure on unit
labor costs. With futures prices pointing
to a gradual decline in oil prices and
with an anticipation of some easing of
pressures on resource utilization, participants generally continued to see core
PCE inflation as likely to trend down a
bit over the next few years, as in their
October projections, and headline inflation as likely to slow more substantially
from its currently elevated level. Nonetheless, participants remained concerned
about upside risks to inflation stemming
from elevated prices of energy and nonenergy commodities; some also cited the
weaker dollar. Participants agreed that
continued stable inflation expectations
would be essential to achieving and sustaining a downward trend to inflation,
that well-anchored expectations couldn't
be taken for granted, and that policymakers would need to continue to watch
inflation expectations closely.
In the Committee's discussion of
monetary policy for the intermeeting period, members judged that the softening
in the outlook for economic growth warranted an easing of the stance of policy
at this meeting. In view of the further
tightening of credit and deterioration of
financial market conditions, the stance
of monetary policy now appeared to be
somewhat restrictive. Moreover, the
downside risks to the expansion, resulting particularly from the weakening of
the housing sector and the deterioration
in credit market conditions, had risen. In
these circumstances, policy easing
would help foster maximum sustainable
growth and provide some additional in-

268 94th Annual Report, 2007
surance against risks. At the same time,
members noted that policy had already
been eased by 75 basis points and that
the effects of those actions on the real
economy would be evident only with a
lag. And some data, including readings
on the labor market, suggested that the
economy retained forward momentum.
Members generally saw overall inflation
as likely to be lower next year, and core
inflation as likely to be stable, even if
policy were eased somewhat at this
meeting; but they judged that some inflation pressures and risks remained, including pressures from elevated commodity and energy prices and the
possibility of upward drift in the public's expectations of inflation. Weighing
these considerations, nearly all members
judged that a 25 basis point reduction in
the Committee's target for the federal
funds rate would be appropriate at this
meeting. Although members agreed that
the stance of policy should be eased,
they also recognized that the situation
was quite fluid and the economic outlook unusually uncertain. Financial
stresses could increase further, intensifying the contraction in housing markets
and restraining other forms of spending.
Some members noted the risk of an unfavorable feedback loop in which credit
market conditions restrained economic
growth further, leading to additional
tightening of credit; such an adverse development could require a substantial
further easing of policy. Members also
recognized that financial market conditions might improve more rapidly than
members expected, in which case a reversal of some of the rate cuts might
become appropriate.
The Committee agreed that the statement to be released after this meeting
should indicate that economic growth
appeared to be slowing, reflecting the
intensification of the housing correction
and some softening in business and con

sumer spending, and that strains in financial markets had increased. The
characterization of the inflation situation could be largely unchanged from
that of the previous meeting. Members
agreed that the resurgence of financial
stresses in November had increased uncertainty about the outlook. Given the
heightened uncertainty, the Committee
decided to refrain from providing an explicit assessment of the balance of risks.
The Committee agreed on the need to
remain exceptionally alert to economic
and financial developments and their effects on the outlook, and members
would be prepared to adjust the stance
of monetary policy if prospects for economic growth or inflation were to
worsen.
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 reducing the lfederal
funds rate to an average of around 4 A percent.
The vote encompassed approval of
the statement below to be released at
2:15 p.m.:
The Federal Open Market Committee
decided today to lower its target for the federal funds rate 25 basis points to 4V4 percent.
Incoming information suggests that economic growth is slowing, reflecting the
intensification of the housing correction and
some softening in business and consumer
spending. Moreover, strains in financial
markets have increased in recent weeks.
Today's action, combined with the policy
actions taken earlier, should help promote
moderate growth over time.

Minutes of FOMC Meetings, December 269
Readings on core inflation have improved
modestly this year, but elevated energy and
commodity prices, among other factors, may
put upward pressure on inflation. In this
context, the Committee judges that some
inflation risks remain, and it will continue to
monitor inflation developments carefully.
Recent developments, including the deterioration in financial market conditions,
have increased the uncertainty surrounding
the outlook for economic growth and inflation. The Committee will continue to assess
the effects of financial and other developments on economic prospects and will act as
needed to foster price stability and sustainable economic growth.
Votes for this action: Messrs. Bernanke,
Geithner, Evans, Hoenig, Kohn,
Kroszner, Mishkin, Poole, and Warsh.
Votes against this action: Mr. Rosengren.
Mr. Rosengren dissented because he
regarded the weakness in the incoming
economic data and in the outlook for the
economy as warranting a more aggressive policy response. In his view, the
combination of a deteriorating housing
sector, slowing consumer and business
spending, high energy prices, and illfunctioning financial markets suggested
heightened risk of continued economic
weakness. In light of that possibility, a
more decisive policy response was
called for to minimize that risk. In any
case, he felt that well-anchored inflation
expectations and the Committee's ability to reverse course on policy would
limit the inflation risks of a larger easing
move, should the economy instead
prove significantly stronger than anticipated.
It was agreed that the next meeting of
the Committee would be held on
Tuesday-Wednesday, January 29-30,
2008.
The meeting adjourned at 1:15 p.m.
Notation Vote
By notation vote completed on November 19, 2007, the Committee unani

mously approved the minutes of the
FOMC meeting held on October 30-31,
2007.
Conference Call
On December 6, 2007, in a joint session
of the Federal Open Market Committee
and the Board of Governors, Board
members and Reserve Bank presidents
reviewed conditions in domestic and
foreign financial markets and discussed
two proposals aimed at improving market functioning. The first proposal was
for the establishment of a temporary
Term Auction Facility (TAF), which
would provide term funding to eligible
depository institutions through an auction mechanism beginning in midDecember. Meeting participants recognized that a TAF would not address all
of the factors giving rise to stresses in
money and credit markets, notably the
ongoing concerns about credit quality
and balance sheet pressures. Nonetheless, most participants viewed the TAF,
which would provide liquidity to more
counterparties and against a broader
range of collateral than used for open
market operations, as a potentially useful tool. Some mentioned that a TAF
could help alleviate year-end pressures
in money markets. A few participants,
however, questioned the need for and
the likely efficacy of the proposal, expressed concerns about the longer-run
incentive effects of a TAF, and felt that
the possible drawbacks could well outweigh any benefits.14 Participants generally regarded the second proposal, to set
up a foreign exchange swap arrangement with the European Central Bank,
as a positive step in international coop-

14. Secretary's Note: The Board of Governors
approved the TAF via notation vote on December
10, 2007 after the staff finalized its proposal for
specifications of the TAF.

270 94th Annual Report, 2007
eration to address elevated pressures in
short-term dollar funding markets.
At the conclusion of the discussion,
with Mr. Poole dissenting, the Committee voted to direct the Federal Reserve
Bank of New York to establish and
maintain a reciprocal currency (swap)
arrangement for the System Open Market Account with the European Central
Bank in an amount not to exceed
$20 billion. Within that aggregate limit,
draws of up to $10 billion were autho-

rized, and the arrangement itself was authorized for a period of up to 180 days,
unless extended by the FOMC. Mr.
Poole dissented because he viewed the
swap agreement as unnecessary in light
of the size of the European Central
Bank's dollar-denominated foreign exchange reserves.
Brian F. Madigan
Secretary

271

Litigation
During 2007, the Board of Governors motion for summary judgment in a Freewas a party in one lawsuit and one ap- dom of Information Act case. On Seppeal filed that year and in six other cases tember 11, 2006, the court of appeals
pending from previous years, for a total affirmed in part and reversed in part the
of eight cases; in 2006, the Board had ruling of the district court, and rebeen a party in a total of seven cases. As manded the case. 463 F.3d 239. On
of December 31, 2007, six cases were March 20, 2007, the case was dismissed
by stipulation of the parties.
pending.
Interactive Media Entertainment and
Barnes v. Greenspan, No. 04-CVGaming Association, Inc. v. Federal Re- 1989 (CKK) (D. District of Columbia,
serve System, No. 07-2625 (D. New Jer- filed November 15, 2004), is a case unsey, filed June 5, 2007), is an action der the Age Discrimination in Employchallenging the implementation of the ment Act.
Unlawful Internet Gambling EnforceJones v. Greenspan, No. 04-CV-1696
ment Act of 2006.
(RMU) (D. District of Columbia, filed
Smith v. Bernanke, No. 07-1710 October 4, 2004), is an employment dis(Sixth Circuit, filed June 4, 2007), is an crimination action. On December 13,
appeal of the dismissal of a district court 2005, the district court granted in part
action (No. 07-10453 (E.D. Michigan)) and denied in part the Board's motion to
challenging the Federal Reserve's han- dismiss and for summary judgment. 402
dling of appellant's consumer com- F. Supp. 2d 294. On June 11, 2007, the
plaint.
court granted the Board's motion for
Chandler v. Bernanke, No. 06-2082 summary judgment as to Counts I and II
(D. District of Columbia, filed Decem- of the plaintiff's First Amended Comber 6, 2006), is an employment discrimi- plaint. 493 F. Supp. 2d 18.
nation action.
Artis v. Greenspan, No. 01-0400 (D.
Price v. Bernanke, No. 06-1569 (D. District of Columbia, filed February 22,
District of Columbia, filed September 8, 2001), is an employment discrimination
2006), was an employment discrimina- action. An identical action, No. 99-2073
tion action. The action was dismissed (EGS) (D. District of Columbia, filed
voluntarily on November 20, 2007.
August 3, 1999), was consolidated with
Inner City Press/Community on the this action on August 15, 2001. On
Move v. Board of Governors, No. 05- January 31, 2007, the District Court
6162 (Second Circuit, filed November granted the Board's renewed motion to
21, 2005), was an appeal of the district dismiss the action. 474 F. Supp. 2d 16.
court's order (No. 04-CV-8337, 380 F. The plaintiffs' motion to alter or amend
Supp. 2d 211 (S.D.N.Y. 2005)) granting judgment is pending.
•
in part and denying in part the Board's

Federal Reserve System
Organization

Federal Reserve System Organization 275

Board of Governors
December 31,2007

Members

OFFICE OF THE SECRETARY

Term expires
January 31,

BEN S. BERNANKE, Chairman1

2020

DONALD L. KOHN, Vice Chairman1 . . 2016
KEVIN M. WARSH

2018

RANDALL S. KROSZNER

2014

Secretary

2008

FREDERIC S. MISHKIN

JENNIFER J. JOHNSON, Secretary
ROBERT DEV. FRIERSON, Deputy Secretary
MARGARET M. SHANKS, Associate

DIVISION OF
INTERNATIONAL FINANCE

Officers
OFFICE OF BOARD MEMBERS

MICHELLE A. SMITH, Director
LARICKE D. BLANCHARD, Assistant to the

Board
WINTHROP P. HAMBLEY, Assistant to the

Board
ROSANNA PIANALTO-CAMERON, Assistant to

the Board
DAVID W. SKIDMORE, Assistant to the Board
BRIAN J. GROSS, Special Assistant to the

Board for Congressional Liaison
ROBERT M. PRIBBLE, Special Assistant to

the Board for Congressional Liaison
LEGAL DIVISION
SCOTT G. ALVAREZ, General Counsel
RICHARD M. ASHTON, Deputy General

Counsel
KATHLEEN M. O'DAY, Deputy General

Counsel
STEPHANIE MARTIN, Associate General

D. NATHAN SHEETS, Director
THOMAS A. CONNORS, Senior Associate

Director
RICHARD T. FREEMAN, Associate Director
STEVEN B. KAMIN, Associate Director
DALE W. HENDERSON, Senior Adviser
KAREN H. JOHNSON, Senior Adviser
JOSEPH E. GAGNON, Deputy Associate

Director
MICHAEL P. LEAHY, Deputy Associate

Director
RALPH W. TRYON, Deputy Associate

Director
TREVOR A. REEVE, Assistant Director
JOHN ROGERS, Assistant Director
DIVISION OF
MONETARY AFFAIRS

BRIAN F. MADIGAN, Director
JAMES A. CLOUSE, Senior Associate

Director

Counsel
ANN MISBACK, Associate General Counsel

DEBORAH J. DANKER, Senior Associate

KATHERINE H. WHEATLEY, Associate

WILLIAM B. ENGLISH, Senior Associate

General Counsel
KIERAN J. FALLON, Assistant General

Counsel
STEPHEN H. MEYER, Assistant General

Counsel
PATRICIA A. ROBINSON, Assistant General

Counsel
CARY K. WILLIAMS, Assistant General

Counsel
1. The designations as Chairman and Vice
Chairman expire on January 31, 2010, and

June 22, 2010, respectively, unless the service of
these members of the Board terminates sooner.

Director
Director
CHERYL L. EDWARDS, Associate Director
ANDREW T. LEVIN, Deputy Associate

Director
WILLIAM NELSON, Deputy Associate

Director
SETH B. CARPENTER, Assistant Director
JOHN B. DURHAM, Assistant Director
ROBERTO PEILI, Assistant Director
GRETCHEN C. WEINBACH, Assistant

Director
JONATHAN H. WRIGHT, Assistant Director
EGON ZAKRAJSEK, Assistant Director

276 94th Annual Report, 2007

Board of Governors—Continued
DIVISION OF RESEARCH
AND STATISTICS

WILLIAM F. TREACY, Adviser

DAVID J. STOCKTON, Director

NORAH M. BARGER, Associate Director
BETSY CROSS, Associate Director

PATRICK M. PARKINSON, Deputy Director
DAVID W. WILCOX, Deputy Director
MYRON L. KWAST, Senior Associate

Director
LAWRENCE SLIFMAN, Senior Associate

Director
J. NELLIE LIANG, Associate Director
DAVID L. REIFSCHNEIDER, Associate

Director
JANICE SHACK-MARQUEZ, Associate

Director
WILLIAM L. WASCHER III, Associate

Director
ALICE PATRICIA WHITE, Associate Director
GLENN B. CANNER, Senior Adviser
DAVID S. JONES, Senior Adviser
STEPHEN D. OLINER, Senior Adviser
MICHAEL S. GIBSON, Deputy Associate

Director
S. WAYNE PASSMORE, Deputy Associate

Director
DANIEL E. SICHEL, Deputy Associate

Director
JOYCE K. ZICKLER, Deputy Associate

Director
MICHAEL S. CRINGOLI, Assistant Director
KAREN E. DYNAN, Assistant Director
DIANA HANCOCK, Assistant Director
MICHAEL T. KILEY, Assistant Director
MICHAEL G. PALUMBO, Assistant Director
ROBIN A. PRAGER, Assistant Director
MARY M. WEST, Assistant Director
DANIEL M. COVITZ, Assistant Director and

Chief
DAVID E. LEBOW, Assistant Director and

Chief
DIVISION OF BANKING SUPERVISION
AND REGULATION
ROGER T. COLE, Director

DEBORAH P BAILEY, Deputy Director
PETER J. PURCELL, Deputy Director
STEVEN M. ROBERTS, Deputy Director

SARKIS YOGHOURTDJIAN, Adviser

GERALD A. EDWARDS, JR., Associate

Director
JON D. GREENLEE, Associate Director
CHARLES H. HOLM, Associate Director
JACK P. JENNINGS II, Associate Director
ROBIN L. LUMSDAINE, Associate Director
WILLIAM G. SPANIEL, Associate Director
CORYANN STEFANSSON, Associate Director
MOLLY S. WASSOM, Associate Director
DAVID M. WRIGHT, Associate Director
KEVIN M. BERTSCH, Deputy Associate

Director
BARBARA J. BOUCHARD, Deputy Associate

Director
JAMES A. EMBERSIT, Deputy Associate

Director
ARTHUR W. LINDO, Deputy Associate

Director
WILLIAM C. SCHNEIDER, JR., Deputy

Associate Director
ROBERT T. ASHMAN, Assistant Director
LISA M. DEFERRARI, Assistant Director
ROBERT T. MAAS, Assistant Director
RICHARD A. NAYLOR II, Assistant Director
NINA A. NICHOLS, Assistant Director
DANA E. PAYNE, Assistant Director
NANCY J. PERKINS, Assistant Director
SABETH I. SIDDIQUE, Assistant Director

DIVISION OF CONSUMER
AND COMMUNITY AFFAIRS
SANDRA F. BRAUNSTEIN, Director

GLENN E. LONEY, Deputy Director
LEONARD CHANIN, Associate Director
MARY T. JOHNSEN, Associate Director
TONDA E. PRICE, Associate Director
MARYANN F. HUNTER, Adviser
SHEILA F. MAITH, Adviser

TIMOTHY R. BURNISTON, Assistant Director
SUZANNE G. KILLIAN, Assistant Director
JAMES A. MICHAELS, Assistant Director

Federal Reserve System Organization 277

Board of Governors—Continued
DIVISION OF
RESERVE BANK OPERATIONS
AND PAYMENT SYSTEMS

DIVISION OF
INFORMATION TECHNOLOGY

LOUISE L. ROSEMAN, Director

GEARY L. CUNNINGHAM, Deputy Director
SHARON L. MOWRY, Deputy Director
WAYNE A. EDMONDSON, Associate Director
LISA M. BELL, Assistant Director
TILLENA G. CLARK, Assistant Director

DONALD V. HAMMOND, Deputy Director
JEFFREY C. MARQUARDT, Deputy Director
PAUL W. BETTGE, Senior Adviser
KENNETH D. BUCKLEY, Associate Director
DOROTHY LACHAPELLE, Associate Director
JACK K. WALTON II, Associate Director

JEFF J. STEHM, Deputy Associate Director
GREGORY L. EVANS, Assistant Director
LISA HOSKINS, Assistant Director
MICHAEL J. LAMBERT, Assistant Director

MAUREEN T. HANNAN, Director

Po KYUNG KIM, Assistant Director
SUSAN F. MARYCZ, Assistant Director
RAYMOND ROMERO, Assistant Director
JILL R. ROSEN, Assistant Director
KOFI A. SAPONG, Assistant Director

OFFICE OF INSPECTOR GENERAL
OFFICE O F STAFF DIRECTOR
FOR

MANAGEMENT

STEPHEN R. MALPHRUS, Staff Director for

Management
CHARLES S. STRUCKMEYER, Deputy Staff

Director

ELIZABETH A. COLEMAN, Inspector

General
ANTHONY J. CASTALDO, Assistant Inspector

General
LAURENCE A. FROEHLICH, Assistant

Inspector General

SHEILA CLARK, Equal Employment

WILLIAM L. MITCHELL, Assistant Inspector

Opportunity Programs Director
LYNN S. FOX, Senior Adviser

HARVEY WITHERSPOON, Assistant Inspector

ADRIENNE D. HURT, Adviser

MANAGEMENT DIVISION
H. FAY PETERS, Director
DARRELL R. PAULEY, Deputy Director
TODD A. GLISSMAN, Senior Associate

Director
MARSHA W. REIDHILL, Senior Associate

Director
BILLY J. SAULS, Senior Associate Director
DONALD A. SPICER, Senior Associate

Director
CHRISTINE M. FIELDS, Associate Director

JAMES R. RIESZ, Deputy Associate Director
KEITH F. BATES, Assistant Director
ELAINE M. BOUTILIER, Assistant Director
CHARLES F. O'MALLEY, Assistant Director
TARA C. TINSLEY-PELITERE, Assistant

Director

General
General

278 94th Annual Report 2007

Federal Open Market Committee
December 31,2007

Members

Officers

BEN S. BERNANKE, Chairman, Board of
Governors

BRIAN F. MADIGAN, Secretary and

TIMOTHY F. GEITHNER, Vice Chairman,

DEBORAH J. DANKER, Deputy Secretary
MICHELLE A. SMITH, Assistant Secretary
DAVID W. SKIDMORE, Assistant Secretary
SCOTT G. ALVAREZ, General Counsel
THOMAS C. BAXTER, JR., Deputy General

President, Federal Reserve Bank of
New York
CHARLES L. EVANS, President, Federal

Reserve Bank of Chicago
THOMAS M. HOENIG, President, Federal

Reserve Bank of Kansas City

Economist

Counsel
D. NATHAN SHEETS, Economist

DONALD L. KOHN, Board of Governors

DAVID J. STOCKTON, Economist

RANDALL S. KROSZNER, Board of

JAMES A. CLOUSE, Associate Economist
THOMAS A. CONNORS, Associate Economist
JEFFREY C. FUHRER, Associate Economist
STEVEN B. KAMIN, Associate Economist
ROBERT H. RASCHE, Associate Economist

Governors
FREDERIC S. MISHKIN, Board of Governors
WILLIAM POOLE, President, Federal

Reserve Bank of St. Louis
ERIC S. ROSENGREN, President, Federal

Reserve Bank of Boston
KEVIN M. WARSH, Board of Governors

Alternate Members
CHRISTINE M. CUMMING, First Vice

President, Federal Reserve Bank of
New York
RICHARD W. FISHER, President, Federal

Reserve Bank of Dallas
SANDRA PIANALTO, President, Federal

Reserve Bank of Cleveland
CHARLES I. PLOSSER, President, Federal

Reserve Bank of Philadelphia
GARY H. STERN, President, Federal

Reserve Bank of Minneapolis

GORDON H. SELLON, JR., Associate

Economist
LAWRENCE SLIFMAN, Associate Economist
DANIEL G. SULLIVAN, Associate Economist
JOSEPH S. TRACY, Associate Economist
DAVID W. WILCOX, Associate Economist
WILLIAM C. DUDLEY, Manager, System

Open Market Account
The Federal Open Market Committee is
made up of the seven members of the Board
of Governors; the president of the Federal
Reserve Bank of New York; and four of the
remaining eleven Reserve Bank presidents,
who serve one-year terms on a rotating basis.
During 2007 the Federal Open Market Committee held eight regularly scheduled meetings and three conference calls (see "Minutes of Federal Open Market Committee
Meetings" in this volume).

