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97th Annual Report
2010

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

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Letter of Transmittal

Board of Governors of the Federal Reserve System
Washington, D.C.
June 2011

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 ninetyseventh annual report of the Board of Governors of the Federal Reserve System.
This report covers operations of the Board during calendar year 2010.
Sincerely,

Ben Bernanke
Chairman

i

Contents

Overview

..................................................................................................................................... 1

About this Report ....................................................................................................................... 1
About the Federal Reserve System .............................................................................................. 1

Monetary Policy and Economic Developments

............................................................ 5

Monetary Policy Report of March 2011 ........................................................................................ 5
Monetary Policy Report of July 2010 .......................................................................................... 48

Banking Supervision and Regulation .............................................................................. 71
Overview .................................................................................................................................. 71
2010 Developments .................................................................................................................. 71
Supervision .............................................................................................................................. 74
Regulation ................................................................................................................................ 94

Consumer and Community Affairs

................................................................................. 97

Rulemaking and Regulations ..................................................................................................... 97
Oversight and Enforcement ..................................................................................................... 103
Responding to Consumer Complaints and Inquiries .................................................................. 112
Supporting Community Economic Development ....................................................................... 114
Consumer Advisory Council ..................................................................................................... 116

Federal Reserve Banks ........................................................................................................ 121
Developments in Federal Reserve Priced Services .................................................................... 121
Developments in Currency and Coin ........................................................................................ 124
Developments in Fiscal Agency and Government Depository Services ....................................... 124
Developments in the Use of Federal Reserve Intraday Credit ..................................................... 127
Electronic Access to Reserve Bank Services ............................................................................ 128
Information Technology ........................................................................................................... 128
Examinations of the Federal Reserve Banks ............................................................................. 128
Income and Expenses ............................................................................................................. 129
SOMA Holdings and Loans ...................................................................................................... 129
Federal Reserve Bank Premises ............................................................................................... 132

Other Federal Reserve Operations .................................................................................. 141
The Board of Governors and the Government Performance and Results Act .............................. 141
Federal Legislative Developments ............................................................................................ 144

ii

Record of Policy Actions of the Board of Governors ............................................. 153
Rules and Regulations ............................................................................................................. 153
Policy Statements and Other Actions ....................................................................................... 157
Special Liquidity Facilities and Other Initiatives ......................................................................... 159
Discount Rates for Depository Institutions in 2010 .................................................................... 161

Minutes of Federal Open Market Committee Meetings ......................................... 163
Meeting Held on January 26–27, 2010 ...................................................................................... 164
Meeting Held on March 16, 2010 ............................................................................................. 190
Meeting Held on April 27–28, 2010 ........................................................................................... 200
Meeting Held on June 22–23, 2010 .......................................................................................... 220
Meeting Held on August 10, 2010 ............................................................................................ 241
Meeting Held on September 21, 2010 ...................................................................................... 251
Meeting Held on November 2–3, 2010 ...................................................................................... 260
Meeting Held on December 14, 2010 ....................................................................................... 280

Litigation ................................................................................................................................. 291
Statistical Tables .................................................................................................................... 293
Federal Reserve System Audits ........................................................................................ 321
Board of Governors Financial Statements ................................................................................. 322
Federal Reserve Banks Combined Financial Statements ........................................................... 342
Office of Inspector General Activities ........................................................................................ 406
Government Accountability Office Reviews ............................................................................... 407

Federal Reserve System Organization

........................................................................... 409
Board of Governors ................................................................................................................. 409
Federal Open Market Committee ............................................................................................. 414
Board of Governors Advisory Councils ..................................................................................... 415
Federal Reserve Bank Branches .............................................................................................. 418

Index ......................................................................................................................................... 435

1

Overview

The Federal Reserve, the central bank of the United
States, is a federal system composed of a central governmental agency—the Board of Governors—and 12
regional Federal Reserve Banks.
The Board of Governors, located in Washington,
D.C., consists of seven members appointed by the
President of the United States and supported by a
2,200-person staff. Besides conducting research,
analysis, and policymaking related to domestic and
international financial and economic matters, the
Board plays a major role in the supervision and regulation of the U.S. banking system and administers
most of the nation’s laws regarding consumer credit
protection. It also has broad oversight responsibility
for the nation’s payments system and the operations
and activities of the Federal Reserve Banks.

About this Report
This report covers Board and System operations and
activities during calendar-year 2010. The report
includes 11 sections:
• Monetary Policy and Economic Developments. Section 1 (beginning on page 5) provides adapted versions of the February 2011 and July 2010 Monetary Policy Report to the Congress.
• Federal Reserve Operations. Sections 2 through 5
(beginning on page 121) provide summaries of
Board and System activities in the areas of banking supervision and regulation, consumer and community affairs, and Reserve Bank operations. It
also summarizes Board compliance with the Government Performance and Results Act of 1993 and
its activities regarding legislative developments that
affected Board operations in 2010.
• Record of Policy Actions. Sections 6 through 8
(beginning on page 153) provide an account of
actions taken by the Board on questions of policy

For More Background on Board
Operations
For more information about the Federal Reserve
Board and the Federal Reserve System, visit the
Board’s website at www.federalreserve.gov/
aboutthefed/default.htm. An online version of this
Annual Report is available at www.federalreserve
.gov/boarddocs/rptcongress.

in 2009, and it also includes the policy actions of
the Federal Open Market Committee (FOMC).1
• Statistical Tables. Section 9 (beginning on page
293) includes 14 statistical tables that provide
updated historical data concerning Board and
System operations and activities.
• Federal Reserve System Audits. Section 10 (beginning on page 321) provides detailed information on
the several levels of audit and review conducted
that concern System operations and activities,
including those provided by outside auditors and
the Board’s Office of Inspector General.
• Federal Reserve System Organization. Section 11
(beginning on page 409) provides listings of key
officials at the Board and in the Federal Reserve
System, including the Board of Governors, its officers, FOMC members, several System councils, and
Federal Reserve Bank and Branch officers and
directors.

About the Federal Reserve System
The Federal Reserve System, which serves as the
nation’s central bank, was created by an act of Congress on December 23, 1913. The System consists of
a seven-member Board of Governors with headquar1

For more information on the FOMC, see the Board’s website at
www.federalreserve.gov/monetarypolicy/fomc.htm.

2

97th Annual Report | 2010

ters in Washington, D.C., and the 12 Reserve Banks
located in major cities throughout the United States.
The Federal Reserve Banks are the operating arms of
the central banking system, carrying out a variety of
System functions, including operating a nationwide
payment system; distributing the nation’s currency
and coin; under authority delegated by the Board of
Governors, supervising and regulating bank holding

■ Federal Reserve Bank city
■
N Board of Governors of the Federal Reserve System, Washington, D.C.

companies and state-chartered banks that are members of the System; serving as fiscal agents of the
U.S. Treasury; and providing a variety of financial
services for the Treasury, other government agencies,
and other fiscal principals.
The maps below and opposite identify Federal
Reserve Districts by their official number, city, and
letter designation.

Overview

■ Federal Reserve Bank city
● Federal Reserve Branch city
■
N Board of Governors of the Federal Reserve System, Washington, D.C.
—Branch boundary

3

5

Monetary Policy and
Economic Developments

As required by section 2B of the Federal Reserve Act,
the Federal Reserve Board submits written reports to
the Congress that contain discussions of “the conduct of monetary policy and economic developments
and prospects for the future.” The Monetary Policy
Report to the Congress, submitted semiannually to the
Senate Committee on Banking, Housing, and Urban
Affairs and to the House Committee on Banking and
Financial Services, is delivered concurrently with testimony given by the Chairman of the Federal Reserve
Board.
The following discussion is an annual review of U.S.
monetary policy and economic developments in 2010.
It includes the text, tables, and selected figures from
the March 1, 2011, report; the figures have been
renumbered, and therefore the figure numbers differ
from those in the report. Also included are the text
and table from Parts 1–3 of the July 21, 2010, report;
Part 4 of that report is identical to the addendum to
the minutes of the June 22−23, 2010, meeting of the
Federal Open Market Committee (FOMC) and is
presented with those minutes in the “Minutes” section of this annual report.
The complete Monetary Policy Reports are 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 2010 meetings of the FOMC (see the
“Minutes” section on page 163) and statistical tables 1–4
(see the “Statistical Tables” section on page 293).

Monetary Policy Report
of March 2011
Part 1
Overview: Monetary Policy
and the Economic Outlook
Economic activity in the United States expanded at a
moderate pace, on average, in the second half of 2010
and early 2011. In the spring and early summer, a

number of key indicators of economic activity softened relative to the readings posted in late 2009 and
the first part of 2010, raising concerns about the
durability of the recovery. In light of these developments—and in order to put the economic recovery
on a firmer footing—the Federal Open Market Committee (FOMC) provided additional monetary policy
stimulus during the second half of 2010 by reinvesting principal repayments from its holdings of agency
debt and agency mortgage-backed securities in
longer-term Treasury securities and by announcing
its intention to purchase an additional $600 billion of
Treasury securities by the end of the second quarter
of 2011.
Financial market conditions improved notably in the
fall of 2010, partly in response to actual and expected
increases in monetary policy accommodation. In
addition, later in the year, the tenor of incoming economic news strengthened somewhat, and the downside risks to economic growth appeared to recede.
Nonetheless, the job market has improved only
slowly. Employment gains have been modest, and
although the unemployment rate fell noticeably in
December and January, the margin of slack in the
labor market remains wide. Meanwhile, despite rapid
increases in commodity prices, longer-term inflation
expectations remained stable, and measures of
underlying consumer price inflation continued to
trend downward on net.
Real gross domestic product (GDP) rose at a moderate rate in the third quarter. Inventories provided the
principal impetus to growth while final sales showed
little vigor—the same pattern that prevailed in the
first half of the year. Less favorable readings that
began to emerge during the second quarter for a
range of indicators—new claims for unemployment
insurance, industrial production, and numerous surveys of business activity, among others—pointed to a
slowing in the pace of the recovery and suggested
that the transition from a recovery boosted importantly by the inventory cycle to one propelled mainly
by private final demand was proceeding only very

6

97th Annual Report | 2010

gradually. Later in the year, however, this process
appeared to gain traction. Indeed, real GDP is estimated to have risen a little faster in the fourth quarter than in the third quarter despite a substantial
slowdown in the pace of inventory investment in the
fourth quarter; final sales increased much more rapidly in the fourth quarter than earlier.
Over the second half of 2010, consumer spending
posted a solid gain, boosted in part by continued,
albeit modest, increases in real wage and salary
income; some waning of the drag on outlays from
earlier declines in household net worth; and a modest
improvement in the availability of consumer credit.
Businesses continued to step up their spending on
equipment and software in response to a brighter
outlook for sales as well as more favorable conditions
in credit markets. In the external sector, the continued
rebound in exports was supported by firming foreign
demand. Meanwhile, the construction sector
remained exceptionally weak.
The continued recovery in economic activity has been
accompanied by only a slow improvement in labor
market conditions. Private payroll employment has
moved up at a relatively tepid rate—about 115,000
per month, on average, since the February 2010
trough in employment—recouping only a small portion of the 8¾ million jobs lost during 2008 and
2009. Over most of this period, the pace of hiring
was insufficient to substantially reduce the unemployment rate. In December and January, however,
the jobless rate was reported to have declined noticeably. In addition to the recent drop in the unemployment rate, some other indicators of labor market
conditions—for example, measures of firms’ hiring
plans—have brightened a bit, raising the prospect
that a pickup in the pace of hiring may be in the offing. That said, the level of the unemployment rate
remains very elevated, and the long-term unemployed
continue to account for a historically large fraction of
overall joblessness.
Consumer price inflation trended down during 2010
as slack in resource utilization restrained cost pressures while longer-term inflation expectations
remained stable. Although the prices of crude oil and
many industrial and agricultural commodities rose
rapidly in the latter half of 2010 and the early part of
2011, overall personal consumption expenditures
(PCE) prices increased at an annual rate of just
1¼ percent over the 12 months ending in January,
which compares with a 2½ percent rise during the
preceding 12 months. Core PCE prices—which

exclude prices for food and energy—rose ¾ percent
in the 12 months ending in January.
Financial market conditions continued to be supportive of economic growth in the second half of 2010
and into 2011. Equity prices rose solidly, reflecting
the more accommodative stance of monetary and fiscal policy, an improved economic outlook, and
better-than-expected corporate earnings reports.
Yields on longer-term Treasury securities declined in
the summer and early autumn, reflecting in part
anticipation of additional monetary policy stimulus,
but subsequently rose as economic prospects
improved and as market expectations of the ultimate
size of FOMC Treasury purchases were revised
down. Despite some volatility, yields on Treasury
securities remained relatively low on balance.
Medium- and longer-term inflation compensation
derived from inflation-indexed Treasury securities
increased since the summer as concerns about deflation eased, though these measures remained within
historical ranges. Interest rates on fixed-rate residential mortgages moved broadly in line with yields on
Treasury securities while the spreads between yields
on corporate bonds and those on Treasury securities
declined; overall, both mortgage rates and corporate
yields continued to be at low levels. Although bank
lending policies generally stayed tight, banks
reported some easing in those conditions on net.
After posting substantial declines since the third
quarter of 2008, total loans held on the books of
banks showed signs of stabilizing in recent months.
Larger nonfinancial corporations with access to capital markets took advantage of favorable financial
conditions to issue debt at a robust pace. Bond and
syndicated loan issuance was strong, particularly
among lower-rated corporate borrowers. Commercial
and industrial loans on banks’ books started to
expand around the end of 2010. Nevertheless, small,
bank-dependent businesses remained constrained in
their access to credit, although some indicators suggested that credit availability for these firms was
beginning to improve.
Household debt appears to have contracted in the
second half of 2010, but at a somewhat slower pace
than earlier in the year. Household mortgage debt
likely continued to decline, as housing demand
remained weak and lending standards were reportedly still stringent. Revolving consumer credit also
contracted. By contrast, nonrevolving consumer
credit—primarily auto and student loans—increased
solidly in the final quarter of 2010.

Monetary Policy and Economic Developments

After first emerging during the spring, concerns
about fiscal and banking developments in Europe
resurfaced later in the year. Although some European sovereigns and financial institutions faced
renewed funding pressures in the fourth quarter, the
repercussions in broader global financial markets
were muted. To help minimize the risk that strains
abroad could spread to the United States, as well as
to continue to support liquidity conditions in global
money markets, the FOMC in December approved
an extension of the temporary U.S. dollar liquidity
swap arrangements with a number of foreign central
banks.
Apparently seeking to boost returns in an environment of low interest rates, investors displayed an
increased appetite for higher-yielding fixed-income
instruments in the second half of 2010 and into 2011,
which likely supported strong issuance of these products and contributed to a narrowing of risk spreads,
such as those on corporate debt instruments. Information from a variety of sources, including the Federal Reserve Board’s Senior Credit Officer Opinion
Survey on Dealer Financing Terms, suggests that use
of dealer-intermediated leverage by financial market
participants rose a bit in recent quarters but
remained well below its pre-crisis levels.1 The condition of financial institutions generally appeared to
improve further, and the regulatory capital ratios of
commercial banks, particularly the largest banks,
moved higher.
With the pace of recovery in output and employment
seen as disappointingly slow and measures of inflation viewed as somewhat low relative to levels judged
consistent with the Committee’s mandate, the
FOMC took several actions to provide additional
support to the economic recovery during the second
half of last year. In August, the FOMC decided to
reinvest principal payments from agency debt and
agency mortgage-backed securities held in the System
Open Market Account (SOMA) in longer-term
Treasury securities to keep constant the size of the
SOMA portfolio and so avoid an implicit tightening
of monetary policy. In November, to provide further
policy accommodation to help support the economic
recovery, the FOMC announced its intention to purchase an additional $600 billion in longer-term Treasury securities by the end of the second quarter of
2011. Throughout the second half of 2010 and early
2011, the FOMC maintained a target range for the
1

The survey is conducted quarterly and is available at
www.federalreserve.gov/econresdata/releases/scoos.htm.

7

federal funds rate of between 0 and ¼ percent and
reiterated its expectation that economic conditions,
including low rates of resource utilization, subdued
inflation trends, and stable inflation expectations,
were likely to warrant exceptionally low levels for the
federal funds rate for an extended period.
The Federal Reserve continued to develop and test
tools to drain or immobilize large volumes of banking system reserves in order to ensure that it will be
able to smoothly and effectively exit from the current
extraordinarily accommodative policy stance at the
appropriate time. The Committee continues to monitor the economic outlook and financial developments, and it will employ its policy tools as necessary
to support the economic recovery and to help ensure
that inflation, over time, returns to levels consistent
with its mandate.
The economic projections prepared in conjunction
with the January FOMC meeting are presented in
Part 4 of this report. In broad terms, FOMC participants anticipated a sustained but modest recovery in
real economic activity this year that would pick up
somewhat in 2012 and 2013. The expansion was
expected to be led by gains in consumer and business
spending that are supported by improvements in
household and business confidence. Nevertheless,
economic growth was expected to be damped by a
number of headwinds, including the gradual pace of
improvements in the labor market, still-stringent borrowing conditions for households and bankdependent small businesses, lingering household and
business uncertainty, and ongoing weakness in real
estate markets. On balance, FOMC participants
anticipated that real GDP would increase at abovetrend rates over the next three years, but not as rapidly as in previous recoveries. Meanwhile, the unemployment rate was projected to fall gradually. Inflation was expected to drift up slowly toward the levels
that Committee participants believe to be most consistent with the Committee’s mandate. Reflecting
their assessment that the recovery appeared to be on
a firmer footing, the participants upgraded slightly
their projections for near-term economic growth relative to the ones they prepared in conjunction with the
November FOMC meeting; otherwise, their projections for economic growth and inflation were little
changed.
Participants generally judged that the uncertainty
attached to their projections for both economic activity and inflation was greater than historical norms. A
substantial majority of participants viewed the risks

8

97th Annual Report | 2010

to both economic growth and inflation as balanced;
only a few saw them as tilted either to the upside or
to the downside. In November, a noticeable share of
participants had seen the risks—particularly those to
economic growth—as tilted to the downside. Participants also reported their assessments of the rates to
which key macroeconomic variables would be
expected to converge over the longer term under
appropriate monetary policy and in the absence of
further shocks to the economy. The central tendencies of these longer-run projections were 2.5 to
2.8 percent for real GDP growth, 5.0 to 6.0 percent
for the unemployment rate, and 1.6 to 2.0 percent for
the inflation rate.

Part 2
Recent Economic
and Financial Developments
Economic activity expanded at a moderate pace, on
balance, in the second half of 2010. According to the
currently available estimates from the Bureau of Economic Analysis, real gross domestic product (GDP)
increased at an annual rate of about 2¾ percent, on
average, over that period (figure 1). In the third quarter, as had been the case in the first half of the year,
much of the increase was the result of inventory
accumulation; in contrast, final sales continued to
rise at a subdued rate. Meanwhile, several indicators
of economic activity had softened from the readings
observed earlier in the year, raising concerns about
the durability of the recovery. Later in the year, howFigure 1. Change in real gross domestic product, 2004–10
Percent, annual rate

4

H2
H1 Q3

Q4
2
+
0_

H1

2
4

2004

2005

2006

2007

2008

2009

2010

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.

ever, the tone of the incoming data on economic
activity brightened somewhat, final sales strengthened, and the recovery appeared to be on a firmer
footing.
Since the middle of 2010, consumer spending has
risen solidly on average, businesses have continued to
increase their outlays for equipment and software,
and exports have moved up further. In contrast, construction of new homes and nonresidential buildings
remains exceptionally weak. Conditions in the labor
market have improved only slowly, with payrolls
increasing at a modest pace. Throughout nearly all of
2010, that pace of employment expansion was insufficient to bring the unemployment rate down meaningfully from its recent peak. In December 2010 and
January of this year, however, the unemployment rate
is estimated to have dropped more noticeably, even
though payroll employment gains remained lackluster. Meanwhile, long-duration joblessness persisted at
near-record levels. With regard to inflation developments, despite rapid increases in commodity prices,
longer-term inflation expectations have remained
stable and consumer price inflation has continued to
trend downward on net.
Conditions in financial markets generally improved
over the course of the second half of 2010 and early
2011 and continued to be supportive of economic
activity. This improvement reflected, in part, additional monetary policy stimulus provided by the Federal Reserve, as well as growing investor confidence
in the sustainability of the economic recovery.
Although yields on Treasury securities rose somewhat, on net, since mid-2010, yields on investmentgrade corporate bonds were little changed at low levels, and yields on speculative-grade bonds declined.
In equity markets, price indexes generally rose,
buoyed by solid corporate earnings and a more positive economic outlook. Commercial banks reported
that they had eased some of their lending standards
and terms, though lending standards remained generally tight and some businesses and households continued to face difficulties obtaining credit. Changes
in interest rates faced by households were mixed. The
improvement in financial conditions was accompanied by some signs of a pickup in the demand for
credit. Borrower credit quality generally improved,
although problems persisted in some sectors of the
economy. Concerns about European banking and fiscal strains increased again in late 2010 after having

Monetary Policy and Economic Developments

eased for a time; however, in contrast to what was
observed in the spring, these concerns left little
imprint on U.S. financial markets.

9

Figure 2. Change in real disposable personal income and in
real wage and salary disbursements, 2004–10
Percent, annual rate

Domestic Developments

Real disposable personal income
Real wage and salary disbursements

8

The Household Sector

Consumer Spending and Household Finance
Real personal consumption expenditures (PCE)
increased at an annual rate of about 3¼ percent in
the second half of 2010, with a particularly brisk rise
in the fourth quarter. The spending gains were supported by the continued, though modest, pickup in
real household incomes, by some fading of the
restraining effects of the earlier sharp declines in
households’ net worth, and by a modest improvement in the availability of consumer credit. Outlays
for durable goods also may have been boosted to
some extent by purchases that had been deferred during the recession. The increases in spending exceeded
the rise in income, and the saving rate edged down
during the second half of the year, though it remains
well above levels that prevailed prior to the recession.
The increase in consumer outlays in the second half
of 2010 partly reflected a step-up in sales of new light
motor vehicles (cars, sport utility vehicles, and
pickup trucks). Sales of light vehicles rose from an
annual rate of 11¼ million units in the second quarter of 2010 to more than 12¼ million units in the
fourth quarter and moved up further in the first part
of 2011. Sales were supported, in part, by further
improvements in credit conditions for auto buyers as
well as by more-generous sales incentives from the
automakers. Real spending in other goods categories
also rose appreciably, while the increase in outlays for
services was more subdued.
The determinants of consumer outlays showed further, albeit gradual, improvement during the second
half of 2010. The level of real disposable personal
income (DPI)—after-tax income adjusted for inflation—which rose rapidly in the first half of the year,
continued to advance in the second half, as real wages
and salaries moved up at an annual rate of 2 percent
(figure 2). The increase in real wage and salary
income reflected the continued, though tepid, recoveries in both employment and hours worked; in contrast, hourly pay was little changed in real terms.
The ratio of household net worth to DPI moved up a
little in the third quarter of 2010 and appears to have
risen further since then, as increases in equity values

6
4

H1
H2

2
+
0_
2
4
6

2004

2005

2006

2007

2008

2009

2010

Source: Department of Commerce, Bureau of Economic Analysis.

likely more than offset further declines in house
prices. Although the wealth-to-income ratio has
trended up since the beginning of 2009 and has
returned to the levels that prevailed prior to the late
1990s, it remains well below its highs in 2006 and
2007. Consumer sentiment rose late in the year,
boosted by gradual improvements in household
assessments of financial and business conditions as
well as job prospects; nevertheless, these gains only
moved sentiment back to or a bit above the low levels
that prevailed at the start of last year.
Household debt likely fell at just under a 2 percent
annual rate in the second half of 2010, a slightly
slower pace than in the first half. The contraction for
2010 as a whole, which was due primarily to ongoing
decreases in mortgage debt, marked the second consecutive annual decline. The reduction in overall
household debt levels, combined with increases in
personal income, resulted in a further decline in the
ratio of household debt to income and in the debt
service ratio—the required principal and interest payments on existing mortgage and consumer debt relative to income (figure 3).
The slowdown in the rate at which household debt
contracted in the latter part of 2010 stemmed in large
part from a modest recovery in consumer credit.
Although revolving consumer credit—mostly credit
card borrowing—continued to contract, the decline
was at a slightly slower rate than in the first half of
the year. Nonrevolving consumer credit, which consists largely of auto and student loans and accounts
for about two-thirds of total consumer credit, rose
2 percent in the second half of 2010 after being about

10

97th Annual Report | 2010

lingering adjustments by banks to the imposition of
new rules under the Credit Card Accountability
Responsibility and Disclosure Act (Credit Card
Act).3

Figure 3. Household debt service, 1980–2010
Percent of disposable income

14

13

12

11

1982

1986

1990

1994

1998

2002

2006

2010

Note: The data are quarterly and extend through 2010:Q3. Debt service payments
consist of estimated required payments on outstanding mortgage and consumer
debt.
Source: Federal Reserve Board, “Household Debt Service and Financial Obligations Ratios,” statistical release.

unchanged in the first half of the year. The pickup in
nonrevolving consumer credit is consistent with
responses to the Senior Loan Officer Opinion Survey
on Bank Lending Practices (SLOOS) indicating that
banks have become increasingly willing to make consumer installment loans; however, lending standards
for these loans likely remained fairly tight.2 In addition, in the most recent survey, a small net fraction of
respondents noted increased demand for consumer
loans, the first time stronger demand was reported
since mid-2005.
Some of the increased willingness to make consumer
loans may reflect improvements in consumer credit
quality. The delinquency rate on auto loans at captive
finance companies moved down in the second half of
2010 to 2.6 percent, close to its longer-run historical
average. Delinquency rates on credit cards at commercial banks and in securitized pools also moved
down to around longer-run averages. However,
charge-off rates on such loans remained well above
historical norms despite having moved lower in the
second half of the year.
Changes in interest rates on consumer loans were
mixed. Interest rates on new auto loans were little
changed, on net, in the second half of 2010 and into
2011. By contrast, interest rates on credit cards generally rose over the same period. A portion of the
increase in credit card interest rates may be due to
2

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.

Issuance of consumer asset-backed securities (ABS)
in the second half of 2010 occurred at about the
same pace as in the first half of the year. Auto loan
ABS issuance continued to be healthy, and the ability
to securitize these loans likely held down interest
rates on the underlying loans. Issuance of ABS
backed by credit card loans, however, remained very
weak, as the sharp contraction in credit card lending
limited the need for new funding and accounting rule
changes implemented at the beginning of 2010 made
securitization of these loans less attractive.4 Yields on
ABS securities and the spreads of such yields over
comparable-maturity interest rate swap rates were
not much changed, on net, over the second half of
2010 and early 2011.
Residential Investment and Housing Finance
Housing activity remained depressed in the second
half of 2010. Homebuilding continues to be
restrained by sluggish demand, the large inventory of
foreclosed or distressed properties on the market, and
the tight credit conditions faced by homebuilders. In
the single-family sector, new units were started at an
average annual rate of about 430,000 units from
July 2010 to January 2011, just 70,000 units above the
quarterly low reached in the first quarter of 2009
(figure 4). In the multifamily market, demand for
apartments appears to be increasing and occupancy
rates have been edging up, as some potential homebuyers may be choosing to rent rather than to purchase a home. Nevertheless, the inventory of unoccupied multifamily units continues to be elevated, and
construction financing remains tight. As a result,
starts in the multifamily sector have averaged an
annual rate of only 135,000 units since the middle of
2010, well below the 300,000-unit rate that had prevailed for much of the previous decade.

3

4

The Credit Card Act includes some provisions that place restrictions on issuers’ ability to impose certain fees and to engage in
risk-based pricing.
In June 2009, the Financial Accounting Standards Board
(FASB) published Statements of Financial Accounting Standards Nos. 166 (Accounting for Transfers of Financial Assets, an
Amendment of FASB Statement No. 140) and 167 (Amendments
to FASB Interpretation No. 46(R)). The statements became
effective at the start of a company’s first fiscal year beginning
after November 15, 2009, or, for companies reporting earnings
on a calendar-year basis, after January 1, 2010.

Monetary Policy and Economic Developments

Figure 4. Private housing starts, 1997–2011

11

Figure 5. Prices of existing single-family houses, 2001–10

Millions of units, annual rate

Index value

100
Single-family

1.6

90
CoreLogic
price index

1.2

FHFA
index

70

.8

60

Multifamily

1997

1999

2001

2003

.4

2005

2007

2009

S&P/Case-Shiller
20-city index

2011

2001

Note: The data are monthly and extend through January 2011.
Source: Department of Commerce, Bureau of the Census.

Home sales surged in the spring ahead of the expiration of the homebuyer tax credit, plunged for a few
months during a payback period, and then recovered
somewhat as the payback effect waned.5 By late 2010
and early 2011, sales of existing single-family homes
were a bit above levels that prevailed in mid-2009,
before the enactment of the first homebuyer tax
credit, while sales of new single-family homes
remained below their mid-2009 levels. Housing
demand has been held back by tight mortgage credit
availability, uncertainty about future real estate values, and continued household concerns about the
outlook for employment and income. Nonetheless,
other determinants of housing demand are favorable
and hold the potential to provide support to home
sales as the economic recovery proceeds. In particular, the low level of mortgage rates and the earlier
declines in house prices have made housing more
affordable for those able to obtain mortgages.
House prices, as measured by several national
indexes, decreased in the latter half of 2010 after having shown tentative signs of leveling off earlier in the
year (figure 5). According to one measure with wide
geographic coverage—the CoreLogic repeat-sales
5

80

In order to receive the homebuyer tax credit, a purchaser had to
sign a sales agreement by the end of April 2010 and close on the
property by the end of September. The first-time homebuyer
tax credit, which was enacted in February 2009 as part of the
American Recovery and Reinvestment Act, was originally
scheduled to expire on November 30, 2009. Shortly before it
expired, the Congress extended the credit to sales occurring
through April 30, 2010, and expanded it to include repeat
homebuyers who had owned and occupied a house for at least
five of the past eight years. Sales of existing homes are measured at closing, while sales of new homes are measured at the
time the contract is signed.

2004

50

2007

201 0

Note: The data are monthly and extend into 2010:Q4. Each index has been normalized so that its peak is 100. Both the CoreLogic price index and the FHFA index
(formerly calculated by the Office of Federal Housing Enterprise Oversight) include
purchase transactions only. The S&P/Case-Shiller index reflects all arm’s-length
sales transactions in selected metropolitan areas.
Source: For CoreLogic, CoreLogic; for FHFA, Federal Housing Finance Agency; for
S&P/Case-Shiller, Standard & Poor’s.

index—house prices fell 6 percent between June and
December and moved below their mid-2009 trough.
House prices continued to be weighed down by the
large inventory of unsold homes—especially distressed properties—and by the sluggish demand for
housing.
Indicators of credit quality in this sector pointed to
continued difficulties amid depressed home values
and elevated unemployment. Serious delinquency
rates on prime and near-prime mortgages edged
down to around 15 percent for adjustable-rate loans
and to about 5 percent for fixed-rate loans—levels
that remain high by historical standards. Delinquency rates for subprime mortgages moved up
slightly toward the end of the year and remained
extremely elevated. One sign of improvement, however, was that the rate at which mortgages transitioned from being current to being newly delinquent
trended lower toward the end of 2010.
Reflecting the ongoing credit quality issues, the number of homes that entered foreclosure in the third
quarter of 2010 jumped to more than 700,000, well
above the pace seen earlier in the year. Late in the
third quarter, concerns about the mishandling of
documentation led some institutions to temporarily
suspend some or all of their foreclosure proceedings.6
6

The Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit
Insurance Corporation are conducting an in-depth interagency

12

97th Annual Report | 2010

(GSE) or the Federal Housing Administration
remained essentially closed.

Figure 6. Mortgage interest rates, 1995–2011
Percent

9
8
Fixed rate

7
6
5
4

Adjustable rate
1996

1999

2002

2005

3
2008

2011

Note: The data, which are weekly and extend through February 23, 2011, are contract rates on 30-year mortgages.
Source: Federal Home Loan Mortgage Corporation.

Despite these announced moratoriums, the pace of
new foreclosures dipped only slightly in the fourth
quarter. Moreover, these moratoriums will likely only
extend, and not put an end to, the foreclosure process
in most cases.
Interest rates on fixed-rate mortgages remained quite
low, on net, by historical standards during the second
half of 2010 and reached record lows in the fourth
quarter (figure 6). The very low levels of mortgage
rates prompted a sizable pickup in refinancing activity for a time, although some households were unable
to refinance because of depressed home values, weak
credit scores, and tight lending standards for mortgages. Mortgage applications for home purchases
were generally subdued in the second half of the
year. Overall, mortgage debt outstanding likely
declined in the second half of 2010 at a pace only
slightly slower than that of the first half.

The Business Sector

Fixed Investment
Real business spending on equipment and software,
which surged in the first half of 2010, rose further in
the second half (figure 7). Firms were likely motivated partly by a desire to replace aging equipment
and to undertake capital spending that had been
deferred during the recession. Improving business
prospects also appear to have been a factor boosting
capital expenditures. As a group, large firms continue
to have ample internal funds, and those with access
to capital markets generally have been able to obtain
bond financing at favorable terms. Although credit
availability for smaller firms and other bankdependent businesses remains constricted, some tentative signs of easing lending standards have
emerged.

Figure 7. Change in real business fixed investment,
2004–10
Percent, annual rate

Structures
Equipment and software

30
H1
20
H2

10
+
0_
10
20
30

2004

2005

2006

2007

2008

2009

2010

Percent, annual rate

High-tech equipment and software
Other equipment excluding transportation

Net issuance of mortgage-backed securities (MBS)
guaranteed by Fannie Mae, Freddie Mac, and Ginnie
Mae was fairly low in the second half of 2010, consistent with the subdued originations of mortgages
used to finance home purchases. The securitization
market for mortgage loans not guaranteed by a
housing-related government-sponsored enterprise

30
H1

20
H2

10
+
0_
10

review of practices at the largest mortgage servicing operations
to examine foreclosure practices generally, but with an emphasis
on the breakdowns that led to inaccurate affidavits and other
questionable legal documents being used in the foreclosure process. See Elizabeth A. Duke (2010), “Foreclosure Documentation Issues,” statement before the Financial Services Subcommittee on Housing and Community Opportunity, U.S. House of
Representatives, November 18, www.federalreserve.gov/
newsevents/testimony/duke20101118a.htm.

20

2004

2005

2006

2007

2008

2009

2010

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

Monetary Policy and Economic Developments

Overall spending on equipment and software rose at
an annual rate of about 10 percent in the second half
of 2010. Although business outlays in the volatile
transportation equipment category plunged in the
fourth quarter, that decline came in the wake of several quarters of sharp increases when vehicle rental
firms were rebuilding their fleets of cars and light
trucks. Meanwhile, spending on information technology (IT) capital—computers, software, and communications equipment—increased appreciably throughout the second half. Gains were apparently spurred
by outlays to replace older, less-efficient IT capital as
well as continued investments by wireless service providers to upgrade their networks. In addition, spending increases for equipment other than transportation and IT—nearly one-half of total equipment outlays—were well maintained and broad based. More
recently, new orders for nondefense capital goods
other than transportation and IT items were little
changed, on net, in December and January; however,
the level of orders remains above shipments, and
business surveys suggest that respondents are upbeat
about business conditions as well as their equipment
spending plans.
Real spending on nonresidential structures other
than those used for drilling and mining remained
depressed, with the level of investment at the end of
2010 down almost 40 percent from its peak in early
2008. However, the rate of decline appears to be
abating: Spending fell at an annual rate of nearly
10 percent in the second half of 2010 after plunging
at a 25 percent rate in the first half. Although outlays
for new power facilities jumped in the second half of
the year, construction of office buildings, commercial
structures, and manufacturing plants all moved down
further. A large overhang of vacant space, depressed
property prices, and an unwillingness of banks to
add to their already high construction loan exposure
still weighed heavily on the sector. In contrast, spending on drilling and mining structures continued to
rise sharply in response to elevated energy prices.
Inventory Investment
Stockbuilding continued in the second half of 2010
at an average pace about in line with the growth of
final sales. Inventory investment surged in the third
quarter, but the pace of accumulation slowed sharply
in the fourth quarter, with the swing magnified by
developments in the motor vehicle sector. Vehicle
stocks rose appreciably in the third quarter as dealers
attempted to rebuild inventories that had become
depleted earlier in the year, but inventories fell in the
fourth quarter as auto sales moved up more rapidly

13

than expected near the end of the year. As for other
items aside from motor vehicles, inventory investment rose during the second half of the year, albeit
more rapidly in the third quarter than in the fourth.
The inventory-to-sales ratios for most industries covered by the Census Bureau’s book-value data, which
had risen significantly in 2009, have moved back to
levels that prevailed before the recession, and surveys
suggest that inventory positions for most businesses
generally are in a comfortable range.
Corporate Profits and Business Finance
Operating earnings per share for S&P 500 firms continued to increase at a solid pace in the third and
fourth quarters of 2010. Most industry groups
reported gains. In aggregate, earnings per share
climbed to near the levels posted in mid-2007, just
prior to the financial crisis.
The already sturdy credit quality of nonfinancial corporations improved further in the second half of
2010. The aggregate debt-to-asset ratio, which provides an indication of corporate leverage, moved
down in the third quarter, as nonfinancial corporations increased their assets by more than they
increased their debt. Credit rating upgrades again
outpaced downgrades and corporate bond defaults
remained sparse. The delinquency rate on commercial and industrial (C&I) loans at commercial banks
moved down in the second half of 2010 to 3 percent.
By contrast, with fundamentals remaining weak,
delinquency and charge-off rates on commercial real
estate (CRE) loans at commercial banks decreased
only modestly from quite elevated levels. Moreover,
the delinquency rate on CRE loans in securitized
pools continued to rise sharply.
Borrowing by nonfinancial corporations continued at
a robust pace in the second half of 2010, driven by
good corporate credit quality, attractive financing
conditions, and an improving economic outlook.
Issuance of corporate bonds was heavy for both
investment-grade and high-yield issues. Borrowing in
the syndicated loan market was also sizable, particularly by speculative-grade borrowers, with the dollar
volume of such loans rebounding sharply from the
low levels seen in 2008 and 2009. Demand for such
loans from institutional investors was strong. Some
of the strength in debt origination was reportedly
due to corporations taking advantage of low interest
rates to reduce debt service costs and extend maturities by refinancing; issuance to finance mergers and
acquisitions also reportedly picked up in the second
half of the year. Meanwhile, commercial paper out-

14

97th Annual Report | 2010

standing remained about flat. C&I loans on banks’
books decreased during the third quarter but started
expanding toward the end of the year, consistent
with responses to the January 2011 SLOOS that
reported some easing of standards and terms and
some firming of demand for C&I loans from large
firms over the previous three months. Relatively large
fractions of respondents to the most recent survey
indicated that they narrowed the spread of C&I loan
rates over their cost of funds somewhat further during the second half of 2010 (figure 8). Nevertheless,
lending standards reportedly remained tight; about
one-half of the respondents to special questions
included in the October 2010 survey indicated that
their lending standards on C&I loans were tighter
than longer-run averages and were likely to remain so
until at least 2012.
Borrowing conditions for small businesses continued
to be tighter than for larger firms, although some
signs of easing began to emerge. In particular, surveys conducted by the National Federation of Independent Business (NFIB) showed a gradual decline
in the share of respondents reporting that credit was
more difficult to obtain than three months previously. Similarly, in the past several surveys, moderate
net fractions of SLOOS respondents have indicated
that banks have eased some loan terms for smaller

Figure 8. Net percentage of domestic banks tightening
standards and widening spreads over the banks’ cost of
funds for large and medium-sized business borrowers,
1998–2011
Percent

100
Spreads

40
20
+
0_

Standards

20
40
60
2002

2005

2008

Banks’ holdings of CRE loans continued to contract
fairly sharply throughout the second half of 2010.
Overall commercial mortgage debt declined at an
annual rate of 6 percent in the third quarter, about
the same pace as in the previous quarter. Responses
to the January SLOOS suggest that banks have not
yet started reversing their tight lending standards in
this sector and that demand, while starting to pick
up, likely remained weak. Despite the strains in CRE
markets, the commercial mortgage-backed securities
(CMBS) market showed tentative signs of improvement in the second half of 2010 and early 2011.
Prices for some of the more highly rated tranches of
existing CMBS rose. Although issuance of new securities remained tepid, the pace has been picking up.
Responses to special questions on the September
Senior Credit Officer Opinion Survey on Dealer
Financing Terms (SCOOS) indicated that demand
for warehousing of CRE loans for securitization had
increased since the beginning of 2010, and that the
willingness to fund CRE loans on an interim basis
had increased somewhat.
A substantial number of initial and secondary equity
offerings for nonfinancial firms were brought to market in the second half of 2010. Deals included an initial public offering by General Motors that was used
to repay a portion of the government’s capital infusion. Nevertheless, equity retirements in the third
quarter through cash-financed mergers and acquisitions and share repurchases once again outpaced
issuance; preliminary data for the fourth quarter (not
shown) suggest a similar pattern.

80
60

1999

borrowers. Judging from responses to both the NFIB
survey and the SLOOS, loan demand by small businesses remained subdued.

2011

Note: The data are drawn from a survey generally conducted four times per year;
the last observation is from the January 2011 survey, which covers 2010:Q4.
Net percentage is the percentage of banks reporting a tightening of standards or a
widening of spreads less the percentage reporting an easing or a narrowing. The
definition for firm size suggested for, and generally used by, survey respondents is
that large and medium-sized firms have annual sales of $50 million or more.
Source: Federal Reserve Board, Senior Loan Officer Opinion Survey on Bank Lending Practices.

The Government Sector

Federal Government
The deficit in the federal unified budget has remained
very wide. The budget deficit for fiscal year 2010,
although down somewhat from fiscal 2009, was
$1.3 trillion. The fiscal 2010 figure was equal to
8¾ percent of nominal GDP, substantially above the
average value of 2 percent recorded during the threeyear period prior to the onset of the recession. The
budget deficit continued to be boosted by spending
commitments from the American Recovery and
Reinvestment Act (ARRA) and other stimulus policy
actions and by the weakness of the economy, which
has reduced tax revenues and boosted payments for
income support. By contrast, the budget effects of

Monetary Policy and Economic Developments

several financial transactions reduced the deficit in
2010: Outlays related to the Troubled Asset Relief
Program (TARP), which added significantly to the
deficit in 2009, helped to shrink the deficit in 2010 as
estimated losses were revised down when many of the
larger TARP recipients repaid their obligations to the
Treasury; in addition, new assistance for the
mortgage-related GSEs was extended at a slower
pace, and depository institutions prepaid three years’
worth of federal deposit insurance premiums. Moreover, the nascent recovery in the economy led to a
small increase in revenues. The deficit is projected by
the Congressional Budget Office to widen in fiscal
2011 to a level similar to the shortfall recorded in fiscal 2009.

15

income support payments; by contrast, other spending has been increasing at rates comparable to those
recorded during fiscal 2010.
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 about 4 percent in the second half
of 2010, a bit less than in the first half of the year.
Nondefense outlays increased more slowly than in
the first half of the year—when spending for the
decennial census ramped up—while defense spending
rose at roughly the same pace as in the first half.

Despite increasing 3 percent in fiscal 2010, tax
receipts remained at very low levels; indeed, at less
than 15 percent of GDP, the ratio of receipts to
national income was at its lowest level in 60 years.
Corporate income taxes surged nearly 40 percent in
fiscal 2010 as profits increased briskly, and Federal
Reserve remittances to the Treasury rose markedly
owing to the expansion of its balance sheet. By contrast, despite rising household incomes, individual
income and payroll taxes moved down in fiscal 2010,
reflecting the tax cuts put in place by the ARRA.
Total tax receipts increased nearly 10 percent over the
first four months of fiscal 2011 relative to the comparable year-earlier period; individual income and payroll taxes turned up, a consequence of the further
recovery in household incomes, and corporate
income taxes continued to rise.

Federal Borrowing
Federal debt expanded appreciably in the second half
of last year, though at a slightly slower pace than in
the first half. The ratio of federal debt held by the
public to nominal GDP rose to more than 60 percent
at the end of 2010 and is projected to reach nearly
70 percent by the end of 2011. Demand for Treasury
securities has been well maintained. Bid-to-cover
ratios at auctions, although somewhat mixed, were
generally within historical ranges during the second
half of 2010 and early 2011. Indicators of foreign
participation at auctions as well as a rise in foreign
custody holdings of Treasury securities by the Federal Reserve Bank of New York pointed to steady
demand from abroad. Demand for these securities
may have been supported by a heightened desire for
relatively safe and liquid assets in light of fiscal
troubles in some European countries.

Outlays decreased 2 percent in fiscal 2010, a development attributable to financial transactions. Excluding
financial transactions, spending rose 9 percent compared with fiscal 2009, mainly because of the effects
of the weak labor market on outlays for income support programs (such as unemployment insurance and
food stamps) as well as increases in Medicaid expenditures and spending associated with the ARRA and
other stimulus-related policies. Net interest payments
rose 5 percent in fiscal 2010, and Social Security
spending increased 3½ percent—its smallest rise in
11 years—as the low rate of consumer price inflation
in the previous year resulted in no cost of living
adjustment. In the first four months of fiscal
2011, total federal outlays rose nearly 5 percent relative to the comparable year-earlier period. Excluding
financial transactions, outlays were up about 1 percent. The relatively small increase so far this fiscal
year for outlays excluding financial transactions
reflects a flattening out of ARRA spending and

State and Local Government
Despite the substantial federal aid provided by the
ARRA, state and local governments remained under
significant fiscal pressure in the second half of 2010.
The strains reflect several factors, including a sharp
drop in tax revenues in late 2008 and 2009 and
increased commitments for Medicaid outlays—a
cyclically sensitive transfer program—all in the context of balanced budget requirements. To address
their budget shortfalls, these governments have been
paring back operating expenditures. Indeed, real consumption expenditures of state and local governments, as measured in the NIPA, fell about 1 percent
in 2010 after decreasing a similar amount in 2009.
The weakness in spending was reflected in the continued reductions in payrolls. Total employment of state
and local governments fell 250,000 during 2010, with
nearly all of the cutbacks at the local level. Construction spending undertaken by these governments was
volatile during 2010 but, on net, was down a bit for

16

97th Annual Report | 2010

the year and remained below the level that prevailed
before the recession despite the infrastructure grants
provided by the federal government as part of the
ARRA. While most capital expenditures are not subject to balanced budget requirements, some of these
expenditures are funded out of operating budgets
subject to these requirements. In addition, a substantial share of debt service payments on the bonds used
to finance capital projects is made out of operating
budgets—a factor that may be limiting the willingness of governments to undertake some new infrastructure projects.
With overall economic activity recovering, state government revenues from income, business, and sales
taxes rose in the second half of 2010. Nevertheless,
state tax collections remain well below their prerecession levels, and available balances in reserve
funds are low. Tax collections at the local level have
fared relatively better. In particular, some localities
appear to have adjusted statutory tax rates so that
declining real estate assessments, which typically significantly lag market prices, are holding down property tax revenues by less than they otherwise would.
However, many localities have seen sharp cutbacks in
their grants-in-aid from state governments, and thus
have experienced significant fiscal pressures. State
and local governments will continue to face considerable budget strains, in part because federal stimulus
grants will be winding down. Moreover, many state
and local governments will need to set aside additional resources in coming years both to meet their
pension obligations and to pay for health benefits
provided to their retired employees.
State and Local Government Borrowing
Issuance of securities by state and local governments
was robust during the latter half of 2010; it surged
near the end of the year as state governments sought
to take advantage of the Build America Bond program before the program expired.7 Issuance of shortterm municipal securities was also strong.
Yields on state and local government bonds rose
noticeably more than those on comparable-maturity
Treasury securities in the second half of 2010 and
early 2011. The rise in yields on municipal securities
may have reflected increased concerns about the fiscal position and financial health of state and local
governments, although the heavy supply of these
7

The Build America Bond program allowed state and local governments to issue taxable bonds for capital projects and receive
a subsidy payment from the Treasury for 35 percent of interest
costs.

Figure 9. Change in real imports and exports of goods and
services, 2004–10
Percent, annual rate

Imports
Exports

H1
Q3
Q4

20

10
+
0_

10

2004

2006

2008

2010

Source: Department of Commerce, Bureau of Economic Analysis.

securities coming to market likely also played a role.
Spreads on credit default swaps for some states
remained volatile but narrowed, on net, from their
peak levels last summer. Downgrades of the credit
ratings of state and local governments continued to
outpace upgrades during the second half of 2010.
Nonetheless, the pace of actual defaults on municipal
issues continued to come down from its peak in 2008.
In recent months, there were substantial outflows
from long-term mutual funds that invest in municipal
bonds.
The External Sector

Supported by the expansion of foreign economic
activity, real exports of goods and services continued
to increase at a solid pace in the second half of 2010,
rising at an annual rate of 8¼ percent (figure 9).
Nearly all major categories of exports rose, with
exports of machinery, agricultural goods, and services registering the largest gains. Moreover, the
increase in export demand was broad based across
trading partners.
Real imports of goods and services decelerated considerably in the second half of 2010, increasing at an
annual rate of only 1¼ percent after surging more
than 20 percent during the first half of last year. The
sharp step-down partly reflected an unusually large
decline in real oil imports, but more important, the
growth in non-oil imports moderated to a pace more
in line with the expansion in U.S. economic activity.
During the second half of 2010, imports of consumer goods, machinery, and services posted the
largest increases. As with exports, the increase in

Monetary Policy and Economic Developments

Figure 10. Prices of oil and nonfuel commodities, 2006–11
December 2005 = 100

140

180

120

160
100

Nonfuel
commodities

80
120
100

60

Oil

40

80
2006

2007

2008

2009

2010

2011

Note: The data are monthly. The oil price is the spot price of West Texas Intermediate crude oil, and the last observation is the average for February 1–22, 2011. The
price of nonfuel commodities is an index of 45 primary-commodity prices and
extends through January 2011.
Source: For oil, the Commodity Research Bureau; for nonfuel commodities, International Monetary Fund.

imports occurred across a wide range of trading
partners.
All told, net exports shaved ½ percentage point off
real GDP growth last year as the rebound in imports
outpaced the recovery in exports for the year as a
whole. The current account deficit widened from
$378 billion in 2009 to an average of $479 billion at
an annual rate, or about 3¼ percent of nominal
GDP, in the first three quarters of 2010.
The spot price of West Texas Intermediate (WTI)
crude oil moved higher over the second half of the
year, rising to an average of $89 per barrel in December, about $11 above the average price that prevailed
over the first six months of the year (figure 10). The
upward movement in oil prices during the second
half of the year largely reflected a widespread
strengthening in global oil demand, particularly in
emerging market economies (EMEs), against a backdrop of constrained supply. The depreciation of the
dollar over this period also contributed somewhat to
the rise in the price of oil. Spot WTI continued to
fluctuate around its December average for much of
the first two months of this year but moved up
sharply in late February.8 Unrest in several Middle
Eastern and North African countries, and uncertainty about its potential implications for global oil
8

supply, has put considerable upward pressure on oil
prices in recent weeks.

Dollars per barrel

200

140

17

The prices of other grades of crude oil have risen by more over
the first two months of this year as the high level of inventories
accumulated at Cushing, Oklahoma, the delivery point for WTI,
has depressed WTI prices.

The price of the long-term futures contract for crude
oil (expiring in December 2019) has generally fluctuated in the neighborhood of $95 per barrel over the
past six months, not much different from the average
over the first half of 2010, although it has moved up
some recently. Accordingly, the sharply upward sloping futures curve that characterized the oil market
since the onset of the financial crisis has flattened
considerably. Concurrent with this flattening of the
futures curve, measured global inventories of crude
oil have declined in recent months, although they
remain high by historical standards.
Nonfuel commodity prices also rose markedly over
the second half of the year and into early 2011, with
increases broad based across a variety of commodities. As with oil, these prices have been supported by
strengthening global economic activity, primarily in
China as well as in other EMEs, and, to a lesser
extent, by the lower dollar. In addition, adverse
weather conditions have reduced harvests and curtailed supplies of important agricultural products in
a number of key exporting countries, including Russia, Ukraine, and the United States.
Prices of non-oil imported goods rose 1¼ percent at
an annual rate over the second half of 2010 and have
increased at an accelerated pace in January, boosted
by higher commodity prices, the depreciation of the
U.S. dollar, and foreign inflation. On net, non-oil
import prices rose a bit more slowly over the second
half of 2010 than in the first half and finished the
year 2 percent higher than at the end of 2009.
National Saving

Total net national saving—that is, the saving of
households, businesses, and governments excluding
depreciation charges—remains low by historical standards. After having reached 3¾ percent of nominal
GDP in 2006, net national saving dropped steadily
over the subsequent three years, reaching roughly
negative 3 percent in the third quarter of 2009. The
widening of the federal budget deficit during the
course of the recession more than accounted for the
downswing in net saving. Since late 2009, net national
saving has moved up, reflecting a sharp rise in private
saving. Nonetheless, the total averaged about negative 1 percent in the third quarter of 2010 (the latest
available data), and the large federal deficit will likely
keep it at low levels in the near term. Currently, real
interest rates are still low despite the depressed rate of

18

97th Annual Report | 2010

Figure 11. Net change in private payroll employment,
2004–11

Figure 12. Civilian unemployment rate, 1977–2011
Percent

Thousands of jobs, 3-month moving average

200

10

+
0_

8

200

6

400
600

4

800

1979
2004

2005

2006

2007

2008

2009

2010

2011

Note: The data are monthly and extend through January 2011.
Source: Department of Labor, Bureau of Labor Statistics.

national saving. If national saving were to remain low
as the economy recovers, interest rates would likely
experience upward pressure, capital formation rates
would likely be low, and borrowing from abroad
would likely be heavy. In combination, such developments would limit the rise in the standard of living of
U.S. residents and hamper the ability of the nation to
meet the retirement needs of an aging population.
The Labor Market

Employment and Unemployment
Conditions in the labor market have continued to
improve only slowly since the middle of 2010. Private
payroll employment rose just 120,000 per month, on
average, over the second half of last year, and payroll
employment gains remained lackluster in January of
2011 (figure 11).9 All told, only about one-seventh of
the 8¾ million jobs lost from the beginning of
2008 to the trough in private payrolls in February 2010 have been recovered. Rather than adding
jobs briskly, businesses have been achieving much of
their desired increases in labor input over the past
year by lengthening the hours worked by their
employees; indeed, by January, the average workweek
had recouped more than one-half of its decrease during the recession.
For most of last year, the overall net increase in hiring was barely sufficient to accommodate the
increase in the size of the labor force, and the unem9

Total employment—private plus government—exhibited sharp
swings from March 2010 to September 2010 as a result of the
hiring of temporary workers for the decennial census.

1987

1995

2003

2011

Note: The data are monthly and extend through January 2011.
Source: Department of Labor, Bureau of Labor Statistics.

ployment rate remained at or above 9½ percent
through November (figure 12). However, the unemployment rate is estimated to have moved down
noticeably in December and January, reaching
9.0 percent—about 1 percentage point below the
highest reading during this episode. The recent
decline in the jobless rate is encouraging, but the
extent of the improvement in underlying labormarket conditions is, as yet, difficult to judge. The
level of unemployment remains very elevated, and
long-duration joblessness continues to account for an
especially large share of the total. Indeed, in January,
nearly 6¼ million persons among those counted as
unemployed—about 44 percent of the total—had
been out of work for more than six months, figures
that were only a little below record levels observed in
the middle of 2010 (figure 13).10 Moreover, the number of individuals who are working part time for economic reasons—another indicator of the underutilization of labor—remained roughly twice its prerecession value. Meanwhile, the labor force
participation rate moved down further in the second
half of the year. The decline in participation was
mainly concentrated among men aged 25 and over
without a college degree.
Several other indicators of labor market conditions,
however, have brightened a bit recently. After showing little progress over the first half of the year, initial
claims for unemployment insurance (an indicator of
the pace of layoffs) generally have trended down in
recent months. Moreover, survey measures of labor
market expectations—such as business plans for
10

The data on the duration of unemployment begin in 1948.

Monetary Policy and Economic Developments

Figure 13. Long-term unemployed, 1977–2011
Percent

40

30

20

19

from the labor compensation data in the NIPA—increased only 1½ percent in 2010, well below the average gain of about 4 percent in the years before the
recession. After adjusting for the rise in consumer
prices, hourly compensation was little changed in
2010. Because nominal hourly compensation and
labor productivity in the nonfarm business sector
rose at roughly the same pace in 2010, unit labor
costs were about flat last year. During the preceding
year, unit labor costs had plunged 3½ percent as a
result of the moderate rise in nominal hourly compensation and the sizable advance in output per hour.

10

Prices
1979

1987

1995

2003

2011

Note: The data are monthly and extend through January 2011. The series shown
is the percentage of total unemployed persons who have been unemployed for
more than 26 weeks.
Source: Department of Labor, Bureau of Labor Statistics.

future hiring and consumer attitudes about future
labor market conditions—improved, on net, over the
second half of 2010 and early this year after having
softened around the middle of last year.
Productivity and Labor Compensation
Labor productivity rose further in the second half of
2010. According to the most recent published data,
output per hour in the nonfarm business sector
increased at an annual rate of about 2½ percent over
that period. Productivity had surged in 2009 as firms
aggressively eliminated many operational inefficiencies and reduced their labor input in an environment
of severe economic stress. Although the recent gains
in productivity have been less rapid, firms nonetheless continue to make efforts to improve the efficiency
of their operations, and they appear to remain reluctant to increase staffing levels in a climate of lingering economic uncertainty.

Consumer price inflation has been trending downward, on net, and survey measures of longer-term
inflation expectations have remained stable, despite
the rapid increases in a variety of commodity prices
during the second half of 2010. Overall prices for
personal consumption expenditures increased
1¼ percent over the 12 months ending in January 2011, compared with a rise of 2½ percent in the
preceding 12-month period (figure 14). The core PCE
price index—which excludes the prices of energy
items as well as those of food and beverages—increased just ¾ percent over the 12 months ending in
January, down from a 1¾ percent rise over the preceding 12 months.
The index of consumer energy prices, which declined
in the first half of 2010, rose rapidly during the second half of the year and early 2011. The index was
boosted by a surge in the prices of gasoline and

Figure 14. Change in the chain-type price index for
personal consumption expenditures, 2004–11
Percent

5

Increases in hourly compensation remained subdued
in 2010, restrained by the wide margin of labor market slack. The employment cost index (ECI) for private industry workers, which measures both wages
and the cost to employers of providing benefits, rose
just 2 percent in nominal terms in 2010—up from an
especially small increase in 2009 but still lower than
the roughly 3 percent pace averaged in the several
years preceding the recession. The rise in the ECI last
year reflected a pickup in the growth of benefits,
after a subdued increase in 2009, and a modest acceleration in wages and salaries. Nominal compensation
per hour in the nonfarm business sector—derived

4
Total
3
2

Excluding food
and energy

1
+
0_
1

2004

2005

2006

2007

2008

2009

2010

2011

Note: The data are monthly and extend through January 2011; changes are from
one year earlier.
Source: Department of Commerce, Bureau of Economic Analysis.

20

97th Annual Report | 2010

home heating oil, which reflected the run-up in the
price of crude oil that began in late summer. In contrast, consumer natural gas prices fell as increases in
supply from new domestic wells helped boost inventories above typical levels. All told, the overall index
of consumer energy prices rose nearly 7 percent during the 12 months ending in January 2011.
The index of consumer food prices rose 1¾ percent
over the 12 months ending in January 2011 as the
prices of beef and pork posted sizable increases. The
price of fruits and vegetables ran up briskly early in
2010 following a couple of damaging freezes, but
these prices turned down in the second half of the
year, leaving them up only slightly for the year as a
whole. However, spot prices in commodity markets
for crops and for livestock moved up sharply toward
the end of last year, pointing to some upward pressure on consumer food prices in the first part of
2011.
The slowdown in core PCE price inflation over the
past year was particularly evident in the prices of
goods other than food and energy, which fell 0.6 percent over the 12 months ending in January 2011. The
decline in these core goods prices occurred despite
sizable increases in the prices of some industrial commodities and materials; the modest degree of passthrough from commodity input costs to retail prices
reflects the relatively small weight of materials inputs
in total production costs. Prices for services other
than energy rose about 1¼ percent over the
12 months ending in January, down from an increase
of almost 2 percent in the preceding 12 months, as
the continued weakness in the housing market put
downward pressure on the rise in housing costs and
as the wide margin of economic slack continued to
restrain price increases for other services.
The widespread slowing in inflation over the past
year is also apparent in a variety of alternative indicators of the underlying trend in inflation (figure 15).
These indicators include trimmed-mean price
indexes, which exclude the most extreme price
increases and price declines in each period, and
market-based measures of core prices, which exclude
prices that must be imputed. These imputed prices
(often referred to as “nonmarket” prices) tend to be
highly erratic.
Survey-based measures of near-term inflation expectations have increased in recent months, likely reflecting the recent run-up in energy and food prices; in

Figure 15. Alternative measures of underlying price
changes in personal consumption expenditures, 2005–11
Percent

Trimmed mean

3

2
Market based
excluding
food and energy
Excluding
food and energy

2005

2006

2007

2008

2009

1

2010

2011

Note: The data are monthly and extend through January 2011. The trimmed-mean
personal consumption expenditures price index excludes the bottom 24 percent
and the top 31 percent of the distribution of monthly price changes and is based
on 178 components.
Source: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Department of Commerce, Bureau of Economic Analysis.

contrast, survey-based measures of longer-term inflation expectations have remained relatively stable over
the past year. In the Thomson Reuters/University of
Michigan Surveys of Consumers, median year-ahead
inflation remained between 2¾ percent and 3 percent
for most of 2010 but then rose above 3 percent in
early 2011. Longer-term expectations in the survey, at
2.9 percent in February, remained in the narrow
range that has prevailed over the past few years. In
the Survey of Professional Forecasters, conducted by
the Federal Reserve Bank of Philadelphia, expectations for the increase in the consumer price index
over the next 10 years edged down, on balance, during 2010 after having been essentially unchanged for
many years.
Financial Developments
In light of the disappointing pace of the progress
toward the Federal Reserve’s dual objectives of maximum employment and price stability, the Federal
Open Market Committee (FOMC) took steps in the
second half of the year to reduce downside risk to
the sustainability of the recovery and to provide further support to economic activity. At its August 2010
meeting, the FOMC decided to keep the Federal
Reserve’s holdings of longer-term securities constant
at their then-current level by reinvesting principal
payments from holdings of agency debt and agency
MBS in longer-term Treasury securities. In November, the FOMC announced its intention to purchase

Monetary Policy and Economic Developments

21

Box 1. The Effects of Federal Reserve Asset Purchases
Between late 2008 and early 2010, with short-term
interest rates already near zero, the Federal Reserve
provided additional monetary accommodation by
purchasing $1.25 trillion in agency mortgage-backed
securities (MBS), about $175 billion in agency debt,
and $300 billion in longer-term Treasury securities.
When incoming economic data in mid-2010 suggested that the recovery might be softening, the Federal Open Market Committee (FOMC) decided to
take further action to fulfill its mandated objectives of
promoting maximum employment and price stability.
First, the Committee decided at its August 2010
meeting to reinvest the principal payments from its
holdings of agency debt and agency MBS in longerterm Treasury securities. Second, it announced in
November its intention to purchase an additional
$600 billion of longer-term Treasury securities by the
end of the second quarter of 2011.
The theory underlying these asset purchases, which
dates back to the early 1950s, posits that asset
prices are affected by the outstanding quantity of
assets. In some models, for example, short- and
long-term assets are imperfect substitutes for one
another in investors’ portfolios, and the term structure of interest rates can be influenced by changes to
the supply of securities at different maturities. As a
result, purchases of longer-term securities by the
central bank can push up the prices and drive down
the yields on those securities. Asset purchases can
also affect longer-term interest rates by influencing
investors’ expectations of the future path of shortterm rates. Similarly, the effect of central bank asset
purchases depends on expectations regarding the
timing and pace of the eventual unwinding of the purchases. Thus, central bank communication may play
a key role in influencing the response of financial
markets to such a program.

of the responses of asset prices to announcements
by the Federal Reserve regarding its first round of
asset purchases have found that the purchases of
Treasury securities, agency debt, and agency MBS
significantly reduced the yields on those securities.1
Similarly, analyses of the responses of asset prices to
the purchases themselves also documented an effect
on the prices of the acquired securities.2 Spillover
effects of the purchase programs to other financial
markets, in turn, appear to have resulted in lower
interest rates on corporate debt and residential mortgages and to have contributed to higher equity valuations and a somewhat lower foreign exchange value
of the dollar. These effects are qualitatively similar to
those that typically result from conventional monetary
policy easing.
Recent research by Federal Reserve staff has provided some estimates of the magnitude of the resulting effects on the economy using the FRB/US macroeconomic model—one of the models developed by
the Federal Reserve Board staff and used for policy
(continued on next page)

1

2

Recent empirical work suggests that the Federal
Reserve’s asset purchase programs have indeed provided significant monetary accommodation. Studies

a further $600 billion in longer-term Treasury securities by the end of the second quarter of 2011 (see
box 1).
Financial market conditions, which had worsened
early in the summer as a result of developments in
Europe and concerns about the durability of the
global recovery, subsequently improved as investors
increasingly priced in further monetary policy
accommodation. Accordingly, real Treasury yields
declined, asset prices increased, and credit spreads
narrowed. A brightening tone to the economic news
starting in the fall bolstered investor sentiment and,

See, for example, Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack (2010), “Large-Scale Asset Purchases by
the Federal Reserve: Did They Work?” Federal Reserve Bank of
New York Staff Reports No. 441 (New York: Federal Reserve Bank
of New York, March); and James Hamilton and Jing (Cynthia) Wu
(2010), “The Effectiveness of Alternative Monetary Policy Tools in
a Zero Lower Bound Environment,” working paper (San Diego:
University of California, San Diego, November). Evidence of similar effects in the United Kingdom from asset purchases by the
Bank of England was found by Michael Joyce, Ana Lasaosa, Ibrahim Stevens, and Matthew Tong (2010), “The Financial Market
Impact of Quantitative Easing,” Working Paper 393 (London:
Bank of England, August).
See, for example, Stefania D’Amico and Thomas B. King (2010),
“Flow and Stock Effects of Large-Scale Asset Treasury Purchases,” Finance and Economics Discussion Series 2010-52
(Washington: Board of Governors of the Federal Reserve System,
September).

together with a reassessment on the part of investors
of the ultimate size of Federal Reserve Treasury purchases, contributed to a backup in interest rates and
in measures of inflation compensation that continued
through year-end. In contrast to the developments
earlier in the year, the reemergence later in the year of
concerns about the financial situation in Europe left
little imprint on domestic financial markets.
Monetary Policy Expectations
and Treasury Rates

In response to indications of a slowing pace of
recovery in U.S. output and employment and a con-

22

97th Annual Report | 2010

Box 1. The Effects of Federal Reserve Asset Purchases—continued
analysis.3 A simulation exercise suggests that the
cumulative effect of the Federal Reserve’s asset purchases since 2008—including the original purchases
of Treasury securities, agency debt, and agency
MBS; the reinvestment of principal payments; and
the additional $600 billion in Treasury security purchases now intended—has been to provide significant and mounting support to economic activity over
time. Although estimates of these effects are subject
to considerable uncertainty, the model results suggest that the purchases have already boosted the
level of real gross domestic product 1¾ percent relative to what it would have been if no such purchases
had occurred, and that this effect will rise to 3 percent by 2012.4 As a result of this stronger recovery in
output, the model also suggests that by 2012 the
asset purchase program will boost private employment about 3 million, and trim the unemployment
rate 1½ percentage points relative to what they otherwise would be. Finally, the simulation results suggest that inflation is currently 1 percentage point
higher than otherwise would have been the case if
the FOMC had never initiated securities purchases,
implying that, in the absence of such purchases, the
economy would now be close to a state of deflation.
Although the asset purchase programs seem to have
provided significant support to economic activity,
some observers have noted that they are not without
risk. One concern that has been voiced is that these
purchase programs have increased the size of the
Federal Reserve’s balance sheet and could result in
monetary accommodation being left in place for too
3

4

Hess Chung, Jean-Phillipe Laforte, David Reifschneider, and John
Williams (2011), “Have We Underestimated the Likelihood and
Severity of Zero Lower Bound Events?” Federal Reserve Bank of
San Francisco Working Paper Series 2011-01 (San Francisco:
Federal Reserve Bank of San Francisco, January).
These effects are based on certain assumptions regarding the
period assets are held and the unwinding of the purchases.
These, and other, assumptions are described in more detail in
Chung and others, “Zero Lower Bound Events,” in box note 3.

tinued downward trend in measures of underlying
inflation, expectations regarding the path for the federal funds rate during 2011 and 2012 were revised
down sharply in the third quarter and investors came
to anticipate further Federal Reserve asset purchases.
The FOMC’s decision to begin additional purchases
of longer-term Treasury securities occurred against
the backdrop of this downward shift in expectations
about monetary policy. Subsequently, expectations
regarding the ultimate size of such purchases were
scaled back as the recovery appeared to strengthen,
downside risks to the outlook seemed to recede

long, leading to excessive inflation. However, in
preparation for removing monetary accommodation,
the Federal Reserve has continued to develop the
tools it will need to raise short-term interest rates and
drain large volumes of reserves when doing so
becomes necessary to achieve the policy stance that
best fosters the Federal Reserve’s macroeconomic
objectives.5 Moreover, the current level of resource
slack in the economy and the recent low readings on
underlying inflation suggest that point is not yet near.
A second concern is that the asset purchase program could result in adverse financial imbalances if,
for example, the lower level of longer-term interest
rates encouraged potential borrowers to employ
excessive leverage to take advantage of low financing costs or led investors to accept an imprudently
small amount of compensation for bearing risk in an
effort to enhance their rates of return. The Federal
Reserve is carefully monitoring financial indicators,
including credit flows and premiums for credit risk,
for signs of potential threats to financial stability. For
example, to monitor leverage provided by dealers to
financial market participants, in June 2010 the Federal Reserve launched the Senior Credit Officer Opinion Survey on Dealer Financing Terms. This survey
provides information on the terms on and availability
of various forms of dealer-intermediated financing,
including funding for securities positions. Moreover,
to better monitor linkages among firms and markets
that could undermine the stability of the financial
system, the Federal Reserve has increased its
emphasis on taking a multidisciplinary approach that
integrates the contributions of economists, specialists in particular financial markets, bank supervisors,
payment systems experts, and other professionals.
An Office of Financial Stability Policy and Research
was created within the Federal Reserve to coordinate
staff efforts to identify and analyze potential risks to
the financial system and broader economy.
5

The ongoing development of these tools is discussed in Part 3.

somewhat, and a tax-cut deal that was seen as supportive of economic activity was passed into law.
The current target range for the federal funds rate of
0 to ¼ percent is consistent with the level that investors expected at the end of June 2010. However, the
date at which monetary policy tightening is expected
to commence has moved back somewhat since the
time of the July 2010 Monetary Policy Report to the
Congress. Quotes on money market futures contracts
indicate that, as of late February, investors anticipate
that the federal funds rate will rise above its current

Monetary Policy and Economic Developments

Figure 16. Interest rates on selected Treasury securities,
2004–11

23

Figure 17. Spreads of corporate bond yields over
comparable off-the-run Treasury yields, by securities
rating, 1997–2011

Percent
Percentage points

10-year

5

18
16

4
2-year

14

3-month

3

12
10

High-yield

2

8
6

1
+
0_

4

BBB

2
+
0_

AA
2004

2005

2006

2007

2008

2009

2010

2011

Note: The data are daily and extend through February 22, 2011.
Source: Department of the Treasury.

range in the first quarter of 2012, about a year later
than the date implied in July 2010. By the end of
2012, investors expect that the effective federal funds
rate will be around 1.3 percent, fairly similar to the
level anticipated in mid-2010.11
Yields on nominal Treasury securities fluctuated considerably in the second half of 2010 and in early 2011
due to shifts in investors’ expectations regarding the
prospects for economic growth and the size of any
asset purchase program that would be conducted by
the Federal Reserve (figure 16). Recently, Treasury
yields declined as investors increased their demand
for the relative safety and liquidity of Treasury securities following political turmoil in the Middle East
and North Africa. On net, yields on 2-year Treasury
notes were up a bit from their levels in mid-2010,
while those on 10-year Treasury securities rose
approximately 40 basis points. Nonetheless, yields on
Treasury securities remained quite low by historical
standards. Uncertainty about longer-term interest
rates, as measured by the implied volatility on
11

When interest rates are close to zero, determining the point at
which financial market quotes indicate that the federal funds
rate will move above its current range can be challenging. The
path described in the text is the mean of a distribution calculated from derivatives contracts on federal funds and Eurodollars. The skewness induced in this distribution by the zero lower
bound causes the mean to be influenced strongly by changes in
uncertainty regarding the policy path, complicating its interpretation. Alternatively, one can use similar derivatives to calculate
the most likely—or “modal”—path of the federal funds rate,
which tends to be more stable. This path has also moved down,
on net, since last summer, but it suggests a flatter overall trajectory for the target federal funds rate, according to which the
effective rate does not rise above its current level until around
the middle of 2012.

1997

1999

2001

2003

2005

2007

2009

2011

Note: The data are daily and extend through February 22, 2011. The spreads
shown are the yields on 10-year bonds less the 10-year Treasury yield.
Source: Derived from smoothed corporate yield curves using Merrill Lynch bond
data.