Federal Reserve System Organization 279

Federal Advisory Council
December 31, 2007

District 10—DAVID C. BOYLES, Chairman

Members
District 1—JAMES C. SMITH, Chairman and

Chief Executive Officer, Webster Bank,
N.A. and Webster Financial Corporation,
Waterbury, Conn.
District 2—THOMAS A. RENYI, Chairman

and Chief Executive Officer, The Bank of
New York, New York, N.Y
District 3—TED T. CECALA, Chairman and

Chief Executive Officer, Wilmington Trust
Company, Wilmington, Del.
District

4—GEORGE

SCHAEFER, JR.,

President and Chief Executive Officer,
Fifth Third Bancorp, Cincinnati, Ohio.
District 5—G. KENNEDY THOMPSON, Chair-

man, President, and Chief Executive
Officer, Wachovia Corporation, Charlotte,
N.C.
District 6—FRED L. GREEN III, President

and Chief Operating Officer, Synovus
Financial Corporation, Columbus, Ga.
District 7—WILLIAM DOWNE, Chief Execu-

tive Officer, Bank of Montreal, Chicago,
111.
District 8—ROBERT G. JONES, President and

Chief Executive Officer, Old National
Bancorp, Evansville, Ind.
District 9—LYLE R. KNIGHT, President and

Chief Executive Officer, First Interstate
BancSystem, Inc., Billings, Mont.

and Director, Colombine Capital Corp.,
Denver, Colo.
District 11—JAMES GOUDGE, Chairman and

Chief Executive Officer, Broadway Bank,
San Antonio, Tex.
District

12—RICHARD

KOVACEVICH,

Chairman, President, and Chief Executive
Officer, Wells Fargo and Company, San
Francisco, Calif.

Officers
G. KENNEDY THOMPSON, President
JAMES C. SMITH, Vice President
JAMES E. ANNABLE, Secretary

The Federal Advisory Council—a statutory
body established under the Federal Reserve
Act—consults with, and advises, the Board
of Governors on all matters within the
Board's jurisdiction. It is composed of one
representative from each Federal Reserve
District, chosen by the Reserve Bank in that
District. The Federal Reserve Act requires
the council to meet in Washington, D.C., at
least four times a year. In 2007, it met on
February 8-9, May 10-11, September 6-7,
and December 6-7. The council met with the
Board on February 9, May 11, September 7,
and December 7, 2007.

280 94th Annual Report, 2007

Consumer Advisory Council
December 31,2007

Members

ANNA MCDONALD RENTSCHLER, BSA

STELLA ADAMS, Founder, S J Adams Con-

sulting, Durham, N.C.
FAITH L. ANDERSON, Vice President—Legal

Compliance and General Counsel, American Airlines Federal Credit Union, Fort
Worth, Tex.
DOROTHY BRIDGES, Chief Executive Officer
and President, Franklin National Bank of
Minneapolis, Minneapolis, Minn.

Of-

ficer, Central Bancompany, Jefferson City,
Mo.
EDNA SAWADY, Managing Director, Market
Innovations, Inc., Orange, Ohio
FAITH

ARNOLD

SCHWARTZ,

Executive

Director, Hope Now Alliance, The
Financial Services Roundtable, Washington, D.C.
EDWARD SIVAK, Director of Policy and Evaluation, Enterprise Corporation of the
CAROLYN CARTER, Attorney, National ConDelta, Jackson, Miss.
sumer Law Center, Boston, Mass.
H. COOKE SUNOO, Director, Asian Pacific
MICHAEL COOK, Vice President of Finance
Islander Small Business Program, Los
and Assistant Treasurer, Wal-Mart Stores,
Angeles, Calif.
Inc., Bentonville, Ark.
STERGIOS THEOLOGIDES, Executive Vice
DONALD S. CURRIE, Executive Director,
President, General Counsel, Morgan
Community Development Corporation of
Stanley Home Loans, Fort Worth, Tex.
Brownsville, Brownsville, Tex.
LINDA TINNEY, Vice President, Community
Development, West Metro Region ManKURT EGGERT, Professor of Law and Director of Clinical Legal Education, Chapman
ager, US Bank, Denver, Colo.
University School of Law, Orange, Calif. Luz URRUTIA, President and Chief Operating Officer, Banuestra Financial CorporaJASON ENGEL, Vice President and Chief Regtion, Roswell, Ga.
ulatory Counsel, Experian, Costa Mesa,
ANSELMO VILLARREAL, Executive Director,
Calif.
LaCasa de Esperanza, Inc., Waukesha,
JOSEPH FALK, Consultant, Akerman SenterWis.
fitt, Miami, Fla.
LOUISE GISSENDANER, Senior Vice Pres- ALAN WHITE, Assistant Professor, Valparaiso University Law School, Valparaiso,
ident, Director of Community DevelopInd.
ment, Fifth Third Bank, Cleveland, Ohio
PATRICIA A. HASSON, President, Consumer

Credit Counseling Service of Delaware
Valley, Inc., Philadelphia, Pa.
DEBORAH HICKOK, Former Vice President,
MoneyGram Payment Systems, Inc.,
Ooltewah, Tenn.
THOMAS P. JAMES, Senior Assistant Attorney
General—Consumer Counsel, Office of
the Illinois Attorney General, Consumer
Fraud Bureau, Chicago, 111.
SARAH

LUDWIG,

Executive

Director,

Neighborhood Economic Development
Advocacy Project, New York, N.Y.
MARK K. METZ, Senior Vice President and
Deputy General Counsel, Wachovia
Corporation, Charlotte, N.C.
LANCE MORGAN, President,

Ho-Chunk,

Incorporated, Winnebago Tribe of Nebraska, Winnebago, Neb.
JOSHUA PEIREZ, Chief Payment System Integrity Officer, MasterCard Worldwide,
Purchase, N.Y.

MARVA E. WILLIAMS, Senior

Program

Officer, Chicago LISC, Chicago, 111.

Officers
LISA SODEIKA, Chair, Executive Vice
President—Corporate
Affairs, HSBC
North America Holdings, Inc., Prospect
Heights, 111.
TONY T. BROWN, Vice Chair, President and
Chief Executive Officer, Uptown Consortium, Inc., Cincinnati, Ohio
The Consumer Advisory Council—a statutory body established pursuant to the 1976
amendments to the Equal Credit Opportunity
Act—advises the Board of Governors on
consumer financial services. Its members,
who are appointed by the Board, are academics, state and local government officials, and
representatives of the financial services industry and of consumer and community interests. In 2007, the council met with the
Board on March 8, June 21, and October 25.

Federal Reserve System Organization 281

Thrift Institutions Advisory Council
December 31, 2007

DAVID E. POULSEN, President and Chief

Members
FRANK E. BERRISH, President and Chief

Executive Officer, Visions Federal Credit
Union, Endicott, N.Y.
ROBERT

CLEMENTS,

Chairman and

Chief Executive Officer, Everbank
Financial Corp., Jacksonville, Fla.
A. THOMAS HOOD, President and Chief

Executive Officer, First Federal Savings
and Loan Association, Charleston, S.C.
KERRY KILLINGER, Chairman and Chief

Executive Officer, Washington Mutual,
Inc., Seattle, Wa.
KENNETH

KORANDA,

President,

Mid

America Bank, Downers Grove, 111.
ARKADI KUHLMANN, Chairman, President,

and Chief Executive Officer, ING
DIRECT USA, Wilmington, Del.
HARRIET MAY, President and Chief Executive Officer, Government Employees
Credit Union, El Paso, Tex.
THOMAS C. MEUSER, Chairman and Chief

Executive Officer, El Dorado Savings
Bank, Placerville, Calif.
F. WELLER MEYER, Chairman, President

and Chief Executive Officer, Acacia
Federal Savings Bank, Falls Church, Va.

Executive Officer, American Express
Centurion Bank, Salt Lake City, Utah
STEVEN J. SWIONTEK, Chairman, President,

and Chief Executive Officer, Gate City
Bank, Fargo, N.D.
DAVID RUSSELL TAYLOR, President and

Chief Executive Officer, Rahway Savings
Institution, Rahway, N.J.

Officers
DAVID RUSSELL TAYLOR, President

F. WELLER MEYER, Vice President

The Thrift Institutions Advisory Council was
established by the Board of Governors to
consult with, and advise, the Board on issues
pertaining to the thrift industry and on other
matters within the Board's jurisdiction. Its
members, who are appointed by the Board,
represent credit unions, savings and loan associations, and savings banks. In 2007, the
council met with the Board on March 16,
June 29, and December 14.

282 94th Annual Report, 2007

Federal Reserve Banks and Branches
December 31,2007

Officers
Chairman*
Deputy Chairman

President
First Vice President

BOSTON2

Lisa M. Lynch
Henri A. Termeer

Eric S. Rosengren
Paul M. Connolly

NEW YORK2

Jerry I. Speyer
Denis M. Hughes

Timothy F. Geithner
Christine M.
Cumming

Buffalo

Alphonso O'NeilWhite

PHILADELPHIA

Doris M. Damm
William F. Hecht

Charles I. Plosser
William H. Stone, Jr.

CLEVELAND

Tanny B. Crane
Alfred M. Rankin, Jr.
James M. Anderson
Robert O. Agbede

Sandra Pianalto
R. Chris Moore

Thomas J. Mackell, Jr.
Lemuel E. Lewis
Cynthia Collins Allner
Jim Lowry

Jeffrey M. Lacker
Sarah G. Green

V. Larkin Martin
D. Scott Davis
Mary am B. Head
H. Britt Landrum, Jr.
Gay Rebel Thompson
Debra K. London
Dave Dennis

Dennis P. Lockhart
Patrick K. Barron

Miles D. White
John A. Canning, Jr.
Timothy M.
Manganello

Charles L. Evans
Gordon Werkema

William Poole
David A. Sapenaro

Little Rock
Louisville

Irl F. Engelhardt
Cynthia J. Brinkley
C. Sam Walls
John L. Huber

Memphis

Meredith B. Allen

MINNEAPOLIS

Frank L. Sims
James J. Hynes
Lawrence R. Simkins

BANK or Branch

Cincinnati
Pittsburgh
RICHMOND
Baltimore
Charlotte
ATLANTA
Birmingham
Jacksonville
Miami
Nashville
New Orleans
CHICAGO2
Detroit

ST.LOUIS

Helena

Officer
in charge of Branch

Kausar Hamdani

Barbara B. Henshaw
Robert B. Schaub

David Beck
Jeffrey S. Kane

Lee C. Jones
Christopher L. Oakley
Juan del Busto
Melvyn K. Purcell
Robert J. Musso

Robert Wiley

Robert A. Hopkins
Maria Gerwing
Hampton
Martha Perine Beard
Gary H. Stern
James M. Lyon
R. Paul Drake

Federal Reserve System Organization 283

Officers—Continued
BANK or Branch
KANSAS CITY ...
Denver
Oklahoma City ....
Omaha
DALLAS
El Paso
Houston
San Antonio
SAN FRANCISCO
Los Angeles
Portland
Salt Lake City
Seattle

Chairman1
Deputy Chairman

President
First Vice President

Robert A. Funk
Lu M. Cordova
Kristy A. Schloss
Richard K. Ratcliffe
James A. Timmerman

Thomas M. Hoenig
Richard K. Rasdall, Jr.

James T. Hackett
Anthony R. Chase
Ron C. Helm
Lupe Fraga
J. Dan Bates

Richard W. Fisher
Helen E. Holcomb

David K.Y. Tang
T. Gary Rogers
James L. Sanford
James H. Rudd
Clark D. Ivory
Mic R. Dinsmore

Janet L. Yellen
John F. Moore

Officer
in charge of Branch

Mark Schweitzer
Chad Wilkerson
Jason Henderson

Robert W. Gilmer
Robert Smith III
Blake Hastings

Mark L. Mullinix
Mary E. Lee
Andrea P. Wolcott
Mark A. Gould

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; Des Moines, Iowa;
Midway at Bedford Park, Illinois; and Phoenix, Arizona.

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,
also attended by the deputy chairmen, were
held in Washington, D.C., on May 30 and
31, and on November 28 and 29, 2007.
The members of the executive committee
of the Conference of Chairmen during 2007
were, Robert A. Funk, chair; V. Larkin Martin, vice chair; and Miles D. White, member.
On November 29, the conference elected
its executive committee for 2008, naming
V. Larkin Martin as chair; Lisa M. Lynch as
vice chair; and David K.Y. Tang 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.
Sandra Pianalto, president of the Federal
Reserve Bank of Cleveland, served as chair
of the conference in 2007, and Jeffrey M.
Lacker, president of the Federal Reserve
Bank of Richmond, served as vice chair.
Gregory L. Stefani, of the Federal Reserve
Bank of Cleveland, served as secretary, and
Sandra Tormoen, of the Federal Reserve
Bank of Richmond, served as assistant
secretary.

284 94th Annual Report, 2007

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.
Helen E. Holcomb, first vice president of
the Federal Reserve Bank of Dallas, served
as chair of the conference in 2007, and James
M. Lyon, first vice president of the Federal
Reserve Bank of Minneapolis, served as vice
chair. Harvey R. Mitchell, of the Federal Reserve Bank of Dallas, served as secretary,
and Sheryl L. Britsch, of the Federal Reserve
Bank of Minneapolis, served as assistant
secretary.
On October 22, 2007, the conference
elected James M. Lyon as chair for 2008-09
and R. Chris Moore, first vice president of
the Federal Reserve Bank of Cleveland, as
vice chair.

Directors
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.
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 member banks of each Federal
Reserve District are classified 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.
The chairs and deputy chairs of the Reserve Bank boards of directors, and the
chairs of the Branches, are listed in the preceding table, titled "Officers." The directors
of the Banks and Branches are listed in the
following table. For each director, the class
of directorship, the director's principal organizational affiliation, and the date the director's term expires are shown.

Federal Reserve System Organization 285
Directors
December 31, 2007
BANK or BRANCH, Category

Name

Title

Term expires
Dec. 31

DISTRICT 1—BOSTON
RESERVE BANK

Class A
Ronald E. Logue
Kathleen C. Marcum
David A. Lentini

Class B
Robert K. Kraft
Michael T. Wedge
Stuart H. Reese

Class C
Samuel O. Thier, M.D
Henri A. Termeer
Lisa M. Lynch

Chairman and Chief Executive Officer, State Street
Corporation, Boston, Massachusetts
President and Chief Executive Officer, Millbury
National Bank, Millbury, Massachusetts
Chairman, President and Chief Executive Officer,
The Connecticut Bank and Trust Company, Hartford,
Connecticut

2007

Chairman and Chief Executive Officer, The Kraft
Group, Foxborough, Massachusetts
Former President and Chief Executive Officer,
BJ's Wholesale Club, Inc., Natick, Massachusetts
Chairman, President and Chief Executive Officer,
MassMutual Financial Group, Springfield,
Massachusetts

2007

Professor of Medicine and Professor of Health Care
Policy-Harvard Medical School, Massachusetts
General Hospital, Boston, Massachusetts
Chairman, President and Chief Executive Officer,
Genzyme Corporation, Cambridge, Massachusetts
William L. Clayton Professor of International Economic
Affairs, The Fletcher School of Law and Diplomacy,
Tufts University, Medford, Massachusetts

2007

2008
2009

DISTRICT 2—NEW YORK
RESERVE BANK

Class A
Jill M. Considine
Charles V. Wait
James Dimon
Class B
Richard S. Fuld, Jr.
Jeffrey R. Immelt
Indra K. Nooyi

Senior Advisor, The Depository Trust Company,
New York, New York
President, Chief Executive Officer, and Chairman,
The Adirondack Trust Company, Saratoga Springs,
New York
Chairman and Chief Executive Officer, JPMorgan Chase
& Co., New York, New York
Chairman and Chief Executive Officer, Lehman
Brothers, New York, New York
Chairman and Chief Executive Officer, General Electric
Company, Fairfield, Connecticut
Chairman and Chief Executive Officer, PepsiCo, Inc.,
Purchase, New York

2007
2008
2009

286 94th Annual Report 2007

Directors—Continued
BANK or BRANCH, Category

Name
Class C
Jerry I. Speyer
Denis M. Hughes
Lee C. Bollinger

Titlf

i me

Term expires
Dec. 31

President and Chief Executive Officer, Tishman Speyer,
New York, New York
President, New York State AFL-CIO, New York,
New York
President, Columbia University, New York, New York

2007

Executive Vice President and Chief Information Officer,
M&T Bank, Buffalo, New York
Regional Director-Region 9, United Auto Workers,
Amherst, New York
Co-Owner, Zuber Farms, LLC, Churchville, New York
President and Chief Executive Officer, Paychex, Inc.,
Rochester, New York

2007

President and Chief Executive Officer, Rochester Gas
and Electric Corporation and New York State Electric
and Gas Corporation, Rochester, New York

2007

2008
2009

BUFFALO BRANCH

Appointed by the
Federal Reserve Bank
Michele D. Trolli
Joseph J. Ashton
Kim J. Zuber
Jonathan J. Judge
Appointed by the
Board of Governors
James P. Laurito

Vacancy
Alphonso O'Neil-White .... President and Chief Executive Officer, HealthNow
New York Inc., Buffalo, New York

2008
2009
2009

2008
2009

DISTRICT 3—PHILADELPHIA
RESERVE BANK

Class A
Wayne R. Weidner
John G. Gerlach
Aaron L. Groff, Jr.

Chairman, National Penn Bancshares, Inc., Boyertown,
Pennsylvania
President and Chief Executive Officer, Pocono
Community Bank, Stroudsburg, Pennsylvania
Chairman, President and Chief Executive Officer,
Ephrata National Bank, Ephrata, Pennsylvania

Class B
P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, Townsends, Inc.
Wilmington, Delaware
Michael F. Camardo
Retired Executive Vice President, Lockheed Martin ITS
Cherry Hill, New Jersey
Garry L. Maddox
President and Chief Executive Officer, A. Pomerantz &
Company, Philadelphia, Pennsylvania
Class C
Doris M. Damm
Charles P. Pizzi
William F. Hecht

President and Chief Executive Officer, ACCU Staffing
Services, Cherry Hill, New Jersey
President and Chief Executive Officer, Tasty Baking
Company, Philadelphia, Pennsylvania
Retired Chairman, President, and Chief Executive
Officer, PPL Corporation, Allentown, Pennsylvania

2007
2008
2009

Federal Reserve System Organization 287

BANK or BRANCH, Category

Name

Titlp
i

nit

Term expires
Dec. 31

DISTRICT 4—CLEVELAND
RESERVE BANK

Class A
Henry L. Meyer III
Bick Weissenrieder
C. Daniel DeLawder
Class B
Les C. Vinney
Vacancy
V. Ann Hailey
Class C
Roy W.Haley
Alfred M. Rankin, Jr.
Tanny B. Crane

Chairman and Chief Executive Officer, KeyCorp,
Cleveland, Ohio
Chairman and Chief Executive Officer, Hocking Valley
Bank, Athens, Ohio
Chairman and Chief Executive Officer, Park National
Bank, Newark, Ohio

2007

Retired President and Chief Executive Officer, STERIS
Corporation, Mentor, Ohio

2007

Retired Executive Vice President, Corporate
Development, Limited Brands, Columbus, Ohio

2008
2009

Chairman and Chief Executive Officer, WESCO
International, Inc., Pittsburgh, Pennsylvania
Chairman, President and Chief Executive Officer,
NACCO Industries, Inc., Cleveland, Ohio
President and Chief Executive Officer, Crane Group
Company, Columbus, Ohio

2007

President, Czar Coal Corporation, Lovely, Kentucky
Principal Partner, Global Lead Management
Consulting, Cincinnati, Ohio
President, Lexington Market, JPMorgan Chase Bank,
NA, Lexington, Kentucky
President and Chief Executive Officer, Great Lakes
Bankers Bank, Gahanna, Ohio

2007
2008

Senior Vice President, Western and Southern Financial
Group, Cincinnati, Ohio
President and Chief Executive Officer, Cincinnati
Children's Hospital Medical Center, Cincinnati, Ohio
President and Chief Executive Officer, Long-Stanton
Manufacturing Companies, Cincinnati, Ohio

2007

President and Chief Executive Officer, Iron and Glass
Bank, Pittsburgh, Pennsylvania

2007

2008
2009

CINCINNATI BRANCH

Appointed by the
Federal Reserve Bank
James H. Booth
Janet B.Reid
Glenn D. Leveridge
Charlotte W. Martin
Appointed by the
Board of Governors
Herbert R. Brown
James M. Anderson
Daniel B. Cunningham

2008
2009

PITTSBURGH BRANCH

Appointed by the
Federal Reserve Bank
Michael J. Hagan

288 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Howard W. Hanna III
Georgiana N. Riley
Margaret Irvine Weir
Appointed by the
Board of Governors
Robert O. Agbede
Sunil T. Wadhwani
Robert A. Paul

Titlp
i me

Term expires
Dec. 31

Chairman and Chief Executive Officer, Howard Hanna
Real Estate Services, Pittsburgh, Pennsylvania
President and Chief Executive Officer, TIGG
Corporation, Bridgeville, Pennsylvania
President, NexTier Bank, Butler, Pennsylvania

2008

President and Chief Executive Officer, Chester
Engineers, Inc., Pittsburgh, Pennsylvania
Chief Executive Officer and Co-founder, iGATE
Corporation, Pittsburgh, Pennsylvania
Chairman and Chief Executive Officer, AmpcoPittsburgh Corporation, Pittsburgh, Pennsylvania

2007

2008
2009

DISTRICT 5—RICHMOND
RESERVE BANK

Class A
Kathleen Walsh CanHunter R. Hollar
Dwight V. Neese

Class B
Harry M. Lightsey, III
Dana S. Boole
Kenneth R. Sparks
Class C
Margaret E. McDermid
Thomas J. Mackell, Jr.
Lemuel E. Lewis

President, Cardinal Bank Washington, Washington, D.C
President and Chief Executive Officer, Sandy Spring
Bancorp and Sandy Spring Bank, Olney, Maryland
Director, President, and Chief Executive Officer,
Provident Community Bank and Provident
Community Bancshares, Inc., Rock Hill,
South Carolina

2007
2008

Senior Vice President-Southern Region Legislative and
External Affairs, AT&T, Columbia, South Carolina
President and Chief Executive Officer, Community
Affordable Housing Equity Corporation, Raleigh,
North Carolina
President and Chief Executive Officer, Ken Sparks
Associates LLC, White Stone, Virginia

2007

Senior Vice President and Chief Information Officer,
Dominion Resources, Inc., Richmond, Virginia
President, Association of Benefit Administrators,
Warrenton, Virginia
Director, Landmark Communications, Inc., Norfolk,
Virginia

2007

President and Chief Executive Officer, SunTrust Bank,
Maryland, Baltimore, Maryland
President and Chief Executive Officer, Hemingway's
Inc., Stevensville, Maryland
Managing Director-Mid-Atlantic, Ballantrae
International, Ltd., Ijamsville, Maryland

2007

2009

2008
2009

BALTIMORE BRANCH

Appointed by the
Federal Reserve Bank
Donald P. Hutchinson
Biana J. Arentz
James T. Brady

2008
2009

Federal Reserve System Organization 289

BANK or BRANCH, Category

Name
Michael L. Middleton
Appointed by the
Board of Governors
William R. Roberts ..
Cynthia Collins Allner
Ronald Blackwell

Title

Term expires
Dec. 31

Chairman and President, Community Bank of
Tri-County, Waldorf, Maryland

2009

President - Verizon Maryland/DC, Verizon Maryland
Inc., Baltimore, Maryland
Principal, Miles & Stockbridge P.C., Baltimore,
Maryland
Chief Economist, AFL-CIO, Washington, D.C.

2007

President and Chief Executive Officer, First South
Bancorp, Inc. and First South Bank, Spartanburg,
South Carolina
President and Chief Executive Officer, North Carolina
Mutual Life Insurance Company, Durham,
North Carolina
Chairman and President, FNB United Corp. and
CommunityONE Bank, N.A., Asheboro,
North Carolina
Chief Risk Officer, Wachovia Corporation, Charlotte,
North Carolina

2007

Dean, Clemson University, College of Business and
Behavioral Science, Clemson, South Carolina
President, PML Associates, Inc., Greenwood,
South Carolina
Automotive Consultant, High Point, North Carolina

2007

2008
2009

CHARLOTTE BRANCH

Appointed by the
Federal Reserve Bank
Barry L. Slider

James H. Speed, Jr
Michael C. Miller
Donald K. Truslow
Appointed by the
Board of Governors
Claude C. Lilly
Linda L. Dolny
Jim Lowry

2008
2009
2009

2008
2009

DISTRICT 6—ATLANTA
RESERVE BANK

Class A
James F. Beall
L. Phillip Humann
Rudy E. Schupp
Class B
Lee M. Thomas
Egbert L.J. Perry
Teri G. Fontenot

Chairman, President, and Chief Executive Officer,
Farmers & Merchants Bank, Centre, Alabama
Executive Chairman, SunTrust Banks, Inc., Atlanta,
Georgia
President and Chief Executive Officer, 1st United Bank,
Boca Raton, Florida

2007

Chairman, President and Chief Executive Officer,
Rayonier, Jacksonville, Florida
Chairman and Chief Executive Officer, The Integral
Group, LLC, Atlanta, Georgia
President and Chief Executive Officer, Woman's
Hospital, Baton Rouge, Louisiana

2007

2008
2009

290 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Class C
David M. Ratcliffe
V. Larkin Martin
D. Scott Davis

Titlp

i me

Term expires
Dec. 31

Chairman, President, and Chief Executive Officer,
Southern Company, Atlanta, Georgia
Managing Partner, Martin Farm, Courtland, Alabama
Chief Financial Officer and Vice Chairman, United
Parcel Service, Atlanta, Georgia

2007

Monroeville President, BankTrust, Monroeville,
Alabama
Chairman and Chief Executive Officer, Alabama
National Bancorporation, Birmingham, Alabama
Consultant, International Union of Operating EngineersLocal 312, Birmingham, Alabama
Managing Partner, Lewis Properties, LLC and Anderson
Investments, LLC, Huntsville, Alabama

2007

President, Ram Tool and Supply Company, Inc.,
Birmingham, Alabama
Chairman of the Board, HOME Place Farms, Inc.,
Prattville, Alabama
President and Chief Executive Officer, Randall-Reilly
Publishing Co., Tuscaloosa, Alabama

2007

President, Amelia Island Plantation Company, Amelia
Island, Florida
President and Chief Executive Officer, The First
Commercial Bank of Florida, Orlando,
Florida
President and Chief Executive Officer, GTE Federal
Credit Union, Tampa, Florida
President, E.T. Consultants, Winter Park, Florida

2007

President and Chief Executive Officer, Landrum Human
Resource Companies, Inc., Pensacola, Florida
President and Founder, US-Africa Free Enterprise
Education Foundation, Tampa, Florida
President and Chief Executive Officer, Prudential
Network Realty, Jacksonville, Florida

2007

2008
2009

BIRMINGHAM BRANCH

Appointed by the
Federal Reserve Bank
John B. Barnett III
John H. Holcomb III
Samuel F. Dodson
Bobby A. Bradley
Appointed by the
Board of Governors
Maryam B. Head
James H. Sanford
F. Michael Reilly

2008
2009
2009

2008
2009

JACKSONVILLE BRANCH

Appointed by the
Federal Reserve Bank
Jack B. Healan, Jr
Alan Rowe
Wendell A. Sebastian
Ellen S. Titen
Appointed by the
Board of Governors
H. Britt Landrum, Jr
Fassil Gabremariam
Linda H. Sherrer

2008

2009
2009

2008
2009

Federal Reserve System Organization 291

BANK or BRANCH, Category

Name

Titlp
1 me

Term expires
Dec. 31

MIAMI BRANCH

Appointed by the
Federal Reserve Bank
Dennis S. Hudson III
Thomas H. Shea
Walter Banks
Leonard L. Abess
Appointed by the
Board of Governors
Gay Rebel Thompson
Edwin A. Jones, Jr
Marvin O'Quinn

Chairman and Chief Executive Officer, Seacoast
Banking Corporation of Florida, Stuart, Florida
Regional Chief Executive Officer, Right Management,
Fort Lauderdale, Florida
President, Lago Mar Resort and Club, Fort Lauderdale,
Florida
Chairman, President, and Chief Executive Officer, City
National Bank of Florida, Miami, Florida

2007

President and Chief Executive Officer, Cement
Industries, Inc., Fort Myers, Florida
President, Angus Investments, Inc., Port St. Lucie,
Florida
President and Chief Executive Officer, Jackson Health
System, Miami, Florida

2007

Chairman and Chief Executive Officer, Citizens
National Bank, Athens, Tennessee
Chairman, First National Bank, Oneida, Tennessee
Retired Senior Vice President, North American
Manufacturing and Supply Chain Management,
Nissan North America, Inc., Smyrna, Tennessee
President and Chief Executive Officer, Tennessee Bun
Company, Nashville, Tennessee

2007

President and Chief Executive Officer, St. Mary's
Health System, Knoxville, Tennessee
President and Chief Executive Officer, The Sage Group,
Brentwood, Tennessee
Vice Chancellor and General Counsel, Vanderbilt
University, Nashville, Tennessee

2007

2008
2008
2009

2008
2009

NASHVILLE BRANCH

Appointed by the
Federal Reser\>e Bank
Paul G. Willson
Michael B. Swain
Daniel A. Gaudette
Cordia W. Harrington
Appointed by the
Board of Governors
Debra K. London
Richard Q. Ford
David Williams 11

2008
2009
2009

2008
2009

NEW ORLEANS BRANCH

Appointed by the
Federal Reserve Bank
David E. Johnson

Chairman and Chief Executive Officer, The First
Bancshares, Inc., and The First, A National Banking
Association, Hattiesburg, Mississippi
R. King Milling
Vice Chairman, Whitney Holding Corporation &
Whitney National Bank, New Orleans, Louisiana
Matthew G. Stuller, Sr. .... Chairman and Chief Executive Officer, Stuller, Inc.,
Lafayette, Louisiana
Christel C. Slaughter
Partner, SSA Consultants, LLC, Baton Rouge, Louisianai

2007

2008
2009
2009

292 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Appointed by the
Board of Governors
Dave Dennis
Earl L. Shipp
Robert S. Boh

Titlp

President and Chief Executive Officer, Specialty
Contractors & Associates, Inc., Gulfport, Mississippi
President-Basic Chemicals Group, The Dow Chemical
Company, Dubai, United Arab Emirates
President and Chief Executive Officer, Boh Bros.
Construction Co., LLC, New Orleans, Louisiana

Term expires
Dec. 31

2007
2008
2009

DISTRICT 7—CHICAGO
RESERVE BANK

Class A
JeffPlagge
Dennis J. Kuester
Michael L. Kubacki
Class B
Ann D. Murtlow
Vacancy
Mark T. Gaffney
Class C
Miles D. White
John A. Canning, Jr.
William C. Foote

Chairman, Chief Executive Officer, and President,
Midwest Heritage Bank, Clive, Iowa
Chairman, Marshall & Ilsley Corporation, Milwaukee,
Wisconsin
Chairman, President, and Chief Executive Officer,
Lakeland Financial Corporation, Warsaw, Indiana

2007

President and Chief Executive Officer, Indianapolis
Power & Light Company, Indianapolis, Indiana

2007

President, Michigan AFL-CIO, Lansing, Michigan

2008
2009

Chairman and Chief Executive Officer, Abbott, Abbott
Park, Illinois
Chairman, Madison Dearborn Partners, LLC, Chicago,
Illinois
Chairman and Chief Executive Officer, USG
Corporation, Chicago, Illinois

2007

President and Chief Executive Officer, Independent
Bank Corporation, Ionia, Michigan
Executive Vice President and Chief Financial Officer,
Pulte Homes, Inc., Bloomfield Hills, Michigan
Chief Executive Officer, ER-One, Inc., Livonia,
Michigan
Chairman, President, and Chief Executive Officer,
Comerica Inc., Dallas, Texas

2007

2008
2009

DETROIT BRANCH

Appointed by the
Federal Reserve Bank
Michael M. Magee, Jr
Roger A. Cregg
Tommi A. White
Ralph W. Babb, Jr.

2008
2008
2009

Federal Reseme System Organization 293

BANK or BRANCH, Category

Name

Titlp
11UC

Appointed by the
Board of Governors
Irvin D.Reid
President, Wayne State University, Detroit, Michigan
Timothy M. Manganello ... Chairman and Chief Executive Officer, BorgWarner
Inc., Auburn Hills, Michigan
Linda S. Likely
Director of Housing and Community Development,
Kent County Community Development Department
and Housing Commission, Grand Rapids,
Michigan

Term expires
Dec. 31

2007
2008
2009

DISTRICT 8—ST. LOUIS
RESERVE BANK

Class A
Lewis F. Mallory, Jr
J. Thomas May
David R. Pirsein
Class B
Paul T. Combs
Vacancy
A. Rogers Yarnell, II
Class C
Irl F. Engelhardt
Cynthia J. Brinkley
Steven H. Lipstein

Chairman and Chief Executive Officer, Cadence
Financial Corporation, Starkville, Mississippi
Chairman and Chief Executive Officer, Simmons First
National Corporation, Pine Bluff, Arkansas
President and Chief Executive Officer, First National
Bank in Pinckneyville, Pinckneyville, Illinois

2007

President, Baker Implement Company, Kennett,
Missouri

2007

President, Yarnell Ice Cream Company, Inc., Searcy,
Arkansas

2008
2009

Chairman, Patriot Coal Corporation, St. Louis, Missouri
President, AT&T Missouri, St. Louis, Missouri
President and Chief Executive Officer, BJC Healthcare,
St. Louis, Missouri

2007
2008
2009

Executive Director, Downtown Little Rock Partnership,
Little Rock, Arkansas
Chairman, Arkansas Best Corporation, Fort Smith,
Arkansas
President and Chief Executive Officer, Southern
Bancorp, Arkadelphia, Arkansas
President, First Security Bancorp, Searcy, Arkansas

2007

Chief Executive Officer, E-Z Mart Stores, Inc.,
Texarkana, Texas

2007

LITTLE ROCK BRANCH

Appointed by the
Federal Reserve Bank
Sharon Priest
Robert A. Young III
Phillip N. Baldwin
William C. Scholl
Appointed by the
Board of Governors
Sonja Yates Hubbard

2008
2008
2009

294 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Cal McCastlain
C.Sam Walls

Titlp
111IC

Term expires
Dec. 31

Partner, Pender & McCastlain, P.A., Little Rock,
Arkansas
Chief Executive Officer, Arkansas Capital Corporation,
Little Rock, Arkansas

2008

Chairman and Chief Executive Officer, Republic Bank
& Trust Company, Louisville, Kentucky
Chief Executive Officer, Ephraim McDowell Health,
Danville, Kentucky
President, Wabash Plastics, Inc., Evansville, Indiana
Consultant, Marion, Kentucky

2007

President, Western Kentucky University, Bowling
Green, Kentucky
Consultant, Louisville, Kentucky
Chief Executive Officer, Schuler Bauer Real Estate
Services, New Albany, Indiana

2007

2009

LOUISVILLE BRANCH

Appointed by the
Federal Reserve Bank
Steven E. Trager
L. Clark Taylor, Jr
John C. Schroeder
Gordon B. Guess
Appointed by the
Board of Governors
Gary A. Ransdell
John L. Huber
Barbara Ann Pop

2008
2008
2009

2008
2009

MEMPHIS BRANCH

Appointed by the
Federal Reserve Bank
Thomas G. Miller

President, Southern Hardware Company, Inc., West
Helena, Arkansas
Director of Sales, Regions Morgan Keegan Private
Levon Mathews
Banking, Memphis, Tennessee
Hunter Simmons
President and Chief Executive Officer, First South Bank
Jackson, Tennessee
David P. Rumbarger, Jr. .... President and Chief Executive Officer, Community
Development Foundation, Tupelo, Mississippi

Appointed by the
Board of Governors
Charles S. Blatteis
Meredith B. Allen
Nick Clark

Member (Partner), The Bogatin Law Firm, PLC,
Memphis, Tennessee
Vice President, Marketing, Staple Cotton Cooperative
Association, Greenwood, Mississippi
Partner, Clark & Clark, Memphis, Tennessee

2007
2008
2008
2009

2007
2008
2009

DISTRICT 9—MINNEAPOLIS
RESERVE BANK

Class A
John H. Hoeven, Jr
Peter J. Haddeland
Thomas W. Scott

Chairman, First Western Bank & Trust, Minot, North
Dakota
President and Chief Executive Officer, First National
Bank, Mahnomen, Minnesota
Chairman of the Board, First Interstate BancSystem,
Inc., Billings, Montana

2007
2008
2009

Federal Reserve System Organization 295

BANK or BRANCH, Category

Name
Class B
Todd L. Johnson
Randy Peterson
William J. Shorma
Class C
Frank L. Sims
John W. Marvin
James J. Hynes

Title

Term expires
Dec. 31

Chairman and Chief Executive Officer, Reuben
Johnson & Son, Inc. and Affiliated Companies,
Superior, Wisconsin
Facility Director, Lake Superior State University, Sault
Ste. Marie, Michigan
President, Shur-Co., Yankton, South Dakota

2007

Corporate Vice President, Transportation, Cargill, Inc.,
Wayzata, Minnesota
Chairman and Chief Executive Officer, Marvin
Windows and Doors, Warroad, Minnesota
Executive Administrator, Twin City Pipe Trades Service
Association, St. Paul, Minnesota

2007

Regional President and Chief Executive Officer, Wells
Fargo Bank Montana, N.A., Billings, Montana
President and Chief Executive Officer, 1 st Bank, Sidney,
Montana
Chief Executive Officer, Anderson ZurMuehlen &
Company, P C , Helena, Montana

2007

General Manager and Chief Executive Officer, Wheat
Montana Farms and Bakery, Three Forks, Montana
President, Washington Corporations, Missoula, Montana

2008

2008
2009

HELENA BRANCH

Appointed by the
Federal Reserve Bank
Joy N. Ott
John L. Franklin
Timothy J. Bartz
Appointed by the
Board of Governors
Dean Folkvord
Lawrence R. Simkins

2008
2009

2009

DISTRICT 10—KANSAS CITY
RESERVE BANK

Class A
Robert C. Fricke

President and Chief Executive Officer, Farmers &
Merchants National Bank, Ashland, Nebraska
Chief Executive Officer, Dickinson Financial
Rick L. Smalley
Corporation, Kansas City, Missouri
Mark W. Schifferdecker .... President and Chief Executive Officer, Girard National
Bank, Girard, Kansas

Class B
Vacancy
Dan L. Dillingham
Kevin K. Nunnink

Chief Executive Officer, Dillingham Insurance, Enid,
Oklahoma
Chairman, Integra Realty Resources, Westwood, Kansas

2007
2008
2009

296 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Class C
Terry L. Moore
Lu M. Cordova

Robert A. Funk

Titlp
1 IllC

Term expires
Dec. 31

President, Omaha Federation of Labor, Omaha,
Nebraska
Chief Executive Officer, Corlund Industries, LLC;
President and General Manager, Almacen Storage
Group, Boulder, Colorado
Chairman and Chief Executive Officer, Express
Personnel Services, Oklahoma City, Oklahoma

2007

President and Chief Executive Officer, First State
Bancorporation, Albuquerque, New Mexico
President and Chief Executive Officer, Vectra Bank
Colorado, Denver, Colorado
President, Pearson Real Estate Co., Inc., Buffalo,
Wyoming

2007

2008

2009

DENVER BRANCH

Appointed by the
Federal Reserve Bank
Michael R. Stanford
Bruce K. Alexander
John D. Pearson

Diane Leavesley
Thomas Williams

2009
2009

Vacancy
Appointed by the
Board of Governors
Kristy A. Schloss

2008

President and Chief Executive Officer, Schloss
Engineered Equipment, Inc., Aurora, Colorado
President, Mercy Loan Fund, Denver, Colorado
President and Chief Executive Officer, Williams Group
LLC, Golden, Colorado