10-year Treasury securities, rose significantly from
November to mid-December, likely in part because of
increased uncertainty about the ultimate size of the
Federal Reserve’s asset purchase program. Interest
rate uncertainty declined subsequently and by early
2011 was only a bit higher, on net, than in mid-2010,
apparently reflecting coalescing market expectations
regarding Federal Reserve purchases.
Measures of medium- and long-term inflation compensation derived from inflation-indexed Treasury
bonds rose, on balance, during the second half of
2010 but remained within their historical ranges.
Both medium- and long-term measures of inflation
compensation fell early in the third quarter as investors grew more concerned about the durability of the
economic recovery, but they then moved back up as
the FOMC was seen as taking additional steps to
help move inflation back toward levels more consistent with its mandate and as economic prospects
improved. Rising energy prices may also have contributed to the increases in medium-term inflation
compensation.
Corporate Debt and Equity Markets

During the second half of 2010 and early 2011, the
spreads between the yields on investment-grade corporate bonds and those on comparable-maturity
Treasury securities narrowed modestly (figure 17).
Similar risk spreads on corporate bonds with belowinvestment-grade ratings narrowed more substantially—as much as 200 basis points. This spread com-

24

97th Annual Report | 2010

pression was consistent with continued improvements
in corporate credit quality as well as increased investor confidence in the durability of the recovery.
Nonetheless, bond spreads now stand near the lower
end of their historical ranges. In the secondary market for syndicated leveraged loans, the average bid
price moved up further, a development that reflected
strong investor demand as well as improved fundamentals. A notable share of loans traded at or above
par in early 2011.
Equity prices have risen sharply since mid-2010. The
rally began amid expectations of further monetary
policy accommodation and was further supported by
robust corporate earnings and an improved economic
outlook. The gains in equity prices were broad based.
Implied volatility for the S&P 500, calculated from
options prices, generally trended down in the second
half of 2010 and early 2011 and reached fairly low
levels, although it increased recently against a backdrop of rising political turmoil in the Middle East
and North Africa.
With some investors apparently seeking to boost
returns in an environment of low interest rates, net
inflows into mutual funds that invest in higheryielding fixed-income instruments, including
speculative-grade bonds and leveraged loans, were
robust in the second half of 2010 and early 2011.
These inflows likely supported strong issuance and
contributed to the narrowing of bond spreads during
this period. Mutual funds focusing on international
debt securities also attracted strong inflows. Inflows
to other categories of bond funds were more modest
so that overall inflows to bond funds in the second
half of 2010 were similar to those in the first half of
the year. Despite the strong gains in U.S. equity markets, mutual funds investing in domestic equities
experienced sizable outflows for much of the second
half of last year, but these funds attracted net inflows
in early 2011. Investments in money market mutual
funds changed little in the second half of 2010—following notable outflows earlier in the year—as the
assets held by these funds continued to generate very
low yields.

maturity overnight index swap rates—a measure of
stress in short-term bank funding markets—reversed
the widening observed in the spring and then
remained fairly narrow despite the reemergence of
concerns about the situation in Europe in the fall
(figure 18). Nevertheless, amid the renewed concerns,
tiering was reportedly evident in dollar funding markets abroad, as institutions located in peripheral
European countries apparently faced reduced access
to funding. Issuance of commercial paper in the
United States by institutions headquartered in
peripheral Europe declined as investors required
notably higher rates to hold this paper.
Besides these strains and some modest, short-lived
year-end pressures, conditions in short-term funding
markets continued to be stable. The spreads between
yields on lower-quality A2/P2-rated paper and
AA-rated asset-backed commercial paper over those
on higher-quality AA-rated nonfinancial paper
remained narrow through the fall and into 2011.
Since last summer, haircuts on securities used as collateral in repurchase agreements (repos), while exhibiting some volatility in the fourth quarter and early
2011, were generally little changed.
Information from the Federal Reserve’s quarterly
Senior Credit Officer Opinion Survey on Dealer
Financing Terms suggested that the major dealers
eased credit terms to most types of counterparties
during the second half of 2010, primarily in response

Figure 18. Libor minus overnight index swap rate, 2007–11
Basis points

350
300
250
200
Three-month
150
100
50
+
0_

One-month

Market Functioning and
Dealer-Intermediated Credit

Conditions in short-term funding markets, which had
experienced notable strains in the spring when investors became concerned about European sovereign
debt and banking issues, generally improved early in
the second half of 2010. Spreads of London interbank offered rates, or Libor, over comparable-

Jan.

July
2007

Jan.

July
2008

Jan.

July
2009

Jan.

July
2010

Jan.
2011

Note: The data are daily and extend through February 22, 2011. An overnight
index swap (OIS) is an interest rate swap with the floating rate tied to an index of
daily overnight rates, such as the effective federal funds rate. At maturity, two parties exchange, on the basis of the agreed notional amount, the difference between
interest accrued at the fixed rate and interest accrued by averaging the floating,
or index, rate. Libor is the London interbank offered rate.
Source: For Libor, British Bankers’ Association; for the OIS rate, Prebon.

Monetary Policy and Economic Developments

to more-aggressive competition from other institutions and to an improvement in the current or
expected financial strength of the counterparties. The
easing of terms occurred primarily for securitiesfinancing transactions, while nonprice terms for overthe-counter derivatives transactions were reportedly
little changed on net. Survey respondents also noted
a general increase in the demand for funding for all
types of securities covered in the survey.
While remaining well below pre-crisis levels, the use
of dealer-intermediated leverage appears to have
gradually increased since the end of the summer,
interrupted by a brief retrenchment in early December when concerns about developments in Europe
intensified. This trend is reflected in the increased
funding of equities by hedge funds and other levered
investors and in an uptick in demand for the funding
of some other types of securities. In addition, recent
leveraged finance deals—involving the new issuance
of high-yield corporate bonds and syndicated leveraged loans—on average reflected greater levering of
the underlying corporate assets, but they nonetheless
generated strong interest on the part of investors in a
very low interest rate environment. However, there
was little evidence that dealer-intermediated funding
of less-liquid assets increased materially, and new
issuance of structured products that embed leverage
and were originated in large volumes prior to the crisis—including, for example, complex mortgage
derivatives—has not resumed on any significant
scale. In general, the appetite for additional leverage
on the part of most market participants—as reflected
in responses to special questions on the September
SCOOS, triparty repo market volumes, and other
indicators—appears to have remained generally
muted, with most investors not fully utilizing their
existing funding capacity.
Measures of liquidity and functioning in most financial markets pointed to generally stable conditions
since mid-2010. In the Treasury market, various indicators, such as differences in prices of securities with
similar remaining maturities and spreads between
yields on on- and off-the-run issues, suggest that the
market continued to operate normally, including during the period when the Federal Reserve was implementing its new asset purchase program. Bid-asked
spreads were generally about in line with historical
averages, and dealer transaction volumes have continued to reverse the declines observed during the financial crisis. In the syndicated loan market, bid-asked
spreads trended down further in the second half of
2010 and in early 2011 as the market continued to

25

Figure 19. Spreads on credit default swaps for selected U.S.
banks, 2007–11
Basis points

400
350
300
Large bank
holding companies

250
200
150
100

Other banks

50
Jan.

July
2007

Jan.

July
2008

Jan.

July
2009

Jan.

July
2010

Jan.
2011

Note: The data are daily and extend through February 22, 2011. Median spreads
for six bank holding companies and nine other banks.
Source: Markit.

recover, although they remained above the levels
observed prior to 2007. Estimates of bid-asked
spreads in corporate bond markets were within historical ranges, as was the dispersion of dealer quotes
in the credit default swap market.
Banking Institutions

Returns on equity and returns on assets for commercial banks in the second half of 2010 improved moderately from earlier in the year but remained well
below the levels that prevailed before the financial
crisis. Profits for the industry as a whole have benefitted considerably in recent quarters from reductions in
loan loss provisioning. However, pre-provision net
revenue decreased over the second half of the year as
net interest margins slid and income from both
deposit fees and trading activities declined.12 About
70 of the more than 6,500 commercial banks in the
United States failed between July and December 2010, down slightly from the 86 failures that
occurred in the first half of the year.
Spreads on credit default swaps written on banking
organizations generally held steady or moved down,
on net, since mid-2010 (figure 19). Moreover, indicators of credit quality at commercial banks showed
signs of improvement. Aggregate delinquency and
charge-off rates moved down, although they remain
high. Loss provisioning stayed elevated, but the
recent reductions generally exceeded the declines in
12

Pre-provision net revenue is the sum of net interest income and
noninterest income less noninterest expense.

26

97th Annual Report | 2010

charge-offs, which suggests that banks expect credit
quality to improve further in coming quarters.
Indeed, for every major loan type, significant net
fractions of banks reported on the January Senior
Loan Officer Opinion Survey that they expect credit
quality to improve during the current year if economic activity progresses in line with consensus
forecasts.
Equity prices of commercial banks moved higher, on
net, since mid-2010. During this period, large commercial banks generally reported earnings that beat
analysts’ expectations, and improved economic prospects were seen as boosting loan demand and supporting loan quality going forward, developments
that would buoy banks’ profitability. Nevertheless,
investors were anxious about the degree to which
future profitability might be negatively affected by a
number of factors, including the quality of assets on
banks’ books, changes in the regulatory landscape,
mortgage documentation and foreclosure issues, and
the potential for some nonperforming mortgages in
securitized pools to be put back to some of the large
banks.
Total assets of commercial banks changed little, on
net, during the second half of 2010, although there
were notable compositional shifts. With demand
weak and lending standards tight, total loans contracted. Nevertheless, the pace at which loans
decreased was not as rapid as in the first half of the
year, in part because banks’ holdings of commercial
and industrial loans picked up and their holdings of
closed-end residential mortgages grew steadily. Partly
offsetting the declines in total loans, banks expanded
their holdings of Treasury securities and agency
MBS, although the growth in their securities holdings
slowed late in the year and into 2011.
Regulatory capital ratios at commercial banks moved
higher, on balance, over the second half of 2010. The
upward trend in capital ratios over the past several
years has been most pronounced at the largest banks
as they accumulated capital while risk-weighted
assets decreased and tangible assets were about
unchanged. Capital requirements for many of these
banks will increase significantly under the new international capital standards, which will restrict the definition of regulatory capital and increase the risk
weights assigned to some assets and off-balance-sheet
exposures. In addition, the Dodd-Frank Wall Street
Reform and Consumer Protection Act requires that
the Federal Reserve issue rules by January 31, 2012,
that will subject bank holding companies with more

than $50 billion in assets to additional capital and
liquidity requirements.
Monetary Aggregates and
the Federal Reserve’s Balance Sheet

The M2 monetary aggregate has expanded at a moderate pace since mid-2010 after rising only slightly in
the first half of last year; for the year as a whole, M2
grew 3.2 percent, the slowest annual increase since
1994.13 As has been the case for some time, the strongest increase was in liquid deposits, the largest component of M2, while small time deposits and retail
money market mutual fund assets continued to contract. Liquid deposits tended to pay slightly morefavorable interest rates than did their close substitutes. The currency component of the money stock
expanded at a faster rate in the second half of 2010
than it had earlier in the year. The monetary base—
essentially equal to the sum of currency in circulation
and the reserve balances of depository institutions
held at the Federal Reserve—contracted slightly during the second half of 2010, although the downward
trend started to reverse late in the period in response
to the Federal Reserve’s new Treasury security purchase program.
The size of the Federal Reserve’s balance sheet
remained at a historically high level throughout the
second half of 2010. In early 2011, the balance sheet
stood at about $2.5 trillion, an increase of around
$200 billion from its level in early July (table 1). The
expansion of the balance sheet was more than
accounted for by an increase in holdings of Treasury
securities, which were up nearly $450 billion since the
summer. The additional holdings of Treasury securities resulted from the FOMC’s August decision to
reinvest the proceeds from paydowns of agency debt
and MBS in longer-term Treasury securities and the
asset purchase program announced at the November
FOMC meeting. To provide operational flexibility
and to ensure that it is able to purchase the most
13

M2 consists of (1) currency outside the U.S. Treasury, Federal
Reserve Banks, and the vaults of depository institutions;
(2) traveler’s checks of nonbank issuers; (3) demand deposits at
commercial banks (excluding those amounts held by depository
institutions, the U.S. government, and foreign banks and official
institutions) less cash items in the process of collection and Federal Reserve float; (4) other checkable deposits (negotiable order
of withdrawal, or NOW, accounts and automatic transfer service accounts at depository institutions; credit union share draft
accounts; and demand deposits at thrift institutions); (5) savings
deposits (including money market deposit accounts); (6) smalldenomination time deposits (time deposits issued in amounts of
less than $100,000) less individual retirement account (IRA)
and Keogh balances at depository institutions; and (7) balances
in retail money market mutual funds less IRA and Keogh balances at money market mutual funds.

Monetary Policy and Economic Developments

27

Table 1. Selected components of the Federal Reserve balance sheet, 2009–11
Millions of dollars
Balance sheet item

Dec. 30, 2009

July 7, 2010

Feb. 23, 2011

Total assets
Selected assets
Credit extended to depository institutions and dealers
Primary credit
Term auction credit
Primary Dealer Credit Facility and other broker-dealer credit
Central bank liquidity swaps
Credit extended to other market participants
Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
Net portfolio holdings of Commercial Paper Funding Facility LLC
Term Asset-Backed Securities Loan Facility
Support of critical institutions
Net portfolio holdings of Maiden Lane LLC, Maiden Lane II LLC, and Maiden Lane III LLC1
Credit extended to American International Group, Inc.
Preferred interests in AIA Aurora LLC and ALICO Holdings LLC
Securities held outright
U.S. Treasury securities
Agency debt securities
Agency mortgage-backed securities (MBS)2
Memo
Term Securities Lending Facility3
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits held by depository institutions
Of which: Term deposits
U.S. Treasury, general account
U.S. Treasury, Supplementary Financing Account
Total capital

2,237,258

2,335,457

2,537,175

19,111
75,918
0
10,272

17
0

24
0

…
1,245

…

…

70

0
14,072
47,532

1
42,278

…
…
20,997

65,024
22,033
25,000

66,996
24,560
25,733

64,902
…
…

776,587
159,879
908,257

776,997
164,762
1,118,290

1,213,425
144,119
958,201

0
2,185,139

…
2,278,523

…
2,484,141

889,678
70,450
1,025,271
…
149,819
5,001
52,119

907,698
62,904
1,061,239
2,122
16,475
199,963
56,934

956,012
59,484
1,297,905
5,070
23,123
124,976
53,035

Note: LLC is a limited liability company.
1
The Federal Reserve has extended credit to several LLCs in conjunction with efforts to support critical institutions. Maiden Lane LLC was formed to acquire certain assets of
the Bear Stearns Companies, Inc. Maiden Lane II LLC was formed to purchase residential mortgage-backed securities from the U.S. securities lending reinvestment portfolio
of subsidiaries of American International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase multisector collateralized debt obligations on which the Financial
Products group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
3
The Federal Reserve retains ownership of securities lent through the Term Securities Lending Facility.
…Not applicable.
Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.”

attractive securities on a relative-value basis, the Federal Reserve temporarily relaxed its 35 percent perissue limit on System Open Market Account
(SOMA) holdings of individual Treasury securities
and will allow SOMA holdings to rise above the previous threshold in modest increments up to a 70 percent per-issue limit; holdings of particular issues
exceed the previous limit for only a small number of
securities. In contrast, holdings of agency debt and
agency MBS declined about $180 billion between
early July and early 2011. The wave of mortgage refinancing that occurred in the autumn in the wake of
the drop in mortgage rates contributed notably to the
sharp decline in Federal Reserve holdings of MBS. In

addition, holdings of agency debt declined as these
securities matured.
Use of regular discount window lending facilities,
such as the primary credit facility, has been minimal
for some time. The Term Asset-Backed Securities
Loan Facility (TALF) was closed on June 30, 2010.
Loans outstanding under the TALF declined from
$42 billion in mid-2010 to $21 billion in early 2011 as
improved conditions in some securitization markets
resulted in prepayments of loans made under the
facility. The other broad-based credit facilities that
the Federal Reserve had introduced to provide liquidity to financial institutions and markets during the

28

97th Annual Report | 2010

financial crisis were closed early in 2010. All loans
extended through these programs had been repaid by
the summer.

Figure 20. U.S. dollar nominal exchange rate, broad index,
2006–11
December 31, 2007 = 100

The portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC,
which were created to acquire certain assets from
troubled systemically important institutions during
the crisis, have generally changed little, on net, since
mid-2010. Current estimates of the fair values of the
portfolios of the three Maiden Lane LLCs exceed the
corresponding loan balances outstanding to each
limited liability company from the Federal Reserve
Bank of New York. Consistent with the terms of the
Maiden Lane LLC transaction, on July 15, 2010, this
limited liability company began making distributions
to repay the loan received from the Federal Reserve
Bank of New York. On January 14, 2011, American
International Group, Inc., or AIG, repaid the credit
extended by the Federal Reserve under the revolving
credit line, and the Federal Reserve was paid in full
for its preferred interests in the special purpose
vehicles AIA Aurora LLC and ALICO Holdings
LLC, thereby reducing the balances in these accounts
to zero.
Stresses in European dollar funding markets in May
led to the reestablishment of liquidity swap lines
between the Federal Reserve and foreign central
banks. Only a small amount of credit has been issued
under the reestablished facilities, which in December
were extended through August 1, 2011.
On the liability side, Federal Reserve notes in circulation increased a bit, from $908 billion to $956 billion.
Reverse repos edged down. Deposits held at the Federal Reserve by depository institutions rose to about
$1.3 trillion. The Supplementary Financing Account
declined early in 2011 following the announcement
by the Treasury that it was suspending new issuance
under the Supplementary Financing Program and
that it would allow that account to fall to $5 billion
as part of its efforts to maximize flexibility in debt
management as federal debt approached the statutory debt limit.

120
115
110
105
100
95

2006

2007

2008

2009

2010

2011

Note: The data, which are in foreign currency units per dollar, are daily. The last
observation for the series is February 22, 2011. 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, Statistical Release H.10, “Foreign Exchange
Rates.”

release of the results of the European Union (EU)
stress tests—and by fears that the recovery in the
United States was slowing. Mounting expectations
that the Federal Reserve might undertake further
asset purchases in response to the weakening economic outlook also weighed on the dollar. Although
the dollar initially dropped a bit more following the
Federal Reserve’s announcement in early November
that it would purchase additional long-term Treasury
securities, it subsequently reversed course as data on
economic activity in the United States began to
strengthen and as investors began to scale back their
expectations of the ultimate size of the Federal
Reserve’s purchase program. In the first two months
of this year, the dollar edged down again as the outlook for economic activity abroad appeared to
strengthen and the financial situation in Europe stabilized. On net, the dollar declined 7 percent on a
trade-weighted basis against a broad set of currencies
over the second half of last year and into the first
two months of this year.

International Developments
International Financial Markets

The foreign exchange value of the dollar declined
over much of the third quarter of 2010 (figure 20).
This decline was spurred in part by some reversal of
flight-to-safety flows—as financial system strains in
Europe temporarily diminished following the July

Foreign benchmark sovereign yields also declined
over much of the third quarter as concerns about the
U.S. recovery and worries that China’s economy
might decelerate more quickly than had been
expected led investors to question the overall strength
of global economic growth. However, foreign yields
subsequently rose as confidence in the global recov-

Monetary Policy and Economic Developments

ery strengthened, leaving foreign benchmark yields
15 to 60 basis points higher on net.
Foreign equity markets rallied following the release
of the EU stress tests in July, and, although those
markets gave back part of these gains in August over
heightened worries about the pace of global economic growth, they nonetheless ended the third quarter higher. Over the fourth quarter and into this year,
foreign equity prices rose further as the global economic outlook improved, notwithstanding renewed
stresses in peripheral Europe. On net, headline equity
indexes in the euro area and Japan are up about 10 to
20 percent from their levels in mid-2010, while
indexes in the major emerging market economies are
about 20 percent higher; all those indexes increased,
on balance, even after having declined a bit recently
in the face of uncertainties about the Middle East
and North Africa.
Although some banks in the euro-area periphery
countries, particularly in Spain, seemed to have better access to capital markets immediately following
the stress test, their costs of funding rose again late in
the year as market concerns about the Irish and
Spanish banking sectors resurfaced. Banks in the
euro-area periphery relied heavily on the weekly and
longer-term funding operations of the European
Central Bank (ECB) over much of this period. The
strains nevertheless spilled over into increased funding costs in dollars for some European banks,
although the reaction was less severe than it had been
in May. Reportedly, many European banks had
already met their dollar funding needs through yearend before these strains occurred. Market participants welcomed the announcement that the swap
lines between the Federal Reserve and the ECB, the
Bank of England, the Swiss National Bank, the Bank
of Japan, and the Bank of Canada would be
extended through August 1.
With the yen at a 15-year high against the dollar in
nominal terms, Japanese authorities intervened in
currency markets on September 15. Japan’s Ministry
of Finance purchased dollars overnight to weaken
the value of the yen, its first intervention operation
since March 2004. The operation caused the yen to
depreciate immediately about 3 percent against the
dollar, but this movement was fairly short lived, as
the yen rose past its pre-intervention level within a
month.
During the third quarter, the EMEs saw an increase
in capital inflows, which added to upward pressures

29

on their currencies and reportedly triggered further
intervention in foreign exchange markets by EME
authorities. Authorities in several EMEs also
announced new measures to discourage portfolio
capital inflows in an attempt to ease upward pressures on their currencies and in their asset markets.
Although capital flows to EMEs appeared to moderate late in the year as long-term interest rates in the
advanced economies rose, intervention and the imposition of capital control measures continued.
The Financial Account

Financial flows in 2010 reflected changes in investor
sentiment over the course of the year, driven in part
by concerns over fiscal difficulties in Europe. Foreign
private investors made large purchases of U.S. Treasury securities in the first half of the year, but these
“flight to quality” demands eased somewhat in the
third quarter with the improvement in conditions in
European markets. Indicators for the fourth quarter
are mixed but suggest that foreign private demand for
U.S. Treasury securities picked up again late in the
year as tensions in European markets reemerged.
Foreign demand for other U.S. securities strengthened in the second half of the year. Net private purchases of both U.S. agency debt and U.S. equities
were strong, and foreign investors made small net
purchases of corporate debt securities, in contrast to
net sales over the previous several quarters. U.S. residents continued to purchase sizable amounts of foreign bonds and equities, including both emerging
market and European securities.
Banks located in the United States continued to lend
abroad, on net, in the third quarter, but at a slower
pace than in the first half of the year, as dollar funding pressures in European interbank markets eased
and banks abroad relied less on U.S. counterparties
for funding. As a result, inflows from increased foreign private purchases of U.S. securities more than
offset the banking outflows in the third quarter, generating net private financial inflows for the first time
since late 2008.
Inflows from foreign official institutions increased in
the third quarter, with inflows primarily coming from
countries seeking to counteract upward pressure on
their currencies by purchasing U.S. dollars in foreign
currency markets. These countries then used the proceeds to acquire U.S. assets, primarily Treasury securities. Available data for the fourth quarter indicate
that foreign official purchases of U.S. Treasury securities slowed as the dollar stabilized.

30

97th Annual Report | 2010

Advanced Foreign Economies

Economic growth in the advanced foreign economies
stepped down in the second half of 2010. To a large
extent, this slowdown reflected standard business
cycle dynamics, as support from fiscal stimulus and
the rebound in global trade and inventories diminished over the course of the year. In Canada, signs of
the maturing recovery were most evident in the
domestic sector, whereas in Japan, exports decelerated as growth in emerging Asian economies moderated. In Europe, the recovery was further restrained
by a reemergence of concerns over fiscal sustainability and banking sector vulnerabilities in some countries. (See box 2.) However, recent indicators of economic activity across the advanced foreign economies
suggest that performance improved moderately
toward the end of 2010. In the manufacturing sector,
purchasing managers indexes have resumed rising

and point to solid expansion. Moreover, the recovery
appears to be gradually spilling over to the retail and
service sectors, with household demand benefiting
from improving labor market conditions and rising
incomes.
Toward year-end, consumer prices in the advanced
foreign economies were boosted by a run-up in food
and energy prices. Japanese 12-month headline consumer price inflation turned slightly positive for the
first time since early 2009, in part because of a hike
in the tobacco tax, and headline inflation in Canada
and the euro area recently moved above 2 percent.
However, inflation in core consumer prices, which
excludes food and energy prices, remained subdued
amid considerable slack in these economies. One
exception was the United Kingdom, where consumer
price inflation—both headline and core—persisted

Box 2. An Update on the European Fiscal Crisis and Policy Responses
The European fiscal crisis has remained a source of
concern in global financial markets despite official
responses over the past year. The crisis began early
in 2010 after large upward revisions to the statistics
on Greek government deficits led to an erosion of
market confidence in the ability of Greece to meet its
fiscal obligations. This situation created spillovers to
other euro-area countries with high debt or deficit
levels. In early May, the European Union (EU) and the
International Monetary Fund (IMF) announced a joint
€110 billion financial support package for Greece; in
addition, the EU established lending facilities of up to
€500 billion, and the European Central Bank (ECB)
began purchasing sovereign securities to ensure the
depth and liquidity of euro-area debt markets. In
response to signs of renewed pressures in dollar
funding markets, the Federal Open Market Committee reopened dollar swap facilities with a number of
foreign central banks.
Financial tensions moderated somewhat over the
summer, in part because of favorable market reaction
to the results of Europe-wide bank stress tests
released in July. Nevertheless, the spreads of yields
on the sovereign bonds of the most vulnerable euroarea countries over those of German bonds remained
elevated. In the autumn, peripheral European sovereign bond spreads, particularly those of Ireland, widened further. Two developments contributed to the
heightened tensions: (1) the discussion of a proposal
for a more permanent financial stability mechanism
for the euro area starting in 2013, which could eventually require the restructuring of private holdings of
sovereign debt; and (2) increased concerns over the
growing real estate loan losses of Irish banks and the
associated funding difficulties. Afflicted in part by

deposit flight and difficulties raising funds in the interbank market, Irish banks became increasingly dependent on funding from the ECB.
With access to market funding increasingly limited,
Ireland agreed on November 28 to a €67.5 billion
financial support package from the EU and the IMF,
with an additional €17.5 billion of Ireland’s own funds
going to stabilize and recapitalize the country’s banking sector. Ireland agreed to implement a four-year
fiscal consolidation effort equal to 9 percent of gross
domestic product, two-thirds of which will be spending cuts, on top of the austerity measures already
adopted in the previous two years.
Following this announcement, markets appeared to
shift their focus to the possibility that official assistance would also be required for other euro-area
countries with high fiscal deficits or debts and vulnerable banking systems. This development led to a rise
in the sovereign bond spreads of Portugal, Spain,
and, to a lesser extent, Italy and Belgium. The fear
that the Irish problems might spread was exacerbated by concerns that funds available under existing
support mechanisms could be insufficient if Spain
were to need external assistance. Partly in response
to the increase in financial strains, the ECB temporarily stepped up its purchases of the debt of vulnerable
euro-area countries and announced following its
December policy meeting that it would delay exit
from its nonstandard liquidity measures. In addition,
European leaders have increasingly indicated their
desire to expand or broaden the mandate of current
support facilities, and European governments are
organizing another round of bank stress tests.

Monetary Policy and Economic Developments

above 3 percent throughout 2010, driven by prior
exchange rate depreciation and increases in the valueadded tax.
Major central banks in the advanced foreign economies have maintained an accommodative monetary
policy stance, although some have taken steps to
remove the degree of accommodation. The Bank of
Canada raised its target for the overnight rate
50 basis points in the third quarter but since then has
held its policy rate at 1 percent. The ECB discontinued refinancing operations at 6- and 12-month
maturities but extended fixed-rate refinancing at
shorter maturities and kept its main refinancing rate
at 1 percent. The Bank of England maintained its
policy rate at 0.5 percent and the size of its Asset
Purchase Facility at £200 billion. The Bank of Japan
took additional steps to ease policy by cutting its target interest rate from 10 basis points to a range of
0 to 10 basis points. In addition, it extended from
three to six months the term for its fixed-rate fundssupplying operation, and it established an asset purchase program of ¥5 trillion to buy a broad range of
financial assets, including government securities,
commercial paper, corporate bonds, exchange-traded
funds, and real estate investment trusts.
Emerging Market Economies

After a robust expansion in the first half of 2010,
economic activity in the EMEs stepped down in the
third quarter before bouncing back to solid growth in
the fourth. On average over the two quarters, real
GDP growth in the EMEs was well above that
observed in the advanced economies. Economic
activity in the EMEs was boosted by domestic
demand, supported by accommodative monetary and
fiscal policies. However, with output appearing to
approach capacity for most countries, authorities in
many EMEs have begun to unwind the stimulus
measures, both monetary and fiscal, put in place during the crisis. The withdrawal of monetary stimulus
has also been driven by a recent pickup in consumer
price inflation, which has reflected, in part, a rise in
commodity prices.
Monetary policy tightening in the EMEs has likely
been tempered by uncertainties about the pace and
durability of the economic recovery in advanced
economies, which remain an important source of
demand for the EMEs. In addition, the exit from
accommodative stances has been complicated by the
return of private capital flows to these economies.
Capital inflows appear to have exerted some upward
pressure on currencies and have raised concerns

31

about the possibility of an overheating in asset prices.
EME authorities have so far adopted a variety of
strategies to cope with increased capital flows, including intervention in foreign exchange markets to slow
the upward movement of domestic currencies, prudential measures targeted to specific markets (such as
the property market), and, in several cases, capital
controls.
Real GDP growth in China slowed a bit in the first
half of last year, but it moved back up in the second
half along with a pickup in inflation, prompting Chinese authorities to continue to tighten monetary
policy. Since last June, bank reserve requirements
increased a total of 250 basis points for the largest
banks, and the benchmark one-year bank lending
rate has risen 75 basis points. Chinese authorities
have also raised the minimum down payment
required for residential property investment in order
to slow rising property prices. Since the announcement last June by Chinese authorities that they
would allow more exchange rate flexibility, the renminbi has appreciated about 4 percent against the
dollar. However, on a real multilateral, tradeweighted basis, which gauges the renminbi’s value
against China’s major trading partners and adjusts
for differences in inflation rates, the renminbi has
depreciated slightly.
In emerging Asia excluding China, the pace of economic growth softened in the third quarter of last
year. There was a steep decline in Singapore’s real
GDP, which often exhibits wide quarterly swings.
Considerable weakness in third-quarter economic
activity was also observed in Malaysia, the Philippines, and Thailand. However, available indicators
suggest that fourth-quarter GDP growth in the
region has picked up again.
In Latin America, real GDP in Mexico and Brazil
also decelerated in the third quarter. Mexican output
has yet to recover fully from the financial crisis; total
manufacturing output slowed over the final two
quarters of the year, largely reflecting lower U.S.
manufacturing growth, which has depressed demand
for exports from Mexico. Economic activity in Brazil,
though having slowed from a very brisk pace in the
first half of the year, has remained solid, supported
by continued fiscal stimulus and high commodity
prices. Brazil’s central bank tightened reserve requirements in December, prompted by concerns about
both the pace of credit creation and the quality of
the credit being extended. In addition, the Brazilian
central bank raised its policy rate 50 basis points in

32

97th Annual Report | 2010

January of this year. The new Brazilian government
has announced some spending cuts to reduce aggregate demand and inflationary pressures.

Part 3
Monetary Policy:
Recent Developments and Outlook
Monetary Policy over the Second Half
of 2010 and Early 2011

The Federal Open Market Committee (FOMC)
maintained a target range for the federal funds rate
of 0 to ¼ percent throughout the second half of 2010
and into 2011. In the statement accompanying each
regularly scheduled FOMC meeting, the Committee
noted that economic conditions, including low rates
of resource utilization, subdued inflation trends, and
stable inflation expectations, were likely to warrant
exceptionally low levels of the federal funds rate for
an extended period. With the unemployment rate
elevated and measures of underlying inflation somewhat low relative to levels that the Committee judged
to be consistent, over the long run, with its dual mandate of maximum employment and price stability, the
FOMC took steps during the second half of 2010 to
provide additional monetary accommodation in
order to promote a stronger pace of economic recovery and to help ensure that inflation, over time,
returns to levels consistent with its mandate. In
August, the FOMC announced that it would keep
constant the Federal Reserve’s holdings of longerterm securities at their then-current level by reinvesting principal payments from agency debt and agency
mortgage-backed securities (MBS) in longer-term
Treasury securities. Then, in November, the FOMC
announced that it intended to purchase an additional
$600 billion of longer-term Treasury securities by the
end of the second quarter of 2011. The Committee
noted that it would regularly review the pace of its
securities purchases and the overall size of the asset
purchase program in light of incoming information.
The information reviewed at the August 10 FOMC
meeting indicated that the pace of the economic
recovery had slowed in recent months and that inflation remained subdued. Private employment had
increased slowly in June and July, and industrial production was little changed in June after a large
increase in May. Consumer spending continued to
rise at a modest rate in June. However, housing activity dropped back, and nonresidential construction
remained weak. In addition, the trade deficit widened
sharply in May. Conditions in financial markets had
become somewhat more supportive of economic

growth since the June meeting, in part reflecting perceptions of diminished risk of financial dislocations
in Europe. Moreover, participants saw some indications that credit conditions for households and
smaller businesses were beginning to improve, albeit
gradually. A further decline in energy prices and
unchanged prices for core goods and services led to a
fall in headline consumer prices in June.
Against this backdrop, the Committee agreed to
make no change in its target range for the federal
funds rate at the August meeting. The economic
expansion was seen as continuing, and most members believed that inflation was likely to stabilize in
coming quarters at rates near recent low readings and
then gradually rise toward levels they considered
more consistent with the Committee’s dual mandate.
Nonetheless, members generally judged that the economic outlook had softened somewhat more than
they had anticipated, and some saw increased downside risks to the outlook for both economic growth
and inflation. The Committee noted that the decline
in mortgage rates since the spring was generating
increased mortgage refinancing activity, which would
accelerate repayments of principal on MBS held in
the System Open Market Account (SOMA), and that
private investors would have to hold more longerterm securities as the Federal Reserve’s holdings ran
off, making longer-term interest rates somewhat
higher than they would have been otherwise. The
Committee concluded that it would be appropriate to
begin reinvesting principal payments received from
agency debt and MBS held in the SOMA by purchasing longer-term Treasury securities; such an action
would keep constant the face value of securities held
in the SOMA and thus avoid the upward pressure on
longer-term interest rates that might result if those
holdings were allowed to decline.
As of the September 21 FOMC meeting, the data
continued to suggest that the economic expansion
was decelerating and that inflation remained low. Private businesses increased employment modestly in
August, but the length of the workweek was
unchanged and the unemployment rate remained
elevated. The rise in business outlays for equipment
and software seemed to have moderated following
outsized gains in the first half of the year. Housing
activity weakened further, and nonresidential construction remained depressed. Industrial production
advanced at a solid pace in July and rose further in
August. Consumer spending continued to increase at
a moderate rate in July and appeared to be moving
up again in August. After falling in the previous three

Monetary Policy and Economic Developments

months, headline consumer prices had risen in July
and August as energy prices retraced some of their
earlier declines, and prices for core goods and services edged up slightly. Credit was viewed by participants as remaining readily available for larger corporations with access to capital markets, and some
reports suggested that credit conditions had begun to
improve for smaller firms. Asset prices had been relatively sensitive to incoming economic data over the
intermeeting period but generally ended the period
little changed on net. Stresses in European financial
markets were seen by participants as broadly contained but were thought to bear watching going forward. Although participants did not expect that the
economy would reenter a recession, many expressed
concern that output growth, and the associated progress in reducing the level of unemployment, could be
slow for some time. Participants noted a number of
factors that were restraining economic growth,
including low levels of household and business confidence, heightened risk aversion, and the still-weak
financial conditions of some households and small
businesses.
The Committee agreed at the September meeting to
maintain the target range for the federal funds rate of
0 to ¼ percent and to leave unchanged the level of its
combined holdings of Treasury securities, agency
debt, and agency MBS in the SOMA. In addition,
members agreed that the statement to be released following the meeting should be adjusted to clarify their
assessment that underlying inflation had been running below levels that the Committee judged to be
consistent with its dual mandate for maximum
employment and price stability. The clarification was
intended, in part, to help anchor inflation expectations and to reinforce the indication that economic
conditions were likely to warrant exceptionally low
levels of the federal funds rate for an extended
period. In light of the considerable uncertainty about
the trajectory of the economy, members saw merit in
accumulating further information before reaching a
decision about providing additional monetary stimulus. In addition, members wanted to consider further
the most effective framework for calibrating and
communicating any additional steps to provide such
stimulus. They noted that unless the pace of economic recovery strengthened or underlying inflation
moved up toward levels consistent with the FOMC’s
mandate, the Committee would consider taking
appropriate action soon.
On October 15, the Committee met by videoconference to discuss issues associated with its monetary

33

policy framework, including alternative ways to
express and communicate the Committee’s objectives, possibilities for supplementing the Committee’s
communication about its policy decisions, the merits
of making smaller and more-frequent adjustments in
the Federal Reserve’s intended securities holdings
rather than larger and less-frequent adjustments, and
the potential costs and benefits of targeting a term
interest rate. The agenda did not encompass consideration of any policy actions, and none were taken.
The information reviewed at the November 2–3
FOMC meeting continued to indicate that the economic recovery was proceeding at a modest rate, with
only a gradual improvement in labor market conditions. Moreover, measures of underlying inflation
were somewhat low relative to levels that the Committee judged to be consistent, over the longer run,
with its dual mandate. Consumer spending, business
investment in equipment and software, and exports
posted further gains in the third quarter, and nonfarm inventory investment stepped up. However, construction activity in both the residential and nonresidential sectors remained depressed, and a significant
portion of the rise in domestic demand was again
met by imports. U.S. industrial production slowed
noticeably in August and September, hiring remained
modest, and the unemployment rate stayed elevated.
While participants considered it quite unlikely that
the economy would slide back into recession, they
noted that continued slow growth and high levels of
resource slack could leave the economic expansion
vulnerable to negative shocks. Participants saw financial conditions as having become more supportive of
economic growth over the course of the intermeeting
period; most, though not all, of the change appeared
to reflect investors’ increased anticipation of a further easing of monetary policy. Headline consumer
price inflation had been subdued in recent months,
despite a rise in energy prices, as core consumer price
inflation trended lower.
Though the economic recovery was continuing,
FOMC members considered progress toward meeting the Committee’s dual mandate of maximum
employment and price stability as having been disappointingly slow. Moreover, members generally
thought that progress was likely to remain slow.
Accordingly, most members judged it appropriate to
provide additional policy accommodation. In their
discussion of monetary policy for the period immediately ahead, Committee members agreed to maintain
the target range for the federal funds rate at 0 to
¼ percent and to continue the Committee’s existing

34

97th Annual Report | 2010

policy of reinvesting principal payments from its
securities holdings into longer-term Treasury securities. The Committee also announced its intention to
purchase a further $600 billion of longer-term Treasury securities at a pace of about $75 billion per
month through the second quarter of 2011. Purchases of additional Treasury securities were
expected to put downward pressure on longer-term
interest rates, boost asset prices, and lead to a modest
reduction in the foreign exchange value of the dollar.
These changes in financial conditions were expected
to promote a somewhat stronger recovery in output
and employment while also helping return inflation,
over time, to levels consistent with the Committee’s
mandate.
The data presented at the December 14 FOMC meeting indicated that economic activity was increasing at
a moderate rate but that the unemployment rate
remained elevated. The pace of consumer spending
picked up in October and November, exports rose
rapidly in October, and the recovery in business
spending on equipment and software appeared to be
continuing. In contrast, residential and nonresidential construction activity was still depressed. Manufacturing production registered a solid gain in October. Nonfarm businesses continued to add workers in
October and November, and the average workweek
moved up. The fiscal package agreed to by the
Administration and the Congress was generally
expected by participants to support the pace of
recovery in 2011. Participants noted that interest
rates at intermediate and longer maturities had risen
substantially over the intermeeting period, while
credit spreads were roughly unchanged and equity
prices had risen moderately. Financial pressures in
peripheral Europe had increased, leading to a financial assistance package for Ireland. Longer-run inflation expectations were stable, but core inflation continued to trend lower. Overall, the information
received during the intermeeting period pointed to
some improvement in the near-term outlook, and
participants expected economic growth to pick up
somewhat going forward. A number of factors, however, were seen as likely to continue restraining the
recovery, including the depressed housing market,
employers’ continued reluctance to add to payrolls,
and ongoing efforts by some households and businesses to reduce leverage. Moreover, the recovery
remained subject to some downside risks, such as the
possibility of a more extended period of weak activity and lower prices in the housing sector as well as
potential financial and economic spillovers if the

banking and sovereign debt problems in Europe were
to worsen further.
Members noted that, while incoming information
over the intermeeting period had increased their confidence that the economic recovery would be sustained, progress toward the Committee’s dual objectives of maximum employment and price stability
continued to be modest, and unemployment and
inflation appeared likely to deviate from the Committee’s objectives for some time. Accordingly, in their
discussion of monetary policy for the period immediately ahead, Committee members agreed to continue
expanding the Federal Reserve’s holdings of longerterm securities as announced in November. The
Committee also decided to maintain the target range
for the federal funds rate at 0 to ¼ percent and to
reiterate its expectation that economic conditions
were likely to warrant exceptionally low levels of the
federal funds rate for an extended period. While the
economic outlook was seen as improving, members
generally felt that the change in the outlook was not
sufficient to warrant any adjustments to the asset
purchase program, and some noted that more time
was needed to accumulate information on the
economy before considering any adjustment. Members emphasized that the pace and overall size of the
purchase program would be contingent on economic
and financial developments; however, some indicated
that they had a fairly high threshold for making
changes to the program.
On December 21, the Federal Reserve announced an
extension through August 1, 2011, of its temporary
U.S. dollar liquidity swap arrangements with the
Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss
National Bank. The authorization of the swap
arrangements had previously been set to expire on
January 31, 2011.
The data reviewed at the January 25–26 FOMC
meeting indicated that the economic recovery was
gaining a firmer footing, though the expansion had
not yet been sufficient to bring about a significant
improvement in labor market conditions. Consumer
spending had risen strongly late in 2010, and the
ongoing expansion in business outlays for equipment
and software appeared to have been sustained in
recent months. Industrial production had increased
solidly in November and December. However, construction activity in both the residential and nonresidential sectors remained weak. Modest gains in

Monetary Policy and Economic Developments

employment had continued, but the unemployment
rate remained elevated. Conditions in financial markets were viewed by participants as having improved
somewhat further over the intermeeting period, as
equity prices had risen and credit spreads on the debt
of nonfinancial corporations had continued to narrow while yields on longer-term nominal Treasury
securities were little changed. Credit conditions were
still tight for smaller, bank-dependent firms, although
bank loan growth had picked up in some sectors.
Despite further increases in commodity prices, measures of underlying inflation remained subdued and
longer-run inflation expectations were stable.
The information received over the intermeeting
period had increased members’ confidence that the
economic recovery would be sustained, and the
downside risks to both economic growth and inflation were viewed as having diminished. Nevertheless,
members noted that the pace of the recovery was
insufficient to bring about a significant improvement
in labor market conditions, and that measures of
underlying inflation were trending downward. Moreover, the economic projections submitted for this
meeting indicated that unemployment was expected
to remain above, and inflation to remain somewhat
below, levels consistent with the Committee’s objectives for some time. Accordingly, the Committee
decided to maintain its existing policy of reinvesting
principal payments from its securities holdings and
reaffirmed its intention to purchase $600 billion of
longer-term Treasury securities by the end of the second quarter of 2011. Members emphasized that the
Committee would continue to regularly review the
pace of its securities purchases and the overall size of
the asset purchase program. In addition, the Committee maintained the target range of 0 to ¼ percent
for the federal funds rate and reiterated its expectation that economic conditions were likely to warrant
exceptionally low levels of the federal funds rate for
an extended period.
Tools for the Withdrawal
of Monetary Policy Accommodation

Although the FOMC continues to anticipate that
economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an
extended period, ultimately the Federal Reserve will
need to begin to tighten monetary conditions to prevent the development of inflationary pressures as the
economy recovers. The Federal Reserve has the tools
it needs to remove policy accommodation at the
appropriate time. One tool is the interest rate paid on
reserve balances. By increasing the rate paid on

35

reserves, the Federal Reserve will be able to put significant upward pressure on short-term market interest rates because banks will not supply short-term
funds to the money markets at rates significantly
below what they can earn by simply leaving funds on
deposit at the Federal Reserve Banks. Two other
tools, executing term reverse repurchase agreements
(RRPs) with the primary dealers and other counterparties and issuing term deposits to depository institutions through the Term Deposit Facility (TDF),
can be used to reduce the large quantity of reserves
held by the banking system; such a reduction would
improve the Federal Reserve’s control of financial
conditions by tightening the relationship between the
interest rate paid on reserves and other short-term
interest rates. The Federal Reserve could also reduce
the quantity of reserves in the banking system by
redeeming maturing and prepaid securities held by
the Federal Reserve without reinvesting the proceeds
or by selling some of its securities holdings.
During the second half of 2010, the Federal Reserve
Bank of New York (FRBNY) conducted a series of
small-scale triparty RRP transactions with primary
dealers using all eligible collateral types, including,
for the first time, agency debt and agency MBS from
the SOMA portfolio.14 The Federal Reserve also conducted a series of small-scale triparty RRP transactions with a set of counterparties that had been
expanded to include approved money market mutual
funds, using Treasury securities, agency debt, and
agency MBS as collateral.
On September 8, the Federal Reserve Board authorized a program of regularly scheduled small-value
offerings of term deposits under the TDF.15 The auctions, which are to occur about every other month,
are intended to ensure the operational readiness of
the TDF and to increase the familiarity of eligible
participants with the auction procedures. Since September, the Federal Reserve has conducted three auctions, each of which offered $5 billion in 28-day
deposits. All of these auctions were well subscribed.
Recent Steps to Increase Transparency

Transparency is an essential principle of modern central banking because it appropriately contributes to
14

15

In a triparty repurchase agreement, both parties to the agreement must have cash and collateral accounts at the same triparty agent, which is by definition also a clearing bank. The triparty agent will ensure that collateral pledged is sufficient and
meets eligibility requirements, and all parties agree to use collateral prices supplied by the triparty agent.
A few TDF auctions had occurred previously, but they were not
part of a regular program.

36

97th Annual Report | 2010

the accountability of central banks to the government and the public and because it can enhance the
effectiveness of central banks in achieving macroeconomic objectives. The Federal Reserve provides
detailed information concerning the conduct of
monetary policy.16 During the financial crisis, the
Federal Reserve developed a public website that contains extensive information on its credit and liquidity
programs, and, in 2009, the Federal Reserve began
issuing detailed monthly reports on these programs.17
Recently, the Federal Reserve has taken further steps
to enhance its transparency and expand the amount
of information it provides to the public. First, on
December 1, the Federal Reserve posted detailed
information on its public website about the individual
credit and other transactions conducted to stabilize
markets during the financial crisis, restore the flow of
credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis.18 As mandated by the DoddFrank Wall Street Reform and Consumer Protection
Act of 2010 (Dodd-Frank Act), transaction-level
details from December 1, 2007, to July 21, 2010, were
provided about entities that participated in the
agency MBS purchase program, used Federal
Reserve liquidity swap lines, borrowed through the
Term Auction Facility, or received loans or other
financial assistance through a program authorized
under section 13(3) of the Federal Reserve Act.
Many of these transactions were conducted through
a variety of broad-based lending facilities and provided liquidity to financial institutions and markets
through fully secured, mostly short-term loans. Other
transactions involved purchases of agency MBS and
16

17

18

Immediately following each meeting, the FOMC releases a
statement that lays out the rationale for the policy decision.
Detailed minutes of each FOMC meeting are made public three
weeks following the meeting. Lightly edited transcripts of
FOMC meetings are released to the public with a five-year lag.
FOMC statements, minutes, and transcripts, as well as other
related information, are available on the Federal Reserve
Board’s website. See Board of Governors of the Federal
Reserve System, “Federal Open Market Committee,” webpage,
www.federalreserve.gov/monetarypolicy/fomc.htm.
See Board of Governors of the Federal Reserve System, “Credit
and Liquidity Programs and the Balance Sheet,” webpage, www
.federalreserve.gov/monetarypolicy/bst.htm; and Board of Governors of the Federal Reserve System, “Monthly Report on
Credit and Liquidity Programs and the Balance Sheet,” webpage, www.federalreserve.gov/monetarypolicy/clbsreports.htm.
These data are available at Board of Governors of the Federal
Reserve System, “Regulatory Reform: Usage of Federal Reserve
Credit and Liquidity Facilities,” webpage, www.federalreserve
.gov/newsevents/reform_transaction.htm.

supported mortgage and housing markets; these
transactions lowered longer-term interest rates and
fostered economic growth. Dollar liquidity swap lines
with foreign central banks posed no financial risk to
the Federal Reserve because the Federal Reserve’s
counterparties were the foreign central banks themselves, not the institutions to which the foreign central banks then lent the funds; these swap facilities
helped stabilize dollar funding markets abroad, thus
contributing to the restoration of stability in U.S.
markets. Other transactions provided liquidity to
particular institutions whose disorderly failure could
have severely stressed an already fragile financial
system.
A second step toward enhanced transparency
involves disclosures going forward. The Dodd-Frank
Act established a framework for the disclosure of
information on credit extended after July 21, 2010,
through the discount window under section 10B of
the Federal Reserve Act or from a section 13(3) facility, as well as information on all open market operation (OMO) transactions. Generally, this framework
requires the Federal Reserve to publicly disclose certain information about discount window borrowers
and OMO counterparties approximately two years
after the relevant loan or transaction; information
about borrowers under future section 13(3) facilities
will be disclosed one year after the authorization for
the facility is terminated. The information to be disclosed includes the name and identifying details of
each borrower or counterparty, the amount borrowed, the interest rate paid, and information identifying the types and amounts of collateral pledged or
assets transferred in connection with the borrowing
or transaction.
Finally, the Federal Reserve has also increased transparency with respect to the implementation of monetary policy. In particular, the Federal Reserve took
steps to provide additional information about its
security purchase operations with the objective of
encouraging wider participation in such operations.
The FRBNY publishes, on an ongoing basis, schedules of purchase operations expected to take place
over the next four weeks; details provided include
lists of operation dates, settlement dates, security
types to be purchased, the maturity date range of eligible issues, and an expected range for the size of
each operation. Results of each purchase operation
are published shortly after it has concluded. In addi-

Monetary Policy and Economic Developments

37

tion, the FRBNY has commenced publication of
information on the prices paid for individual securities in its purchase operations.19

tent, over the longer run, with the Committee’s dual
mandate of maximum employment and price
stability.

Part 4
Summary of Economic Projections

As indicated in table 1, relative to their previous projections in November 2010, participants anticipated
somewhat more rapid growth in real GDP this year,
but they did not significantly alter their expectations
for the pace of the expansion in 2012 and 2013 or for
the longer run. Participants made only minor
changes to their forecasts for the path of the unemployment rate and for the rate of inflation over the
next three years. Although most participants anticipated that the economy would likely converge to sustainable rates of increase in real GDP and prices over
five or six years, a number of participants indicated
that they expected that the convergence of the unemployment rate to its longer-run level would require
additional time.

The following material appeared as an addendum to
the minutes of the January 25–26, 2011, meeting of
the Federal Open Market Committee.
In conjunction with the January 25–26, 2011, Federal
Open Market Committee (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, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2011 to 2013
and over the longer run. The projections were based
on information available through the end of the
meeting and on each participant’s assumptions about
factors likely to affect economic outcomes, including
his or her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that each participant deems
most likely to foster outcomes for economic activity
and inflation that best satisfy his or her interpretation of the Federal Reserve’s dual objectives of maximum employment and stable prices. Longer-run projections represent each participant’s assessment of
the rate to which each variable would be expected to
converge over time under appropriate monetary
policy and in the absence of further shocks.
As depicted in figure 1, FOMC participants’ projections for the next three years indicated that they
expect a sustained recovery in real economic activity,
marked by a step-up in the rate of increase in real
gross domestic product (GDP) in 2011 followed by
further modest acceleration in 2012 and 2013. They
anticipated that, over this period, the pace of the
recovery would exceed their estimates of the longerrun sustainable rate of increase in real GDP by
enough to gradually lower the unemployment rate.
However, by the end of 2013, participants projected
that the unemployment rate would still exceed their
estimates of the longer-run unemployment rate. Most
participants expected that inflation would likely
move up somewhat over the forecast period but
would remain at rates below those they see as consis19

General information on OMOs, including links to the prices
paid in recent purchases of Treasury securities, is available on
the FRBNY’s website at www.newyorkfed.org/markets/pomo/
display/index.cfm.

As they did in November, participants judged the
level of uncertainty associated with their projections
for real economic activity and inflation as unusually
high relative to historical norms. Most continued to
see the risks surrounding their forecasts of GDP
growth, the unemployment rate, and inflation over
the next three years to be generally balanced. However, fewer noted downside risks to the likely pace of
the expansion and, accordingly, upside risks to the
unemployment rate than in November; fewer also
saw downside risks to inflation.
The Outlook

The central tendency of participants’ forecasts for the
change in real GDP in 2011 was 3.4 to 3.9 percent,
somewhat higher than in the November projections.
Participants stated that the economic information
received since November indicated that consumer
spending, business investment, and net exports
increased more strongly at the end of 2010 than
expected earlier; industrial production also expanded
more rapidly than they previously anticipated. In
addition, after the November projections were prepared, the Congress approved fiscal stimulus measures that were expected to provide further impetus to
household and business spending in 2011. Moreover,
participants noted that financial conditions had
improved since November, including a rise in equity
prices, a pickup in activity in capital markets, reports
of easing of credit conditions in some markets, and
an upturn in bank lending in some sectors. Many
participants viewed the stronger tenor of the recent
information, along with the additional fiscal stimulus,
as suggesting that the recovery had gained some

38

97th Annual Report | 2010

Figure 1. Central tendencies and ranges of economic projections, 2011–13 and over the longer run
Percent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0_
1

Actual

2

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Unemployment rate

10
9
8
7
6
5

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Core PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual. The data for the change in real GDP, PCE inflation, and core
PCE inflation shown for 2010 incorporate the advance estimate of GDP for the fourth quarter of 2010, which the Bureau of Economic Analysis released on January 28, 2011.
This information was not available to FOMC meeting participants at the time of their meeting.

Monetary Policy and Economic Developments

39

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, January 2011
Percent
Central tendency1

Range2

Variable

Change in real GDP
November projection
Unemployment rate
November projection
PCE inflation
November projection
Core PCE inflation3
November projection

2011

2012

2013

Longer run

2011

2012

2013

Longer run

3.4 to 3.9
3.0 to 3.6
8.8 to 9.0
8.9 to 9.1
1.3 to 1.7
1.1 to 1.7
1.0 to 1.3
0.9 to 1.6

3.5 to 4.4
3.6 to 4.5
7.6 to 8.1
7.7 to 8.2
1.0 to 1.9
1.1 to 1.8
1.0 to 1.5
1.0 to 1.6

3.7 to 4.6
3.5 to 4.6
6.8 to 7.2
6.9 to 7.4
1.2 to 2.0
1.2 to 2.0
1.2 to 2.0
1.1 to 2.0

2.5 to 2.8
2.5 to 2.8
5.0 to 6.0
5.0 to 6.0
1.6 to 2.0
1.6 to 2.0

3.2 to 4.2
2.5 to 4.0
8.4 to 9.0
8.2 to 9.3
1.0 to 2.0
0.9 to 2.2
0.7 to 1.8
0.7 to 2.0

3.4 to 4.5
2.6 to 4.7
7.2 to 8.4
7.0 to 8.7
0.7 to 2.2
0.6 to 2.2
0.6 to 2.0
0.6 to 2.0

3.0 to 5.0
3.0 to 5.0
6.0 to 7.9
5.9 to 7.9
0.6 to 2.0
0.4 to 2.0
0.6 to 2.0
0.5 to 2.0

2.4 to 3.0
2.4 to 3.0
5.0 to 6.2
5.0 to 6.3
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are 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 (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The November projections were made in
conjunction with the meeting of the Federal Open Market Committee on November 2–3, 2010.
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 consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

strength—a development seen as likely to carry into
2011—and that the expansion was on firmer footing.
Participants expected that the expansion in real economic activity this year would continue to be supported by accommodative monetary policy and by
ongoing improvement in credit and financial market
conditions. The strengthening in private demand was
anticipated to be led by increases in consumer and
business spending; over time, improvements in household and business confidence and in labor market
conditions would likely reinforce the rise in domestic
demand. Nonetheless, participants recognized that
the information available since November also indicated that the expansion remained uneven across sectors of the economy, and they expected that the pace
of economic activity would continue to be moderated
by the weakness in residential and nonresidential construction, the still relatively tight credit conditions in
some sectors, an ongoing desire by households to
repair their balance sheets, business caution about
hiring, and the budget difficulties faced by state and
local governments.

businesses, increasing household and business confidence, and a favorable outlook for U.S. exports. Several participants noted that, in such an environment,
and with labor market conditions anticipated to
improve gradually, the restraints on household
spending from past declines in wealth and the desire
to rebuild savings should abate. A number of participants saw such conditions fostering a broader and
stronger recovery in business investment, with a few
noting that the market for commercial real estate had
recently shown signs of stabilizing. Nonetheless, participants saw a number of factors that would likely
continue to moderate the pace of the expansion.
Most participants expected that the recovery in the
housing market would remain slow, restrained by the
overhang of vacant properties, prospects for weak
house prices, and the difficulties in resolving foreclosures. In addition, some participants expected that
the fiscal strains on the budgets of state and local
governments would damp their spending for a time
and that the federal government sector would likely
be a drag on economic activity after 2011.

Participants expected that the economic expansion
would strengthen further in 2012 and 2013, with the
central tendencies of their projections for the growth
in real GDP moving up to 3.5 to 4.4 percent in 2012
and then to 3.7 to 4.6 percent in 2013. Participants
cited, as among the likely contributors to a sustained
pickup in the pace of the expansion, a continued
improvement in financial market conditions, further
expansion of credit availability to households and

Participants anticipated that a gradual but steady
reduction in the unemployment rate would accompany the pickup in the pace of the economic expansion over the next three years. The central tendency
of their forecasts for the unemployment rate at the
end of 2011 was 8.8 to 9.0 percent—a decline of less
than 1 percentage point from the actual rate in the
fourth quarter of 2010. Although participants generally expected further declines in the unemployment

40

97th Annual Report | 2010

rate over the subsequent two years—to a central tendency of 6.8 to 7.2 percent at the end of 2013—they
anticipated that, at the end of that period, unemployment would remain noticeably higher than their estimates of the longer-run rate. Many participants
thought that, with appropriate monetary policy and
in the absence of further shocks, the unemployment
rate would continue to converge gradually toward its
longer-run rate within five to six years, but a number
of participants indicated that the convergence process would likely be more extended.
While participants viewed the projected pace of the
expansion in economic activity as the principal factor
underlying their forecasts for the path of the unemployment rate, they also indicated that their projections were influenced by a number of other factors
that were likely to contribute to a relatively gradual
recovery in the labor market. In that regard, several
participants noted that dislocations associated with
the uneven recovery across sectors of the economy
might retard the matching of workers and jobs. In
addition, a number of participants viewed the modest pace of hiring in 2010 as, in part, the result of
business caution about the durability of the recovery
and of employers’ efforts to achieve additional
increases in productivity; several participants also
cited the particularly slow recovery in demand experienced by small businesses as a factor restraining new
job creation. With demand expected to strengthen
across a range of businesses and with business confidence expected to improve, participants anticipated
that hiring would pick up over the forecast period.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2011

2012

2013

±1.3
±0.7
±1.0

±1.7
±1.3
±1.0

±1.8
±1.5
±1.1

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1990 through 2009 that were released in the winter by
various private and government forecasters. As described in box 3, under certain
assumptions, there is about a 70 percent probability that actual outcomes for real
GDP, unemployment, and consumer prices will be in ranges implied by the
average size of projection errors made in the past. Further information is in David
Reifschneider and Peter Tulip (2007), “Gauging the Uncertainty of the Economic
Outlook from Historical Forecasting Errors,” Finance and Economics Discussion
Series 2007-60 (Washington: Board of Governors of the Federal Reserve System,
November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

in 2012 and 2013 widened somewhat relative to 2011
and showed that inflation was expected to drift up
modestly. In 2013, the central tendency of forecasts
for both the total and core inflation rates was 1.2 to
2.0 percent. For most participants, inflation in 2013
was not expected to have converged to the longer-run
rate of inflation that they individually considered
most consistent with the Federal Reserve’s dual mandate for maximum employment and stable prices.
However, a number of participants anticipated that
inflation would reach its longer-run rate within the
next three years.
Uncertainty and Risks

Participants continued to expect that inflation would
be relatively subdued over the next three years and
kept their longer-run projections of inflation
unchanged. Many participants indicated that the persistence of large margins of slack in resource utilization should contribute to relatively low rates of inflation over the forecast horizon. In addition, participants noted that appropriate monetary policy,
combined with stable longer-run inflation expectations, should help keep inflation in check. The central
tendency of their projections for overall personal
consumption expenditures (PCE) inflation in 2011
was 1.3 to 1.7 percent, while the central tendency of
their forecasts for core PCE inflation was lower—
1.0 to 1.3 percent. Increases in the prices of energy
and other commodities, which were very rapid in
2010, were anticipated to continue to push headline
PCE inflation above the core rate this year. The central tendency of participants’ forecasts for inflation

Most participants continued to share the view that
their projections for economic activity and inflation
were subject to a higher level of uncertainty than was
the norm during the previous 20 years.20 They identified a number of uncertainties that compounded the
inherent difficulties in forecasting output growth,
unemployment, and inflation. Among them were
uncertainties about the nature of economic recoveries
from recessions associated with financial crises, the
effects of unconventional monetary policies, the persistence of structural dislocations in the labor market, the future course of federal fiscal policy, and the
global economic outlook.
20

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1990 to 2009. Box 3 discusses the
sources and interpretation of uncertainty in the economic forecasts and explains the approach used to assess the uncertainty
and risks attending the participants’ projections.

Monetary Policy and Economic Developments

Box 3. Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers 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 gross domestic product (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 would imply a probability of about 70 percent that actual GDP would expand within a range of
1.7 to 4.3 percent in the current year, 1.3 to 4.7 percent in the second year, and 1.2 to 4.8 percent in the
third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.0 to 3.0 percent in the current and second years, and 0.9 to
3.1 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, are weighted to the 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.

41

Almost all participants viewed the risks to their forecasts for the strength of the recovery in real GDP as
broadly balanced. By contrast, in November, the distribution of views had been somewhat skewed to the
downside. In weighing the risks to the projected
growth rate of real economic activity, some participants noted the upside risk that the recent strengthening of aggregate spending might mark the beginning of a more normal cyclical rebound in economic
activity in which consumer spending might be
spurred by pent-up demand for household durables
and in which business investment might be accelerated by the desire to rebuild stocks of fixed capital. A
more-rapid-than-expected easing of credit availability was also seen as a factor that might boost the
pickup in private demand. As to the downside risks,
many participants pointed to the recent declines in
house prices and the potential for a slower resolution
of existing problems in mortgage and real estate markets as factors that could have more-adverse-thanexpected consequences for household spending and
bank balance sheets. In addition, several participants
expressed concerns that, in an environment of only
gradual improvement in labor market and credit conditions, households might be unusually focused on
reducing debt and boosting saving. A number of participants also saw a downside risk in the possibility
that the fiscal problems of some state and local governments might lead to a greater retrenchment in
their spending than currently anticipated. Finally,
several participants expressed concerns that the
financial and fiscal strains in the euro area might spill
over to U.S. financial markets.
The risks surrounding participants’ forecasts of the
unemployment rate were also broadly balanced and
generally reflected the risks attending participants’
views of the likely strength of the expansion in real
activity. However, a number of participants noted
that the unemployment rate might decline less than
they projected if businesses were to remain hesitant
to expand their workforces because of uncertainty
about the durability of the expansion or about
employment costs or if mismatches of workers and
jobs were more persistent than anticipated.
Most participants judged the risks to their inflation
outlook over the period from 2011 to 2013 to be
broadly balanced as well. Compared with their views
in November, several participants no longer saw the
risks as tilted to the downside, and an additional participant viewed the risks as weighted to the upside. In
assessing the risks, a number of participants indicated that they saw the risks of deflation or further

42

97th Annual Report | 2010

unwanted disinflation to have diminished. Many participants identified the persistent gap between their
projected unemployment rate and its longer-run rate
as a risk that inflation could be lower than they projected. A few of those who indicated that inflation
risks were skewed to the upside expressed concerns
that the expansion of the Federal Reserve’s balance
sheet, if left in place for too long, might erode the
stability of longer-run inflation expectations. Alternatively, several participants noted that upside risks
to inflation could arise from persistently rapid
increases in the costs of energy and other
commodities.
Diversity of Views

Figures 2.A and 2.B detail the diversity of participants’ views regarding the likely outcomes for real
GDP growth and the unemployment rate in 2011,
2012, 2013, and over the longer run. The dispersion
in these projections reflected differences in participants’ assessments of many factors, including the
likely evolution of conditions in credit and financial
markets, the timing and the degree to which various
sectors of the economy and the labor market will
recover from the dislocations associated with the
deep recession, the outlook for economic and financial developments abroad, and appropriate future
monetary policy and its effects on economic activity.
For 2011 and 2012, the dispersions of participants’
forecasts for the strength in the expansion of real

GDP and for the unemployment rate were somewhat
narrower than they were last November, while the
ranges of views for 2013 and for the longer run were
little changed.
Figures 2.C and 2.D provide the corresponding information about the diversity of participants’ views
regarding the outlook for total and core PCE inflation. These distributions were somewhat more tightly
concentrated for 2011, but for 2012 and 2013, they
were much the same as they were in November. In
general, the dispersion in the participants’ inflation
forecasts for the next three years represented differences in judgments regarding the fundamental determinants of inflation, including estimates of the
degree of resource slack and the extent to which such
slack influences inflation outcomes and expectations
as well as estimates of how the stance of monetary
policy may influence inflation expectations. Although
the distributions of participants’ inflation forecasts
for 2011 through 2013 continued to be relatively
wide, the distribution of projections of the longerrun rate of overall inflation remained tightly concentrated. The narrow range illustrates the broad similarity in participants’ assessments of the approximate
level of inflation that is consistent with the Federal
Reserve’s dual objectives of maximum employment
and price stability.

Monetary Policy and Economic Developments

43

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2012

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2013

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

Percent range
Note: Definitions of variables are in the general note to table 1.

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

44

97th Annual Report | 2010

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

2012

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

2013

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

Percent range
Note: Definitions of variables are in the general note to table 1.

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Monetary Policy and Economic Developments

45

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2012

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2013

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

Percent range
Note: Definitions of variables are in the general note to table 1.

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

46

97th Annual Report | 2010

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2011–13
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2012

14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2013

14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

Percent range
Note: Definitions of variables are in the general note to table 1.

1.31.4

1.51.6

1.71.8

1.92.0

Monetary Policy and Economic Developments

Abbreviations
ABS

asset-backed securities

AIG

American International Group, Inc.

ARRA

American Recovery and Reinvestment Act

C&I

commercial and industrial

CMBS

commercial mortgage-backed securities

CRE

commercial real estate

Credit Card
Act
Credit Card Accountability Responsibility and Disclosure Act
DPI

disposable personal income

ECB

European Central Bank

ECI

employment cost index

EME

emerging market economy

EU

European Union

FASB

Financial Accounting Standards Board

FOMC

Federal Open Market Committee; also, the Committee

FRBNY

Federal Reserve Bank of New York

GDP

gross domestic product

GSE

government-sponsored enterprise

IMF

International Monetary Fund

IRA

individual retirement account

IT

information technology

Libor

London interbank offered rate

LLC

limited liability company

MBS

mortgage-backed securities

NFIB

National Federation of Independent Business

NIPA

national income and product accounts

NOW

negotiable order of withdrawal

OMO

open market operation

PCE

personal consumption expenditures

repo

repurchase agreement

RRP

reverse repurchase agreement

SCOOS

Senior Credit Officer Opinion Survey on Dealer Financing Terms

SLOOS

Senior Loan Officer Opinion Survey on Bank Lending Practices

SOMA

System Open Market Account

TALF

Term Asset-Backed Securities Loan Facility

TARP

Troubled Asset Relief Program

TDF

Term Deposit Facility

WTI

West Texas Intermediate

47

48

97th Annual Report | 2010

Monetary Policy Report of July 2010
Part 1
Overview: Monetary Policy
and the Economic Outlook
Economic activity expanded at a moderate pace in
the first half of 2010 after picking up in the second
half of 2009. Some of the increase in real gross
domestic product (GDP) in the first half of the year
came from a continued turn in the inventory cycle.
But more broadly, activity was bolstered by ongoing
stimulus from monetary and fiscal policies and generally supportive financial conditions. In the labor market, payrolls rose modestly and hours per worker
increased; nevertheless, employment remained significantly below pre-recession levels and unemployment
receded only slightly from its recent high. Meanwhile,
consumer price inflation edged lower.
Financial markets, although volatile, generally supported economic growth in the first half of 2010.
Bank credit, however, remained tight for many borrowers. Moreover, in the second quarter, uncertainty
about the consequences of the fiscal pressures in a
number of European countries and about the durability of the global recovery led to large declines in
equity prices around the world and produced strains
in some short-term funding markets. According to
the projections prepared in conjunction with the June
meeting of the Federal Open Market Committee
(FOMC), meeting participants (members of the
Board of Governors and presidents of the Federal
Reserve Banks) continue to expect that economic
activity will expand at a moderate rate over the second half of 2010 and in 2011. However, participants’
current projections for economic growth are somewhat weaker than those prepared for the April
FOMC meeting, and unemployment is expected to
fall even more slowly than had been anticipated in
April. Largely because of uncertainty about the
implications of developments abroad, the participants also indicated somewhat greater concern about
the downside risks to the economic outlook than
they had at the time of the April meeting.
After rising at an annual rate of about 4 percent, on
average, in the second half of 2009, U.S. real GDP
increased at a rate of 2¾ percent in the first quarter
of 2010, and available information points to another
moderate gain in the second quarter. Some of the
impetus to the continued recovery in economic activity during the first half of the year came from inven-

tory investment as businesses started to rebuild
stocks after the massive liquidation in the latter part
of 2008 and in 2009. In addition, final sales continued to firm as personal consumption expenditures
(PCE) rose and as business fixed investment was
spurred by capital outlays that had been deferred
during the downturn and by the need of many businesses to replace aging equipment. In the external
sector, exports continued to rebound, providing
impetus to domestic production, while imports were
lifted by the recovery in domestic demand. On the
less favorable side, outlays for nonresidential construction have declined further this year, and despite
a transitory boost from the homebuyer tax credit,
housing construction has continued to be weighed
down by weak demand, a large inventory of distressed or vacant houses, and tight credit conditions
for builders and some potential buyers. In addition,
state and local governments are still cutting spending
in response to ongoing fiscal pressures.
The upturn in economic activity has been accompanied by a modest improvement in labor market conditions. On average, private-sector employment rose
100,000 per month over the first half of 2010, with
increases across a wide range of industries; businesses also raised their labor input by increasing
hours per worker. Nonetheless, the pace of hiring to
date has not been sufficient to bring about a significant reduction in the unemployment rate, which averaged 9¾ percent in the second quarter, only slightly
below its recession high of 10 percent in the fourth
quarter of 2009. Long-term unemployment has continued to worsen.
On the inflation front, prices of energy and other
commodities have declined in recent months, and
underlying inflation has trended lower. The overall
PCE price index rose at an annual rate of about
¾ percent over the first five months of 2010 (compared with an increase of about 2 percent over the
12 months of 2009), while price increases for consumer expenditures other than food and energy
items—so-called core PCE—slowed from 1½ percent
over the 12 months of 2009 to an annual rate of
1 percent over the first five months of 2010. FOMC
participants expect that, with substantial resource
slack continuing to restrain cost pressures and
longer-term inflation expectations stable, inflation is
likely to be subdued for some time.
Domestic financial conditions generally showed
improvement through the first quarter of 2010, but

Monetary Policy and Economic Developments

the fiscal strains in Europe and the uncertainty they
engendered subsequently weighed on financial markets. As a result, foreign and domestic equity price
indexes fell appreciably in the second quarter, and
pressures emerged in dollar funding markets; safehaven flows lowered sovereign yields in most of the
major advanced economies and boosted the foreign
exchange value of the dollar and the Japanese yen.
Over the first half of the year, investors marked
down expectations for the path of U.S. monetary
policy in response to economic and financial developments and to the FOMC’s continued indication that
it expected economic conditions to warrant exceptionally low levels of the federal funds rate for an
extended period. These same factors, as well as safehaven flows, contributed to a decline in Treasury
rates. Some private borrowing rates, including mortgage rates, also fell. Broad equity price indexes
declined, on net, over the first half of 2010.
Consumer credit outstanding continued to fall,
though at a less rapid pace than in the second half of
last year. Larger corporations with access to capital
markets were able to issue bonds to meet their
financing needs, although some smaller businesses
reportedly had considerable difficulties obtaining
credit. Standards on many categories of bank loans
remained tight, and loans on banks’ books continued
to contract, although somewhat less rapidly than
around year-end. Commercial bank profitability
stayed low by historical standards, as loan losses
remained at very high levels.
To support the economic expansion, the FOMC
maintained a target range for the federal funds rate
of 0 to ¼ percent throughout the first half of 2010.
To complete the purchases previously announced,
over the first three months of the year, the Federal
Reserve also conducted large-scale purchases of
agency mortgage-backed securities and agency debt
in order to provide support to mortgage lending and
housing markets and to improve overall conditions in
private credit markets. In light of improved functioning of financial markets, the Federal Reserve closed
by the end of June all of the special liquidity facilities
that it had created to support markets in late 2007
and in 2008. However, in response to renewed dollar
funding pressures abroad, in May the Federal
Reserve reestablished swap lines with the Bank of
Canada, the Bank of England, the Bank of Japan,
the European Central Bank, and the Swiss National
Bank. The Federal Reserve continued to develop its
tools for draining reserves from the banking system

49

to support the withdrawal of policy accommodation
when such action becomes appropriate. The Committee is monitoring the economic outlook and financial
developments, and it will employ its policy tools as
necessary to promote economic recovery and price
stability.
The economic projections prepared in conjunction
with the June FOMC meeting are presented in Part 4
of this report. In general, FOMC participants anticipated that the economic recovery would proceed at a
moderate pace. The expansion was expected to be
restrained in part by household and business uncertainty, persistent weakness in real estate markets, only
gradual improvement in labor market conditions,
waning fiscal stimulus, and slow easing of credit conditions in the banking sector. The projected increase
in real GDP was only a little faster than the economy’s longer-run sustainable growth rate, and thus the
unemployment rate was anticipated to fall only
slowly over the next few years. Inflation was expected
to remain subdued over this period. The participants’
projections for economic activity and inflation were
both somewhat lower than those prepared in conjunction with the April FOMC meeting, mainly
because of the incoming economic data and the
anticipated effects of developments abroad on the
U.S. economy.
Participants generally judged that the degree of
uncertainty surrounding the outlook for both economic activity and inflation was greater than historical norms. About one-half of the participants viewed
the risks to the growth outlook as tilted to the downside, whereas in April, a large majority had seen the
risks to growth as balanced; most continued to see
balanced risks surrounding their inflation projections. Participants also reported their assessments of
the rates to which macroeconomic variables would be
expected to converge over the longer run under
appropriate monetary policy and in the absence of
further shocks to the economy. The central tendencies of these longer-run projections were 2.5 to
2.8 percent for real GDP growth, 5.0 to 5.3 percent
for the unemployment rate, and 1.7 to 2.0 percent for
the inflation rate.

Part 2
Recent Economic
and Financial Developments
Real gross domestic product (GDP) increased at an
annual rate of 2¾ percent in the first quarter of 2010
after rising about 4 percent on average in the second

50

97th Annual Report | 2010

half of 2009, and it apparently posted another moderate gain in the second quarter.1 Some of the impetus to the continued recovery in economic activity in
the first half of the year came from inventory investment as businesses started to rebuild stocks after the
massive liquidation in the latter part of 2008 and in
2009. In addition, final sales continued to firm as
consumer spending moved up, businesses raised their
outlays for equipment and software, and demand for
U.S. exports strengthened. In contrast, the underlying pace of activity in the housing sector has
improved only marginally since hitting bottom in
2009. In the labor market, employment rose gradually over the first half of 2010 and average weekly
hours worked increased, but the unemployment rate
fell just slightly. Headline consumer price inflation
has been low this year, as energy prices have dropped
and core inflation has slowed.
The gradual healing of the financial system that
began in the spring of 2009 continued through the
early spring of 2010. In the first quarter, financial
market conditions generally became more supportive
of economic activity, with yields and spreads on corporate bonds declining, broad equity price indexes
rising, and measures of stress in many short-term
funding markets falling to near their pre-crisis levels.
In late April and early May, however, concerns about
the effects of fiscal pressures in a number of European countries led to increases in credit spreads on
many U.S. corporate bonds, declines in broad equity
price indexes, and a renewal of strains in some shortterm funding markets. Even so, over the first half of
the year, mortgage rates and yields on U.S. corporate
securities remained at low levels.

drop in stock prices during the spring unwound some
of the earlier increase in wealth and—all else being
equal—may restrain the rise in real PCE in the second half of the year. The personal saving rate has
fluctuated in a fairly narrow range since the middle
of 2009, and it stood at 4 percent in May.
The gains in consumer spending during the first half
of 2010 were widespread. Sales of new light motor
vehicles (cars, sport utility vehicles, and pickup
trucks) rose from an annual rate of 10¾ million units
in the fourth quarter of 2009 to 11¼ million units in
the second quarter, supported in part by favorable
financing conditions for auto buyers. Spending for
other goods started the year on a strong note—perhaps boosted by pent-up demand for purchases that
had been deferred during the recession—though it
appears to have cooled somewhat during the spring.
Real outlays for services increased modestly after
having only edged up in 2009.
Aggregate real disposable personal income (DPI)—
personal income less personal current taxes, adjusted
to remove price changes—rose at an annual rate of
more than 3½ percent over the first five months of
the year after barely increasing in 2009. Real wage
and salary income, which had fallen appreciably in
2009, has regained some lost ground this year, as
employment and hours of work have turned up and
as real hourly wages have been bolstered by the very
low rate of PCE price inflation. One measure of real
wages—average hourly earnings of all employees,
adjusted for the rise in PCE prices—increased at an
annual rate of roughly 1 percent over the first five
months of 2010 after having been about flat over the
12 months of 2009.

Domestic Developments
The Household Sector

Consumer Spending and Household Finance
Personal consumption expenditures (PCE) appear to
have posted a moderate advance in the first half of
2010 after turning up in the second half of 2009. The
improvement in employment and hours worked, and
the associated pickup in real household incomes, provided important impetus to spending. The rise in
household net worth in 2009 and the first quarter of
2010 also likely helped buoy spending, although the
1

The oil spill in the Gulf of Mexico is having serious consequences for the environment and for many individuals and firms
in the affected localities. However, the disaster does not appear
to have registered sizable effects on the national economy to
date.

With equity values up and house prices holding
steady, the ratio of household net worth to DPI
edged higher in the first quarter of 2010 after
increasing appreciably over the last three quarters of
2009. Nonetheless, the wealth-to-income ratio at that
time was well below the highs of 2006 and 2007.
Moreover, equity prices have fallen substantially since
the end of the first quarter, a development that has
not only depressed net worth but has also adversely
affected consumer sentiment in recent months.
Households continued to reduce their debt in the first
half of 2010. Total household debt contracted at an
annual rate of about 2½ percent in the first quarter
of 2010, with both mortgage debt and consumer
credit posting declines. The fall in consumer credit
was less rapid than it had been in the second half of

Monetary Policy and Economic Developments

2009, a development that is consistent with banks’
increased willingness to extend consumer installment
loans that has been reported in recent results of the
Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS).2 However, SLOOS respondents also continued to report weak demand for such
loans. Reflecting the contraction in household debt,
debt service payments—the required principal and
interest on existing mortgages and consumer debt—
fell as a fraction of disposable income.
Changes in interest rates on consumer loans were
mixed during the first half of 2010. Interest rates on
new auto loans edged down on balance, and spreads
on these loans relative to Treasury securities of comparable maturity remained near their average levels
over the past decade. Interest rates on credit card
loans rose through the first half of 2010; part of the
increase early in the year may be attributable to
adjustments made by banks prior to the imposition
of new rules in February under the Credit Card
Accountability Responsibility and Disclosure (Credit
CARD) Act.3

51

housing activity appears to have remained weak this
year despite a historically low level of mortgage interest rates. In an environment of soft demand, a large
inventory of foreclosed or distressed properties on
the market, and limits on the availability of financing
for builders and some potential buyers, homebuilding
has stayed at a slow pace. In the single-family sector,
new units were started at an average annual rate of
about 510,000 units between January and June—just
150,000 units above the quarterly low reached in the
first quarter of 2009. Activity in the multifamily sector has continued to be held down by elevated
vacancy rates and tight credit conditions; starts averaged just 100,000 units at an annual rate during the
first half of 2010, essentially the same as in the second half of 2009 and well below the norm of
350,000 units per year that had prevailed over the
decade prior to the financial crisis.

Although delinquency rates on auto loans at captive
finance companies and on credit card loans at commercial banks edged down in the first quarter of
2010, they remained at elevated levels. Charge-off
rates for credit card loans at commercial banks were
also high.

Home sales surged in the spring, but these increases
likely were driven by purchases that were pulled forward to qualify for the homebuyer tax credit.5 Sales
of existing single-family houses jumped to an annual
rate of 5 million units on average in April and May,
½ million units above their first-quarter pace. However, new home sales agreements—which also appear
to have gotten a lift in April from the looming expiration of the tax credit—plummeted in May, and other
indicators of housing demand generally remain
lackluster.

The Federal Reserve’s Term Asset-Backed Securities
Loan Facility (TALF) continued to support the issuance of consumer asset-backed securities (ABS) until
its closure for such securities on March 31.4 Subsequently, issuance of consumer ABS was solid during
the second quarter. Yields on such securities fell on
balance during the first quarter, and spreads on highquality credit card and auto loan ABS relative to
comparable-maturity Treasury securities declined to
levels last seen in 2007.

Meanwhile, house prices, as measured by a number
of national indexes, appear to be reaching bottom.
For example, the LoanPerformance repeat-sales price
index, which had dropped 30 percent from its peak in
2006 to its trough in 2009, has essentially moved sideways this year. This apparent end to the steep drop in
house prices should begin to draw into the market
potential buyers who had been reluctant to purchase
homes when prices were perceived to be at risk of
significant further declines.

Residential Investment and Housing Finance
Home sales and construction were boosted in the
spring by the homebuyer tax credit. But looking
through this temporary improvement, underlying

Delinquency rates on most categories of mortgages
showed tentative signs of leveling off over the first
several months of 2010 but remain well above levels
posted a year earlier. As of May, serious delinquency
rates on prime and near-prime loans had edged down
to about 15 percent for variable-rate loans and to

2

3

4

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.
The Credit CARD Act includes some provisions that place
restrictions on issuers’ ability to impose certain fees and to
engage in risk-based pricing.
The TALF extended loans to finance investment in ABS. The
TALF remained open until June 30 for loans backed by newly
issued commercial mortgage-backed securities.

5

In order to receive the homebuyer tax credit, a purchaser had to
sign a sales agreement by the end of April. As the law was written, the purchaser had to close on the property by June 30, but
the closing deadline was recently changed to September 30.
Sales of existing homes are measured at closing, while sales of
new homes are measured at the time the contract is signed.

52

97th Annual Report | 2010

about 5 percent for fixed-rate loans.6 For subprime
loans, as of April (the latest data available), delinquency rates moved down to about 40 percent for
variable-rate loans and slightly less than 20 percent
for fixed-rate loans. About 650,000 homes entered
the foreclosure process in the first quarter of 2010,
only slightly below the elevated pace seen in 2009.
On balance, interest rates on fixed-rate mortgages
decreased over the first half of 2010, a move that
partly reflected the decline in Treasury yields over
that period. Some financial market participants had
reportedly expressed concerns that rates would rise
following the March 31 end of large-scale purchases
of agency mortgage-backed securities (MBS) by the
Federal Reserve. However, mortgage rates changed
little around that date, and spreads have remained
relatively narrow.
Despite the further fall in mortgage rates, the availability of mortgage financing continued to be constrained. The April 2010 SLOOS indicated that while
banks had generally ceased tightening lending standards on all types of mortgages, they had not yet
begun to ease those standards from the very stringent
levels that had been imposed over the past few years.
Perhaps reflecting the stringency of lending standards and low levels of home equity for many homeowners, over the first quarter of 2010 indicators of
refinancing activity showed only a modest pickup
from the subdued levels posted in the second half of
2009. Refinancing appeared to pick up late in the second quarter. Overall, residential mortgage debt contracted at a somewhat faster pace in the first half of
2010 than it had in the second half of the previous
year.
Net issuance of MBS guaranteed by Fannie Mae,
Freddie Mac, or Ginnie Mae fell during the first half
of 2010 after having expanded briskly in the second
half of 2009; the fall was largely attributable to weak
demand for mortgages and to sizable prepayments on
outstanding MBS stemming from repurchases by
Fannie Mae and Freddie Mac of large numbers of
delinquent mortgages out of the pools of mortgages
backing agency MBS. The securitization market for
mortgage loans not guaranteed by a housing-related
government-sponsored enterprise (GSE) or the Federal Housing Administration remained essentially
closed.
6

A mortgage is defined as seriously delinquent if the borrower is
90 days or more behind in payments or the property is in
foreclosure.

The Business Sector

Fixed Investment
Real business fixed investment turned up in the
fourth quarter of 2009 after more than a year of
steep declines, and it appears to have risen further in
the first half of 2010. The pickup occurred entirely in
spending for equipment and software (E&S), which
rebounded in response to the improvement in sales,
production, and profits. Moreover, businesses have
ample internal funds at their disposal. And although
bank lending remains constrained—especially for
small businesses—firms with access to capital markets have generally been able to finance E&S projects
with the proceeds of bond issuance at favorable
terms.
Real outlays for E&S rose at an annual rate of
11½ percent in the first quarter after an even larger
increase in the fourth quarter. As it had in the fourth
quarter, business spending on motor vehicles rose
briskly, and outlays on information technology (IT)
capital—computers, software, and communications
equipment—continued to be spurred by the need to
replace older, less-efficient equipment and by the
expansion of the infrastructure for wireless communications networks. In addition, investment in equipment other than transportation and IT jumped in the
first quarter after falling more than 15 percent in
2009. More recently, orders and shipments for a wide
range of equipment rose appreciably this spring,
pointing to another sizable increase in real E&S outlays in the second quarter.
Investment in nonresidential structures continued to
decline in the first half of 2010 against a backdrop of
high vacancy rates, low property prices, and difficult
financing conditions. Real outlays on structures outside of the drilling and mining sector fell at an annual
rate of 27½ percent in the first quarter after falling
18 percent in 2009, and the incoming data point to
continued weakness in the second quarter. Construction of manufacturing facilities appears to have
firmed somewhat in recent months and outlays in the
power category—though volatile from quarter to
quarter—have retained considerable vigor, but spending on office and commercial structures remained on
a steep downtrend through May. Meanwhile, real
spending on drilling and mining structures has
posted solid increases in recent quarters in response
to the rebound in oil and natural gas prices in the second half of last year; nonetheless, this pickup in
activity follows a massive decline in the first half of

Monetary Policy and Economic Developments

2009, and spending in this sector is still well below
late-2008 levels.
Inventory Investment
The pace of inventory liquidation slowed dramatically in late 2009 as firms acted to bring production
into closer alignment with sales, and businesses began
restocking in the first quarter of 2010. That swing in
inventory investment added nearly 2 percentage
points to the rise in real GDP in the first quarter.
Nonetheless, firms appear to be keeping a tight rein
on stocks. For example, in the motor vehicle sector,
manufacturers held second-quarter production of
light vehicles to a pace that pushed days’ supply
below historical norms—even after adjusting for the
reduction over the past couple of years in the number
of models, trim lines, and dealerships. Outside of
motor vehicles, real inventories rose modestly in the
first quarter, and the limited available information
suggests that stockbuilding remained at about this
pace in the spring. The inventory-to-sales ratios for
most industries covered by the Census Bureau’s
book-value data have moved back into a more comfortable range after rising sharply in 2009.
Corporate Profits and Business Finance
Operating earnings per share for S&P 500 firms continued to bounce back in the first quarter of 2010.
In percentage terms, the recent advances were
stronger among financial firms, as their profits
rebounded from depressed levels, though profits at
nonfinancial firms also posted solid increases. Analysts’ forecasts point to an expected moderation in
profit gains in the second quarter.
The credit quality of nonfinancial corporations has
shown improvement this year. Credit rating upgrades
outpaced downgrades through May, and very few
corporate bond defaults have occurred this year.
Although delinquency rates for commercial and
industrial (C&I) loans edged down to about 4 percent
in the first quarter of 2010, they remained near the
higher end of their range over the past 20 years.
Delinquency rates for commercial real estate (CRE)
loans held steady as rates on construction and land
development loans remained near 20 percent.
Reflecting an improved economic outlook and a
somewhat more hospitable financing environment,
particularly for larger firms, borrowing by nonfinancial businesses expanded over the first two quarters
of 2010 after having fallen during the second half of
2009. Net issuance of corporate bonds increased
through April as businesses took advantage of rela-

53

tively low interest rates to issue longer-term debt, and
net issuance of commercial paper turned positive.
However, bond issuance fell in May as a result of the
market volatility and pullback from risk that accompanied European financial developments. C&I loans
declined through May before flattening out in June,
while CRE lending contracted steeply throughout the
first half of the year.
The decline in commercial bank lending to businesses
is partly attributable to weak demand for such loans,
as suggested by answers to the April 2010 SLOOS. In
addition, respondents to the April survey reported
that banks increased premiums charged on riskier
C&I loans over the previous three months; and
although a small net fraction of banks reported easing standards on those loans, the severe bout of
tightening reported over the past several years has yet
to be materially unwound. Moreover, a moderate net
fraction of banks tightened standards on CRE loans
over the first quarter of 2010.
Small businesses face relatively tight credit conditions
given their lack of direct access to capital markets.
Results from the May 2010 Survey of Terms of Business Lending indicated that the spread between the
average interest rate on loans with commitment sizes
of less than $1 million—loans that were likely made
to smaller businesses—and swap rates of comparable
maturity edged down in the second quarter but
remained quite elevated. In surveys conducted by the
National Federation of Independent Business, the
net fraction of small businesses reporting that credit
had become more difficult to obtain over the preceding three months remained at historically high levels
during the first half of 2010. However, the fraction of
businesses that cited credit availability as the most
important problem that they faced remained small.
New issuance in the commercial mortgage-backed
securities (CMBS) market, which had resumed in
November 2009 with a securitization supported by
the Federal Reserve’s TALF program, continued at a
very low level in the first half of 2010. The expiration
of the legacy CMBS portion of the TALF program
on March 31 had little apparent effect on issuance,
and spreads on AAA-rated CMBS relative to
comparable-maturity Treasury securities generally fell
over the first half of the year, though they remained
elevated in comparison with their pre-crisis levels.
In the equity market, combined issuance from seasoned and initial offerings by nonfinancial firms
slowed a bit in the first quarter of 2010. Meanwhile,

54

97th Annual Report | 2010

equity retirements due to cash-financed merger and
acquisition deals and share repurchases increased
somewhat, leaving net equity issuance modestly
negative.
The Government Sector

Federal Government
The deficit in the federal unified budget appears to be
stabilizing—albeit at a very high level—after its sharp
run-up in fiscal year 2009. Indeed, over the first nine
months of fiscal 2010, the deficit was a little smaller
than that recorded a year earlier, and the ongoing
recovery in economic activity should help shore up
revenues over the remainder of the fiscal year. Nonetheless, the deficit is still on track to exceed 9 percent
of nominal GDP for fiscal 2010 as a whole, only a
shade below the 10 percent figure for 2009 and substantially above the average value of 2 percent of
GDP for fiscal years 2005 to 2007, prior to the onset
of the recession and financial crisis. The budget costs
of financial stabilization programs, which added significantly to the deficit in fiscal 2009, have helped
reduce the deficit this year as the sum of (1) repayments and downward revisions of expected losses in
the Troubled Asset Relief Program (TARP) and
(2) banks’ required prepayments to the Federal
Deposit Insurance Corporation of three years of
deposit insurance premiums has exceeded the additional payments by the Treasury to the housingrelated GSEs. However, the deficit has continued to
be boosted by the American Recovery and Reinvestment Act (ARRA) and other policy actions and by
the still-low level of economic activity, which is
damping revenues and pushing up cyclically sensitive
outlays.
After falling 16½ percent in fiscal 2009, federal
receipts edged up ½ percent in the first nine months
of fiscal 2010 compared with the same period in fiscal 2009; they currently stand around 14½ percent of
GDP—the lowest percentage in 60 years. Taken
together, individual income and payroll taxes were
4½ percent lower than a year earlier, in part because
of the weakness in wage and salary income last fall
and the low level of net final payments on 2009 tax
liabilities this spring; in addition, the revenue provisions in ARRA had a larger negative effect on individual collections during the first nine months of fiscal 2010 than they did during the comparable period
of fiscal 2009. In contrast, corporate receipts turned
back up after a dramatic drop in 2008 and 2009.

Outlays through June were nearly 3 percent lower
than those during the first nine months of fiscal
2009, but the decrease was more than accounted for
by a marked downswing in total net outlays for the
TARP, the GSE conservatorship, and federal deposit
insurance. Excluding these financial transactions,
outlays rose 10 percent compared with a year earlier,
mainly because of the effects of the weak labor market on income-support programs (such as unemployment insurance and food stamps) and because of the
spending associated with ARRA and other stimulusrelated policies. In addition, net interest payments
have been pushed up by the higher levels of outstanding debt.
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 only 1 percent in the first quarter.
Defense spending—which tends to be erratic from
quarter to quarter—posted just a small rise, and nondefense purchases only inched up after a large
stimulus-related increase in the second half of 2009.
Real federal purchases likely increased somewhat
faster in the second quarter, boosted by the surge in
hiring for the decennial census.
Federal Borrowing
Federal debt held by the public is projected to reach
more than 65 percent of nominal GDP by the end of
this year, the highest ratio seen in more than 50 years.
Despite the increase in financing needs, Treasury auctions have been mostly well received so far this year,
and bid-to-cover ratios at those auctions were generally strong. Demand for Treasury securities was likely
boosted by a desire for relatively safe and liquid
assets in light of concerns about the consequences of
fiscal strains in a number of European countries.
Indicators of foreign demand for U.S. Treasury debt
remained solid.
State and Local Government
State and local governments, facing difficult situations, have continued to reduce expenditures on consumption and gross investment. Over the first six
months of 2010, these governments cut roughly
100,000 jobs after a similar reduction in the second
half of 2009 and kept a tight rein on operating
expenditures to satisfy balanced budget requirements.
Real construction expenditures dropped in the fourth
quarter of 2009 and remained low in the first half of

Monetary Policy and Economic Developments

2010 despite the availability of federal stimulus funds
and supportive conditions in municipal bond markets. Capital expenditures are not typically subject to
balanced budget requirements; however, debt service
payments on the bonds used to finance capital projects are generally made out of operating budgets
(and thus must compete with Medicaid and other
high-priority programs for scarce funding), which
may be deterring governments from undertaking new
infrastructure projects.
As is the case at the federal level, the hemorrhaging
of revenues that took a heavy toll on state and local
budgets in 2008 and 2009 seems to be easing, and
governments will continue to receive significant
amounts of federal stimulus aid through the end of
the year. Still, total state tax collections are well
below their pre-recession levels, and available balances in reserve funds are low. At the local level,
property taxes held up well through the first quarter,
likely in part because lower real estate assessments
have been offset by hikes in statutory tax rates in
some areas; however, further increases in tax rates
may encounter resistance, and many local governments are facing steep cutbacks in state aid. Moreover, many state and local governments will need to
set aside money in coming years to rebuild their
employee pension funds after the financial losses
experienced over the past couple of years and to fund
their ongoing obligations to provide health care to
their retired employees.
State and Local Government Borrowing
Despite concerns over the fiscal positions and the
financial health of state and local governments, the
municipal bond market remained receptive to issuers
over the first half of the year. Issuance of long-term
municipal bonds was solid and continued to be supported by the Build America Bond program, which
was authorized under ARRA.7 Short-term municipal
bond issuance was moderate but generally consistent
with typical seasonal patterns.
Interest rates on long-term municipal bonds on balance fell a bit less than those on comparable-maturity
Treasury securities, leaving the ratio of their yields
slightly elevated by historical standards. Downgrades
of state and local government debt by credit agencies
continued to exceed upgrades.
7

The Build America Bond program allows state and local governments to issue taxable bonds for capital projects and receive
a subsidy payment from the Treasury for 35 percent of interest
costs.

55

The External Sector

Following a substantial rebound in the second half of
2009, both real exports and imports continued to
increase at a robust pace in the first quarter of this
year. While the cyclical recovery in real exports of
goods and services remained strong, growth slowed
from its 20 percent annual rate in the second half of
last year to an 11 percent rate in the first quarter of
2010. Exports in almost all major categories
expanded, with sales of industrial supplies, high-tech
equipment, and services registering large increases.
Exports of aircraft were the exception, as they
slumped after a sizable increase in the fourth quarter
of last year. Export demand from Mexico, Japan,
Canada, and emerging Asia excluding China was
especially vigorous, while exports to the European
Union and China were flat. Data for April and May
suggest that exports continued to rise at a solid pace
in the second quarter.
Real imports of goods and services rose at an annual
rate of 15 percent in the first quarter, about the same
pace as in the fourth quarter of last year. All major
categories of imports rose, especially industrial supplies (including petroleum), capital goods, and consumer goods. Data for April and May suggest that
imports continued to climb robustly in the second
quarter, with automotive products and computers
registering notable increases.
In the first quarter of 2010, the U.S. current account
deficit reached an annual rate of $436 billion,
approximately 3 percent of GDP. The current
account deficit has widened a little over the past few
quarters, as imports have outpaced exports.
The spot price of a barrel of West Texas Intermediate crude oil started the year at about $80 and had
risen to $86 by early May, continuing the rebound
from last year’s recession-induced lows as the global
economic recovery progressed. The price has since
moved back down to about $77 as a result of
increased concerns about the sustainability of the
global recovery. The prices of longer-term futures
contracts for crude oil (that is, those expiring in
December 2018) also fell, from $100 per barrel in
early May to $92 per barrel in mid-July. The upwardsloping futures curve is consistent with the view that,
despite mounting worries about the near-term
growth outlook, oil prices will rise again as global
demand strengthens over the medium term.
Nonfuel commodity prices have been mixed in 2010.
Food prices have been roughly flat so far this year.

56

97th Annual Report | 2010

Prices for metals and agricultural raw materials have
been volatile; prices for these commodities rose into
early April, as the global recovery continued, but
since then have fallen sharply, reflecting the stronger
value of the dollar and growing uncertainty about
the outlook for the global economy. Market commentary also suggests that prices for metals have
fallen because of concerns that policy tightening in
China may slow its demand for those commodities.
Prices of imported goods rose briskly in early 2010,
boosted by the depreciation of the dollar in foreign
exchange markets and the rise in commodity prices in
late 2009. In the second quarter of this year, as commodity prices declined and the dollar appreciated,
import price inflation slowed. Prices for imports of
finished goods have, on average, been little changed
in 2010.
National Saving

Total net national saving—that is, the saving of
households, businesses, and governments excluding
depreciation charges—remains very low by historical
standards. After having reached 3¾ percent of nominal GDP in 2006, net national saving dropped
steadily over the subsequent three years; since the
start of 2009, it has averaged negative 2½ percent of
nominal GDP. The widening of the federal budget
deficit over the course of the recession has more than
accounted for the downswing in net saving since
2006, and the large federal deficit will likely cause
national saving to remain low in the near term.
Because the demand for funds for capital investment
is currently relatively meager, the low rate of national
saving is not being translated into higher real interest
rates or increased foreign borrowing. However, if not
boosted over the longer term, persistent low levels of
national saving will likely be associated with upward
pressure on interest rates, low rates of capital formation, and heavy borrowing from abroad, which would
limit 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.
The Labor Market

over the first half of the year.8 Firms have also raised
their labor input by increasing hours per worker.
Indeed, the average workweek of employees, which
had dropped sharply over the course of the recession,
ticked up toward the end of 2009 and rose considerably over the first half of 2010; by June, it had
recouped nearly one-half of its earlier decrease. The
job gains to date have only been sufficient to about
match the rise in the number of jobseekers, and the
unemployment rate in the second quarter, at 9¾ percent on average, was only slightly below the recession
high of 10 percent reached in the fourth quarter of
last year.
Other indicators are also consistent with a gradual
improvement in labor market conditions this year.
Measures of hiring and job openings have moved up
from the low levels of 2009, as have readings from
private surveys of hiring plans. In addition, layoffs
have come down, although the relatively flat profile
of initial claims for unemployment insurance in
recent months suggests that the pace of improvement
may have slowed lately.
The economy remains far from full employment. The
job gains this year have reversed only a small portion
of the nearly 8½ million jobs lost during 2008 and
2009, and the unemployment rate is still at its highest
level since the early 1980s. Moreover, long-term
unemployment has continued to worsen—in June,
6.8 million persons, 600,000 more than at the end of
2009 and nearly one-half of the total unemployed,
had been out of work for six months or more. Also,
the number of workers who are working part time for
economic reasons—another indicator of the underutilization of labor—has fallen only slightly this year
and stands at nearly twice its pre-recession level.
Productivity and Labor Compensation
Labor productivity has continued to rise briskly,
although not as rapidly as in 2009. According to the
latest published data, output per hour in the nonfarm
business sector rose at an annual rate of 2¾ percent
in the first quarter after a 5½ percent advance in
2009. The continuing strong productivity gains
reflect ongoing efforts by firms to improve the effi8

Employment and Unemployment
The labor market bottomed out around the turn of
the year and is now adding jobs across a range of
industries, albeit at a modest pace. After falling
steeply through most of 2009, nonfarm private payroll employment rose 100,000 per month, on average,

Total employment—private plus government—has exhibited
unusually sharp swings of late, mainly because of the hiring of
temporary workers for the decennial census. Census hiring
started in earnest in March and peaked at about 400,000 in
May. In June, the winding down of the census subtracted
225,000 workers from government payrolls. Apart from the census, government employment fell slightly on net over the first
half of the year because of cutbacks at state and local governments.

Monetary Policy and Economic Developments

ciency of their operations and their reluctance to
increase their labor input in an uncertain economic
environment.
Increases in hourly compensation continue to be
restrained by the wide margin of slack in the labor
market. The 12-month change in the employment
cost index for private industry workers, which measures both wages and the cost to employers of providing benefits, has been 2 percent or less since the start
of 2009 after several years of increases in the neighborhood of 3 percent. Compensation per hour in the
nonfarm business sector—a measure derived from
the labor compensation data in the NIPA—has also
slowed noticeably over the past couple of years;
though erratic from quarter to quarter, this measure
rose just 1½ percent over the year ending in the first
quarter of 2010. Similarly, average hourly earnings—
the timeliest measure of wage developments—rose
1¾ percent in nominal terms over the 12 months ending in June; as suggested earlier, this measure appears
to have posted a modest increase in real terms over
this period as a consequence of the low rate of consumer price inflation of late.
Reflecting the small rise in hourly compensation and
the sizable advance in labor productivity, unit labor
costs in the nonfarm business sector declined 4¼ percent over the year ending in the first quarter of 2010.
Over the preceding year, unit labor costs had been
flat.

57

through midyear. Gasoline prices registered sizable
decreases—especially in May and June—reflecting
the ample inventories and drop in the price of crude
oil in May. Although spot prices for natural gas were
pushed up during the winter by unusually cold
weather in some major consuming regions, they too
fell on net over the spring and early summer as inventories remained high. Retail prices for electricity have
fluctuated this year in response to movements in the
cost of fossil fuel inputs, but on net they have
changed little since the end of 2009.
Consumer food prices rose at an annual rate of
1¾ percent between December 2009 and May 2010,
boosted by higher prices for meats and for fruits and
vegetables. Farm prices drifted down through the end
of June as reports on crop production pointed to an
abundant harvest, though they have moved up a bit
in recent weeks.
The slowdown in core PCE inflation has been centered in prices of core goods, which declined at an
annual rate of 1½ percent, on net, over the first five
months of 2010 after rising 1½ percent in 2009. The
deceleration in core goods prices was widespread and
occurred despite sizable increases in prices for some
industrial commodities and materials. Meanwhile,
prices of services other than energy posted only a
small increase over this period, as the softness in the
housing market continued to put downward pressure
on housing costs and as prices of other services were
restrained by the wide margin of economic slack.

Prices

Inflation diminished further in the first half of 2010.
After rising 2 percent over the 12 months of 2009,
the overall PCE chain-type price index increased at
an annual rate of just ¾ percent between December 2009 and May 2010 as energy prices fell. The core
PCE price index—which excludes the prices of
energy items as well as those of food and beverages—
rose at an annual rate of 1 percent over the first
5 months of the year, compared with a rate of
1½ percent over the 12 months of 2009. This moderation was also evident in the appreciable slowing of
inflation measures such as trimmed means and medians, which exclude the most extreme price movements in each period. Longer-run inflation expectations have been stable this year, with most surveybased measures remaining within the narrow ranges
that have prevailed for the past few years.
Consumer energy prices continued to increase in
January after a steep rise in the second half of 2009,
but they turned down in February and fell further

Survey measures of inflation expectations have been
relatively stable this year. In the preliminary Thomson Reuters/University of Michigan Surveys of Consumers for July, median year-ahead inflation expectations stood at 2.9 percent. Median 5- to 10-year inflation expectations were also at 2.9 percent in early
July—a reading that is in line with the average value
for 2009 and the first half of 2010. In the Survey of
Professional Forecasters, conducted by the Federal
Reserve Bank of Philadelphia, expectations for the
increase in the consumer price index over the next
10 years remained around 2½ percent in the second
quarter, a level that has been essentially unchanged
for many years.
Financial Developments
The recovery of the financial system that began in
the spring of 2009 generally continued through the
early spring of 2010, but in recent months concerns
about spillovers from the fiscal pressures in a number
of European countries and the durability of the

58

97th Annual Report | 2010

global recovery have led to the reemergence of strains
in some markets.
Monetary Policy Expectations
and Treasury Rates

On balance over the first half of 2010, market participants pushed back their expected timing of the
first increase in the target federal funds rate from its
current range of 0 to ¼ percent, and they scaled back
their expectations of the pace with which monetary
policy accommodation would be removed. Quotes on
money market futures contracts imply that, as of
mid-July 2010, investors’ expected trajectory for the
federal funds rate rises above the current target range
in the first quarter of 2011, two quarters later than
the quotes implied at the start of 2010. Investors also
expect, on average, that the effective federal funds
rate will be around 1 percent by the middle of 2012,
about 1¼ percentage points lower than anticipated at
the beginning of this year. The expected path for
monetary policy appeared to move lower in response
to the mounting fiscal strains in Europe and weakerthan-expected U.S. economic data releases. The drop
probably also reflected Federal Reserve communications, including the repetition in the statement
released after each meeting of the Federal Open Market Committee that economic conditions are likely to
warrant exceptionally low levels of the federal funds
rate for an extended period.
Yields on longer-term nominal Treasury securities fell
noticeably, on net, over the first half of the year,
while two-year yields fell somewhat less. Yields were
generally little changed during the first quarter but
dropped in the second quarter along with the decline
in the expected path for monetary policy. Increased
demand for Treasury securities by investors looking
for a haven from volatility in other markets has likely
contributed to the decline in yields. On balance, over
the first half of the year, yields on 2-year Treasury
notes decreased about ½ percentage point to about
¾ percent, and yields on 10-year notes fell about
¾ percentage point to about 3 percent.
Yields on Treasury inflation-protected securities, or
TIPS, declined substantially less than those on their
nominal counterparts over the first half of the year,
resulting in lower medium- and long-term inflation
compensation. The decline in inflation compensation
may have partly reflected a drop in inflation expectations given the subdued rates of growth in major
price indexes over the period and indications that
economic slack would remain substantial for some
time. However, inferences about investors’ inflation

expectations based on TIPS have been complicated
over recent years by special factors such as the safehaven demands for nominal Treasury securities and
changes over time in the relative liquidity of TIPS
and nominal Treasury securities.
Other Interest Rates and Equity Markets

In the commercial paper market, over the first half of
2010, yields on lower-quality A2/P2-rated paper and
on AA-rated asset-backed commercial paper rose a
bit from low levels, pushing up spreads over higherquality AA-rated nonfinancial commercial paper.
Even so, spreads on both types of assets remain near
the low end of the range observed since the fall of
2007.
Yields on corporate bonds rated AA and BBB fell by
less than those on comparable-maturity Treasury
securities over the first half of the year, resulting in a
noticeable increase in risk spreads. Yields on
speculative-grade corporate bonds fell during much
of the first quarter but rose sharply during the second, leaving yields higher on net over the period and
spreads somewhat more elevated. The widening of
spreads appears to reflect a decrease in demand for
risky assets stemming from concerns about developments in Europe and the outlook for the global
economy.
Similarly, broad equity price indexes, which rose in
the first quarter, owing both to relatively strong earnings reports and to some better-than-expected economic data releases, fell back in the second quarter.
The second-quarter decline was broad based, encompassing most major equity market categories, and
was consistent with movements in the prices of a
wide variety of other asset classes. Implied volatility
of the S&P 500, as calculated from option prices,
spiked upward in May before receding somewhat,
then ended the first half of the year at a still-elevated
level.
Against a backdrop of declining equity prices and
increases in equity market volatility, equity mutual
funds experienced outflows in the second quarter;
they had posted modest inflows in the first quarter
after having been nearly flat for much of 2009. Most
categories of bond funds and hybrid funds (which
invest in a mix of bonds and equities) continued to
show sizable inflows in the first half of 2010,
although high-yield bond funds registered outflows
as spreads widened in the second quarter. Money
market mutual funds recorded large outflows, likely

Monetary Policy and Economic Developments

reflecting the very low yields on those assets relative
to other short-term investments.
Financial Market Functioning

Financial market functioning continued to improve,
on balance, during the first half of 2010. However,
strains emerged in some markets. For example, the
spread between the London interbank offered rate
(Libor) and the rate on comparable-maturity overnight index swaps (OIS)—a measure of stress in
short-term bank funding markets—widened over the
first half of the year. The increases in Libor-OIS
spreads were more pronounced at longer maturities.
In securities financing markets, bid-asked spreads
and haircuts applied to collateral fell slightly.

59

Conditions in the leveraged loan market continued to
improve on balance over the first half of 2010. Gross
issuance of such loans picked up slightly during that
period from very low levels in 2009, as loan pools
issuing collateralized loan obligations (CLOs) moved
to reinvest the cash received from companies that had
paid down older loans with the proceeds of bond
issues. New CLO issuance, which had nearly ceased
in the second half of 2009, also began to pick up in
the second quarter of 2010. The recovery in investor
demand for syndicated loans was evident in the secondary market as well, where average bid-asked
spreads declined, on net, over the first half of 2010,
and bid prices moved closer to par.
Financial Institutions

In order to expand the availability of information on
developments with respect to credit and leverage outside the traditional banking sector, the Federal
Reserve initiated a Senior Credit Officer Opinion
Survey on Dealer Financing Terms (SCOOS). The
SCOOS surveys senior credit officers at about
20 U.S. and foreign dealers that, in the aggregate,
provide the vast majority of the financing of dollardenominated securities to nondealers and are the
most active intermediaries in over-the-counter (OTC)
derivative instruments. The survey will be conducted
on a quarterly basis. In the first survey, conducted in
late May and early June, dealers generally reported
that the terms at which they provided credit were
tight relative to those at the end of 2006.9 However,
they noted some loosening of terms for both securities financing and OTC derivative transactions, on
net, over the previous three months for certain classes
of clients—including hedge funds, institutional investors, and nonfinancial corporations—and intensified
pressures by those clients to negotiate more-favorable
terms. At the same time, they reported a pickup in
demand for financing across several collateral types
over the past three months.
The SCOOS results are consistent with market commentary suggesting that financial system leverage
had begun to pick up in early 2010. However, leverage reportedly fell back in May against the backdrop
of heightened market volatility. Hedge funds, which
had earned solid returns on average during the first
few months of the year, posted a sharp decline
in May.

9

The SCOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/econresdata/releases/scoos.htm.

Investor sentiment regarding the outlook for commercial banks, which had generally improved during
the first quarter, became more pessimistic during the
second quarter. Equity prices of commercial banks
generally outperformed the broader market over the
first quarter, before declining about in line with
equity market indexes during the second. Bank
equity prices were likely boosted slightly by modest
improvements in returns on equity and assets in the
first quarter, although both profitability measures
remained near the bottom end of their ranges of the
past 20 years. After adjusting for the effects of
changes in the accounting treatment of securitized
assets, net interest margins rose noticeably in the first
quarter, while provisions for loan losses declined,
consistent with responses to the January SLOOS that
pointed to an improvement in banks’ outlook on
credit quality.10 Smaller commercial banks collectively registered their first profitable quarter in more
than a year in the first quarter.
Credit default swap (CDS) spreads for banking institutions—which primarily reflect investors’ assessments of and willingness to bear the risk that those
institutions will default on their debt obligations—in10

The Financial Accounting Standards Board’s Statements of
Financial Accounting Standards Nos. 166 and 167 (FAS 166
and 167) modified the basis for determining whether a firm
must consolidate securitized assets (as well as the associated
liabilities and equity) onto its balance sheet. Most banking institutions were required to implement the standards in the first
quarter of 2010. Banks are estimated to have brought $435 billion of loans back onto their books, of which about threefourths were credit card loans, and increased their allowance for
loan and lease losses by about $36 billion. For additional detail
on the effects of FAS 166 and 167 on banks’ balance sheets, see
the “Notes on the Data” portion of Board of Governors of the
Federal Reserve System, Statistical Release H.8, “Assets and
Liabilities of Commercial Banks in the United States,”
www.federalreserve.gov/releases/h8/h8notes.htm.

60

97th Annual Report | 2010

creased on net over the first half of the year, particularly for larger banking organizations. The widening
in CDS spreads reportedly reflected uncertainty
about the outcome of legislation to reform the financial system as well as concerns about developments in
Europe and their implications for the robustness of
the U.S. and global economic recovery. The overall
delinquency rate on loans held by commercial banks
increased somewhat in the first quarter of 2010, as
continued deterioration in the credit quality of residential mortgages offset decreases in delinquency
rates on most other categories of loans.
With loan demand reportedly continuing to be weak
and credit conditions remaining tight, total loans on
banks’ books contracted during the first half of the
year, though less rapidly than they had during the
second half of 2009. After adjusting for the effects of
changes in the accounting treatment of securitizations, all major categories of loans posted sizable
declines. Securities holdings rose, on balance, reflecting substantial accumulation of Treasury securities.
Cash assets also posted noticeable increases. However, total and risk-weighted assets shrank even as
banks continued to raise capital, resulting in
increases in regulatory capital ratios to historical
highs.
Monetary Aggregates and
the Federal Reserve’s Balance Sheet

The M2 monetary aggregate rose only modestly in
the first half of 2010.11 Liquid deposits expanded
moderately, likely reflecting heightened household
demand for safe and liquid assets. That increase was
only partially offset by continued large outflows from
small time deposits and retail money market mutual
funds that likely reflected the very low rates of return
offered on those products compared with other
assets. The currency component of the money stock
expanded moderately in the first half of the year. The
monetary base—roughly equal to the sum of cur11

M2 consists of (1) currency outside the U.S. Treasury, Federal
Reserve Banks, and the vaults of depository institutions;
(2) traveler’s checks of nonbank issuers; (3) demand deposits at
commercial banks (excluding those amounts held by depository
institutions, the U.S. government, and foreign banks and official
institutions) less cash items in the process of collection and Federal Reserve float; (4) other checkable deposits (negotiable order
of withdrawal, or NOW, accounts and automatic transfer service accounts at depository institutions; credit union share draft
accounts; and demand deposits at thrift institutions); (5) savings
deposits (including money market deposit accounts); (6) smalldenomination time deposits (time deposits issued in amounts of
less than $100,000) less individual retirement account (IRA)
and Keogh balances at depository institutions; and (7) balances
in retail money market mutual funds less IRA and Keogh balances at money market mutual funds.

rency in circulation and the reserve balances of
depository institutions held at the Federal Reserve—
increased at a 3½ percent annual rate in the first half
of 2010, well below the 30 percent rate posted in the
second half of 2009. The slower growth rate was
largely attributable to the more gradual expansion in
reserve balances as the Federal Reserve’s program of
large-scale asset purchases came to an end.
The size of the Federal Reserve’s balance sheet
remained at a historically high level in mid-2010
(table 1). Total Federal Reserve assets on July 7, 2010,
stood at about $2.3 trillion, about $100 billion more
than at the end of 2009. The increase is largely attributable to the completion on March 31 of the Federal
Reserve’s program to purchase agency debt and
agency mortgage-backed securities. Securities holdings, the vast majority of Federal Reserve assets,
increased from about $1.8 trillion to about $2.1 trillion over the first half of the year.
On February 1, 2010, in light of improved functioning in financial markets, the Federal Reserve closed
the Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility, the Commercial
Paper Funding Facility, the Primary Dealer Credit
Facility, and the Term Securities Lending Facility. On
March 8, the Federal Reserve conducted the final
auction under the Term Auction Facility. With the
closure of these facilities, the amount of credit
extended by these programs fell to zero from roughly
$100 billion at year-end. In addition, the terms on
the primary credit facility were adjusted to increase
the cost of funds to ¾ percent and to reduce the typical maturity of these loans to one day.12 In response,
primary credit declined from about $19 billion to
about $17 million over the first half of the year. On
June 30, the Federal Reserve closed the Term AssetBacked Securities Loan Facility (TALF). About
$42 billion in TALF loans, which have maturities of
three or five years, remain on the Federal Reserve’s
balance sheet.
These broad-based programs, which were introduced
during the crisis to provide liquidity to financial institutions and markets, contributed to the stabilization
of financial markets and helped support the flow of
credit to the economy—at no loss to the taxpayer. All
of the loans extended through these programs that
have come due have been repaid in full, with interest.

12

The primary credit rate had been ½ percent, and the maximum
maturity of primary credit loans had been 90 days.

Monetary Policy and Economic Developments

Table 1. Selected components of the Federal Reserve
balance sheet, 2009–10
Millions of dollars
Balance sheet item

Dec. 30, 2009

July 7, 2010

Total assets
Selected assets
Credit extended to depository institutions
and dealers
Primary credit
Term auction credit
Central bank liquidity swaps
Primary Dealer Credit Facility and other
broker-dealer credit
Credit extended to other market participants
Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility
Net portfolio holdings of Commercial Paper
Funding Facility LLC
Term Asset-Backed Securities Loan Facility
Support of critical institutions
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC1
Credit extended to American International Group,
Inc.
Preferred interests in AIA Aurora LLC and ALICO
Holdings LLC
Securities held outright
U.S. Treasury securities
Agency debt securities
Agency mortgage-backed securities (MBS)2
Memo
Term Securities Lending Facility3
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits held by depository institutions
Of which: Term deposits
U.S. Treasury, general account
U.S. Treasury, supplemental financing account
Total capital

2,237,258

2,335,457

19,111
75,918
10,272

17
…
1,245

0

…

0

…

14,072
47,532

1
42,278

65,024

66,996

22,033

24,560

25,000

25,733

776,587
159,879
908,257

776,997
164,762
1,118,290

0
2,185,139

…
2,278,523

889,678
70,450
1,025,271
…
149,819
5,001
52,119

907,698
62,904
1,061,239
2,122
16,475
199,963
56,934

Note: LLC is a limited liability company.
The Federal Reserve has extended credit to several LLCs in conjunction with
efforts to support critical institutions. Maiden Lane LLC was formed to acquire
certain assets of the Bear Stearns Companies, Inc. Maiden Lane II LLC was
formed to purchase residential mortgage-backed securities from the U.S.
securities lending reinvestment portfolio of subsidiaries of American
International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase
multisector collateralized debt obligations on which the Financial Products
group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
3
The Federal Reserve retains ownership of securities lent through the Term
Securities Lending Facility.
…Not applicable.
Source: Federal Reserve Board.
1

The credit provided to American International
Group, Inc. (AIG), increased slightly, on net, over
the first half of the year, in part because additional
borrowing through this facility was used to pay down
outstanding commercial paper that had been issued

61

to the Commercial Paper Funding Facility LLC (limited liability company). The net portfolio holdings of
Maiden Lane LLC—which was created in conjunction with efforts to avoid a disorderly failure of the
Bear Stearns Companies, Inc.—increased as the
recovery in financial markets boosted the fair value
of the assets held in that LLC. Consistent with the
terms of the transaction, the distribution of the proceeds realized on the asset portfolio held by Maiden
Lane LLC will occur on a monthly basis going forward unless otherwise directed by the Federal
Reserve. The monthly distributions will cover the
expenses and repay the obligations of the LLC,
including the principal and interest on the loan from
the Federal Reserve Bank of New York, according to
the priority established in the terms of the transaction. The portfolio holdings of Maiden Lane II LLC
and Maiden Lane III LLC—which were created in
conjunction with efforts to avoid the disorderly failure of AIG—decreased as prepayments and redemptions of some of the securities held in those portfolios were used to pay down the loans extended by the
Federal Reserve Bank of New York. The Federal
Reserve does not expect to incur a net loss on any of
the secured loans provided during the crisis to help
prevent the disorderly failure of systemically significant financial institutions.
On the liabilities side of the Federal Reserve’s balance sheet, reserve balances averaged just over $1 trillion over the first six months of 2010. The Federal
Reserve made preparations to conduct small-scale
reverse repurchase operations to ensure its ability to
use agency MBS collateral for such transactions, and
the first small-value auctions in the Term Deposit
Facility program were conducted in June and July.
Reverse repurchase operations and the Term Deposit
Facility are among the tools that the Federal Reserve
will have at its disposal to drain reserves from the
banking system at the appropriate time. The Treasury’s supplementary financing account, which had
fallen to about $5 billion when the statutory debt
ceiling was approached last year, returned to its previous level of about $200 billion after the statutory
debt ceiling was raised in early 2010.
On April 21, the Federal Reserve System released the
2009 annual comparative financial statements for the
combined Federal Reserve Banks, the 12 individual
Federal Reserve Banks, the LLCs that were created as
part of the Federal Reserve’s response to strains in
financial markets, and the Board of Governors. The
statements showed that the Reserve Banks’ comprehensive income was just over $53 billion for the year

62

97th Annual Report | 2010

ending December 31, 2009, an increase of nearly
$18 billion from 2008. The increase in earnings was
primarily attributable to the increase in the Federal
Reserve’s holdings of agency debt and agency MBS.
The consolidated LLCs also contributed to the
increase in the Reserve Banks’ comprehensive
income. The Reserve Banks transferred more than
$47 billion of their $53 billion in comprehensive
income to the U.S. Treasury in 2009, an increase of
more than $15 billion—or about 50 percent—from
the amount transferred in 2008.
International Developments
International Financial Markets

In recent months, global financial markets have been
roiled by the Greek fiscal crisis and the resultant concerns about the European outlook more broadly (see
box 1). Fears about the exposure of euro-area finan-

cial institutions to Greece and other vulnerable euroarea countries also resulted in pressure in dollar
funding markets (see box 2). Risk-related flows into
safe investments lifted the value of the dollar and
lowered yields on the sovereign bonds of most major
advanced economies, including the United States. On
net for the first half of the year, the dollar has appreciated, and foreign stock markets and the yields on
benchmark sovereign bonds have moved down.
In the first quarter of this year, a sense that the U.S.
recovery was proceeding more rapidly than the recovery in Europe led the dollar to appreciate against the
euro and sterling, while strong growth in emerging
Asia led the dollar to depreciate against many emerging market currencies. These divergent movements
left the Federal Reserve’s broadest measure of the
nominal trade-weighted foreign exchange value of

Box 1. European Fiscal Stress and Policy Responses
The fiscal crisis in Greece and its ramifications for
Europe have been a source of anxiety in global financial markets in recent months. Concerns about
Greece began mounting around the turn of the year
after announcements revealed the government’s deficit to be considerably larger than initially estimated.
Despite the announcement by the Greek government
of plans to implement significant fiscal consolidation,
the spread of yields on Greek sovereign bonds over
those of German bonds soared during the spring, as
market confidence in the ability of Greece to meet its
fiscal obligations diminished. At the same time, concerns also spread to other euro-area countries with
high debt and deficit ratios, including Portugal,
Spain, and Ireland. On May 2, with the Greek government and banking sectors having difficulty obtaining
market finance, the European Union and International
Monetary Fund (IMF) announced a joint €110 billion
financial support package for Greece. Disbursement
of the support, in the form of loans to be distributed
over three years, is contingent on aggressive fiscal
consolidation, which would bring the country’s budget deficit from almost 14 percent of gross domestic
product in 2009 to below 3 percent by 2014.
The announcement of the May 2 package assuaged
investor concerns only briefly. Spreads on Greek sovereign debt and that of other vulnerable euro-area
economies moved up sharply in the week after the
announcement, and dollar funding strains for many
euro-area institutions intensified.
In response, European leaders announced much
broader stabilization measures on May 10. One set of
initiatives addressed sovereign risk, providing up to

€500 billion in funds—€60 billion through a European
Financial Stabilization Mechanism and €440 billion
from a special purpose vehicle, the European Financial Stabilization Facility, which is authorized to raise
funds in capital markets backed by guarantees from
euro-area member states. These funds may also be
augmented with bilateral loans from the IMF. The
European Central Bank (ECB) simultaneously
announced that it was prepared to purchase government and private debt securities to ensure the depth
and liquidity of euro-area debt markets that were
considered dysfunctional. In addition, the ECB
expanded its liquidity provision facilities. Finally, to
forestall an emerging shortage of dollar liquidity, the
Federal Reserve reopened temporary U.S. dollar
liquidity swap lines with the ECB and four other
major central banks.
The announcement of these measures and the subsequent purchases of sovereign debt by the ECB led
to an improvement in market sentiment and a considerable drop in spreads, but spreads have since
moved up. This renewed increase is due, at least in
part, to market concerns about the growth implications of the significant and synchronized fiscal consolidation efforts being implemented across the euro
area.
Considerable uncertainties also remain about the
exposure of financial institutions to vulnerable countries and about the financial position of these institutions more generally. European governments are currently working to address these uncertainties through
a coordinated set of bank stress tests.

Monetary Policy and Economic Developments

Box 2. Dollar Funding Pressures and
the Reinstitution of Central Bank
Swap Lines
In March, dollar funding pressures began to
reemerge in the euro area as uncertainties about the
condition of some euro-area financial institutions
were amplified by concerns about their possible
exposures to Greece and other peripheral euro-area
economies. The London interbank offered rate, or
Libor, for U.S. dollars increased sharply in late April.
In response to the intensification of these dollar funding strains, the Federal Open Market Committee
reestablished dollar liquidity swap lines on May 9 and
10 with the European Central Bank (ECB), the Bank
of England, the Bank of Canada, the Bank of Japan,
and the Swiss National Bank. So far, drawings on the
lines have been limited, with only the ECB and the
Bank of Japan attracting any bidders in their dollar
tender operations.
Draws on these lines have been limited because the
central banks are offering dollar liquidity in their markets at rates equal to the overnight index swap rate
plus 100 basis points—rates that have exceeded the
cost of dollar funding available to most institutions
from alternative sources. However, these facilities
were designed to provide a backstop, and as such,
even with limited credit extensions, they are supporting the functioning of dollar funding markets and
helping to curtail uncertainties in those markets.

the dollar little changed by the end of the first quarter. Foreign equity indexes generally rose modestly
during the first quarter, as the effect of improving
growth prospects in some regions was only partly offset by concerns about Greece. Those concerns led
yields on the sovereign bonds of Germany and
France to drift down, as investors shifted into those
assets.
By late April, the problems in Greece were exacerbating concerns about fiscal sustainability in Europe and
growth in the region more broadly. The increase in
perceived risk caused the dollar to appreciate noticeably from mid-April to the end of May and led to
sharp declines in foreign stock markets. The yields on
the sovereign bonds of France and Germany fell further, and yields on the sovereign bonds of other
advanced economies began falling as well, driven by
flight-to-safety flows and expectations that policy
tightening would occur later than had previously
been expected.
Steps taken by European countries in early May to
provide assistance to Greece and other countries with

63

fiscal vulnerabilities supported some improvement in
market sentiment; equity prices temporarily halted
their decline by early June and the dollar depreciated
somewhat, likely reflecting a modest reversal of
flight-to-safety flows. Over the past month, however,
worries about global growth prospects have intensified, and yields on advanced economy sovereign
bonds have drifted down further.
The Financial Account

Financial flows in the first quarter of this year
reflected a growing imprint of the strains in Europe.
Data for the first quarter and indicators for the second quarter point to unusually large purchases of
U.S. Treasury securities by private foreigners so far
this year, likely indicating a flight to quality as fiscal
problems in Europe mounted. Foreign demand for
other U.S. securities remained mixed. Net purchases
of U.S. agency debt stayed weak, while net purchases
of U.S. equities, which were strong in the first quarter, appear to have weakened in the second quarter.
Foreign private investors continued to sell U.S. corporate debt securities, on net, but at a slower pace in
the second quarter. Conversely, U.S. residents continued to purchase sizable amounts of foreign bonds
and equities, including both emerging market and
European securities.
Banks located in the United States sharply increased
net lending abroad, generating net private capital
outflows. These outflows were spurred in part by the
reemergence of dollar funding pressures in European
interbank markets; such pressures had been acute at
the height of the global financial crisis in late 2008
but had subsided by the middle of last year.
Inflows from foreign official institutions remained
strong through the first quarter. Most of these
inflows were from countries seeking to counteract
upward pressure on their currencies by purchasing
U.S. dollars on foreign currency markets. These
countries then used the proceeds to acquire U.S.
assets, primarily Treasury securities. Available data
for the second quarter indicate that foreign official
purchases of U.S. Treasury securities slowed in line
with the strengthening of the dollar.
Advanced Foreign Economies

Notwithstanding the ongoing strains on the European economy, the data on economic activity abroad
that we have received to date do not show significant
effects of these strains and suggest that a moderate
recovery is under way. In the first quarter, the recovery from last year’s recession gathered momentum in

64

97th Annual Report | 2010

the advanced foreign economies, driven by a rebound
in world trade and continuing improvement in business sentiment. Growth was particularly robust in
Japan, which benefited from rising exports to emerging Asia, and in Canada, where private domestic
demand remained strong. Economic growth was less
vigorous in the euro area, where consumption and
investment spending declined again, and in the
United Kingdom, where consumption was held back
by the hike in the value-added tax in January.
Monthly indicators of economic activity across the
advanced foreign economies suggest widespread
growth in the second quarter. Industrial production
has continued to rebound, business confidence has
improved further, and purchasing managers indexes
remain at levels consistent with solid expansion.
However, indicators of household spending showed
considerable variation across countries, with retail
sales expanding rapidly in Canada but declining in
the euro area. Such variation in part reflected differences in labor market developments. Canadian
employment has rebounded this year, while euro-area
employment has stagnated. As described earlier,
increasing concerns about sovereign debt and banking systems in some euro-area countries have affected
a wide array of financial markets. However, while
these stresses are materially restraining economic
activity in Greece and several other European countries, they have not yet had a broader effect on economic indicators in the other major advanced foreign
economies.
Twelve-month consumer price inflation picked up a
bit in the advanced foreign economies early this year,
largely owing to increases in the prices of energy and
other commodities, but inflation remained below target in the euro area and Canada and continued to be
negative in Japan. Core consumer price inflation,
excluding food and energy, remained subdued in
these economies, as considerable economic slack persisted. In contrast, headline inflation in the United
Kingdom rose above 3 percent this year, driven by
exchange rate depreciation and the increase in the
value-added tax.
After cutting policy rates to very low levels in 2009,
most major foreign central banks have kept rates
unchanged so far this year. The Bank of Canada,
however, tightened monetary policy in June, raising
its target for the overnight rate 25 basis points to
½ percent, amid signs of strong growth and diminishing excess capacity in the Canadian economy. The
European Central Bank kept its main refinancing

rate at 1 percent and, in the second quarter, took
additional measures to provide liquidity: extending
the period over which it promised to provide fixedrate refinancing with full allotment, adjusting its collateral requirements on repurchase agreements to
ensure that Greek government debt would remain eligible, and buying the debt of some euro-area countries in the secondary market. The Bank of Japan
kept its targeted rate near zero and added a new lending facility aimed at encouraging private-bank lending to businesses.
Emerging Market Economies

The emerging market economies, which have led the
recovery from the global financial crisis, have continued to grow strongly thus far this year.
In emerging Asia, aggregate real GDP growth picked
up to an impressive double-digit pace in the first
quarter. Indicators suggest that growth likely slowed
to a more sustainable but still-rapid pace in the second quarter. In China, domestic demand has been
strong, with retail sales registering significant gains.
The accompanying rapid growth of imports has provided a boost to other economies in the region and to
commodity exporters around the world. However,
Chinese real GDP decelerated in the second quarter,
reflecting a slowdown in fixed investment and tighter
credit conditions. Rising property prices and concerns about the volume and quality of lending led
authorities to clamp down on bank lending through
a variety of prudential measures. Authorities also
began to tighten monetary policy and have raised
required reserve ratios for banks a cumulative
150 basis points since January. In late June, Chinese
authorities announced that they would take steps to
increase the flexibility of the renminbi. The renminbi
has subsequently appreciated about 1 percent against
the dollar.
In Latin America, real GDP growth dipped in the
first quarter, with output declines in Mexico, Chile,
and Venezuela offsetting rapid growth in Brazil. The
fall in output in Mexico reflected both a sharp
decline in Mexico’s agricultural sector and deceleration in the manufacturing sector, but other indicators, including very strong exports, were more
upbeat. Brazilian economic activity continued to
show strength in the first quarter, with real GDP
expanding at a double-digit rate, boosted by fiscal
stimulus and strong demand for the country’s commodity exports. Brazil’s central bank has recently
tightened monetary policy, raising the policy rate a
cumulative 150 basis points since late April.

Monetary Policy and Economic Developments

Inflation in emerging market economies rose at the
end of 2009 and into 2010, reflecting increases in
food and energy prices and, particularly in the case of
Mexico, special factors such as tax increases. Consumer price readings from recent months suggest that
these price pressures are waning.

Part 3
Monetary Policy:
Recent Developments and Outlook
Monetary Policy over the First Half of 2010

The Federal Open Market Committee (FOMC)
maintained a target range for the federal funds rate
of 0 to ¼ percent throughout the first half of 2010 in
order to continue to promote economic recovery and
price stability. In the statement accompanying each
regularly scheduled FOMC meeting, the Committee
noted that economic conditions, including low rates
of resource utilization, subdued inflation trends, and
stable inflation expectations, were likely to warrant
exceptionally low levels of the federal funds rate for
an extended period. At the end of March, the Federal Reserve concluded its purchases of agency
mortgage-backed securities (MBS) and agency debt
under its large-scale asset purchase programs, which
were undertaken to provide support to mortgage
lending and housing markets and to improve overall
conditions in private credit markets. Also, in light of
improved functioning of financial markets, by the
end of June the Federal Reserve had closed all of the
special liquidity facilities that it had created to support markets during the crisis. However, in response
to the reemergence of strains in U.S. dollar shortterm funding markets in Europe, the Federal Reserve
and five foreign central banks announced in May the
reestablishment of temporary U.S. dollar liquidity
swap facilities.
At its January 26–27 meeting, the Committee agreed
that the incoming information, though mixed, indicated that overall economic activity had strengthened
in recent months, about in line with expectations.
Consumer spending was well maintained in the
fourth quarter, and business expenditures on equipment and software appeared to expand substantially.
However, the improvement in the housing market
had slowed, and spending on nonresidential structures continued to fall. Available data suggested that
the pace of inventory liquidation had diminished
considerably in the fourth quarter, providing a sizable
boost to economic activity, and especially to industrial production. In the labor market, layoffs subsided
noticeably in the final months of 2009, but the unem-

65

ployment rate remained elevated and hiring stayed
quite limited. The weakness in labor markets continued to be an important concern for the Committee;
moreover, the prospects for job growth remained a
significant source of uncertainty in the economic
outlook, particularly for consumer spending. Financial market conditions were supportive of economic
growth. Nonetheless, net debt financing by nonfinancial businesses was near zero in the fourth quarter
after being negative in the third, consistent with sluggish demand for credit and tight lending standards
and terms at banks. Increases in energy prices pushed
up headline consumer price inflation, but core consumer price inflation remained subdued.
In their discussion of monetary policy for the period
ahead, Committee members agreed that neither the
economic outlook nor financial conditions had
changed appreciably since the December meeting and
that no changes to the Committee’s large-scale asset
purchase programs or to its target range for the federal funds rate of 0 to ¼ percent were called for. Further, policymakers reiterated their anticipation that
economic conditions were likely to warrant exceptionally low rates for an extended period. The Committee affirmed its intention to purchase a total of
$1.25 trillion of agency MBS and about $175 billion
of agency debt by the end of the first quarter and to
gradually slow the pace of these purchases to promote a smooth transition in markets. Committee
members agreed that with substantial improvements
in most financial markets, including interbank markets, the statement following the meeting would indicate that on February 1, 2010, the Federal Reserve
would close several special liquidity facilities and that
the temporary swap lines with foreign central banks
would expire. In addition, the statement would say
that the Federal Reserve was in the process of winding down the Term Auction Facility (TAF) and that
the final auction would take place in March 2010.
As had been announced, on February 1, 2010, the
Federal Reserve closed the Primary Dealer Credit
Facility, the Term Securities Lending Facility, the
Commercial Paper Funding Facility, and the AssetBacked Commercial Paper Money Market Mutual
Fund Liquidity Facility. The temporary swap lines
with foreign central banks expired on the same day.
On February 18, 2010, the Federal Reserve
announced a further normalization of the terms of
loans made under the primary credit facility. The rate
charged on these loans was increased from ½ percent
to ¾ percent, effective on February 19, and the typical maximum maturity for such loans was shortened

66

97th Annual Report | 2010

to overnight, effective on March 18, 2010. The Federal Reserve also announced on February 18 that the
minimum bid rate on the final TAF auction on
March 8 had been raised to 50 basis points, ¼ percentage point higher than in previous auctions. The
Federal Reserve noted that the modifications were
not expected to lead to tighter financial conditions
for households and businesses and did not signal any
change in the outlook for the economy or for monetary policy.
The data reviewed at the March 16 FOMC meeting
suggested that economic activity expanded at a moderate pace in early 2010. Business investment in
equipment and software seemed to have picked up,
and consumer spending increased further in January.
Private employment would likely have turned up in
February but for the snowstorms that affected the
East Coast. Meeting participants agreed that available indicators suggested that the labor market
appeared to be stabilizing. Output in the manufacturing sector continued to trend higher as firms
increased production to meet strengthening final
demand and to slow the pace of inventory liquidation. On the downside, housing activity remained flat
and nonresidential construction weakened further.
Meanwhile, a sizable increase in energy prices had
pushed up headline consumer price inflation in
recent months; in contrast, core consumer price inflation was quite low. Participants agreed that financial
market conditions remained supportive of economic
growth. Spreads in short-term funding markets were
near pre-crisis levels, and risk spreads on corporate
bonds and measures of implied volatility in equity
markets were broadly consistent with historical
norms given the outlook for the economy. Participants were also reassured by the absence of any signs
of renewed strains in financial market functioning as
a consequence of the Federal Reserve’s winding
down of its special liquidity facilities. However, bank
lending was still contracting, and interest rates on
many bank loans had risen further in recent months.
Against this backdrop, Committee members agreed
that it would be appropriate to maintain the target
range of 0 to ¼ percent for the federal funds rate and
to complete the Committee’s previously announced
purchases of $1.25 trillion of agency MBS and about
$175 billion of agency debt by the end of March.
Nearly all members judged that it was appropriate to
reiterate in the Committee’s statement the expectation that economic conditions—including low levels
of resource utilization, subdued inflation trends, and
stable inflation expectations—were likely to warrant

exceptionally low levels of the federal funds rate for
an extended period. In light of the improved functioning of financial markets, Committee members
agreed that it would be appropriate for the statement
to indicate that the previously announced schedule
for closing the Term Asset-Backed Securities Loan
Facility (TALF) was being maintained. On
March 31, the TALF closed for loans backed by collateral other than newly issued commercial MBS.
The information reviewed at the April 27–28 FOMC
meeting suggested that, on balance, the economic
recovery was proceeding at a moderate pace and that
the deterioration in the labor market was likely coming to an end. Consumer spending continued to post
solid gains in the first three months of the year, and
business investment in equipment and software
appeared to have increased significantly further in
the first quarter. In addition, growth of manufacturing output remained brisk, and gains became more
broadly based across industries. However, residential
construction, while having edged up, was still
depressed, construction of nonresidential buildings
remained on a steep downward trajectory, and state
and local governments continued to retrench. Consumer price inflation remained low. Meeting participants expected that business investment would be
supported by improved conditions in financial markets. Large firms with access to capital markets
appeared to be having little difficulty in obtaining
credit, and in many cases they also had ample
retained earnings with which to fund their operations
and investment. However, many participants noted
that, while financial market conditions had generally
improved, bank lending was still contracting and that
smaller firms in particular continued to face substantial difficulty in obtaining bank loans. Members saw
an escalation of financial strains in Europe as a risk
to the outlook, although the attendant effects on
global market conditions were only beginning to be
felt.
Members agreed that no adjustments to the federal
funds rate target range were warranted at the meeting. On balance, the economic outlook had changed
little since the March meeting. Even though the
recovery appeared to be continuing and was expected
to strengthen gradually over time, most members
projected that economic slack would continue to be
elevated for some time, with inflation remaining
below rates that would be consistent in the longer run
with the Federal Reserve’s dual objectives of maximum employment and price stability. In addition,
nearly all members judged that it was appropriate to

Monetary Policy and Economic Developments

reiterate the expectation that economic conditions
were likely to warrant exceptionally low levels of the
federal funds rate for an extended period. In light of
the improved functioning of financial markets, Committee members again agreed that it would be appropriate for the statement to indicate that the previously announced schedule for closing the TALF was
being maintained.
On May 9, 2010, the Committee met by conference
call to discuss developments in global financial markets and possible policy responses. Over the previous
several months, financial market concerns about the
ability of Greece and some other euro-area countries
to contain their sizable budget deficits and finance
their debt had increased. Conditions in short-term
funding markets in Europe had deteriorated, and
global financial markets more generally had been
volatile and less supportive of economic growth.
In connection with the possible implementation by
the European authorities of a number of measures to
promote fiscal sustainability and support financial
market functioning, some major central banks had
requested that dollar liquidity swap lines with the
Federal Reserve be reestablished. The Committee
agreed that such arrangements could be helpful in
limiting the strains in dollar funding markets and the
adverse implications of recent developments for the
U.S. economy. In order to promote the transparency
of these arrangements, participants also agreed that
it would be appropriate for the Federal Reserve to
publish the swap contracts and to release on a weekly
basis the amounts of draws under the swap lines by
central bank counterparty. It was recognized that the
Committee would need to consider the implications
of swap lines for bank reserves and overall management of the Federal Reserve’s balance sheet. Participants noted the importance of appropriate consultation with U.S. government officials and emphasized
that a reestablishment of the lines should be contingent on strong and effective actions by authorities in
Europe to address fiscal sustainability and support
financial markets.
At the conclusion of its discussion, the Committee
voted unanimously to authorize the Chairman to
agree to reestablish swap lines with the European
Central Bank (ECB), the Bank of England, the Swiss
National Bank, the Bank of Japan, and the Bank of
Canada. The arrangements with the Bank of England, the ECB, the Swiss National Bank, and the
Bank of Japan would provide those central banks

67

with the capacity to conduct tenders of U.S. dollars
in their local markets at fixed rates for full allotment,
similar to arrangements that had been in place previously. The arrangement with the Bank of Canada
would support draws of up to $30 billion, as was the
case previously. The swap arrangements were authorized through January 2011.
The information reviewed at the June 22–23 FOMC
meeting suggested that the economic recovery was
proceeding at a moderate pace in the second quarter.
Businesses continued to increase employment and
lengthen workweeks in April and May, but the unemployment rate remained elevated. Industrial production registered strong and widespread gains, and
business investment in equipment and software rose
rapidly. Consumer spending appeared to have moved
up further in April and May. However, housing starts
dropped in May, and nonresidential construction
remained depressed. Falling energy prices held down
headline consumer prices in April and May, while
core consumer prices edged up.
Financial markets had become somewhat less supportive of economic growth since the April meeting,
with developments in Europe a leading cause of
greater global financial market tensions. Risk spreads
for many corporate borrowers had widened noticeably, equity prices had fallen appreciably, and the dollar had risen in value against a broad basket of other
currencies. Participants saw these changes as likely to
weigh to some degree on household and business
spending over coming quarters.
The Committee agreed to make no change in its target range for the federal funds rate at the meeting.
Although the economic outlook had softened somewhat, and a number of meeting participants saw the
risks to the outlook as having shifted to the downside, all saw the economic expansion as likely to be
strong enough to continue raising resource utilization, albeit more slowly than they had previously
anticipated. In addition, they saw inflation as likely
to stabilize near recent low readings in coming quarters and then gradually rise toward more desirable
levels. Nearly all members again judged that it was
appropriate to indicate in the statement released following the meeting that economic conditions were
likely to warrant exceptionally low levels of the federal funds rate for an extended period. Participants
noted that in addition to continuing to develop and
test instruments to exit from the period of unusually
accommodative monetary policy, the Committee

68

97th Annual Report | 2010

would need to consider whether further policy stimulus might become appropriate if the economic outlook were to worsen appreciably.
Tools for the Withdrawal
of Monetary Policy Accommodation

Although the FOMC continues to anticipate that
economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an
extended period, ultimately the Federal Reserve will
need to begin to tighten monetary conditions to prevent the development of inflation pressures as the
economy recovers. That tightening will be accomplished partly through changes that will affect the
composition and size of the Federal Reserve’s balance sheet.
The Federal Reserve has developed a number of tools
that will facilitate the removal of policy accommodation and reduce the quantity of reserves held by the
banking system at the appropriate time. These tools
encompass (1) raising the interest rate paid on excess
reserve balances (the IOER rate), (2) executing term
reverse repurchase agreements (RRPs) with the primary dealers and other counterparties, (3) issuing
term deposits to depository institutions through the
Term Deposit Facility (TDF), (4) redeeming maturing and prepaid securities held by the Federal
Reserve without reinvesting the proceeds, and (5) selling securities held by the Federal Reserve. All but the
first of these tools would shrink the supply of reserve
balances; the last two would also reduce the size of
the Federal Reserve’s balance sheet.
Interest on Excess Reserves Rate
In their discussion of the IOER rate at the January
meeting, all participants agreed that raising that rate
and the target for the federal funds rate would be a
key element of a move to less-accommodative monetary policy. Most participants thought that it likely
would be appropriate to reduce the supply of reserve
balances, to some extent, before raising the IOER
rate and the target for the federal funds rate, in part
because reducing the supply of reserve balances
would tighten the link between short-term market
rates and the IOER rate. However, several participants noted that draining operations might be seen
as a precursor to tightening and should be undertaken only when the Committee judged that an
increase in its target for the federal funds rate would
soon be appropriate. For the same reason, a few
believed that it would be better to drain reserves concurrently with the eventual increase in the IOER and
target rates.