2007

Chairman of the Board, FirstBank, Antlers, Oklahoma
President, Oklahoma Community Capital Corporation,
Broken Arrow, Oklahoma
President, RGF, Inc., Oklahoma City, Oklahoma
Board Vice-Chairman, President and Chief Operating
Officer, LSB Industries, Inc., Oklahoma City,
Oklahoma

2007
2007

President, Agee Energy, LLC, Oklahoma City,
Oklahoma

2007

2008
2009

OKLAHOMA CITY BRANCH

Appointed by the
Federal Reserve Bank
Steve Burrage
Terry M. Almon
Fred M. Ramos
Barry H. Golsen

Appointed by the
Board of Governors
Steven C. Agee
Vacancy
Richard K. Ratcliffe

Chairman, Ratcliffe's Inc., Weatherford, Oklahoma

2008
2009

Federal Reserve System Organization 297

BANK or BRANCH, Categoiy

Name

Title

Term expires
Dec. 31

OMAHA BRANCH

Appointed by the
Federal Reserve Bank
Cynthia Hardin Milligan ... Dean-College of Business Administration, University of
Nebraska-Lincoln, Lincoln, Nebraska
President and Chief Executive Officer, Platte Valley
Mark A. Sutko
State Bank, Kearney, Nebraska
President and Chief Executive Officer, AmeriSphere
Rodrigo Lopez
Multifamily Finance, L.L.C., Omaha, Nebraska
Chief Executive Officer and Trust Officer, Adams Bank
Todd S. Adams
& Trust, Ogallala, Nebraska
Appointed by the
Board of Governors
Lyn Wallin Ziegenbein
James A. Timmerman
Charles R. Hermes

Executive Director, Peter Kiewit Foundation, Omaha,
Nebraska
Chief Financial Officer, Timmerman and Sons Feeding
Company, Springfield, Nebraska
President, Dutton-Lainson Company, Hastings,
Nebraska

2007
2008
2009
2009

2007
2008
2009

DISTRICT 11—DALLAS
RESERVE BANK

Class A
David S. Barnard
Richard W. Evans, Jr
Pete Cook
Class B
Robert A. Estrada
James B. Bexley
Margaret H. Jordan
Class C
Herb Kelleher
James T. Hackett
Anthony R. Chase

Chairman and Chief Executive Officer, The National
Banks of Central Texas, Gatesville, Texas
Chairman and Chief Executive Officer, Cullen/Frost
Bankers, Inc., San Antonio, Texas
President and Chief Executive Officer, First National
Bank of Alamogordo, Alamogordo, New Mexico

2007

Chairman, Estrada Hinojosa & Company, Inc., Dallas,
Texas
Professor, Finance, Sam Houston State University,
Huntsville, Texas
President and Chief Executive Officer, Dallas Medical
Resource, Dallas, Texas

2007

Executive Chairman, Southwest Airlines, Dallas, Texas
Chairman, President, and Chief Executive Officer,
Anadarko Petroleum Corporation, Houston, Texas
Chairman and Chief Executive Officer, ChaseSource,
L.P., Houston, Texas

2007
2008

Regional President, State National Bank, El Paso, Texas

2007

2008
2009

2009

EL PASO BRANCH

Appointed by the
Federal Reserve Bank
F. James Volk

298 94th Annual Report 2007

Directors—Continued
BANK or BRANCH, Category

Name
D. Kirk Edwards
Fred J. Loya
Gerald J. Rubin
Appointed by the
Board of Governors
Cecilia Ochoa Levine
Ron C. Helm
William V. Flores

Titlp

1 lllc

Term expires
Dec. 31

President, MacLondon Royalty Company, Odessa,
Texas
Chairman, Fred Loya Insurance, El Paso, Texas
Chairman, President, and Chief Executive Officer, Helen
of Troy Limited, El Paso, Texas

2008

President, MFI International Mfg., LLC, El Paso, Texas
Owner, Helm Land and Cattle Company, Van Horn,
Texas
Deputy Secretary, New Mexico Higher Education
Department, Santa Fe, New Mexico

2007
2008

Managing Director, RBC Capital Markets, Houston,
Texas
Chairman, President, and Chief Executive Officer, DX
Service Company, Inc., Houston, Texas
President and Chief Executive Officer, Baylor College
of Medicine, Houston, Texas
Chairman and Chief Executive Officer, The First
National Bank of Bryan, Bryan, Texas

2007

President and Chief Executive Officer, El Paso
Corporation, Houston, Texas
Chairman and Chief Executive Officer, Tejas Office
Products, Inc., Houston, Texas
President, Apex Enterprises, Inc., Houston, Texas

2007

Owner, Gur Parsaad Properties, Ltd., San Antonio,
Texas
Chairman and Chief Executive Officer, U.S. Packers &
Processors, Harlingen, Texas
President, Southern Distributing, Laredo, Texas
Founder and President, SRV Holdings, Austin, Texas

2007

President, The University of Texas at San Antonio, San
Antonio, Texas
Chairman and Chief Executive Officer, Richter
Architects, Corpus Christi, Texas
President, Southwest Research Institute, San Antonio,
Texas

2007

2008
2009

2009

HOUSTON BRANCH

Appointed by the
Federal Reserve Bank
Jodie L. Jiles
S. Reed Morian
Peter G. Traber, M.D.
Timothy N. Bryan
Appointed by the
Board of Governors
Douglas L. Foshee
Lupe Fraga
Nancy T. Chang

2008
2008
2009

2008
2009

SAN ANTONIO BRANCH

Appointed by the
Federal Reserve Bank
G.P.Singh
Matt F. Gorges
Guillermo F. Trevino
Steven R. Vandegrift
Appointed by the
Board of Governors
Ricardo Romo
Elizabeth Chu Richter
J. Dan Bates

2008
2008
2009

2008
2009

Federal Reserve System Organization 299

BANK or BRANCH, Category

Name

Titlp
1 Hit;

Term expires
Dec. 31

DISTRICT 12—SAN FRANCISCO
RESERVE BANK

Class A
Richard W. Decker, Jr
Candace H. Wiest
Kenneth P. Wilcox
Class B
Jack McNally
Karla S. Chambers .
Blake W. Nordstrom
Class C
David K.Y. Tang
Douglas W. Shorenstein
T. Gary Rogers

Chairman and Co-Founder, Belvedere Capital Partners
LLC, San Francisco, California
President and Chief Executive Officer, West Valley
National Bank, Avondale, Arizona
President and Chief Executive Officer, S VB Financial
Group and Silicon Valley Bank, Santa Clara,
California

2007

Principal, JKM Consulting, Sacramento, California
Vice President and Co-Owner, Stahlbush Island Farms,
Inc., Corvallis, Oregon
President, Nordstrom, Inc., Seattle, Washington

2007
2008

Managing Partner, Asia, K&L Gates, Seattle,
Washington
Chairman and Chief Executive Officer, Shorenstein
Properties LLC, San Francisco, California
Retired Chairman and Chief Executive Officer, Dreyer's
Grand Ice Cream, Inc., Oakland, California

2007

Chairman, President, and Chief Executive Officer, East
West Bank, Pasadena, California
Managing Partner, Thomas & Mack Co., Las Vegas,
Nevada

2007

2008
2009

2009

2008
2009

Los ANGELES BRANCH

Appointed by the
Federal Reserve Bank
Dominic Ng
Peter M. Thomas
Vacancy
Andrew J. Sale
Appointed by the
Board of Governors
James L. Sanford
Ann E. Sewill
Anita Santiago

Partner, Media and Entertainment Leader - Pacific
Southwest Area, Ernst & Young LLP, Los Angeles,
California

2008
2009
2009

Corporate Vice President, Northrop Grumman
Corporation, Los Angeles, California
President, Community Foundation Land Trust,
California Community Foundation, Los Angeles,
California
Chief Executive Officer, Anita Santiago Advertising,
Santa Monica, California

2007

Regional President, Wells Fargo Bank, Portland, Oregon
President, Don Pancho Authentic Mexican Foods, Inc.,
Salem, Oregon

2007
2008

2008
2009

PORTLAND BRANCH

Appointed by the
Federal Reserve Bank
Alan V. Johnson
George J. Puentes

300 94th Annual Report, 2007

Directors—Continued
BANK or BRANCH, Category

Name
Peggy Y. Fowler

Titlp
1 Hie

Term expires
Dec. 31

Chief Executive Officer and President, Portland General
Electric, Portland, Oregon
President and Chief Executive Officer, West Coast
Bancorp, Lake Oswego, Oregon

2008

Chief Executive Officer and Principal, Ferguson
Wellman Capital Management, Inc., Portland, Oregon
William D. Thorndike, Jr. .. Chairman and President, Medford Fabrication, Medford,
Oregon
David Y. Chen
Managing Director, Equilibrium Capital Group LLC,
Portland, Oregon

2007

Robert D. Sznewajs
Appointed by the
Board of Governors
James H. Rudd

2009

2008
2009

SALT LAKE CITY BRANCH

Appointed by the
Federal Reserve Bank
Michael M. Mooney
A. Scott Anderson
Deborah S. Bayle
Scott L. Hymas
Appointed by the
Board of Governors
Gary L. Crocker
Clark D. Ivory
Edwin E. Dahlberg

President, Idaho Region, Bank of the Cascades, Boise,
Idaho
President and Chief Executive Officer, Zions Bank, Salt
Lake City, Utah
President and Chief Executive Officer, United Way of
Salt Lake, Salt Lake City, Utah
Chief Executive Officer, RC Willey, Salt Lake City,
Utah

2007

Chairman of the Board, Merrimack Pharmaceuticals,
Inc., Salt Lake City, Utah
Chief Executive Officer, Ivory Homes, Ltd., Salt Lake
City, Utah
President and Chief Executive Officer, St. Luke's Healthi
System, Boise, Idaho

2007

2008
2008
2009

2008
2009

SEATTLE BRANCH

Appointed by the
Federal Reserve Bank
Vacancy
Kenneth M. Kirkpatrick .... President, Washington State, U.S. Bank, Seattle,
Washington
H. Stewart Parker
President and Chief Executive Officer, Targeted
Genetics Corporation, Seattle, Washington
President and Chief Executive Officer, Cascade
Carol K. Nelson
Financial Corporation, Everett, Washington
Appointed by the
Board of Governors
Mic R. Dinsmore
James R. Gill
Helvi K. Sandvik

President, Infrastructure Investment Division, Stark
Investments, Seattle, Washington
President, Pacific Northwest Title Holding Company,
Seattle, Washington
President, NANA Development Corporation,
Anchorage, Alaska

2007
2008
2008
2009

2007
2008
2009

Members of the Board of Governors, 1913-2007 301

Members of the Board of Governors, 1913-2007
Appointed Members
Federal Reserve
District

Date initially took
oath of office

Charles S. Hamlin

Boston

Aug. 10, 1914

Paul M. Warburg
Frederic A. Delano
W.P.G. Harding
Adolph C. Miller

New York
Chicago
Atlanta
San Francisco

Aug.
Aug.
Aug.
Aug.

Albert Strauss
Henry A. Moehlenpah
Edmund Platt

New York
Chicago
New York

Oct. 26, 1918
Nov. 10, 1919
June 8, 1920

David C. Wills
John R. Mitchell
Milo D. Campbell
Daniel R. Crissinger
George R. James

Cleveland
Minneapolis
Chicago
Cleveland
St. Louis

Sept. 29, 1920
May 12, 1921
Mar. 14, 1923
May 1, 1923
May 14, 1923

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

May 14, 1923
Oct. 4, 1927
Sept. 16, 1930
May 18, 1931
May 19, 1933
June 14, 1933

J.J. Thomas
Marriner S. Eccles

Kansas City
San Francisco

June 14, 1933
Nov. 15, 1934

Joseph A. Broderick
John K. McKee
Ronald Ransom
Ralph W. Morrison
Chester C. Davis

New York
Cleveland
Atlanta
Dallas
Richmond

Feb.3,1936
Feb. 3, 1936
Feb. 3,1936
Feb. 10, 1936
June 25, 1936

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

Mar. 30, 1938
Mar. 14, 1942
Apr. 4, 1946
Feb. 14, 1947
Apr. 15, 1948
Sept. 1, 1950
Sept. 1, 1950
Apr. 2, 1951

A.L. Mills, Jr.

San Francisco

Feb. 18, 1952

J.L. Robertson

Kansas City

Feb. 18, 1952

C. Canby Balderston
Paul E. Miller

Philadelphia
Minneapolis

Aug. 12, 1954
Aug. 13, 1954

Name

10, 1914
10, 1914
10, 1914
10, 1914

Other datesl

Reappointed in 1916 and 1926. Served
until Feb. 3, 1936.2
Term expired Aug. 9, 1918.
Resigned July 21, 1918.
Term expired Aug. 9, 1922.
Reappointed in 1924. Reappointed in 1934
from the Richmond District. Served until
Feb. 3, 1936.2
Resigned Mar. 15, 1920.
Term expired Aug. 9, 1920.
Reappointed in 1928. Resigned Sept. 14,
1930.
Term expired Mar. 4, 1921.
Resigned May 12, 1923.
Died Mar. 22, 1923.
Resigned Sept. 15, 1927.
Reappointed in 1931. Served until Feb. 3,
1936.3
Died Nov. 28, 1930.
Resigned Aug. 31, 1930.
Resigned May 10, 1933.
Term expired Jan. 24, 1933.
Resigned Aug. 15, 1934.
Reappointed in 1936 and 1948. Resigned
May 31, 1961.
Served until Feb. 10, 1936.2
Reappointed in 1936, 1940, and 1944.
Resigned July 14, 1951.
Resigned Sept. 30, 1937.
Served until Apr. 4, 1946.2
Reappointed in 1942. Died Dec. 2, 1947.
Resigned July 9, 1936.
Reappointed in 1940. Resigned Apr. 15,
1941.
Served until Sept. 1, 1950.2
Served until Aug. 13, 1954.2
Resigned Nov. 30, 1958.
Died Dec. 4, 1949.
Resigned Mar. 31, 1951.
Resigned Jan. 31, 1952.
Resigned June 30, 1952.
Reappointed in 1956. Term expired
Jan. 31, 1970.
Reappointed in 1958. Resigned Feb. 28,
1965.
Reappointed in 1964. Resigned Apr. 30,
1973.
Served through Feb. 28, 1966.
Died Oct. 21, 1954.

302 94th Annual Report, 2007

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
Ben. S. Bernanke
Kevin M. Warsh
Randall S. Kroszner
Frederic S. Mishkin

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
Atlanta
New York
Richmond
Boston

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.
Resigned June 1, 1975.
Jan. 4, 1972
Resigned Jan. 2, 1976.
June 5, 1972
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.
Served until Feb. 7, 1986.2
Jan. 5, 1976
Feb. 13, 1976 Died Nov. 19, 1978.
Resigned Feb. 24, 1978.
June 1, 1976
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 Aug. 11, 1987.
May 28, 1980 Resigned Sept. 1, 1985.
Mar. 31, 1982 Resigned Apr. 30, 1986.
July 2, 1984
Resigned Mar. 11, 1991.
Served through Feb. 9, 1994.
Feb. 7, 1986
Resigned Aug. 3, 1990.
Feb. 7, 1986
Aug. 19, 1986 Resigned July 31, 1989.
May 26, 1987 Resigned Dec. 31,2001.
Aug. 11, 1987 Resigned Jan. 31,2006.
Aug. 15, 1988 Resigned Apr. 30, 1995.
May 21, 1990 Resigned Feb. 14, 1994.
Nov. 26, 1991 Resigned Feb. 5, 1997.
Served through June 30, 1998.
Dec. 2, 1991
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 Resigned Apr. 28, 2006.
Nov. 5, 1997 Resigned Aug. 31,2005.
Resigned Mar. 30, 2007
Dec. 7, 2001
Dec. 7, 2001 Resigned June 20, 2006.
Resigned June 21, 2005.
Aug. 5, 2002
Aug. 5, 2002
Feb. 1,2006
Feb. 24, 2006
Mar. 1,2006
Sept. 5, 2006

Name

Other dates1

Members of the Board of Governors, 1913-2007

303

Appointed Members—Continued
Name

Term

Chairmen3
Charles S. Hamlin
W.P.G. 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
Ben Bernanke

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-Jan. 31, 20065
Feb. 1,2006-

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.
Donald L. Kohn

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-Apr. 28, 2006
June 23, 2006-

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 Feb. 3,
1948, to Apr. 15, 1948.
5. Served as Chairman Pro Tempore from Mar. 3,
1996, to June 20, 1996.

304 94th Annual Report, 2007
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

306

94th Annual Report, 2007

1. Federal Reserve Open Market Transactions, 2007
Millions of dollars
Type of security and transaction

Apr.

U.S. TREASURY SECURITIES1

0
0
66,169
66,169
0

0
0
70,706
70,706
0

0
0
88,466
88,466
0

0
0
76,560
76,560
0

Others within 1 year
Gross purchases ..
Gross sales
Maturity shifts . . .
Exchanges
Redemptions

ooooo

817
0
0
0
0

ooooo

1,394
0
0
0
0

1 to 5 years
Gross purchases .
Gross sales
Maturity shifts ..
Exchanges

oooo

1,061
0
0
0

oooo

3,742
0
0
0

5 to 10 years
Gross purchases
Gross sales
Maturity shifts
Exchanges

oooo

290
0
0
0

More than 10 years
Gross purchases .
Gross sales
Maturity shifts ..
Exchanges

oooo

640
0
0
0

All maturities
Gross purchases . . .
Gross sales
Redemptions

ooo

1,878
0
0

ooo

Outright transactions 2
Treasury bills
Gross purchases
Gross sales
Exchanges
For new bills
Redemptions

6,066
0
0

Net change in U.S. Treasury securities
For notes see end of table.

1,878

6,066

Statistical Tables 307
1.—Continued

0
0
75,502
75,502
10,000

0
0
62,083
62,083
0

0
0
62,143
62,143
0

0
0
83,590
83,590
0

0
0
24,580
24,580
39,178

0
0
839,687
839,687
49,178

0
0
39,178

10,680
0
50,414

-39,178

-39,734

oooo
oooo

ooooo
oooo
oooo

ooooo
oooo
oooo
ooo

ooooo

oooo

-11,236

oooo

oooo
ooo

ooo

ooooo
oooo

oooo
oooo

ooooo
oooo
oooo

oooo

0
0
11,236

oooo

2,736

7,539
0
0
0

oooo

ooo

oooo

2,736
0
0

2,211
0
0
0
1,236

oooo

2,736
0
0
0

Total

oooo

0
0
0
0
1,236

Dec.

ooo

ooooo

0
0
72,690
72,690
0

Nov.

oooo

0
0
62,340
62,340
0

Oct.

oooo

0
0
94,858
94,858
0

Sept.

Aug.

ooooo

July

oooo

June

oooo

May

308 94th Annual Report, 2007
1. Federal Reserve Open Market Transactions, 2007—Continued
Millions of dollars
Type of security and transaction

Jan.

Feb.

Mar.

Apr.

FEDERAL AGENCY OBLIGATIONS

Outright transactions 2
Gross purchases
Gross sales
Redemptions

0
0
0

Repurchase agreements3
Gross purchases
Gross sales

176,000
184,750

193,750
180,500

228,250
240,250

179,500
161,250

Reverse repurchase agreements 4
Gross purchases
Gross sales

630,544
633,309

696,788
704,054

843,250
840,887

739,145
739,251

-11,515

5,984

-9,637

18,143

-11,515

7,862

-9,637

24,209

Net change in federal agency obligations
TEMPORARY TRANSACTIONS

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. Transactions exclude changes in compensation for
the effects of inflation on the principal of inflationindexed securities. Transactions include the rollover of
inflation compensation into new securities.

2. Excludes the effect of temporary transactions—
repurchase agreements, matched sale-purchase agreements (MSPs), and reverse repurchase agreements
(RRPs).
3. Cash value of agreements, which are collateralized
by U.S. government and federal agency securities.
4. Cash value of agreements, which are collateralized
by U.S. Treasury securities.

Statistical Tables 309
1.—Continued

May

July

June

0
0

Sept.

Aug.

Oct.

Nov.

Dec.