With respect to longer-run approaches to implementing monetary policy, most policymakers saw benefits
in continuing to use the federal funds rate as the
operating target for implementing monetary policy,
so long as other money market rates remained closely
linked to the federal funds rate. Many thought that
an approach in which the primary credit rate was set
above the Committee’s target for the federal funds
rate and the IOER rate was set below that target—a
corridor system—would be beneficial. Participants
recognized, however, that the supply of reserve balances would need to be reduced considerably to lift
the federal funds rate above the IOER rate. Participants noted that their judgments were tentative, that
they would continue to discuss the ultimate operating
regime, and that they might well gain useful information about longer-run approaches during the eventual
withdrawal of policy accommodation.
Reverse Repurchase Agreements
At the January meeting, staff reported on successful
tests of the Federal Reserve’s ability to conduct term
RRPs with primary dealers by arranging several
small-scale transactions using Treasury securities and
agency debt as collateral; staff anticipated that the
Federal Reserve would be able to execute term RRPs
against MBS later in the year and would have the
capability to conduct RRPs with an expanded set of
counterparties shortly thereafter. The staff updated
the Committee on the status of work on RRPs at
subsequent meetings.
Term Deposit Facility
In late December 2009, the Federal Register published a notice requesting the public’s input on a proposal for a TDF. At the January FOMC meeting,
Federal Reserve staff indicated that they would analyze comments from the public in the coming weeks
and then prepare a final proposal for the Board’s
consideration. On April 30, the Federal Reserve
Board announced that it had approved amendments
to Regulation D (Reserve Requirements of Depository Institutions) authorizing the Reserve Banks to
offer term deposits to institutions that are eligible to
receive earnings on their balances at Reserve Banks.
On May 10, the Federal Reserve Board authorized
up to five small-value offerings of term deposits
under the TDF, which were designed to ensure the
effectiveness of TDF operations and to provide eligible institutions with an opportunity to gain familiarity with the procedures. The first of these offerings, for $1 billion in 14-day term deposits, was conducted on June 14. The auction had a stop-out rate
of 27 basis points and a bid-to-cover ratio of slightly

Monetary Policy and Economic Developments

more than 6. The second offering, for $2 billion in
28-day deposits, was conducted on June 28. That
auction had a stop-out rate of about 27 basis points
and a bid-to-cover ratio of about 5½. The third, for
$2 billion in 84-day term deposits, was conducted on
July 12. That auction had a stop-out rate of 31 basis
points and a bid-to-cover ratio of about 3¾.
Asset Redemptions and Sales
Over the course of the FOMC meetings conducted in
the first half of 2010, participants discussed the eventual size and composition of the Federal Reserve’s
balance sheet and longer-run strategies for asset
redemptions and sales. Participants agreed that any
longer-run strategy for asset sales and redemptions
should be consistent with the achievement of the
Committee’s objectives of maximum employment
and price stability. Policymakers were also unanimous in the view that it will be appropriate to shrink
the supply of reserve balances and the size of the
Federal Reserve’s balance sheet substantially over
time. Moreover, they agreed that it will eventually be
appropriate for the System Open Market Account to
return its domestic holdings to only securities issued
by the U.S. Treasury, as was the case before the financial crisis. Meeting participants also agreed that sales
of agency debt and agency MBS should be implemented in accordance with a framework communicated well in advance and be conducted at a gradual
pace that potentially could be adjusted in response to
developments in economic and financial conditions.
Most participants favored deferring asset sales for
some time, and a majority preferred beginning asset
sales after the first increase in the FOMC’s target for
short-term interest rates. Such an approach would
postpone any asset sales until the economic recovery
was well established and would maintain short-term
interest rates as the Committee’s key monetary policy

69

tool. Participants agreed that the current policy of
redeeming and not replacing agency debt and agency
MBS as those securities mature or are prepaid helped
make progress toward the Committee’s goals regarding the size and composition of the Federal Reserve’s
balance sheet. Many policymakers saw benefits to
eventually adopting an approach of reinvesting
maturing Treasury securities in bills and shorter-term
coupon issues to shift the maturity composition of
the Federal Reserve’s portfolio toward the structure
that had prevailed prior to the financial crisis. Several
meeting participants thought the Federal Reserve
should eventually hold a portfolio composed largely
of shorter-term Treasury securities.
Participants expressed a range of views about the
appropriate timing and pace of asset sales and
redemptions, and Committee members did not reach
final decisions about those issues over the course of
the meetings in the first half of 2010. Participants
agreed that it would be important to maintain flexibility regarding these issues given the uncertainties
associated with the unprecedented size and composition of the Federal Reserve’s balance sheet and its
effects on financial conditions. For the time being,
meeting participants agreed that the Federal Reserve
should continue the interim approach of allowing all
maturing agency debt and all prepayments of agency
MBS to be redeemed without replacement while rolling over all maturing Treasury securities. At the June
meeting, participants recognized that in light of the
increased downside risks to an already gradual recovery from a deep recession, the Committee also
needed to review its options for providing additional
monetary stimulus should doing so become necessary. Participants will continue to consider the Committee’s portfolio management strategy at future
meetings.

71

Banking Supervision and Regulation

The Federal Reserve has supervisory and regulatory
authority over a variety of financial institutions and
activities with the goal of promoting a safe, sound,
and stable banking and financial system that supports the growth and stability of the U.S. economy.

Overview
The Federal Reserve is the federal supervisor and
regulator of all U.S. bank holding companies
(BHCs), including financial holding companies and
state-chartered commercial banks that are members
of the Federal Reserve System. At the end of 2010,
2,193 banks were members of the Federal Reserve
System and were operating 57,694 branches. These
banks accounted for 34 percent of all commercial
banks in the United States and for 71 percent of all
commercial banking offices. In overseeing these organizations, 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. BHCs, and the U.S. operations of foreign banking organizations. Furthermore,
through the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank
Act), the Federal Reserve has been assigned additional responsibilities for additional institutions,
including systemically important nonbank financial
firms and systemically important financial utilities. In
addition, the act transfers authority for consolidated
supervision of more than 400 savings and loan holding companies (SLHCs) and their non-depository
subsidiaries from the Office of Thrift Supervision
(OTS) to the Federal Reserve, effective July 21, 2011.
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 BHCs
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 its responsibilities, the Federal Reserve coordinates supervisory activities with
the other federal banking agencies, state agencies,
functional regulators (that is, regulators for insurance, securities, and commodities firms), and foreign
bank regulatory agencies.
This report highlights several topics relevant to the
Federal Reserve’s supervisory and regulatory activities in 2010:
• safety and soundness
• supervisory policy
• supervisory information technology
• staff development
• regulation of the U.S. banking structure
• enforcement of other laws and regulations

2010 Developments
During 2010, the U.S. banking system and financial
markets improved further, continuing their recovery
from the financial crisis that started in mid-2007.
Performance of bank holding companies. While a
turnaround in BHC performance was evident during
2010, performance remains weak by historical standards, and the industry recovery could face challenges due to ongoing and elevated nonperforming
asset levels. U.S. BHCs, in aggregate, reported earnings of $80.8 billion for the year ending December 31, 2010, compared to $12.9 billion for the full
year 2009. Much of this improvement was due to
lower loan loss provisioning and consequent reserve
releases. The proportion of unprofitable BHCs,
although down from 42 percent in 2009, remains high

72

97th Annual Report | 2010

at 27 percent, which encompasses roughly 24 percent
of industry assets. Nonperforming assets present a
significant challenge to industry recovery, with the
nonperforming asset ratio down only slightly to
4.1 percent of loans and foreclosed assets from
4.7 percent in 2009. Weaknesses were broad based,
encompassing residential mortgages (first-lien), commercial real estate—especially non-owner nonfarm
nonresidential and construction other than singlefamily—and commercial and industrial (C&I) loans.
In 2010, an additional 73 BHCs that received funds
from the U.S. Department of the Treasury’s (Treasury) Troubled Asset Relief Program (TARP) repaid
all funds received. As of year-end, 73 BHCs that
received funds from Treasury’s TARP repaid all
funds received, and Treasury reports that approximately 82 percent of all distributed TARP’s funds
has been repaid.1 (Also see “Bank Holding
Companies” on page 76).
Performance of state member banks. Similar to
BHCs, the turnaround at state member banks in 2010
was muted. As a group, state member banks reported
a profit of $6.1 billion, up from aggregate losses
totaling $4.6 billion in 2009, but low by historical
norms. While earnings were up due largely to lower
provisions ($17.7 billion versus $26.4 billion in
2009) and modest securities gains ($0.6 billion versus
losses of $4.2 billion in 2009), almost a fifth of all
state member banks continue to report losses. Mirroring trends at BHCs, the nonperforming assets
ratio remained relatively unchanged at 4.3 percent of
loans and foreclosed assets, reflecting both contracting loan balances and ongoing weaknesses in asset
quality. Growth in problem loans slowed during
2010, but weakness encompassed nonfarm nonresidential lending, residential mortgages, and C&I
loans. The number of foreclosed properties continued
to increase, particularly those associated with construction and land development and one- to fourfamily residential lending. The risk-based capital
ratios for state member banks improved during 2010
in the aggregate, and the percent of state member
banks deemed well capitalized under prompt corrective action standards increased moderately to 97 percent from 95 percent at year-end 2009. In 2010, 18
state member banks with $8.5 billion in assets failed,
with losses of $1.4 billion according to Federal
Deposit Insurance Corporation (FDIC) estimates.
(Also see “State Member Banks” on page 76.)

1

The TARP statistics only include those BHCs that did not participate in the Supervisory Capital Assessment Program in 2009.

Impact of the Dodd-Frank Act. One of the most
prominent events of 2010 was the passage of the
Dodd-Frank Act. The Dodd-Frank Act closed a gap
in the regulatory framework by subjecting designated
systemically important nonbank financial institutions
to prudential regulation and consolidated supervision
and by providing a mechanism for orderly resolution
in the event of the failure of such an institution. A
key aspect the Dodd-Frank Act is a set of enhanced
standards for all systemically important financial
institutions. Other elements of the act included creation of a Financial Stability Oversight Council,2
limits on certain types of proprietary trading, establishment of financial sector concentration limits,
development of risk-retention requirements for securitizations, and improved oversight of over-thecounter (OTC) derivatives activity. In 2010, the Federal Reserve began the process of implementing elements of the Dodd-Frank Act through several
proposed rulemakings (see “Capital Adequacy
Standards” on page 83). For more detail on the
impact of Dodd-Frank, see “Savings and Loan
Holding Company Transfer” on page 77 and “Federal Legislative Developments” on page 144.
Capital adequacy. In addition, during 2010, the Federal Reserve was instrumental in augmenting standards related to capital adequacy of banking institutions. Federal Reserve staff worked proactively with
the other federal banking agencies and with banking
supervisors from other Basel Committee member
countries to finalize a comprehensive and farreaching reform package for internationally active
banking organizations, issued in December 2010.
This package aims to strengthen global capital and
liquidity regulations, to be implemented in various
stages in the coming years. In addition, the Federal
Reserve worked with other U.S. banking agencies to
issue for comment proposed rules to revise their
market-risk capital rules, consistent with changes
made at the Basel Committee level. Also, the Federal
Reserve began implementing some of the provisions
of the Dodd-Frank Act related to capital adequacy.
(See “Supervisory Policy” on page 83.)
Other policy initiatives. Other key policy initiatives
included guidelines for evaluating proposals by large
BHCs to undertake capital actions in 2011. The
guidelines outlined the criteria to be used by supervisors when evaluating any capital distribution proposal (see “Capital Adequacy Standards” on
page 83). The Federal Reserve and other banking
2

The Federal Reserve is a member of this newly formed council.

Banking Supervision and Regulation

agencies also issued policy statements on underwriting standards for small business loans originated
under the Treasury’s Small Business Lending Fund
(SBLF) Program. The agencies also issued guidelines
for funding and liquidity risk management, appraisals, and incentive compensation. (See box 1 and
“Other Policy Issues” on page 90).

Bank examinations and inspections. In light of supervisory lessons learned, the Federal Reserve began
augmenting its processes for conducting examinations and inspections as needed. A prominent
example is the enhanced approach to supervision of
the largest, most complex organizations that takes a
macroprudential and multidisciplinary approach to

Box 1. Incentive Compensation
In June 2010, the Federal Reserve issued final supervisory guidance aimed at ensuring that incentive
compensation arrangements at financial organizations take into account risk and are consistent with
safe and sound practices (Guidance on Sound Incentive Compensation Policies at www.federalreserve
.gov/newsevents/press/bcreg/20100621a.htm).
Importantly, the other federal banking agencies—the
Office of the Comptroller of the Currency, the OTS,
and the FDIC—joined the Federal Reserve in adopting the guidance, ensuring that the principles embedded in the guidance will apply to all banking organizations regardless of their federal supervisor.
The interagency guidance is principles-based, recognizing that the methods used to achieve appropriately risk-sensitive compensation arrangements likely
will differ significantly across and within organizations. Importantly, the interagency guidance is oriented to the risk-taking incentives created by incentive compensation arrangements and not the level or
amount of incentive compensation. Because improperly structured compensation arrangements for both
executive and non-executive employees may pose
safety-and-soundness risks, the guidance applies
not only to top-level managers, but also to other
employees who have the ability to materially affect
the risk profile of an organization, either individually
or as part of a group.
The guidance adopted by the federal banking agencies is based on three key principles: (1) incentive
compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner
that does not encourage employees to expose their
organizations to imprudent risk; (2) these arrangements should be compatible with effective controls
and risk management; and (3) these arrangements
should be supported by strong corporate governance, including active and effective oversight by the
organization’s board of directors. These principles,

73

and the guidance more generally, are consistent with
the Principles for Sound Compensation Practices
issued in April 2009 by the Financial Stability Board
and associated implementation standards.
The Board, in cooperation with other regulatory
agencies, also conducted two supervisory initiatives
designed to spur and monitor progress toward
improved arrangements, identify emerging best practices, and advance the state of practice more generally in the industry. The first initiative, a horizontal
review of incentive compensation practices at large
complex banking organizations, will be completed in
early 2011. This review has involved a multidisciplinary group of over 150 individuals, all of the banking agencies, and multiple project phases. Supervisory teams reviewed existing incentive compensation
practices and related risk-management and corporate governance processes, evaluated plans and
timetables for enhancements, and conducted more
detailed reviews of a few specific business lines.
Supervisors have observed and encouraged real,
positive change in the incentive compensation practices of these banking organizations.
Additionally, the agencies incorporated oversight of
incentive compensation arrangements into the regular examination process for smaller organizations.
These reviews will be tailored to take account of the
size, complexity, and other characteristics of these
banking organizations.
Federal Reserve staff will prepare a report sometime
after the conclusion of the 2010 bonus season, in
consultation with the other federal banking agencies,
on trends and developments in compensation practices at banking organizations. (For information on
rulemaking/guidance required under the Dodd-Frank
Act on incentive-based compensation, see “Changes
to Banking Regulation and Supervision” in the “Federal Legislative Developments” chapter.)

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97th Annual Report | 2010

supervision, making greater use of the broad range of
skills of the Federal Reserve staff to promote financial stability. (Also see “Examinations and Inspections” below and table 1.)

Supervision
Safety and Soundness
To promote the safety and soundness of banking
organizations, the Federal Reserve conducts on-site
examinations and inspections, conducts off-site surveillance and monitoring, and takes enforcement and
other supervisory actions as necessary. The Federal
Reserve also provides training and technical assistance to foreign supervisors and minority-owned and
de novo depository institutions.
Examinations and Inspections
The Federal Reserve conducts examinations of state
member banks, the U.S. branches and agencies of
foreign banks, and Edge Act and agreement corporations. In a process distinct from examinations, it conducts inspections of BHCs and their nonbank sub-

sidiaries. Whether an examination or an inspection is
being conducted, the review of operations entails
1. an evaluation of the adequacy of governance provided by the board and senior management,
including an assessment of internal policies, procedures, controls, and operations;
2. an assessment of the quality of the riskmanagement and internal control processes in
place to identify, measure, monitor, and control
risks;
3. an assessment of the key financial factors of
capital, asset quality, earnings, and liquidity; and
4. a review for compliance with applicable laws and
regulations.
Table 1 provides information on examinations and
inspections conducted by the Federal Reserve during
the past five years.
The Federal Reserve uses a risk-focused approach to
supervision, with activities directed toward identifying the areas of greatest risk to banking organizations and assessing the ability of the organizations’

Table 1. State Member Banks and Bank Holding Companies, 2006–2010
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
1

2010

2009

2008

2007

2006

829
1,697
912
722
190

845
1,690
850
655
195

862
1,854
717
486
231

878
1,519
694
479
215

901
1,405
761
500
261

482
15,986
677
654
491
163
23

488
15,744
658
640
501
139
18

485
14,138
519
500
445
55
19

459
13,281
492
476
438
38
16

448
12,179
566
557
500
57
9

4,362
991
3,340
3,199
167
3,032
141

4,486
1,018
3,264
3,109
169
2,940
155

4,545
1,008
3,192
3,048
107
2,941
144

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

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

430
43

479
46

557
45

597
43

599
44

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

Banking Supervision and Regulation

management processes to identify, measure, monitor,
and control those risks. Key aspects of the riskfocused approach to consolidated supervision of the
largest institutions (see box 2) supervised by the Federal Reserve include

75

est extent possible on assessments and information developed by other relevant domestic and
foreign supervisors and functional regulators;

1. developing an understanding of each organization’s legal and operating structure, and its primary strategies, business lines, and riskmanagement and internal control functions;

3. maintaining continual supervision of these organizations—including through meetings with
banking organization management and analysis
of internal and external information—so that the
Federal Reserve’s understanding and assessment
of each organization’s condition remains current;

2. developing and executing a tailored supervisory
plan that outlines the work required to maintain a
comprehensive understanding and assessment of
each institution, incorporating reliance to the full-

4. assigning to each organization a supervisory team
composed of Reserve Bank staff who have skills
appropriate for the organization’s risk profile; and

Box 2. Large Bank Supervision
The Dodd-Frank Act closed critical gaps in the regulatory framework by ensuring systemically important
nonbank financial institutions would be subject to
consolidated supervision and by providing a mechanism for orderly resolution in the event of the failure
of such an institution. But, the crisis of 2008 also
highlighted the critical importance of effective supervision of all systemically important institutions to
reduce the potential for a destabilizing collapse of a
troubled financial institution.
Well in advance of the passage of the Dodd-Frank
Act, the Federal Reserve established an internal
working group to enhance the effectiveness of the
conduct of its supervisory activities. The working
group, which comprised senior officials from the
Board of Governors and the Reserve Banks, was
charged with identifying key areas for improving
supervision, as well as with laying out the actions
necessary to effect those improvements. The working group identified needed improvements in each of
three critical supervisory activities:
1. the identification of key risks and vulnerabilities;
2. the design and execution of the appropriate
supervisory responses to these risks and concerns; and
3. effective communication from supervisors to
institutions about the risks and vulnerabilities
that have been identified and related remedial
requirements.
In response, to improve risk identification of both
safety-and-soundness issues at individual institutions
and broader risks to the financial system, the Federal
Reserve is incorporating a more macroprudential orientation. To enhance the design and execution of
supervisory activities, such as horizontal examinations and stress tests, we are adopting a multidisci-

plinary approach supported by rigorous quantitative
analysis. Further, to facilitate greater agility and effectiveness in our supervisory responses, our corporate
governance for large bank supervision now involves
more senior and centralized System expertise.
The structure and governance of large bank supervision has been reorganized to support these objectives. The Large Institution Supervision Coordinating
Committee (LISCC) was established as a multidisciplinary group of senior Federal Reserve officials to
provide strategic and policy direction for supervisory
activities, to ensure that systemic risk concerns are
fully integrated in supervisory planning, and to facilitate improved consistency and quality of supervision.
Through the LISCC, an expansive breadth of expertise from within the Federal Reserve System—in the
research divisions, markets group, and clearing and
settlement functions— informs and complements the
work of our supervisors. A multidisciplinary Operating
Committee has been implemented to support the
LISCC at the staff level. Like the LISCC, the Operating Committee incorporates participation from specialized skills from across the System in all phases of
supervision for the most complex institutions.
Increased use of data-driven modeling and forecasting techniques, such as in the stress testing of lowprobability, high-impact events, will allow supervisors
to better anticipate and mitigate systemic risks.
These tools are being used to assess potential risks
and to support supervisors’ assessment of an institution’s internal capital assessment practices. Under
this framework, the Federal Reserve will increase its
use of horizontal examinations and scenario analysis,
extend its focus to macroprudential issues, and
increase cooperation with primary and functional
supervisors.

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97th Annual Report | 2010

5. promoting Systemwide and interagency
information-sharing through automated systems
and other mechanisms.
For other sized banking organizations, the riskfocused consolidated supervision program provides
that examination and inspection procedures are tailored to each banking organization’s size, complexity,
risk profile, and condition. The supervisory program
for an institution, regardless of its asset size, entails
both off-site and on-site work, including development of supervisory plans, pre-examination visits,
detailed documentation, and preparation of examination reports tailored to the scope and findings of
the examination.
State Member Banks

At the end of 2010, 829 state-chartered banks
(excluding nondepository trust companies and private banks) were members of the Federal Reserve
System. These banks represented approximately
13 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 full-scope, on-site examination
of these banks is required at least once a year,
although certain well-capitalized, well-managed organizations having total assets of less than $500 million
may be examined once every 18 months.3 The Federal Reserve conducted 722 exams of state member
banks in 2010.
Bank Holding Companies

At year-end 2010, a total of 5,464 U.S. BHCs were in
operation, of which 4,844 were top-tier BHCs. These
organizations controlled 5,443 insured commercial
banks and held approximately 99 percent of all
insured commercial bank assets in the United States.
Federal Reserve guidelines call for annual inspections
of large BHCs 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
3

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.

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. Inspections of BHCs, including financial
holding companies, are built around a rating system
introduced in 2005. The system reflects the shift in
supervisory practices 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 depository institution. The fourth component, Depository Institution (D), is intended to mirror the primary supervisor’s rating of the subsidiary
depository institution.4 Noncomplex BHCs with
consolidated assets of $1 billion or less are subject to
a special supervisory program that permits a more
flexible approach.5 In 2010, the Federal Reserve conducted 654 inspections of large BHCs and 3,199
inspections of small, noncomplex BHCs.
Financial Holding Companies

Under the Gramm-Leach-Bliley Act, BHCs 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. As of year-end 2010, 430 domestic BHCs
and 43 foreign banking organizations had financial
holding company status. Of the domestic financial
holding companies, 34 had consolidated assets of
$15 billion or more; 101, between $1 billion and
$15 billion; 68, between $500 million and $1 billion;
and 227, less than $500 million.

4

5

Each of the first two components has four subcomponents: Risk
Management— (1) Board and Senior Management Oversight;
(2) Policies, Procedures, and Limits; (3) Risk Monitoring and
Management Information Systems; and (4) Internal Controls.
Financial Condition— (1) Capital, (2) Asset Quality, (3) Earnings, and (4) Liquidity.
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 BHC is complex or
noncomplex (www.federalreserve.gov/boarddocs/srletters/2002/
sr0201.htm).

Banking Supervision and Regulation

Box 3. Interagency Coordination of
the Savings and Loan Holding
Company Transfer
The Federal Reserve is engaged in a range of activities to implement the transfer of consolidated supervision of SLHCs from the OTS. Federal Reserve staff
is working closely with the OTS, whose staff is providing valuable information, expertise, and consultation during this transition period. Additionally, the
Federal Reserve is working with staff at the Office of
the Comptroller of the Currency and the FDIC in light
of the critical role that these primary federal regulators play in contributing to the Federal Reserve’s
knowledge of consolidated holding companies.

Savings and Loan Holding Company Transfer
The Dodd-Frank Act transfers authority for consolidated supervision of SLHCs and their nondepository subsidiaries from the OTS to the Federal
Reserve, effective July 21, 2011. The overriding principles include securing an orderly transfer of information and knowledge (see box 3), ensuring that
there are no gaps in holding company supervision,
and providing the thrift industry with information on
a flow basis so as to increase certainty and minimize
unnecessary disruption during the transition period.
Any company that controls a depository institution
should be held to appropriate prudential standards,
including those for capital, liquidity, and risk management. As such, the Federal Reserve intends to create an oversight regime for thrift holding companies
that is consistent with, and is as rigorous as, the
supervisory regime applicable to BHCs. Consequently, the Federal Reserve intends, to the greatest
extent possible, taking into account any unique characteristics of SLHCs and the requirements of the
Home Owners’ Loan Act (HOLA), to carry out
supervisory oversight of SLHCs on a comprehensive
consolidated basis, consistent with the established
approach to BHC supervision.6 To this end, Federal
Reserve staff is reviewing all elements of its BHC
supervision program to determine whether and how
to incorporate SLHCs into the program, consistent
with HOLA. The program includes
• understanding the structure of holding companies
and material activities of these companies,
6

See SR letter 08-9/CA 08-12, which sets forth the holding company supervision, “Consolidated Supervision of Bank Holding
Companies and the Combined U.S. Operations of Foreign
Banking Organizations” (www.federalreserve.gov/boarddocs/
srletters/2008/SR0809.htm).

77

• evaluating risks posed by nonbanking activities in a
holding company structure,
• imposing prudential standards on a consolidated
basis, and
• assessing the consumer compliance risk profile for
holding companies.
As the Federal Reserve develops plans for other
aspects of the Dodd-Frank Act, it will extend these
existing approaches to the supervisory programs for
SLHCs, as appropriate.
The Dodd-Frank Act gives the Federal Reserve the
authority to require grandfathered unitary SLHCs
that conduct activities other than financial activities
to establish an intermediate holding company over
all, or a portion of, the financial activities. The Federal Reserve has established a working group to consider the issues associated with this authority and its
potential advantages to effective supervision of such
grandfathered companies. The Federal Reserve will
implement this authority only after a proposed rule
has been published for notice and public comment.
The Federal Reserve anticipates that all regulations,
as appropriate, relating to (1) supervision of SLHCs
and nondepository institution subsidiaries of
SLHCs; (2) transactions with affiliates; (3) extensions
of credit to executive officers, directors, and principal
shareholders; and (4) tying arrangements will continue and will be enforceable by the appropriate
agency. A working group is conducting an analysis of
OTS and Federal Reserve regulations and guidance
documents to determine policy or technical differences and to assess whether there are any gaps. The
Federal Reserve will decide which OTS regulations
should be amended after the transfer date, in conjunction with a broad assessment of the holding
company standards to be applied to SLHCs and
other policy considerations. The Federal Reserve will
make changes, when necessary, to any transferred
OTS regulations after public notice and opportunity
for comment.
The Federal Reserve and the OTS are engaged in
detailed discussions on the range of operational
issues that they need to address during the transition
period. In addition to detailed briefings on legal and
regulatory issues, the OTS staff has provided information on its holding company program and on current supervisory issues. The agencies signed a memorandum of understanding (MOU) to facilitate the
sharing of confidential supervisory information dur-

78

97th Annual Report | 2010

ing the transition. This will allow the Federal Reserve
to become familiar with the condition of each SLHC
coming under its jurisdiction and to identify resource
requirements needed on the transfer date. The Federal Reserve will integrate SLHCs into its existing
programs that align institutions with institutional
portfolios based on their size and complexity. For
instance, smaller, noncomplex SLHCs will be supervised in the Community Banking Organization portfolio while larger, more complex SLHCs will be
supervised in the Regional or Large Banking Organization portfolios. The Federal Reserve Board has
assigned each SLHC to a responsible Reserve Bank.7
To facilitate the transition process, and pursuant to
the MOU, examiners from the Federal Reserve are
joining certain OTS examinations prior to the transfer date to gather information and learn about the
OTS supervisory process. Discussions are well under
way about the orderly transition of the caseload from
the OTS to the Reserve Banks.
International Activities
The Federal Reserve supervises the foreign branches
and overseas investments of member banks, Edge
Act and agreement corporations, and BHCs (including the investments by BHCs 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 BHCs, 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. Examiners
also visit the overseas offices of U.S. banks to obtain
financial and operating information and, in some
instances, to test their adherence to safe and sound
banking practices and compliance with rules and
regulations or to evaluate an organization’s efforts to
implement corrective measures. 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 Office of the Comptroller of the
Currency (OCC). At the end of 2010, 53 member
7

See SR letter 05-27/CA letter 05-11, “Responsible Reserve Bank
and Inter-District Coordination,” (www.federalreserve.gov/
boarddocs/srletters/2005/SR0527.htm).

banks were operating 567 branches in foreign countries and overseas areas of the United States; 31
national banks were operating 508 of these branches,
and 22 state member banks were operating the
remaining 59. In addition, 18 nonmember banks
were operating 26 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
agreements 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 investments that are
broader than those permissible for member banks. At
year-end 2010, 51 banking organizations, operating
10 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, BHCs, and certain
nonbanking companies. Foreign banks continue to
be significant participants in the U.S. banking
system. As of year-end 2010, 173 foreign banks from
52 countries operated 205 state-licensed branches
and agencies, of which six were insured by the FDIC,
and 50 OCC-licensed branches and agencies, of
which four were insured by the FDIC. These foreign
banks also owned eight Edge Act and agreement corporations and two commercial lending companies. In
addition, they held a controlling interest in 55 U.S.
commercial banks. Altogether, the U.S. offices of
these foreign banks at the end of 2010 controlled
approximately 17 percent of U.S. commercial banking assets. These 173 foreign banks also operated 92
representative offices; an additional 54 foreign banks

Banking Supervision and Regulation

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 18 months, either by the Federal
Reserve or by a state or other federal regulator. In
most cases, on-site examinations are conducted at
least once every 12 months, but the period may be
extended to 18 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 465 examinations in
2010.
Compliance with Regulatory Requirements
The Federal Reserve examines institutions for compliance with a broad range of legal requirements,
including anti-money-laundering (AML) 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 Board’s 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

The Treasury regulations 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, tax, or regulatory proceedings. The BSA and

79

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
BSA compliance programs and that the programs be
formally approved by bank boards of directors. The
Federal Reserve is responsible for examining institutions for compliance with applicable AML laws and
regulations and conducts such examinations in accordance with the Federal Financial Institutions Examination Council (FFIEC) Bank Secrecy Act/AntiMoney Laundering Examination Manual.8
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 nonbank
entities 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 2010, the Federal Reserve continued as the lead
agency in four interagency examinations of large,
multiregional data processing servicers, and it
assumed leadership in one additional examination
late in the year.
Fiduciary Activities

The Federal Reserve has supervisory responsibility
for state member banks and state member nondepository trust companies that reported $53.1 trillion
and $36.5 trillion of assets, respectively, as of yearend 2010. These assets were held in various fiduciary
8

The FFIEC is an interagency body of financial regulatory agencies established to prescribe uniform principles, standards, and
report forms and to promote uniformity in the supervision of
financial institutions. The Council has six voting members: the
Board of Governors of the Federal Reserve System, the FDIC,
the National Credit Union Administration, the OCC, the OTS,
and the chair of the State Liaison Committee.

80

97th Annual Report | 2010

and custodial capacities. On-site examinations of
fiduciary and custodial activities are risk-focused and
entail the review of an organization’s compliance
with laws, regulations, and general fiduciary principles, including effective management of conflicts of
interest; management of legal, operational, and reputational risk exposures; and audit and control procedures. In 2010, Federal Reserve examiners conducted
111 on-site fiduciary examinations, excluding transfer
agent examinations, of state member banks.
Transfer Agents

As directed by the Securities Exchange Act of 1934,
the Federal Reserve conducts specialized examinations of those state member banks and BHCs 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 2010, the Federal Reserve conducted on-site transfer agent examinations at seven of the 38 state member banks and
BHCs that were registered as transfer agents.
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 the Treasury regulations governing dealing
and brokering in government securities. Twelve state
member banks and six state branches of foreign
banks have notified the Board that they are government securities dealers or brokers not exempt from
the Treasury’s regulations. During 2010, the Federal
Reserve conducted six examinations of broker–dealer
activities 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 BHCs 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 10 entities that
dealt in municipal securities during 2010, seven 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 Board 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) or the National Credit Union
Administration (NCUA).
At the end of 2010, 531 lenders other than banks,
brokers, or dealers were registered with the Federal
Reserve. Other federal regulators supervised 178 of
these lenders, and the remaining 353 were subject to
limited Federal Reserve supervision. The Federal
Reserve exempted 153 lenders from its on-site inspection program on the basis of their regulatory status
and annual reports. Thirty-four inspections were conducted during the year.
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 cease-and-desist orders, written
agreements, prompt corrective action directives,
removal and prohibition orders, and civil money penalties. In 2010, the Federal Reserve completed 264
formal enforcement actions. Civil money penalties
totaling $33,010 were assessed. As directed by statute,
all civil money penalties are remitted to either the
Treasury or the Federal Emergency Management
Agency. Enforcement orders and prompt corrective
action directives, 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/apps/
enforcementactions/).
In addition to taking these formal enforcement
actions, the Reserve Banks completed 639 informal
enforcement actions in 2010. Informal enforcement

Banking Supervision and Regulation

actions include MOU 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 BHCs in the
period 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.

81

major upgrades to the web-based PRISM application
were completed.
The Federal Reserve works through the FFIEC Task
Force on Surveillance Systems to coordinate surveillance activities with the other federal banking
agencies.
Training and Technical Assistance
The Federal Reserve provides training and technical
assistance to foreign supervisors and minority-owned
and de novo depository institutions.
International Training and Technical Assistance

The primary off-site monitoring tool used by the
Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SRSABR). Drawing mainly 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
BHCs 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.

In 2010, 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. The Federal
Reserve, along with the OCC, the FDIC, and the
Treasury, was 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. The Federal
Reserve also contributes to the regional training provision under the Asia Pacific Economic Cooperation
Financial Regulators’ Training Initiative.

Federal Reserve analysts use Performance Report
Information and Surveillance Monitoring (PRISM),
a querying tool, 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 BHCs. During 2010, four

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,

In 2010, the Federal Reserve offered a number of
training courses exclusively for foreign supervisory
authorities, both in the United States and in a number of foreign jurisdictions. Federal Reserve staff also
took part in technical assistance and training missions led by the International Monetary Fund (IMF),
the World Bank, the Asian Development Bank, the
Basel Committee on Banking Supervision (Basel
Committee), and the Financial Stability Institute.

• 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

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97th Annual Report | 2010

• aims to help members develop banking laws, regulations, and supervisory practices that conform to
international best practices.

• presentations on the New Markets Tax Credits
Program (NMTC) at the National Interagency
Community Reinvestment Conference in New
Orleans, in partnership with the CDFI Fund;

The Federal Reserve contributes significantly to
ASBA’s organizational management and to its training and technical assistance activities.

• a presentation on NMTCs at the National Bankers
Association Legislative Regulatory Conference; and

Initiatives for Minority-Owned and
De Novo Depository Institutions

• a series of advanced NMTC webinars as part of a
collaborative interagency effort.

The Partnership for Progress program is a Federal
Reserve System program created to preserve and promote minority-owned, woman-owned, and de novo
depository institutions (MBOs). Launched in 2008,
the program seeks to help these institutions compete
effectively in today’s marketplace by offering them a
combination of one-on-one guidance and targeted
workshops on topics of particular relevance in terms
of starting and growing a bank in a safe and sound
manner. In addition, training and information on
resources are provided through an extensive public
website (www.fedpartnership.gov). Designated Partnership for Progress coordinators serve as local program contacts in each of the 12 Reserve Bank Districts and at the Board to answer questions and coordinate assistance for institutions requesting guidance.
The Board Oversight Committee is committed to further enhancing support for MBOs who are facing
increasing marketplace challenges, as many operate
in some of the hardest hit regions and are adversely
impacted by the recent recession and sluggish economic recovery. The Board also appointed a new
national coordinator to lead the program. The program district coordinators and the Board Oversight
Committee will conduct two program conferences
annually to discuss the program activities, meet with
MBO bankers and industry experts, and report/
coordinate the program Systemwide initiatives.
During 2010, the Federal Reserve hosted a variety of
workshops and seminars including
• an information session for Federal Reserve examination staff on the condition of minority banks
and the application of the Partnership for Progress
program;
• a series of seven seminars on Community Development Financial Institutions (CDFI) programs and
Small Business Lending programs;
• a workshop on Financial Intelligence for Developing Executives to increase expertise in analyzing
financial data and performance metrics;

The seminars on the NMTC and CDFI programs
helped minority bankers to better understand how
these programs can be used as a source of funding.
Along with the FDIC, OCC, and OTS, the Federal
Reserve sponsored the NMTC guidance program.
The Federal Reserve participated in the FDIC Investor Series to share information with minority bankers
and investors interested in purchasing bank assets or
starting banks.9 The Federal Reserve also participated in the National Bankers Association (NBA)
Annual Convention to discuss priorities for the NBA
and minority banks during 2011 and possible program initiatives to improve support for minority
banks.
Additionally, the Federal Reserve coordinates its
efforts with those of the other agencies through participation in an annual interagency conference for
minority depository institutions. For the federal bank
regulatory agencies, the conference provides an
opportunity to meet with senior managers from
minority-owned institutions and gain a better understanding of the institutions’ unique challenges and
opportunities. Finally, the agencies offer training
classes and sessions on emerging banking issues.
Business Continuity/Pandemic Preparedness
In 2010, the Federal Reserve continued its efforts to
strengthen the resilience of the U.S. financial system
in the event of unexpected disruptions, including
focused supervisory efforts to evaluate the resiliency
of the banking institutions under its jurisdiction. The
Federal Reserve revised, jointly with other regulatory
agencies, its analysis of firms subject to the Interagency Paper on Sound Practices to Strengthen the
Resilience of the U.S. Financial System (Sound Practices paper).10 Subsequently, the Federal Reserve
notified firms with business lines falling within the
9

10

The FDIC Investor Series was held at events in Atlanta, Harlem, Houston, Los Angeles, Miami, and San Francisco.
The population under review included core clearing and settlement organizations and firms that play a critical role in financial

Banking Supervision and Regulation

parameters of the Sound Practices paper of the resiliency requirements and began meeting with those
firms to assess their implementation plans and timeframes for implementation.
The Federal Reserve, together with other federal and
state financial regulators, is a member of the Financial Banking Information Infrastructure Committee
(FBIIC), which was formed to improve coordination
and communication among financial regulators,
enhance the resiliency of the financial services sector
of U.S. critical infrastructures and key resources, and
promote the public/private partnership. The FBIIC
has established emergency communication protocols
to maintain effective communication among members in the event of an emergency. The members of
the FBIIC will convene by conference call no later
than 90 minutes following the first public report of
an event to share situational and operational status
reports. As a member of FBIIC, the Federal Reserve
is then responsible for establishing and maintaining
communication with the institutions for which they
have primary supervisory authority and for ensuring
coordination between public affairs and media relations staff.

Supervisory Policy
The Federal Reserve’s supervisory policy function,
carried out by the Board, is responsible for developing guidance for examiners and banking organizations as well as regulations for banking organizations
under the Federal Reserve’s supervision. The Board,
often in conjunction with the other federal banking
agencies, issues rulemakings, public SR letters, and
other policy statements and guidance in order to
carry out its supervisory policy function. Federal
Reserve staff also 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 Financial Stability
Board, the Joint Forum, and the International
Accounting Standards Board.
Capital Adequacy Standards
In 2010, the Board issued several rulemakings and
guidance documents related to capital adequacy standards, including several joint proposed rulemakings
with the other federal banking agencies to address
provisions of the Dodd-Frank Act.
markets and are subject to resiliency guidelines issued in
April 2003 (www.federalreserve.gov/boarddocs/srletters/2003/
sr0309.htm).

83

• In response to the Dodd-Frank Act’s requirement
to remove references to, or requirements of reliance on, the use of credit ratings in federal regulations, the federal banking agencies issued an
advanced notice of proposed rulemaking (ANPR)
seeking comment on alternatives to the use of
credit ratings in the risk-based capital rules. The
ANPR (1) describes how the agencies’ risk-based
capital standards currently reference ratings;
(2) sets forth the factors the agencies will consider
in assessing potential alternatives to the use of
credit ratings; and (3) describes briefly, and
requests comment on, potential alternatives to the
use of credit ratings. The ANPR is available at
www.gpo.gov/fdsys/pkg/FR-2010-08-25/pdf/201021051.pdf.
• The federal banking agencies issued for comment a
notice of proposed rulemaking (NPR) to amend
the advanced approaches capital adequacy framework, consistent with certain provisions of the
Dodd-Frank Act. The proposed rule would require
a banking organization operating under the
advanced approaches framework to meet, on an
ongoing basis, the higher of the generally applicable and the advanced approaches minimum riskbased capital standards. The NPR is available at
http://edocket.access.gpo.gov/2010/pdf/2010-32190
.pdf.
• In order to implement certain market risk-related
changes to the Basel Accord, the Board, the OCC,
and the FDIC issued for comment an NPR to
revise their market-risk capital rules. The proposed
revisions would (1) better capture positions for
which the market-risk capital rules are appropriate,
(2) reduce procyclicality in market-risk capital
requirements, (3) enhance the rules’ sensitivity to
risks that are not adequately captured by the current regulatory measurement methodologies, and
(4) increase market discipline through enhanced
disclosures. The NPR is available at http://edocket
.access.gpo.gov/2011/pdf/2010-32189.pdf.
• The federal banking agencies issued a statement
clarifying the risk weight for claims on, or guaranteed by, the FDIC. The statement is available at
www.federalreserve.gov/boarddocs/srletters/2010/
sr1004a1.pdf.
• The Federal Reserve issued guidelines for evaluating proposals by large BHCs to undertake capital
actions in 2011 in a revised temporary addendum
to SR letter 09-4, “Dividend Increases and Other
Capital Distributions for the 19 Supervisory Capital Assessment Program Firms.” The guidelines

84

97th Annual Report | 2010

state that any capital distribution proposal will be
evaluated on the basis of a number of criteria
including, for example, the firm’s ability to absorb
losses over the next two years under several scenarios, the firm’s plans to meet Basel III capital
requirements, and the firm’s plans to repay U.S.
government investments, if applicable. The guidelines are available at www.federalreserve.gov/
boarddocs/srletters/2009/SR0904_Addendum.pdf.
In 2010, Board and Reserve Bank staff conducted
supervisory analyses of a number of complex capital
issuances, private capital investments, and novel
transactions to determine their qualification for
inclusion in regulatory capital and consistency with
safety and soundness. For certain transactions, staff
required banking organizations to make changes necessary for instruments to satisfy these criteria.
Board staff participated in making determinations
regarding tier 1 qualification of capital issuances arising from the review of applications for private capital
investments in banking organizations, including
banking organizations in severely impaired condition. The focus of these analyses is compliance with
the Board’s capital standards for inclusion in tier 1
capital, as well as consistency with safety and soundness to ensure that the terms of such private investments do not (1) impede prudent action by issuing
banking organizations to address financial problems
or (2) impair the Federal Reserve’s ability to take
appropriate supervisory action.
Board staff also continued in 2010 to work closely
with the Treasury and the other federal banking
agencies in making determinations related to the tier
1 capital eligibility of capital instruments issued to
Treasury under the Community Development Financial Institutions Program and securities issued to the
Small Business Lending Fund, initiated by Congress
in 2010.
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 improve the stability of the
international banking system. (See box 4 for a list of
Basel Committee publications on risk-management
practices.)
Basel III

During 2010, Federal Reserve staff worked proactively with the other federal banking agencies and

Box 4. Risk Management
The Federal Reserve contributed to supervisory
policy papers, reports, and recommendations issued
by the Basel Committee during 2010 and aimed at
improving the supervision of banking organizations’
risk-management practices. Publications during 2010
included
• Sound practices for back testing counterparty
credit risk models (final document, issued in
December at www.bis.org/publ/bcbs185.htm);
• Report and recommendations of the Cross-border
Bank Resolution Group (final document, issued in
March at www.bis.org/publ/bcbs169.htm);
• Operational risk–supervisory guidelines for the
Advanced Measurement Approaches (consultative
paper, issued in December at www.bis.org/publ/
bcbs184.htm); and
• Range of methodologies for risk and performance
alignment of remuneration (consultative paper,
issued in October at www.bis.org/publ/bcbs178
.htm).

with banking supervisors from Basel Committee
member countries to finalize a comprehensive and
far-reaching reform package for internationally active
banking organizations. On December 16, 2010, the
Basel Committee issued “Basel III: A global regulatory framework for more resilient banks and banking
systems,” with the overarching goal of increasing the
resiliency of the banking system by strengthening
global capital and liquidity regulations. International
implementation of Basel III is scheduled to begin
January 1, 2013, and certain aspects are subject to
transitional arrangements.
Basel III increases the quantity and quality of the
regulatory capital base in several ways. Importantly,
it establishes a new minimum common equity tier
1 to risk-weighted assets ratio of 4.5 percent. This is
the first time that the risk-based capital framework
will include an explicit capital standard based on tangible common equity, which is the highest form of
capital. To instill market confidence in the regulatory
capital framework, common equity tier 1 is subject to
strict eligibility criteria, and regulatory deductions
from capital are taken from common equity tier 1.
Regulatory deductions include deferred tax assets
associated with net operating losses, all intangible
assets (except mortgage servicing rights), and defined
benefit pension fund assets to which the banking
organization does not have unfettered and unrestricted access. Mortgage servicing rights, deferred
tax assets associated with timing differences, and sig-

Banking Supervision and Regulation

nificant investments in unconsolidated financial
firms are subject to a strict individual and aggregate
limit of 10 percent and 15 percent of common equity
tier 1, respectively; amounts above these limits must
be deducted from common equity tier 1.
Basel III tightens the criteria for tier 1 eligibility to
ensure that all tier 1 capital can absorb losses on a
going concern basis—those instruments that no longer qualify as tier 1 capital will be phased-out over an
agreed-upon timeframe and either included in tier 2
capital or fully excluded from regulatory capital.
Instruments that no longer qualify as tier 2 capital
will be phased-out from regulatory capital. Under
Basel III, the minimum tier 1 to risk-weighted assets
ratio is increased from 4 percent to 6 percent, while
the total capital to risk-weighted assets ratio remains
at 8 percent.
Basel III introduces a series of measures to promote
the buildup of capital buffers in good times that can
be drawn upon in periods of stress. It requires banking organizations to hold a capital conservation buffer composed of common equity tier 1 above the
regulatory minimum levels. The capital conservation
buffer is calibrated at 2.5 percent of risk-weighted
assets to enable banking organizations to maintain
capital levels above the minimum requirements
throughout a significant sector-wide downturn.
Under Basel III, banking organizations that fail to
maintain this 2.5 percent capital conservation buffer
will face mandatory regulatory restrictions on
the percentage of earnings that they can pay out in
the form of capital distributions or employee discretionary bonus payments. Together, the minimum
capital requirements plus the capital conservation
buffer translate into 7 percent common equity tier 1,
8.5 percent tier 1, and 10.5 percent total capital to
risk-weighted assets ratio requirements.
Subject to national discretion, Basel III also introduces a countercyclical capital buffer that fluctuates
between 0 and 2.5 percent of risk-weighted assets
that could be triggered when a relevant measure
indicative of steep credit expansion hits a specified
threshold. The countercyclical buffer would effectively work as an extension of the capital conservation buffer and should contribute to a more stable
banking system by helping to dampen economic and
financial shocks.
Moreover, Basel III strengthens capital requirements
for counterparty credit-risk exposures arising from
banking organizations’ derivatives and securities

85

financing activities. The reforms also provide market
participants with incentives to move OTC derivative
contracts to central counterparties, helping reduce
systemic risk across the financial system.
Basel III introduces an international leverage ratio
designed to contain the buildup of excessive on- and
off-balance-sheet leverage in the banking system and
to safeguard against attempts to arbitrage the riskbased capital requirements. The leverage ratio will be
subject to a parallel run period, during which the
Basel Committee will test a minimum tier 1 to quarterly average on- and off-balance-sheet assets ratio of
3 percent. U.S. banking organizations have long been
subject to a simple leverage ratio, but most banks
outside the United States have not. Adoption of an
international leverage ratio should help to put U.S.
banking organizations on a more level playing field
with their foreign bank peers.
Basel III adopts a global minimum liquidity standard
for internationally active banking organizations that
includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio (the net stable funding ratio). The liquidity
coverage ratio promotes short-term resiliency by
ensuring that banking organizations have sufficient
high-quality liquid assets to survive an acute stress
scenario lasting for one month, whereas the net stable
funding ratio was designed to capture structural
liquidity mismatches and to promote resiliency over a
longer-term horizon. The framework also includes a
common set of monitoring metrics to assist supervisors in identifying and analyzing liquidity risk trends
at both the banking organization and systemwide
levels.
The Board, along with the other federal banking
agencies, expects to issue during 2011 an interagency
NPR describing how the agencies intend to implement Basel III in the United States, followed by an
interagency final rule in 2012.
Joint Forum

In 2010, the Federal Reserve continued to participate
in the Joint Forum—an international group of supervisors of the banking, securities, and insurance
industries established to address varied issues crossing the traditional borders of these sectors, including
the regulation of financial conglomerates. The Joint
Forum operates under the aegis of the Basel Committee, the International Organization of Securities
Commissions, and the International Association of
Insurance Supervisors. National supervisors of these

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97th Annual Report | 2010

three sectors, who are members of the Joint Forum’s
founding organizations, work together to carry out
the responsibilities of the Joint Forum.
The Joint Forum, through its founding organizations,
issued a report in 2010 that reviewed developments in
modeling risk aggregation and suggested improvements to the current modeling techniques used by
complex firms to aggregate risks. During the year, the
Federal Reserve also contributed to Joint Forum
projects that will result in the issuance of reports or
papers in the near future.
Financial Sector Assessment Program

Beginning in 2009 and extending into 2010, the Federal Reserve and other banking agencies underwent a
Financial Sector Assessment Program (FSAP)
review. The FSAP is a joint IMF and World Bank
program designed to promote national and international financial stability and growth and to help
strengthen the financial systems of member countries. The IMF views the FSAP as an integral part of
their national assessments.
The Division of Banking Supervision and Regulation
led an interagency effort to prepare for, and respond
to, the IMF’s assessment of the effectiveness of U.S.
banking supervision. As part of this review, the Federal Reserve and other federal banking agencies
jointly prepared a self assessment against the Basel
Core Principles for Effective Banking Supervision
(BCPs). For each principle and associated criteria,
the self assessment includes a summary of applicable
legal and regulatory provisions and a description of
how the principles are put into practice, with specific
citations regarding procedures. The U.S. BCP self
assessment was made public in August of 2009 on
Treasury’s website (www.treasury.gov).
Based on the self assessment and several weeks of
on-site work, the IMF concluded that the U.S. banking agencies were compliant with 96 percent of the
BCPs, which are effectively best practices for banking
supervision. The IMF’s recommendations for
improvement incorporated a number of initiatives
already in process, including conducting stress tests;
joining international efforts to initiate supervisory
colleges for large, globally active U.S. banks; and
directing large banks to improve their ability to
aggregate risks across legal entities and product lines
to identify risk concentrations and correlations.

Accounting Policy
The Federal Reserve strongly endorses sound corporate governance and effective accounting and auditing practices for all regulated financial institutions.
Accordingly, the Federal Reserve’s supervisory policy
function is 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 interact with key constituents
in the accounting and auditing professions, including
standard-setters, accounting firms, the financial services industry, accounting and financial sector trade
groups, and other financial sector regulators. The
Federal Reserve also participates in the Basel Committee’s Accounting Task Force, which represents the
Basel Committee at international meetings on
accounting, auditing, and disclosure issues affecting
global banking organizations. These efforts help
inform our understanding of current domestic and
international practices and proposed standards and
our formulation of policy positions based on the
potential impact of changes in standards or guidance
(or other events) on the financial sector. As a consequence, Federal Reserve staff routinely provide informal input to standard-setters, as well as formal input
through public comment letters on proposals, to
ensure appropriate and transparent financial statement reporting.
During 2010, addressing challenges related to financial sector accounting and reporting remained a priority for Federal Reserve staff. Issues during the year
included fair value accounting, accounting for
impairment in securities and other financial instruments, and accounting for asset securitizations and
other off-balance-sheet items. As discussed below, to
address these and other issues, the Federal Reserve
participated in activities arising from general market
conditions and in support of efforts related to financial stability.
Federal Reserve staff participated in a number of
discussions with accounting and auditing standardsetters. In response to requests for comment, staff
• provided comment letters to the Financial
Accounting Standards Board (FASB) on proposals

Banking Supervision and Regulation

related to the accounting for financial instruments,
derivative instruments, hedging activities, troubled
debt restructurings, and leases; and
• provided a comment letter on the International
Accounting Standards Board’s (IASB’s) financial
instrument impairment proposal and contributed
to the development of numerous other comment
letters related to accounting and auditing matters
that were submitted to the IASB and the International Auditing and Assurance Standards Board
through the Basel Committee.
Federal Reserve staff participated in the development
and issuance of a Risk Retention report to Congress
on the potential impact of credit-risk retention
requirements on securitization markets. The report
was required by the Dodd-Frank Act and highlights
the potential interaction between risk retention,
accounting standards, and regulatory capital requirements. Federal Reserve staff also participated in
other supervisory activities to assess additional interactions between accounting standards and regulatory
reform efforts.
The Federal Reserve issued supervisory guidance to
financial institutions and supervisory staff on
accounting matters, as appropriate, and participated
in a number of supervisory related activities. For
example, Federal Reserve staff
• issued guidance to address supervisory considerations relating to business combinations and other
acquisitions when the fair value of net assets
acquired exceeded the acquisition price;
• participated in activities related to structured
finance, derivatives, trust preferred securities, new
capital instruments, and loan participations;
• developed and participated in a number of domestic and international training programs to educate
supervisors about new and emerging accounting
and reporting topics affecting financial institutions; and
• supported the efforts of the Reserve Banks in
financial institution supervisory activities related to
financial accounting, auditing, reporting, and
disclosure.
The Federal Reserve supports the concept of achieving a single widely accepted set of high-quality global
accounting standards. Federal Reserve staff provided
input to the Securities and Exchange Commission
(SEC) on issues related to the convergence of U.S.
generally accepted accounting principles and Interna-

87

tional Financial Reporting Standards (IFRS), including challenges that would need to be addressed before
establishing a date for U.S. companies to utilize
IFRS. The Federal Reserve supported the efforts of
the FASB and the IASB to continue toward the
achievement of converged standards, which should
help to improve comparability of financial reporting
across national jurisdictions and promote more efficient capital allocation. Given the Federal Reserve’s
unique perspectives on the challenges facing financial
institutions and our role in the financial markets,
staff participated on the joint FASB and IASB
Financial Crisis Advisory Group. Federal Reserve
staff also participated on the FASB’s Valuation
Resource Group, which was created to assist the
FASB in matters involving valuation for financial
reporting purposes.
Credit-Risk Management
The Federal Reserve works with the other federal
banking agencies to develop guidance on the management of credit risk; to coordinate the assessment
of regulated institutions’ credit risk; and to ensure
that institutions properly identify, measure, and manage credit risk.
Lending to Creditworthy Small Businesses

In February 2010, the Federal Reserve, along with
the other banking agencies, issued guidance to examiners that reinforced the message that institutions
should strive to meet the credit needs of creditworthy
small business borrowers and that the supervisory
agencies will not hinder those efforts.11 This guidance
directs examiners and bankers alike to be mindful of
the effects of excessive credit tightening on the
broader economy. As a general matter, the Federal
Reserve does not expect examiners to adversely classify loans based solely on a decline in collateral value
where, for example, the borrower has stable revenue
streams and demonstrates the ability to repay the
loan. To this end, we implemented training for examiners and conducted outreach to the banking industry to underscore this expectation. The 2010 guidance is the latest in a series of actions taken by the
Federal Reserve and the other banking agencies to
support sound bank lending and the credit intermediation process.
In an effort to encourage prudent commercial real
estate (CRE) loan workouts, the Federal Reserve led
11

See Interagency Statement on Meeting the Credit Needs of
Creditworthy Small Business Borrowers, (February 2010), www
.federalreserve.gov/newsevents/press/bcreg/20100205a.htm.

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97th Annual Report | 2010

the development of interagency guidance issued in
October 2009 regarding CRE loan restructurings and
workouts.12 In January 2010, the Federal Reserve
launched a comprehensive Systemwide training initiative to further underscore our expectations regarding CRE. These initiatives themselves build off of
guidance that the Federal Reserve and other federal
banking agencies issued in November 2008 to
encourage banks to meet the needs of creditworthy
borrowers, in a manner consistent with safe and
sound banking practices, and to take a balanced
approach in assessing a borrower’s ability to repay.13
Achieving this balance will not always be easy. That is
why we have emphasized to both bankers and our
examiners the importance of careful analysis of the
circumstances of individual borrowers.
In addition to our outreach to banks and bank examiners, the Federal Reserve has conducted a number of
forums in 2010 to better understand the difficulties
faced by small businesses. In mid-November, the
Board and the Federal Reserve Bank of San Francisco, in conjunction with the Small Business Administration, held small business forums in San Francisco
and Los Angeles. We then conducted a series of
meetings on small business access to credit hosted by
the Reserve Banks, followed by a capstone event at
the Board of Governors.
Interagency Appraisal and Evaluation Guidelines

In December 2010, the Federal Reserve, FDIC,
NCUA, OCC, and OTS jointly issued the revised
Interagency Appraisal and Evaluation Guidelines14
that replaces the 1994 Interagency Appraisal and
Evaluation Guidelines and reflects consideration of
comments received on the November 2008 proposal
to revise the guidelines. The new guidelines clarify the
agencies’ long-standing expectations for an institution’s appraisal and evaluation program. The core
principles of the 1994 guidelines are retained in the
new guidelines. Further, the new guidelines clarify the
agencies’ expectations for an institution’s collateral
valuation function, considering changes in appraisal
practices and technologies since 1994. The new material in the 2010 guidelines is based largely on guidance documents that the agencies have issued over
12

13

14

See Policy Statement on Prudent Commercial Real Estate (CRE)
Loan Workouts, (October 2009), www.federalreserve.gov/
newsevents/press/bcreg/20091030a.htm.
See Interagency Statement on Meeting the Needs of Creditworthy
Borrowers (November 2008), www.federalreserve.gov/
newsevents/press/bcreg/20081112a.htm.
See SR letter 10-16, www.federalreserve.gov/boarddocs/srletters/
2010/sr1016.htm.

the past several years regarding independence in the
appraisal and evaluation functions, appraisals for
residential tract development lending, and revisions
to Uniform Standards of Professional Appraisal
Practice. There is also an expanded discussion on the
conditions under which an institution’s real estate–
related transactions might be exempted from the
agencies’ appraisal regulations.
Shared National Credit Program

In September 2010, the Federal Reserve and the
other federal banking agencies released summary
results of the 2010 annual review of the Shared
National Credit (SNC) Program. The agencies established the program in 1977 to promote the efficient
and consistent review and classification of shared
national credits. A SNC is any loan or formal loan
commitment—and any asset, such as other real
estate, stocks, notes, bonds, and debentures taken as
debts previously contracted—extended to borrowers
by a supervised institution, its subsidiaries, and affiliates. A SNC must have an original loan amount that
aggregates to $20 million or more and either (1) is
shared by three or more unaffiliated supervised institutions under a formal lending agreement or (2) a
portion of which is sold to two or more unaffiliated
supervised institutions, with the purchasing institutions assuming their pro rata share of the credit risk.
The 2010 SNC review was based on analyses of
credit data as of December 31, 2009, provided by
federally supervised institutions. The SNC portfolio
totaled $2.5 trillion, with 8,292 credit facilities to
approximately 5,600 borrowers. From the previous
period, the dollar volume of the portfolio declined by
$362 billion or 12.6 percent, and the number of credits declined by 663, or 7.4 percent. Although the 2010
review found that credit quality improved from the
previous period, the volume and percentage of criticized and classified assets remained high.15 Criticized
assets declined by $194 billion to $448 billion, a
30 percent decline from 2009 findings. Criticized
assets represented 17.8 percent of the portfolio, compared with 22.3 percent in the 2009 review. Classified
credits declined by $142 billion, a 31.8 percent
decline. Classified credits represented 12.1 percent of
the portfolio, compared with 15.5 percent in the 2009
review. Credits rated special mention (or potentially
weak) declined by $52 billion to $143 billion, a
15

Criticized assets are composed of special mention and classified
assets. Special mention assets are loans and securities that
exhibit potential weakness but are not classified. Classified
assets are loans and securities that exhibit well-defined weaknesses or a distinct possibility of loss.

Banking Supervision and Regulation

26.7 percent decline. Special mention credits represented 5.7 percent of the portfolio, compared with
6.8 percent in the 2009 review. The reduction in the
level of criticized and classified assets is attributed to
improved borrower operating performance, debt
restructurings, bankruptcy resolutions, and greater
borrower access to bond and equity markets. Industry groups demonstrating significant improvement in
credit quality included automotive, materials and
commodities, and finance and insurance.
Continuing the trend from 2008, the number of credits originated in 2009 declined compared with prior
years, but observed underwriting standards were generally satisfactory and improved over prior years. Performance of the SNC portfolio remained influenced
by its significant exposure to credits originated in
2006 and 2007 that are characterized by weak underwriting standards. Refinancing risk within the portfolio is also significant, with nearly 67 percent of criticized commitments maturing between 2012 and 2014.
Compliance Risk Management
The Federal Reserve works with international and
domestic supervisors to develop guidance that promote compliance with BSA/AML and counter terrorism laws.
Bank Secrecy Act and
Anti-Money-Laundering Compliance

In 2010, the Federal Reserve continued to actively
promote the establishment and maintenance of effective BSA/AML compliance risk-management programs. For example, the Federal Reserve issued guidance in April 2010 providing BHCs and their nonbank subsidiaries more flexibility in filing Suspicious
Activity Reports (SARs). This additional flexibility
permits these entities to file the type of SAR form
that is most applicable to their business activities.
Also, Federal Reserve supervisory staff participated
in several interagency projects designed to clarify
regulatory expectations, including developing and
issuing guidance on (1) beneficial ownership,
(2) sharing SARs, and (3) examination procedures for
monitoring compliance with the Unlawful Internet
Gambling Enforcement Act.
The Federal Reserve currently chairs the FFIEC
BSA/AML working group, which is a monthly forum
for the discussion of pending BSA policy and regulatory matters, and participates in the Treasury-led
BSA Advisory Group, which includes representatives
of regulatory agencies, law enforcement, and the
financial services industry and covers all aspects of

89

the BSA. Since 2009, the FFIEC BSA/AML working
group meetings have included, on a quarterly basis,
the SEC, the Commodity Futures Trading Commission, the Internal Revenue Service, and the Office of
Foreign Assets Control (OFAC) in order to share and
discuss information on BSA/AML examination procedures and general trends more broadly.
The FFIEC BSA/AML working group also is
responsible for updating the FFIEC BSA/AML
Examination Manual (Manual). The FFIEC created
and publicly released the Manual as part of its ongoing commitment to provide current and consistent
guidance on risk-based policies, procedures, and processes for banking organizations to comply with the
BSA and safeguard their operations from money
laundering and terrorist financing.
In 2009 and 2010, the Federal Reserve chaired the
drafting group that updated the Manual; a revised
version was issued in April 2010. Among the significant modifications to the Manual are the following:
streamlined and reorganized procedures for reviewing BSA/AML compliance programs; a new section
on reviewing bulk currency shipments; a reorganized
discussion of suspicious activity monitoring and
reporting; updated requirements for Currency Transaction Report exemptions; clarification of expectations for determining the severity of regulatory violations; and updated discussions of recent developments in electronic banking, Automated Clearing
House transactions, prepaid cards, cover payments,
and third-party processor customers.
The Federal Reserve and other federal banking agencies continued during 2010 to regularly share examination findings and enforcement proceedings with
the Financial Crimes Enforcement Network under
the interagency MOU that was finalized in 2004, and
with the Treasury’s OFAC under the interagency
MOU that was finalized in 2006.
International Coordination on
Sanctions, Anti-Money Laundering, and
Counter-Terrorism Financing

The Federal Reserve participates in a number of
international coordination initiatives related to sanctions, money laundering, and terrorism financing.
For example, the Federal Reserve has a long-standing
role in the U.S. delegation to the intergovernmental
Financial Action Task Force (FATF) and its working
groups, contributing a banking supervisory perspective to formulation of international standards on
these matters. In 2010, the Federal Reserve actively

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97th Annual Report | 2010

contributed to the development of a FATF typologies report that addressed the use of new payment
methods to launder money. Also, the Federal Reserve
continued to participate in a subcommittee of the
Basel Committee that focuses on AML and counterterrorism financing issues.
Banks’ Securities Activities
In 2010, the Federal Reserve continued to provide
examiner training on Regulation R, which implemented certain key exceptions for banks from the
definition of the term “broker” under section 3(a) (4) of the Securities Exchange Act of 1934,
as amended by the Gramm-Leach-Bliley Act. Regulation R was adopted jointly by the Board and the
SEC, with a compliance date for most banks of
January 1, 2009, for most aspects of the regulation,
and January 1, 2011 for certain trust and fiduciary
activity-related aspects of the regulation.
Other Policy Issues
In 2010, the Board approved guidance and policy
statements on a number of issues.
• The agencies issued a statement on underwriting
standards for small business loans originated under
the Treasury’s SBLF Program. Pursuant to the
Small Business Jobs Act of 2010, the Secretary of
the Treasury is authorized to purchase up to
$30 billion in preferred stock and other financial
instruments from eligible financial institutions to
increase the availability of credit for small businesses that qualify for the program. The statement
is available at www.federalreserve.gov/boarddocs/
srletters/2010/sr1017a1.pdf.
• The federal banking agencies, in conjunction with
the Conference of State Bank Supervisors (CSBS),
released supervisory guidance in March 2010 on
their expectations for sound funding and liquidity
risk-management practices. This policy statement,
adopted by each of the agencies, summarizes the
principles of sound liquidity risk management
issued previously and, when appropriate, supplements them with the “Principles for Sound Liquidity Risk Management and Supervision” (issued in
September 2008 by the Basel Committee on Banking Supervision). The policy statement emphasizes
the importance of cash-flow projections; diversified funding sources; stress testing; a cushion of
liquid assets; and a formal, well-developed contingency funding plan as primary tools for measuring
and managing liquidity risk. The guidance is available at www.federalreserve.gov/newsevents/press/
bcreg/20100317a.htm.

• The federal banking agencies, along with the
NCUA and the FFIEC State Liaison Committee,
issued an advisory reminding depository institutions of supervisory expectations for sound practices in managing interest-rate risk. The advisory
reiterated the importance of effective riskmanagement practices related to interest-risk exposures and described interest-rate-risk management
techniques used by effective risk managers. The
advisory is available at www.federalreserve.gov/
newsevents/press/bcreg/20100107a.htm.
• The federal banking agencies issued guidance
reminding institutions of supervisory expectations
on sound practices for managing risks associated
with funding and credit concentrations arising
from correspondent relationships with other financial institutions. The guidance is available at www
.federalreserve.gov/newsevents/press/bcreg/
20100430a.htm.
• The federal banking agencies issued supervisory
guidance related to bargain purchases and acquisitions assisted by the FDIC and the NCUA. The
guidance was issued primarily to address supervisory considerations relating to bargain purchase
gains and the impact such gains have on the application approval process. The guidance is available
at www.federalreserve.gov/boarddocs/srletters/
2010/SR1012a1.pdf.
• The federal banking agencies, the NCUA, and the
CSBS issued an interagency statement to assist
financial institutions and their customers affected
by the explosion and oil spill related to the Deepwater Horizon Mobile Offshore Drilling Unit in
the Gulf of Mexico. The statement encouraged
financial institutions to consider measures to assist
creditworthy borrowers affected by the Gulf oil
spill and stated that examiners would consider the
unusual circumstances of banks and credit unions
in affected areas when determining the appropriate
supervisory response to safety-and-soundness
issues. The interagency statement is available at
www.federalreserve.gov/newsevents/press/bcreg/
20100714a.htm.
• The federal banking agencies, together with the
FCA and the NCUA, issued jointly developed rules
requiring mortgage loan originators who are
employees of institutions regulated by these agencies to meet the registration requirements of the
Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (the S.A.F.E. Act). The S.A.F.E.
Act requires these agencies to jointly develop and
maintain a system for registering residential mort-

Banking Supervision and Regulation

gage loan originators using the National Mortgage
Licensing System and Registry. The Federal
Reserve also issued guidance that discussed
S.A.F.E. Act requirements and implementation
considerations. The rules are available at www
.federalreserve.gov/newsevents/press/bcreg/
20100728a.htm.
Regulatory Reports
The Federal Reserve’s supervisory policy function is
also 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 other federal agencies and relevant state
supervisors, including foreign bank supervisors as
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. BHCs periodically submit reports that provide information
about their financial condition and structure. This
information is essential to formulating and conducting bank regulation and supervision. It is also used in
responding to requests by Congress and the public
for information about BHCs and their nonbank subsidiaries. Foreign banking organizations also are
required to periodically submit reports to the Federal
Reserve.
• FR Y-9 series reports—the FR Y-9C, FR Y-9LP,
and FR Y-9SP—provide standardized financial
statements for BHCs 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 BHC mergers
and acquisitions, and to analyze a holding company’s overall financial condition.
• Nonbank subsidiary reports—the FR Y-11, FR
2314, FR Y-7N, and FR 2886b—help the Federal
Reserve determine the condition of BHCs that are
engaged in nonbank activities and also aid in monitoring the number, nature, and condition of the
companies’ nonbank subsidiaries.
• The FR Y-8 report provides information on transactions between an insured depository institution
and its affiliates that are subject to section 23A of
the Federal Reserve Act; it is used to monitor bank

91

exposures to affiliates and to ensure banks’ compliance with section 23A of the Federal Reserve Act.
• The FR Y-10 report provides data on changes in
organization structure at domestic and foreign
banking organizations.
• The FR Y-6 and FR Y-7 reports gather additional
information on organization structure and shareholders from domestic banking organizations and
foreign banking organizations, respectively; the
information is used to monitor structure so as to
determine compliance with provisions of the Bank
Holding Company Act and Regulation Y and to
assess the ability of a foreign banking organization
to continue as a source of strength to its U.S.
operations.
During 2010, a number of revisions to the FR Y-9C
report were implemented. The revisions included
items to identify other-than-temporary impairment
losses on debt securities; additional items for unused
credit card lines and other unused commitments and
a related additional item for other loans; reformatting
of the schedule that collects information on quarterly
averages; additional items for assets covered by FDIC
loss-sharing agreements; and clarification of the
instructions for unused commitments.
Also effective December 2010, the FR Y-9C and FR
Y-9SP were revised to collect new footnote items
associated with the Treasury’s Community Development Capital Initiative program.
In 2010, the Federal Reserve proposed the following
revisions to the FR Y-9C for implementation in 2011:
(1) break out by loan category of other loans and
leases that are troubled debt restructurings for those
that (a) are past due 30 days or more or in nonaccrual status or (b) are in compliance with their modified terms and clarify reporting of restructured
troubled debt consumer loans; (2) break out other
consumer loans into automobile loans and all other
consumer loans in several schedules; (3) break out
commercial mortgage-backed securities issued or
guaranteed by U.S. government agencies and sponsored agencies; (4) create a new Schedule HC-V, Variable Interest Entities, for reporting major categories
of assets and liabilities of consolidated variable interest entities (VIEs); (5) break out loans and other real
estate owned (OREO) information covered by FDIC
loss-sharing agreements by loan and OREO category; (6) break out life insurance assets into data
items for general account and separate account life
insurance assets; (7) add new data items for the total

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97th Annual Report | 2010

assets of captive insurance and reinsurance subsidiaries; (8) add new income statement items for credit
valuation adjustments and debit valuation adjustments included in trading revenues (for BHCs with
total assets of $100 billion or more); (9) revise reporting instructions in the areas of construction lending,
one- to four-family residential mortgage banking
activities, and maturity and repricing data; and
(10) collect expanded information on the quarterlyaverages schedule.
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 provide the most current statistical data
available for evaluating institutions’ corporate applications, identifying areas of focus for both on-site
and off-site examinations, and considering monetary
and other public policy issues. 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.
During 2010, the FFIEC implemented revisions to
the Call Report. The revisions included (1) items to
identify other-than-temporary impairment losses on
debt securities; (2) additional items for unused credit
card lines and other unused commitments and a
related additional item for other loans; (3) new items
pertaining to reverse mortgages; (4) an additional
item on time deposits and revisions to reporting of
brokered deposits; and (5) additional items for assets
covered by FDIC loss-sharing agreements. In addition, revisions were made to change the reporting frequency of the number of certain deposit accounts
from annually to quarterly; to eliminate an item for
internal allocations of income and expense from foreign offices; to clarify the instructions for unused
commitments; and to change the reporting frequency
of loans to small businesses and small farms from
annually to quarterly.
Also during 2010, the FFIEC proposed the following
revisions to the Call Report for implementation in
2011: (1) break out by loan category of other loans
and leases that are troubled debt restructurings for

those that (a) are past due 30 days or more or in nonaccrual status or (b) are in compliance with their
modified terms and clarify reporting of restructured
troubled debt consumer loans; (2) break out other
consumer loans into automobile loans and all other
consumer loans in several schedules; (3) break out
commercial mortgage-backed securities issued or
guaranteed by U.S. government agencies and sponsored agencies; (4) add a new memorandum item for
the estimated amount of nonbrokered deposits
obtained through the use of deposit listing service
companies; (5) break out existing items for deposits
of individuals, partnerships, and corporations into
deposits of individuals and deposits of partnerships
and corporations; (6) create a new Schedule HC-V,
Variable Interest Entities, for reporting major categories of assets and liabilities of consolidated VIEs;
(7) break out loans and OREO information covered
by FDIC loss-sharing agreements by loan and
OREO category; (8) break out life insurance assets
into data items for general account and separate
account life insurance assets; (9) add new data items
for the total assets of captive insurance and reinsurance subsidiaries; (10) add new income statement
items for credit valuation adjustments and debit valuation adjustments included in trading revenues (for
banks with total assets of $100 billion or more);
(11) change reporting frequency from annually to
quarterly for the data reported in Schedule RC-T,
Fiduciary and Related Services, on collective investment funds and common trust funds; and (11) revise
reporting instructions in the areas of construction
lending, one- to four-family residential mortgage
banking activities, and maturity and repricing data.
In addition, during 2010, the FFIEC proposed several revisions to the Report of Assets and Liabilities
of U.S. Branches and Agencies of Foreign Banks
(FFIEC 002) to (1) collect additional detail on trading assets, (2) revise the reporting instructions in
Schedule E for reporting of time deposits of
$100,000 or more, and (3) expand the data collected
on Schedule Q, Financial Assets and Liabilities
Measured at Fair Value.