Total

0
0
0

174,250
190,000

177,750
188,250

185,000
180,000

209,000
200,750

236,500
230,250

268,750
265,000

318,750
319,750

249,250
250,250

2,596,750
2,591,000

752,100
749,528

672,056
669,588

673,157
673,778

722,358
725,162

669,935
669,850

786,360
788,726

715,682
713,543

761,133
769,202

8,662,508
8,676,878

-13,178

-8,032

4,379

5,446

6,334

1,385

1,139

-9.070

-8,622

-10,442

-8,032

4,379

-5,791

6,334

1,385

1,139

-48,248

-48357

310

94th Annual Report, 2007

2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities,
December 31, 2005-2007
Millions of dollars
December 31

Change

Description
2007

2006

2005

2006 to
2007

2005 to
2006

740,611

778,915

744,215

-38,304

34,700

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

153,829
74,012

193,034
83,985

187,370
83,900

-39,205
-9,973

5,664
85

101,447
240,562
81,947
88,814

129,594
224,177
67,645
80,479

128,287
210,745
56,699
77,215

-28,147
16,385
14,302
8,335

1,307
13,432
10,946
3,264

By type
Bills
Notes
Bonds

227,841
401,776
110,995

277,019
402,367
99,528

271,270
380,118
92,827

-49,178
-591
11,467

5,749
22,249
6,701

FEDERAL AGENCY SECURITIES

Held outrightl
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

0
0
0

46,500

40,750

46,750

5,750

-6,000

Matched sale-purchase agreements
Foreign official and international accounts
Dealers

0
0
0

Reverse repurchase agreements3
Foreign official and international accounts
Dealers

43,985
43,985
0

29,615
29,615
0

30,505
30,505
0

14,370
14,370
0

-890
-890
0

0
0
0

By issuer
Federal National Mortgage Association
TEMPORARY TRANSACTIONS

Repurchase agreements2

NOTE: Components may not sum to totals because of
rounding.
1. Excludes the effect of temporary transactions—
repurchase agreements, matched sale-purchase agreements (MSPs), and reverse repurchase agreements
(RRPs).

2. Cash value of agreements, which are collateralized
by U.S. government and federal agency securities.
3. Cash value of agreements, which are collateralized
by U.S. Treasury securities.

Statistical Tables 31
3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions,
December 31, 2007
Reserve Bank
All Federal Reserve Banks

Primary credit1

Secondary credit2

Seasonal credit3

4.75

5.25

4.70

NOTE: For details on rate changes over the course of
2007, see the section on discount rates in the chapter
"Record of Policy Actions of the Board of Governors."
1. Primary credit is generally available for very short
terms as a backup source of liquidity to depository institutions that are in generally sound financial condition in the
judgment of the lending Federal Reserve Bank.
2. Secondary credit is available in appropriate circumstances to depository institutions that do not qualify for
primary credit.

3. Seasonal credit is available to help relatively small
depository institutions meet regular seasonal needs for
funds that arise from a clear pattern of intra-yearly movements in their deposits and loans. The discount rate on
seasonal credit takes into account rates charged by market
sources of funds and is reestablished on the first business
day of each two-week reserve maintenance period.

312

94th Annual Report, 2007

4. Reserve Requirements of Depository Institutions, December 31, 2007

Requirements
Type of deposit
Percentage of deposits

Effective date

0
3
10

12-20-07
12-20-07
12-20-07

Nonpersonal time deposits

12-27-90

Eurocurrency liabilities

12-27-90

Net transaction accounts1
$0 million-$9.3 million2
More than $9.3 million-$43.9 million3
More than $43.9 million

NOTE: Required reserves must be held in the form of
vault cash and, if vault cash is insufficient, also in the
form of a deposit with a Federal Reserve Bank. An institution that is a member of the Federal Reserve System
must hold that deposit directly with a Reserve Bank; an
institution that is not a member of the System can maintain that deposit directly with a Reserve Bank or with
another institution in a pass-through relationship. Reserve
requirements are imposed on commercial banks, savings
banks, savings and loan associations, credit unions, U.S.
branches and agencies of foreign banks, Edge corporations, and agreement corporations.
1. Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts, NOW
accounts, share draft accounts, telephone or preauthorized
transfer accounts, ineligible banker's acceptances, and
affiliate-issued obligations maturing in seven days or less.
Net transaction accounts are total transaction accounts
less amounts due from other depository institutions and
less cash items in the process of collection.

For a more detailed description of these deposit types,
see Form FR 2900 at www.federalreserve.gov/boarddocs/
reportforms/.
2. The amount of net transaction accounts subject to a
reserve requirement ratio of 0 percent (the "exemption
amount") is adjusted each year by statute. The exemption
amount is adjusted upward by 80 percent of the previous
year's (June 30 to June 30) rate of increase in total reservable liabilities at all depository institutions. No adjustment is made in the event of a decrease in such liabilities.
3. The amount of net transaction accounts subject to a
reserve requirement ratio of 3 percent is the "low reserve
tranche." By statute, the upper limit of the low reserve
tranche is adjusted each year by 80 percent of the previous year's (June 30 to June 30) rate of increase or
decrease in net transaction accounts held by all depository
institutions.

Statistical Tables 313
5. Banking Offices and Banks Affiliated with Bank Holding Companies in the United
States, December 31, 2006 and 2007
Commercial banks !
Type of office

Member

Total

Nonmember

Total
Total

National

Statechartered
savings
banks

State

All banking offices
BANKS

Number, Dec. 31, 2006

7,731

Changes during 2007
New banks
Banks converted
into branches
Ceased banking
operation"
Other^
Net change
Number, Dec. 31, 2007

7^67

2,592

1,695

897

4,775

364

181

173

133

-272

-268

-115

-79

-36

-153

-4

-39
0
-130

-31
0
-126

-13
-15
-103

-8
-20
-80

-5
5
-23

-18
15
-23

-8
0
-4

7,601

7,241

2,489

1,615

874

4,752

360

80,872

77,792

55,099

40,760

14^39

22,693

3,080

BRANCHES AND
ADDITIONAL OFFICES

Number, Dec. 31, 2006
Changes during 2007
New branches
Branches converted
from banks
Discontinued2
Other3
Net Change

3,258

3,088

1,966

1,474

492

1,122

170

272
-3,338
0
192

258
-3,275
84
155

133
-2,662
1,067
504

91
-2,152
1,157
570

42
-510
-90
-66

125
-613
-983
-349

-63
-84
37

Number, Dec. 31, 2007

81,064

77,947

55,603

41330

14,273

22344

3,117

Banks affiliated with bank holding companies
BANKS

Number, Dec. 31, 2006

6,187

6,062

2,274

1,477

797

3,788

125

Changes during 2007
BHC-affiliated
new banks
Banks converted
into branches
Ceased banking
operation"
Other
Net Change

190

180

126

-224

-220

-96

-65

-31

-124

-4

-35
0
-69

-29
0
-69

-13
-16
-71

-8
-16
-51

-5
0
-20

-16
16
2

-6
0
0

Number, Dec. 31, 2007

6,118

5,993

2,203

1,426

777

3,790

125

NOTE: Includes banking offices and BHCs in U.S. territories and possessions.
1. For purposes of this table, banks are entities that are
defined as banks in the Bank Holding Company Act, as
amended, which is implemented by 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.

314 94th Annual Report, 2007
6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1984-2007 and Month-End 2007
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
Securities
held
outright1

Repurchase
agreements2

Loans

Gold
stock

Special
drawing
rights
certificate
account

Treasury
currency
outstanding 3

Other
Federal
Reserve
assets

Total

833

12,347

186,384

11,096

4,618

16,418

Float

1984

167,612

2,015

3,577

1985
1986
1987
1988
1989

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

988
1,261
811
1,286
1.093

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

1990
1991
1992
1993
1994

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

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

20,402
21,014
21,447
22,095
22,994

1995
1996
1997
1998
1999

380,831
393,132
431,420
452,478
478,144

13,862
21,583
23,840
30,376
140,640

135
85
2,035
17
233

231
5,297
561
1,009
407

33,483
32,222
32,044
37,692
34,799

428,543
452,319
489,901
521,573
654,223

11,050
11,048
11,047
11,046
11,048

10,168
9,718
9,200
9,200
6,200

24,003
24,966
25,543
26,270
28,013

2000
2001
2002
2003
2004

511,833
551,685
629,416
666,665
717,819

43,375
50,250
39,500
43,750
33,000

110
34
40
62
43

795
698
832
211
927

36,896
36,885
38,574
40,214
42,161

593,009
639,552
708,363
750,901
793,950

11,046
11,045
11,043
11,043
11,045

2,200
2,200
2,200
2,200
2,200

31,643
33,017
34,597
35,468r
36,434

2005
2006
2007

744,215
778,915
740,611

46,750
40,750
46,500

72
67
48,636

891
-326
-8

39,319
39,885
66,308

831,247
859,290
902,048

11,043
11,041
11,041

2,200
2,200
2,200

36,540
38,206r
38,681

For notes see end of table.

Statistical Tables 315
6 A.—Continued

Factors absorbing reserve funds

Currency
in
circulation

Reverse
repurchase
agreements4

Treasury
cash
holdings5

Deposits with Federal Reserve Banks,
other than reserve balances

Treasury

Foreign

Required
clearing
balances

Other

Other
Federal
Reserve
liabilities
and
capital

Reserve
balances
with
Federal
Reserve
Banks 6

513

5,316

253

867

1,126

5,952

20,693

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

1,041

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

286,963
307,756
334,701
365,271
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

1,960
3,946
5,897
6,332
4,196

8,147
8,113
7,984
9,292
11,959

36,698
25,467
26,182
28,619
26,593

424,244
450,648
482,327
517,484
628,359

0
0
0
0
0

270
249
225
85
109

5,979
7,742
5,444
6,086
28,402

386
167
457
167
71

5,167
6,601
6,679
6,781
7,482

12,342
13,829
15,500
16,354
17,256

24,444
17,923
24,159
19,525
16,545

593,694
643,301
687,518
724.187
754,877

0
0

450
425
367
321
270

5,149
6,645
4,420
5,723
5,912

216
61
136
162
80

1,382

21,091
25,652
30,783

6,332
8,525
10,534
11,829
9,963

17,962
17,083
18,977
19,793
26,378

12,713
8,953
12,007
11,229
14,080

794,014
820.1761
828.938

30,505
29,615
43,985

202
252
259

4,573
4,708
16,120

83
98
96

2,144

8,650'
6,842
6,615

30,466
36,231
41.975

10,393
11.857
14,152

183,796

917
1,027

548
1,298

242
1,706

372
397
876
932
892
900
1,605
1,261

820
1,152

717
1,285

958
1,830

316 94th Annual Report, 2007
6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1984-2007 and Month-End 2007—Continued
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Gold
stock

Special
drawing
rights
certificate
account

Treasury
currency
outstanding 3

11,041
11,041
11,041
11,041
11,041
11,041
11,041
11.041
11,041
11,041
11,041
11,041

2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2,200
2.200
2,200

38,254
38,305
38,371
38,414
38,462
38,521
38,541
38,595
38,639
38,695
38,765
38,681

Period
Securities
held
outright1

2007
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec

Repurchase
agreements2

778,863
780,793
780,901
787,188
790,272
790,522
790,800
779,642
779,632
779,586
779,701
740,611

32,000
45,250
33,250
51,500
35,750
25,250
30,250
38,500
44,750
48,500
47,500
46.500

Loans

1,326

22
27
70
115
204
247

Float

-1,482
-1,012
-869

102

202
92
33

-622
-1,273
-1,164
-714
-729
-745
-814

48,636

-8

1,342

Other
Federal
Reserve
assets

Total

40,335
37,940
40,048
40,986
38,759
40,610
41,471
38,905
41,355
42,054
40,545
66,308

851,042
862,993
853,357
879.846
864,274
855,313
861,604
857,674
865,210
869,487
866,965
902,048

Statistical Tables 317
6 A.—Continued

Factors absorbing reserve funds

Currency
in
circulation

Reverse
repurchase
agreements4

Treasury
cash
holdings5

Deposits with Federal Reserve Banks,
other than reserve balances

Treasury

802,599
808,078
805,586
806,998
814,007
812,794
813.387
815,020
810,607
815,303
817,259
828,938

32,379
39,645
37,283
37,389
34,817
32,349
32,970
35,774
35,689
38,055
35,916
43,985

175
204
301
299
286
306
300
329
336
301
266
259

Foreign

90
91
91
95
93
197
94
94
112
601
97
96

285
274
224
316
256
210
305
330
245
287
285
1,830

NOTE: Components may not sum to totals because of
rounding.
1. Includes U.S. Treasury and federal agency securities. U.S. Treasury securities include securities lent to
dealers, which are fully collateralized by other U.S. Treasury securities. Federal agency securities are included at
face value.
2. Cash value of agreements, which are collateralized
by U.S. Treasury and federal agency securities.
3. Includes currency and coin (other than gold) issued
directly by the Treasury. The largest components are

6,836
6,738
6,990
6,508
6,580
6,395
6,466
6,613
6,469
6,586
6,486
6,615

36,727
38,147
38,912
39,069
39.275
39,277
39.667
40,612
41,548
41,849
42,571
41,975

Other

6,053
5,194
4,245
29,504
5,340
4,649
5,126
4,579
5,539
4,307
4,669
16,120

Required
clearing
balances

Other
Federal
Reserve
liabilities
and
capital

Reserve
balances
with
Federal
Reserve
Banks6

17,392
16,168
11,338
11,322
15,322
10,898
15,071
6,158
16,545
14.134
11,421
14,152

fractional and dollar coins. For details see "U.S. Currency
and Coin Outstanding and in Circulation," Treasury Bulletin.
4. Cash value of agreements, which are collateralized
by U.S. Treasury securities.
5. Coin and paper currency held by the Treasury, as
well as any gold in excess of the gold certificates issued
to the Reserve Bank.
6. Excludes required clearing balances and adjustments to compensate for float.
r Revised.

318

94th Annual Report, 2007

6B. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1918-1983
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
Securities
held
outright1

Repurchase
agreements 2

Loans

Float3

All
other4

Other
Federal
Reserve
assets5

Gold
stock 6
Total

Special
drawing
rights
certificate
account

Treasury
currency
outstanding 7

1918
1919

239
300

0
0

1,766
2,215

199
201

294
575

0
0

2,498
3,292

2,873
2,707

1,795
1,707

1920
1921
1922
1923
1924

287
234
436
80
536

0
0
0
54
4

2,687
1,144

119
40
78
27
52

262
146
273
355
390

0
0
0
0
0

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

1925
1926
1927
1928
1929

367
312
560
197
488

8
3
57
31
23

643
637
582

63
45
63
24
34

378
384
393
500
405

0
0
0
0
0

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

1930
1931
1932
1933
1934

686
775

43
42
4
2
0

251
638

1,851
2,435
2,430

372
378
41
137
21

0
0
0

98
7

21
20
14
15
5

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

1935
1936
1937
1938
1939

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

1940
1941
1942
1943
1944

2,184
2,254
6,189
11,543
18,846

0
0
0
0
0

3
3
6
5
80

80
94
471
681
815

8
10
14
10
4

0
0
0
0
0

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

0
0
0
0
0

249
163
85
223
78

578
580
535
541
534

2
1
1
1
2

0
0
0
0
0

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

20,725
23,605
24.034
25,318
24,888

53
196
663
598
44

67
19
156
28
143

1,368
1,184

967
935
808

3
5
4
2
1

0
0
0
0
0

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

24,391
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

0
0
0
0
0

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.

618
723
320

1,056

632

235

Statistical Tables 319
6B.—Continued

Factors absorbing reserve funds

Currency
in
circulation

Deposits with
Federal Reserve Banks,
other than reserve balances
Treasury
cash
holdings8
Treasury

Foreign

Member bank
reserves9
Other
Required
Federal
clearing
Reserve
5 balances
accounts

Other

Other
Federal
Reserve
liabilities
and
capital5

With
Federal
Reserve
Banks

Currency
and
coin10

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

-AA
-56
63
-41
-73

2 All
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

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

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
111
839
907

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

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

288
385

51
51

96
73

25
28

118
208

0
0

1,636
1,890

0
0

5,325
4,403
4,530
4,757
4,760

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

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

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

2,212
2,194
2,487
2,389
2,355

4.603
5,360
5,388
5,519
5,536

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

5,882
6,543
6,550
6,856
7,598

2,566
2,376
3,619
2.706
2,409

544
244
142
923
634

29
99

226
160
235
242
256

253
261
263
260
251

0
0
0
0
0

8,732
11,160
15.410
20,499
25,307

2,213
2.215
2,193
2.303
2,375

368
867
799
579
440

1,133

1,360
1,204

599
586
485
356
394

284
291
256
339
402

28,515
28,952
28,868
28,224
27.600

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

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

767
775
761
683
391

394
441
481
358
504

402
322
356
111
345

172

774
793

1.123

Excess 11 - 12

1,585
1,822

4,951
5,091

199
397

Required11

1,122

841

1,654

562
1,499
1,202
1,018

389
-570

763
258

-135

320

94th Annual Report, 2007

6B. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items,
Year-End 1918-1983—Continued
Millions of dollars
Factors supplying reserve funds
Federal Reserve Bank credit outstanding
Period
Gold
stock 6

Special
drawing
rights
certificate
account

Treasury
currency
outstanding 7

Securities
held
outright1

Repurchase
agreements 2

Loans

Float 3

All
other4

Other
Federal
Reserve
assets 5

1960
1961
1962
1963
1964

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

1965
1966
1967
1968
1969

40,478
43,655
48,980
52,937
57,154

290
661
170
0
0

137
173
141
186
183

2,248
2,495
2,576
3,443
3,440

187
193
164
58
64

0
0
0
0
2,743

43,340
47,177
52,031
56,624
64,584

13,733
13,159
11,982
10.367
10,367

5,575
6,317
6,784
6,795
6,852

1970
1971
1972
1973
1974

62,142
69,481
71,119
80,395
84,760

335
39

4,261
4,343
3,974
3,099
2,001

57
261
106
68
999

1,123
1,068
1,260
1,152
3,195

67,918
76,515
78,551
86,072
92,208

10,732
10,132
10,410
11,567
11,652

400
400
400
400
400

7,147
7,710
8.313
8.716
9,253

1975
1976
1977
1978
1979

3,688
2,601
3,810
6,432
6,767

1.126

3,312
3,182
2,442
4,543
5,613

102,461
110,892
118,745
131,327
140,705

11,599
11,598
11,718
11,671
11,172

500
1,200
1,250
1,300
1,800

10,218
10,810
11,331
11,831
13,083

1980
1981
1982
1983

4,467
1,762
2,735
1,605

776
195

8,739
9,230
9,890
8,728

146,383
153,136
63,659
172,464

11,160
11,151
11,148
11,121

2,518
3,318
4,618
4,618

13,427
13,687
13,786
15,732

1,323

111
100
954

1,981
1,258

92,789
100,062
108,922
117,374
124,507

1,335
4,031
2,352
1,217
1,660

211

128,038
136,863
144,544
159,203

2,554
3,485
4,293
1,592

299
25
265
1,174
1,454
1,809
1,601

111
918

991
954
587
704

1,480

N O T E : 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.
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.

418

Total

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 dividends, 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 "US. Currency
and Coin Outstanding and in Circulation," Treasury Bulletin.

Statistical Tables 321
6B.—Continued

Factors absorbing reserve funds

Currency
in
circulation

32,869
33,918
35,338
37.692
39,619

Deposits with
Federal Reserve Banks,
other than reserve balances
Treasury
cash
holdings8
Treasury

377
422
380
361
612

Foreign

217
279
247
171
229

533
320
393
291
321

668
416

355
588
563
747
807

Other
Required
Federal
clearing
Reserve
balances
5
accounts

Other

485
465
597
880
820

Member bank
reserves9
Other
Federal
Reserve
liabilities
and
capital5

With
Federal
Reserve
Banks

Currency
and
coin10

Required11

Excess 11 - 12

0
0
0
0
0

17,081
17,387
17,454
17,049
18,086

2,544
2,544
3,262
4,099
4,151

18,988
18,988
20,071
20,677
21.663

637
96
645
471
574

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

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
32.496
32,044
35,268
37,011

-460
1,035

9gi2
-1,360
-3,798

941
1,044
1,007
1,065
1,036

1,176
1,344

1,123

695
596

1,312

150
174
135
216
134

57,903
61,068
66,516
72,497
79,743

431
460
345
317
185

1,156
2.020
1,855
2.542
2,113

148
294
325
251
418

1,233
1.41913
1.275 li

0
0
0
0
0

86,547
93,717
103,811
114,645
125,600

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
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

-1,10314
-1,535
-1,265
-893
-2,835

136,829
144,774
154,908
171,935

441
443
429
479

3,062
4,301
5,033
3,661

411
505
328
191

617
781

0
0
0
0

0
117
436

4,671
5,261
4,990
5,392

27,456
25,111
26,053
20,413

13,654
15,576
16.666
17,821

40,558
42.145
41.391
39.179

675
-1.442
1,328
-945

42,056
44.663
47,226
50,961
53,950

760

703

999
840

1,033

851

211
-147
-773
-1,353

8. Coin and paper currency held by the Treasury, as
well as any gold in excess of the gold certificates issued
to the Reserve Bank.
9. 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.
10. Between December 1, 1959, and November 23,
1960, part was allowed as reserves; thereafter, all was
allowed.
11. 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.
12. 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):

1,013

1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84;
1974—Ql, $67; Q2, $58. The transition period ended
with the second quarter of 1974.
13. For the period before July 1973, includes certain
deposits of domestic nonmember banks and foreignowned 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 is 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.
14. Adjusted to include waivers of penalties for reserve
deficiencies, in accordance with change in Board policy,
effective November 19, 1975.
. . . Not applicable.