Supervisory Information Technology
The Federal Reserve’s supervisory information technology function, carried out by the Board’s Division
of Banking Supervision and Regulation and the
Reserve Banks under the guidance of the Subcommittee on Supervisory Administration and Technology, works to identify requirements and set priorities

Banking Supervision and Regulation

for information technology initiatives in the supervision and regulation (S&R) business line.
In 2010, the supervisory information technology
function (1) developed an Application Portfolio
framework and established an application architecture repository for all of the supervisory applications;
(2) deployed simplified and secure single sign-on for
most S&R applications; (3) identified and implemented technology infrastructure improvements to
shift information technology investments to more
efficient computing platforms and technologies;
(4) researched and provided infrastructure in support
of workgroup team collaboration and workflow
automation to efficiently share technology demand
across infrastructure assets; (5) conducted Systemwide architecture blueprint workshops to shift from
building custom systems to adopting light technologies and shared solutions; and (6) established a technology community plan to exchange best practices,
case studies, and allow for proactive sharing of
knowledge and improve technical problem solving.
National Information Center
The National Information Center (NIC) is the Federal Reserve’s comprehensive repository for supervisory, financial, and banking-structure data. It is also
the main repository for many supervisory documents.
NIC includes (1) data on banking structure throughout the United States as well as foreign banking concerns; (2) the National Examination Desktop, which
enables supervisory personnel as well as federal and
state banking authorities to access NIC data; (3) the
Banking Organization National Desktop, an application that facilitates secure, real-time electronic
information-sharing and collaboration among federal
and state banking regulators for the supervision of
banking organizations; and (4) the Central Document and Text Repository, 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 2010,
work continued on upgrading the entire NIC infrastructure to provide easier access to information, a
consistent Federal Reserve enterprise information
data repository, a comprehensive metadata repository, and uniform security across the Federal Reserve
System. Comprehensive testing was performed and
implementation began in May 2010. Application
developers began to transition their applications to
use the new infrastructure, and all applications are
expected to be completed during 2011. Also during

93

the year, numerous programming changes were made
to NIC applications in support of business needs and
to converge and streamline supervisory applications
where possible. A system of record was created for
exam/inspection dates, including the calculation of
the start dates for institutions supervised by the Federal Reserve System and transmitting those requirements to a work scheduling system. Another system
of record was created for tracking issues resulting
from examinations.
The NIC also supports the Shared National Credit
Modernization project (SNC Mod), a multiyear,
interagency, information technology development
effort to improve the efficiency and effectiveness of
the systems that support the SNC Program. SNC
Mod focuses on a complete rewrite of the current
legacy systems to take advantage of modern technology to enhance and extend the system’s capabilities.
The primary focus during 2010 was the development
of a set of examination support tools (SNCnet) to be
used by the interagency teams of examiners during
the annual SNC examination. The new SNCnet
system will be used during the execution of the 2011
SNC exam.
Finally, the Federal Reserve participated in a number
of technology-related initiatives supporting the
supervision function as part of FFIEC task forces
and interagency committees. These efforts support
standardized data collections and cross agency information sharing. Work in this area will continue to be
important as the agencies work through the implementation of the Dodd-Frank Act.

Staff Development
The Federal Reserve’s staff development program is
responsible for the ongoing development of nearly
2,605 professional supervisory staff to ensure that
they have the skills necessary to meet their evolving
supervisory responsibilities. The Federal Reserve also
provides course offerings to staff at state banking
agencies. Training activities in 2010 are summarized
in table 2.
Examiner Commissioning Program
The Examiner Commissioning Program (ECP)
involves approximately 22 weeks of instruction. Individuals move through a combination of classroom
offerings, self-paced assignments, and on-the-job
training over a period of two to five years. Achievement is measured by two professionally validated
proficiency examinations: the first proficiency exam

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97th Annual Report | 2010

Table 2. Training for Banking Supervision and Regulation, 2010
Number of enrollments
Course sponsor or type

Federal Reserve
personnel

State and federal
banking agency
personnel

1,464
208
9
11,855

279
254
6
1,471

Federal Reserve System
FFIEC
The Options Institute2
Rapid ResponseTM
1
2

Instructional time
(approximate training
days)1

Number of course
offerings

395
268
3
10

79
67
1
75

Training days are approximate. System courses were calculated using five days as an average, with FFIEC courses calculated using four days as an average.
The Options Institute, an educational arm of the Chicago Board Options Exchange, provides a three-day seminar on the use of options in risk management.

is required of all ECP participants, and the second
proficiency exam is offered in two specialty areas—
(a) safety and soundness and (b) consumer compliance. A third specialty, in information technology,
requires that individuals earn the Certified Information Systems Auditor certification offered by the
Information Systems Audit Control Association. In
2010, 227 examiners passed the first proficiency exam
and 87 passed the second proficiency exam (69 in
safety and soundness and 18 in consumer
compliance).
Continuing Professional Development
Other formal and informal learning opportunities are
available to examiners, including other schools and
programs offered within the System and FFIECsponsored schools. System programs are also available to state and federal banking agency personnel.
The Rapid Response® program, introduced in 2008,
offers System and state personnel 60–90 minute teleconference presentations on emerging issues or
urgent training needs associated with implementation
or issuance of new laws, regulations, or guidance.

Regulation
Regulation of the U.S. Banking Structure
The Federal Reserve administers five federal statutes
that apply to BHCs, 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 International 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 interna-

tional operations of domestic banking organizations;
or the U.S. banking operations of foreign banks. The
proposals concern BHC formations and acquisitions,
bank mergers, and other transactions involving bank
or nonbank firms. In 2010, the Federal Reserve acted
on 699 proposals representing 1,366 individual applications filed under the five statutes. Many of these
proposals involved banking organizations in less than
satisfactory financial condition.
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 BHC through
the acquisition of one or more banks in the United
States. Once formed, a BHC must receive Federal
Reserve approval before acquiring or establishing
additional banks. Also, BHCs 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. Depending on the circumstances,
these activities may or may not require Federal
Reserve approval in advance of their commencement.
When reviewing a BHC 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 applicable law. In the case of
a foreign banking organization seeking to acquire
control of a U.S. bank, the Federal Reserve also considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated
basis by its home-country supervisor. In 2010, the

Banking Supervision and Regulation

Federal Reserve acted on 312 applications and
notices filed by BHCs to acquire a bank or a nonbank firm, or to otherwise expand their activities,
including proposals involving private equity firms.
A BHC 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 2010,
the Federal Reserve acted on three stock repurchase
proposals by a BHC.
The Federal Reserve also reviews elections submitted
by BHCs seeking financial holding company status
under the authority granted by the Gramm-LeachBliley Act. BHCs seeking financial holding company
status must file a written declaration with the Federal
Reserve. In 2010, 12 domestic financial holding company declarations and one foreign bank declaration
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 relevant 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
2010, the Federal Reserve approved 96 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 BHC to obtain approval from the relevant
federal banking agency before completing the transaction. The Federal Reserve is responsible for reviewing changes in the control of state member banks
and BHCs. 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

95

the bank or BHC being acquired; the future 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
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 2010, the
Federal Reserve approved 133 change in control
notices related to state member banks and BHCs,
including proposals involving private equity firms.
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 2010, the Federal Reserve acted on new
and merger-related branch proposals for 584 domestic branches and granted prior approval for the establishment of seven new foreign branches.
State member banks must also obtain Federal
Reserve approval to establish financial subsidiaries.
These subsidiaries may engage in activities that are
financial in nature or incidental to financial activities,
including securities-related and insurance agencyrelated activities. In 2010, no financial subsidiary
application was approved.
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 2010, the Fed-

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97th Annual Report | 2010

eral Reserve approved 51 applications and notices for
overseas investments by U.S. banking organizations,
many of which represented investments through
Edge Act or agreement corporations.
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;
whether the home country of the foreign bank is
developing a legal regime or is participating in multilateral efforts to address money laundering; and the
foreign bank’s record in complying with U.S. law. In
2010, the Federal Reserve approved nine 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 BHC, 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 application and notice, the related

H.2A release gives 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.

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 are not members of BHCs
and 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 2010, 13 state member banks were registered
with the Board under the Securities Exchange Act.
Securities Credit
Under the Securities Exchange Act, the Board is
responsible for regulating credit in certain transactions involving the purchasing or carrying of securities. The Board’s Regulation T limits the amount of
credit that may be provided by securities brokers and
dealers when the credit is used to 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, 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 and the NCUA examine lenders
under their respective jurisdictions; and the Federal
Reserve examines other Regulation U lenders.

97

Consumer and Community Affairs

The Division of Consumer and Community Affairs
(DCCA) has primary responsibility for carrying out
the Board’s consumer protection program. DCCA
augments its dedicated expertise in consumer protection law, regulation, and policy with resources from
other functions of the Board and the Federal Reserve
System to write and interpret regulations, educate
and inform consumers, and enforce laws and regulations for consumer financial products and services.
Key elements of the division’s program include:
• rulemaking, utilizing a team of attorneys to write
regulations that implement legislation, update
regulations to respond to changes in the marketplace, design consumer-tested disclosures to provide consumers consistent and vital information on
financial products, and prohibit unfair and deceptive acts and practices;
• supervision and enforcement of state member
banks and bank holding companies and their nonbank affiliates to ensure that consumer protection
rules are being followed;
• consumer complaint and inquiry processes to assist
consumers in resolving grievances with their financial institutions and to answer their questions;
• consumer education to inform consumers about
what they need to know when making decisions
about their financial services options;
• research to understand the implications of policy
on consumer financial markets;
• outreach to national and local government agencies, consumer and community groups, academia,
and industry to gain a broad range of perspectives,
and to inform policy decisions and effective practices; and
• support for national and local agencies and organizations that work to protect and promote community development and economic empowerment to
historically underserved communities.

Rulemaking and Regulations
Credit Card Reform
Throughout 2010, the Federal Reserve worked to
implement the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the Credit Card
Act). Consistent with the effective dates set by Congress, the Federal Reserve’s rulemakings to implement the Credit Card Act were divided into three
stages. As discussed in the Federal Reserve’s 2009
Annual Report, the first stage was completed in 2009
and the second stage in January 2010. In June 2010,
the Board completed the third stage of rulemaking,
which is discussed in greater detail below. Subsequently, the Board proposed clarifications to the
rules implementing the Credit Card Act. In addition,
the Board released reports on credit card use by small
businesses and on college credit card agreements.
Implementing the Credit Card Act: Stage Three
In June, the Board approved a final rule to protect
credit card users from unreasonable late payment and
other penalty fees and to require credit card issuers to
reconsider interest rate increases imposed since the
beginning of 2009. This rule went into effect on
August 22, 2010.1 With the approval of this rule, the
Board’s rulemaking to implement the provisions of
the Credit Card Act was complete.
Reasonable Penalty Fees

The final rule requires that penalty fees imposed by
card issuers be reasonable and proportional to the
violation of the account terms. Among other things,
the rule prohibits credit card issuers from charging a
penalty fee of more than $25 for paying late or otherwise violating the account’s terms, unless the consumer has engaged in repeated violations or the
issuer can show that a higher fee represents a reason1

See press release (June 15, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100615a.htm.

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97th Annual Report | 2010

able proportion of the costs it incurs as a result of
violations. The rule also prohibits credit card issuers
from charging penalty fees that exceed the dollar
amount associated with the consumer’s violation.
For example, card issuers will no longer be permitted
to charge a $39 fee when a consumer is late making a
$20 minimum payment. Instead, the fee cannot
exceed $20. In addition, the rule bans “inactivity”
fees, such as fees imposed when a consumer doesn’t
use the account to make new purchases. Lastly, the
rule prevents issuers from charging multiple penalty
fees based on a single late payment or other violation
of the account terms.
Reevaluation of Interest Rate Increases

The rules also require issuers that have increased a
consumer’s interest rates to evaluate whether the reasons for the increase have changed and, if appropriate, to reduce the rate. Specifically, the rule requires
credit card issuers to reevaluate at least every six
months annual percentage rates increased on or after
January 1, 2009. In addition, the rule requires that
notices of rate increases for credit card accounts disclose the principal reasons for the increase.
Clarifications
In October, the Board proposed clarifications to its
rules implementing the Credit Card Act.2 The proposal is intended to enhance consumer protections
and to resolve areas of uncertainty so that card issuers fully understand their compliance obligations. In
particular, the proposal would clarify that:
• the same protections exist for promotional programs that waive interest charges for a specified
period of time as exist for promotional programs
that apply a reduced rate for a specified period;
• fees charged to consumers prior to the opening of
a credit card account are covered by the same limitations as fees charged during the first year after
the account is opened; together, these fees may not
exceed 25 percent of the account’s initial credit
limit; and
• a card issuer must consider a consumer’s individual
income, not household income, when evaluating the
consumer’s ability to make the required payments
for a new credit card or for a higher credit limit on
an existing account.

Small Business Credit Card Use
and Credit Card Market
In May, the Board released a Report to Congress on
the Use of Credit Cards by Small Businesses and the
Credit Card Market for Small Businesses.3 The report
was submitted to Congress in accordance with a provision of the Credit Card Act requiring the Board to
conduct a review of the use of credit cards by businesses with no more than 50 employees and of the
credit card market for these businesses. In performing
its review and preparing the report, the Board gathered data and other information from a number of
sources: major issuers of small business credit cards,
trade associations representing small business owners, and two consumer credit reporting agencies.
Board staff also worked with a small business trade
association to help develop some credit card-related
questions for inclusion in their survey of small business owners, added special questions to a quarterly
Board survey of banks’ senior loan officers, and
obtained from a vendor data regarding credit card
direct mail offers to small businesses. Board staff
reviewed the results of consumer testing conducted
from 2006 to 2008 pertaining to disclosures given in
connection with consumer credit card accounts, and
considered customer complaint information maintained within the Board’s own databases and provided by small business credit card issuers. Finally,
Board staff reviewed existing surveys, studies,
reports, and research related to small businesses’ use
of credit cards.
Among other things, the report discusses how small
businesses use credit cards and describes issuers’
practices in marketing and pricing small business
credit cards. The report also summarizes small businesses’ access to new credit cards during 2009 and
small business credit card terms and conditions. In
addition, the report reviews disclosures provided to
small business credit card customers and other issuer
practices. Finally, the report considers the potential
benefits and adverse effects of applying disclosure
and substantive requirements similar to those in the
Truth in Lending Act, as amended by the Credit
Card Act, to small business credit cards.
College Credit Card Agreements
In October, the Board released a report that contains
payment and account information about more than
1,000 agreements between credit card issuers and
3

2

See press release (October 19, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20101019a.htm.

See Other Reports to the Congress (May 2010), www
.federalreserve.gov/boarddocs/rptcongress/smallbusinesscredit/
smallbusinesscredit.pdf.

Consumer and Community Affairs

99

Box 1. Credit Where Credit Is Due: Supporting Small Business Access to Credit
Small businesses are often characterized as the lifeblood of America’s economy, providing vital jobs and
services, and the embodiment of the nation’s entrepreneurial spirit. In 2010, in the aftermath of the
financial crisis and lingering economic challenges,
credit for small businesses was tight. The matter of
access to credit for small businesses emerged as an
important issue for the System’s community affairs
agenda. In response, the Board led an initiative on
financing for small businesses. The initiative was
designed to gather information and perspectives to
help the Federal Reserve and other key stakeholders
craft responses to the immediate and intermediate
needs of creditworthy small businesses.
The first phase of the small business initiative was to
collect information about the financing challenges
facing small businesses given the economic climate
at the time. The Federal Reserve’s Community Affairs
Offices (CAOs) leveraged their role as convener and
catalyst to host a series of more than 40 meetings,
workshops, and conferences with key players in the
public sector, small business, and lending communities. The gatherings were used to collect and share
information on factors affecting the supply of and
demand for small business credit and capital. The
community affairs staff aggregated the information
and elicited key themes and findings from the
regional meetings so that potential solutions and
follow-up discussions could be addressed.
The information-gathering process culminated in
July 2010 when the Board hosted the Addressing the
Financing Needs of Small Businesses summit for a

institutions of higher education or affiliated organizations that provide for the issuance of credit cards
to students.4 The Credit Card Act requires issuers to
submit to the Board annually their agreements with
educational institutions or affiliated organizations,
such as alumni associations. The Board’s report covers 1,044 agreements that were in effect during 2009.
Among other things, the report lists the largest agreements by the dollar amount of payments made to the
institution or organization during 2009, by the total
number of accounts opened under the agreement
during 2009, and by the total number of accounts
opened under the agreement that remained open at
the end of 2009 (regardless of when the account was
opened).
4

See press release (October 25, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20101025b.htm.

national audience of key decision-makers, including
leaders from community development financial institutions, banks, small businesses and trade groups,
and government agencies as panelists and participants. The forum provided an opportunity to discuss
promising solutions and key policy recommendations
identified in the regional gatherings. Keynote remarks
were given by Federal Reserve Chairman Ben Bernanke, Governor Elizabeth Duke, and Administrator
of the U.S. Small Business Administration Karen
Mills. Additionally, a summary of key insights and
themes from these meetings was included as an
addendum to Chairman Bernanke’s monetary policy
testimony, provided on July 21, 2010 (see the Board’s
website at www.federalreserve.gov/newsevents/
testimony/bernanke20100721a.htm).
Throughout 2010, the small business initiative
assisted in identifying strategies for enhancing
access to financing for small businesses, and for
improving the quality and infrastructure of small business technical support. The initiative also underscored the need for greater coordination between
key stakeholder groups, including federal, state, and
local agencies, as well as representatives from the
public, nonprofit, and private sectors. Going forward,
the CAOs will continue to work with partners to foster
promising solutions for small businesses across the
country by coordinating a series of regional forums
with Reserve Banks for financial institutions and
Community Development Financial Institutions, and
identifying key lessons and promising practices to
ensure that small businesses get the credit they
need.

In addition, the Board launched a new online database,
www.federalreserve.gov/collegecreditcardagreements,
which provides additional information about the
agreements submitted to the Board. Users can access
the complete agreement text to see the information
submitted by card issuers regarding payments and
accounts. Users may also search for agreements by
card issuer, by educational institution or organization, or by the city or state in which the institution or
organization is located.

Overdraft Services and Gift Card Rules
Restrictions on Overdraft Fees
In May, the Board announced final clarifications to
aspects of its November 2009 final rule under Regulation E (Electronic Fund Transfers) and its December 2008 final rule under Regulation DD (Truth in

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97th Annual Report | 2010

Savings) pertaining to overdraft services.5 The final
clarifications address questions that have arisen
under both the Regulation E and DD final rules and
provide further guidance regarding compliance with
certain aspects of the final overdraft rules. In particular, the final clarifications explain that the prohibition in Regulation E on assessing overdraft fees without the consumer’s affirmative consent applies to all
institutions, including those with a policy and practice of declining automated teller machine (ATM)
and one-time debit card transactions when an
account has insufficient funds. The final clarifications
also make certain technical corrections and conforming amendments.
Restrictions on Fees and
Expiration Dates for Gift Cards
In March, the Board announced final rules to restrict
the fees and expiration dates that may apply to gift
cards.6 The rules protect consumers from certain
unexpected costs and require that gift card terms and
conditions be clearly stated. The final rules prohibit
dormancy, inactivity, and service fees on gift cards
unless (1) the consumer has not used the certificate
or card for at least one year, (2) no more than one
such fee is charged per month, and (3) the consumer
is given clear and conspicuous disclosures about the
fees. In addition, expiration dates for funds underlying gift cards must be at least five years after the date
of issuance, or five years after the date when funds
were last loaded. The new rules generally cover retail
gift cards, which can be used to buy goods or services
at a single merchant or affiliated group of merchants,
and network-branded gift cards, which are redeemable at any merchant that accepts the card brand.
The final rules, which had an effective date of
August 22, 2010, were issued under Regulation E to
implement the gift card provisions in the Credit
Card Act.
In August, the Board announced an interim final rule
implementing recent legislation modifying the effective date of certain disclosure requirements applicable to gift cards under the Credit Card Act.7 For
gift certificates, store gift cards, and general-use prepaid cards produced prior to April 1, 2010, the legislation and interim final rule delay the August 22,
2010 effective date of these disclosures until Janu5

6

7

See press release (May 28, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100528a.htm.
See press release (March 23, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100323a.htm.
See press release (August 11, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100811a.htm.

ary 31, 2011, provided that several conditions are
met. In October, after a public comment period, the
Board finalized the August interim final rule.8

Mortgage Reform
Throughout 2010, the Board proposed significant
new rules designed to enhance consumer protections
and disclosures for home mortgage transactions,
including reverse mortgages. The Board also proposed a rule to revise the coverage of escrow account
requirements for first-lien “jumbo” mortgages, in
order to implement provisions of the Dodd-Frank
Wall Street Reform and Consumer Protection Act of
2010 (the Dodd-Frank Act). In addition, the Board
adopted final rules to protect mortgage borrowers
from unfair, abusive, or deceptive lending practices
that can arise from loan originator compensation
practices, as well as rules to implement provisions of
the Mortgage Disclosure Improvement Act of 2008
(MDIA) and the Helping Families Save Their Homes
Act of 2009.
Consumer Protections and Disclosures for
Home Mortgage Transactions
In August, the Board proposed enhanced consumer
protections and disclosures for home mortgage transactions.9 The proposal includes significant changes to
Regulation Z and represents the second phase of the
Board’s comprehensive review and update of the
mortgage lending rules. The proposed changes reflect
the results of consumer testing by the Board.
Reverse Mortgages

Reverse mortgages are complex products available to
older consumers, some of whom may be more vulnerable to abusive practices. To help consumers
understand these products, the Federal Reserve’s proposal would require creditors to provide improved
disclosures that explain particular features unique to
reverse mortgages. In order to protect consumers
from unfair practices related to reverse mortgages,
the proposal also would:
• prohibit creditors from conditioning a reverse
mortgage on the consumer’s purchase of another
financial or insurance product, so that consumers
are not forced to buy financial products that can be
costly or may not be beneficial, such as annuities or
long-term care insurance;
8

9

See press release (October 19, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20101019b.htm.
See press release (August 16, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100816e.htm.

Consumer and Community Affairs

• require that a consumer receive counseling about
reverse mortgages before any nonrefundable fee
can be imposed (except a fee for the counseling
itself) or the loan can be closed, to help ensure that
consumers understand these complex products
before they become obligated on the loan; and
• prohibit creditors from steering consumers to specific reverse mortgage counselors or compensating
counselors or counseling agencies, to ensure that
the counseling is unbiased.

101

rate higher than the rate required by the lender (commonly referred to as a “yield spread premium”).
Under the new rule, however, a loan originator may
not receive compensation that is based on the interest
rate or other loan terms. This will prevent loan originators from providing consumers loans with higher
interest rates or other less-favorable terms to increase
their own compensation. Loan originators can continue to receive compensation that is based on a percentage of the loan amount, which is a common
practice.

Right of Rescission

A consumer generally has three business days after
the loan closing to rescind certain home-secured
loans, but this right may be extended for up to three
years if the creditor fails to provide the consumer
with certain disclosures or the notice of the right to
rescind. The proposed revisions would:
• simplify and improve the notice of the right to
rescind provided to consumers at closing;
• revise the list of disclosures that, if not properly
made, can trigger an extended right to rescind, to
focus on disclosures that testing shows are most
important to consumers; and
• clarify creditors’ obligations when the extended
right to rescind is asserted.
In addition, the Board’s proposal includes other
amendments related to home-secured credit. For
example, the proposed rules would ensure that consumers receive new disclosures when the parties agree
to modify the key terms of an existing mortgage loan
and clarify loan servicers’ duty to respond within a
reasonable amount of time when a consumer
requests information about the owner of the loan.
Protections against Mortgage
Loan Originator Practices
In August, the Board issued final rules to protect
mortgage borrowers from unfair or abusive practices
related to loan originator compensation.10 The new
rules apply to mortgage brokers and the companies
that employ them, as well as mortgage loan officers
employed by depository institutions and other
lenders.

The rule also prohibits a loan originator that receives
compensation directly from the consumer from also
receiving compensation from the lender or another
party. In consumer testing, the Board found that consumers generally are not aware of the payments lenders make to loan originators and how those payments
can affect the consumer’s total loan cost. The new
rule seeks to ensure that consumers who agree to pay
the originator directly do not also pay the originator
indirectly through the interest rate, thereby paying
more in total compensation than they realize.
Anti-Steering Protections

The final rule prohibits loan originators from directing, or “steering,” a consumer to accept a mortgage
loan that is not in the consumer’s best interest in
order to increase the originator’s compensation. To
facilitate compliance with the anti-steering rule, loan
originators would be deemed to comply by ensuring
that consumers can choose from loan options that
include the loan with the lowest interest rate and the
loan with the least amount of points and origination
fees, rather than the loans that maximize the originator’s compensation.
The final rules take effect on April 1, 2011.11
Disclosures for Mortgage Payment Changes
In August, the Board issued an interim final rule
revising the disclosure requirements for closed-end
mortgage loans under Regulation Z, in order to
implement provisions of the MDIA that require
lenders to disclose how borrowers’ regular mortgage
payments can change over time.12 The MDIA, which
amended TILA, seeks to ensure that mortgage borrowers are alerted to the risks of payment increases

Yield Spread Premiums

Previously, lenders commonly compensated loan
originators more if a borrower accepts an interest
10

See press release (August 16, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100816d.htm.

11

12

At the time the rules were issued, they were to take effect on
April 1, 2011. However, a delay imposed under a temporary
court order resulted in the rules becoming effective on April 6,
2011.
See press release (August 16, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100816b.htm.

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97th Annual Report | 2010

before they take out mortgage loans with variable
rates or payments. Accordingly, under the interim
rule, lenders’ cost disclosures must include a payment
summary in the form of a table, stating the following:
• the initial interest rate together with the corresponding monthly payment;
• for adjustable-rate or step-rate loans, the maximum
interest rate and payment that can occur during the
first five years and a “worst case” example showing
the maximum rate and payment possible over the
life of the loan; and
• the fact that consumers might not be able to avoid
increased payments by refinancing their loans.
The interim rule also requires lenders to disclose certain features, such as balloon payments or options to
make only minimum payments that will cause loan
amounts to increase. All of the disclosures required
in the interim rule were developed through several
rounds of qualitative consumer testing, including
one-on-one interviews with consumers around the
country.
Lenders must comply with the interim rule for applications they receive on or after January 30, 2011, as
specified in the MDIA.
In December, the Board approved an interim rule
amending Regulation Z to clarify certain aspects of
the August interim rule implementing provisions of
the MDIA, in response to public comments.13 Creditors have the option of complying with either the
Board’s August 2010 interim rule as originally published or as revised by the December interim rule
until October 1, 2011, at which time compliance with
the December interim rule will become mandatory.
Rules for Jumbo Mortgage Escrow Accounts
In August, the Board proposed a rule to revise the
escrow requirements for higher-priced first-lien
“jumbo” mortgages, in order to implement a provision of the Dodd-Frank Act.14 Jumbo mortgages are
loans that exceed the conforming loan-size limit for
purchase by Freddie Mac, as specified in the DoddFrank Act. The proposed rule would increase the
annual percentage rate (APR) threshold that determines whether a mortgage lender must establish an
escrow account for property taxes and insurance for
13

14

See press release (December 22, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20101222a.htm.
See press release (August 16, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100816a.htm.

first-lien jumbo mortgages. In July 2008, the Board
issued rules requiring creditors to establish escrow
accounts for first-lien loans if a loan’s APR is
1.5 percentage points above the applicable prime
offer rate. Under the proposed revisions, the escrow
requirements would apply for jumbo mortgages only
if the loan’s APR is 2.5 percentage points or more
above the applicable prime offer rate. The APR
threshold for non-jumbo mortgages remains
unchanged.
Notifying Consumers When
Mortgages Are Sold or Transferred
In August, the Board issued final rules amending
Regulation Z to implement a provision of the Helping Families Save Their Homes Act of 2009 requiring
that consumers receive notice when their mortgage
loan is sold or transferred.15 The new disclosure
requirement became effective when the statute was
enacted and aims to ensure that consumers know
who owns their mortgage loan. Consistent with the
statute, the final rule requires purchasers or assignees
that acquire loans to provide written disclosures notifying consumers of the sale or transfer of their mortgage loans within 30 days.
To provide compliance guidance, the Board had
issued interim rules in November 2009. Compliance
with the August 2010 final rules is mandatory on
January 1, 2011.
Real Estate Appraisals
In October, the Board issued an interim final rule to
ensure that real estate appraisers are free to use their
independent professional judgment in assigning
home values without influence or pressure from those
with interests in the transactions.16 The rule also
seeks to ensure that appraisers receive customary and
reasonable payments for their services. The interim
final rule includes several provisions that protect the
integrity of the appraisal process when a consumer’s
home is securing the loan. The interim final rule
• prohibits coercion and other similar actions
designed to cause appraisers to base the appraised
value of properties on factors other than their independent judgment;
• prohibits appraisers and appraisal management
companies hired by lenders from having financial
15

16

See press release (August 16, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100816a.htm.
See press release (October 19, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20101018a.htm.

Consumer and Community Affairs

or other interests in the properties or the credit
transactions;
• prohibits creditors from extending credit based on
appraisals if they know beforehand of violations
involving appraiser coercion or conflicts of interest, unless the creditors determine that the values of
the properties are not materially misstated;
• requires that creditors or settlement service providers that have information about appraiser misconduct file reports with the appropriate state licensing
authorities; and
• requires the payment of reasonable and customary
compensation to appraisers who are not employees
of the creditors or of the appraisal management
companies hired by the creditors.
The interim final rule is required by the Dodd-Frank
Act, and compliance is mandatory as of April 1,
2011.
Public Hearings on Regulation C
Between July and September 2010, the Board held a
series of four public hearings on Regulation C, which
implements the Home Mortgage Disclosure Act
(HMDA), at the Federal Reserve Banks of Atlanta,
San Francisco, and Chicago, and at the Board in
Washington, D.C.17 The purpose of these hearings
was threefold: (1) to evaluate whether revisions to
Regulation C in 2002 helped gather useful and accurate information on the mortgage market, (2) to
assess the need for additional data and other
improvements, and (3) to identify areas for future
research on emerging mortgage market issues.

Oversight and Enforcement
The Board’s Division of Consumer and Community
Affairs develops and supports supervisory policy and
examination procedures for consumer protection
laws and regulations, as well as the Community Reinvestment Act (CRA), as part of its supervision of
state-chartered, depository institutions, and foreign
banking organizations that are members of the Federal Reserve System. The division also administers
the Federal Reserve System’s risk-focused program
for assessing consumer compliance risk in the largest
bank and financial holding companies in the System.
Division staff ensure consumer compliance risk is
effectively integrated into the consolidated supervi17

See press release (April 23, 2010), www.federalreserve.gov/
newsevents/press/bcreg/20100423a.htm.

103

sion of the holding company. The division also oversees the efforts of the 12 Reserve Banks to ensure
that consumer protection laws and regulations are
fully and fairly enforced. Division staff provide guidance and expertise to the Reserve Banks on consumer
protection regulations, bank and bank holding company application analysis and processing, examination and enforcement techniques and policy matters,
examiner training, and emerging issues. Staff also
review Reserve Bank supervisory reports, examination work products, and consumer complaint analyses and responses. Finally, staff members participate
in interagency activities that promote uniformity in
examination principles, standards, and processes.
In addition, throughout 2010, the System established
and implemented a policy for conducting riskfocused consumer compliance supervision of, and the
investigation of consumer complaints against, nonbank subsidiaries of bank holding companies
(BHCs) and foreign banking organizations
(FBOs) with activities covered by the consumer protection laws and regulations the Federal Reserve has
the authority to enforce. This policy is designed to
enhance understanding of the consumer compliance
risk profile of nonbank subsidiaries and to guide
supervisory activities for these entities. Initial supervisory activities first targeted those nonbank subsidiaries considered to be of highest risk to the Federal
Reserve System.18
Examinations are the Federal Reserve’s primary
method of enforcing compliance with consumer protection laws and assessing the adequacy of consumer
compliance risk-management systems within regulated entities. During the 2010 reporting period, the
Reserve Banks conducted 300 consumer compliance
examinations of the System’s 858 state member
banks and three examinations of foreign banking
organizations.19

18

19

Federal Reserve Board of Governors, 2009 Consumer Affairs
Letters, Consumer Compliance Supervision Policy for Nonbank
Subsidiaries of Bank Holding Companies and Foreign Banking
Organizations, CA-09-8, September 14, 2009, www
.federalreserve.gov/boarddocs/caletters/2009/0908/caltr0908.htm.
The foreign banking organizations examined by the Federal
Reserve are organizations that operate 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 covered by consumer protection laws.
There are 197 such institutions throughout the Federal Reserve
System.

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97th Annual Report | 2010

Community Reinvestment Act Compliance
The CRA requires that the Federal Reserve and other
federal banking and thrift agencies encourage financial institutions to help meet the credit needs of the
local communities in which they do business, including low and moderate income areas, consistent with
safe and sound operations.
To carry out this mandate, the Federal Reserve
• examines state member banks to assess their compliance with the CRA,
• analyzes applications for mergers and acquisitions
by state member banks and bank holding companies in relation to CRA performance, and
• disseminates information on community development techniques to bankers and the public through
Community Development offices within the
Reserve Banks.
The Federal Reserve assesses and rates the CRA performance of state member banks in the course of
examinations conducted by staff at the Reserve
Banks. During the reporting period, the Reserve
Banks conducted CRA examinations of 267 banks.
Of those banks, 24 were rated “Outstanding,” 237
were rated “Satisfactory,” five were rated “Needs to
Improve,” and one was rated “Substantial
Non-Compliance.”
In September 2010, the Federal Reserve and other
federal banking and thrift regulatory agencies
announced a final rule to implement a provision of
the Higher Education Opportunity Act (HEOA),
which requires the agencies to consider low-cost
higher education loans to low-income borrowers as a
positive factor when assessing a financial institution’s
record of meeting community credit needs under the
CRA. In addition, the rule also incorporated a CRA
statutory provision that allows the agencies to consider a financial institution’s capital investment, loan
participation, and other ventures with minorityowned financial institutions, women-owned institutions, and low-income credit unions as factors in
assessing the institution’s CRA record.
In December 2010, the Federal Reserve and the other
federal banking and thrift regulatory agencies revised
the CRA regulations to support community stabilization activities in neighborhoods affected by high
numbers of foreclosures. The final rule encourages
depository institutions to support, enable, or facilitate projects or activities that meet the “eligible uses”

criteria described in section 2301(c) of the Housing
and Economic Recovery Act of 2008 (HERA), as
amended, and that are conducted in designated target areas identified in plans approved by the U.S.
Department of Housing and Urban Development
(HUD) under the Neighborhood Stabilization Program (NSP).
In addition to this revision to the CRA regulations,
the Federal Reserve and the other federal banking
and thrift regulatory agencies held public hearings in
four cities (Arlington, VA; Atlanta, GA; Chicago, IL;
and Los Angeles, CA) and invited the public to comment on ways that the CRA regulations should be
revised to better reflect current banking practices.
The agencies are considering ways to update the
regulations to reflect changes in the financial services
industry, including how banking services are delivered to consumers, to ensure that CRA continues to
encourage institutions to meet community credit
needs effectively. In addition to public hearings, the
agencies invited written comments through
August 31, 2010. The Federal Reserve received nearly
1,200 comment letters.
Mergers and Acquisitions
in Relation to the CRA
During 2010, the Board considered and approved six
banking merger applications.
• An application by First Niagara Financial Group,
Inc., Buffalo, NY, to acquire Harleysville National
Corp., Harleysville, PA, was approved in March.
• An application by Premier Commerce Bancorp,
Inc., Palos Hills, IL, to acquire G.R. Bancorp, Ltd.,
Grand Ridge, IL, was approved in July.
• An application by The Toronto-Dominion Bank,
Toronto, Canada, to acquire The South Financial
Group, Inc. Greenville, SC, was approved in July.
• An application by Metcalf Bank, Lees Summit,
MO, to purchase certain assets and assume certain
liabilities of The First National Bank of Olathe,
Olathe, KS, was approved in September.
• An application by SKBHC Holdings, LLC,
Corona Del Mar, CA, to acquire Starbuck Bancshares, Inc., Starbuck, MN, was approved in
October.
• An application by Caja de Ahorros de Valencia,
Catellon Y Alicante, Valencia, Spain to become a
bank holding company by acquiring control of
CM Florida Holdings, Inc., Coral Gables, FL, and
City National Bancshares, Inc. and its subsidiary,

Consumer and Community Affairs

City National Bank of Florida, both of Miami,
FL, was approved in December.
(Four other protested applications were withdrawn
by the applicants.)
Members of the public had the opportunity to submit comments on the applications; their comments
raised various issues. Several comments referenced a
failure to make credit available to certain minority
groups and to low- and moderate-income individuals
and in low- and moderate-income geographies,
including insufficient branch presence in low-income
geographies. Other comments cited predatory and
discriminatory lending practices with respect to residential mortgages, credit card loans, and small business loans. Another comment alleged enabling predatory servicing and loss mitigation practices, as well as
unethical business practices, as evidenced by a recent
U.S. Securities and Exchange Commission civil lawsuit. Several comments warned of inadequate plans
to meet communities’ credit needs and a reduction in
access to credit for affected communities.
The Board also considered 75 applications with outstanding issues involving compliance with consumer
protection statutes and regulations, including fair
lending laws and the CRA. Some of those issues
involved unfair and deceptive practices, as well as
concerns about stored value cards. Sixty of those
applications were approved and 15 were withdrawn.

Fair Lending Enforcement
The Federal Reserve is committed to ensuring that
the institutions it supervises comply fully with the
federal fair lending laws—the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act. Fair
lending reviews are conducted regularly within the
supervisory cycle. Additionally, examiners may conduct fair lending reviews outside of the usual supervisory cycle, if warranted by fair lending risk. When
examiners find evidence of potential discrimination,
they work closely with the division’s Fair Lending
Enforcement Section, which brings additional legal
and statistical expertise to the examination and
ensures that fair lending laws are enforced consistently and rigorously throughout the Federal Reserve
System.
The Federal Reserve enforces the ECOA and the provisions of the Fair Housing Act that apply to lending
institutions. The ECOA prohibits creditors from dis-

105

criminating against any applicant, in any aspect of a
credit transaction, on the basis of race, color, religion, national origin, sex or 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 purchasing of mortgage
loans, on the basis of race, color, religion, sex, handicap, familial status, or national origin.
Pursuant to the ECOA, if the Board has reason to
believe that a creditor has engaged in a pattern or
practice of discrimination in violation of the ECOA,
the matter will be referred to the U.S. Department of
Justice (DOJ). The DOJ reviews the referral and
determines whether further investigation is warranted. A DOJ investigation may result in a public
civil enforcement action or settlement. The DOJ may
decide instead to return the matter to the Federal
Reserve for administrative enforcement. When a matter is returned to the Federal Reserve, staff ensures
that the institution takes all appropriate corrective
action.
During 2010, the Board referred eight matters to
the DOJ.
• Three referrals involved redlining, or discrimination against potential borrowers based upon the
racial composition of their neighborhoods, in violation of the ECOA and the Fair Housing Act.
Based on an analysis of each bank’s lending practices, its marketing, the location of its branches,
and its delineated assessment area under the CRA,
the Board determined that the banks avoided lending in minority neighborhoods.
• One referral involved discrimination in mortgage
pricing, in violation of the ECOA and the Fair
Housing Act. The lender charged AfricanAmerican borrowers higher APRs than nonHispanic white borrowers for mortgage loans originated through its wholesale channel and guaranteed by the Federal Housing Administration or the
Department of Veterans Affairs. Legitimate pricing
factors failed to explain the pricing disparities.
• One referral involved discrimination in the pricing
of unsecured and automobile loans on the basis of
national origin, in violation of the ECOA. The
lender charged Hispanic borrowers higher interest
rates than non-Hispanic borrowers for unsecured

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97th Annual Report | 2010

and automobile loans, and the disparities could not
be explained by legitimate pricing factors.
• Three referrals involved discrimination on the basis
of marital status, in violation of the ECOA. The
banks improperly required spousal guarantees and
signatures on commercial or agricultural loans, in
violation of Regulation B.
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 violation is remedied by the bank. Most lenders readily
agree to correct fair lending violations. In fact, lenders often take corrective steps as 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.
Monitoring Emerging Fair Lending Issues
The Federal Reserve continues to carefully monitor
credit markets for emerging fair lending risks. Developments in the financial industry surrounding loan
modification and credit-tightening practices continue
to raise potential fair lending concerns. Mortgage servicers face challenges managing the fair lending risk
of their activities in the midst of increasing modification activity. Additionally, some lenders have adopted
policies that could potentially pose a disproportionate impact on minorities, such as branch closings and
tighter credit standards in specific geographic markets. In response to these trends, the Federal Reserve
continues to carefully monitor lenders’ practices for
potential fair lending violations. In accordance with
the Interagency Fair Lending Examination Procedures, the Federal Reserve conducts examinations to
evaluate whether lenders’ policies may violate fair
lending laws by having an illegal disparate impact on
minorities, and to identify steering, redlining, reverse
redlining, and other fair lending violations. These
risk-focused examinations include loan modification
reviews when appropriate. Loan modification fair
lending reviews include an analysis of servicer data
for any evidence of potential disparate treatment or
impact.
Financial Fraud Enforcement Task Force
As an active member of the Financial Fraud
Enforcement Task Force (FFETF), the Federal
Reserve coordinates with other federal agencies to

ensure consistent and collaborative enforcement of
the fair lending laws. The director of the Federal
Reserve’s Division of Consumer and Community
Affairs co-chairs the FFETF’s Nondiscrimination
Working Group with the assistant attorney general
for DOJ’s Civil Rights Division, deputy general
counsel of HUD, and the attorney general for the
State of Illinois. One of the Working Group’s key initiatives, led by HUD, DOJ, and the Federal Reserve,
is to ensure that discrimination does not occur when
borrowers receive loans backed by the Federal Housing Administration (FHA). In addition, the Federal
Reserve is taking a leading role in the Working
Group’s effort to analyze data on Treasury’s Home
Affordable Modification Program for any evidence of
potential discrimination by participating servicers.

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 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, as well
as any personal property securing the loan, are covered by flood insurance for the term of the loan. The
law requires the Board and other federal financial
institution regulatory agencies to impose civil money
penalties when they find a pattern or practice of violations of the regulation. The civil money penalties
are payable to the Federal Emergency Management
Agency (FEMA) for deposit into the National Flood
Mitigation Fund.
During 2010, the Board imposed civil money penalties (CMPs) against three state member banks. The
dollar amount of the penalties, which were assessed
via consent orders, totaled $33,010.

Coordination with Other
Federal Banking Agencies
The member agencies of the Federal Financial Institutions Examination Council (FFIEC) develop uniform examination principles, standards, procedures,
and report formats. In 2010, the FFIEC member
organizations issued the examination procedures and
guidance regarding a number of regulations.
• Interagency Examination Procedures for the Regulation on Risk-Based Pricing Notices (Regulation V).

Consumer and Community Affairs

The revised examination procedures address
changes to the Fair Credit Reporting Act (FCRA),
as amended by the Fair and Accurate Credit Transactions Act of 2003. The regulation requires a
creditor to provide a consumer with a notice when,
based on the consumer’s credit report, the creditor
provides credit to the consumer on materially less
favorable terms than it provides to other consumers. The regulation provides creditors with several
methods for determining which consumers must
receive risk-based pricing notices. As an alternative
to providing risk-based pricing notices, the regulation permits creditors to provide consumers who
apply for credit with a free credit score and information about their score.20
• Interagency Examination Procedures for Regulation E–Electronic Fund Transfers (revised). The
revised examination procedures incorporate the
Board’s revisions to the gift card provisions of
Regulation E. For cards produced prior to April 1,
2010, the revisions modify the effective date of certain disclosure and card expiration requirements in
the gift card provisions of the Credit Card Act.21
• Reverse Mortgage Products: Guidance for Managing Compliance and Reputation Risks. The interagency guidance addresses the compliance and
reputation risks associated with reverse mortgages
and focuses on ways in which lenders can mitigate
several areas of regulatory concern, including misleading communication with consumers through
marketing and advertisements, and potential conflicts of interest and abusive practices in connection with reverse mortgage transactions.22
• Interagency Examination Procedures for Regulation Z–Truth in Lending (revised). The revised
examination procedures incorporate the 2009
amendments to Regulation Z, as a result of the
Credit Card Act. The Credit Card Act amended
TILA and established a number of new requirements for open-end consumer credit plans. The
Credit Card Act provisions were effective in three
stages, and these procedures reflect the third and
final stage of revisions, which incorporate rules to
protect credit card users from unreasonable late
20

21

22

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1014/caltr1014.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1012/caltr1012.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1011/caltr1011.htm.

107

payment fees and other penalty fees. They also
require credit card issuers to evaluate interest rate
increases imposed since January 1, 2009.23 (These
procedures were superseded by revised Regulation Z examination procedures issued on January 28, 2011, and ultimately by revised procedures
issued on March 18, 2011.)
• Interagency Examination Procedures for Regulation DD–Truth in Savings (revised).The revised
examination procedures incorporate the 2010 technical clarifications to Regulation DD. These clarifications require use of the term Total Overdraft Fees
when disclosing such fees on periodic statements
and provide guidance for disclosing consumer
account balance information through automated
systems for retail sweep accounts.24
• Interagency Supervisory Guidance for Institutions
Affected by the Deepwater Horizon Oil Spill. This
guidance reminds financial institutions that they
retain the flexibility to work with borrowers that
may need additional time to resolve financial
uncertainties related to the effects of the oil spill.25
• Interagency Examination Procedures for Regulation E–Electronic Fund Transfers (revised). The
revised examination procedures incorporated the
Board’s recent amendments to Regulation E
regarding overdraft fees and gift cards, which went
into effect on July 1, 2010, and August 22, 2010,
respectively. Section 205.17 of amended Regulation E prohibits financial institutions from charging fees for overdrafts on ATM and one-time debit
card transactions, unless a consumer opts in to the
overdraft service for those types of transactions.
Section 205.20 of amended Regulation E restricts
the fees and expiration dates that may apply to gift
cards. The rules protect consumers from certain
unexpected costs and require that gift card terms
and conditions be clearly stated. The rules generally cover retail gift cards, which can be used to buy
goods or services at a single merchant or affiliated
group of merchants, and network-branded gift
cards, which are redeemable at any merchant that

23

24

25

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2011/1103/caltr1103.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1009/caltr1009.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/srletters/2010/SR1013.htm.

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97th Annual Report | 2010

accepts the card brand.26 (These procedures were
superseded by revised Regulation E examination
procedures issued, on October 22, 2010.)
• Interagency Examination Procedures for Regulation Z–Truth in Lending (revised). The revised
examination procedures incorporated amendments
to Regulation Z that became effective, on July 1,
2010, which revised the requirements for credit
card disclosures provided with applications and
solicitations, at account opening, and on periodic
statements. The new disclosure requirements were
also imposed for convenience checks and advertisements.27 (These procedures were initially superseded by revised Regulation Z examination procedures issued on August 20, 2010, which were then
replaced by revised examination procedures issued
on January 28, 2011, and ultimately by revised procedures issued on March 18, 2011.)
• Interagency Examination Procedures Regarding the
Duties of Furnishers of Information. These examination procedures incorporate the 2010 changes to
Regulation V, which implements the Fair Credit
Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003. The changes
require furnishers of consumer information to
(1) implement written policies and procedures
regarding the accuracy and integrity of consumer
information that it furnishes to a consumer reporting agency, (2) consider the interagency guidelines
concerning information accuracy and integrity
when developing written policies and procedures,
and (3) conduct a reasonable investigation of disputes submitted by consumers concerning the
accuracy of any information contained in a consumer report that pertains to an account or other
relationship that the furnisher has or had with the
consumer.28
• Revised Interagency Questions and Answers on
Community Reinvestment. The interagency questions and answers interpret the CRA regulations
and provide guidance to financial institutions and
the public. The revised questions and answers provide examples of ways an institution could determine that its community services are targeted to
26

27

28

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1012/caltr1012.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2011/1103/caltr1103.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1005/caltr1005.htm.

low- and moderate-income individuals. In addition,
the agencies revised the question and answer on
reporting requirements for community development loans and made a conforming change to the
question and answer that provides examples of
“other loan data.”29
• Interagency Examination Procedures for Regulation Z–Truth in Lending (revised). The revised
examination procedures incorporate the 2009
amendments to Regulation Z, as a result of the
Credit Card Act. The Credit Card Act amended
TILA and established a number of new requirements for open-end consumer credit plans. The
Credit Card Act provisions were effective in three
stages, and these procedures reflect the second
stage of revisions, which protect consumers from
unexpected increases in credit card interest rates on
existing balances, require card issuers to consider a
consumer’s ability to make the required payments,
establish special requirements for extensions of
credit to consumers who are under the age of 21,
and limit the assessment of fees for exceeding the
credit limit on a credit card account. The examination procedures also implemented provisions of
HEOA that became effective on February 14, 2010.
Under the HEOA amendments, creditors that
extend private education loans must provide disclosures about loan terms on or with the loan application, when the loan is approved, and when the loan
is consummated.30 (These procedures were initially
superseded by revised Regulation Z examination
procedures issued on June 25, 2010, then January 28, 2011, and ultimately replaced by revised
examination procedures issued on March 18,
2011.)

Training for Bank Examiners
Ensuring that financial institutions comply with laws
that protect consumers and encourage community
reinvestment is an important part of the bank examination and supervision process. As the number and
complexity of consumer financial transactions grow,
training for examiners of the organizations under the
Federal Reserve’s supervisory responsibility becomes
even more important. The staff development function is responsible for the ongoing development of
the professional consumer compliance supervisory
29

30

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2010/1002/caltr1002.htm.
Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2011/1103/caltr1103.htm.

Consumer and Community Affairs

staff, and ensuring that these staff members have the
skills necessary to meet their supervisory responsibilities now and in the future.
Consumer Compliance
Examiner Training Curriculum
The consumer compliance examiner training curriculum consists of six courses focused on various consumer protection laws, regulations, and examining
concepts. In 2010, these courses were offered in 10
sessions, and training was delivered to a total of 165
System consumer compliance examiners and staff
members, and 12 state banking agency examiners.
When appropriate, courses are delivered via alternative methods, such as the Internet or other distancelearning technologies. For instance, several courses
use 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.
Board and Reserve Bank staff regularly review the
core curriculum for examiner training, updating subject matter and adding new elements as appropriate.
During 2010, staff initiated one curriculum review.
The Fair Lending Examination Techniques (FLET)
course was reviewed in order to incorporate technical
changes in policy and laws, along with changes in
instructional delivery techniques. This course is
designed to equip assistant level examiners with the
skills and knowledge to plan and conduct a riskfocused fair lending examination, and incorporates
the FFIEC fair lending examination procedures. The
risk-focused examination approach and the procedures require considerable examiner judgment in the
planning stages of an examination.
In addition, a real estate workshop was held to train
consumer compliance examiners. The workshop provided an overview of new and revised mortgage regulations, including in-class exercises for participants to
apply their knowledge. Subsequent to the workshop,
staff produced and distributed compact discs of the
workshop to the 12 Reserve Banks for use in “trainthe-trainer” sessions.
Life-long Learning
In addition to providing core examiner training, the
Staff Development function emphasizes the importance of continuing life-long learning. Opportunities
for continuing learning include special projects and
assignments, self-study programs, rotational assignments, the opportunity to instruct at System schools,

109

mentoring programs, and an annual consumer compliance examiner forum, where senior consumer compliance examiners receive information on emerging
compliance issues, and are able to share best practices from across the System.
In 2010, the System continued to offer “Rapid
Response” sessions, which are a powerful delivery
method for just-in-time training. Debuted in 2008,
Rapid Response sessions offer examiners one-hour
teleconference presentations on emerging issues or
urgent training needs that result from the implementation of new laws, regulations, or supervisory guidance. A total of six consumer compliance Rapid
Response sessions were designed, developed, and presented to System staff during 2010.

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 12 Federal Reserve Banks, the FFIEC member agencies, and other federal enforcement agencies.31
Regulation B (Equal Credit Opportunity)
The FFIEC agencies reported that approximately
82 percent of the institutions examined during the
2010 reporting period were in compliance with Regulation B, compared with 81 percent for the 2009
reporting period. The most frequently cited violations involved
• failure to provide a timely and/or accurate notice of
approval, counteroffer, or adverse action within 30
days after receiving a completed credit application;
• improperly requiring a borrower to obtain the signature of a spouse or other person in order to be
considered for credit approval; and
• failure to collect information about applicants
seeking credit primarily for the purchase or refinancing of a principal residence, including applicant race, ethnicity, sex, marital status, and age, for
government monitoring purposes.
The Board and the Office of the Comptroller of the
Currency (OCC) each initiated one formal Regula31

Because the agencies use different methods to compile the data,
the information presented here supports only general conclusions. The 2010 reporting period was July 1, 2009, through
June 30, 2010.

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97th Annual Report | 2010

tion B-related public enforcement action during the
reporting period, while the Office of Thrift Supervision (OTS) initiated five and the Federal Deposit
Insurance Corporation (FDIC) initiated 15.32 There
were no other enforcement actions by FFIEC
agencies.
The other agencies that enforce the ECOA—the Federal Trade Commission (FTC), the Farm Credit
Administration (FCA), the Department of Transportation (DOT), 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 the entities
they supervise. The FCA’s examination activities
revealed that most Regulation B violations involved
either (1) creditors’ failure to request or provide
information for government monitoring purposes or
(2) creditors providing inadequate and/or untimely
statements of specific reasons for adverse actions.
None of these agencies initiated formal enforcement
actions relating to Regulation B during the reporting
period.
Regulation E (Electronic Fund Transfers)
The FFIEC agencies reported that approximately
93 percent of the institutions examined during the
2010 reporting period were in compliance with Regulation E, compared with 94 percent for the 2009
reporting period. The most frequently cited violations involved failure to
• provide a written explanation to the consumer
when an investigation determines that no account
error or a different error has occurred;
• provisionally credit the consumer’s account for the
amount of an alleged error when an investigation
into the alleged error cannot be completed within
10 business days; and
• 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 with an
institution for an electronic fund transfer service.
The FDIC initiated 12 formal Regulation E-related
enforcement actions during the reporting period.
32

Consumer compliance public enforcement actions are categorized by regulation throughout the report. Because some
enforcement actions include violations of more than one regulation, the overall sum of actions derived from each regulation
will be greater than the actual total number of enforcement
actions initiated, which was 54.

There were no other enforcement actions by FFIEC
agencies or the SEC. The FTC filed one action
against a company for violating a 2008 court order
related to, among other things, a Regulation E
violation.
Regulation M (Consumer Leasing)
The FFIEC agencies reported that 100 percent of the
institutions examined during the 2010 reporting
period were in compliance with Regulation M, which
is the same compliance rate as the 2009 reporting
period. The FFIEC agencies did not issue any public
enforcement actions specific to Regulation M during
the period.
Regulation P (Privacy of Consumer
Financial Information)
The FFIEC agencies reported that approximately
98 percent of the institutions examined during the
2010 reporting period were in compliance with Regulation P, which is the same rate of compliance as the
2009 reporting period. The most frequently cited violations involved failure to
• provide clear and conspicuous initial privacy
notices to customers,
• provide customers with a clear and conspicuous
annual notice reflecting the institution’s privacy
policies and practices, and
• disclose the institution’s information sharing practices in initial, annual, and revised privacy notices.
The OCC initiated two formal Regulation P-related
enforcement actions during the reporting period,
while the FDIC initiated six.33 There were no other
enforcement actions by FFIEC agencies.
Regulation Z (Truth in Lending)
The FFIEC agencies reported that approximately
82 percent of the institutions examined during the
2010 reporting period were in compliance with Regulation Z, compared with 92 percent for the 2009
reporting period. The most frequently cited violations involved
• failure to accurately disclose the finance charges in
closed-end credit transactions;
• for certain residential mortgage transactions, failure to provide a good faith estimate of the required
disclosures before consummation, or not later than
33

The FDIC’s reported information in this area relates to part
332—Privacy of Consumer Financial Information—of the
agency’s regulations and not Regulation P.

Consumer and Community Affairs

three business days after receipt of a written loan
application; and
• failure to provide complete and accurate disclosures for open-end credit secured by a consumer’s
dwelling (home equity plans).
In addition, 170 banks supervised by the Federal
Reserve, FDIC, OCC, and OTS were required, under
the Interagency Enforcement Policy in Regulation Z,
to reimburse a total of approximately $2.12 million
to consumers for understating APRs and/or finance
charges in their consumer loan disclosures.
The Board initiated one formal Regulation Z-related
enforcement action during the reporting period, the
OTS initiated one, the OCC initiated four, and the
FDIC initiated 18. The DOT continued to prosecute
one air carrier for its alleged improper handling of
credit card refund requests and other Federal Aviation Act violations.
Regulation AA (Unfair or Deceptive
Acts or Practices)
The FFIEC agencies reported that approximately
99 percent of the institutions examined during the
2010 reporting period were in compliance with Regulation AA, which is the same rate of compliance as
for the 2009 reporting period. The OTS initiated
three formal Regulation AA-related enforcement
actions, the OCC initiated three, and the FDIC initiated seven during the reporting period. There were
no other enforcement actions by FFIEC agencies.
Regulation CC (Availability of Funds
and Collection of Checks)
The FFIEC agencies reported that approximately
90 percent of institutions examined during the 2010
reporting period were in compliance with Regulation CC, which is the same rate of compliance as for
the 2009 reporting period. The most frequently cited
violations involved failure to

111

• make available on the next business day the lesser
of $100 or the aggregate amount of checks deposited that are not subject to the next-day availability
requirement,
• make funds deposited from local and certain other
checks available for withdrawal within the times
prescribed by the regulation, and
• provide required information to the consumer
when placing an exception hold on an account.
The OCC initiated two formal Regulation CC-related
enforcement actions during the reporting period,
while the FDIC initiated seven. There were no other
enforcement actions by FFIEC agencies.
Regulation DD (Truth in Savings)
The FFIEC agencies reported that approximately
86 percent of institutions examined during the 2010
reporting period were in compliance with Regulation DD, compared with 87 percent for the 2009
reporting period. The most frequently cited violations involved
• failure to provide required initial account
disclosures;
• inappropriate use of the phrase “annual percentage
yield” in an advertisement without providing
required additional terms and conditions; and
• failure to provide account disclosures clearly and
conspicuously, in writing, and in a form that the
consumer may keep.
The FDIC initiated 17 formal Regulation DD-related
enforcement actions during the reporting period.
There were no other enforcement actions by FFIEC
agencies.

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97th Annual Report | 2010

Responding to Consumer Complaints
and Inquiries

Table 1. Complaints against state member banks and
selected nonbank subsidiaries of bank holding companies
about regulated practices, by Regulation/Act, 2010

The Federal Reserve investigates complaints against
state member banks and selected nonbank subsidiaries of bank holding companies (Federal Reserve
Regulated Entities), and forwards complaints against
other creditors and businesses to the appropriate
enforcement agency.34 Each Reserve Bank investigates complaints against state member banks and
selected nonbank subsidiaries in its District. The
Federal Reserve also responds to consumer inquiries
on a broad range of banking topics, including consumer protection questions.

Regulation/Act
Regulation AA (Unfair or Deceptive Acts or Practices)
Regulation B (Equal Credit Opportunity)
Regulation BB (Community Reinvestment)
Regulation C (Home Mortgage Disclosure)
Regulation CC (Expedited Funds Availability)
Regulation D (Reserve Requirements)
Regulation DD (Truth in Savings)
Regulation E (Electronic Funds Transfers)
Regulation G (Disclosure / Reporting of CRA-Related
Agreements)
Regulation H (National Flood Insurance Act / Insurance Sales)
Regulation M (Consumer Lending)
Regulation P (Privacy of Consumer Financial Information)
Regulation Q (Payment of Interest)
Regulation V (Fair and Accurate Credit Transactions)
Regulation Z (Truth in Lending)
Fair Credit Reporting Act
Fair Debt Collection Practices Act
Fair Housing Act
Home Ownership Counseling
HOPA (Homeowners Protection Act)
Real Estate Settlement Procedures Act
Right to Financial Privacy Act
Total

In late 2007, the Federal Reserve established Federal
Reserve Consumer Help (FRCH) to centralize the
processing of consumer complaints and inquiries. In
2010, FRCH processed 49,525 cases. Of these cases,
more than half (26,324) were inquiries and the
remainder (23,201) were complaints, with most cases
received directly from consumers. Approximately
3 percent of cases were referred to the Federal
Reserve from other agencies.
While consumers can contact FRCH by telephone,
fax, mail, e-mail, or online, most FRCH consumer
contacts occurred by telephone (51 percent). Nevertheless, 44 percent (21,563) of complaint and inquiry
submissions were made electronically (including
e-mail, online submissions, and fax) and the online
form page received over 406,000 visits during the
year.

Consumer Complaints
Complaints against Federal Reserve Regulated Entities totaled 7,461 in 2010. Approximately 33 percent
(2,468) of these complaints were closed without
investigation pending the receipt of additional information from consumers. Nearly 2 percent (140) of
the total complaints are still under investigation. Of
the remaining complaints, 69 percent (3,343) involved
unregulated practices and 31 percent (1,510) involved
regulated practices.
Complaints about Regulated Practices
The majority of regulated practice complaints concerned checking accounts (32 percent), real estate
(27 percent), and credit cards (11 percent). The most
common checking account complaints related to
34

Effective September 14, 2009, CA Letter 09-08, www
.federalreserve.gov/boarddocs/caletters/2009/0908/caltr0908.htm.

Number
39
82
3
1
103
5
370
203
0
30
7
26
7
3
403
69
62
22
0
4
67
4
1,510

insufficient funds or overdraft charges and procedures (52 percent), disputed withdrawal of funds
(10 percent), funds availability not as expected (7 percent), and disputed crediting of funds (5 percent).
The most common real estate complaints by problem
code related to: credit denied—other (13 percent),
payment errors and delays (10 percent), credit—
rates, terms, and fees (10 percent), and escrow
account problems (9 percent). Complaints by product code related to: home-purchase loans (60 percent), home refinance and closed-end loans (25 percent), and home equity credit lines (10 percent).35
The most common credit card complaints related to
interest rates, terms, and fees (17 percent), payment
errors and delays (11 percent), billing error resolutions (11 percent), and bank debt collection tactics
(10 percent).
Forty-six regulated complaints alleging discrimination were received. Of these, 22 complaints (less than
2 percent of total regulated complaints) alleged discrimination on the basis of prohibited borrower
35

Real estate loans include adjustable-rate mortgages; residential
construction loans; open-end home equity lines of credit; home
improvement loans; home purchase loans; home refinance/
closed-end loans; and reverse mortgages.

Consumer and Community Affairs

113

Table 2. Complaints against state member banks and selected nonbank subsidiaries of bank holding companies about
regulated practices, by product type, 2010
Subject of complaint/product type

All complaints
Number

Total
Discrimination alleged
Real estate loans
Credit Cards
Other loans
Nondiscrimination complaints
Checking accounts
Real estate loans
Credit cards

traits or rights.36 Twenty-eight percent of discrimination complaints were related to the race, color,
national origin, or ethnicity of the applicant or borrower. Thirteen percent of discrimination complaints
were related to either the age or handicap of the
applicant or borrower. There were two violations
where discrimination was alleged; one involved a real
estate loan and the other involved a motor vehicle
loan.
In 87 percent of investigated complaints against Federal Reserve Regulated Entities, evidence revealed
that institutions correctly handled the situation. Of
the remaining 13 percent of investigated complaints,
34 percent were deemed violations of law, 21 percent
were identified errors which were corrected by the
bank, 8 percent were referred to other agencies, and
the remainder were matters involving litigation or
factual disputes, withdrawn complaints, internally
referred complaints, or information was provided to
the consumer. The most common violations involved
real estate loans and checking accounts.
Complaints about Unregulated Practices
As required by section 18(f) of the Federal Trade
Commission Act, the Board continued to monitor
complaints about banking practices not subject to
existing regulations, with a focus on instances of
potential unfair or deceptive practices. In 2010, the
Board received 3,343 complaints against Federal
Reserve Regulated Entities that involved these
unregulated practices. Most complaints were related
to real estate concerns (37 percent), checking account
activity (33 percent), and credit cards (6 percent).
36

Prohibited basis includes: race, color, religion, national origin,
sex, marital status, age, applicant income derived from public
assistance programs, or applicant reliance on provisions of the
Consumer Credit Protection Act.

1,510

Complaints involving violations
Percent
100

Number

Percent

68

4.5

27
6
13

1.8
0.4
0.9

2
0
1

0.1
0
0.1

486
384
165

32.2
25.4
10.9

18
23
4

1.2
1.5
0.3

More specifically, consumers most frequently complained about issues involving insufficient funds or
overdraft charges and procedures; debt collection/
foreclosures; interest rates, terms, and fees; depository forgery, fraud, embezzlement, or theft; opening
and closing deposit accounts; procedure and policy
concerns; and disputed withdrawals of funds.
Complaints about Loan Modifications
and Foreclosures
In 2010, the Federal Reserve received 1,050 complaints related to loan modifications and foreclosures. Of these, consumers complained primarily
about home purchase loans (79 percent), home
refinance/closed-end loans (9 percent), and adjustable rate mortgage loans (6 percent). The top three
consumer protection issues documented with specific
codes were: debt collection/foreclosure (47 percent);
interest rates, terms, and fees (27 percent); and credit
denied (4 percent).
Complaint Referrals
In 2010, the Federal Reserve forwarded 15,505 complaints against other banks and creditors to the
appropriate regulatory agencies and government
offices for investigation. To minimize the time
required to re-route complaints to these agencies,
referrals were transmitted electronically.
The Federal Reserve forwarded 21 complaints to
HUD that alleged violations of the Fair Housing
Act.37 The Federal Reserve’s investigation of these
complaints revealed no evidence of illegal credit
discrimination.
37

A memorandum of understanding between HUD and the federal bank regulatory agencies requires that complaints alleging a
violation of the Fair Housing Act be forwarded to HUD.

114

97th Annual Report | 2010

Consumer Inquiries
The Federal Reserve received 26,324 consumer inquiries in 2010, covering a wide range of topics. The top
three consumer protection issues documented with
specific codes were: adverse action notices received
pursuant to the Equal Credit Opportunity Act (7 percent), exchange or issuance of coin or currency
(2 percent), and credit denials for reasons other than
prohibited basis (2 percent). Consumers were typically directed to other resources, including other federal agencies or written materials, to address their
inquiries.
The System’s FRCH also empowers consumers in
recognizing and reporting scams. The site contains
consumer information alerting consumers to characteristics of a scam and provides a link for reporting
information on a product or service they suspect of
being a scam. Fifty-four scams were tracked through
FRCH in 2010, and sent to the appropriate federal
authorities for investigation and prosecution.

Supporting Community
Economic Development
The Federal Reserve System’s Community Affairs
Offices (CAOs) work to promote community economic development and fair access to credit for lowand moderate-income communities and populations.
As a decentralized function, the CAOs at each of the
12 Reserve Banks design activities to respond to the
specific needs of the communities they serve, with
oversight from Board staff. They provide information
and promote awareness of investment opportunities
to financial institutions, government agencies, and
organizations that serve low- and moderate-income
communities and populations. Similarly, the Board’s
CAO promotes and coordinates Systemwide, highpriority efforts; in particular, Board community
affairs staff focus on issues that have public policy
implications.

Small Business Finance and
Mobile Banking Issues
The financial crisis and the economic downturn
resulted in constrained credit conditions during 2010,
raising significant concerns regarding access to credit
for small businesses. To gain a better understanding
of the issues, needs, and programs and policies that
would be helpful, the CAOs undertook a comprehensive initiative to convene small business owners, lend-

ers, community leaders, and government officials to
support small businesses’ access to credit. (See “Box 1.
Credit Where Credit Is Due: Supporting Small Business Access to Credit” on page 99, for more details.)
In addition, DCCA recognized the importance of
understanding and gaining insight into the fastevolving dynamics in mobile banking. In 2010, staff
convened an emerging issues forum entitled Cash,
Check, or Cell Phone? Protecting Consumers in a
Mobile Finance World. The forum brought together
banking and industry leaders, vendors of mobile
financial services, researchers, consultants, payment
services firms, consumer advocates, and regulators to
discuss the new opportunities and challenges presented by emerging technologies in banking and payments. The forum proceedings, including podcasts
and presentations, are available to the public through
the Board’s website.38 The important innovations in
mobile finance now underway will change the way
consumers conduct financial transactions with their
bank, merchants, and other consumers. As mobile
finance technologies, standards, and business models
continue to advance, DCCA will continue to monitor
their evolution to ensure that consumers are
adequately protected as they take advantage of
promising new products and services.

Vacant Properties and
Neighborhood Stabilization
In 2010, issues related to high rates of foreclosure
continued to dominate the System’s community
affairs agenda. While each Reserve Bank addressed
the impact of foreclosure on low- and moderateincome communities—through programming tailored to the particular needs of communities in their
Districts—the CAOs of the 12 Reserve Banks (under
the sponsorship of their presidents) worked closely
with the Board to develop the Mortgage Outreach
and Research Efforts (MORE) Initiative.39 The goal
of MORE is to leverage the Federal Reserve’s substantial knowledge of and expertise in mortgage markets in ways that are useful to policymakers, community organizations, financial institutions, and the
public.40
As a key element of the MORE initiative, the System
produced a volume on real estate owned (REO) prop38

39
40

More information about the forum is available at www
.federalreserve.gov/communityaffairs/national/2010mobile.
To read about the MORE initiative, see www.chicagofed.org.
Resources for Stabilizing Communities is available at www
.federalreserve.gov/communitydev/stablecommunities.htm.

Consumer and Community Affairs

115

Box 2. What You Need to Know: Consumer Ed from the Fed
The Federal Reserve’s consumer protection regulations affect consumers every day, but, due to numerous recent regulatory and legislative changes, many
consumers may not understand, or be aware of, their
new rights and obligations as consumers. The new
regulatory protections can impact consumers who
are making a purchase with a credit or debit card,
opening a checking account, taking out a mortgage
loan, or using another financial product or service.
Recognizing this as an opportunity to educate consumers about the changes, the Board launched a
new consumer education series, What You Need to
Know, in 2010 to provide consumers with plainlanguage information about new consumer protections (see the Board’s website at www.federalreserve
.gov/consumerinfo/wyntk.htm).
The first publication in the series, What You Need to
Know: New Credit Card Rules, was released in February 2010 to coincide with the launch of a new
microsite that focuses on the changes to credit card
rules. The site also includes basic facts about common credit card options, interest rates, and fees, as
well as information about common credit card problems, such as lost or stolen cards. Interactive features help consumers learn more about credit card
offers and new features of their monthly statements.
When the Board issued new rules regarding gift
cards, another publication was added to the series.
What You Need to Know: New Rules for Gift Cards
describes the different types of gift cards (store vs.
logo cards) and the new limitations and required fee
disclosures. The educational piece also informs consumers that certain types of cards—reloadable prepaid cards and rewards cards—are not covered
under the new rules.

erties and neighborhood stabilization issues. More
specifically, with the goal of helping communities to
address the effects of concentrated foreclosures, the
Board worked with the Federal Reserve Banks of
Boston and Cleveland to produce a special volume of
research that examines important questions about
lender-owned real estate.
The publication, REO and Vacant Properties: Strategies for Neighborhood Stabilization, consists of a
series of papers that explore regional differences and
present perspectives from the various participants
involved in REO disposition—sellers, buyers, non-

In June, the Board added What You Need to Know:
New Overdraft Rules for Debit and ATM Cards to the
series to accompany the release of new debit card
rules. This piece provides consumers with an easyto-understand overview of the facts about banks’
overdraft policies and consumers’ rights under the
new rules in order to help them make educated decisions about whether or not to “opt in” to overdraft
protection and what to do if they change their mind.
It is crucial that consumers understand how credit
decisions are made, and the Federal Reserve and the
Federal Trade Commission issued new rules in
2010 to help consumers get more information about
how their credit report or credit score can impact a
lender’s decision. In advance of the rules’ 2011 effective date, What You Need to Know: New Rules about
Credit Decisions and Notices was released to help
consumers find and understand their credit standing
and to exercise their rights in applying for credit. This
publication also describes the various notices that
may be issued to consumers in response to a credit
application or credit account, and instructions about
what to do if they receive a notice.
What You Need to Know: New Rules for Mortgage
Transfers was created in conjunction with new regulations effective January 1, 2011, which require that
consumers be notified when their mortgage loan has
been sold or transferred. This publication helps consumers understand who owns their mortgage loan
and who they can contact to handle certain issues,
including payment disputes and loan modifications.
The What You Need to Know series demonstrates
the Federal Reserve’s commitment to helping consumers understand how consumer protection regulations impact them and to providing them with the
information they need to make good financial
decisions.

profits, and municipalities.41 The authors were drawn
from national nonprofits, large holders of servicers of
REOs, community affairs researchers, and academics.
Chapters in the publication addressed a wide range
of questions: What factors can bring about stability
in a high-foreclosure neighborhood? and What are
the incentives of the various parties to REO transactions? The publication was made public at the REO
and Vacant Property Strategies for Neighborhood Stabilization Summit, a Board-hosted event that exam41

The publication is available online at www.federalreserve.gov/
events/conferences/2010/reovpsns/downloads/reo_20100901.pdf.

116

97th Annual Report | 2010

ined the community impacts of foreclosed and
vacant properties, held in September 2010. At the
summit, key findings from a Federal Reserve research
project on local uses of NSP funds initiated in 2009
were also released.
In an effort to address the current foreclosure issues,
the Board also continued its partnership with NeighborWorks America® (NWA), which was initiated in
2009 to continue to leverage the System’s resources
with those of the NWA.42 As part of the partnership,
the Board has coordinated the development and distribution of a new quarterly survey to the NWA
organizations and the National Foreclosure Mitigation Counseling (NFMC) Program grantees and subgrantees. The survey is intended to gather information on loan modification efforts, rental housing,
unemployment, and key emerging issues faced by
low- and moderate-income communities. The survey
was distributed to approximately 850 organizations.

Community Data Initiative
By complementing information-sharing and partnership roles with a rigorous analytical capacity, community affairs is able to provide reliable information that
has helped to identify and close data gaps for lowand moderate-income communities. In 2010, the
Board launched the Community Data Initiative
(CDI), a CAO collaborative research project. The
goal of the CDI project is to provide Board and
Reserve Bank leadership with systematic and relevant
community conditions and trend information on a
consistent basis. The quarterly or biannual e-polling
of selected district community stakeholders provides
ongoing intelligence of current and emerging community development issues. To date, there are seven
beta site Reserve Banks that are administering webbased polls and surveys. Two additional Reserve
Banks are reviewing their capacity and resources for
launching community stakeholder polls in 2011.

Other Community Development Initiatives
In 2010, the Board began working with the Federal
Reserve Bank of San Francisco to prepare for the
2011 biennial Community Affairs Research Conference.44 A call for papers was released in May and
submissions were due in September. Community
Affairs expanded its paper submission review committee to include a number of key economists from
the Board’s Division of Research and Statistics, as
well as the Board’s DCCA staff, in order to tap the
Board’s pool of subject matter experts.

Consumer Advisory Council
The Consumer Advisory Council—whose members
represent consumer and community organizations,
the financial services industry, academic institutions,
and state agencies—advises the Board on matters of
Board-administered laws and regulations as well as
other consumer-related financial services issues.
Council meetings, open to the public, were held in
March, June, and October of 2010. See a list of
Council members on page 416; also, visit the Board’s
website for transcripts of Council meetings.45
Among the significant topics of discussion for the
Council in 2010 were
• the Credit Card Act,
• proposed changes to Regulation Z to enhance consumer protection and improve disclosures for
reverse mortgage transactions and other home
mortgage loans,
• HMDA,
• CRA, and
• issues related to foreclosures and neighborhood
stabilization.

The Credit Card Act
CRA Public Hearings
Throughout 2010, the Board partnered with the
FDIC, OCC, and OTS to hold a series of joint public
hearings in four cities to receive public comments as
they consider updates to regulations governing procedures for assessing a financial institution’s performance under the CRA.43
42

43

More information about the NWA is available at www
.stablecommunities.org.
More information about the hearings is available at www
.federalreserve.gov/communitydev/cra_hearings.htm.

In its March meeting, the Council discussed proposed amendments to Regulation Z that would
implement the provisions of the Credit Card Act
requiring that credit card penalty fees be reasonable
44

45

More information about the conference is available at www.frbsf
.org/community/conferences/2011ResearchConference.
The transcript from the March meeting is available at www
.federalreserve.gov/aboutthefed/cac_20100325.pdf. The transcript from the June meeting is available at www.federalreserve
.gov/aboutthefed/cac_20100617.pdf. The transcript from the
October meeting will be available at www.federalreserve.gov/
aboutthefed/cac.htm.

Consumer and Community Affairs

and proportional and that credit card issuers reevaluate annual percentage rate increases at least once
every six months. Members generally commended the
overall shift toward transparency and simplicity in
credit card terms and pricing represented by the regulations implementing the Credit Card Act. They
commented that additional and clearer up-front
information would benefit consumers in their shopping and help credit card issuers to be more
competitive.
The members also engaged in discussions regarding
the requirement to reevaluate rate increases, as well as
the issue of defining penalty fee provisions, with several consumer representatives and an industry representative urging the Board to set specific dollar
amounts for penalty fees and expressing concern
about giving discretion to issuers to set penalty fees.
On the other hand, several industry representatives
expressed the view that the Board should not set specific penalty fees, but rather that issuers should be
permitted to set the fees based on the Board’s rules
about what factors should be considered and how
certain calculations should be made. They also noted
that other Credit Card Act provisions require clear
disclosures of penalty fees to consumers. Regarding
the provisions about costs incurred as a result of violations of account terms, some industry representatives expressed concern about the restrictiveness of
the proposed standards and urged the Board to allow
consideration of a broader range of costs related to
violations.

Proposed Rules Regarding Home
Mortgage Transactions
In its October meeting, the Council discussed the
Board’s proposed rules to amend Regulation Z to
enhance consumer protection and improve disclosures for reverse mortgage transactions and other
home mortgage loans.
Reverse Mortgages
Members praised the Board’s steps to improve the
disclosures for reverse mortgages, pointing particularly to the proposed revision of the total annual loan
cost disclosure so that it shows how the reverse mortgage balance grows over time in dollar amounts. A
consumer representative urged the Board to go further and develop standard disclosures that all reverse
mortgage creditors must use. Both consumer and

117

industry representatives also supported the requirement that borrowers obtain counseling from a counselor or counseling agency that meets the counselor
qualification standards established by HUD, with
members emphasizing the importance of in-person,
one-on-one counseling and the need for counseling in
languages other than English.
Members also supported the provision to prohibit
creditors from requiring a consumer to purchase
another financial or insurance product as a condition
of obtaining a reverse mortgage. Consumer representatives expressed concern about the proposed 10-day
safe harbor in the anti-tying rule, urging the Board to
designate a longer time period or not to establish a
safe harbor at all.
Right of Rescission
Consumer representatives criticized proposed
changes to the right to rescission under Regulation Z
that would require the consumer to tender the principal balance less interest and fees, and any damages
and costs, before the creditor is required to release its
security interest. Consumer representatives noted
that few borrowers would be able to tender the principal and expressed preference for the current form of
the rescission process, which gives borrowers some
leverage and temporarily halts the foreclosure process
so that the lender and borrower can negotiate a
workout.
Members had a mixed reaction to the Board’s
consumer-tested, proposed revised notice of the right
to rescind, which would include a “tear-off ” form for
consumers to sign and send to the creditor and also
would require creditors to provide only one copy of
the rescission notice to the consumer. While some
members supported the one-copy requirement and
tear-off format as a way to simplify paperwork, others held the view that consumers should continue to
receive two copies, and still others urged the Board to
develop a standard form for the rescission notice that
all lenders must use.
In the discussion about the proposed rules relating to
material disclosures, some consumer representatives
expressed their opposition to the provision allowing a
$100 tolerance for erroneous disclosure of the
monthly payment amount, stating that $100 is a significant amount for many borrowers and that an
error of that magnitude should be considered
material.

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97th Annual Report | 2010

Home Mortgage Disclosure Act (HMDA)
Members discussed the advantages and disadvantages of suggested changes to Regulation C, which
implements HMDA, including a proposal to collect
additional information. Industry representatives
urged the Board to take into account the time and
resource burdens that would be imposed on institutions, particularly smaller institutions, in collecting
and ensuring the integrity of an expanded set of
data, as well as potentially reporting it more quickly.
They also indicated that there should be a clear purpose and benefit for requiring any additional data
collection and recommended waiting until other
financial regulatory reforms have been implemented
before making significant changes to HMDA.
Consumer representatives supported the collection of
more data so that regulators and policymakers can
better identify and track problematic products and
practices, such as fair lending issues, and more effectively direct resources to particular populations or
communities. They expressed the view that the value
of additional data outweighs the costs of collecting
and reporting it. Consumer representatives recommended several additions to the data, including
applicants’ credit score, age, and primary language,
as well as additional loan information, such as loanto-value ratio, originator channel, and underwriting
characteristics (interest rate, prepayment penalty,
fees). The inclusion of expanded underwriting data
was supported by an industry representative, who
noted that such information could be helpful in clarifying whether disparate pricing is justified.
Both consumer and industry representatives pointed
to privacy issues that could arise with the collection
of more data. Some members recommended the
adoption of a model like that of the U.S. Census,
using a credentialing and monitoring system to give
limited data access to trusted researchers. Members
also commented on the need to standardize and
streamline data-collection efforts across government
agencies and to coordinate with other data requirements of the Dodd-Frank Act.

Community Reinvestment Act (CRA)
In the context of the interagency hearings, Council
members discussed possible ways to modernize the
regulations that implement the CRA to reflect
changes in the financial services industry, changes in
how banking services are delivered to consumers
today, and current housing and community develop-

ment needs. Members praised the Federal Reserve
and other federal regulators for the proposed rule to
expand existing CRA consideration for neighborhood stabilization activities. Two consumer representatives expressed the view that institutions’ performance related to REO properties, such as maintaining properties and paying taxes, should be carefully
scrutinized under the CRA and recommended
deductions for institutions engaging in practices that
negatively impact communities.
Both consumer and industry representatives supported extending CRA coverage beyond depository
institutions to include all institutions that offer certain financial products and services, such as nonbank
affiliates of depository institutions, credit unions,
and other non-bank financial services providers.
Consumer and industry members also agreed that
regulators should differentiate among strong, mediocre, and inadequate CRA performance more consistently and effectively. In particular, they recommended the implementation of incentives to encourage institutions to strive for an “Outstanding” rating,
such as a longer time between examinations or other
operational or financial benefits that would decrease
institutions’ costs and whose savings could be reinvested in communities.
Consumer and industry members stated that community development services get relatively little credit
currently in CRA examinations and supported giving
more weight to such activities by allocating a
larger percentage of the service test to them or by
creating a new community development test. The
activities for which they recommended more credit
included community development loans, particularly
those other than single-family lending; products and
services to reach unbanked or formerly banked consumers; loan modifications; financial education and
asset-building efforts; and indirect services and lending through partners.
Members presented a variety of views related to geographic coverage under the CRA, but both industry
and consumer members urged regulators to loosen
the constraints that the assessment-area analysis puts
on banks’ investments in national funds, which often
direct resources to rural areas and other underserved
markets. Members stated that, under the current
approach, banks are limited to investing in proprietary funds directed toward their geographic assessment areas. However, some industry representatives
also recommended that the geographic scope con-

Consumer and Community Affairs

tinue to incorporate a connection to the local deposit
base and to the physical distribution of products and
services through local branches.

Foreclosures and Neighborhood
Stabilization
Throughout 2010, the Council discussed lossmitigation efforts, including the Administration’s
Home Affordable Modification Program (HAMP),
neighborhood stabilization initiatives and challenges,
and other issues related to foreclosures.
In the discussions about HAMP and other lossmitigation efforts, some consumer representatives
noted that they had seen slight improvement in mortgage servicers’ capacity, but generally held the view
that servicing problems continued to be numerous
and systemic. They pointed to issues such as lost or
misplaced documentation, delays in making a decision about whether to grant a loan modification,
delays in moving borrowers from trial modifications
to permanent modifications, steering of borrowers to
in-house modification programs with less favorable
terms, a lack of response to borrower communications, and the use of “foreclosure mill” law firms that
charge high fees to borrowers to make the modification effective. They also stated that foreclosures continue to be filed while borrowers are in the trial modification period. In addition, consumer representatives expressed concern about the lack of information
provided to borrowers who are denied a HAMP
modification and the absence of a process to appeal
the denial.
Later in 2010, members discussed reports of
improper “robo-signing” activities by servicers, with
several consumer representatives noting that housing
counselors had long warned about such problematic
practices and questioning why regulators had not
scrutinized them sooner. Though members generally
expressed hesitation about the advisability of a
national moratorium, consumer representatives urged
servicers and lenders to halt foreclosures until they
had reviewed their processes and corrected any deficiencies. They also urged regulators to investigate
carefully servicers’ practices, particularly payments
by volume for affidavits and other documentation
work performed by outside vendors.
Industry representatives expressed support for the
corrective action to address problematic practices but
stated that many financial institutions had targeted

119

significant resources to address the increasing volume
of foreclosures with the goal of keeping borrowers in
their homes. They also noted that institutions must
balance the sometimes competing interests of borrowers, investors, and safety and soundness
considerations.
Members provided a variety of perspectives about
HAMP itself and possible areas of improvement for
the program. Both consumer and industry members
expressed support for the change in HAMP requiring
up-front income verification and for the HAMP
effort targeting unemployed borrowers. Noting the
qualification limits for the HAMP unemployment
initiative, members pointed to the need for other
approaches to help unemployed and underemployed
borrowers, such as the successful programs used in
Pennsylvania and other states. Both industry and
consumer representatives expressed concerns about
HAMP’s net-present-value (NPV) model, such as the
way redefault rates are assigned and the results produced for borrowers with second liens or with substantial equity in their home
Several consumer and industry representatives
endorsed a focus on principal write-downs as a key
way to achieve sustainable modifications. Some consumer representatives also expressed support for judicial mortgage modifications in the bankruptcy context as an additional tool to deal with foreclosures.
Throughout 2010, the Council also discussed the
effects of foreclosures that extend beyond households
to the surrounding community and efforts such as
the federal NSP to address the challenges of stabilizing communities. Members expressed concern about
banks not maintaining their REO properties or not
completing foreclosure sales, leading to “toxic titles,”
and urged federal regulators to increase oversight of
regulated institutions regarding these issues. A consumer representative emphasized the need for postforeclosure solutions to prevent prolonged negative
impacts particularly on lower-income communities
and communities of color, where properties are likely
to remain REO status for much longer than in other
areas. In addition, an industry representative
expressed concern about increasing investor purchases of REOs and urged consideration of ways to
give potential owner-occupants a better chance to
acquire properties. Several members pointed to the
importance of collaborative efforts among public,
private, and nonprofit entities and initiatives that
strategically target particular neighborhoods.

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97th Annual Report | 2010

Other Discussion Topics
At the March meeting, Council members discussed
short-term, small-dollar loan products offered by
depository institutions, including tax refund anticipation loans (RALs), and consumer protection issues
related to such products. Both consumer and industry representatives agreed that RALs should be
strictly regulated and recommended more education
about the timing of tax refunds and more outreach
to unbanked consumers, particularly at tax time,
about saving and building wealth.
Members also encouraged regulated financial institutions to offer affordable, sustainable small-dollar
loans and expressed concern about unregulated entities offering such loans with problematic features,
including high APRs that result from the short term
and fees of these loans. Some members expressed the
view that the APR is not a useful shopping tool for
consumers. An industry representative noted the
challenges in the business model for this product,
stating that institutions face reputational risk. A consumer representative urged the Board and other regulators to help improve the development of this product by clarifying capital requirements and assisting to
define what constitutes a responsible, profitable
small-dollar loan product.
At the June meeting, the Council addressed issues
relating to the flow of credit to small businesses,
including specific credit gaps, the role of small business support service providers, promising practices
related to technical assistance, and alternative lending
sources. Several members noted the need to give particular attention to small businesses in rural areas,
which are often undercapitalized. Some members
also recommended measures to make the Treasury
Department’s New Markets Tax Credit program
more amenable to investments in small businesses. A
consumer representative praised the Board for its
ongoing dialogue with the Small Business Administration (SBA) and expressed support for efforts to

highlight SBA programs and ensure their continued
effectiveness, such as by bolstering the secondary
market for certain SBA loans.
A consumer representative commented that small
business credit is often closely connected with personal credit and encouraged lenders to consider alternative credit data related to personal credit history
when underwriting small business borrowers. One
member expressed support for additional consumer
protections for small business credit cards, much like
the protections provided by the Credit Card Act of
2009 for consumer credit cards.
At the October meeting, Council members discussed
the Board’s interim final rule to ensure that real
estate appraisers are free to use their independent
professional judgment in assigning home values without influence or pressure from those with interests in
the transactions. Members generally agreed that the
appraisal independence requirements should apply
not only to consumer credit transactions secured by a
consumer’s principal dwelling but also to consumer
loans secured by other dwellings, such as a second
home. Members disagreed, however, about whether
appraisers should be permitted to consider the sales
contract in connection with rendering an opinion of
value.
Regarding other appraisal issues, one member urged
the Board to impose bonding, insurance, or capitalization requirements on appraisers so that judgments
against them can be effective. An industry representative expressed concern about the quality of appraisals
generally, particularly for those from appraisal management companies with high volume, and commented that the proposed rules would help to
improve appraisal quality. Some consumer representatives commented on the importance of being able
to communicate with appraisers, especially those who
are not familiar with a certain community or neighborhood, to help inform them about the area.

121

Federal Reserve Banks

The Federal Reserve Banks provide “payment services” to depository and certain other institutions,
distribute the nation’s currency and coin to depository institutions, and serve as fiscal agents and
depositories for the U.S. government and other entities. The Reserve Banks also contribute to setting
national monetary policy and supervision and regulation of banks and other financial entities operating in
the United States (discussed in the preceding sections
of this report).

Developments in Federal
Reserve Priced Services
Federal Reserve Banks provide a range of payment
and related services to depository institutions, including collecting checks, operating an automated clearinghouse (ACH) service, transferring funds and secu-

rities, 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

1

Financial data reported throughout this chapter—including revenue, other income, costs, income before taxes, and net
income—can be linked to the pro forma financial statements
found at the close of this section.

Table 1. Priced Services Cost Recovery
Millions of dollars, except as noted
Year
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2001–2010

Revenue from services1

Operating expenses and
imputed costs2

Targeted return on equity3

Total costs

Cost recovery (percent)4,5

960.4
918.3
881.7
914.6
993.8
1,029.7
1,012.3
873.8
675.4
574.7
8,834.6

901.9
891.7
931.3
842.6
834.4
874.8
912.9
820.4
707.5
532.8
8,250.4

109.2
92.5
104.7
112.4
103.0
72.0
80.4
66.5
19.9
13.1
773.7

1,011.1
984.3
1,036.0
955.0
937.4
946.8
993.3
886.9
727.5
545.9
9,024.1

95.0
93.3
85.1
95.8
106.0
108.8
101.9
98.5
92.8
105.3
97.9

Note: Here and elsewhere in this chapter, components may not sum to totals or yield percentages shown because of rounding. Amounts in bold are restated due to changes in
previously reported data.
1
For the 10-year period, includes revenue from services of $8,286.2 million and other income and expense (net) of $548.4 million.
2
For the 10-year period, includes operating expenses of $7,900.5 million, imputed costs of $95.5 million, and imputed income taxes of $254.4 million.
3
Beginning in 2009, given the uncertain long-term effect that the payment of interest on reserve balances held by depository institutions at the Reserve Banks would have on
the level of clearing balances, the PSAF has been adjusted to reflect the actual clearing balance levels maintained; previously, the PSAF was calculated based on a projection
of clearing balance levels.
4
Revenue from services divided by total costs.
5
For the 10-year period, cost recovery is 95.1 percent, including the reduction in equity related to ASC 715 reported by the priced services.

122

97th Annual Report | 2010

as the private-sector adjustment factor (PSAF).2 Over
the past 10 years, Reserve Banks have recovered
97.9 percent of their priced services costs, including
the PSAF (see table 1).3
In 2010, Reserve Banks recovered 105.3 percent of
total priced services costs, including the PSAF.4 The
Banks’ operating costs and imputed expenses totaled
$532.8 million. Revenue from operations totaled
$566.7 million and other income was $7.9 million,
resulting in net income from priced services of
$41.8 million.5
The Reserve Banks are engaged in a number of technology initiatives that will modernize their priced services processing platforms over the next several years.
The Banks are in the process of implementing a new
end-to-end electronic check-processing system to
improve the efficiency and reliability of their current
check-processing operations. They also continued
efforts to migrate the FedACH and Fedwire Funds
services off a mainframe system and to a distributed
computing environment.

Commercial Check-Collection Service
In 2010, Reserve Banks recovered 107.1 percent of
the total costs of their commercial check-collection
service, including the related PSAF. The Banks’ operating expenses and imputed costs totaled $326.5 million. Revenue from operations totaled $353.6 million
2

3

4

5

In addition to income taxes and the return on equity, the PSAF
includes three other imputed costs: interest on debt, sales taxes,
and an assessment for deposit insurance by the Federal Deposit
Insurance Corporation (FDIC). Board of Governors assets and
costs that are related to priced services are also 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.
Effective December 31, 2006, the Reserve Banks implemented
the Financial Accounting Standards Board’s Statement of
Financial Accounting Standards (SFAS) No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement
Plans [Accounting Standards Codification (ASC) Topic 715
(ASC 715), Compensation–Retirement Benefits], which has
resulted in the recognition of a $267.6 million reduction in
equity related to the priced services’ benefit plans through 2010.
Including this reduction in equity, which represents a decline in
economic value, results in cost recovery of 95.1 percent for the
10-year period. For details on how implementing ASC 715
affected the pro forma financial statements, refer to notes 3 and
5 to the “Pro Forma Financial Statements for Federal Reserve
Priced Services” at the end of this chapter.
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.
Other income is investment income earned on clearing balances
net of the cost of earnings credits, an amount termed net
income on clearing balances.

and other income totaled $4.9 million, resulting in
net income of $31.9 million. In 2010, check-service
revenue from operations decreased $128.1 million
from 2009.6 Reserve Banks handled 7.7 billion checks
in 2010, a decrease of 10.2 percent from 2009 (see
table 2). The decline in Reserve Bank check volume
continues to be influenced by nationwide trends away
from the use of checks and toward greater use of
electronic payment methods.7 By year-end 2010,
99.7 percent of Reserve Bank check deposits and
98.4 percent of Reserve Bank check presentments
were being made electronically through Check 21
products.8
Because of the rapid adoption of electronic check
processing, the Reserve Banks were able to complete
the consolidation of their paper check-processing
offices ahead of schedule, in 2010 instead of 2011.
Under this multiyear initiative, which began in 2003,
the Reserve Banks have reduced the number of
offices at which they process paper checks from 45 to
one. Beginning in February 2010, the Cleveland
Reserve Bank operated the only paper checkprocessing site for the System. Further, the System’s
electronic check processing was consolidated at one
Federal Reserve site.

Commercial Automated
Clearinghouse Services
In 2010, the Reserve Banks recovered 103.4 percent
of the total costs of their commercial ACH services,
including the related PSAF. Reserve Bank operating
expenses and imputed costs totaled $105.2 million.
6

7

8

In 2008, the Reserve Banks discontinued the transportation of
commercial checks between their check-processing offices. As a
result, in 2010, there were no costs or imputed revenues associated with the transportation of commercial checks between
Reserve Bank check-processing offices.
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 2010 Federal Reserve Payments Study: Noncash
Payment Trends in the United States, 2006–2009” (December 2010), www.frbservices.org/files/communications/pdf/press/
2010_payments_study.pdf.
The Check Clearing for the 21st Century Act (Check 21), which
became effective in 2004, was designed to foster innovation in
payment systems and to enhance efficiency by reducing some of
the legal impediments to check truncation. The law facilitates
check truncation by creating a new negotiable instrument called
a substitute check, which permits banks to truncate original
checks, to process check information electronically, and to
deliver substitute checks to banks that want to continue receiving paper checks.
The Reserve Banks also offer non-Check 21 electronicpresentment products. In 2010, 0.3 percent of Reserve Banks’
deposit volume was presented to paying banks using these
products.

Federal Reserve Banks

123

Table 2. Activity in Federal Reserve priced services, 2008–2010
Thousands of items
Percent change
Service

Commercial check
Commercial ACH
Fedwire funds transfer
National settlement
Fedwire securities transfer

2010

7,711,833
10,232,757
127,762
522
7,913

2009

8,584,929
9,966,260
127,357
464
10,519

2008

9,545,424
10,040,388
134,220
469
11,717

2009 to 2010

2008 to 2009

-10.2
2.7
0.3
12.5
-24.6

-10.1
-0.7
-5.1
-1.1
-10.2

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

Revenue from ACH operations totaled $109.9 million
and other income totaled $1.6 million, resulting in
net income of $6.3 million. The Reserve Banks processed 10.2 billion commercial ACH transactions, an
increase of 2.7 percent from 2009, which was in line
with industry ACH volume growth.
The Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 required the Board to work
with the Reserve Banks to expand the use of the
ACH for making international payments and remittances. In 2010, the Reserve Banks expanded their
cross-border ACH product offerings to additional
countries in Latin America and Europe to facilitate
the provision of low-cost payment and remittance
services by depository institutions in the United
States. By year-end 2010, depository institutions were
able to send payments using the Reserve Banks’ FedGlobal service to 22 countries in Europe, 12 countries
in Latin America, and Canada. The Reserve Banks,
however, found it challenging to increase the use of
FedGlobal services by individuals and businesses for
making outbound payments. In particular, while outbound government payments increased 1.8 percent in
2010, to about 103,000 payments per month, outbound payments by individuals and businesses
declined 5.4 percent, to slightly less than 3,000 payments per month, which included payments sent
through the long-established service offerings to
Canada and Mexico.

Fedwire Funds and National Settlement
Services
In 2010, Reserve Banks recovered 100.6 percent of
the costs of their Fedwire Funds and National Settlement Services, including the related PSAF. Reserve
Bank operating expenses and imputed costs for these
operations totaled $77.9 million in 2010. Revenue

from these services totaled $79.1 million, and other
income amounted to $1.2 million, resulting in a net
income of $2.4 million.
Fedwire Funds Service
The Fedwire Funds Service allows participants to use
their balances at Reserve Banks to transfer funds to
other participants. In 2010, the number of Fedwire
funds transfers originated by depository institutions
increased 0.3 percent from 2009, to approximately
127.8 million. The average daily value of Fedwire
funds transfers in 2010 was $2.4 trillion, a decrease of
3.6 percent from the previous year.
National Settlement Service
The National Settlement Service is a multilateral
settlement system that allows participants in privatesector clearing arrangements to settle transactions
using Federal Reserve balances. In 2010, the service
processed settlement files for 19 local and national
private-sector arrangements, a decrease from the 41
arrangements active in 2009. The decrease in the
number of arrangements was primarily the result of
consolidation among check clearinghouses. The
Reserve Banks processed slightly more than 6,900
files that contained around 522,000 settlement entries
for these arrangements in 2010. Activity in 2010 represents both a decrease from the 10,500 files processed in 2009 and an increase from the 464,000
settlement entries processed in 2009.

Fedwire Securities Service
In 2010, the Reserve Banks recovered 102.8 percent
of the total costs of the priced-service component of
their Fedwire Securities Service, including the related
PSAF. The Banks’ operating expenses and imputed
costs for providing this service totaled $23.2 million
in 2010. Revenue from the service totaled $24.1 mil-

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97th Annual Report | 2010

lion, and other income totaled $0.4 million, resulting
in a net income of $1.2 million.
The Fedwire Securities Service allows participants to
transfer electronically to other participants in the service certain securities issued by the U.S. Treasury,
federal government agencies, government-sponsored
enterprises, and certain international organizations.9
In 2010, the number of non-Treasury securities transfers processed via the service decreased 24.6 percent
from 2009, to approximately 7.9 million.

Float
The Federal Reserve had daily average credit float of
$1,795.7 million, compared with daily average credit
float of $1,976.4 million in 2009.10

Developments in Currency and Coin
The Federal Reserve Board is the issuing authority
for the nation’s currency (in the form of Federal
Reserve notes). In 2010, the Board paid the U.S.
Treasury’s Bureau of Engraving and Printing (BEP)
$598.2 million for producing 5.6 billion Federal
Reserve notes.
The Federal Reserve Banks distribute currency and
coin through depository institutions to meet public
demand. The Reserve Banks also receive currency
and coin from circulation through these institutions.
The Reserve Banks received 35.4 billion Federal
Reserve notes from circulation in 2010, a 0.4 percent
increase from 2009, and distributed 36.3 billion notes
into circulation (payments) in 2010, a 1.4 percent
increase from 2009. The value of Federal Reserve
notes in circulation increased 6.0 percent in 2010, to
$942.0 billion, largely because of demand for $100
notes. The Reserve Banks received 62.4 billion coins
from circulation in 2010, a 4.5 percent decrease from
2009, and made payments of 69.1 billion coins into
circulation, a 0.2 percent increase from 2009.
9

10

The expenses, revenues, volumes, and fees reported here are for
transfers of securities issued by federal government agencies,
government-sponsored enterprises, and certain international
organizations. Reserve Banks provide Treasury securities services in their role as the U.S. Treasury’s fiscal agent. These services are not considered priced services. For details, see “Treasury Securities Service,” on page 125.
Credit float occurs when the Reserve Banks present items for
collection to the paying bank prior to providing credit to the
depositing bank (debit float occurs when the Reserve Banks
credit the depositing bank prior to presenting items for collection to the paying bank).

In 2010, the Reserve Banks finished implementing a
program to extend the useful life of the System’s BPS
3000 high-speed currency-processing machines. The
program replaced the operating systems of the equipment, significantly improving the Reserve Banks’
processing efficiency. Reserve Banks continue to
develop a new cash automation platform that will
enhance controls of the Banks’ cash operations and
improve their efficiency, provide a responsive management information reporting system with superior
and flexible reporting tools, facilitate business continuity and contingency planning, and enhance the
support provided to Reserve Bank customers and
business partners. In 2010, the Banks terminated the
development contract with the primary vendor and
redefined the design for the new system.
The Board continues to work with the BEP and the
U.S. Secret Service to produce and issue a moresecure, new-design $100 note. In late 2010, the Board
announced that the new-design $100 note would be
released later than the planned February 2011 issue
date because the BEP observed that the paper was
occasionally creasing during production. The Board
will announce a new issue date once the problem has
been resolved.

Developments in Fiscal Agency and
Government Depository Services
As fiscal agents and depositories for the federal government, the Federal Reserve Banks auction Treasury
securities, process electronic and check payments for
Treasury, collect funds owed to the federal government, maintain Treasury’s bank account, and
develop, operate, and maintain a number of automated systems to support Treasury’s mission. The
Reserve Banks also provide certain fiscal agency and
depository services to other entities; these services are
primarily related to book-entry securities.
Treasury and other entities fully reimbursed the
Reserve Banks for the costs of providing fiscal
agency and depository services. In 2010, reimbursable
expenses amounted to $456.4 million, compared with
$450.3 million in 2009 (see table 3). Support for
Treasury programs accounted for 93.9 percent of the
cost, and support for other entities accounted for
6.1 percent. The Reserve Banks actively monitor program expenses, and they strive to contain these costs
while providing the resources necessary to accomplish program objectives.

Federal Reserve Banks

125

Table 3. Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2008–2010
Thousands of dollars
Agency and service
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
Collection services
Cash-management services
Computer infrastructure development and support
Other services
Total
Other Treasury
Total
Total, Treasury
Other Federal Agencies
Total, other agencies
Total reimbursable expenses

Treasury Securities Services
The Reserve Banks work closely with Treasury’s
Bureau of the Public Debt in support of the borrowing needs of the federal government. The Banks auction, issue, maintain, and redeem securities; provide
customer service; and operate the automated systems
supporting paper U.S. savings bonds and book-entry
marketable Treasury securities (bills, notes, and
bonds). Treasury securities services consist of retail
securities programs (which primarily serve individual
investors) and wholesale securities programs (which
serve institutional customers).

Retail Securities Programs
The Reserve Banks continued to support Treasury’s
efforts to improve the quality and efficiency of securities services provided to retail customers. The
Banks process paper U.S. savings bonds transactions
and book-entry marketable Treasury securities transactions for securities held in Legacy Treasury Direct.
Reserve Bank operating expenses for the retail securities programs were $73.1 million in 2010, compared
with $73.7 million in 2009.
In early 2010, Treasury announced plans to eliminate
the issuance of paper payroll savings bonds through
traditional employer-sponsored savings plans. As of
September 30, 2010, federal employees are no longer

2010

2009

2008

73,104
10,136
30,750
1,980
1,646
117,615

73,679
8,815
30,216
2,333
1,375
116,417

72,374
9,305
37,072
4,464
910
124,124

112,224
37,611
48,226
66,461
8,815
273,337

104,355
37,967
49,046
66,958
7,393
265,719

108,219
49,180
48,676
65,059
7,577
278,711

37,793
428,744

40,390
422,527

27,017
429,852

27,700
456,445

27,758
450,285

31,292
461,144

able to purchase paper savings bonds through payroll
deduction. The Reserve Banks printed and mailed
more than 16 million savings bonds in 2010, a 20 percent decrease from 2009. Treasury also announced a
strategy to transition retail customers from legacy
products (such as paper savings bonds) to the Bureau
of the Public Debt’s web-based Treasury Direct
system, which supports investments in marketable
Treasury securities and electronic savings bonds.
The Reserve Banks continued working with the
Bureau of the Public Debt on the Treasury Retail
E-Services initiative, which aims to lower costs, provide a high-quality customer service experience, provide more opportunities for customer self-service,
and eliminate duplicative processes.

Wholesale Securities Programs
The Reserve Banks support wholesale securities programs through the sale, issuance, safekeeping, and
transfer of marketable Treasury securities for institutional investors. Reserve Bank operating expenses in
2010 in support of Treasury securities auctions were
$30.7 million, compared with $30.2 million in 2009.
In 2010, the Banks conducted 301 Treasury securities
auctions, compared with 283 in 2009. The increase in
the number of auctions was attributable primarily to
the increased number of cash-management bill
auctions.

126

97th Annual Report | 2010

Operating expenses associated with securities safekeeping and transfer activities were $10.1 million in
2010, compared with $8.8 million in 2009. The cost
increase is attributable to higher Treasury securities
transfer volume. In 2010, the number of Fedwire
Treasury securities transfers increased 13 percent
from 2009, to approximately 11.5 million.

Payments Services
The Reserve Banks work closely with Treasury’s
Financial Management Service and other government agencies to process payments to individuals and
companies. For example, the Banks process Social
Security and veterans’ benefits, income tax refunds,
vendor payments, and other types of payments.
Reserve Bank operating expenses for paymentsrelated activity totaled $112.2 million in 2010, compared with $104.4 million in 2009. The increase in
expenses is largely due to expanded requirements for
several Treasury projects, notably the stored value
card (SVC) and Go Direct programs.
The Reserve Banks manage the SVC program, which
provides stored value cards for use by military personnel on military bases. In 2010, the SVC program’s
expenses increased 14 percent, to $17.1 million,
because of program expansion. The Reserve Banks
also support Treasury’s Go Direct initiative, an ongoing effort focused on converting check benefit payments to direct deposit or debit card. In 2010,
expenses for Go Direct increased 23 percent, to more
than $2.8 million, in connection with the expansion
of the Go Direct marketing campaign and a callcenter buildout.

responsibility for the Federal Reserve Electronic Tax
Application function to a commercial bank designated by Treasury.
The Reserve Banks continue to operate Pay.gov, an
application supporting Treasury’s program that
allows the public to use the Internet to authorize and
initiate payments to federal agencies. During the year,
the Pay.gov program was expanded to include several
new agencies and, as a result, collection volumes
increased.
The Reserve Banks also support the government’s
centralized delinquent debt-collection program. Specifically, the Banks develop and maintain software
that facilitates the collection of delinquent debts
owed to federal agencies and states by matching federal payments against delinquent debts, including
past-due child support payments owed to custodial
parents.

Treasury Cash-Management Services
Treasury maintains an operating cash account at the
Reserve Banks to function the various transactions
discussed in the preceding sections of this chapter,
and it may instruct the Banks to invest funds from its
account in interest-bearing accounts with qualified
depository institutions.
The Reserve Banks also provide collateralmanagement and collateral-monitoring services for
Treasury programs that have collateral requirements.
Reserve Bank operating expenses related to Treasury
cash-management services totaled $48.2 million in
2010, compared with $49.0 million in 2009.

Collection Services
The Reserve Banks also work closely with Treasury’s
Financial Management Service to collect funds owed
the federal government, including fees for goods and
services. Reserve Bank operating expenses in 2010
related to collections services remained roughly the
same as in 2009, totaling $37.6 million.
Throughout 2010, the Reserve Banks continued to
support Treasury’s Collections and Cash Management Modernization (CCMM) initiative, a multiyear
effort to simplify, modernize, and improve the services, systems, and processes supporting Treasury’s
collections and cash-management programs. In connection with the CCMM initiative, the Reserve
Banks discontinued processing paper federal tax
deposit coupons and, in late 2010, transitioned

During 2010, the Reserve Banks continued to support Treasury’s effort to modernize its financial management processes, with a focus on improving centralized government accounting and reporting functions. The Banks worked with Treasury to identify
potential long-term efficiency improvements in the
way the Banks account for government payments
and collections processes. The Banks also collaborated with the Financial Management Service on several ongoing software development efforts, such as
the Governmentwide Accounting and Reporting
Modernization initiative.

Services Provided to Other Entities
When permitted by federal statute or when required
by the Secretary of the Treasury, the Reserve Banks

Federal Reserve Banks

127

Figure 1. Aggregate Daylight Overdrafts, 2008–2010

$ Billions

200
180
160
140
120
100
80
Peak daylight overdrafts

60

Average daylight overdrafts

40
20
0

Q1

Q2

Q3

Q4

Q1

Q2

2008

Q3

Q2

Q3

Q4

$1.1 trillion in their Federal Reserve accounts overnight, while the daily value of funds transferred over
just the Federal Reserve’s funds transfer system was
about $2.4 trillion. Institutions held historically high
levels of overnight balances at the Reserve Banks in
2010 while demand for daylight overdrafts on average
remained historically low.12 In 2010, average daylight
overdrafts across the System decreased to about
$6 billion from nearly $10 billion in 2009, a decrease
of about 35 percent (see figure 1).13 The average level
of peak daylight overdrafts, however, increased to
almost $60 billion in 2010 from $55 billion in 2009,
an increase of about 8 percent.14 In 2010, institutions
paid about $6 million in daylight overdraft fees.

11

Developments in the Use of Federal
Reserve Intraday Credit
12

The Board’s Payment System Risk (PSR) policy governs the use of Federal Reserve Bank intraday credit,
also known as daylight overdrafts. A daylight overdraft occurs when an institution’s account activity
creates a negative balance in the institution’s Federal
Reserve account at any time in the operating day.11
Daylight overdrafts enable institutions to send payments more freely throughout the day than if institutions were limited strictly by their available funds balance. In 2010, institutions held on average about

Q1

2010

2009

provide fiscal agency and depository services to other
domestic and international entities. Reserve Bank
operating expenses for services provided to other
entities were $27.7 million in 2010, compared with
$27.8 million in 2009. Book-entry securities issuance
and maintenance activities account for a significant
amount of the work performed for other entities,
with the majority performed for the Federal Home
Loan Mortgage Association, the Federal National
Mortgage Association, and the Government
National Mortgage Association. Cost increases associated with book-entry securities issuance and maintenance activities were offset primarily by reductions
in the cost of postal money-order processing. Postal
money orders are processed primarily in image form,
resulting in operational improvements, lower staffing
levels, and lower costs to the U.S. Postal Service.

Q4

13

14

When an institution ends a day with a negative balance, the
institution incurs an overnight overdraft. The Federal Reserve
strongly discourages overnight overdrafts by imposing penalties
and taking administrative action against institutions that incur
overnight overdrafts. Institutions that require overnight credit
are encouraged to approach the Federal Reserve’s discount window to borrow funds as necessary.
The decision to pay interest on reserve balances, implemented
October 2008, likely contributed significantly to the increase in
overnight balances and the subsequent reduction in daylight
overdrafts. For example, in 2007, average overnight balances
held at the Reserve Banks were $15 billion and average daylight
overdrafts were $60 billion.
Average daylight overdrafts are calculated daily by summing all
negative balances incurred by institutions across the Federal
Reserve System for each minute of the Fedwire operating day (9
p.m. to 6:30 p.m. ET, or 21.5 hours). This sum is then divided by
the number of minutes in the day (1,291 minutes) to arrive at the
average overdraft.
Peak overdrafts are calculated daily by summing the negative
balances of all institutions on a minute-by-minute basis

128

97th Annual Report | 2010

In preparation for PSR policy changes effective as of
March 24, 2011, throughout 2010 the Reserve Banks
modified the systems they use to record collateral
pledges and to track daylight overdrafts.15 The revisions, in part, allow eligible institutions to collateralize daylight overdrafts and pay no fee for these
overdrafts.

Electronic Access to
Reserve Bank Services
The Reserve Banks provide depository institutions
with a variety of alternatives for electronically accessing the Banks’ financial services payment and information services. These electronic-access solutions are
designed to meet the individual connectivity and contingency requirements of depository institution customers. FedLine Direct is a Reserve Bank service that
permits unattended computer-to-computer access to
the Banks’ payment services through dedicated connections. Another service, FedLine Command, offers
an unattended, computer-to-computer, batch-file
solution for accessing Reserve Bank ACH services at
a cost lower than that for FedLine Direct. Yet
another service, FedLine Advantage, provides webbased access to the Banks’ payment services, while
FedLine Web permits access to information services
and limited transaction services. In 2010, the Reserve
Banks announced the restructuring of their electronic access offerings to better meet depository institutions’ need for access options that include certain
value-added services.

Information Technology
In 2010, the Federal Reserve Banks continued to
improve the efficiency, effectiveness, and security of
information technology (IT) services and operations.
To improve the efficiency and overall quality of
operations, major multiyear initiatives were undertaken to consolidate the management and function of
the Federal Reserve’s help desk, server, and network
operations. Significant progress was made, and the
overall program met or exceeded its goals for the
year.

15

throughout the Fedwire operating day. The most negative of
these minute-by-minute balances is the peak overdraft.
Details about the revisions to the PSR policy are available at
www.federalreserve.gov/newsevents/press/other/20081219a.htm,
and the policy that became effective on March 24, 2011, is available at www.federalreserve.gov/paymentsystems/psr_policy.htm.

In addition, Federal Reserve Information Technology
(FRIT) continued to lead the Reserve Banks’ transition to a more robust information security program,
one that is based on guidance from the National
Institute of Science and Technology and adapted to
the Federal Reserve’s environment.16

Examinations of the
Federal Reserve Banks
The Reserve Banks and the consolidated limited
liability company (LLC) entities are subject to several
levels of audit and review.17 The combined financial
statements of the Reserve Banks (see “Federal
Reserve Banks Combined Financial Statements” on
page 342 in the “Federal Reserve System Audits” section of this report) as well as the annual financial
statements of each of the 12 Banks and the consolidated LLC entities are audited annually by an independent auditing firm retained by the Board of Governors.18 In addition, the Reserve Banks, including
the consolidated LLC entities, are subject to oversight by the Board of Governors, which performs its
own reviews.
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. Within this framework, the
management of each Reserve Bank annually provides
an assertion letter to its board of directors that confirms adherence to COSO standards. Similarly, each
consolidated LLC entity annually provides an assertion letter to the board of directors of the Federal
Reserve Bank of New York (the New York Reserve
Bank).
In 2010, the Board engaged Deloitte & Touche LLP
(D&T) to audit the combined and individual financial statements of the Reserve Banks and those of the
16

17

18

FRIT supplies national infrastructure and business line technology services to the Federal Reserve Banks and provides thought
leadership regarding the System information technology architecture and business use of technology. The National Institute of
Science and Technology is a nonregulatory federal agency
within the U.S. Department of Commerce.
The consolidated LLCs were funded by the New York Reserve
Bank, and acquired financial assets and financial liabilities pursuant to the policy objectives. The consolidated LLCs were
determined to be variable interest entities, and the New York
Reserve Bank is considered to be the controlling financial interest holder of each.
Each LLC reimburses the Board of Governors—from the entity’s available net assets—for the fees related to the audit of its
financial statements.

Federal Reserve Banks

consolidated LLC entities. In 2010, D&T also conducted audits of internal controls over financial
reporting for each of the Reserve Banks and the four
consolidated LLC entities that remained in operation
at December 31, 2010.19 Fees for D&T’s services
totaled $8 million, of which $2 million was for the
audits of the consolidated LLC entities. To ensure
auditor independence, the Board requires that D&T
be independent in all matters relating to the audits.
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 the Reserve Banks, or in any
other way impairing its audit independence.
The Board’s reviews 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 Bank and consolidated
LLC entity on an ongoing basis and conduct a comprehensive on-site review of each Bank at least once
every three years.
The reviews also include an assessment of the internal audit function’s conformance to International
Standards for the Professional Practice of Internal
Auditing, conformance to applicable policies and procedures, and the audit department’s efficiency.
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
(SOMA) at the New York Reserve Bank and the foreign currency operations conducted by that Reserve
Bank. In addition, D&T audits the year-end schedule
of participated asset and liability accounts and the
related schedule of participated income accounts.
The FOMC receives the external audit reports and a
report on the division’s examination.

Income and Expenses
Table 4 summarizes the income, expenses, and distributions of net earnings of the Reserve Banks for
2010 and 2009. Income in 2010 was $79,301 million,
compared with $54,463 million in 2009.
19

The financial statements of the Commercial Paper Funding
Facility LLC (CPFF), which were released on August 17, 2010,
did not include an audit of internal controls over financial
reporting.

129

Expenses totaled $7,358 million: $3,489 million in
operating expenses, $2,687 million in interest paid to
depository institutions on reserve balances and earnings credits granted to depository institutions,
$94 million in interest expense on securities sold
under agreements to repurchase, $422 million in
assessments for Board of Governors expenditures,
$623 million for new currency costs, and $43 million
for Consumer Financial Protection Bureau and
Office of Financial Research costs. Net additions to
and deductions from current net income showed a
net profit of $9,746 million, which consists of
$782 million in realized gains on federal agency and
government-sponsored enterprise mortgage-backed
securities (GSE MBS), $7,560 million in net income
associated with consolidated LLCs, $850 million of
other additions, and $554 million in unrealized gains
on investments denominated in foreign currencies
revalued to reflect current market exchange rates.
Dividends paid to member banks, set at 6 percent of
paid-in capital by section 7(1) of the Federal Reserve
Act, totaled $1,583 million, $155 million more than
in 2009; this 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.
Distributions to the U.S. Treasury in the form of
interest on Federal Reserve notes totaled $79,268 million in 2010, up from $47,431 million in 2009; the distributions equal net income after the deduction of
dividends paid and the amount necessary to equate
the Reserve Banks’ surplus to paid-in capital.
The “Statistical Tables” section of this report provides more detailed information on the Reserve
Banks and the LLCs. Table 9 is a statement of condition for each Reserve Bank; table 10 details the
income and expenses of each Reserve Bank for 2010;
table 11 shows a condensed statement for each
Reserve Bank for the years 1914 through 2010; and
table 13 gives the number and annual salaries of officers and employees for each Reserve Bank. A
detailed account of the assessments and expenditures
of the Board of Governors appears in the Board of
Governors Financial Statements (see “Federal
Reserve System Audits” on page 407 ).

SOMA Holdings and Loans
The Reserve Banks’ average net daily holdings of
securities and loans during 2010 amounted to

130

97th Annual Report | 2010

Table 4. Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2010 and 2009
Millions of dollars
Item
Current income
Current expenses
Operating expenses1
Interest paid to depository institutions and earnings credits granted
Interest expense on securities sold under agreements to repurchase
Current net income
Net additions to (deductions from) current net income
Profit on sales of federal agency and government-sponsored enterprise mortgage-backed securities
Profit on foreign exchange transactions
Net income (loss) from consolidated LLCs
Provisions for loan restructuring2
Other additions3
Assessments by the Board of Governors
For Board expenditures
For currency costs
For Consumer Financial Protection Bureau and Office of Financial Research costs4
Change in funded status of benefit plans
Comprehensive income before distributions to Treasury
Dividends paid
Transferred to surplus and change in accumulated other comprehensive income
Distributions to U.S. Treasury5
1
2
3

4

5

2009

79,301
6,270
3,489
2,687
94
73,031
9,746
782
554
7,560
0
850
1,088
422
623
43
46
81,735
1,583
884
79,268

54,463
5,979
3,694
2,187
98
48,484
4,820
879
172
5,588
-2,621
802
888
386
502
0
1,007
53,423
1,428
4,564
47,431

Includes a net periodic pension expense of $529 million in 2010 and $663 million in 2009.
Represents the economic effect of the interest rate reduction made pursuant to the April 17, 2009, restructuring of the American International Group, Inc. loan.
Includes dividends on preferred securities, unrealized gain (loss) on Term Asset-Backed Securities Loan Facility loans, and compensation paid by Citigroup, Inc. and Bank of
America Corporation for the New York Reserve Bank’s and Richmond Reserve Bank’s commitments to provide funding support, net of related expenses.
The Board of Governors assesses the Reserve Banks to fund the operations of the Consumer Financial Protection Bureau and, for a two-year period, the Office of Financial
Research.
Interest on Federal Reserve notes.

$2,123,773 million, an increase of $344,327 million
from 2009 (see table 5).20

SOMA Securities Holdings
The average daily holdings of Treasury securities
increased by $177,595 million, to an average daily
amount of $837,078 million. The average daily holdings of GSE debt securities increased by $68,717 million, to an average daily amount of $166,810 million.
The average daily holdings of federal agency and
GSE MBS increased by $605,375 million, to an average daily amount of $1,079,230 million.
20

2010

Open market operations (OMOs)—the purchase and sale of
securities in the open market by a central bank—are a key tool
used by the Federal Reserve in the implementation of monetary
policy. The System Open Market Account (SOMA) is the Federal Reserve’s portfolio of securities held for the purpose of
these purchases and sales.

These increases are due to the purchase of Treasury
securities, GSE debt securities, and federal agency
and GSE MBS through a large-scale asset purchase
program. There were no holdings of securities purchased under agreements to resell in 2010, compared
with average daily holdings of $3,616 million in similar purchases from 2009; the average daily balance of
securities sold under agreements to repurchase was
$58,476 million, a decrease of $9,361 million from
2009. Average daily holdings of foreign currency
denominated assets in 2010 were $24,936 million,
compared with $24,898 million in 2009. The average
daily balance of central bank liquidity swap drawings
was $989 million in 2010 and $177,688 million in
2009.
The average rates of interest earned on the Reserve
Banks’ holdings of Treasury securities decreased to
3.15 percent and the average rates on GSE debt secu-

Federal Reserve Banks

131

Table 5. System Open Market Account (SOMA) Holdings and Loans of the Federal Reserve Banks, 2010 and 2009
Millions of dollars except as noted
Item

U.S. Treasury securities1
Government-sponsored enterprise debt securities1
Federal agency and government-sponsored enterprise
mortgage-backed securities2
Foreign currency denominated assets3
Central bank liquidity swaps4
Securities purchased under agreements to resell
Other SOMA assets5
Securities sold under agreements to repurchase
Other SOMA liabilities6
Total SOMA holdings
Primary, secondary. and seasonal credit
Term auction credit
Total loans to depository institutions
Asset-Backed Commercial Paper Money Market Mutual
Fund Liquidity Facility (AMLF)
Primary Dealer Credit Facility (PDCF) and other
broker-dealer credit
Credit extended to American International Group, Inc.
(AIG), net7
Term Asset-Backed Securities Loan Facility (TALF)8
Total loans to others
Total loans
Total SOMA holding and loans

Average daily assets (+)/liabilities (–)
2010

2009

837,078
166,810
1,079,230
24,936
989
…
288
-58,476
-799
2,050,056
4,709
7,105
11,814

Current income (+)/expense (–)

Average interest rate (percent)

2010

2009

2010

2009

659,483
98,093

26,373
3,510

22,873
2,048

3.15
2.10

3.47
2.09

473,855
24,898
177,688
3,616
458
-67,837
-182
1,370,072
40,405
291,487
332,892

44,839
223
12
…
…
-94
…
74,863
32
18
50

20,407
296
2,168
13
1
-98
…
47,708
204
786
990

4.15
0.89
1.21
0.00
0.00
0.16
0.00
3.65
0.68
0.25
0.42

4.31
1.19
1.22
0.36
0.22
0.14
0.00
3.48
0.50
0.27
0.30

…

7,653

…

73

…

0.95

…

7,502

…

36

…

0.48

11.93
1.92
5.62
1.35
3.69

10.22
1.78
5.83
1.35
2.99

22,874
39,029
61,903
73,717
2,123,773

39,099
23,228
77,482
409,374
1,779,446

2,728
750
3,478
3,528
78,391

3,996
414
4,519
5,509
53,217

1

Face value, net of unamortized premiums and discounts.
Face value of the securities, which is the remaining principal balance of the underlying mortgages, net of unamortized premiums and discounts. Does not include unsettled
transactions.
3
Includes accrued interest. Foreign currency denominated assets are revalued daily at market exchange rates.
4
Dollar value of foreign currency held under these agreements valued at the exchange rate to be used when the foreign currency is returned to the foreign central bank. This
exchange rate equals the market exchange rate used when the foreign currency was acquired from the foreign central bank.
5
Cash and short-term investments related to the federal agency and government-sponsored enterprise mortgage-backed securities portfolio.
6
Related to the purchases of federal agency and government-sponsored enterprise mortgage-backed securities that the seller fails to deliver on the settlement date.
7
Average daily balance includes outstanding principal and capitalized interest net of unamortized deferred commitment fees and allowance for loan restructuring, and
excludes undrawn amounts and credit extended to consolidated limited liability companies.
8
Represents the remaining principal balance. Excludes amount necessary to adjust TALF loans to fair value at December 31, which is reported in “Other assets” in the
Statement of Condition of the Federal Reserve Banks in Table 9A in the “Statistical Tables” section of this report.
…Not applicable.
2

rities increased to 2.10 percent in 2010. The average
rate of interest earned on federal agency and GSE
MBS decreased to 4.15 percent in 2010. The average
interest rates for securities sold under agreements to
repurchase increased to 0.16 percent in 2010. The
average rates of interest earned on foreign currency
denominated assets and central bank liquidity swaps
decreased to 0.89 percent and 1.21 percent, respectively, in 2010.

Lending
In 2010, average daily primary, secondary, and seasonal credit extended decreased by $35,696 million to
$4,709 million, and average daily term auction credit

extended under the Term Auction Facility decreased
$284,382 million to $7,105 million. The average rate
of interest earned on primary, secondary, and seasonal credit increased to 0.68 percent in 2010, from
0.50 percent in 2009, while the average interest rate
on term auction credit decreased to 0.25 percent in
2010, from 0.27 percent in 2009.
The average daily balance of credit extended to the
American International Group, Inc. (AIG) in 2010
was $22,874 million; this balance earned interest at
an average rate of 11.93 percent. On January 14,
2011, all outstanding draws under the AIG revolving
line of credit and the related accrued interest, capitalized interest, and capitalized commitment fees were

132

97th Annual Report | 2010

paid in full as a result of the closing of the AIG
recapitalization plan.21
The average daily balance of Term Asset-Backed
Securities Loan Facility (TALF) loans in 2010 was
$39,029 million, which earned interest at an average
rate of 1.92 percent. The Board of Governors’
authorization for the extension of new TALF loans
expired in 2010. The authorization for TALF loans
collateralized by newly-issued asset-backed securities
(ABS) and legacy commercial mortgage-backed securities (CMBS) expired March 31 and TALF loans
collateralized by newly issued CMBS expired June 30.
The authorization to lend under the Primary Dealer
Credit Facility and the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility expired on February 10, 2010. There were no balances outstanding under these facilities during 2010.

Investments of the Consolidated LLCs
Additional lending facilities established during 2008
and 2009, under authority of section 13(3) of the
Federal Reserve Act, involved creating and lending to
the consolidated LLC entities (see table 6). Consistent with generally accepted accounting principles,
the assets and liabilities of these LLCs have been
consolidated with the assets and liabilities of the New
York Reserve Bank in the preparation of the statements of condition included in this report.22 The
21

22

On September 30, 2010, AIG announced an agreement with the
U.S. Department of the Treasury, the Federal Reserve Bank of
New York and the trustees of the AIG Credit Facility Trust on a
recapitalization plan designed to accelerate repayment of its
obligations to American taxpayers. The plan resulted in the full
repayment and termination of the Reserve Bank’s AIG credit
facility.
The consolidation of the variable interest entities (VIEs) was
assessed in accordance with Financial Accounting Standards
Board Accounting Standards Codification Topic 810 (ASC
810) Consolidation, which requires a VIE to be consolidated by
its controlling financial interest holder. A Reserve Bank consolidates a VIE if it has a controlling financial interest, which is
defined as the power to direct the significant economic activities
of the entity and the obligation to absorb losses or the right to

proceeds at the maturity or the liquidation of the
consolidated LLCs’ assets will be used to repay the
loans extended by the New York Reserve Bank.

Federal Reserve Bank Premises
Several Reserve Banks took action in 2010 to
upgrade and refurbish their facilities. The multiyear
renovation programs at the New York and St. Louis
Reserve Banks’ headquarters buildings continued.
The New York Reserve Bank completed a program
to enhance the business resiliency of its IT systems
and to upgrade facility support for the Bank’s open
market operations, central bank services, and data
center operations.
Security-enhancement programs continued at several
facilities, including the construction of a remote
vehicle-screening facility for the Dallas Reserve
Bank, and the design of main entrance lobby security
improvements for the Chicago and Dallas Reserve
Banks’ headquarters buildings.
Additionally, the San Francisco Reserve Bank continued its efforts to sell the former Seattle Branch
building.
For more information on the acquisition costs and
net book value of the Federal Reserve Banks and
Branches, see table 14 on page 320 in the “Statistical
Tables” section of this report.
receive benefits of the entity that could potentially be significant
to the VIE. To determine whether it is the controlling financial
interest holder of a VIE, the Reserve Bank evaluates the VIE’s
design, capital structure, and relationships with the variable
interest holders. As a consequence of the consolidation, the
extensions of credit from the New York Reserve Bank to the
consolidated LLCs are eliminated, the net assets of the consolidated LLCs appear as assets in table 9 in the “Statistical Tables”
section of this report, and the liabilities of the consolidated
LLCs to entities other than the New York Reserve Bank, including those with recourse only to the portfolio holdings of the
consolidated LLCs, are included in “Other liabilities” in statistical table 9A.

Federal Reserve Banks

133

Table 6. Key financial data for Consolidated Limited Liability Companies, 2010 and 2009
Millions of dollars

Item

Commercial Paper
Funding Facility LLC
(CPFF)1
2010

2009

TALF LLC1

2010

2009

Maiden Lane LLC1

2010

2009

Maiden Lane II LLC1

2010

2009

Maiden Lane III LLC1

2010

2009

Total LLCs

2010

2009

Net portfolio assets of the consolidated LLCs and the net position of the New York Reserve Bank (FRBNY) and subordinated interest holders
Net portfolio assets2
…
14,233
665
298
27,961
28,140
16,457
15,912
23,583
22,797
68,666 81,380
Liabilities of consolidated LLCs
…
-173
0
0
-915
-1,137
-2
-2
-4
-3
-921
-1,315
…
14,060
665
298
27,046
27,003
16,455
15,910
23,579
22,794
67,745 80,065
Net portfolio assets available3
Loans extended to the
consolidated LLCs by the
…
9,379
0
0
25,845
29,233
13,485
16,005
14,071
18,500
53,401 73,117
FRBNY4
Other beneficial interests4, 5
…
…
106
102
1,315
1,248
1,071
1,037
5,366
5,193
7,858
7,580
Total loans and other beneficial
interests
…
9,379
106
102
27,160
30,481
14,556
17,042
19,437
23,693
61,259 80,697
Cumulative change in net assets since the inception of the program6
Allocated to FRBNY
…
4,681
-65
20
0
-2,230
1,582
-95
2,775
0
4,292
2,654
Allocated to other beneficial
interests
…
…
624
176
-114
-1,248
317
-1,037
1,367
-899
2,194
-3,184
Cumulative change in net assets
…
4,681
559
196
-114
-3,478
1,899
-1,366
4,142
-899
6,486
-530
Summary of consolidated LLC net income, including a reconciliation of total consolidated LLC net income to the consolidated LLC net income recorded by FRBNY
Portfolio interest income7
213
4,224
1
0
1,133
1,476
794
1,088
2,299
3,032
4,440
9,820
Interest expense on loans
extended by FRBNY8
-4
-598
0
0
-205
-146
-186
-238
-204
-296
-599
-1,278
Interest expense–other
0
0
-4
-2
-66
-61
-34
-33
-173
-171
-277
-267
Portfolio holdings gains (losses)
1
8
0
0
2,571
-102
2,467
-604
3,141
-1,239
8,180
-1,937
Professional fees
-2
-30
-1
-1
-69
-55
-10
-12
-22
-27
-104
-125
Net income (loss) of consolidated
LLCs
208
3,604
-4
-3
3,364
1,112
3,031
201
5,041
1,299
11,640
6,213
Less: Net income
(loss) allocated to other
beneficial interests
…
…
-75
699
1,135
-61
1,353
-34
2,266
1,299
4,679
1,903
Net income
(loss) allocated to FRBNY
208
3,604
71
-702
2,229
1,173
1,678
235
2,775
0
6,961
4,310
Add: Interest expense on loans
extended by FRBNY, eliminated
in consolidation
4
598
0
0
205
146
186
238
204
296
599
1,278
Net income (loss) recorded by
FRBNY
212
4,202
719
(702)
2,434
1,319
1,864
473
2,979
296
7,560
5,588
1

2

3
4
5
6

7
8

9

CPFF LLC was formed to provide liquidity to the commercial paper market. The last commercial paper purchases by the CPFF matured on April 26, 2010, and the CPFF was
dissolved on August 30, 2010. TALF LLC was formed in 2009 to purchase assets of the Term Asset-Backed Securities Loan Facility, which was formed to improve market
conditions for asset-backed securities. Maiden Lane LLC was formed to acquire certain assets of Bear Stearns; Maiden Lane II LLC and Maiden Lane III LLC were formed to
acquire certain assets of AIG and its subsidiaries.
TALF, Maiden Lane, Maiden Lane II, and Maiden Lane III holdings are recorded at fair value. Fair value reflects an estimate of the price that would be received upon selling an
asset if the transaction were to be conducted in an orderly market on the measurement date. CPFF holdings are recorded at book value, which includes amortized cost and
related fees.
Represents the net assets available for repayment of loans extended by FRBNY and “other beneficiaries” of the consolidated LLCs.
Book value. Includes accrued interest.
The other beneficial interest holders are the U.S. Treasury for TALF LLC, JPMorgan Chase for Maiden Lane LLC, and AIG for Maiden Lane II LLC and Maiden Lane III LLC.
Represents the allocation of the change in net assets and liabilities of the consolidated LLCs that are available for repayment of the loans extended by FRBNY and the other
beneficiaries of the consolidated LLCs. The differences between the fair value of the net assets available and the face value of the loans (including accrued interest) are
indicative of gains or losses that would be incurred by the beneficiaries if the assets had been fully liquidated at prices equal to the fair value.
Interest income is recorded when earned and includes amortization of premiums, accretion of discounts, and paydown gains and losses.
Interest expense recorded by each consolidated LLC on the loans extended by FRBNY is eliminated when the LLCs are consolidated in FRBNY's financial statements and, as a
result, the consolidated LLCs’ net income (loss) recorded by FRBNY is increased by this amount.
FRBNY earned $327 million on TALF loans during the year ended December 31, 2010, in addition to the net income attributable to TALF LLC. Earnings on TALF loans include
interest income of $750 million, loss on the valuation of loans of $436 million, and administrative fees of $13 million.

134

97th Annual Report | 2010

Pro Forma Financial Statements for Federal Reserve Priced Services
Table 7: Pro Forma Balance Sheet for Federal Reserve Priced Services, December 31, 2010 and 2009
Millions of dollars
Item
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
Prepaid FDIC asset
Deferred tax asset
Total long-term assets
Total assets
Short-term liabilities
Clearing balances and balances
Deferred-availability items
Short-term debt
Short-term payables
Total short-term liabilities
Long-term liabilities
Long-term debt
Accrued benefit costs
Total long-term liabilities
Total liabilities
Equity (including accumulated other comprehensive loss of $267.6 million
and $478.3 million at December 31, 2010 and 2009, respectively)
Total liabilities and equity (Note 3)

2010

2009

248.8
3,463.4
45.6
1.2
17.2
374.5

317.4
4,112.9
49.8
1.5
19.4
449.7
4,150.6

245.3
57.3
65.6
354.7
25.0
132.4

4,950.7
346.3
81.4
76.3
77.1
31.2
231.4

880.2
5,030.8
2,487.6
1,814.7
0.0
43.6

843.7
5,794.5
3,173.6
1,728.3
0.0
146.9

4,345.9
0.0
392.3

5,048.8
0.0
436.8

392.3
4,738.2

436.8
5,485.5

292.6
5,030.8

309.0
5,794.5

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.

Federal Reserve Banks

135

Table 8: Pro Forma Income Statement for Federal Reserve Priced Services, 2010 and 2009
Millions of dollars
Item

2010

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)

2009
566.7
503.9
62.9

-3.2
0.0
5.1
6.3

662.7
713.8
-51.1
-3.2
0.0
9.1
3.4

8.2
54.6

10.7
-2.7

16.6
-3.9

7.9
62.5
20.7
41.8
13.1

9.2
-60.3

12.7
-47.6
-15.5
-32.1
19.9

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.

Table 9: Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2010
Millions of dollars
Item
Revenue from services (Note 4)
Operating expenses (Note 5)
Income from operations
Imputed costs (Note 6)
Income from operations after imputed costs
Other income and expenses, net (Note 7)
Income before income taxes
Imputed income taxes (Note 6)
Net income
Memo: Targeted return on equity (Note 6)
Cost recovery (percent) (Note 8)

Total

Commercial check
collection

Commercial ACH

Fedwire funds

Fedwire securities

566.7
503.9
62.9
8.2
54.6
7.9
62.5
20.7
41.8
13.1
105.3

353.6
306.5
47.0
4.2
42.9
4.9
47.7
15.8
31.9
8.1
107.1

109.9
100.1
9.8
2.0
7.9
1.6
9.4
3.1
6.3
2.6
103.4

79.1
75.1
4.0
1.6
2.4
1.2
3.5
1.2
2.4
1.9
100.6

24.1
22.1
2.0
0.5
1.5
0.4
1.8
0.6
1.2
0.6
102.8

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.

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97th Annual Report | 2010

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 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 and
deposit balances arising from float are assumed to be invested in a portfolio of
investments, shown as imputed investments.
Receivables are composed of fees due the Reserve Banks for providing priced services and the share of suspense-account and difference-account balances related to
priced services.
Materials and supplies are the inventory value of short-term assets.
Prepaid expenses include salary advances and travel advances for priced-service
personnel.
Items in process of collection are gross Federal Reserve cash items in process of
collection (CIPC), stated on a basis comparable to that of a commercial bank.
They reflect adjustments for intra-System items that would otherwise be doublecounted 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, an estimate of the assets of the Board of Governors used in the development of priced
services, an imputed prepaid FDIC asset (see note 6), and a deferred tax asset
related to the priced services pension and postretirement benefits obligation (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 clearing balances. Long-term assets are
financed with long-term liabilities and core clearing balances. As a result, no shortor long-term debt is imputed. Other short-term liabilities include clearing balances
maintained at Reserve Banks. Other long-term liabilities consist of accrued
postemployment, postretirement, and qualified and nonqualified pension benefits
costs and obligations on capital leases.
Effective December 31, 2006, the Reserve Banks implemented the Financial
Accounting Standard Board’s (FASB) Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and

Federal Reserve Banks

Other Postretirement Plans (codified in FASB Accounting Standards Codification
(ASC) Topic 715 (ASC 715), Compensation–Retirement Benefits), which requires
an employer to record the funded status of its benefit plans on its balance sheet. In
order to reflect the funded status of its benefit plans, 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. This resulted in an adjustment to
the pension and benefit plans 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), which is included in equity. The
Reserve Bank priced services recognized a net pension asset in 2010 and 2009. The
increase in the funded status resulted in a corresponding decrease in accumulated
other comprehensive loss of ($210.7) million in 2010.
To satisfy the FDIC requirements for a well-capitalized institution, equity is
imputed at 10 percent of total risk-weighted assets.
(4) Revenue
Revenue represents fees charged 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 of the Board
of Governors related to the development of priced services. Board expenses were
$7.2 million in 2010 and $7.8 million in 2009.
Effective January 1, 1987, the Reserve Banks implemented SFAS No. 87, Employers’ Accounting for Pensions (codified in ASC 715). Accordingly, the Reserve Bank
priced services recognized qualified pension-plan operating expenses of $53.8 million in 2010 and $121.2 million in 2009. Operating expenses also include the nonqualified pension expense of $4.4 million in 2010 and $2.3 million in 2009. The
implementation of SFAS No. 158 (ASC 715) 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.
As a result, these expenses do not include amounts related to changes in the
funded status of the Reserve Banks’ benefit plans, which are reflected in AOCI
(see note 3).

137

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97th Annual Report | 2010

The income statement by service reflects revenue, operating expenses, imputed
costs, other income and expenses, 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 2010 and 2009 as follows (in millions):

Check
ACH
Fedwire funds
Fedwire securities
Total

2010

2009

14.6
5.5
3.9
1.9
25.9

22.0
5.0
3.3
1.8
32.1

(6) Imputed Costs
Imputed costs consist of income taxes, return on equity, interest on debt, sales
taxes, an 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 serve 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 applied to the
equity on the balance sheet to impute the profit that would have been earned had
the services been provided by a private-sector firm. On October 9, 2008, the Federal Reserve began paying interest on required reserve and excess balances held by
depository institutions at Reserve Banks as authorized by the Emergency Economic Stabilization Act of 2008. Beginning in 2009, given the uncertain long-term
effect that payment of interest on reserve balances would have on the level of
clearing balances, the equity used to determine the imputed profit has been
adjusted to reflect the actual clearing balance levels maintained; previously, projections of clearing balance levels were used.
Interest is imputed on the debt assumed necessary to finance priced-service assets;
however, no debt was imputed in 2010 or 2009.
Effective in 2007, the Reserve Bank priced services imputed a one-time FDIC
assessment credit. In 2009, the credit offset $8.0 million of the imputed $11.4 million assessment, resulting in zero remaining credit. The imputed FDIC assessment
also reflects the increased rates and new assessment calculation methodology
approved in 2009, which resulted in a prepaid FDIC asset of $25.0 million in 2010
and $31.2 million in 2009 on the priced services balance sheet.
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, 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.

Federal Reserve Banks

The following shows the daily average recovery of actual float by the Reserve
Banks for 2010 in millions of dollars:
Total float
Unrecovered float
Float subject to recovery
Sources of recovery of float
As-of adjustments
Direct charges
Per-item fees

-1,795.1
1.4
-1,796.5
0.6
4.7
-1,801.8

Unrecovered float includes float generated by services to government agencies and
by other central bank services. As-of adjustments and direct charges refer to float
that is created by the observance of nonstandard 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 2010 and 2009.
(7) Other Income and Expenses
Other income and expenses consist of investment and interest income on clearing
balances and the cost of earnings credits. Investment income on clearing balances
for 2010 and 2009 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 investment return is applied to the required portion of the clearing balance. Other income also includes imputed interest on the portion of clearing balances set aside as required reserves. Expenses for earnings credits granted to
depository institutions on their clearing balances are based on a discounted average coupon-equivalent yield on three-month Treasury bills.
(8) Cost Recovery
Annual cost recovery is the ratio of revenue, including other income, to the sum of
operating expenses, imputed costs, imputed income taxes, and targeted return on
equity.

139

141

Other Federal Reserve Operations

The Board of Governors and the
Government Performance and
Results Act

performance plans, are listed below. Updated documents will be posted on the website as they are
completed.

Mission
Overview
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 measures of
performance, and discusses the evaluation of
performance.
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 validation of data and verification of
results. The performance report discusses the Board’s
performance in relation to its goals.
The strategic plan, performance plan, and performance report are available on the Board’s website, at
www.federalreserve.gov/boarddocs/rptcongress. The
Board’s mission statement and a summary of the
Federal Reserve’s strategic and performance goals, as
set forth in the most recently released strategic and

The mission of the Board is to foster the stability,
integrity, and efficiency of the nation’s monetary,
financial, and payment systems to promote optimal
macroeconomic performance.

Goals and Objectives
The Federal Reserve has six primary strategic goals
with interrelated and mutually reinforcing elements.
To achieve these strategic goals, which cover four different functional areas, the Board has established a
number of annual performance goals, which are
described in this section.
Monetary Policy Function
Strategic Goal

Conducting monetary policy that promotes the
achievement of the Federal Reserve’s statutory objectives of maximum employment and stable prices
Annual Performance Goals

Informed monetary policy: Staying abreast of recent
developments in and prospects for the U.S. and
global economies and financial markets so that monetary policy decisions are well informed
Understanding of macroeconomics and markets:
Enhancing our knowledge of the structural and
behavioral relationships in the macroeconomic and
financial markets, and improving the quality of the
data used to gauge economic performance, through
developmental research activities
Effective implementation of monetary policy: Implementing monetary policy effectively in highly unusual
economic, financial, and monetary circumstances

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97th Annual Report | 2010

Contribution to international efforts: Contributing to
the development of U.S. international policies and
procedures, in cooperation with the U.S. Department
of the Treasury and other agencies, with respect to
global financial markets, international organizations,
and participation in international groups

rations between the Board, the Federal Reserve
Banks, and other agencies and organizations

Expanded public awareness of monetary policy: Promoting understanding of Federal Reserve policy
among other government officials and the general
public

Policy: Fostering the integrity, efficiency, and accessibility of U.S. payment and settlement systems

Supervisory and Regulatory Function

Annual Performance Goals

Strategic Goals

Safety and soundness: Promoting a safe, sound, competitive, and accessible banking system and financial
stability
Consumer protection: Developing regulations, policies, and programs designed to inform and protect
consumers, to enforce federal consumer protection
laws, to strengthen market competition, and to promote access to banking services in historically underserved markets
Annual Performance Goals

Financial stability and risk containment: Promoting
overall financial stability by identifying emerging
financial problems so that significant crises can be
averted
Accessibility of the banking system: Providing 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
Financial system efficiency: Enhancing efficiency and
effectiveness by addressing the supervision function’s
procedures, technology, and resource allocation
Effective oversight of financial institutions: Promoting
the compliance of domestic and foreign banking
organizations (those under Federal Reserve supervision) with relevant laws, rules, regulations, policies,
and guidelines through a comprehensive and effective
supervision program
Consumer protection: Being a leader in, and a facilitator in helping shape the national dialogue on, consumer protection in the financial services arena
Relationship building: Promoting, developing, and
strengthening effective communications and collabo-

Payment System Policy and
Oversight Function
Strategic Goals

Oversight: Providing oversight of Reserve Banks

Effective System strategies, projects, and operations:
Producing high-quality assessments and oversight of
Federal Reserve System strategies, projects, and
operations, including adoption of technology to meet
the business and operational needs of the Federal
Reserve
Efficient, accessible payment systems: Developing
sound, effective policies and regulations that foster
the integrity, efficiency, and accessibility of payment,
clearing, and settlement systems and overseeing U.S.
dollar payment, clearing, and securities settlement
systems by assessing their risks and risk-management
approaches against relevant policy objectives and
standards
Analysis of system dynamics and risks: Conducting
research and analysis that contributes to policy development and increases the Board’s and others’ understanding of payment system dynamics and risk
Internal Board Support
Strategic Goal

Fostering the integrity, efficiency, and effectiveness of
Board programs and operations
Annual Performance Goals

High-caliber staff: Developing appropriate policies,
oversight mechanisms, and measurement criteria to
ensure that the recruiting, training, and retention of
staff meet Board needs
Fair, equal treatment of employees: Establishing,
encouraging, and enforcing a climate of fair and
equitable treatment for all employees regardless of
race, creed, color, national origin, age, or sex
Effective planning and management: Providing strategic planning and financial management support
needed for sound business decisions

Other Federal Reserve Operations

Security of information: Providing cost-effective and
secure information resource management services to
Board divisions, supporting divisional distributedprocessing requirements, and providing analysis on
information technology issues to the Board, Reserve
Banks, other financial regulatory institutions, and
central banks

143

Safe, secure work environment: Providing safe, modern, secure facilities and necessary support for activities conducive to efficient and effective Board
operations

144

97th Annual Report | 2010

Federal Legislative Developments
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Dodd-Frank Act) (Pub. L.
No. 111–203), enacted on July 21, is one of the most
significant pieces of legislation affecting the U.S.
financial regulatory framework in many years. The
act includes many of the reforms championed by the
Federal Reserve to help strengthen the financial
system and reduce the likelihood of future financial
crises. For example, the legislation creates an interagency council to monitor and coordinate responses
to emerging threats to the financial system; requires
that large bank holding companies and systemically
designated financial firms be subject to enhanced
prudential standards to reduce the risks they may
present to the financial system; provides for the consolidated supervision of all systemically important
financial institutions; gives the government an important additional tool to safely wind down financial
firms whose failure could pose a threat to U.S. financial stability; and provides for the strengthened supervision of systemically important payment, settlement,
and clearing utilities. In addition, the act enhances
the transparency of the Federal Reserve while preserving the Federal Reserve’s independence, which is
crucial to the effective implementation of monetary
policy.
The Small Business Jobs Act of 2010 (the Jobs
Act) (Pub. L. No. 111–240), enacted on September 27, established a $30-billion Small Business Lending Fund (SBLF), which is designed to promote small
business lending through Treasury investment in capital instruments issued by eligible banking
organizations.
Following is a summary of the key provisions of the
Dodd-Frank Act as they relate to the Federal
Reserve, as well as a more detailed overview of the
SBLF.