322

94th Annual Report, 2007

7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank,
June 30, 2007 and 2006
Millions of dollars, except as noted
Member banks
Item

Total
Total

National

State

Nonmember
banks

2007
ASSETS

7,204,435
5,604,391
5,601,554
1,600,044

5,626,102
4,347,814
4,345,747
1,278,288

4,530,594
3,514,026
3,512,167
1,016,568

1,095,508
833,788
833,580
261,720

1,578,333
1,256,577
1,255,807
321,756

258,968
1,341,075
262,729

142,174
1,136,113
209,416

91,109
925,459
173,718

51,065
210,654
35,698

116,794
204,962
53,313

5,461,849
80,081
636,731
4,745,036
1,041,223

4,080,633
65,636
457,956
3,557,041
831,355

3,266,165
53,471
365,853
2,846,842
675,149

814,468
12,165
92,104
710,199
156,206

1,381,216
14,445
178,775
1,187,995
209,867

7,322

Loans and investments
Loans, gross
Net
Investments
U.S. Treasury and federal agency
securities
Other
Cash assets, total

2,553

1,673

880

4,769

LIABILITIES

Deposits, total
Interbank
Other transactions
Other nontransactions
Equity capital
Number of banks

2006
ASSETS

Loans and investments
Loans, gross
Net
Investments
U.S. Treasury and federal agency
securities
Other
Cash assets, total

6,782,584
5,177,276
5,175,292
1,605,308

5,298,487
4,018,755
4,017,598
1,279,731

4,224,793
3,218,246
3,217,313
1,006,547

1,073,694
800,509
800,285
273,184

1,484,097
1,158,520
1,157,693
325,576

285,687
1,319,621
277,134

162,185
1,117,546
219,429

102,455
904,092
182,292

59,730
213,454
37,137

123,502
202,075
57,704

5,255,716
88,201
679,778
4,487,738
949,489

3,987,644
74,038
485,240
3,428,366
760,868

3,185,042
60,177
38,663
2,738,202
624,281

802,603
13,861
98,577
690,164
136,587

1,268,072
14,163
194,538
1,059,372
188,621

7,453

2,672

1,776

896

4,781

LIABILITIES

Deposits, total
Interbank
Other transactions
Other nontransactions
Equity capital
Number of banks

NOTE: Includes U.S.-insured commercial banks located
in the United States but not U.S.-insured commercial
banks operating in U.S. territories or possessions. Data

are domestic assets and liabilities (except for those components reported on a consolidated basis only). Components may not sum to totals because of rounding.

Statistical Tables 323
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. 1 .
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 that may be extended for
the purpose of purchasing or carrying "margin securities" (as defined in the regulations) when the loan is
collateralized by such securities. The margin requirement,
expressed as a percentage, is the difference between the
market value of the securities being purchased or carried
(100 percent) and the maximum loan value of the

Convertible
bonds

Short sales,
T only1

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

collateral as prescribed by the Board. Regulation T was
adopted effective October 1, 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 into
Regulation U, effective April 1, 1998.
1. From October 1, 1934, to October 31, 1937, the
requirement was the margin "customarily required" by
brokers and dealers.

324

94th Annual Report, 2007

9. Statement of Condition of the Federal Reserve Banks, by Bank,
December 31, 2007 and 2006
Millions of dollars
Total

Boston

Item
2007

2006

2007

2006

ASSETS

Gold certificate account
Special drawing rights certificate account
Coin
Loans
Term auction credit1
Other loans to depository institutions ...
Securities purchased under agreements
to resell (triparty)2
U.S. Treasury securities bought outright3
Total loans and securities
Items in process of collection
Bank premises
Other assets
Denominated in foreign currencies 4
Other5
Interdistrict settlement account
Total assets

11,037
2,200
1,179
40,000
8,636

11,037
2,200
801

' ' 67

449
115
36
0
178

486
115
27

i
o

46,500
740,611
835,748
2,220
2,144

40,750
778,915
819,731
4,276
1,953

2,143
34,132
36,453
82
120

37,169
37,178
97
117

47,295
16,915
0
918,737

20,482
18,015
0
878,494

1,222
822
-1,356
37,942

491
782
124
39,416

1,010,262
218,571
791,691
43,985

958,680
175,661
783,019
29,615

38,832
5,886
32,946
2,027

39,020
3,020
36,000
1,413

20,767
16,120
96
2,020
39,003
2,227
4,930
881,837

18,699
4,708
98
1,496
25,002
4,602
5,608
847,846

531
0
1
31
563
92
215
35,843

549
0
1
42
592

18,450
18,450
918,737

15,324
15,324
878,494

1,049
1,049
37,942

1,010,262
218.571
791,691

958,680
175,661
783,019

11,037
2,200
35,328
743,126
791,691

11,037
2,200
0
769,782
783,019

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
Other6
Total deposits
Deferred credit items
Other liabilities and accrued dividends7
Total liabilities

352
267
38,624

CAPITAL ACCOUNTS

Capital paid in
Surplus
Total liabilities and capital accounts .
FEDERAL RESERVE NOTE STATEMENT

Federal Reserve notes outstanding
Less: Held by Banks not subject to collateralization
Collateralized Federal Reserve notes
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
For notes see end of table.

396
396
39,416

Statistical Tables 325
9.—Continued

New York
2007

Philadelphia

2006

2007

Cleveland

2006

2007

Richmond

2006

2007

2006

4.053
874
55

4,139
874
47

455
83
88

463
83
53

428
104
113

446
104
73

869
147
134

853
147
78

33,957
5,888

0
0

12
841

775
130

16,838
268,173
324,856
42
216

40,750
288,297
329,047
70
212

2,057
32,765
34,822
317
64

33,817
33,817
649
58

1,903
30,308
33,064
268
153

33,633
33,633
451
158

4,029
64,168
69,102
154
186

64,704
64,704
237
170

11,503
6,700
-12,606
335,691

5,707
7,099
-29,471
317,724

5,587
713
794
42,924

1,152
1,055
836
38,166

3,354
750
-741
37,494

1,569
759
-2,264
34,929

12,633
1,446
-1,177
83,494

5,625
1,502
4,858
78,174

356,941
74,297
282,644
15,927

341,947
56,821
285,126
10,961

41,729
7,564
34,165
1,946

38,658
6,957
31,700
1,286

39,353
7,130
32,223
1,800

36,516
6,709
29,807
1,279

80,552
13,767
66,785
3,811

75,090
11,394
63,695
2,460

9,158
16,120
66
698
26,042
51
1,790
326,454

6.609
4,708
69
821
12,207
111
1,864
310,270

2,664
0
5
92
2,760
215
211
39,297

584
0
2
1
587
718
255
34,547

447
0
3
12
461
200
228
34,912

954
0
3
32
990
405
275
32,756

1,780
0
11
503
2,294
112
500
73302

2,748
0
11
121
2,880
384
569
69,987

4,619
4,619
335,691

3,727
3,727
317,724

1,813
1,813
42,924

1,810
1,810
38,166

1,291
1,291
37,494

1,087
1,087
34,929

4,996
4,996
83,494

4,093
4,093
78,174

326 94th Annual Report, 2007
9. Statement of Condition of the Federal Reserve Banks, by Bank,
December 31, 2007 and 2006—Continued
Millions of dollars
Atlanta

Chicago

Item
2007

2006

2007

2006

ASSETS

Gold certificate account
Special drawing rights certificate account
Coin
Loans
Term auction credit1
Other loans to depository institutions
Securities purchased under agreements
to resell (triparty)2
US. Treasury securities bought outright3
Total loans and securities
Items in process of collection
Bank premises
Other assets
Denominated in foreign currencies4
Other5
Interdistrict settlement account
Total assets

1,117
166
153
25
0

1,023
166
93
'' 3

903
212
137

947
212
100

1,080
1,259

24
71,520
71,544
241
206

4,313
68,690
73,028
229
230

65,208
65,211
324
232

3,900
62,120
68,359
155
205

3,939
1,473
3,909
84,243

1,382
1,430
12,404
82,264

2,648
1,258
6,133
80,010

1,357
1,481
-3,742

111,626
36,017
75,609
4,080

98,175
23,938
74,237
2,479

86,265
13,560
72,705
3,689

79,818
14,202
65,616
2,719

975
0
3
166
1,144
143
418
8133

1,980
0
3
63
2,046
473
476
79,711

910
0
2
161
1,073
516
396
78381

1,395
0
3
105
1,503
276
515
70,630

1,425
1.425

1,276
1.276

814
814

858
858

84,243

82,264

80,010

72346

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
Other6
Total deposits
Deferred credit items
Other liabilities and accrued dividends7
Total liabilities
CAPITAL ACCOUNTS

Capital paid in
Surplus
Total liabilities and capital accounts
NOTE: Components may not sum to totals because of
rounding.
1. In December 2007, the System established the temporary Term Auction Facility, which provides credit to eligible depository institutions.
2. On February 15, 2007, the System began allocating
the activity related to securities purchased under agreements to resell to all Reserve Banks.

3. Includes securities loaned—fully collateralized by
U.S. Treasury securities pledged with Federal Reserve
Banks—and excludes securities purchased under agreements to resell.
4. Valued daily at market exchange rates. Includes deposits held under foreign currency arrangements with two
central banks of $24 million at December 31, 2007.

Statistical Tables 327
9.—Continued

Minneapolis

St. Louis
2007

2006

2007

326
71
50

328
71
39

203
30
45

1,050
0

0
3

1,486
23,671
26,207
13
115

24,747
24,747
196
80

928
14,777
15,708
97
113

513
515

223
552

851
316

2006

2007

San Francisco

Dallas

Kansas City
2006

2007

2006

2007

2006

335
66
72

324
66
62

613
98
130

575
98
81

1,286
234
165

1,242
234
117

0
7

1,400
0

' 0

1,701
330

15,835
15,857
219
116

1,505
23,974
25,486
214
269

22,808
22,815
560
159

2,043
32,540
35,983
126
257

34,957
34,957
348
260

5,355
85,293
92,680
522
218

86^218
86,219
884
185

380
348

544
513

271
480

653
690

236
751

3,848
1,720

2,089
1,777

211
30
31

' "22

3,742

1,807

2.140

-237

5,239

4,734

-2,425

3,537

-3,651

7,414

31,551

28,045

19,503

16,955

32,740

29,469

36,124

40,844

97,021

100,160

32,982
3,770
29,212

29,169
3,175
25,994

19,219
2,790
16,429

17,442
2,549
14,893

33,316
3,212
30,103

30,770
3,717
27,053

57,270
24,860
32,410

57,150
19,391
37,759

112,177
25,719
86,459

114,925
23,787
91,138

1,406

941

878

602

1,424

867

1,933

1,329

5,066

3,278

289
0
0
55
344

434
0
0
24
458

1,104
0
1
38
1,143

455
0
1
18
474

449
0
0
45
495

546
0
1
32
579

635
0
1
59
695

705
0
0
37
742

1,823
0
3
161
1,987

1,741
0
4
200
1,946

38
192

103
217

223
122

288
147

157
172

435
183

129
230

306
284

353
456

749
556

31,192

27,713

18,794

16,404

32352

29,117

35397

40,420

94,321

97,667

180
180

166
166

355
355

276
276

194
194

176
176

363
363

212
212

1,350
1,350

1,247
1,247

31,551

28,045

19,503

16,955

32,740

29,469

36,124

40,844

97,021

100,160

5. The System total includes depository institution
overdrafts of $6 million for 2007 and $2 million for 2006.
6. Includes international organization deposits of $144
million for 2007 and 2006. These deposits are primarily
held by the Federal Reserve Bank of New York.

7. Includes exchange-translation account reflecting the
monthly revaluation of foreign exchange commitments at
market exchange rates.
. . . Not applicable.

328

94th Annual Report, 2007

10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007
Thousands of dollars
Item

Total

Boston

New York

Philadelphia

Cleveland

Loans
U.S. Treasury securities
Foreign currencies
Priced services
Compensation received for
services provided1
Other

71,345
40,297,924
574,525
878,405

275
1.868,185
14,775
0

54,696
14,791,753
141,114
65,475

142
1,765,843
65,450
0

940
1,668,195
40,965
0

634,819
119.007

46,972
2,967

38,486
2,663

79,931
2,893

Total

42,576,025

1,933,174

29,040
72,331
15,154,409

1,872,583

1,792,924

1,499,112
505,516
109,849
132,372
71,187
141,444

82,288
22,023
1,271
4,009
3,337
2,885

302,889
92,280
103,149
13,120
9,947
20,876

70,493
25,444
173
2,047
2,469
8,460

93,093
34,555
243
5,913
4,648
21,457

81,675
43,320
70,668

1.517
788
5,065

2,475
3,392
9,140

2,302
521
5,321

6,214
869
6,733

32,610
92,998
39,285
49.166
39.883

4,976
6,737
4.300
3,183
1,663

4,765
16,209
7,833
14,929
6,822

1,567
4,066
2.739
326
2,205

1.954
8.767
2,771
187
3,625

28,060
3.592
117,996
78,276

3,142
281
6,444
4,394

3,972
1,434
10,459
7,491

1,155
412
6,066
4,694

1,372
162
7,887
6,390

CURRENT INCOME

CURRENT EXPENSES

Salaries and other personnel
expenses
Retirement and other benefits .
Net periodic pension expense2
Fees
Travel
Software expenses
Postage and other shipping
costs
Communications
Materials and supplies
Building expenses
Taxes on real estate
Property depreciation
Utilities
Rent
Other
Equipment
Purchases
Rentals
Depreciation
Repairs and maintenance
Earnings credit costs
Compensation paid for service
costs incurred1
Other
Recoveries
Expenses capitalized3

240.354

12,415

65,453

9.140

15,618

634,819
81,956
-104.730
-20,873

0
21,453
-15.658
-1,615

28,955
71,392
-13,831
-9,547

0
11,746
-3,569
-339

0
15,994
-3,755
-516

Total
Reimbursements
Net expenses

3,968,537
-458,331
3,510,206

174,897
-25,073
149.824

773,605
-109,437
664,168

157,437
-30,812
126,625

234,181
-62,455
171,726

For notes see end of table.

Statistical Tables 329
10.—Continued
Dallas

San Francisco

954
1,263,466
6,678
0

2,199
1,773,992
7,849
0

1.873
4,570.014
47.550
0

78,665
1,215

81,241
1,847

47,010
2.409

69,178
8,678

1,317,356

896,765

1,354,187

1,833,458

4,697,294

114.948
46,292
439
10,174
7,452
4,866

77,558
27,363
449
7,719
3,910
5,256

79,344
25,979
565
2,631
3,147
3,878

96,941
27.660
664
7,011
5,242
4,535

83,391
33,613
164
1,565
3,737
5.300

150.765
46,892
1,220
3,592
9,113
5,656

45,885
1,786
7,942

3,819
1.429
5,726

2,203
1,277
3,059

2,480
1,883
3,902

1,939
1,277
4,516

4,252
1,791
5,304

5,168
1,743
5.834

2,408
8,990
3,740
16,146
3,728

3,293
9.419
4,063
566
3,975

2.231
11,380
2,294
5,933
5,724

637
5.247
1,634
1,738
1,481

3,186
4,702
1,976
253
1,731

201
982
677
4,518
399

3,914
8,975
4,027
199
4,945

3,479
7,523
3,232
1,188
3,585

4,709
249
37,635
16.668

2,471
417
8,597
9.556

1,780
295
9.714
6.544

1,071
143
5,318
2,770

1,460
18
4,603
2,798

2,704
28
6,358
3,470

1,579
88
5,326
5,367

2.644
65
9,590
8,134

53,827

15,051

22,197

4,612

4,138

6,913

5,616

25,374

0
-282,072
-28,656
-2,610

596.523
25,921
-8.174
-640

9,341
56,591
-8,038
-345

0
79,734
-2,313
-1,158

0
19,214
-993
-611

0
16,823
-4,473
-863

0
30,145
-9,366
-488

0
15,016
-5,905
-2,141

292,034
-29,720
262,314

930,868
-12,264
918,603

320,790
-5,238
315,551

229,709
-114,707
115,003

166,285
-29,292
136,993

187,521
-11,028
176,493

199,444
-15,021
184,423

301,765
-13.283
288.483

Minneapolis Kansas City

Richmond

Atlanta

Chicago

St. Louis

3,505
3,435,771
153,751
0

137
3,617,951
47,228
753,440

2,514
3,457,351
32,571
59,491

2.596
1,280,394
6,233
0

1,515
805,010
10,360
0

55,800
11,376

459
5,448

81,786
5,299

26,252
1,881

3,660,202

4,424,663

3,639,012

212,395
76,590
774
62,831
10,765
55,807

135,008
46,823
740
11,761
7,420
2,467

3,421
26,566
8,125

330

94th Annual Report, 2007

10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007—Continued
Thousands of dollars
Item

Total

Boston

New York

Philadelphia

Cleveland

39,065,820

1,783,349

14,490,241

1,745,959

1,621,198

1,885,770
580
1,886,350

49,346
17
49,363

447,281
29
447,310

242,599
91
242,690

131,895
236
132,131

-1,687,918
-9
-1,687,927

-78,664
0
-78,664

-615,495
0
-615,495

-74,232
0
-74,232

-70,285
-8
-70,293

198,423

-29,301

-168,185

168,458

61,839

296,125
576,306

7,534
30,970

74,183
123,566

34,464
32,084

20,766
26,174

38,391,806

1,715,543

14,124,306

1,847,864

1,636,096

324,481

3,596

228,568

4,924

5,345

38,716,287

1,719,139

14,352,874

1,852,789

1,641,441

992,353

34,714

253,678

108,613

65,679

34,598,401

1,031,048

13,207,574

1,740,672

1,371,427

3,125,533

653,378

891,622

3,504

204,335

15,324,288
18,449,821

396,093
1,049,471

3,727,084
4,618,706

1,809,826
1,813,329

1,086.735
1,291,070

PROFIT AND LOSS

Current net income
Additions to (+) and deductions
from (—) current net income4
Profits on foreign exchange
transactions
Other additions
Total additions
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 expenditures 5 ...
Cost of currency
Net income before payment to
U.S. Treasury
Change in funded status of
benefit plans6
Comprehensive income before
payment to U.S. Treasury .
Dividends paid
Payments to U.S. Treasury
(interest on Federal
Reserve notes)
Transferred to/from surplus and
change in accumulated
other comprehensive
income
Surplus, January 1
Surplus, December 31 .

NOTE: Components may not sum to totals because of
rounding.
1. The Federal Reserve Bank of Atlanta has overall
responsibility for managing the Reserve Banks' provision
of check and ACH services and recognizes total System
revenue for these services. The Federal Reserve Bank of
New York has overall responsibility for managing the
Reserve Banks' provision of Fedwire funds transfer and
securities transfer services and recognizes the total System revenue for these services. The Federal Reserve Bank
of Chicago has overall responsibility for managing the
Reserve Banks' provision of electronic access services to
depository institutions and recognizes the total System
revenue for these services. The Federal Reserve Bank of
Atlanta, the Federal Reserve Bank of New York, and the
Federal Reserve Bank of Chicago compensate the other
Reserve Banks for the costs incurred in providing these
services.
2. Reflects the effect of Financial Accounting Standards Board Statement of Financial Accounting StanDigitizeddardsFRASER
for 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 an increase in expenses of $97,419 thousand. The expenses
related to the Retirement Benefit Equalization Plan and
the Supplemental Employee Retirement Plan are recorded
by each Federal Reserve Bank.
3. Includes expenses for labor and materials capitalized and depreciated or amortized as charges to activities
in the periods benefited.
4. 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.
5. For additional details, see the chapter "Board of
Governors Financial Statements."
6. Subsquent to the adoption of SFAS 158 at December 31, 2006, the Reserve Banks recognize the change in
funded status of pension and postretirement benefit plans
as an element of other comprehensive income.