The Dodd-Frank Act
Financial Stability Oversight Council
The act establishes a new Financial Stability Oversight Council (FSOC) charged with a number of
important duties, including monitoring and identifying emerging risks to financial stability across the
entire financial system, identifying potential regulatory gaps, and coordinating the agencies’ responses
to potential systemic risks. The FSOC is composed of
the Treasury Secretary (who is also chairperson of

the FSOC); the Chairman of the Federal Reserve
Board; the heads of the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency (OCC), Securities and Exchange Commission
(SEC), Federal Deposit Insurance Corporation
(FDIC), Commodity Futures Trading Commission
(CFTC), Federal Housing Finance Agency (FHFA),
and National Credit Union Administration (NCUA);
and an independent member with insurance expertise
appointed by the President and confirmed by the
Senate.
The act instructs the FSOC to designate as systemically important large, interconnected nonbank financial companies and financial market utilities
(FMUs) that could pose a threat to U.S. financial
stability. Further, the act identifies the Board as the
consolidated supervisor of any nonbank financial
firm designated by the FSOC as systemically important (referred to in the act as “nonbank financial
companies supervised by the Board”).
The act requires the FSOC to annually report to and
testify before Congress on significant financial market and regulatory developments, potential emerging
threats to U.S. financial stability, and recommendations for promoting market discipline and maintaining investor confidence. With the submission of the
annual report to Congress, each voting member of
the FSOC must either state that he or she believes the
FSOC, the government, and the private sector are
taking all reasonable steps to ensure financial stability and mitigate systemic risk, or identify what
actions he or she believes need to be taken.
The act also establishes a new Office of Financial
Research (OFR) within the Treasury Department to
collect, standardize, and analyze data for the FSOC
and member agencies in connection with the FSOC’s
duties. The OFR will be headed by a director
appointed by the President with the advice and consent of the Senate.
Systemic Designations and Enhanced
Prudential Standards for Financial Firms
The act requires the Board to establish heightened
prudential standards for nonbank financial companies supervised by the Board and for bank holding
companies (BHCs) with assets of $50 billion or
more.1 These heightened standards must be more
stringent than the standards that apply to other non1

Foreign banking organizations that are subject to the Bank
Holding Company Act (BHC Act) and meet the asset threshold
are also subject to the Board’s heightened prudential standards.

Other Federal Reserve Operations

bank financial companies and BHCs that do not
pose similar risks to the financial system. In particular, these heightened standards must include riskbased capital and leverage requirements, liquidity
requirements, overall risk-management requirements,
concentration limits, and “living will” and credit
exposure reporting requirements. In addition to the
mandatory heightened standards, the Board may
establish standards for designated nonbank financial
companies and BHCs with assets of $50 billion or
more relating to contingent capital, enhanced public
disclosure, short-term debt limits, and such other
prudential standards as deemed appropriate.
The act also requires the Board to conduct and publish summary results of annual stress tests of systemic nonbank financial firms and BHCs with
$50 billion or more in assets. Such firms also are
required to conduct their own stress tests on a semiannual basis. The act requires financial firms with
more than $10 billion in assets to conduct annual
stress tests in accordance with regulations established
by the respective primary federal financial regulatory
agency.
Changes to Banking
Regulation and Supervision
The act makes a variety of changes to the laws
designed to protect the safety and soundness of
banking organizations and that are administered by
the Federal Reserve. For example, section 171 of the
act establishes floors for regulatory capital requirements applied to domestic BHCs, savings and loan
holding companies (SLHCs), and designated nonbank financial companies supervised by the Board.
Specifically, section 171 requires the minimum leverage and risk-based capital requirements for such
institutions to be no lower than the requirements
applied to insured depository institutions at any time
in the future and not quantitatively lower than the
requirements applied to insured depository institutions on July 21, 2010. The Board’s Basel II
Advanced rules, proposed on December 15, 2010,
incorporate the floors prescribed by the act. In addition, the act sets guidelines for whether certain
instruments may be counted as regulatory capital.
Sections 608, 609, and 615 of the act enhance the
limitations on transactions among a BHC, a subsidiary bank, and its affiliates. Specifically, the act clarifies that a “covered transaction” for the purposes of
sections 23A and 23B of the Federal Reserve Act
includes any credit exposure of a bank to an affiliate
arising from derivative transactions or securities bor-

145

rowing and lending transactions with such affiliate.
In addition, the act eliminates certain exemptions
from sections 23A and 23B for subsidiaries of BHCs
and requires that any purchase of assets by a bank
from an insider must be on market terms.
The act also requires the Board to incorporate a
financial stability factor into certain regulatory determinations. Specifically, for certain transactions governed by the Bank Holding Company Act and Bank
Merger Act, sections 163 and 604 require the Board
to take into account risks to the stability of the U.S.
banking or financial system. Moreover, section 173
adds financial stability to the list of factors that the
Board may consider when acting on an application
by a foreign bank to open an office in the United
States. Specifically, the Board may consider whether
the foreign bank’s home country has adopted or is
making demonstrable progress toward adopting a
financial regulatory system that mitigates risk to the
stability of the U.S. financial system. Section 604 of
the act authorizes the Board to incorporate financial
stability into its supervision of BHCs.
Section 606(a) of the act provides that a BHC must
be well capitalized and well managed at the holding
company level in order to become and remain a
financial holding company (FHC) eligible to engage
in expanded activities. In addition, section 163(b)
provides that in order to use authority under section 4(k) of the Federal Reserve Act to acquire a
nonbank company with $10 billion or more in assets,
a nonbank financial company that is supervised by
the Board or a BHC with $50 billion or more in consolidated assets must obtain the Board’s prior
approval. Further, section 164 applies restrictions on
management interlocks to nonbank financial companies supervised by the Board.
Section 956 of the act requires the Board to issue a
joint rulemaking or guidance with other federal regulators to prohibit incentive-based compensation
arrangements at institutions with $1 billion or more
in assets (covered financial institutions) that encourage inappropriate risks by providing excessive compensation, or potentially leading to material financial
loss. In addition, the regulations or guidance must
require covered financial institutions to disclose to
their appropriate federal regulator sufficient information concerning the structure of incentive-based compensation arrangements to monitor compliance with
these restrictions. These new regulations or guidelines
will supplement the guidance the Board and other
federal banking regulators issued on June 21,

146

97th Annual Report | 2010

2010, to ensure that incentive compensation arrangements at financial organizations take into account
risk and are consistent with safe and sound practices.
Section 165(d) requires the Board and the FDIC to
jointly issue a rule requiring that nonbank financial
companies supervised by the Board and BHCs with
$50 billion or more in total consolidated assets prepare and update plans for orderly resolution under
the Bankruptcy Code and report (1) credit exposures
to other significant financial firms and (2) credit
exposures of significant financial firms to the reporting company.
Further, the act generally eliminates the limitations
under the Gramm-Leach-Bliley Act that restricted
the Board’s ability to examine, obtain reports from,
or take enforcement action against a functionally
regulated subsidiary of a BHC, such as a brokerdealer or insurance company. The Board, however,
must continue to rely on examinations conducted by
the subsidiary’s primary bank supervisors or functional regulators to the fullest extent possible and
notify such supervisors before conducting an examination of the subsidiary.
Separately, section 605 of the act requires the Board
to examine the activities of nonbank subsidiaries of
BHCs—other than functionally regulated subsidiaries—that are permissible for the organization’s subsidiary banks in the same manner, subject to the
same standards, and with the same frequency as if
such activities were conducted in the organization’s
lead subsidiary depository institution. Section 612 of
the act prohibits a depository institution that is subject to a formal enforcement order or memorandum
of understanding with respect to a significant supervisory matter from converting its charter unless the
current and proposed supervisors establish a plan
that addresses the problems at the depository institution and that will be implemented and monitored by
the new supervisor.
Section 939A of the act requires all federal agencies
to review their regulations, including capital rules,
and remove any reference to credit ratings. Each
agency must substitute an alternative standard of
credit-worthiness that it deems appropriate. On
August 10, 2010, the federal banking agencies issued
an advance notice of proposed rulemaking regarding
alternatives to the use of credit ratings in risk-based
capital rules for banking organizations.

Finally, effective July 21, 2011, section 627 of the act
repeals the prohibition on payment of interest on
demand deposits currently implemented by the
Board’s Regulation Q.
Savings and Loan Holding Companies
The act transfers all supervisory and regulatory
authority over SLHCs to the Board from the Office
of Thrift Supervision (OTS). Effective on July 21,
2011, the act grants the Board the authority to examine, obtain reports from, and establish consolidated
capital standards for SLHCs. The FDIC and OCC
will exercise similar authority over thrift institutions.
On January 25, 2011, the Board, in conjunction with
the OTS, OCC, and FDIC, issued a report to Congress on the agencies’ plans to implement the transfer
of OTS authorities.
The act contains several provisions designed to preserve the traditional separation of banking and commercial activities and support the Board’s supervision and regulation of SLHCs. First, the act provides
that an SLHC will be allowed to conduct expanded
activities permissible to an FHC, such as insurance
underwriting, only if such SLHC satisfies the same
capital, managerial, and Community Reinvestment
Act criteria that govern whether a BHC qualifies as
an FHC. In addition, the act instructs the Board to
issue regulations establishing criteria for determining
when a grandfathered unitary SLHC that engages in
commercial activities must form an intermediate
holding company (IHC) through which to conduct
its financial activities. Such IHCs would be subject to
Board supervision as an SLHC, and the Board may
promulgate regulations to restrict or limit transactions between the IHC and any affiliate.
The “Volcker Rule”: Prohibitions against
Proprietary Trading and Other Activities
Section 619 of the act generally prohibits banking
entities from engaging in proprietary trading or from
investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund. Proprietary trading does not include transactions
entered into on behalf of customers or in connection
with underwriting or market-making-related activities, risk-mitigating hedging activities, or investments
in small business investment companies or other similar qualifying investments. The act also provides that
nonbank financial companies supervised by the
Board that engage in such activities or have such
investments will be subject to additional capital

Other Federal Reserve Operations

requirements, quantitative limits, or other restrictions. These prohibitions and other provisions of section 619 are commonly known as the “Volcker Rule.”
As required by the act, on January 18, 2011, the
FSOC issued a study and made recommendations on
the implementation of the Volcker Rule. The Board,
OCC, FDIC, CFTC, and SEC are responsible for
developing and adopting regulations to implement
the prohibitions and restrictions of the Volcker Rule,
and must adopt implementing rules not later than
October 18, 2011.
The Board alone is responsible for adopting rules to
implement the conformance provisions of the Volcker Rule, which provide a banking entity or a nonbank financial company supervised by the Board a
period of time after the effective date of the Volcker
Rule to bring its activities into compliance with the
Volcker Rule and the agencies’ implementing regulations. On February 9, 2011, the Board issued a final
rule implementing the conformance period.
Financial Sector Concentration Limit
Section 622 of the act establishes a financial sector
concentration limit that generally prohibits a financial company from merging or consolidating with, or
acquiring, another company if the resulting company’s consolidated liabilities would exceed 10 percent
of the aggregate consolidated liabilities of all financial companies. As required by the act, on January 18, 2011, the FSOC completed a study of the
concentration limit’s effect on financial stability and
other factors and made recommendations regarding
modifications to the concentration limit that the
FSOC believes would more effectively implement section 622.
The Board is required to adopt regulations to implement the financial sector concentration limit that
reflect, and are in accordance with, the FSOC’s recommendations. The Board must prescribe these rules
no later than October 18, 2011.
Regulation of Derivatives
Markets and Products
The act makes a number of significant changes to the
regulation of derivatives, which it refers to as
“swaps” and “security-based swaps,” and participants in the derivatives markets. The act divides the
regulation of the derivatives markets between the
SEC, which will regulate security-based swaps, and
the CFTC, which will regulate all other swaps. The

147

act generally requires (1) all standardized derivatives
to be centrally cleared and traded on an exchange or
registered execution facility; (2) all derivatives to be
reported to registered data repositories; (3) all derivatives dealers (“swap dealers”) and major market participants (“major swap participants”) to register with
the SEC and/or the CFTC; and (4) the establishment
of new, regulated organizations to support the
derivatives market, including exchanges, clearing
organizations, and data repositories. In general, the
act mandates that the SEC and CFTC consult with
the Board before issuing rules to implement the new
regulatory regime applicable to derivatives.
In addition, the Board and the other federal banking
agencies are required to adopt joint rules that establish capital and margin requirements for banks,
BHCs, SLHCs, foreign banks, foreign bank branches,
and Edge Act and agreement corporations that are
swap dealers or major swap participants.
Derivatives “Push-Out”
Section 716 of the act, commonly referred to as the
derivatives “push-out” provision, prohibits banks
and other institutions receiving certain kinds of federal assistance from engaging in derivatives activities,
except for derivatives used for hedging or other riskmitigating purposes and derivatives involving interest
or other rates; derivatives that reference assets that
are eligible for bank investment (including foreign
exchange, gold, and silver); and cleared credit default
swaps. These institutions will be required to push out
all other derivatives activities, including derivatives
on agricultural commodities, energy, and other metals; equity derivatives; and uncleared credit default
swaps to a separately capitalized affiliate. The Board
and the other federal banking agencies must establish
a transition period of up to 24 months after the effective date of the derivatives push-out provision for
institutions to bring their activities into compliance
with the derivatives push-out restrictions.
Credit-Risk Retention Study and Regulations
Section 941(b) of the act imposes certain credit-risk
retention obligations on securitizers or originators of
assets securitized through the issuance of assetbacked securities. Section 941 also requires the
Board, in conjunction with other federal agencies, to
jointly prescribe regulations implementing these
credit-risk retention requirements. On October 19,
2010, the Board issued a report on the effect of the
new risk-retention requirements to be developed and
implemented by the federal agencies, and of State-

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97th Annual Report | 2010

ments of Financial Accounting Standards Nos. 166
and 167.2 The report highlights the significant differences in market practices and performance across
securitizations backed by different types of assets.
Payment, Settlement, and Clearing
Activities and Utilities
Sections 112(a)(2)(J) and 804(a) of the act give the
FSOC the authority to identify and designate as systemically important an FMU if the FSOC determines that failure of or a disruption to the FMU
could create or increase the risk of significant liquidity or credit problems spreading among financial
institutions or markets and thereby threaten the stability of the U.S. financial system. In addition, the
FSOC may designate payment, clearing, or settlement activities it determines are systemically important. On November 23, 2010, the FSOC issued an
advanced notice of proposed rulemaking on the criteria and analytical framework that it should apply in
designating FMUs under the act.
In addition, section 805(a) of the act authorizes the
Board to prescribe risk-management standards governing the operations of designated FMUs (except
for designated FMUs that are registered with the
CFTC as derivative clearing organizations or registered with the SEC as clearing agencies, which are
subject to the applicable risk-management standards
contained in regulations prescribed by the CFTC or
SEC, respectively). Under section 807, the Board may
examine and take enforcement action against designated FMUs for which it is the supervisory agency.
In addition, the Board may consult on and participate in any examination of a designated FMU led by
another supervisory agency and recommend the
supervisory agency take enforcement action against
the designated FMU. Section 809 of the act also
authorizes the Board to require a designated FMU to
submit reports and data in order to assess the safety
and soundness of the utility and the systemic risk
that the FMU’s operations pose to the financial
system.
Section 806(a) of the act also makes designated
FMUs eligible for Federal Reserve services. Specifically, the Board may authorize a Reserve Bank to
establish and maintain an account for and provide
deposit and payment services to the designated
FMU. In addition, section 806(b) of the act states
2

See Board of Governors of the Federal Reserve System (2010),
“Report to the Congress on Risk Retention” (October), available at http://federalreserve.gov/boarddocs/rptcongress/
securitization/riskretention.pdf.

that, in unusual and exigent circumstances and when
a designated FMU demonstrates that it is unable to
secure adequate credit accommodations from other
banking institutions, the Board, after consultation
with the Secretary of the Treasury, may authorize a
Reserve Bank to provide discount and borrowing
privileges to the designated FMU.
Debit Interchange
Section 1075 of the act restricts the interchange fees
that issuers may receive for electronic debit card
transactions. Specifically, the interchange fee an
issuer receives for a particular transaction must be
reasonable and proportional to the cost incurred by
the issuer with respect to the transaction. The act
requires the Board to set standards for determining
whether an interchange fee is reasonable and proportional to the issuer’s cost and permits the Board to
adjust the interchange fee to account for an issuer’s
fraud-prevention costs. It also authorizes the Board
to prescribe regulations in order to prevent circumvention or evasion of the interchange fee restrictions.
The interchange fee restrictions do not apply to issuers that, together with affiliates, have less than
$10 billion in assets, to debit cards issued pursuant to
government-administered payment programs, or to
certain general-use prepaid cards. In addition, the act
requires the Board to prescribe rules prohibiting network exclusivity arrangements and routing restrictions in connection with electronic debit card transactions. On December 16, 2010, the Board requested
comment on proposed rules implementing section 1075 of the act.
Resolution Framework
The act creates a special resolution process that
allows the government to wind down a failing systemically important financial institution whose disorderly collapse would pose substantial risks to the
financial system and the broader economy. Specifically, title II of the act permits the FDIC to be
appointed as receiver for a failing nonbank financial
company. This optional resolution framework is triggered only by a recommendation of two-thirds of the
Federal Reserve Board and the FDIC’s board of
directors and a determination by the Secretary of the
Treasury, in consultation with the President, that
(1) the company is in default or in danger of default,
(2) the failure of the company and its resolution
under otherwise applicable federal or state law would
have serious adverse effects on financial stability in
the United States, and (3) resolution under the new
regime would avoid or mitigate these adverse effects.
The SEC would substitute for the FDIC in the rec-

Other Federal Reserve Operations

ommendation process if the firm or its largest subsidiary is a broker-dealer.
The act vests in the FDIC, as receiver for the failed
company, powers similar to those it has when acting
as a receiver for a failed bank. Specifically, the FDIC
may stabilize the company with loans or guarantees,
sell assets or operations, and transfer assets and
liabilities to a bridge company. The act requires the
FDIC to ensure that creditors and shareholders of
the failed company bear losses and that directors and
management responsible for the company’s failure
are removed. The act also allows the FDIC to obtain
temporary funding for a resolution by borrowing
from the Treasury, subject to certain limits. Importantly, any borrowings from the Treasury must be
repaid through proceeds from the sale of the failed
company’s operations. If such proceeds are insufficient to fully repay all borrowings from the Treasury,
assessments would be made on certain creditors of
the failed firm and, if necessary, on financial companies that have $50 billion or more in total assets.
Federal Reserve Lending,
Transparency, and Governance
Lending

The act eliminates the Board’s authority to authorize
a Federal Reserve Bank to extend credit to a specific
individual, partnership, or corporation under section 13(3) of the Federal Reserve Act. Importantly,
however, the act provides that the Board may authorize a Federal Reserve Bank to extend credit under
section 13(3) to an individual, partnership, or corporation as part of a program or facility with broadbased eligibility, with the approval of the Secretary of
the Treasury. The Board must, in consultation with
the Secretary of the Treasury, promulgate rules and
procedures for section 13(3) lending. Such policies
and procedures must ensure that collateral is of sufficient quality to protect taxpayers from losses, credit is
extended to provide liquidity and not to assist a failing financial company, and the Federal Reserve Bank
assigns a lendable value to all collateral for the purposes of determining that the loan is secured.
Transparency

As required by the act, on December 1, 2010, the
Board publicly identified each entity, including foreign central banks, that had participated in or
received assistance between December 1, 2007, and
July 21, 2010, through the Term Auction Facility, the
Agency Mortgage-Backed Securities Purchase Program, foreign currency liquidity swap lines, or facili-

149

ties established under section 13(3). In the case of
broad-based facilities, details provided by the Board
included the name of the borrower, the amount borrowed, the date the credit was extended, the interest
rate charged, information about collateral, and other
relevant credit terms. Similar information was provided for the draws of foreign central banks on their
dollar liquidity swap lines with the Federal Reserve.
For agency mortgage-backed securities transactions,
details included the name of the counterparty, the
security purchased or sold, and the date, amount,
and price of the transaction. Going forward, the act
requires the Board to publicly disclose certain information regarding participants in all future credit
facilities established under section 13(3), and borrowers or counterparties in discount window and open
market transactions. All such disclosure is required
within one year after the termination of any section 13(3) facility or two years after any discount
window or open market transaction occurs.
Additionally, the act directs the Government
Accountability Office (GAO) to conduct audits of
certain Federal Reserve functions. Specifically, the act
requires the GAO to conduct a one-time audit of any
liquidity program or facility established between
December 1, 2007, and July 21, 2010. GAO is
instructed to analyze the operational integrity,
accounting, financial reporting, and internal controls
of each facility; the effectiveness of security and collateral policies in mitigating risk to the Federal
Reserve and taxpayers; whether one or more specific
participants were favored over other eligible institutions; the use of contractors for the facility or program; and the existence of any conflicts of interest.
The act also allows the GAO to conduct similar
operational audits of future credit facilities and discount window and open market transactions.
The act further requires the GAO to conduct an
audit of Reserve Bank governance to examine
whether the selection process for Class B and Class C
directors fulfills the Federal Reserve Act’s public
interest requirement and whether the selection of
Class A directors by member banks creates actual or
potential conflicts of interest. Class A directors of
each Reserve Bank represent the stockholding member banks of the Federal Reserve District. Class B
and Class C directors represent the public and are
chosen by member banks and by the Board of Governors, respectively, with due, but not exclusive, consideration to the interests of agriculture, commerce,
industry, services, labor, and consumers. Class B and
Class C directors may not be officers, directors, or

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97th Annual Report | 2010

employees of any bank. In addition, Class C directors may not be stockholders of any bank. The
Board annually designates one Class C director at
each District Bank as chair of the board of directors
and another Class C director as deputy chair.
Governance

The act modifies the procedures for appointing
Reserve Bank presidents by excluding Class A directors from the appointment process. Accordingly,
Reserve Bank presidents will be chosen only by the
Class B and Class C directors. The act also prevents
the Board from delegating to the Reserve Banks certain Board responsibilities, including the establishment of policies relating to supervision and
regulation.
Pursuant to section 342 of the act, the Board, and
each Reserve Bank, has established an Office of
Minority and Women Inclusion responsible for matters relating to diversity in management, employment, and business activities.
The act also establishes a new Vice Chairman for
Supervision at the Board, to be appointed by the
President with the advice and consent of the Senate.
The Vice Chairman for Supervision will be responsible for developing policy recommendations for the
Board regarding the supervision and regulation of
financial firms, and for overseeing the supervision
and regulation of such firms. The Vice Chairman for
Supervision must also testify semiannually before
Congress.
Consumer Financial Protection
Establishment of the Consumer
Financial Protection Bureau

Title X of the act creates within the Federal Reserve
an independent Consumer Financial Protection
Bureau (CFPB) to ensure that consumers have access
to financial markets and that such markets are fair,
transparent, and competitive. The CFPB will be led
by a director selected by the President and confirmed
by the Senate. The CFPB will assume rulemaking
authority for most federal consumer protection statutes. It also will have exclusive authority to conduct
examinations, require reports, and take enforcement
actions regarding the federal consumer protection
laws with respect to nondepository institutions that
are engaged in certain markets, such as the mortgage
business, or that are otherwise larger participants in
the consumer financial services industry. With respect
to large depository institutions (with $10 billion or

more in total assets), the CFPB will have exclusive
authority to conduct examinations and require
reports and primary authority to take enforcement
actions with respect to the federal consumer protection laws. Employees of the Federal Reserve and
other federal agencies who are necessary to the
administration of federal consumer protection laws
will be transferred from their current agency to the
CFPB. The Secretary of the Treasury, in consultation
with the affected regulatory agencies, has designated
July 21, 2011, as the transfer date to the CFPB.
Additional Enhancements to
Consumer Financial Protection

The act prohibits certain mortgage lending practices
and places new restrictions on predatory lending.
Many of these statutory reforms are similar to recent
regulatory initiatives by the Board. For example,
similar to final rules issued by the Board in
August 2010, section 1403 of the act prohibits mortgage originators from receiving compensation based
on loan terms other than principal amount and from
steering consumers to unaffordable or predatory
mortgages. Other mortgage provisions in the act bear
resemblance to the Board’s 2008 rules for higherpriced loans under the Home Ownership and Equity
Protection Act and broaden some rules to apply to all
mortgages. For instance, the act prohibits creditors
from making residential mortgage loans unless the
consumer has a reasonable ability to repay the loan.
Further, section 1461 of the act requires escrow
accounts for taxes and insurance on higher-priced
first-lien mortgages. This section also amends the
Truth in Lending Act to provide a separate, higher
threshold for mortgage loans that exceed the maximum principal balance eligible for sale to Freddie
Mac in determining coverage of the escrow requirement. The Board requested comment on August 16,
2010, on a proposed rule to increase the annual percentage rate threshold used to determine whether a
mortgage lender is required to establish an escrow
account for property taxes and insurance for first-lien
jumbo mortgage loans.
In addition, the act instructs the Board to prescribe
interim final rules to ensure the independence of real
estate appraisers, with final rules to be issued jointly
by the federal banking agencies, the CFPB, and
FHFA. The Board issued such interim final rules on
October 18, 2010. The act also requires certain new
disclosures for negative amortization, adjustable rate
mortgages, and escrows.

Other Federal Reserve Operations

The Small Business Jobs Act
The Jobs Act established the SBLF and authorized
the Secretary of the Treasury to purchase up to
$30 billion in tier 1-qualifying preferred stock or
equivalents from eligible financial institutions with
no more than $10 billion in consolidated assets. The
SBLF promotes lending to small businesses by conditioning a participating institution’s dividend rate on
the amount by which it increases its small business
lending.
The dividend rate on SBLF funding will begin at
5 percent and may be reduced to as low as 1 percent,
depending on the amount by which the participating
institution increases lending to small businesses. If
the institution does not increase lending in the first
two years, however, the rate will increase to 7 percent.
After 4.5 years, the rate will increase to 9 percent

151

unless the institution has not already repaid the
SBLF funding.
To apply, eligible institutions must provide a small
business lending plan to the institution’s primary federal regulator. An institution may not participate in
the program if it or any of its subsidiary depository
institutions (as applicable) are on the FDIC’s problem bank list or have been on the list in the past 90
days. A participating institution may exit the program by repaying the SBLF funding at any time with
the approval of its primary federal regulator. Subject
to certain conditions, participating institutions may
refinance capital purchase program instruments they
previously issued to Treasury through the SBLF.3
3

For more information on the SBLF, visit the Treasury Department’s website at www.treasury.gov/resource-center/sbprograms/Pages/Small-Business-Lending-Fund.aspx.

153

Record of Policy Actions
of the Board of Governors

This report provides a summary account of policy
actions taken by the Board in 2010, as implemented
through (1) rules and regulations, (2) policy statements and other actions, (3) special liquidity facilities
and other initiatives, and (4) discount rates for
depository institutions. All actions were approved by
a unanimous vote of the Board members, unless indicated otherwise.1 More information on the actions
with italicized dates is available via the online version
of the Annual Report, from the “Reading Rooms” on
the Board’s FOIA web page, or on request from the
Board’s Freedom of Information Office.

Rules and Regulations
Regulation D
Reserve Requirements of
Depository Institutions
[Docket No. R-1381]
On April 21, 2010, the Board approved a final rule to
authorize Reserve Banks to offer interest-bearing
deposits of a specified maturity, or “term deposits,”
to institutions that are eligible to receive earnings on
balances held in their Federal Reserve accounts. Term
deposits will be offered through a Term Deposit
Facility and are intended to facilitate the conduct of
monetary policy by providing a tool for managing
the aggregate quantity of reserve balances. (See “Special Liquidity Facilities and Other Initiatives” on
page 159.) Term deposits are separate and distinct
from balances maintained in an institution’s master
account at a Reserve Bank as well as from those
maintained in an excess balance account. The Board
also approved minor amendments to its Policy on
Payment System Risk to address transactions associated with term deposits. The final rule is effective
June 4, 2010.
1

Vice Chairman Kohn’s term as Vice Chairman expired on
June 23, 2010, and he remained a member of the Board until
September 1, 2010. Vice Chair Yellen and Governor Raskin
joined the Board on October 4, 2010.

Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Regulation E
Electronic Fund Transfers
[Docket No. R-1377]
On March 19, 2010, the Board approved a final rule
to implement the gift card provisions of the Credit
Card Accountability Responsibility and Disclosure
Act (the Credit Card Act). The final rule prohibits
dormancy, inactivity, and service fees on gift cards,
unless (1) the consumer has not used the gift certificate or card for at least one year, (2) no more than
one such fee is charged per month, and (3) the consumer is given clear and conspicuous disclosures
about the fees. Expiration dates for funds underlying
gift cards must be at least five years after the date of
issuance, or five years after the date when funds were
last loaded on the card. The rule generally covers
retail gift cards, which can be used to buy goods or
services from a single merchant or an affiliated group
of merchants, and network-branded gift cards, which
are redeemable at any merchant that accepts the card
brand. The rule is effective August 22, 2010.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.
On August 10, 2010, the Board approved an interim
final rule with request for comment to implement legislation modifying the effective date of certain disclosure requirements applicable to gift cards under the
Credit Card Act. For gift certificates, store gift cards,
and general-use prepaid cards produced before
April 1, 2010, the legislation and interim final rule
delay the August 22, 2010, effective date of these disclosures until January 31, 2011, provided that several
specified conditions are met.

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97th Annual Report | 2010

Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
On October 18, 2010, the Board approved a final rule
implementing the January 31, 2011, effective date for
certain gift cards, as specified in the interim final rule.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Regulation E
Electronic Fund Transfers
Regulation DD
Truth in Savings
[Docket Nos. R-1343 and R-1315]
On May 27, 2010, the Board approved amendments
to clarify certain provisions of the November 2009
final rule on Regulation E and the December 2008
final rule on Regulation DD. In particular, the
amendments clarify that the Regulation E prohibition on assessing overdraft fees without a consumer’s
affirmative consent, or “opt in,” applies to all institutions, including those that have a policy of declining
ATM and one-time debit card transactions when an
account has insufficient funds. For Regulation DD,
the amendments address the application of the 2008
rule to retail sweep programs and clarify the terminology for overdraft fee disclosures. The amendments, which make other technical and conforming
changes, are effective July 6, 2010 (except for the
Regulation DD provision regarding the “Total Overdraft Fees” terminology, which is effective October 1,
2010).
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Regulation H
Membership of
State Banking Institutions
in the Federal Reserve System
[Docket No. R-1357]
On April 12, 2010, the Board, acting with the Federal
Deposit Insurance Corporation, Office of the Comptroller of the Currency, Office of Thrift Supervision,
National Credit Union Administration, and Farm

Credit Administration, approved final rules to implement the registration requirements of the Secure and
Fair Enforcement for Mortgage Licensing Act
(S.A.F.E. Act). Under the S.A.F.E. Act, mortgage
loan originators who are employees of agencyregulated institutions must register with the Nationwide Mortgage Licensing System and Registry and
are generally prohibited from originating residential
mortgage loans unless they register. As part of the
registration process, residential mortgage loan originators must furnish information and fingerprints for
background checks, and originators will receive a
unique identifier that will enable consumers to access
employment and other information about them from
the registry. The final rules further provide that
agency-regulated institutions must (1) require their
employees who act as residential mortgage loan originators to comply with the S.A.F.E. Act’s registration
and other requirements and (2) adopt and follow
written policies and procedures designed to ensure
compliance with these requirements. The agencies
published their final rules on July 28, 2010. The
Board also approved conforming amendments to
Regulation K (International Banking Operations) to
include an uninsured state-licensed branch or agency
of a foreign bank or commercial lending company
owned or controlled by a foreign bank and any residential mortgage loan originator that it employs. The
rules are effective October 1, 2010, and the 180-day
registration period for mortgage loan originators
subject to the agencies’ rules begins January 31, 2011.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Regulation H
Membership of
State Banking Institutions
in the Federal Reserve System
Regulation Y
Bank Holding Companies
and Change in Bank Control
[Docket No. R-1368]
On January 4, 2010, the Board, acting with the Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, and Office of Thrift
Supervision, approved final rules amending the general and advanced risk-based capital adequacy frameworks to (1) eliminate the exclusion of certain con-

Record of Policy Actions of the Board of Governors

solidated asset-backed commercial paper programs
from risk-weighted assets; (2) add a reservation of
authority permitting the agencies to require banking
organizations to treat off-balance-sheet entities as if
they were consolidated for risk-based capital purposes; and (3) provide for an optional two-quarter
delay, followed by an optional two-quarter partial
implementation period, for most of the effects on
risk-weighted assets and tier 2 capital resulting from
a banking organization’s implementation of Financial Accounting Standards Nos. 166 and 167. The
final rule is effective March 29, 2010. Banking organizations may elect to comply with the rule as of the
beginning of their first annual reporting period that
begins after November 15, 2009.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Regulation Z
Truth in Lending
[Docket No. R-1384]
On June 14, 2010, the Board approved a final rule to
implement certain provisions of the Credit Card Act
intended to ensure that penalty fees imposed by
credit card issuers are reasonable and proportional to
the violation. Among other changes, the rule (1) prohibits credit card issuers from charging a penalty fee
of more than $25 if a consumer pays late or otherwise violates the account’s terms, unless the consumer has engaged in repeated violations or the
issuer can show that a higher fee represents a reasonable proportion of the costs it incurred as a result of
the violations; (2) prohibits issuers from charging
penalty fees that exceed the dollar amount associated
with a consumer’s violation; (3) prevents issuers from
charging multiple penalty fees based on a single late
payment or other violation of the account terms; and
(4) bans “inactivity” fees, such as fees based on a
consumer’s failure to use the account to make new
purchases. The rule also requires credit card issuers
that have increased rates since January 1, 2009, to
evaluate whether the reasons for the increase have
changed and, if appropriate, to reduce the rate. The
rule is effective August 22, 2010.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

155

[Docket No. R-1378]
On August 1, 2010, the Board approved a final rule to
implement a requirement in the Helping Families
Save Their Homes Act that consumers receive written
notice after their mortgage loan has been sold or
transferred. Under the act, a purchaser or assignee
that acquires a mortgage loan must provide the
required disclosures in writing within 30 days. The
final rule is effective January 1, 2011.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
[Docket No. R-1366]
On August 11, 2010, the Board approved an interim
rule with request for comment that revises the disclosure requirements for closed-end mortgage loans.
Under the interim rule, which implements certain
requirements of the Mortgage Disclosure Improvement Act, creditors extending consumer credit
secured by real property or a dwelling must disclose
certain summary information about interest rates and
payment changes in a tabular format, including the
initial interest rate together with the corresponding
monthly payment. The disclosures must also include
a statement that consumers might not be able to
avoid increased payments by refinancing their loans.
For adjustable-rate or step-rate loans, creditors must
disclose the maximum interest rate and payment that
can occur during the first five years and a “worstcase” example showing the possible maximum rate
and payment due over the life of the loan. The rule
also requires creditors to disclose certain features,
such as balloon payments or options to make only
minimum payments, that will cause loan amounts to
increase. The interim final rule is effective October 25, 2010, and compliance is mandatory January 30, 2011.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
On December 21, 2010, the Board approved an
interim rule with request for comment to clarify certain aspects of the August 11, 2010, interim rule
(published in September 2010), in response to public
comments. This revised interim rule is effective January 30, 2011, and compliance is mandatory October 1, 2011.

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97th Annual Report | 2010

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.
[Docket No. R-1366]
On August 11, 2010, the Board approved a final rule
to protect mortgage borrowers from unfair or abusive
lending practices that can arise from certain loanoriginator compensation practices. The final rule prohibits payments to loan originators, including mortgage brokers and loan officers, that are based on the
terms or conditions of a transaction, other than the
amount of credit extended. The final rule also prohibits a loan originator receiving compensation
directly from a consumer from also receiving compensation from the lender or another party. In addition, the final rule prohibits loan originators from
directing, or “steering,” consumers to a loan that is
not in the consumer’s interest in order to increase the
originator’s compensation. The final rule is effective
April 1, 2011.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
[Docket No. R-1394]
On October 18, 2010, the Board approved an interim
final rule with request for comment to implement
provisions of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (the Dodd-Frank
Act) that establish new requirements for appraiser
independence in consumer credit transactions
secured by a consumer’s principal dwelling. The rule
ensures that real estate appraisers are free to use their
independent professional judgment, without influence or pressure from parties who may have an interest in a transaction. The rule also seeks to ensure that
appraisers receive customary and reasonable payments for their services. Among other provisions, the
interim final rule (1) prohibits coercion and other
similar actions designed to cause appraisers to base
the appraised value of properties on factors other
than their independent judgment, (2) prohibits
appraisers and appraisal management companies
hired by lenders from having financial or other interests in the properties or the credit transactions, and
(3) requires creditors or settlement service providers
that have information about appraiser misconduct to
file reports with the appropriate state licensing
authorities. The interim final rule is effective December 27, 2010, and compliance is mandatory April 1,
2011.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Regulation Z
Truth in Lending
Regulation AA
Unfair or Deceptive Acts or Practices
[Docket Nos. R-1370, R-1286, and R-1383]
On January 7, 2010, the Board approved a final rule
amending Regulation Z to implement certain provisions of the Credit Card Act. The final rule protects
consumers who use credit cards from a number of
costly practices. In particular, the rule (1) protects
consumers from unexpected increases in credit card
interest rates by generally prohibiting increases in a
rate during the first year after an account is opened
and increases in a rate that applies to an existing
credit card balance; (2) prohibits creditors from issuing a credit card to a consumer who is younger than
the age of 21, unless certain requirements are met;
(3) requires creditors to obtain a consumer’s consent
before charging fees for transactions that exceed the
credit limit; (4) limits the high fees associated with
subprime credit cards; and (5) prohibits creditors
from allocating payments in ways that maximize
interest charges. In addition, the rule bans creditors
from imposing interest charges using the “two-cycle”
billing method, in which charges are based on balances on days in the current billing cycle and in the
previous billing cycle. The Board also withdrew certain amendments to Regulation Z and Regulation AA because those amendments were superseded.
The final rule is effective February 22, 2010. Compliance with most aspects of the rule is mandatory
July 1, 2010, although compliance with certain provisions is mandatory February 22, 2010.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Regulation BB
Community Reinvestment
[Docket No. R-1360]
On August 31, 2010, the Board, acting with the Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, and Office of Thrift

Record of Policy Actions of the Board of Governors

Supervision, approved a joint final rule to implement
a provision of the Higher Education Opportunity
Act that requires the agencies to consider low-cost
education loans provided to low-income borrowers
when assessing an institution’s record of meeting
community credit needs under the Community Reinvestment Act (CRA). The joint final rule also incorporates a CRA provision that allows the agencies to
consider a financial institution’s capital investment,
loan participation, and other ventures undertaken in
cooperation with minority- or women-owned financial institutions and low-income credit unions as a
factor when assessing the institution’s CRA record.
The joint final rule is effective November 3, 2010.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
[Docket No. R-1387]
On November 22, 2010, the Board, acting with the
Federal Deposit Insurance Corporation, Office of
the Comptroller of the Currency, and Office of
Thrift Supervision, approved a joint final rule
amending the agencies’ CRA regulations to revise the
term “community development” to include loans,
investments, or services of the type eligible for funding under the Neighborhood Stabilization Program
that benefit certain areas designated by the Department of Housing and Urban Development. The joint
final rule is effective January 19, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Rules Regarding
Access to Personal Information
under the Privacy Act of 1974
[Docket No. R-1313]
On October 4, 2010, the Board approved a final rule
amending its Privacy Act regulation to waive copying
fees for Privacy Act requests by current or former
Board employees or applicants for Board employment and to permit current and former Board
employees to make Privacy Act requests in person or
in writing to the Board office that maintains the
record. The rule also permits certain consultations
regarding the disclosure of medical records, changes
the time limits for responding to requests for access
to information, updates exemptions, and makes

157

minor editorial and technical changes for clarity and
consistency with the Board’s published systems of
records. The final rule is effective October 18, 2010.
Voting for this action: Chairman Bernanke and
Governors Warsh, Duke, and Tarullo.

Policy Statements and Other Actions
Maximum Maturity of
Primary Credit Loans
On February 17, 2010, the Board approved a reduction in the maximum maturity of primary credit
loans at the discount window for most depository
institutions from 28 days to overnight, effective
March 18, 2010. Before August 2007, the maximum
available term of primary credit was generally overnight but was subsequently lengthened in order to
enhance banks’ access to term funds and thus support their ability to lend to households and businesses. The maximum available term was lengthened
to 30 days (on August 17, 2007) and to 90 days (on
March 16, 2008) and then shortened to 28 days (on
November 12, 2009).
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Interagency Questions and Answers
Regarding Community Reinvestment
[Docket No. OP-1349]
On March 1, 2010, the Board, acting with the Federal
Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision, approved final revised Interagency Questions
and Answers Regarding Community Reinvestment.
The revisions include examples of ways an institution
could determine that its community services are targeted to low- and moderate-income individuals and a
discussion of reporting requirements for community
development loans. The revised questions and
answers, which consolidate and supersede the agencies’ previously published versions, are effective
March 11, 2010.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

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97th Annual Report | 2010

Interagency Policy Statement on
Funding and Liquidity Risk Management

Guidance on Sound Incentive
Compensation Policies

[Docket No. OP-1362]

[Docket No. OP-1374]

On March 12, 2010, the Board, acting with the Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, Office of Thrift Supervision, National Credit Union Administration, and
the Conference of State Bank Supervisors, approved
an interagency statement to provide depository institutions with consistent supervisory expectations
regarding sound practices for managing funding and
liquidity risk. The policy statement summarizes the
agencies’ past principles in this area, and when
appropriate, supplements them with the “Principles
for Sound Liquidity Risk Management and Supervision,” issued by the Basel Committee on Banking
Supervision in September 2008.

On June 16, 2010, the Board, acting with the Federal
Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision, approved final interagency guidance on incentive compensation policies at banking organizations.
The guidance is designed to ensure that incentive
compensation arrangements do not encourage
imprudent risk taking and do not undermine the
safety and soundness of the organization or create
undue risks to the financial system. The guidance
applies not only to top-level managers but also to
other employees who have the ability to materially
affect the risk profile of an organization, either individually or as part of a group. The guidance is effective June 25, 2010.

Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Correspondent Concentration Risks
[Docket No. OP-1369]
On April 26, 2010, the Board, acting with the Federal
Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision, approved final interagency guidance on managing concentration risks arising from correspondent
banking relationships. The guidance highlights the
need for financial institutions to identify, monitor,
and manage credit and funding concentrations to
other institutions on a stand-alone and organizationwide basis. In addition, the guidance addresses the
supervisory expectation that financial institutions
should perform appropriate due diligence on all
credit exposures to, and funding transactions with,
other financial institutions as part of their riskmanagement policies and procedures. The policy is
effective May 4, 2010.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

Reverse Mortgage Products:
Guidance for Managing
Compliance and Reputation Risks
On August 2, 2010, the Board approved final interagency guidance, issued by the Federal Financial
Institutions Examination Council on behalf of its
members, addressing reverse mortgages, which are
loan products typically offered to elderly consumers.
The guidance emphasizes the consumer protection
concerns raised by these products and stresses the
importance of mitigating their compliance and reputational risks. The guidance is effective October 18,
2010.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.

Community Depository Institutions
Advisory Council
On September 10, 2010, the Board approved the
establishment of an advisory council to represent
insured community depository institutions. Members
of the Community Depository Institutions Advisory
Council (CDIAC) will be selected from the representatives of banks, thrift institutions, and credit unions
who serve on newly created local advisory councils at
the 12 Reserve Banks. CDIAC will replace the Thrift

Record of Policy Actions of the Board of Governors

Institutions Advisory Council. The Reserve Bank
councils are expected to begin meeting in 2011, with
meetings of CDIAC to follow later in the year.
Voting for this action: Chairman Bernanke and
Governors Warsh, Duke, and Tarullo.

Office of Financial Stability
Policy and Research
On October 26, 2010, the Board approved the establishment of the Office of Financial Stability Policy
and Research to bring together economists, banking
supervisors, markets experts, and other Federal
Reserve staff to support the Board’s financial stability responsibilities, including its expanded responsibilities in this area under the Dodd-Frank Act. The
office will develop and coordinate staff efforts to
identify and analyze potential risks to the financial
system and the broader economy by, among other
activities, monitoring asset prices, leverage, financial
flows, and other market-risk indicators; following
developments at key institutions; and analyzing policies to promote financial stability. It will also support
the supervision of large financial institutions and the
Board’s participation on the Financial Stability Oversight Council.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Interagency Appraisal and
Evaluation Guidelines
[Docket No. OP-1338]
On December 1, 2010, the Board, acting with the
Federal Deposit Insurance Corporation, Office of
the Comptroller of the Currency, Office of Thrift
Supervision, and National Credit Union Administration, approved final supervisory guidance on sound
practices by financial institutions for real estate
appraisals and evaluations. The guidelines, which
replace 1994 appraisal guidelines, (1) address the
agencies’ recent supervisory issuances on appraisal
practices; (2) address advancements in information
technology used in collateral valuation practices; and
(3) clarify standards for the industry’s appropriate
use of analytical methods and technological tools in
developing evaluations. Financial institutions should
review their appraisal and evaluation programs to
ensure they are consistent with the guidelines. The
guidelines are effective December 10, 2010.

159

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Office of Diversity and Inclusion
On December 16, 2010, the Board approved the
establishment of the Office of Diversity and Inclusion in accordance with a provision of the DoddFrank Act that also applies to the Reserve Banks and
other federal financial regulatory agencies. The office
will incorporate the activities of the Board’s current
Equal Employment Opportunity Programs Office, as
well as foster diversity in the Board’s procurements
and assist with developing standards to assess the
diversity practices of the entities the Board regulates.
The office will work with Board staff in areas that
include procurement, staffing, banking supervision
and regulation, and consumer and community affairs
to carry out its statutory responsibilities.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

Special Liquidity Facilities
and Other Initiatives
Special Liquidity Facilities
On January 27, 2010, the Federal Reserve announced
that the following special liquidity facilities would
close as scheduled on February 1, 2010, in light of
improved functioning of financial markets: AssetBacked Commercial Paper Money Market Mutual
Fund Liquidity Facility, Commercial Paper Funding
Facility, Primary Dealer Credit Facility, and Term
Securities Lending Facility. The Federal Reserve also
announced the final Term Auction Facility (TAF)
amounts and dates ($50 billion in 28-day credit on
February 8 and $25 billion in 28-day credit on
March 8, 2010) and affirmed that the expiration
dates for the Term Asset-Backed Securities Loan
Facility (TALF) remained set at June 30, 2010, for
loans backed by newly issued commercial mortgagebacked securities and March 31, 2010, for loans
backed by all other types of collateral. For more
information on the establishment and purposes of
these and the Federal Reserve’s other special facilities
and initiatives, see the Annual Reports for 2008 and
2009.

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97th Annual Report | 2010

On February 17, 2010, the Board approved an
increase in the minimum bid rate for the TAF from
¼ percentage point to ½ percent for the final auction
on March 8, 2010. (See “Discount Rates for Depository Institutions in 2010” on page 161 for further discussion of the TAF.)
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.
On July 9, 2010, the Board approved a request by the
Department of the Treasury (Treasury) to reduce
from $20 billion to $4.3 billion the credit protection
provided for the TALF under the Troubled Asset
Relief Program (TARP). Any losses on the TALF
program, which closed on June 30, 2010, with
$43 billion in loans outstanding, would first be
absorbed by the accumulated excess of the TALF
loan interest payments over the Federal Reserve’s
cost of funds and then by the TARP funds.
Voting for this action: Chairman Bernanke and
Governors Kohn, Warsh, Duke, and Tarullo.
On December 1, 2010, the Board posted detailed
information on its public website about transactions
conducted through the Federal Reserve’s special
liquidity facilities from December 1, 2007, to July 21,
2010, in accordance with the Dodd-Frank Act. Similar transaction-level detail was provided for the Federal Reserve’s dollar liquidity swaps with foreign central banks and for purchases of agency mortgagebacked securities. The transaction-level details
available include the name of the institution, the
amount of the transaction, the interest rate charged,
information about collateral, and other relevant
terms of the programs.

Other Initiatives
American International Group, Inc.
On September 29, 2010, the Board authorized the
Federal Reserve Bank of New York (Reserve
Bank) to enter into a recapitalization plan for the
American International Group, Inc. (AIG). The
recapitalization plan is designed to restructure and
facilitate repayment of the financial support provided
to AIG by the Reserve Bank and Treasury. The plan
consists of the following basic terms:
• Repayment of the outstanding balance (including
all accrued interest and fees) on AIG’s revolving
credit facility with the Reserve Bank on an acceler-

ated basis using the cash proceeds from the dispositions of certain AIG assets, notably the initial public offering of the AIA Group Limited (AIA) and
the sale of American Life Insurance Company
(ALICO), and termination of the facility.
• AIG’s purchase of up to $22 billion of the Reserve
Bank’s preferred interests in two special-purpose
vehicles that owned AIA and ALICO, respectively
(the Reserve Bank had earlier taken the preferred
interests in partial repayment of the revolving
credit facility). To fund the purchase of the preferred interests, AIG would draw on Treasury’s
preferred stock commitment for AIG under the
TARP and then transfer the preferred interests to
Treasury in consideration for the TARP funding.
• Repayment of the Reserve Bank’s remaining preferred interests with the proceeds of the dispositions of AIA and ALICO, and retention of any
unpaid preferred interests by the Reserve Bank.
• Conversion of Treasury’s outstanding preferred
equity interests in AIG into common stock
of AIG.
• Conversion of the preferred equity interest issued
by AIG and held to the AIG Credit Facility Trust
as a condition of the Reserve Bank’s revolving
credit facility into common stock of AIG and
transfer of the common stock to Treasury.
Voting for this action: Chairman Bernanke and
Governors Warsh, Duke, and Tarullo.
Term Deposit Facility
On May 7, 2010, the Board approved up to five
small-value offerings of term deposits under the
Term Deposit Facility (TDF). (The Board had previously authorized Reserve Banks to offer term deposits to eligible institutions. See “Rules and
Regulations” on page 153.) The small-value offerings
are designed to ensure the effectiveness of TDF
operations and provide eligible institutions with an
opportunity to gain familiarity with term deposit
procedures. The Board also approved a basic structure for the small-value TDF offerings. Similar to
many money market instruments, the term deposits
offered will be simple fixed-rate instruments with
maturities of 84 days or less and will be issued primarily through competitive single-price auctions.
TDF offerings will also include a noncompetitive
bidding option to ensure access to term deposits for
smaller institutions.

Record of Policy Actions of the Board of Governors

Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.
On September 7, 2010, the Board approved a program of ongoing small-value TDF auctions.
Although the terms and frequency of these auctions
may evolve over time, the Board anticipates that they
will be held about every other month.
Voting for this action: Chairman Bernanke and
Governors Warsh, Duke, and Tarullo.

Discount Rates for Depository
Institutions in 2010
Under the Federal Reserve Act, the boards of directors of the Federal Reserve Banks must establish
rates on discount window loans to depository institutions at least every 14 days, subject to review and
determination by the Board of Governors.

Primary Credit
Primary credit, the Federal Reserve’s main lending
program for depository institutions, 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
and 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.
Over the period from mid-August 2007 to early 2010,
the Federal Reserve allowed depository institutions
to borrow primary credit for longer periods to
address liquidity pressures during the financial crisis.
At the beginning of 2010, the maximum maturity of
primary credit was 90 days, renewable by the borrower. Effective January 14, 2010, the maximum
maturity of such financing was reduced to 28 days in
light of improvement in financial market conditions.
On February 18, 2010, the Board announced a further reduction in the typical maturity for primary
credit loans to overnight effective March 18, 2010.

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
2010, 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 money-market yields, typically
resulting in a rate close to the federal funds rate
target.
At year-end, the secondary and seasonal credit rates
were 1¼ percent and ¼ percent, respectively.3

Term Auction Facility Credit
In December 2007, the Federal Reserve established a
temporary Term Auction Facility (TAF). Under the
TAF, the Federal Reserve auctioned term funds to
depository institutions that were in generally sound
financial condition and were eligible to borrow under
the primary credit program. The amount of each
auction was determined in advance by the Federal
Reserve, and the interest rate on TAF credit was
determined as the rate at which all bids could be fulfilled, up to the maximum auction amount and subject to a minimum bid rate. Originally, the minimum
bid rate for TAF auctions was determined based on a
measure of the average expected overnight federal
funds rate over the term of the credit being auctioned. For TAF auctions from January 2009 to February 2010, the minimum bid rate was set at a level
equal to the rate of interest that banks earn on excess
reserve balances, which was ¼ percent over this
period. On February 18, 2010, the Board announced
that it had raised the minimum bid rate to ½ percent.
On June 25, 2009, in light of the improvement in
financial conditions and reduced usage of the TAF,
the Federal Reserve trimmed the size of upcoming
TAF auctions. The Federal Reserve anticipated that,

During 2010, the Board approved one change to the
primary credit rate, an increase from ½ percent to
¾ percent effective February 19, 2010.2
2

From the inception of the primary credit program in 2003
through mid-2007, the spread of the primary credit rate over the

161

3

FOMC’s target rate was ordinarily 100 basis points. In
August 2007, the Board approved a narrowing of this spread to
50 basis points and in 2008, approved a further narrowing to
25 basis points. The 2010 increase in the primary credit rate
widened the spread back to 50 basis points. Throughout 2010,
the FOMC maintained a target range for the federal funds rate
of 0 to ¼ percent.
For current and historical discount rates, see www
.frbdiscountwindow.org/.

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97th Annual Report | 2010

if market conditions continued to improve in coming
months, TAF funding would be reduced gradually
further. Throughout the second half of 2009, the
Federal Reserve gradually reduced the amounts provided under the TAF. On January 27, 2010, the Federal Reserve announced that the final TAF auction
would take place on March 8, 2010. There were a
total of three TAF auctions held in 2010: $75 billion
in 28-day credit was offered on January 11, $50 billion in 28-day credit was offered on February 8, and
$25 billion in 28-day credit was offered at the final
auction on March 8.4

Votes on Changes to Discount Rates
for Depository Institutions
About every two weeks during 2010, the Board
approved proposals by the 12 Reserve Banks to
4

For more information on TAF auctions, including minimum
bid rates and the auction-determined rates on TAF credit, see
www.federalreserve.gov/monetarypolicy/taf.htm.

maintain the formulas for computing the secondary
and seasonal credit rates. Until the final TAF auction
was conducted, the Board also approved the auction
procedure for determining the rate for the TAF about
every two weeks. Details on the one action by the
Board to approve changes to the primary credit rate
are provided below.
February 17, 2010. Effective February 19, 2010, the
Board approved establishment of the rate for discounts and advances under the primary credit program (primary credit rate) of ¾ percent (an increase
from ½ percent) for the 12 Federal Reserve Banks.
Voting for this action: Chairman Bernanke, Vice
Chairman Kohn, and Governors Warsh, Duke,
and Tarullo.

163

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. Changes in
the instruments during the year are reported in the
minutes for the individual meetings.1
1

As of January 1, 2010, the Federal Reserve Bank of New York
was operating under the Domestic Policy Directive approved at
the December 15–16, 2009, Committee meeting and the Authorization for Domestic Open Market Operations as amended
June 23, 2009. The other policy instruments (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, 2010, were approved
at the January 27–28, 2009, meeting.

164

97th Annual Report | 2010

Meeting Held on January 26–27, 2010
A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
January 26, 2010, at 2:00 p.m. and continued on
Wednesday, January 27, 2010, at 8:30 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Christine Cumming, Charles L. Evans, Richard Fisher,
Narayana Kocherlakota, and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee
Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively
Brian F. Madigan
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist

Alan D. Barkema, Thomas A. Connors,
William B. English, Jeff Fuhrer, Steven B. Kamin,
Simon Potter, Lawrence Slifman, Mark S. Sniderman,
Christopher J. Waller, and David W. Wilcox
Associate Economists
Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Bank Supervision and
Regulation, Board of Governors
Robert deV. Frierson1
Deputy Secretary, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director
for Management, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson2
Assistant to the Board, Office of Board Members,
Board of Governors
Sherry Edwards, Andrew T. Levin, and
William R. Nelson
Senior Associate Directors, Division of Monetary
Affairs, Board of Governors
David Reifschneider and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Stephen A. Meyer
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Stephen D. Oliner
Senior Adviser, Division of Research and Statistics,
Board of Governors
Michael Leahy
Associate Director, Division of International Finance,
Board of Governors
Daniel E. Sichel
Associate Director, Division of Research and
Statistics, Board of Governors
1
2

Attended Tuesday’s session only.
Attended Wednesday’s session only.

Minutes of Federal Open Market Committee Meetings

Michael G. Palumbo
Deputy Associate Director, Division of Research and
Statistics, Board of Governors
Egon Zakrajšek
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Carol C. Bertaut
Senior Economist, Division of International Finance,
Board of Governors
Louise Sheiner
Senior Economist, Division of Research and
Statistics, Board of Governors
Mark A. Carlson and Kurt F. Lewis
Economists, Division of Monetary Affairs,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Carol Low
Open Market Secretariat Specialist, Division of
Monetary Affairs, Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Harvey Rosenblum
Executive Vice President, Federal Reserve Bank
of Dallas
David Altig, Spence Hilton, Loretta J. Mester, and
Glenn D. Rudebusch
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, New York, Philadelphia, and San Francisco,
respectively
Warren Weber
Senior Research Officer, Federal Reserve Bank
of Minneapolis
David C. Wheelock
Vice President, Federal Reserve Bank of St. Louis
Julie Ann Remache
Assistant Vice President, Federal Reserve Bank
of New York
Hesna Genay
Economic Advisor, Federal Reserve Bank of Chicago
Robert L. Hetzel
Senior Economist, Federal Reserve Bank
of Richmond

165

Annual Organizational Matters
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 26, 2010, had
been received and that these individuals had executed
their oaths of office.
The elected members and alternate members were as
follows:
William C. Dudley
President of the Federal Reserve Bank of New York,
with
Christine Cumming
First Vice President of the Federal Reserve Bank
of New York, as alternate.
Eric Rosengren
President of the Federal Reserve Bank of Boston,
with
Charles I. Plosser
President of the Federal Reserve Bank
of Philadelphia, as alternate.
Sandra Pianalto
President of the Federal Reserve Bank of Cleveland,
with
Charles L. Evans
President of the Federal Reserve Bank
of Chicago, as alternate.
James Bullard
President of the Federal Reserve Bank of St. Louis,
with
Richard Fisher
President of the Federal Reserve Bank of Dallas, as
alternate.
Thomas M. Hoenig
President of the Federal Reserve Bank of Kansas
City, with
Narayana Kocherlakota, 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 2011,
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,

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they would cease to have any official connection with
the Federal Open Market Committee:
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Brian F. Madigan
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas Baxter
Deputy General Counsel
Richard M. Ashton
Assistant General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist
Alan D. Barkema
Thomas A. Connors
William B. English
Jeff Fuhrer
Steven B. Kamin
Simon Potter
Lawrence Slifman
Mark S. Sniderman
Christopher J. Waller
David W. Wilcox
Associate Economists
By unanimous vote, the Committee amended its Program for Security of FOMC Information with the
addition of a summary of the rule that governs noncitizen access to FOMC information.

By unanimous vote, the Federal Reserve Bank of
New York was selected to execute transactions for
the System Open Market Account.
By unanimous vote, Brian Sack was selected to serve
at the pleasure of the Committee as Manager, System
Open Market Account, with the understanding that
his selection was subject to being satisfactory to the
Federal Reserve Bank of New York.
In his annual review of the Committee’s authorizations for domestic open market operations and foreign currency transactions, the Manager noted that
the Desk recommended continuing to use dollar roll
transactions in the process of settling agency
mortgage-backed securities (MBS) purchases, and
that staff proposed adding a sentence to the directive
to authorize using dollar roll transactions after
March 31 for the purpose of settling MBS purchases
executed by that date. He also noted that the Desk
intended to conduct reverse repurchase agreements
(RRPs) over the course of the coming year to ensure
the readiness of the Federal Reserve’s tools for
absorbing bank reserves. Such transactions were
authorized by the Committee’s resolution of November 24, 2009. Finally, he indicated that the Desk was
developing the capability to conduct agency MBS
administration, trading, and settlement using internal
resources, but it would continue to use agents to conduct these tasks until that capability was fully
developed.
By unanimous vote, the Committee approved the
Authorization for Domestic Open Market Operations (shown below) with amendments to paragraph
4 that allow the use of “securities that are direct obligations of, or fully guaranteed as to principal and
interest by, any agency of the United States” in temporary short-term investment transactions with foreign and international accounts and fiscal agency
accounts. The Guidelines for the Conduct of System
Open Market Operations in Federal-Agency Issues
remained suspended.

Authorization for Domestic Open Market
Operations (Amended January 26, 2010)
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:

Minutes of Federal Open Market Committee Meetings

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; and
B. To buy or sell in the open market U.S. government securities, and securities that are
direct obligations of, or fully guaranteed as to
principal and interest by, any agency of the
United States, for the System Open Market
Account under agreements to resell or repurchase such securities or obligations (including
such transactions as are commonly referred
to as repo and reverse repo transactions) 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
counterparties.
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 use agents in agency MBS-related
transactions.
3. 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 and securities that are
direct obligations of any agency of the United
States, held in the System Open Market Account,
to dealers at rates that shall be determined by
competitive bidding. The Federal Reserve 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

167

may reject bids that could facilitate a dealer’s ability to control a single issue as determined solely
by the Federal Reserve Bank of New York.
4. 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
the Federal Reserve Bank of New York:
A. For the System Open Market Account, to sell
U.S. government securities, and securities
that are direct obligations of, or fully guaranteed as to principal and interest by, any
agency of the United States, to such accounts
on the bases set forth in paragraph 1.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 the 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
securities, and securities that are direct obligations of, or fully guaranteed as to principal
and interest by, any agency of the United
States, 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.
5. 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 and to take actions
that result in material changes in the composition

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and size of the assets in the System Open Market
Account other than those anticipated by the
Committee at its most recent meeting. Any such
adjustment shall be made in the context of the
Committee’s discussion and decision at its most
recent meeting and the Committee’s long-run
objectives for price stability and sustainable economic growth, and shall be based on economic,
financial, and monetary developments during the
intermeeting period. Consistent with Committee
practice, the Chairman, if feasible, will consult
with the Committee before making any
adjustment.
By unanimous vote, the Authorization for Foreign Currency Operations, the Foreign Currency
Directive, and the Procedural Instructions with
Respect to Foreign Currency Operations were
reaffirmed in the form shown below. The vote to
reaffirm these documents included approval of
the System’s warehousing agreement with the
U.S. Treasury.

Authorization for Foreign Currency
Operations (Reaffirmed January 26, 2010)
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New
York, for the System Open Market Account, to
the extent necessary to carry out the Committee’s
foreign currency directive and express authorizations by the Committee pursuant thereto, and in
conformity with such procedural instructions as
the Committee may issue from time to time:
A. To purchase and sell the following foreign
currencies in the form of cable transfers
through spot or forward transactions on the
open market at home and abroad, including
transactions with the U.S. Treasury, with the
U.S. Exchange Stabilization Fund established
by section 10 of the Gold Reserve Act of
1934, with foreign monetary authorities, with
the Bank for International Settlements, and
with other international financial institutions:
Australian dollars
Brazilian reais
Canadian dollars
Danish kroner
euro
Japanese yen

Korean won
Mexican pesos
New Zealand dollars
Norwegian kroner
Pounds sterling
Singapore dollars
Swedish kronor
Swiss francs
B. To hold balances of, and to have outstanding
forward contracts to receive or to deliver, the
foreign currencies listed in paragraph A
above.
C. To draw foreign currencies and to permit foreign banks to draw dollars under the reciprocal currency arrangements listed in paragraph
2 below, provided that drawings by either
party to any such arrangement shall be fully
liquidated within 12 months after any
amount outstanding at that time was first
drawn, unless the Committee, because of
exceptional circumstances, specifically authorizes a delay.
D. To maintain an overall open position in all
foreign currencies not exceeding $25.0 billion.
For this purpose, the overall open position in
all foreign currencies is defined as the sum
(disregarding signs) of net positions in individual currencies, excluding changes in dollar
value due to foreign exchange rate movements and interest accruals. The net position
in a single foreign currency is defined as
holdings of balances in that currency, plus
outstanding contracts for future receipt,
minus outstanding contracts for future delivery of that currency, i.e., as the sum of these
elements with due regard to sign.
2. The Federal Open Market Committee directs the
Federal Reserve Bank of New York to maintain
reciprocal currency arrangements (“swap”
arrangements) for the System Open Market
Account for periods up to a maximum of
12 months with the following foreign banks,
which are among those designated by the Board
of Governors of the Federal Reserve System
under section 214.5 of Regulation N, Relations
with Foreign Banks and Bankers, and with the
approval of the Committee to renew such
arrangements on maturity:

Minutes of Federal Open Market Committee Meetings

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 1.A above shall, unless otherwise expressly authorized by the Committee, be at
prevailing market rates. For the purpose of providing an investment return on System holdings
of foreign currencies or for the purpose of adjusting interest rates paid or received in connection
with swap drawings, transactions with foreign
central banks may be undertaken at nonmarket
exchange rates.
4. It shall be the normal practice to arrange with
foreign central banks for the coordination of foreign currency transactions. In 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

169

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, the Vice
Chairman’s 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 the Manager’s 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.
8. Staff officers of the Committee are authorized to
transmit pertinent information on System foreign

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97th Annual Report | 2010

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.

Foreign Currency Directive (Reaffirmed
January 26, 2010)
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 International
Monetary Fund regarding exchange arrangements under IMF Article IV.