Statistical Tables 331
10.—Continued
Richmond

Atlanta

Chicago

St. Louis

Minneapolis Kansas City

Dallas

San Francisco

3,397.889

3,506,059

3.323,461

1,202,353

759,772

1,177,694

1,649,035

4,408.811

501,282
18
501,300

162.120
40
162,160

102,302
51
102,354

20,439
23
20.461

33,756
17
33,773

21,153
5
21,158

26,785
16
26,800

146.812
37
146,849

-144.330
0
-144,330

-151,710
0
-151,710

-145,835
0
-145,835

-53,846
0
-53,846

-33,880
0
-33,880

-52,984
0
-52,984

-74,666
0
-74,666

-191,992
0
-191,992

356,970

10,450

-43,481

-33,385

-107

-31,825

-47,866

-45,143

77.265
51,241

24.941
78,926

16,506
56,393

3,198
19,551

5,485
14,880

3,421
23,518

4,380
30,903

23.982
88,099

3.626,352

3,412,643

3,207,080

1,146,219

739,300

1,118,929

1,565,886

4,251,587

22.519

5,717

14,711

3,536

10,627

3,547

13,535

7,854

3,648,871

3.418,359

3,221,792

1,149,756

749,927

1,122,477

1,579,422

4,259.441

263,167

78,220

52,775

10,398

19,522

11.109

17,019

77,460

2,483,025

3,191,589

3,212,649

1,125,614

651,634

1,093.644

1,410,713

4,078,811

902,679

148,551

-43,632

13,743

78,771

17,724

151,689

103,171

4.093,301
4,995,979

1,276,288
1,424,838

858.091
814,459

166,206
179,950

275.762
354,533

176,344
194,068

211,742
363,431

1,246,817
1,349,988

332

94th Annual Report 2007

11. Income and Expenses of the Federal Reserve Banks, 1914-2007
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
-4,673

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

810
719
729
800
1,372
1,406
,680
,748
,725
,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

-93
311
-1,413
-12,307
-4,430
-1,737
486
-1,631
2,232
2,390
11,488
721
-1,568
23,768
3,222
-830
-626
1,973
-34,318
-12,122

,704
,840
,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

For notes see end of table.

Change in
funded status
of benefit
plans

Statistical Tables 333
11.—Continued

Payments to J.S. Treasury
Dividends
paid

Trn n O fV^ITfH
I ItlllolCllCU

Statutory
transfers2

Interest on
Federal Reserve
notes

to/from surplus
(section 13b)

Transferred
to/from surplus
and change in
accumulated other
comprehensive
income
(section 7)

217
1,743
6,804
5,541
5,012

2,704

U34
48,334
70,652

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

-2,298
-7,058
11,021
-917
6,510
607
353
2,616
1,862
4,534

1,134

8,215
8,430
8,669
8,911
9,500
10,183
10,962
11,523
11,920
12,329
13,083
13,865
14,682
15,558
16.442
17,712
18,905
20,081
21,197
22,722

2,011
' 298
227
177
120
25

-60
28
103
67
-419
-426

82
141
198
245
327
248
67
36

-54
-4
50
135
201
262
28
87

75,284
166,690
193,146
196,629
254,874
291,935
342,568
276,289
251,741
401,556
542,708
524,059
910,650

17,617
571
3,554
40,327
48,410
81,970
81,467
8,366
18,523
21,462
21,849
28.321
46,334
40,337
35,888
32,710
53,983
61,604
59,215
-93,601

334 94th Annual Report, 2007
11. Income and Expenses of the Federal Reserve Banks, 1914-2007—Continued
Thousands of dollars

Federal Reserve
Bank and period

Current
income

Net
expenses

Net additions
or
deductions (-)

Assessments by
Board of Governors
Board
expenditures

Costs
of currency

Change in
funded status
of benefit
plans

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

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
-49,616
-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 .
.
2003 .
.
2004 .
.
2005 .
.
2006 .
.
2007 .
.

33,963,992
31,870,721
26,760,113
23,792,725
23,539,942
30,729,357
38,410,427
42,576,025

1,971,688
2,084,708
2,227,078
2,462,658
2,238,705
2,889,544
3,263,844
3,510,206

-1,500,027
-1,117,435
2,149,328
2,481,127
917,870
-3,576,903
-158,846
198,417

188,067
295,056
205,111
297,020
272,331
265,742
301,014
296,125

435,838
338,537
429,568
508,144
503,784
477,087
491,962
576,306

324,481

5,000,926

9,408318

324,481

Total, 1914-2007

753,465,666

58,857,462

4,240,213

Statistical Tables 335
11.—Continued

Payments to U.S. Treasury
Dividends
paid

Statutory
transfers 2

Interest on
Federal Reserve
notes

Tranlsferred
X X U l o l v l 1 K/VJ
to/from surplus
(section 13b)

Transferred
to/from surplus
and change in
accumulated other
comprehensive
income
(section 7)

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

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

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

25,343,892
27,089,222
24,495,490
22,021,528
18,078,003
21,467,545
29,051,678
34,598,401

4,114,865
517,580
1,068,598
466,796
2.782,587
1,271,672
4,271,828
3,125,533

5.517,716
20,658,972
17,785,942

409,614
428,183
483,596
517,705
582,402
780,863
871,255
992,353
9,731,130

44,113,958

608,526^61

-4

24^92,209 3

336

94th Annual Report, 2007

11. Income and Expenses of the Federal Reserve Banks, 1914-2007—Continued
Thousands of dollars

Current
income

Net
expenses

Net additions
or
deductions (-) 1

Aggregate for each
Bank, 1914-2007
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco

39,756,660
264,885,985
28,242,547
44,376,296
58,583,264
44,873,400
88,896,622
25,558,056
13,120,386
26,840,812
34,245,323
84,086,318

3,566,677
9,049,099*
2,902,768
3,441,220
4,847,517
7,446,218
6,781,169
2,712,204
2,686,112
3,577,546
3,632,776
6,214,156

Total

753,465,666

56,857,462

Federal Reserve
Bank and period

NOTE: Components may not sum to totals because of
rounding.
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.

Assessments by
Board of Governors

Change in
funded status
of benefit
plans

Board
expenditures

Costs
of currency

-77,524
665,437
281,126
358,964
1,048,500
300,910
570,303
9,337
129,244
71,878
291,082
590,956

214,794
1,242,376
232,919
363,689
746,343
375,667
542,013
118,324
145,784
150,184
222,824
646,010

549,944
2,904,656
407,154
538,490
776,985
738,885
1,061,746
341,279
171,112
345,207
468,457
1,104,404

3,596
228,568
4,924
5,345
22,519
5,717
14,711
3,536
10.627
3,547
13,535
7,854

4,240,213

5,000,926

9,408,318

324,481

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 337
11.—Continued

Payments to U.S. Treasury
Dividends
paid

Transferred
to/from surplus
(section 13b)

Transferred to/from
surplus and change
in accumulated other
comprehensive
income
(section 7) 5

Statutory
transfers2

Interest on
Federal Reserve
notes

445,359
2,429,684
516,216
715,167
1,667,095
695,724
969,454
218,704
276,350
259,149
367,830
1,170,398

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

31,082,719
225,798,033
21,177,901
35,255,476
42,455,863
31,464,800
74,300,302
20.042,912
9,051,982
21,017,971
27,815,769
69,062,633

135
-433
291
-10
-72
5
12
-27
65
-9
55
-17

1,243,599
7,049,415
1,979,232
1,599,529
6,076,623
1,745,497
1,233,130
303,695
512,625
316,487
531,427
1,800,950

9,731,130

44,113,958

608,526,361

-4

24392,209 3

3. The $24,392,209 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); $106,000 thousand
(1996), $107,000 thousand (1997), and $3,752,000 thousand (2000) transferred to the Treasury as statutorily required; and $1,848,716 thousand related to the implementation of SFAS No. 158 (2006), and was increased by

transfer of $11,131 thousand from reserves for contingencies (1955); leaving a balance of $18,449,821 thousand
on December 31, 2007.
4. This amount is reduced by $2,815,225 thousand
for expenses of the System Retirement Plan. See note 2,
table 10.
5. Beginning in 2006, accumulated other comprehensive income is reported as a component of surplus.
. . . Not applicable.

338

94th Annual Report, 2007

12. Operations in Principal Departments of the Federal Reserve Banks, 2004-2007

Operation
Millions of pieces
Currency processed
Currency destroyed
Coin received
Checks handled
U.S. government checks1
Postal money orders
All other3
Securities transfers2
Funds transfers
Automated clearinghouse transactions
Commercial
Government
Millions of dollars
Currency processed
Currency destroyed
Coin received
Checks handled
U.S. government checks1
Postal money orders
All other3
Securities transfers2
Funds transfers
Automated clearinghouse transactions
Commercial
Government

2005

2004

35,653
6,509
63,255

37,694
6,766
59,705

36,463
6,551
56,080

36,242
6,748
55,655

214
164
10,001
24
135

222
171
11,083
22
134

216
176
12,228
22
132

234
187
13,904
20
125

9,363
1,027

8,231
992

7,339
964

6,486
941

642,168
104,082
6,124

664,592
84,742
5,779

639,832
83,187
5,412

625,127
90,943
5,403

256,994
31,626
15,897,747
435,577,505
670,665,569

269,073
28,066
16,442,820
377,258,592
572,645,790

252,192
28,395
15,684,615
368,896,819
518,546,733

277,649
29,045
14,287,740
313,425,252
478,946,947

14,547,234
3,716,928

13,124,434
3,474,364

12,801,914
3,156,556

12,543,907
2,913,189

1. Starting in 2005, this category includes government
checks handled electronically (electronic checks);
amounts in bold are restatements to reflect the inclusion
of electronic checks.
2. In 2006, the title of this category changed from

2006

2007

previous years, but the composition of the category remained the same. Therefore, the data are comparable with
data reported in previous years.
3. Amounts in bold are restatements.

Statistical Tables 339
13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks,
December 31, 2007

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 ..

rotal

Employees
Number
Number

Number

300,700
398,200
289,000
294,100
323,000
289,000
289,000
356,000
391.000
356,100
289,000
360,300

66
289
57
57
78
79
83
79
43
78
61
74

11,705,861
58,962,284
9,156,100
9,097,275
12,092,800
13,820,595
13,151,804
12,257,140
6,663,760
13,349,302
9,740,198
14,269,134

834
2,435
964
1,450
1,647
1,822
1,292
937
1,101
1,244
1,172
1,652

68
51
32
36
42
33
53
58
87
23
20
68

60,844,958
209,318,220
55,399,380
74,076,101
97,039,847
108,183,543
86,678,366
55,858,832
63,751,595
71,299,571
66,113,025
119,451,612

969
2,776
1,054
1,544
1,768
1,935
1,429
1,075
1,232
1,346
1,254
1,795

72,851,519
268,678,705
64,844,480
83,467,476
109,455,647
122,293,138
100,119,170
68,471,972
70,806,355
85,004,973
76,142,223
134,081,046

5,909,456

770

67,164,988

810

73,074,444

1,830,900

2,896,647

4,727,547

1,090

192,006,609

17,354

574

3,935,400

Salaries
(dollars)2

Salary
(dollars)2

Office of
Employee
Benefits . . . .
Total

Other officers

1. Under current policies, the appointment salaries of
Federal Reserve Bank presidents are normally 85 percent
of the salary-range midpoint (an 85 compa-ratio), with
the exception of the New York Reserve Bank president,
whose appointment salary normally is set at a 95 comparatio. The Board has discretion to approve a higher starting salary if requested by a Reserve Bank's board of
directors.
On January 1 each year, all presidents receive salary
increases equal to the percentage increase in the midpoint
of their respective salary ranges. In addition, on every
third-year anniversary of his or her initial appointment
(through year 9), each president receives a salary increase
that results in a compa-ratio as follows: year 3, 95 (for the
New York Bank, 105); year 6, 105 (New York, 115);
year 9, 115 (New York, 125).

Fulltime

Parttime

(dollars)2

1,138,076,686 19,030 1,334,018,695

There continue to be tiered salary ranges for Reserve
Bank officers, including presidents, reflecting differences
in the costs of labor in the head-office cities. The Board
reviews Reserve Bank officer salary ranges and Reserve
Bank placement in the salary tiers annually. In 2007, New
York and San Francisco were in tier 1, which had a
midpoint for presidents' salaries of $379,300. Boston,
Philadelphia, Richmond, Atlanta, Chicago, Minneapolis,
and Dallas were in tier 2, which had a midpoint for
presidents' salaries of $340,000. Cleveland, St. Louis,
and Kansas City were in tier 3, which had a midpoint for
presidents' salaries of $309,600.
2. Annualized salary liability based on salaries in effect on December 31, 2007.
. . . Not applicable.

340

94th Annual Report, 2007

14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks
and Branches, December 31, 2007
Thousands of dollars
Acquisition costs
Federal Reserve
Bank or
Branch

Land

Buildings
(including
vaults)1

Building machinery and
equipment

Total

Net
book
value

BOSTON . . .

27,293

135,431

28,808

191,532

119,760

NEW YORK

20,103

267,634

70,071

357,808

Other
real
estate 3

215,622

PHILADELPHIA . . .

7,312

90,205

13,999

111,516

64,495

CLEVELAND .
Cincinnati
Pittsburgh

4,219
2,737
1,739

123,320
29,516
19,388

27,333
14,351
15,361

154,872
46,604
36,488

109,497
23,489
19,674

RICHMOND
Baltimore . . .
Charlotte

25,539
6,482
3,130

113,311
32,939
34,985

44,779
5,924
6,961

183,628
45,345
45,076

129,047
26,728
29,804

ATLANTA ..
Birmingham .
Jacksonville .
Miami
Nashville
New Orleans

22,735
5,347
1,779
4,254
603
3,785

149,949
12,749
21,515
24,825
5,690
8,873

16,367
1,525
3,967
4,916
3,542
5,529

189,052
19,621
27,261
33,996
9,835
18,187

163,202
12,962
17,051
22,136
4,529
9,658

CHICAGO
Detroit

4,512
9,980

168,948
72,437

20,681
10,690

194,141
93,107

116,158
88,645

ST. LOUIS
Little Rock
Memphis

8,428
0
2,472

110,052
0
14,127

14,348
0
5,162

132,828
0
21,761

100,552
0
14,048

MINNEAPOLIS
Helena

15,666
2,890

104,953
9,716

13,834
943

134,453
13,549

103,464
9,276

KANSAS CITY
Denver
Oklahoma City .
Omaha

37,501
3,511
0
3,559

217,038
9,167
0
7,374

0
4,502
0
1,726

254,539
17,179
0
12,658

254,539
8,039
0
6,207

DALLAS
El Paso
Houston
San Antonio .

36,166
262
23,699
826

110,487
3,426
104,631
8,227

24,205
1,698
8,653
2,491

170,858
5,386
136,983
11,544

119,762
1,182
129,728
6,038

SAN FRANCISCO
Los Angeles
Salt Lake City
Seattle

20,129
6,306
1,294
8,136

98,264
71,643
4,680
73,234

22,650
14,807
1,467
4,545

141,043
92,755
7,441
85,915

79,893
57,963
2,972
77,486

322^92

2,258,733

415,838

2,996,963

2,143,606

11,339

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.

4,106

7,204

3. Covers acquisitions for banking-house purposes and
Bank premises formerly occupied and being held pending
sale.
. . . Not applicable.

Federal Reserve System Audits

343

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 conducts audits, reviews, and investigations relating to the Board's programs and operations as well as to
Board functions delegated to the Reserve Banks.

The Reserve Banks' financial statements are audited annually by an independent outside auditor retained by the
Board of Governors. In addition, the Reserve Banks are subject to annual examination by the Board. As discussed in the
chapter "Federal Reserve Banks," the
Board's 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 Government
Accountability Office.
•

345

Board of Governors Financial Statements
The financial statements of the Board for 2007 were audited by
Deloitte & Touche LLP, independent auditors.

Deloitte
INDEPENDENT AUDITORS' REPORT
The Board of Governors of the Federal Reserve System:
We have audited the accompanying balance sheet of the Board of Governors of the Federal
Reserve System (the "Board") as of December 31, 2007, and the related statements of
revenues and expenses and changes in cumulative results of operations, and cash flows for the
year 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 audit.
The financial statements of the Board for the year ended December 31, 2006 were audited by
other auditors whose report, dated April 17, 2007, expressed an unqualified opinion on those
statements and included an explanatory paragraph related to adoption of the Financial Accounting Standard Board Statement No. 158, Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans.
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. 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 consideration of internal control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Board's internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such 2007 financial statements present fairly, in all material respects, the
financial position of the Board of Governors of the Federal Reserve System as of December
31, 2007, and the results of its operations and its cash flows for the year 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 report dated
March 19, 2008 on our consideration of the Board's internal control over financial reporting
and on our tests of its compliance with certain provisions of laws, regulations, contracts, and
agreements and other matters. The purpose of that report is to describe the scope of our testing
of internal control over financial reporting and compliance and the results of that testing, and
not to provide an opinion on the internal control over financial reporting or on compliance.
That report is an integral part of an audit performed in accordance with Government Auditing
Standards, and should be considered in assessing the results of our audit.

March 19. 2008
Washington, D.C.

346 94th Annual Report, 2007

BALANCE SHEETS
Year ending December 31,
2007
2006
ASSETS
CURRENT ASSETS

Cash
Accounts receivable
Prepaid expenses and other assets

$ 44,613,728
2,996,318
4,653,684

$ 60,030,706
2,625,907
3,916,608

52,263,730

66,573,221

153,350,880
166,119
153,516,999

151,205,386
343,899
151,549,285

$205,780,729

$218,122,506

$ 20,400,282
5,647,053
18,429,601
108,755
702,122

$ 10,950,470
5,421,666
16,334,512
327,663
366,304

45,287,813

33,400,615

0
2,201,675
7,972,469
8,855,613

108,755
1,354,662
8,111,829
6,515,301

Total long-term liabilities

19,029,757

16,090,547

Total liabilities

64,317,570

49,491,162

7,084,672
(17,542,943)
153,408,244
(1,486,814)

33,500,269
(14,325,986)
151,112,867
(1,655,806)

141,463,159

168,631,344

$205,780,729

$218,122,506

Total current assets
NONCURRENT ASSETS

Property and equipment, net (Note 4)
Other assets
Total noncurrent assets
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 5)
Accumulated postretirement benefit obligation (Note 6)
Accumulated postemployment benefit obligation (Note 7)

CUMULATIVE RESULTS OF OPERATIONS

Working capital
Unfunded long-term liabilities
Net investment in assets
Accumulated other comprehensive income (loss) (Note 8)
Total cumulative results of operations
Total liabilities and cumulative results of operations

See accompanying notes to financial statements.

Board of Governors Financial Statements 347
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
STATEMENTS OF REVENUES AND EXPENSES
AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS
Year ending December 31,
2007
2006
BOARD OPERATING REVENUES

Assessments levied on Federal Reserve Banks for Board
operating expenses and capital expenditures
Other revenues

$296,124,700
10,365,414

$301,013,500
8,508,949

306,490,114

309,522,449

197,656,442
39,451,541
36,300,185
13,557,498
8,998,496
8,619,615
6.678,514
8,836.143
3,890.191
1,976.765
7,861,901

182,239,595
35,853,297
23,944,564
13,058,667
9,185,840
8,820,503
6,637,765
4,560,368
2,634,459
1,505,470
7,435,067

333,827,291

295,875,595

Total operating revenues
BOARD OPERATING EXPENSES

Salaries
Retirement and insurance
Contractual services and professional fees
Depreciation, amortization, and net losses on disposals
Utilities
Travel
Software
Postage and supplies
Repairs and maintenance
Printing and binding
Other expenses
Total operating expenses

(27,337,177)

RESULTS OF OPERATIONS

13,646,854

CURRENCY COSTS

Assessments levied on Federal Reserve Banks
for currency costs
Expenses for printing, transporting, and
retiring Federal Reserve Notes

576,306,073
576,306,073

491,962,202

CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES

491,962,202

TOTAL RESULTS OF OPERATIONS

(27,337,177)

13,646,854

CUMULATIVE RESULTS OF OPERATIONS, Beginning of period

168,631,344

156,640,296

OTHER COMPREHENSIVE INCOME

Adjustment to initially apply SFAS No. 158 (Note 8)
Amortization of prior service cost
Amortization of net actuarial loss
Net actuarial loss arising during the year

0
(23,831)
113,142
79.681
168,992

Total Other Compehensive Income
CUMULATIVE RESULTS OF OPERATIONS, End of period

(1,655,806)
0
0
0
(1,655,806)

$141,463,159

See accompanying notes to financial statements.

$168,631,344

348 94th Annual Report, 2007
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
STATEMENTS OF CASH FLOWS
Year ending December 31,
2007
2006
CASH FLOWS FROM OPERATING ACTIVITIES

RESULTS OF OPERATIONS

$(27,337,177)

$13,646,854

13,433,306
124,192

13,047,064
11,603

Adjustments to reconcile results of operations
to net cash provided by (used in) operating activities:
Depreciation
Net losses on disposals of property and equipment
Increase (decrease) in assets:
Accounts receivable, prepaid expenses and other assets

(929,708)

(5,955,880)
561,094
878,028
(417,407)
541,165
1,874,539
1,403,936
(1,655,806)

613,676

Net cash provided by operating activities

(812,482)

9,449,812
225,387
2,095,089
335,818
847,013
(139,360)
2,340,312
168,992

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
Accumulated other comprehensive income

23,122,708

CASH FLOWS FROM INVESTING ACTIVITIES

Proceeds from disposals
Capital expenditures

65,988
(15,768,979)
(15,702,991)

(8,822,500)

(327,663)

(239,937)

(327,663)

Net cash used in investing activities

7,212
(8,829,712)

(239,937)

CASH FLOWS FROM FINANCING ACTIVITIES

Capital lease payments
Net cash used in financing activities
NET INCREASE (DECREASE) IN CASH

(15,416,978)

14,060,271

CASH BALANCE, Beginning of period

60,030,706

45,970,435

$ 44,613,728

$60,030,706

CASH BALANCE, End of period

See accompanying notes to financial statements.

Board of Governors Financial Statements 349
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
NOTES TO FINANCIAL STATEMENTS
AS OF AND FOR THE YEARS ENDING
DECEMBER 31, 2007 AND 2006
(1)

STRUCTURE

The Federal Reserve System (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, DC based staff numbering approximately 1,900, 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 results of operations and activities of the Board.
Combined financial statements for the Federal Reserve
Banks are included in the Board's annual report to the
Speaker of the House of Representatives.
(2) OPERATIONS AND SERVICES

The Board's responsibilities require thorough analysis
of domestic and international financial and economic developments. The Board carries out those responsibilities
in conjunction with other components of the Federal Reserve System. The Board also supervises and regulates
the operations of the Federal Reserve Banks, exercises
broad responsibility in the nation's payments system, and
administers most of the nation's laws regarding consumer
credit protection. Policy regarding open market operations is established by the Federal Open Market Committee. However, the Board has sole authority over changes
in reserve requirements, and it must approve any change
in the discount rate initiated by a Federal Reserve Bank.
The Board also plays a major role in the supervision
and regulation of the U.S. banking system. It has supervisory responsibilities for state-chartered banks that are
members of the Federal Reserve System, bank holding
companies, foreign activities of member banks, and U.S.
activities of foreign banks.
(3) SIGNIFICANT ACCOUNTING POLICIES

Basis of Accounting—The Board prepares its financial
statements in accordance with accounting principles generally accepted in the United States of America.
Revenues—The Board assesses the Federal Reserve
Banks for operating expenses and additions to property,
which are based on expected cash needs.

Currency Costs—Federal Reserve Banks issue new and
fit currency to the public and destroy currency already in
circulation as it becomes unfit or when a new design is
issued. Each year, the Board orders new currency from
the U.S. Department of Treasury's Bureau of Engraving
and Printing. The Board incurs expenses and assesses the
Federal Reserve Banks for printing, transporting, and retiring Federal Reserve Notes. These expenses and assessments are reported separately from the Board's operating
transactions in the Board's Statement of Revenues and
Expenses and Cumulative Results of Operations.
Allowance for Doubtful Accounts—Accounts receivable considered uncollectible are charged against the allowance account in the year they are deemed uncollectible. The allowance for doubtful accounts is adjusted
monthly, based upon a review of outstanding receivables.
Property, Equipment, and Software—The Board's
property, buildings, equipment, and software are stated at
cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on a straightline basis over the estimated useful lives of the assets,
which range from three to ten years for furniture and
equipment, ten to fifty years for building equipment and
structures, and two to ten years for software. Upon the
sale or other disposition of a depreciable asset, the cost and
related accumulated depreciation or amortization are removed from the accounts and any gain or loss is recognized.
The Board complies with Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which requires that certain costs incurred in the development of internal use software be capitalized and amortized over its useful life.
Art Collections—The Board has collections of works
of art, historical treasures, and similar assets. These collections are maintained and held for public exhibition in
furtherance of public service. Proceeds from any sales of
collections are used to acquire other items for collections.
As permitted by Statement of Financial Accounting Standards (SFAS) No. 116, Accounting for Contributions Received and Contributions Made, the cost of collections
purchased by the Board is charged to expense in the year
purchased and donated collection items are not recorded.
The value of the Board's collections has not been determined.
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 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 2006 amounts have been reclassified to conform with 2007 presentation.
SFAS No. 158, Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans—The
Board initially applied the provisions of SFAS No. 158,
Employers' Accounting for Defined Benefit Pension and
Other Postretirement Plans, at December 31, 2006. This
accounting standard requires recognition of the overfunded or underfunded status of a defined benefit post-

350 94th Annual Report, 2007
retirement plan in the Balance Sheets, and recognition of
changes in the funded status in the years in which the
changes occur through comprehensive income. The transition rules for implementing the standard required applying the provisions as of the end of the year of initial
implementation, and the effect as of December 31, 2006
is recorded as "Adjustment to initially apply SFAS No.
158" in the Statements of Revenues and Expenses and
Changes in Cumulative Results of Operations.

(5) ACCUMULATED RETIREMENT BENEFITS

(4) PROPERTY AND EQUIPMENT

The following is a summary of the components of the
Board's property and equipment, at cost, net of accumulated depreciation and amortization.
2007

Land
Buildings and
improvements
Furniture and
equipment
Software in use
Software in process
Construction in
process
Less accumulated
depreciation and
amortization
Property and equipment,
net

2006

$ 18,640,314 $ 18,640,314
149,968,504

147,504,169

55,625,014
14,745,157
2,064,438

47,271,434
13,681,508
941,912

1,550,565
242,593,992

360,967
228,400,304

(89,243,112)

(77,194,918)

$153,350,880 $151,205,386

Construction in process includes costs incurred in 2007
and 2006 for long-term security projects and building
enhancements.
The Board entered into capital leases for printing
equipment, which terminate in 2008. Furniture and equipment includes $1,230,000 in 2007 and 2006 for capitalized leases. Accumulated depreciation includes
$1,123,000 and $867,000 for capitalized leases as of 2007
and 2006, respectively. The Board paid interest related to
these capital leases in the amount of $31,000 and $54,000
for 2007 and 2006, respectively.
The future minimum lease payments required under
the capital leases and the present value of the net minimum lease payments as of December 31, 2007, are as
follows:
2008
Total minimum lease
payments
Less: Amount representing
maintenance
Net minimum lease
payments
Less: Amount representing
interest
Present value of net minimum
lease payments
Less: Current maturities of
capital lease payments ..
Long-term capital lease
obligations

$ 138,279
(26,743)
111,536
(2,781)
108,755
(108,755)
$

Substantially all of the Board's employees participate
in the Retirement Plan for Employees of the Federal
Reserve System (System Plan). The System Plan provides retirement benefits to employees of the Board, the
Federal Reserve Banks, and the Office of Employee Benefits of the Federal Reserve System (OEB). The Federal
Reserve Bank of New York, on behalf of the System,
recognizes the net asset and costs associated with the
System Plan in its financial statements. Costs associated
with the System Plan are not redistributed to other participating employers.
Employees of the Board who became employed prior
to 1984 are covered by a contributory defined benefits
program under the System Plan. Employees of the Board
who became employed 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. Based
on actuarial calculations, it was determined that employer
funding contributions were not required for the years
2007 and 2006, and the Board was not assessed a contribution for these years.
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. Activity for the BEP for 2007 and 2006 is
summarized in the following tables:
2007
2006
Change in projected
benefit obligation
Benefit obligation,
beginning of year ...
$1,354,662
$ 536,339
Service cost
329,282
185,483
Interest cost
87,837
45,004
Plan participants'
contributions
0
0
Plan amendments
0
0
Actuarial (gain)/loss
453,526
596,114
Benefits paid
(23,632)
(8,278)
Benefit obligation,
end of year
$2,201,675
$1,354,662
Accumulated benefit
obligation,
end of year
Weighted-average
assumptions used to
determine benefit
obligation as of
December 31
Discount rate
Rate of compensation
increase
Change in plan assets
Fair value of plan assets,
beginning of year...
Employer contributions ..
Plan participants'
contributions
Benefits paid
Fair value of plan assets,
end of year

$ 685,170

$ 546,854

6.25%

5.75%

5.00%

4.50%

0
23,632

0
(23,632)
$

0
8,278
0
(8,278)

Board of Governors Financial Statements 351
2006

2007

Reconciliation of funded
status, end of year
Funded status
Net actuarial (gain) loss ..
Prior service (credit) cost ..
Prepaid (Accrued)
pension cost
Amounts recognized in
the financial statements
consist of
Prepaid benefit cost
Accrued benefit liability ..
Intangible asset
Accumulated other
comprehensive
income
Net amount recognized ..
Components of net
periodic benefit cost
Service cost—benefits
earned during the
period
Interest cost on projected
benefit obligation ...
Expected return on plan
assets
Amortization of prior
service (credit) cost ..
Amortization of (gains)
losses
Amortization of initial
(asset) obligation ...
Net periodic benefit cost
(credit)

$(2,201,675)
1,006,257
(233,404)

$(1,354,662)
580,386
(247,417)

$(1,428,822)

$(1,021,693)

0
(1,428,822)
0

(332,969)
$(1,354,662)

$ 329,282

5; 185,483

87,837

45,004

(14,013)

27,655

Expected benefit
payments:
2008
2009
2010
2011
2012
2013-2017

430,761

3> 216,474

6.00%

5.75%

4.50%

82,134

82,134
96,170
109,602
120,750
127,690
724,518

$ 79,561
(14,013)
$ 65,548

A relatively small number of Board employees participate in the Civil Service Retirement System (CSRS) or
the Federal Employees' Retirement System (FERS).
These defined benefit plans are administered by the U.S.
Office of Personnel Management, which determines the
required employer contribution levels. The Board's contributions to these plans totaled $316,000 and $334,000 in
2007 and 2006, respectively. The Board has no liability
for future payments to retirees under these programs and
is not accountable for the assets of the plans.
Employees of the Board may also participate in the
Federal Reserve System's Thrift Plan. Board contributions to members' accounts are based upon a fixed
percentage of each member's basic contribution and were
$9,542,000 and $8,964,000 in 2007 and 2006,
respectively.
(6) ACCUMULATED POSTRETIREMEN! BENEFITS

The Board provides certain life insurance programs for
its active employees and retirees. Activity for 2007 and
2006 is summarized in the following tables:

Weighted-average
assumptions used to
determine net periodic
benefit cost for years
ended December 31
Discount rate
Rate of compensation
increase
Expected cashflows
Expected employer
contributions:
2008

0
(1,021,693)
0

(772,853)
$(2,201,675)

2006

2007

Estimated amounts that
will be amortized from
accumulated other
comprehensive income
into net periodic benefit
cost (credit) in 2008 are
shown below:
Net actuarial (gain)/loss ..
Prior service (credit)/cost ..
Total

2007

Change in benefit
obligation
Benefit obligation,
beginning of year ...
Service cost
Interest cost
Plan participants'
contributions
Plan amendments
Actuarial (gain) loss
Benefits paid
Benefit obligation,
end of year

2006

$8,111,829
198,791
479,903

$8,273,831
230,567
470,256

0
0
(533.208)
(284,846)
$7,972,469

$8,111.829

6.25%

6.00%

Weighted-average
assumptions used to
determine benefit
obligation as of
December 31
Discount rate
Change in plan assets
Fair value of plan assets,
beginning of year...
Employer contribution ...
Plan participants'
contributions
Benefits paid
Fair value of plan assets,
end of year

0
0
(603,500)
(259,325)

0
284,846

0
(284,846)
$

0
259,325
0
(259,325)

352 94th Annual Report, 2007
2006

2007

Reconciliation of funded
status at end of year
Benefit obligations
Unrecognized net
actuarial (gain) loss ..
Unrecognized prior
service cost
Amount recognized,
end of year
Amounts recognized in
the financial statements
consist of
Liability:
Accrued benefit cost
Accumulated other
comprehensive
income
Net amount recognized ..

Amounts recognized in
accumulated other
comprehensive income
consist of:
Net actuarial loss (gain) ..
Prior service cost (credit) ..
Transition obligation
(asset)
Deferred curtailment
(gain) loss

$(7,972,469)

$(8,111,829)

$(7,972,469)

$(8,111,829)

$(7,972,469)

$(8,111,829)

0
0
$(7,972,469)

0
0
$(8,111,829)

803,702
(89,741)

$ 1,422,398
(99,560)

$
Components of net
periodic benefit cost
Service cost—benefits
earned during the
period
Interest cost on projected
benefit obligation ...
Expected return on plan
assets
Amortization of prior
service (credit) cost ..
Amortization of (gains)
losses
Amortization of initial
(asset) obligation ...
Net periodic benefit cost
(credit)

2007

0
713,961

0
$ 1,322,838

Expected cashflows
Expected employer
contributions:
2008

$ 293,767

Expected benefit
payments:
2008
2009
2010
2011
2012
2013-2017

2006

$ 293,767
326,227
352,683
368,728
384,026
2,300,954

Estimated amounts that
will be amortized from
accumulated other
comprehensive income
into net periodic benefit
cost (credit) in 2008 are
shown below:
Net actuarial (gain) loss ...
Prior service (credit) cost ..
Total

$
$

7,425
(9,818)
(2,393)

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 $10,311,000 and
$9,607,000 in 2007 and 2006, respectively.
(7) ACCUMULATED POSTEMPLOYMENT BENEFITS

198,791

230,567

479,902

470,256

(9,818)

85,487
0
$

Weighted-average
assumptions used to
determine net periodic
benefit cost for years
ended December 31
Discount rate

120,022
0

754,362

5.75%

811,027

5.50%

The Board provides certain postemployment benefits
to eligible former or inactive employees and their dependents during the period subsequent to employment but
prior to retirement. Postemployment costs were actuarially determined using a December 31 measurement date
and discount rates of 5.75 percent as of December 31,
2007 and 2006. The accrued postemployment benefit
costs recognized by the Board for the years ended December 31, 2007 and 2006, were $3,055,000 and $1,963,000,
respectively.
(8) ACCUMULATED OTHER COMPREHENSIVE INCOME

Following is a reconciliation of beginning and ending
balances of accumulated other comprehensive income.

Board of Governors Financial Statements 353

Amount related
to defined benefit
retirement plans
Balance at
January 1,
2006
Adjustment to
initially apply
SFAS
No. 158
Balance at
December 31,
2006
Change in funded
status of
benefit plans:
Amortization of
prior service
costs
Amortization of
net actuarial
gain (loss) ..
Net actuarial
(gain) loss
arising during
the year
Change in funded
status of
benefit
plans—
other
comprehensive
income
gain (loss) ..
Balance at
December 31,
2007

Amount related
to postretirement
benefits other
than pensions

332,969

1,322,837

332,969

$ 1,322,837

Total accumulated
other comprehensive income (loss)
Change in funded
status of
benefit
plans—
other
comprehensive
income
gain (loss) ...
Balance at
December 31,
2007

168,992
$(1,486,814)

Additional detail regarding the classification of
accumulated other comprehensive income is included in
notes 5 and 6.
14,013

9,818

(27,655)

(85,487)

453,526

(533,207)

(9) COMMITMENTS AND CONTINGENCIES

Leases
The Board has entered into several operating leases to
secure office, training and warehouse space. Minimum
annual payments under the operating leases having an
initial or remaining noncancelable lease term in excess of
one year at December 31, 2007, are as follows:

2008
2009
2010
2011
After 2011 . .
..
439,884
$

772,853

(608,876)
$

713,961

$ 1,623,970
1,961,223
2.013,281
1,944,142
9,118,887
$16,661,503

Rental expenses under the operating leases were
$539,000 and $193,000 in 2007 and 2006, respectively.
Deferred Leases

Total accumulated
other comprehensive income (loss)
Balance at
January 1,
2006
Adjustment to
initially apply
SFAS
No. 158
Balance at
December 31,
2006
Change in funded
status of
benefit plans:
Amortization of
prior service
costs
Amortization of
net actuarial
gain (loss)
Net actuarial
(gain) loss
arising during
the year

(1,655,806)

The Board's operating leases contain rent abatements
and scheduled rent increases. According to accounting
principles generally accepted in the United States of
America, rent abatements and scheduled rent increases
must be considered in determining the annual rent expense to be recognized. The deferred rent represents the
difference between the actual lease payments and the rent
expense recognized. The current balance of deferred rent
is $318,000 and $8,000 in 2007 and 2006, respectively.
Commitments

$ (1,655,806)

(23,831)
113,142

79,681

The Board has entered into an agreement with the
Federal Deposit Insurance Corporation and the Office of
the Comptroller of the Currency, through the Federal Financial Institutions Examination Council (the Council) to
fund a portion of enhancements and maintenance fees for
a central data repository project through 2013. The estimated total Board expense to support this effort is
$7.5 million.
In 2007, the Council began a rewrite of the Home
Mortgage Disclosure Act processing system, for which
the Board provides data processing services. The estimated total Board expense to support this effort is
$3.2 million through 2010.

354 94th Annual Report, 2007
Litigation

2007

The Board is subject to contingent liabilities which
include litigation cases. These contingent liabilities arise
in the normal course of operations and their ultimate
disposition is unknown. Based on information currently
available to management, it is management's opinion that
the expected outcome of these matters, individually or in
the aggregate, will not have a materially adverse effect on
the financial statements. Management believes the Board
has substantial defenses and that the likelihood of an
adverse judgment is remote.
(io)

FEDERAL FINANCIAL INSTITUTIONS EXAMINATION
COUNCIL

The Board is one of the five member agencies of the
Council, and currently performs certain management
functions for the Council. The five agencies which are
represented on the Council are the Board, Federal Deposit
Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and
Office of Thrift Supervision. The Board's financial statements do not include financial data for the Council. Activity related to the Board and Council for 2007 and 2006 is
summarized in the following table:
2007

Council expenses charged
to the Board
Assessments for
operating expenses .
Central Data
Repository
Uniform Bank
Performance
Report
Total Council
expenses
charged to
the Board
Board expenses charged
to the Council
Data processing
related services
Administrative
services
Total Board
expenses
charged to
the Council

2006

$ 108,163

$ 109.760

1,167,449

740,003

192,026

204,617

$1,467,638

$1,054,380

$4,457,647

$3,429,499

190,800

183,000

$4,648,447

$3,612,499

2006

$384,142

$395,551

$ 64,087

Accounts receivable due
from the Council ...
Accounts payable due
to the Council

54,870

(11) FEDERAL RESERVE BANKS

The Board performs certain functions for the Resrvve
Banks in conjunction with its responsibilities for the System, and the Reserve Banks provide certain adminisirative functions for the Board. Activity related to the Board
and Reserve Banks for 2007 and 2006 is summarized in
the following table:
As of December 31,
2007

Reserve Bank expenses
charged to the Board
Data processing and
communication
Contingency site
Total Reserve Bank
expenses charged
to the Board

2,064,110 $
1,152,166

2006

2,161,298
1,087,429

3,216,276 $

3,248,727

Board expenses charged
to the Reserve Banks
Assessments for
currency costs
$576,306,073 $491,962,202
Assessments for
operating expenses
296,124,700 301,013,500
of the Board
704,840
731,999
Data processing
Total Board expenses
charged to the
Reserve Banks ... $873,135,613 $793,707,701
Accounts receivable due
from Federal Reserve
Banks
$
Accounts payable due
to the Reserve
Banks
$

1,270,582 $

854,142

10 $

12,417

(12) THE OFFICE OF EMPLOYEE BENEFITS OF THE
FEDERAL RESERVE SYSTEM

OEB administers certain System benefit programs on
behalf of the Board and the Reserve Banks, and costs
associated with the OEB's activities are assessed to the
Board and Reserve Banks. The Board was assessed
$2,866,676 and $2,380,474 in 2007 and 2006,
respectively.

Board of Governors Financial Statements 355

Deloitte
INDEPENDENT AUDITORS' REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED UPON THE AUDIT PERFORMED IN ACCORDANCE
WITH GOVERNMENT AUDITING STANDARDS
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 year ended December 31, 2007, and have issued our
report thereon dated March 19, 2008. 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