Procedural Instructions with Respect to
Foreign Currency Operations (Reaffirmed
January 26, 2010)
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, unless otherwise directed by 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 1.B.
D. Any swap drawing proposed by a foreign
bank not exceeding the larger of (i) $200 million or (ii) 15 percent of the size of the swap
arrangement.
2. The Manager shall clear with the Committee (or
with the Subcommittee, if the Subcommittee
believes that consultation with the full Committee

Minutes of Federal Open Market Committee Meetings

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.
Developments in Financial Markets and the
Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
reported on developments in domestic and foreign
financial markets during the period since the Committee met on December 15–16, 2009. Financial market conditions remained supportive of economic
growth, though volatility in securities markets
increased notably toward the end of the intermeeting
period. Year-end funding pressures were minimal. No
market strains had appeared as a result of the imminent closing, on February 1, of most of the Federal
Reserve’s special liquidity facilities. The Manager
also reported on System open market operations in
agency debt and agency MBS during the intermeeting period. The Desk continued to gradually slow the
pace of its purchases of these securities as it moved
toward completing the Committee’s program of asset
purchases by March 31. The Desk also continued to
engage in dollar roll transactions in agency MBS
securities to facilitate settlement of its outright purchases. The Federal Reserve’s total assets remained a
bit above $2.2 trillion, as the increase in the System’s
holdings of securities was almost entirely offset by a
further decline in usage of the System’s credit and
liquidity facilities. By unanimous vote, the Committee ratified the Desk’s transactions. Participants
agreed that the Desk should continue the interim
approach of not reinvesting the proceeds of maturing
or prepaid agency securities and MBS held by the
Federal Reserve. The Desk had continued to reinvest
the proceeds of maturing Treasury securities by
acquiring newly auctioned Treasury securities issued

171

on the same day its existing holdings matured; participants agreed that the Desk should continue this
practice for now, but the Committee would consider
further its policy for redeeming or reinvesting maturing Treasury securities. There were no open market
operations in foreign currencies for the System’s
account during the intermeeting period.
Staff briefed the Committee on current usage of the
discount window and other liquidity facilities and
suggested additional steps policymakers could take to
normalize the Federal Reserve’s liquidity provision.
These steps included continuing to scale back
amounts offered through the Term Auction Facility
(TAF); returning to the pre-crisis standard of oneday maturity for primary credit loans to all but the
smallest depository institutions; and increasing, initially to 50 basis points from 25 basis points, the
spread between the primary credit rate and the upper
end of the Committee’s target range for the federal
funds rate. Setting the spread reflects a balance
between two objectives: encouraging depository institutions to use the discount window as a backup
source of liquidity when they are faced with temporary liquidity shortfalls or when funding markets are
disrupted, and discouraging depository institutions
from relying on the discount window as a routine
source of funds when other funding is generally available. The spread was 100 basis points before the
financial crisis emerged; the Federal Reserve narrowed the spread to 50 basis points and then to
25 basis points as part of its response to the financial
crisis. Participants judged that improvements in bank
funding markets warranted reducing amounts offered
at TAF auctions toward zero in three steps over the
next few months, while noting that they would be
prepared to modify that plan if necessary to support
financial stability and economic growth. They agreed
that it would soon be appropriate to return the maturity of primary credit loans to overnight and to
widen the spread between the primary credit rate and
the top of the Committee’s target range for the federal funds rate. Several participants noted that the
optimal spread could depend, in part, on the Committee’s eventual decisions about the most suitable
approach to implementing U.S. monetary policy over
the longer term. Participants generally agreed that
such steps to return the Federal Reserve’s liquidity
provision to a normal footing would be technical
adjustments to reflect the notable diminution of the
market strains that had made the creation of new
liquidity facilities and expansion of existing facilities
necessary and emphasized that such steps would not
indicate a change in the Committee’s assessment of

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97th Annual Report | 2010

the appropriate stance of monetary policy or the
proper time to begin moving to a less accommodative
policy stance.
Secretary’s note: After the FOMC meeting, the
Chairman, acting under authority delegated by
the Board of Governors, directed that TAF auction amounts be reduced to $50 billion for the
February 8 auction and to $25 billion for the final
TAF auction, to be held on March 8.
Staff also briefed policymakers about tools and strategies for an eventual withdrawal of policy accommodation and summarized linkages between these tools
and strategies and alternative frameworks for implementing monetary policy in the longer run. The tools
for moving to a less accommodative policy stance
encompassed (1) raising the interest rate paid on
excess reserve balances (the IOER rate); (2) executing
term reverse repurchase agreements with the primary
dealers; (3) executing term RRPs with a broader
range of counterparties; (4) using a term deposit
facility (TDF) to absorb excess reserves; (5) redeeming maturing and prepaid securities held by the Federal Reserve without reinvesting the proceeds; and
(6) selling securities held by the Federal Reserve
before they mature. All but the first of these tools
would shrink the supply of reserve balances; the last
two would also shrink the Federal Reserve’s balance
sheet. The Desk already had successfully tested its
ability to conduct term RRPs with primary dealers
by arranging several small-scale transactions using
Treasury securities and agency debt as collateral; staff
anticipated that the Federal Reserve would be able to
execute term RRPs against MBS early this spring
and would have the capability to conduct RRPs with
an expanded set of counterparties soon after. In
coming weeks, staff would analyze comments
received in response to a Federal Register notice, published in late December, requesting the public’s input
on the TDF proposal. Staff would then prepare a
final proposal for the Board’s consideration. A TDF
could be operational as soon as May.
Staff described several feasible strategies for using
these six tools to support a gradual return toward a
more normal stance of monetary policy: (1) using
one or more of the tools to progressively reduce the
supply of reserve balances—which rose to an exceptionally high level as a consequence of the expansion
of the Federal Reserve’s liquidity and lending facilities and subsequent large-scale asset purchases during the financial crisis—before raising the IOER rate
and the target for the federal funds rate; (2) increas-

ing the IOER rate in line with an increase in the federal funds rate target and concurrently using one or
more tools to reduce the supply of reserve balances;
and (3) raising the IOER rate and the target for the
federal funds rate and using reserve draining tools
only if the federal funds rate did not increase in line
with the Committee’s target.
Participants expressed a range of views about the
tools and strategies for removing policy accommodation when that step becomes appropriate. All agreed
that raising the IOER rate and the target for the federal funds rate would be a key element of a move to
less accommodative monetary policy. Most thought
that it likely would be appropriate to reduce the supply of reserve balances, to some extent, before the
eventual increase in the IOER rate and in the target
for the federal funds rate, in part because doing so
would tighten the link between short-term market
rates and the IOER rate; however, several noted that
draining operations might be seen as a precursor to
tightening and should only be undertaken when the
Committee judged that an increase in its target for
the federal funds rate would soon be appropriate. For
the same reason, a few judged that it would be better
to drain reserves concurrently with the eventual
increase in the IOER and target rates.
With respect to longer-run approaches to implementing monetary policy, most policymakers saw benefits
in continuing to use the federal funds rate as the
operating target for implementing monetary policy,
so long as other money market rates remained closely
linked to the federal funds rate. Many thought that
an approach in which the primary credit rate was set
above the Committee’s target for the federal funds
rate and the IOER rate was set below that target—a
corridor system—would be beneficial. Participants
recognized, however, that the supply of reserve balances would need to be reduced considerably to lift
the funds rate above the IOER rate. Several saw
advantages to using the IOER rate, rather than a target for a market rate, to indicate the stance of policy.
Participants noted that their judgments were tentative, that they would continue to discuss the ultimate
operating regime, and that they might well gain useful information about longer-run approaches during
the eventual withdrawal of policy accommodation.
Finally, staff noted that the Committee might want
to address both the eventual size of the Federal
Reserve’s balance sheet and its composition. Policymakers were unanimous in the view that it will be
appropriate to shrink the supply of reserve balances

Minutes of Federal Open Market Committee Meetings

and the size of the Federal Reserve’s balance sheet
substantially over time. Moreover, they agreed that it
will eventually be appropriate for the System Open
Market Account to return to holding only securities
issued by the U.S. Treasury, as it did before the financial crisis. Several thought the Federal Reserve should
hold, eventually, a portfolio composed largely of
shorter-term Treasury securities. Participants agreed
that a policy of redeeming and not replacing agency
debt and MBS as those securities mature or are prepaid would contribute to achieving both goals and
thus would be appropriate. Many thought it would
also be desirable to redeem some or all of the Treasury securities owned by the Federal Reserve as they
mature, recognizing that at some point in the future
the Federal Reserve would need to resume purchases
of Treasury securities to offset reductions in other
assets and to accommodate growth in the public’s
demand for U.S. currency. Participants expressed a
range of views about asset sales. Most judged that a
future program of gradual asset sales could be helpful in shrinking the size of the Federal Reserve’s balance sheet, reducing reserve balances, and shifting the
composition of securities holdings back toward
Treasury securities; however, many were concerned
that such transactions could cause market disruptions and have adverse implications for the economic
recovery, particularly if they were to begin before the
recovery had become self-sustaining and before the
Committee had determined that a tightening of
financial conditions was appropriate and had begun
to raise short-term interest rates. Several thought it
important to begin a program of asset sales in the
near future to ensure that the Federal Reserve’s balance sheet shrinks more quickly and in a more predictable manner than could be achieved solely by
redeeming maturing securities and not reinvesting
prepayments; they judged that a program of asset
sales spread over a number of years would underscore the Committee’s determination to exit from the
period of exceptionally accommodative monetary
policy in a manner and at a pace that would keep
inflation contained without having large effects on
asset prices or market interest rates. A few suggested
that the pace of asset sales, and potentially of purchases, could be adjusted over time in response to
developments in the economy and the evolution of
the economic outlook. The Committee made no decisions about asset sales at this meeting.
Staff Review of the Economic Situation
The information reviewed at the January 26–27 meeting suggested that economic activity continued to
strengthen in recent months. Consumer spending was

173

well maintained in the fourth quarter, and business
expenditures on equipment and software appeared to
expand substantially. However, the improvement in
the housing market slowed, and spending on nonresidential structures continued to fall. Recent data suggested that the pace of inventory liquidation diminished considerably last quarter, providing a sizable
boost to economic activity. Indeed, industrial production advanced at a solid pace in the fourth quarter. In the labor market, layoffs subsided noticeably
in the final months of last year, but the unemployment rate remained elevated and hiring stayed weak.
Meanwhile, increases in energy prices pushed up
headline consumer price inflation even as core consumer price inflation remained subdued.
Some indicators suggested that the deterioration in
the labor market was abating. The pace of job losses
continued to moderate: The three-month change in
private nonfarm payrolls had become progressively
less negative since early 2009; that pattern was widespread across industries. The unemployment rate was
essentially unchanged from October through December. The labor force participation rate, however, had
declined steeply since the spring, likely reflecting, at
least in part, adverse labor market conditions. Moreover, hiring remained weak, the total number of individuals receiving unemployment insurance—including extended and emergency benefits—continued to
climb, the average length of ongoing unemployment
spells rose steeply, and joblessness became increasingly concentrated among the long-term
unemployed.
Total industrial production (IP) rose in December,
the sixth consecutive increase since its trough. The
gain in December primarily resulted from a jump in
output at electric and natural gas utilities caused by
unseasonably cold weather. Manufacturing IP edged
down after large and widespread gains in November.
For the fourth quarter as a whole, the solid increase
in manufacturing IP reflected a recovery in motor
vehicle output, rising export demand, and a slower
pace of business inventory liquidation. Output of
consumer goods, business equipment, and materials
all rose in the fourth quarter, though the average
monthly gains in these categories were a little smaller
than in the third quarter. The available near-term
indicators of production suggested that IP would
increase further in coming months.
Consumer spending continued to trend up late last
year but remained well below its pre-recession level.
After a strong increase in November, real personal

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97th Annual Report | 2010

consumption expenditures appeared to drop back
some in December. Retail sales may have been held
down by unusually bad weather, but purchases of
new light motor vehicles continued to increase. The
fundamental determinants of household spending—
including real disposable income and wealth—
strengthened modestly, on balance, near the end of
the year but were still relatively weak. Despite the
improvement from early last year, measures of consumer sentiment remained low relative to historical
norms, and terms and standards on consumer loans,
particularly credit card loans, stayed very tight.

quarter. The pace of real business inventory liquidation appeared to decrease considerably in the fourth
quarter. After three quarters of sizable declines, real
nonfarm inventories shrank at a more modest pace in
October, and book-value data for this category suggested that inventories may have increased in real
terms in November. Available data suggested that the
change in inventory investment—including a sizable
accumulation in wholesale stocks of farm products—
made an appreciable contribution to the increase in
real gross domestic product (GDP) in the fourth
quarter.

The recovery in the housing market slowed in the second half of 2009, even though a number of factors
supported housing demand. Interest rates for conforming 30-year fixed-rate mortgages remained historically low. In addition, the Reuters/University of
Michigan Surveys of Consumers reported that the
number of respondents who expected house prices to
increase continued to exceed the number who
expected prices to decrease. Sales of existing singlefamily homes rose strongly from July to November
but fell in December, a pattern that suggested sales
were pulled ahead in anticipation of the originally
scheduled expiration of the first-time homebuyer
credit on November 30. Still, existing home sales
remained above their level in earlier quarters. Sales of
new homes also turned down in November and
December, retracing part of their recovery earlier in
the year. Similarly, starts of single-family homes
retreated a little from June to December after
advancing briskly last spring. The pace of construction was slow enough that even the modest pace of
new home sales was sufficient to further reduce the
overhang of unsold new single-family houses.

Consumer price inflation was modest in December
after being boosted in the preceding two months by
increases in energy prices. Core consumer price inflation remained subdued. Price increases for nonenergy services slowed early last year and remained
modest throughout 2009, reflecting declining prices
for housing services and perhaps the deceleration in
labor costs. Price increases for core goods were quite
modest during the second half of 2009. According to
survey results, households’ expectations of near-term
inflation increased in January; in addition, median
longer-term inflation expectations edged up, though
they remained near the lower end of the narrow
range that has prevailed over the past few years.

Real spending on equipment and software apparently
rose robustly in the fourth quarter following a slight
increase in the previous quarter. Spending on hightech equipment, in particular, appeared to increase at
a considerably more rapid clip in the fourth quarter
than in the third; both orders and shipments of hightech equipment rose markedly, on net, in October
and November. Business purchases of motor vehicles
likely also climbed in the fourth quarter. Outside of
the transportation and high-tech sectors, business
outlays on equipment and software appeared to
change little in the fourth quarter. Conditions in the
nonresidential construction sector generally remained
poor. Real spending on structures outside of the
drilling and mining sector dropped in the third quarter; data on nominal expenditures through November
pointed to an even faster rate of decline in the fourth

The U.S. international trade deficit widened in
November, as a sharp rise in nominal imports outpaced an increase in exports. The rise in exports was
driven primarily by a large gain in agricultural
exports, which was partially offset by a decline in
exports of consumer goods that followed robust
growth in October. Imports of oil accounted for
roughly one-third of the increase in total imports,
though most other categories of imports also
recorded gains.
Incoming data suggested that activity in advanced
foreign economies continued to expand in the fourth
quarter, though at a moderate pace. However, unemployment rates remained elevated and consumption
indicators were mixed. Credit conditions improved
further, as lending to the private sector expanded in
some economies. Increases in export and import volumes pointed to a gradual recovery in international
trade. Economic activity in emerging market economies continued to expand in the fourth quarter,
although at a pace slower than that of the third quarter. Within emerging Asia, growth appeared to have
remained robust in China and to have slowed elsewhere. In Latin America, indicators pointed to a continuation of growth in much of the region, although

Minutes of Federal Open Market Committee Meetings

growth in Mexico appeared to slow significantly following the third quarter’s outsized gain. Amid rising
energy prices, 12-month headline inflation for
December picked up in all advanced foreign economies except Japan, where deflation moderated only
mildly. Headline inflation continued to rise in emerging Asia, driven by energy and food prices. In Latin
America, headline inflation remained below its earlier elevated pace.
Staff Review of the Financial Situation
The decision by the FOMC to keep the target range
for the federal funds rate unchanged at the December
meeting and its retention of the “extended period”
language in the statement were widely anticipated by
market participants and elicited little price response.
Later in the intermeeting period, the expected path of
the federal funds rate implied by federal funds and
Eurodollar futures quotes shifted down slightly as
investors apparently interpreted Federal Reserve
communications, including the discussion of largescale asset purchases in the FOMC minutes, as pointing to a more protracted period of accommodative
monetary policy than had been anticipated. By contrast, yields on 2- and 10-year nominal Treasury securities were about unchanged on net. Inflation compensation based on 5-year Treasury inflationprotected securities (TIPS) increased; the increase
likely reflected higher inflation risk premiums and a
further improvement in TIPS market liquidity, along
with some rise in inflation expectations owing, in
part, to increases in oil prices. Inflation compensation 5 to 10 years ahead declined slightly.
Financial market conditions remained supportive of
economic growth over the intermeeting period, and
short-term funding markets were generally stable.
Spreads between London interbank offered rates
(Libor) and overnight index swap (OIS) rates at oneand three-month maturities remained low, while
spreads at the six-month maturity continued to edge
down. Spreads on A2/P2-rated commercial paper
(CP) and AA-rated asset-backed CP held steady at
the low end of the range that has prevailed since mid2007. Strong demand for Treasury bills in the cash
and repurchase agreement (repo) market, together
with a seasonal decline in bills outstanding, put
downward pressure on both bill yields and shortterm repo rates. Although year-end pressures in
short-term funding markets were generally modest
amid ample liquidity, the repo market experienced
some year-end dislocations, with a few transactions
reportedly occurring at negative interest rates. Use of
Federal Reserve credit facilities edged lower over the

175

intermeeting period, and market commentary suggested little concern about the impending expiration
of a number of the facilities.
After trending higher for most of the intermeeting
period, broad stock price indexes subsequently
reversed course amid elevated volatility, ending the
period little changed on balance. The gap between
the staff’s estimate of the expected real equity return
over the next 10 years for S&P 500 firms and the real
10-year Treasury yield—a rough gauge of the equity
risk premium—stayed about the same and remained
well above its average level during the past decade.
Over the intermeeting period, yields on both
investment-grade and speculative-grade corporate
bonds edged down, while those on comparablematurity Treasury securities held steady. Estimates of
bid-asked spreads for corporate bonds—a measure of
liquidity in the corporate bond market—remained
steady. In the leveraged loan market, average bid
prices rose further and bid-asked spreads were little
changed.
Overall, net debt financing by nonfinancial businesses was near zero in the fourth quarter after
declining in the third, consistent with weak demand
for credit and still tight credit standards and terms at
banks. In December, gross public equity issuance by
nonfinancial firms maintained its solid pace and issuance by financial firms increased noticeably, as several large banks issued shares and used the proceeds
to repay capital injections they had received from the
Troubled Asset Relief Program. Financing conditions for commercial real estate, however, remained
strained. Moody’s index of commercial property
prices showed another drop in October, bringing the
index back to its 2002 level. Delinquency rates on
loans in commercial mortgage-backed securities
pools increased further in December. The average
interest rate on 30-year conforming fixed-rate residential mortgages increased slightly over the intermeeting period but remained within the narrow range
of values over recent months. Consumer credit contracted for the 10th consecutive month in November,
owing to a further steep decline in revolving credit.
Credit card interest rate spreads continued to
increase in November. In contrast, spreads on new
auto loans extended their downtrend through early
January. Delinquency rates on consumer loans
remained high in recent months. Issuance of credit
card asset-backed securities was minimal in October
and November but picked up in December after the
Federal Deposit Insurance Corporation announced a
temporary extension of safe-harbor rules for its han-

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97th Annual Report | 2010

dling of securitized assets should a sponsoring bank
be taken into receivership.
Commercial bank credit continued to contract in
December, as an increase in banks’ securities holdings was more than offset by a large drop in total
loans. Commercial and industrial loans and commercial real estate loans again fell markedly. Although a
substantial fraction of banks continued to tighten
their credit policies on commercial real estate loans in
the fourth quarter, lending standards for most other
types of loans were little changed, according to the
January Senior Loan Officer Opinion Survey on
Bank Lending Practices. Nonetheless, standards and
terms on all major loan types remained tight, and the
demand for loans reportedly weakened further.
M2 continued to expand sluggishly in December.
Growth of liquid deposits remained robust, but small
time deposits and retail money market mutual funds
again contracted at a rapid pace in response to the
low yields on those assets. The monetary base and
total bank reserves were roughly flat, as the contraction in credit outstanding from the Federal Reserve’s
liquidity and credit facilities was about offset by the
Desk’s purchases of agency debt and MBS.
Over the intermeeting period, benchmark sovereign
yields in most advanced foreign economies displayed
some volatility but ended little changed on net.
Global sovereign bond offerings since the start of the
year had been reasonably well received, although
mounting fiscal concerns made investors more reluctant to hold debt issued by the Greek government;
sovereign yields rose in Greece and, to a lesser extent,
in several other countries where fiscal issues have
raised concerns among investors. All major foreign
central banks kept their policy rates unchanged. Foreign equity prices generally ended the intermeeting
period down. European financial stocks declined
substantially, as early profit reports for the fourth
quarter from a few banks rekindled some concerns
about the health of the banking system. The broad
nominal index of the foreign exchange value of the
dollar rose, reportedly reflecting a growing perception that U.S. growth prospects were better than
those in Europe and Japan. Concerns that policy
tightening by China might restrain the global recovery also may have contributed to the dollar’s appreciation against many currencies late in the period.
Staff Economic Outlook
In the forecast prepared for the January FOMC
meeting, the staff revised up its estimate of the

increase in real GDP in the fourth quarter of 2009.
The upward revision was in inventory investment; the
staff’s projection of the increase in final demand was
unchanged. Nonfarm businesses apparently moved
earlier to stem the pace of inventory liquidation than
the staff had anticipated. As a result, the economy
likely entered 2010 with production in closer alignment with sales than the staff had expected in midDecember. Apart from the fluctuations in inventories, economic developments largely were as the staff
had anticipated. The incoming information on the
labor market and industrial production was broadly
consistent with staff expectations, and, though housing activity seemed to be on a lower-than-anticipated
trajectory, recent data on business capital spending
were slightly above expectations. The staff continued
to project a moderate recovery in economic activity
over the next two years, with economic growth supported by the accommodative stance of monetary
policy and by a further waning of the factors that
weighed on spending and production over the past
two years. The staff also continued to expect that
resource slack would be taken up only gradually over
the forecast period.
The staff’s forecasts for some slowing of core and
headline inflation over the next two years were little
changed. There were no significant surprises in the
incoming price data, substantial slack in resource utilization was still expected to put downward pressure
on costs, and longer-term inflation expectations
remained relatively stable. Given staff projections for
consumer energy prices, headline inflation was projected to run somewhat above core inflation in 2010
but to slow to the same subdued rate as core inflation
in 2011.
Participants’ Views on Current Conditions and
the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks—provided projections for economic
growth, the unemployment rate, and consumer price
inflation for each year from 2010 through 2012 and
over a longer horizon. Longer-run projections represent each participant’s assessment of the rate to
which each variable would be expected to converge
over time under appropriate monetary policy and in
the absence of further shocks. Participants’ forecasts
through 2012 and over the longer run are described
in the Summary of Economic Projections, which is
attached as an addendum to these minutes.

Minutes of Federal Open Market Committee Meetings

In their discussion of the economic situation and
outlook, participants agreed that the incoming data
and information received from business contacts,
though mixed, indicated that economic growth had
strengthened in the fourth quarter, that firms were
reducing payrolls at a less rapid pace, and that downside risks to the outlook for economic growth had
diminished a bit further. Participants saw the economic news as broadly in line with the expectations
for moderate growth and subdued inflation in 2010
that they held when the Committee met in midDecember; moreover, financial conditions were much
the same, on balance, as when the FOMC last met.
Accordingly, participants’ views about the economic
outlook had not changed appreciably. Many noted
the evidence that the pace of inventory decumulation
slowed quite substantially in the fourth quarter of
2009 as firms increased output to bring production
into closer alignment with sales. Participants saw the
slower pace of inventory reductions as a welcome
indication that, in general, firms no longer had large
inventory overhangs. But they observed that business
contacts continued to report great reluctance to build
inventories, increase payrolls, and expand capacity.
Participants expected the economic recovery to continue, but most anticipated that the pickup in output
and employment growth would be rather slow relative to past recoveries from deep recessions. A moderate pace of expansion would imply slow improvement in the labor market this year, with unemployment declining only gradually. Most participants
again projected that the economy would grow somewhat more rapidly in 2011 and 2012, generating a
more pronounced decline in the unemployment rate,
as financial conditions and the availability of credit
continue to improve. In general, participants saw the
upside and downside risks to the outlook for economic growth as roughly balanced. Participants
agreed that underlying inflation currently was subdued and was likely to remain so for some time.
Some noted the risk that, with output well below
potential over the next couple of years, inflation
could edge further below the rates they judged most
consistent with the Federal Reserve’s dual mandate
for maximum employment and price stability; others,
focusing on risks to inflation expectations and the
challenge of removing monetary accommodation in a
timely manner, saw inflation risks as tilted toward the
upside, especially in the medium term.
The weakness in labor markets continued to be an
important concern for the FOMC; moreover, the
prospects for job growth remained an important

177

source of uncertainty in the economic outlook, particularly in the outlook for consumer spending.
While the average pace of layoffs diminished substantially in recent months, few firms were hiring. The
unusually large fraction of individuals who were
working part time for economic reasons, as well as
the uncommonly low level of the average workweek,
pointed to a gradual increase in payrolls for some
time even if hours worked were to increase substantially as the economic recovery proceeded. Indeed,
many business contacts again reported that they
would be cautious in hiring, saying they expected to
meet any near-term increase in demand by raising
existing employees’ hours and boosting productivity,
thus delaying the need to add employees. If businesses were able to continue generating large productivity gains, as in recent quarters, then firms would
need to hire fewer workers in the near term to meet
rising demands for their products. But if the unusually rapid productivity growth seen in recent quarters
was not sustained, then job growth could pick up significantly as productivity returned to sustainable levels. The rise in employment of temporary workers in
recent months appeared to be continuing; historical
experience suggested that increased use of temporary
help could presage a broader increase in job growth.
Participants generally saw the data and anecdotal evidence as indicating moderate growth in demands for
goods and services, although with substantial variation across sectors. Consumer spending appeared to
be increasing modestly. Reports on holiday sales were
mixed. Retailers indicated that consumers appeared
more willing to buy but that they remained unusually
sensitive to pricing. Business contacts continued to
report that they were limiting investment outlays
pending resolution of uncertainty about sales prospects and future tax and regulatory policies; moreover, they had substantial excess capacity and thus
little need to expand production facilities. Even so,
the data indicated solid growth in business spending
on high-tech equipment in recent months. Anecdotal
evidence suggested that such spending was being
driven by opportunities to reduce costs and by
replacement investment that firms had deferred during the downturn. By and large, participants judged
that residential investment had stabilized but did not
expect housing construction to make a sizable contribution to economic growth during the next year or
two. Commercial construction continued to trend
down, primarily reflecting weak fundamentals,
though financing constraints probably were also
playing a role. Stronger economic growth abroad was

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contributing to growth in U.S. exports, thus helping
support the recovery in industrial production in the
United States.
Policymakers judged that financial conditions were,
on balance, about as supportive of growth as when
the Committee met in December. Though volatility
in equity prices increased late in the intermeeting
period, broad equity price indexes were about
unchanged overall, private credit spreads narrowed
somewhat, and financial markets generally continued
to function significantly better than early last year.
All categories of bank loans, however, continued to
contract sharply. Survey evidence suggested that
banks had ceased tightening standards on most types
of business and consumer loans, though commercial
real estate loans were a notable exception. Anecdotal
evidence suggested that some banks were starting to
look for opportunities to expand lending.
Though headline inflation had been variable, largely
reflecting swings in energy prices, core measures of
inflation were subdued and were expected to remain
so. One participant noted that core inflation had
been held down in recent quarters by unusually slow
increases in the price index for shelter, and that the
recent behavior of core inflation might be a misleading signal of the underlying inflation trend. Reports
from business contacts suggested less price discounting, but pricing power remained limited. Wage
growth continued to be restrained, and unit labor
costs were still falling. Energy prices had dropped
back in recent weeks, but many participants saw
upward pressures on commodity prices associated
with expanding global economic activity as an inflation risk. However, some noted that the high degree
of slack in resource utilization posed a downside risk
to inflation. Survey measures of expected future
inflation were fairly stable, but some market-based
measures of inflation expectations and inflation risk
suggested continuing concern among market participants about the risk of higher medium-term inflation, perhaps reflecting large fiscal deficits and the
size of the Federal Reserve’s balance sheet.
Though participants agreed there was considerable
slack in resource utilization, their judgments about
the degree of slack varied. The several extensions of
emergency unemployment insurance benefits
appeared to have raised the measured unemployment
rate, relative to levels recorded in past downturns, by
encouraging some who have lost their jobs to remain
in the labor force. If that effect were large—some
estimates suggested it could account for 1 percentage

point or more of the increase in the unemployment
rate during this recession—then the reported unemployment rate might be overstating the amount of
slack in resource utilization relative to past periods of
high unemployment. Several participants observed
that the necessity of reallocating labor across sectors
as the recovery proceeds, as well as the loss of skills
caused by high levels of long-term unemployment
and permanent separations, could reduce the economy’s potential output, at least temporarily; historical
experience following large adverse financial shocks
suggests such an effect. On the other hand, if recent
productivity gains were to be sustained, as some business contacts indicated they would be, potential output currently could be higher than standard measures
suggested, and the high level of the unemployment
rate could be a more accurate indication of slack in
resource utilization than usual measures of the output gap.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, members agreed that no changes to the Committee’s large-scale asset purchase programs or to its
target range for the federal funds rate were warranted
at this meeting, inasmuch as the asset purchase programs were nearing completion and neither the economic outlook nor financial conditions had changed
appreciably since the December meeting. Accordingly, the Committee affirmed its intention to purchase a total of $1.25 trillion of agency MBS and
about $175 billion of agency debt by the end of the
current quarter and to gradually slow the pace of
these purchases to promote a smooth transition in
markets. The Committee emphasized that it would
continue to evaluate its purchases of securities in
light of the evolving economic outlook and conditions in financial markets. Members recognized that
references to “purchases” of securities would need to
be modified as the completion of the asset purchase
programs draws near. One member recommended
that the FOMC replace the portion of the statement
that indicates the Committee will evaluate its “purchases” of securities with an indication that the
Committee will evaluate its “holdings” of securities.
The change in wording would encompass the possibility that the Committee might decide, at some
point, either to sell securities or to purchase additional securities. Other members judged that it would
be premature to make such a change in the statement
before observing economic and financial conditions
as the Committee’s current asset purchase program
comes to a close. Accordingly, the Committee

Minutes of Federal Open Market Committee Meetings

decided to retain the reference to securities “purchases” for the time being. The Committee also
affirmed its 0 to ¼ percent target range for the federal funds rate and, based on the outlook for a
gradual economic recovery, decided to reiterate its
anticipation that economic conditions, including low
levels of resource utilization, subdued inflation
trends, and stable inflation expectations, were likely
to warrant exceptionally low rates for an extended
period. Members agreed that the path of short-term
rates going forward would depend on the evolution
of the economic outlook.
Committee members and Board members agreed
that, with few exceptions, the functioning of most
financial markets, including interbank markets, no
longer showed significant impairment. Accordingly
they agreed that the statement to be released following the meeting would indicate that the Federal
Reserve would be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility, the Commercial Paper Funding Facility, the
Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1, 2010. Committee members also agreed to announce that temporary
liquidity swap arrangements between the Federal
Reserve and other central banks would expire on
February 1. In addition, the statement would say that
amounts available through the Term Auction Facility
would be scaled back further, with $50 billion of
28-day credit to be offered on February 8 and
$25 billion of 28-day credit to be offered at the final
auction of March 8. The statement also would note
that the anticipated expiration dates for the Term
Asset-Backed Securities Loan Facility remained
June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities, and March 31,
2010, for loans backed by all other types of collateral.
Members emphasized that they were prepared to
modify these plans if necessary to support financial
stability 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 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 seeks conditions in reserve

179

markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to purchase agency debt and
agency MBS during the intermeeting period
with the aim of providing support to private
credit markets and economic activity. The timing
and pace of these purchases should depend on
conditions in the markets for such securities and
on a broader assessment of private credit market
conditions. The Desk is expected to execute purchases of about $175 billion in housing-related
agency debt and about $1.25 trillion of agency
MBS by the end of the first quarter. The Desk is
expected to gradually slow the pace of these purchases as they near completion. The Committee
anticipates that outright purchases of securities
will cause the size of the Federal Reserve’s balance sheet to expand significantly in coming
months. The Committee directs the Desk to
engage in dollar roll transactions as necessary to
facilitate settlement of the Federal Reserve’s
agency MBS transactions to be conducted
through the end of the first quarter, as directed
above. The System Open Market Account Manager and the Secretary will keep the Committee
informed of ongoing developments regarding
the System’s balance sheet that could affect the
attainment over time of the Committee’s objectives of maximum employment and price
stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in December suggests
that economic activity has continued to
strengthen and that the deterioration in the
labor market is abating. Household spending is
expanding at a moderate rate but remains constrained by a weak labor market, modest income
growth, lower housing wealth, and tight credit.
Business spending on equipment and software
appears to be picking up, but investment in
structures is still contracting and employers
remain reluctant to add to payrolls. Firms have
brought inventory stocks into better alignment
with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace
of economic recovery is likely to be moderate for
a time, the Committee anticipates a gradual
return to higher levels of resource utilization in a
context of price stability.

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97th Annual Report | 2010

With substantial resource slack continuing to
restrain cost pressures and with longer-term
inflation expectations stable, inflation is likely to
be subdued for some time.

Kohn, Sandra Pianalto, Eric Rosengren, Daniel K.
Tarullo, and Kevin Warsh.

The Committee will maintain the target range
for the federal funds rate at 0 to ¼ percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels of the federal funds rate for an
extended period. To provide support to mortgage lending and housing markets and to
improve overall conditions in private credit markets, the Federal Reserve is in the process of
purchasing $1.25 trillion of agency mortgagebacked securities and about $175 billion of
agency debt. In order to promote a smooth transition in markets, the Committee is gradually
slowing the pace of these purchases, and it
anticipates that these transactions will be
executed by the end of the first quarter. The
Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial
markets.

Mr. Hoenig dissented because he believed it was no
longer advisable to indicate that economic and financial conditions were likely to “warrant exceptionally
low levels of the federal funds rate for an extended
period.” In recent months, economic and financial
conditions improved steadily, and Mr. Hoenig was
concerned that, under these improving conditions,
maintaining short-term interest rates near zero for an
extended period of time would lay the groundwork
for future financial imbalances and risk an increase in
inflation expectations. Accordingly, Mr. Hoenig
believed that it would be more appropriate for the
Committee to express an expectation that the federal
funds rate would be low for some time—rather than
exceptionally low for an extended period. Such a
change in communication would provide the Committee flexibility to begin raising rates modestly. He
further believed that moving to a modestly higher
federal funds rate soon would lower the risks of
longer-run imbalances and an increase in long-run
inflation expectations, while continuing to provide
needed support to the economic recovery.

In light of improved functioning of financial
markets, the Federal Reserve will be closing the
Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility, the Commercial
Paper Funding Facility, the Primary Dealer
Credit Facility, and the Term Securities Lending
Facility on February 1, as previously
announced. In addition, the temporary liquidity
swap arrangements between the Federal Reserve
and other central banks will expire on February 1. The Federal Reserve is in the process of
winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit will be
offered at the final auction on March 8. The
anticipated expiration dates for the Term AssetBacked Securities Loan Facility remain set at
June 30 for loans backed by new-issue commercial mortgage-backed securities and March 31
for loans backed by all other types of collateral.
The Federal Reserve is prepared to modify these
plans if necessary to support financial stability
and economic growth.”

It was agreed that the next meeting of the Committee
would be held on Tuesday, March 16, 2010. The
meeting adjourned at 1:20 p.m. on January 27, 2010.

Voting for this action: Ben Bernanke, William C.
Dudley, James Bullard, Elizabeth Duke, Donald L.

Voting against this action: Thomas M. Hoenig.

Notation Vote
By notation vote completed on January 5, 2010, the
Committee unanimously approved the minutes of the
FOMC meeting held on December 15–16, 2009.
Brian F. Madigan
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the January 26–27, 2010, FOMC
meeting, the members of the Board of Governors
and the presidents of the Federal Reserve Banks, all
of whom participate in deliberations of the FOMC,
submitted projections for output growth, unemployment, and inflation for the years 2010 to 2012 and
over the longer run. The projections were based on
information available through the end of the meeting
and on each participant’s assumptions about factors
likely to affect economic outcomes, including his or

Minutes of Federal Open Market Committee Meetings

181

uncertainty, only gradual improvement in labor market conditions, and slow easing of credit conditions
in the banking sector. Participants generally expected
that it would take some time for the economy to converge fully to its longer-run path—characterized by a
sustainable rate of output growth and by rates of
employment and inflation consistent with their interpretation of the Federal Reserve’s dual objectives—
with a sizable minority of the view that the convergence process could take more than five to six years.
As in November, nearly all participants judged the
risks to their growth outlook as generally balanced,
and most also saw roughly balanced risks surrounding their inflation projections. Participants continued
to judge the uncertainty surrounding their projections for economic activity and inflation as unusually
high relative to historical norms.

her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that the participant deems most
likely to foster outcomes for economic activity and
inflation that best satisfy his or her interpretation of
the Federal Reserve’s dual objectives of maximum
employment and stable prices. Longer-run projections represent each participant’s assessment of the
rate to which each variable would be expected to converge over time under appropriate monetary policy
and in the absence of further shocks.
FOMC participants’ forecasts for economic activity
and inflation were broadly similar to their previous
projections, which were made in conjunction with the
November 2009 FOMC meeting. As depicted in
figure 1, the economic recovery from the recent recession was expected to be gradual, with real gross
domestic product (GDP) expanding at a rate that was
only moderately above participants’ assessment of its
longer-run sustainable growth rate and the unemployment rate declining slowly over the next few
years. Most participants also anticipated that inflation would remain subdued over this period. As indicated in table 1, a few participants made modest
upward revisions to their projections for real GDP
growth in 2010. Beyond 2010, however, the contours
of participants’ projections for economic activity and
inflation were little changed, with participants continuing to expect that the pace of the economic
recovery will be restrained by household and business

The Outlook
Participants’ projections for real GDP growth in 2010
had a central tendency of 2.8 to 3.5 percent, a somewhat narrower interval than in November. Recent
readings on consumer spending, industrial production, and business outlays on equipment and software were seen as broadly consistent with the view
that economic recovery was under way, albeit at a
moderate pace. Businesses had apparently made
progress in bringing their inventory stocks into closer
alignment with sales and hence would be likely to
raise production as spending gained further momentum. Participants pointed to a number of factors that

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, January 2010
Percent
Central tendency1

Range2

Variable

Change in real GDP
November projection
Unemployment rate
November projection
PCE inflation
November projection
Core PCE inflation3
November projection

2010

2011

2012

Longer run

2010

2011

2012

Longer run

2.8 to 3.5
2.5 to 3.5
9.5 to 9.7
9.3 to 9.7
1.4 to 1.7
1.3 to 1.6
1.1 to 1.7
1.0 to 1.5

3.4 to 4.5
3.4 to 4.5
8.2 to 8.5
8.2 to 8.6
1.1 to 2.0
1.0 to 1.9
1.0 to 1.9
1.0 to 1.6

3.5 to 4.5
3.5 to 4.8
6.6 to 7.5
6.8 to 7.5
1.3 to 2.0
1.2 to 1.9
1.2 to 1.9
1.0 to 1.7

2.5 to 2.8
2.5 to 2.8
5.0 to 5.2
5.0 to 5.2
1.7 to 2.0
1.7 to 2.0

2.3 to 4.0
2.0 to 4.0
8.6 to 10.0
8.6 to 10.2
1.2 to 2.0
1.1 to 2.0
1.0 to 2.0
0.9 to 2.0

2.7 to 4.7
2.5 to 4.6
7.2 to 8.8
7.2 to 8.7
1.0 to 2.4
0.6 to 2.4
0.9 to 2.4
0.5 to 2.4

3.0 to 5.0
2.8 to 5.0
6.1 to 7.6
6.1 to 7.6
0.8 to 2.0
0.2 to 2.3
0.8 to 2.0
0.2 to 2.3

2.4 to 3.0
2.4 to 3.0
4.9 to 6.3
4.8 to 6.3
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are 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 (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The November projections were made in
conjunction with the meeting of the Federal Open Market Committee on November 3–4, 2009.
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 consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

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97th Annual Report | 2010

Figure 1. Central tendencies and ranges of economic projections, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

would support the continued expansion of economic
activity, including accommodative monetary policy,
ongoing improvements in the conditions of financial
markets and institutions, and a pickup in global economic growth, especially in emerging market economies. Several participants also noted that fiscal policy
was currently providing substantial support to real
activity, but said that they expected less impetus to
GDP growth from this factor later in the year. Many
participants indicated that the expansion was likely
to be restrained not only by firms’ caution in hiring
and spending in light of the considerable uncertainty
regarding the economic outlook and general business
conditions, but also by limited access to credit by
small businesses and consumers dependent on bankintermediated finance.
Looking further ahead, participants’ projections were
for real GDP growth to pick up in 2011 and 2012; the
projections for growth in both years had a central
tendency of about 3½ to 4½ percent. As in November, participants generally expected that the continued repair of household balance sheets and gradual
improvements in credit availability would bolster
consumer spending. Responding to an improved sales
outlook and readier access to bank credit, businesses
were likely to increase production to rebuild their
inventory stocks and increase their outlays on equipment and software. In addition, improved foreign
economic conditions were viewed as supporting
robust growth in U.S. exports. However, participants
also indicated that elevated uncertainty on the part of
households and businesses and the very slow recovery of labor markets would likely restrain the pace of
expansion. Moreover, although conditions in the
banking system appeared to have stabilized, distress
in commercial real estate markets was expected to
pose risks to the balance sheets of banking institutions for some time, thereby contributing to only
gradual easing of credit conditions for many households and smaller firms. In the absence of further
shocks, participants generally anticipated that real
GDP growth would converge over time to an annual
rate of 2.5 to 2.8 percent, the longer-run pace that
appeared to be sustainable in view of expected demographic trends and improvements in labor productivity.
Participants anticipated that labor market conditions
would improve only slowly over the next several
years. Their projections for the average unemployment rate in the fourth quarter of 2010 had a central
tendency of 9.5 to 9.7 percent, only a little below the
levels of about 10 percent that prevailed late last year.
Consistent with their outlook for moderate output

183

growth, participants generally expected that the
unemployment rate would decline only about 2½ percentage points by the end of 2012 and would still be
well above its longer-run sustainable rate. Some participants also noted that considerable uncertainty
surrounded their estimates of the productive potential of the economy and the sustainable rate of
employment, owing partly to substantial ongoing
structural adjustments in product and labor markets.
Nonetheless, participants’ longer-run unemployment
projections had a central tendency of 5.0 to 5.2 percent, the same as in November.
Most participants anticipated that inflation would
remain subdued over the next several years. The central tendency of their projections for personal consumption expenditures (PCE) inflation was 1.4 to
1.7 percent for 2010, 1.1 to 2.0 percent for 2011, and
1.3 to 2.0 percent for 2012. Many participants anticipated that global economic growth would spur
increases in energy prices, and hence that headline
PCE inflation would run slightly above core PCE
inflation over the next year or two. Most expected
that substantial resource slack would continue to
restrain cost pressures, but that inflation would rise
gradually toward their individual assessments of the
measured rate of inflation judged to be most consistent with the Federal Reserve’s dual mandate. As in
November, the central tendency of projections of the
longer-run inflation rate was 1.7 to 2.0 percent. A
majority of participants anticipated that inflation in
2012 would still be below their assessments of the
mandate-consistent inflation rate, while the remainder expected that inflation would be at or slightly
above its longer-run value by that time.
Uncertainty and Risks
Nearly all participants shared the judgment that their
projections of future economic activity and unemployment continued to be subject to greater-thanaverage uncertainty.3 Participants generally saw the
risks to these projections as roughly balanced,
although a few indicated that the risks to the unemployment outlook remained tilted to the upside. As in
November, many participants highlighted the difficulties inherent in predicting macroeconomic outcomes in the wake of a financial crisis and a severe
3

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1989 to 2008. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in economic forecasts and
explains the approach used to assess the uncertainty and risk
attending participants’ projections.

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97th Annual Report | 2010

prices of energy and other commodities that would
place upward pressure on overall inflation.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2010

2011

2012

±1.3
±0.6
±0.9

±1.5
±0.8
±1.0

±1.6
±1.0
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1989 through 2008 that were released in the winter by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

recession. In addition, some pointed to uncertainties
regarding the extent to which the recent run-up in
labor productivity would prove to be persistent, while
others noted the risk that the deteriorating performance of commercial real estate could adversely
affect the still-fragile state of the banking system and
restrain the growth of output and employment over
coming quarters.
As in November, most participants continued to see
the uncertainty surrounding their inflation projections as higher than historical norms. However, a few
judged that uncertainty in the outlook for inflation
was about in line with typical levels, and one viewed
the uncertainty surrounding the inflation outlook as
lower than average. Nearly all participants judged the
risks to the inflation outlook as roughly balanced;
however, two saw these risks as tilted to the upside,
while one regarded the risks as weighted to the downside. Some participants noted that inflation expectations could drift downward in response to persistently low inflation and continued slack in resource
utilization. Others pointed to the possibility of an
upward shift in expected and actual inflation, especially if extraordinarily accommodative monetary
policy measures were not unwound in a timely fashion. Participants also noted that an acceleration in
global economic activity could induce a surge in the

Diversity of Views
Figures 2.A and 2.B provide further details on the
diversity of participants’ views regarding the likely
outcomes for real GDP growth and the unemployment rate in 2010, 2011, 2012, and over the longer
run. The distribution of participants’ projections for
real GDP growth this year was slightly narrower than
the distribution of their projections last November,
but the distributions of the projections for real GDP
growth in 2011 and in 2012 were little changed. The
dispersion in participants’ output growth projections
reflected, among other factors, the diversity of their
assessments regarding the current degree of underlying momentum in economic activity, the evolution of
consumer and business sentiment, and the likely pace
of easing of bank lending standards and terms.
Regarding participants’ unemployment rate projections, the distribution for 2010 narrowed slightly, but
the distributions of their unemployment rate projections for 2011 and 2012 did not change appreciably.
The distributions of participants’ estimates of the
longer-run sustainable rates of output growth and unemployment were essentially the same as in November.
Figures 2.C and 2.D provide corresponding information about the diversity of participants’ views regarding the inflation outlook. For overall and core PCE
inflation, the distributions of participants’ projections for 2010 were nearly the same as in November.
The distributions of overall and core inflation for
2011 and 2012, however, were noticeably more tightly
concentrated than in November, reflecting the
absence of forecasts of especially low inflation. The
dispersion in participants’ projections over the next
few years was mainly due to differences in their judgments regarding the determinants of inflation,
including their estimates of prevailing resource slack
and their assessments of the extent to which such
slack affects actual and expected inflation. In contrast, the relatively tight distribution of participants’
projections for longer-run inflation illustrates their
substantial agreement about the measured rate of
inflation that is most consistent with the Federal
Reserve’s dual objectives of maximum employment
and stable prices.

Minutes of Federal Open Market Committee Meetings

Figure 2. A. Distribution of participants’ projections for the change in real GDP, 2010–12 and over the longer run

185

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97th Annual Report | 2010

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2010–12 and over the longer run

187

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97th Annual Report | 2010

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2010–12

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189

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers 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 gross domestic product (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 would imply a probability of about 70 percent that actual GDP would expand within a range of
1.7 to 4.3 percent in the current year, 1.5 to 4.5 percent in the second year, and 1.4 to 4.6 percent in the
third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.1 to 2.9 percent in the current year and 1.0 to 3.0 percent in the
second and third 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, are weighted to the 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.

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97th Annual Report | 2010

Meeting Held on March 16, 2010
A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
March 16, 2010, at 8:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Christine Cumming, Charles L. Evans,
Richard W. Fisher, Narayana Kocherlakota,
and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee
Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively
Brian F. Madigan
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist

Thomas A. Connors, William B. English,
Steven B. Kamin, Lawrence Slifman,
Christopher J. Waller, and David W. Wilcox
Associate Economists
Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Bank Supervision and
Regulation, Board of Governors
Robert deV. Frierson
Deputy Secretary, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director
for Management, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Sherry Edwards and Andrew T. Levin
Senior Associate Directors, Division of Monetary
Affairs, Board of Governors
David Reifschneider and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Michael G. Palumbo
Deputy Associate Director, Division of Research and
Statistics, Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Min Wei
Senior Economist, Division of Monetary Affairs,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Valerie Hinojosa and Randall A. Williams
Records Management Analysts, Division of Monetary
Affairs, Board of Governors
James M. Lyon
First Vice President, Federal Reserve Bank
of Minneapolis

Minutes of Federal Open Market Committee Meetings

Jamie J. McAndrews and Harvey Rosenblum
Executive Vice Presidents, Federal Reserve Banks
of New York and Dallas, respectively
David Altig, Craig S. Hakkio, Loretta J. Mester,
Glenn D. Rudebusch, Mark E. Schweitzer,
Daniel G. Sullivan, and John A. Weinberg
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Kansas City, Philadelphia, San Francisco,
Cleveland, Chicago, and Richmond, respectively
Giovanni Olivei
Vice President, Federal Reserve Bank of Boston
Joshua Frost
Assistant Vice President, Federal Reserve Bank
of New York
Jonathan Heathcote
Senior Economist, Federal Reserve Bank
of Minneapolis

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
reported on developments in domestic and foreign
financial markets during the period since the Committee met on January 26–27, 2010. The net effect of
these developments was that financial conditions had
become modestly more supportive of economic
growth. No market strains emerged in conjunction
with the Federal Reserve’s closing of nearly all of its
remaining special liquidity facilities over the intermeeting period. On February 1, the Primary Dealer
Credit Facility, the Commercial Paper Funding Facility, the Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility, and the
Term Securities Lending Facility were closed, and the
Federal Reserve’s temporary currency swap lines with
foreign central banks expired. Financial markets also
adjusted smoothly to the final offering of funds
through the Term Auction Facility on March 8.
The Manager noted that securitized credit markets
had not shown substantial strain from the anticipated
end of new credit extensions under the Term AssetBacked Securities Loan Facility (TALF), which was
scheduled to close on June 30 for loans backed by
new-issue commercial mortgage-backed securities
(CMBS) and on March 31 for loans backed by all

191

other types of collateral.1 Spreads on asset-backed
securities remained tight while issuance—the bulk of
which was being financed outside of TALF—continued to be fairly strong. While the cumulative volume
of borrowing from the TALF had expanded fairly
steadily in recent months, the volume of repayments
of TALF loans had also risen as borrowers were able
to secure funding from other sources on more favorable terms. As a result, the net amount of outstanding TALF credit had leveled out and would likely
decline going forward as a result of continuing
repayments.
In his report on System open market operations, the
Manager noted that over the period since the Committee had met in January, the Federal Reserve’s total
assets had risen to about $2.3 trillion, as an increase
in the System’s holdings of securities was partly offset by the declining usage of the System’s credit and
liquidity facilities. The Desk continued to gradually
slow the pace of its purchases of agency mortgagebacked securities (MBS) and agency debt as it moved
toward completing the Committee’s previously
announced asset purchases by the end of March. The
Desk’s purchases of agency MBS were on track to
meet the targeted amount of $1.25 trillion, while its
purchases of agency debt would likely cumulate to
slightly less than $175 billion. The Desk continued to
engage in dollar roll transactions in agency MBS
securities to facilitate settlement of its outright purchases. There were no open market operations in foreign currencies for the System’s account over the
intermeeting period. By unanimous vote, the Committee ratified the Desk’s transactions. Participants
also agreed that the Desk should continue the interim
approach of allowing all maturing agency debt and
all prepayments of agency MBS to be redeemed without replacement.
In addition, the Manager reported on recent progress
in the development of reserve draining tools, including the initiation of a program for expanding the set
of counterparties in conducting reverse repurchase
agreements, and the staff gave a presentation on
potential approaches for tightening the link between
short-term market interest rates and the interest rate
paid on reserve balances held at the Federal Reserve
Banks.
1

The final non-CMBS subscription had already occurred in early
March and the final subscription for legacy CMBS would take
place soon after the FOMC meeting; subscriptions for newissue CMBS would continue through June.

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97th Annual Report | 2010

Secretary’s note: A staff memorandum was provided to members of the Board of Governors and
Federal Reserve Bank presidents summarizing
public comments on last December’s Federal Register notice regarding the establishment of a term
deposit facility, but that topic was not discussed at
this meeting.
The staff also briefed the Committee on potential
approaches for managing the Treasury securities held
by the Federal Reserve. To date, the Desk had been
reinvesting all maturing Treasury securities by
exchanging those holdings for newly issued Treasury
securities, but an alternative strategy would be to
allow some or all of those Treasury securities to
mature without reinvestment. Redeeming all of its
maturing Treasury holdings would significantly
reduce the size of the Federal Reserve’s balance sheet
over coming years and hence could be helpful in limiting the need to use other reserve draining tools such
as reverse repurchase agreements and term deposits.
Redemptions would also lower the interest rate sensitivity of the Federal Reserve’s portfolio over time.
Nevertheless, the initiation of a redemption strategy
might generate upward pressure on market rates,
especially if that measure led investors to move up
their expected timing of policy firming. Participants
agreed that the Committee would give further consideration to these matters and that in the interim the
Desk should continue its current practice of reinvesting all maturing Treasury securities.

Staff Review of the Economic Situation
The information reviewed at the March 16 meeting
suggested that economic activity expanded at a moderate pace in early 2010. Business investment in
equipment and software seemed to have picked up,
consumer spending increased further in January, and
private employment would likely have turned up in
February in the absence of the snowstorms that
affected the East Coast. Output in the manufacturing
sector continued to trend higher as firms increased
production to meet strengthening final demand and
to slow the pace of inventory liquidation. On the
downside, housing activity remained flat and the
nonresidential construction sector weakened further.
Meanwhile, a sizable increase in energy prices pushed
up headline consumer price inflation in recent
months; in contrast, core consumer price inflation
was quite low.
Available indicators suggested that the labor market
might be stabilizing. Declines in private payrolls

slowed markedly in recent months, and, in the
absence of the snowstorms, private employment
probably would have risen in February. The average
workweek for production and nonsupervisory workers fell back in February after ticking up in January;
however, the drop was likely due to the storms. The
unemployment rate was unchanged at 9.7 percent in
February, and the labor force participation rate
inched up over the past two months. However, the
level of initial claims for unemployment insurance
benefits remained high.
After increasing briskly in the second half of 2009,
industrial production (IP) continued to expand, on
net, in the early months of 2010, rising sharply in
January and remaining little changed in February
despite some adverse effects of the snowstorms.
Recent production gains remained broadly based
across industries, as firms continued to boost production to meet rising domestic and foreign demand and
to slow the pace of inventory liquidation. Capacity
utilization in manufacturing rose further, to a level
noticeably above its trough in June, but remained well
below its longer-run average. As a result, incentives
for manufacturing firms to expand production capacity were weak. The available indicators of near-term
manufacturing activity pointed to moderate gains in
IP in coming months.
Consumer spending continued to move up. Although
sales of new automobiles and light trucks softened
slightly, on average, in January and February, real
outlays for a wide variety of non-auto goods and
food services increased appreciably, and real outlays
for other services remained on a gradual uptrend. In
contrast to the modest recovery in spending, measures of consumer sentiment remained relatively
downbeat in February and had improved little, on
balance, since a modest rebound last spring. Household income appeared less supportive of spending
than at the January meeting, reflecting downward
revisions to estimates by the Bureau of Economic
Analysis of wages and salaries in the second half of
2009. The ratio of household net worth to income
was little changed in the fourth quarter after two
consecutive quarters of appreciable gains.
Activity in the housing sector appeared to have flattened out in recent months. Sales of both new and
existing homes had turned down, while starts of
single-family homes were about unchanged despite
the substantial reduction in inventories of unsold
new homes. Some of the recent weakness in sales
might have been due to transactions that had been

Minutes of Federal Open Market Committee Meetings

pulled forward in anticipation of the originally
scheduled expiration of the tax credit for first-time
homebuyers in November 2009; nonetheless, the
underlying pace of housing demand likely remained
weak. The slowdown in sales notwithstanding, housing demand was being supported by low interest rates
for conforming fixed-rate 30-year mortgages and
reportedly by a perception that real estate values were
near their trough.
Real spending on equipment and software increased
at a solid pace in the fourth quarter of 2009 and
apparently rose further early in the first quarter of
2010. Business outlays for motor vehicles seemed to
be holding up after a sharp increase in the fourth
quarter, purchases of high-tech equipment appeared
to be rising briskly, and incoming data pointed to
some firming in outlays on other equipment. The
recent gains in investment spending were consistent
with improvements in many indicators of business
demand. In contrast, conditions in the nonresidential
construction sector generally remained poor. Real
outlays on structures outside of the drilling and mining sector fell again in the fourth quarter, and nominal expenditures dropped further in January. The
weakness was widespread across categories and likely
reflected rising vacancy rates, falling property prices,
and difficult financing conditions for new projects.
However, real spending on drilling and mining structures increased strongly in response to the earlier
rebound in oil and natural gas prices.
The pace of inventory liquidation slowed considerably in late 2009. As measured in the national income
and product accounts, real nonfarm inventories
excluding motor vehicles were drawn down at a much
slower pace in the fourth quarter than in each of the
preceding two quarters. Available data for January
indicated a further small liquidation of real stocks
early this year in the manufacturing and wholesale
trade sectors. The ratio of book-value inventories to
sales (excluding motor vehicles and parts) edged
down again in January and stood well below the
recent peak recorded near the end of 2008. Inventories remained elevated for equipment, materials, and,
to a lesser degree, construction supplies, while inventories of consumer goods and business supplies
appeared to be low relative to demand.
Although rising energy prices continued to boost
overall consumer price inflation, consumer prices
excluding food and energy were soft, as a wide variety of goods and services exhibited persistently low
inflation or outright price declines. On a 12-month

193

change basis, core personal consumption expenditures (PCE) price inflation slowed in January 2010
compared with a year earlier, as a marked and fairly
widespread deceleration in market-based core PCE
prices was partly offset by an acceleration in nonmarket prices. Survey expectations for near-term inflation were unchanged over the intermeeting period;
median longer-term inflation expectations edged
down to near the lower end of the narrow range that
prevailed over the previous few years. With regard to
labor costs, the revised data on wages and salaries
showed that last year’s deceleration in hourly compensation was even sharper than was evident at the
January meeting.
The U.S. international trade deficit widened in
December but narrowed slightly in January, ending
the period a little larger. Both exports and imports
rose sharply in December before pulling back somewhat the following month. For the period as a whole,
the rise in exports was broadly based, with notable
gains in aircraft and industrial supplies. Oil and other
industrial supplies accounted for much of the
increase in imports over the two months, while purchases of consumer products declined.
Economic performance in the advanced foreign
economies was mixed in the fourth quarter, with real
gross domestic product (GDP) advancing sharply in
Canada and Japan but rising only slightly in the euro
area and the United Kingdom. That divergence
appeared to have persisted in the first quarter, as
indicators pointed to continued rapid economic
growth in Canada and moderate expansion in Japan
but somewhat anemic growth in Europe. In the
emerging market economies, rebounding global
trade, inventory restocking, and increased domestic
demand supported generally robust fourth-quarter
growth. Continued rapid expansion in China and
several other Asian economies offset slowdowns elsewhere in the region. In Latin America, Mexican
activity was buoyed by rising manufacturing and
exports to the United States, while Brazil’s economy
again grew briskly. Headline consumer price inflation
picked up around the world over the past two
months, principally reflecting increases in food and
energy prices. Excluding food and energy, consumer
prices were generally more subdued.

Staff Review of the Financial Situation
The decision by the Federal Open Market Committee
(FOMC) at the January meeting to keep the target
range for the federal funds rate unchanged and to

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retain the “extended period” language in the statement was widely anticipated by market participants.
However, investors reportedly read the statement’s
characterization of the economic outlook as somewhat more upbeat than they had anticipated, and
Eurodollar futures rates rose a bit in response. The
changes to the terms for primary credit and the Term
Auction Facility that were announced on February 18 resulted in a small increase in near-term
futures rates, but this reaction proved short lived, as
the statement and subsequent Federal Reserve communications—including the Chairman’s semiannual
congressional testimony—emphasized that the modifications were technical adjustments and did not signal any near-term shifts in the overall stance of monetary policy.
On balance, incoming economic data led investors to
mark down the expected path of the federal funds
rate over the intermeeting period. By contrast, yields
on 2-year and 10-year nominal Treasury securities
edged up, on net, over the period. Yields on Treasury
inflation-protected securities (TIPS) rose at all
maturities, reportedly buoyed by investor anticipation of heavier TIPS issuance and by reduced
demand for TIPS by retail investors. Reflecting these
developments, inflation compensation—the difference between nominal yields and TIPS yields for a
given term to maturity—declined over the period, a
move that was supported by the somewhat weakerthan-expected economic data and the publication of
lower-than-expected readings on consumer prices.
Conditions in short-term funding markets remained
generally stable over the intermeeting period. Spreads
between London interbank offered rates (Libor) and
overnight index swap (OIS) rates at one- and threemonth maturities stayed low, while six-month
spreads edged down somewhat further. Spreads of
rates on A2/P2-rated commercial paper and on
AA-rated asset-backed commercial paper over the
AA nonfinancial rate were also little changed at low
levels. The Federal Reserve continued to taper its
large-scale asset purchases and wind down the emergency lending facilities with no apparent adverse
effects on financial markets or institutions.
Broad stock price indexes rose, on net, over the intermeeting period, boosted in part by favorable earnings
reports from the retail sector. Bank equity prices outperformed the broader equity markets. Optionimplied volatility on the S&P 500 index dropped
back to post-crisis lows after increasing earlier in the
period on concerns about Chinese monetary policy

tightening and fiscal strains in Europe. Nonetheless,
the gap between the staff’s estimate of the expected
real equity return over the next 10 years for S&P 500
firms and the real 10-year Treasury yield—a rough
measure of the equity risk premium—remained well
above its average over the past decade. Yields on
investment-grade corporate bonds, as well as their
spreads over yields on comparable-maturity Treasury
securities, were about unchanged over the intermeeting period; investment-grade risk spreads were near
the levels that prevailed late in 2007. Yields and
spreads on speculative-grade bonds edged down, and
secondary-market prices of leveraged loans rose
further.
Overall, net debt financing by nonfinancial firms was
about zero over the first two months of 2010, consistent with firms’ weak demand for credit and banks’
tight credit policies. Gross public equity issuance by
nonfinancial firms was robust in the fourth quarter
of 2009. Since the turn of the year, gross public
equity issuance by nonfinancial firms slowed somewhat, while announcements of both new share repurchase programs and cash-financed mergers and
acquisitions picked up. Public equity issuance by
financial firms declined in January and February following very strong issuance in December, when several large banks issued equity to facilitate the repayment of capital received under the Troubled Asset
Relief Program. Gross bond issuance by financial
firms remained solid. The contraction in commercial
mortgage debt accelerated in the fourth quarter. The
dollar value of commercial real estate sales remained
very low in February, and the share of properties
sold at a nominal loss inched higher. The delinquency
rate on commercial mortgages in securitized pools
increased in January, and the delinquency rate on
commercial mortgages at commercial banks rose in
the fourth quarter. The percentage of delinquent construction loans at banks also ticked higher in the
fourth quarter. Nonetheless, indexes of commercial
mortgage credit default swaps changed little, on balance, over the intermeeting period.
Since the January meeting, yields and spreads on
agency MBS were little changed despite the continued tapering of the Federal Reserve’s purchases of
these securities, and residential mortgage interest
rates and spreads were roughly flat. Net issuance of
MBS by Fannie Mae and Freddie Mac remained
subdued through the end of January. Consumer
credit expanded in January, its first increase since
January 2009. Despite low and stable spreads on consumer asset-backed securities (ABS), the amount of

Minutes of Federal Open Market Committee Meetings

ABS issued in the first two months of the year was
somewhat below that in the fourth quarter, reflecting
the very weak pace of consumer credit originations
late last year. The spread of credit card interest rates
over two-year Treasury yields ticked up in January,
while spreads on new auto loans declined slightly, on
net, over the intermeeting period. Delinquency rates
on credit card loans in securitized pools and on auto
loans at captive finance companies remained elevated
in January but were down a bit from their recent
peaks.
Total bank credit contracted substantially in January
and February. Banks’ securities holdings declined at
a modest pace after several months of steady growth,
and total loans on banks’ books continued to drop.
Commercial and industrial (C&I) loans continued
falling, as spreads of interest rates on C&I loans over
comparable-maturity market instruments climbed
further in the first quarter and nonfinancial firms’
need for external finance apparently remained subdued. Commercial real estate loans also posted significant declines. Household loans on banks’ books
contracted as well, in part because of a pickup in
bank securitizations of first-lien residential mortgages with the government-sponsored enterprises in
February. Consumer loans originated by banks
declined, primarily reflecting a large drop in credit
card loans. In contrast, other consumer loans—including auto, student, and tax advance loans—were
roughly flat during January and February.
M2 decreased in January, owing partly to a contraction in liquid deposits. Many institutions opted out
of the Federal Deposit Insurance Corporation’s
Transaction Account Guarantee Program because of
the higher fees associated with participation after
year-end, reportedly driving depositors to transfer
funds out of transaction accounts and into alternative investments outside of M2. M2 expanded in February, however, as liquid deposits resumed their
growth. Small time deposits and retail money market
mutual funds contracted in January and, to a lesser
extent, in February, while currency declined a bit in
January but advanced notably in February. The monetary base rose in both months, as the increase in
reserve balances resulting from the ongoing largescale asset purchases by the Federal Reserve more
than offset the contraction in balances associated
with the decline in credit outstanding under the
System’s liquidity and credit facilities.
Movements in foreign financial markets since the
January meeting were importantly influenced by con-

195

cerns over fiscal problems in Greece. Spreads on
Greek government debt relative to German bunds
widened appreciably before falling back as press
reports indicated that euro-area countries were discussing a possible aid package for Greece and the
Greek government announced further deficit reduction measures. Spreads on debt issued by several
other European countries followed a similar pattern
over the intermeeting period. The Bank of England
(BOE) and the European Central Bank (ECB) held
rates steady during the period, and the BOE elected
not to expand its Asset Purchase Facility, which
reached its limit at the end of January. In early
March, the ECB announced several steps to normalize its provision of liquidity. Equity prices in most
foreign countries were up moderately since the January FOMC meeting. Likely reflecting the concerns
about Greece as well as weak economic data in
Europe, the dollar appreciated notably against sterling and the euro over the intermeeting period. However, the dollar declined against most emerging market currencies, which were buoyed by brightening
growth prospects, leaving the broad trade-weighted
value of the dollar down a bit since the January
meeting.

Staff Economic Outlook
In the forecast prepared for the March FOMC meeting, the staff’s outlook for real economic activity was
broadly similar to that at the time of the January
meeting. In particular, the staff continued to anticipate a moderate pace of economic recovery over the
next two years, reflecting the accommodative stance
of monetary policy and a further diminution of the
factors that had weighed on spending and production
since the onset of the financial crisis. The staff did
make modest downward adjustments to its projections for real GDP growth in response to unfavorable
news on housing activity, unexpectedly weak spending by state and local governments, and a substantial
reduction in the estimated level of household income
in the second half of 2009. The staff’s forecast for the
unemployment rate at the end of 2011 was about the
same as in its previous projection.
Recent data on consumer prices and unit labor costs
led the staff to revise down slightly its projection for
core PCE price inflation for 2010 and 2011; as before,
core inflation was projected to be quite subdued at
rates below last year’s pace. Although increased oil
prices had boosted overall inflation over recent
months, the staff anticipated that consumer prices
for energy would increase more slowly going forward,

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97th Annual Report | 2010

consistent with quotes on oil futures contracts. Consequently, total PCE price inflation was projected to
run a little above core inflation this year and then
edge down to the same rate as core inflation in 2011.

recovery would contribute to stronger bank balance
sheets and so to an increased availability of credit to
households and small businesses, which would in turn
help boost the economy further.

Participants’ Views on Current Conditions
and the Economic Outlook

While participants saw incoming information as
broadly consistent with continued strengthening of
economic activity, they also highlighted a variety of
factors that would be likely to restrain the overall
pace of recovery, especially in light of the waning
effects of fiscal stimulus and inventory rebalancing
over coming quarters. While recent data pointed to a
noticeable pickup in the pace of consumer spending
during the first quarter, participants agreed that
household spending going forward was likely to
remain constrained by weak labor market conditions,
lower housing wealth, tight credit, and modest
income growth. For example, real disposable personal
income in January was virtually unchanged from a
year earlier and would have been even lower in the
absence of a substantial rise in federal transfer payments to households. Business spending on equipment and software picked up substantially over
recent months, but anecdotal information suggested
that this pickup was driven mainly by increased
spending on maintaining existing capital and updating technology rather than expanding capacity. The
continued gains in manufacturing production were
bolstered by growing demand from foreign trading
partners, especially emerging market economies.
However, a few participants noted the possibility that
fiscal retrenchment in some foreign countries could
trigger a slowdown of those economies and hence
weigh on the demand for U.S. exports.

In their discussion of the economic situation and
outlook, participants agreed that economic activity
continued to strengthen and that the labor market
appeared to be stabilizing. Incoming information on
economic activity received over the intermeeting
period was somewhat mixed but generally confirmed
that the economic recovery was likely to proceed at a
moderate pace. On the positive side, recent data
pointed to significant gains in retail sales, a substantial pickup in business spending on equipment and
software, and a further expansion of goods exports.
Moreover, the latest labor market readings had been
mildly encouraging, with a considerable increase in
temporary employment, especially in the manufacturing and information technology sectors. However,
housing starts had remained flat at a depressed level,
investment in nonresidential structures was still
declining, and state and local government expenditures were being depressed by lower revenues. Moreover, consumer sentiment continued to be damped by
very weak labor market conditions, and firms
remained reluctant to add to payrolls or to commit to
new capital projects. Participants saw recent inflation
readings as suggesting a slightly greater deceleration
in consumer prices than had been expected. In light
of stable longer-term inflation expectations and the
likely continuation of substantial resource slack, they
generally anticipated that inflation would be subdued
for some time.
Participants agreed that financial market conditions
remained supportive of economic growth. Spreads in
short-term funding markets were near pre-crisis levels, and risk spreads on corporate bonds and measures of implied volatility in equity markets were
broadly consistent with historical norms given the
outlook for the economy. Participants were also reassured by the absence of any signs of renewed strains
in financial market functioning as a consequence of
the Federal Reserve’s winding down of its special
liquidity facilities. In contrast, bank lending was still
contracting and interest rates on many bank loans
had risen further in recent months. Participants
anticipated that credit conditions would gradually
improve over time, and they noted the possibility of a
beneficial feedback loop in which the economic

Some labor market indicators displayed positive signals over the intermeeting period, including a pickup
in temporary employment and increased job postings. Indeed, nonfarm payrolls might well have
increased in February in the absence of weather disruptions. Nevertheless, participants were concerned
about the scarcity of job openings, the elevated level
of unemployment, and the extent of longer-term
unemployment, which was seen as potentially leading
to the loss of worker skills. Moreover, the downward
trend in initial unemployment insurance claims
appeared to have leveled off in recent weeks, while
hiring remained at historically low rates. Information
from business contacts and evidence from regional
surveys generally underscored the degree to which
firms’ reluctance to add to payrolls or start large
capital projects reflected their concerns about the
economic outlook and uncertainty regarding future
government policies. A number of participants

Minutes of Federal Open Market Committee Meetings

pointed out that the economic recovery could not be
sustained over time without a substantial pickup in
job creation, which they still anticipated but had not
yet become evident in the data.
Participants were also concerned that activity in the
housing sector appeared to be leveling off in most
regions despite various forms of government support, and they noted that commercial and industrial
real estate markets continued to weaken. Indeed,
housing sales and starts had flattened out at
depressed levels, suggesting that previous improvements in those indicators may have largely reflected
transitory effects from the first-time homebuyer tax
credit rather than a fundamental strengthening of
housing activity. Participants indicated that the pace
of foreclosures was likely to remain quite high;
indeed, recent data on the incidence of seriously
delinquent mortgages pointed to the possibility that
the foreclosure rate could move higher over coming
quarters. Moreover, the prospect of further additions
to the already very large inventory of vacant homes
posed downside risks to home prices.
Participants referred to a wide array of evidence as
indicating that underlying inflation trends remained
subdued. The latest readings on core inflation—
which exclude the relatively volatile prices of food
and energy—were generally lower than they had
anticipated, and with petroleum prices having leveled
out, headline inflation was likely to come down to a
rate close to that of core inflation over coming
months. While the ongoing decline in the implicit
rental cost for owner-occupied housing was weighing
on core inflation, a number of participants observed
that the moderation in price changes was widespread
across many categories of spending. This moderation
was evident in the appreciable slowing of inflation
measures such as trimmed means and medians, which
exclude the most extreme price movements in each
period.
In discussing the inflation outlook, participants took
note of signs that inflation expectations were reasonably well anchored, and most agreed that substantial
resource slack was continuing to restrain cost pressures. Measures of gains in nominal compensation
had slowed, and sharp increases in productivity had
pushed down producers’ unit labor costs. Anecdotal
information indicated that planned wage increases
were small or nonexistent and suggested that large
margins of underutilized capital and labor and a
highly competitive pricing environment were exerting
considerable downward pressure on price adjust-

197

ments. Survey readings and financial market data
pointed to a modest decline in longer-term inflation
expectations over recent months. While all participants anticipated that inflation would be subdued
over the near term, a few noted that the risks to inflation expectations and the medium-term inflation outlook might be tilted to the upside in light of the large
fiscal deficits and the extraordinarily accommodative
stance of monetary policy.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, members agreed that it would be appropriate
to maintain the target range of 0 to ¼ percent for the
federal funds rate and to complete the Committee’s
previously announced purchases of $1.25 trillion of
agency MBS and about $175 billion of agency debt
by the end of March. Nearly all members judged that
it was appropriate to reiterate the expectation that
economic conditions—including low levels of
resource utilization, subdued inflation trends, and
stable inflation expectations—were likely to warrant
exceptionally low levels of the federal funds rate for
an extended period, but one member believed that
communicating such an expectation would create
conditions that could lead to financial imbalances. A
number of members noted that the Committee’s
expectation for policy was explicitly contingent on
the evolution of the economy rather than on the passage of any fixed amount of calendar time. Consequently, such forward guidance would not limit the
Committee’s ability to commence monetary policy
tightening promptly if evidence suggested that economic activity was accelerating markedly or underlying inflation was rising notably; conversely, the duration of the extended period prior to policy firming
might last for quite some time and could even
increase if the economic outlook worsened appreciably or if trend inflation appeared to be declining further. A few members also noted that at the current
juncture the risks of an early start to policy tightening exceeded those associated with a later start,
because the Committee could be flexible in adjusting
the magnitude and pace of tightening in response to
evolving economic circumstances; in contrast, its
capacity for providing further stimulus through conventional monetary policy easing continued to be
constrained by the effective lower bound on the federal funds rate.
Members noted the importance of continued close
monitoring of financial markets and institutions—including asset prices, levels of leverage, and underwrit-

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97th Annual Report | 2010

ing standards—to help identify significant financial
imbalances at an early stage. At the time of the meeting the information collected in this process, including that by supervisory staff, had not revealed emerging misalignments in financial markets or widespread
instances of excessive risk-taking. All members
agreed that the Committee would continue to monitor the economic outlook and financial developments
and would employ its policy tools as necessary to
promote economic recovery and price stability.
In light of the improved functioning of financial
markets, Committee members agreed that it would be
appropriate for the statement to be released following
the meeting to indicate that the previously
announced schedule for closing the Term AssetBacked Securities Loan Facility was being maintained. The Committee also discussed possible
approaches for formulating and communicating key
elements of its strategy for removing extraordinary
monetary policy accommodation at the appropriate
time. No decisions about the Committee’s exit strategy were made at this meeting, but participants
agreed to give further consideration to these issues at
a later date.
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 seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to complete the execution of its
purchases of about $1.25 trillion of agency MBS
and of about $175 billion in housing-related
agency debt by the end of March. The Committee directs the Desk to engage in dollar roll
transactions as necessary to facilitate settlement
of the Federal Reserve’s agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee
informed of ongoing developments regarding
the System’s balance sheet that could affect the
attainment over time of the Committee’s objectives of maximum employment and price
stability.”

The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in January suggests that
economic activity has continued to strengthen
and that the labor market is stabilizing. Household spending is expanding at a moderate rate
but remains constrained by high unemployment,
modest income growth, lower housing wealth,
and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is
declining, housing starts have been flat at a
depressed level, and employers remain reluctant
to add to payrolls. While bank lending continues
to contract, financial market conditions remain
supportive of economic growth. Although the
pace of economic recovery is likely to be moderate for a time, the Committee anticipates a
gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack continuing to
restrain cost pressures and longer-term inflation
expectations stable, inflation is likely to be subdued for some time.
The Committee will maintain the target range
for the federal funds rate at 0 to ¼ percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels of the federal funds rate for an
extended period. To provide support to mortgage lending and housing markets and to
improve overall conditions in private credit markets, the Federal Reserve has been purchasing
$1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those
purchases are nearing completion, and the
remaining transactions will be executed by the
end of this month. The Committee will continue
to monitor the economic outlook and financial
developments and will employ its policy tools as
necessary to promote economic recovery and
price stability.
In light of improved functioning of financial
markets, the Federal Reserve has been closing
the special liquidity facilities that it created to
support markets during the crisis. The only
remaining such program, the Term Asset-

Minutes of Federal Open Market Committee Meetings

Backed Securities Loan Facility, is scheduled to
close on June 30 for loans backed by new-issue
commercial mortgage-backed securities and on
March 31 for loans backed by all other types of
collateral.”
Voting for this action: Ben Bernanke, William C.
Dudley, James Bullard, Elizabeth Duke, Donald L.
Kohn, Sandra Pianalto, Eric Rosengren, Daniel K.
Tarullo, and Kevin Warsh.
Voting against this action: Thomas M. Hoenig.
Mr. Hoenig dissented because he believed it was no
longer advisable to indicate that economic and financial conditions were likely to warrant “exceptionally
low levels of the federal funds rate for an extended
period.” Mr. Hoenig was concerned that communicating such an expectation could lead to the buildup
of future financial imbalances and increase the risks
to longer-run macroeconomic and financial stability.
Accordingly, Mr. Hoenig believed that it would be
more appropriate for the Committee to express its
anticipation that economic conditions were likely to

199

warrant “a low level of the federal funds rate for
some time.” Such a change in communication would
provide the Committee flexibility to begin raising
rates modestly. He further believed that making such
an adjustment to the Committee’s target for the federal funds rate sooner rather than later would reduce
longer-run risks to macroeconomic and financial stability while continuing to provide needed support to
the economic recovery.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, April 27–28,
2010. The meeting adjourned at 1:00 p.m. on
March 16, 2010.

Notation Vote
By notation vote completed on February 16, 2010,
the Committee unanimously approved the minutes of
the FOMC meeting held on January 26–27, 2010.
Brian F. Madigan
Secretary

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97th Annual Report | 2010

Meeting Held on April 27–28, 2010

David J. Stockton
Economist

A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
April 27, 2010, at 2:00 p.m. and continued on
Wednesday, April 28, 2010, at 9:00 a.m.

Alan D. Barkema, Thomas A. Connors,
William B. English, Jeff Fuhrer, Steven B. Kamin,
Simon Potter, Lawrence Slifman, Mark S. Sniderman,
Christopher J. Waller, and David W. Wilcox
Associate Economists

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Christine Cumming, Charles L. Evans,
Narayana Kocherlakota, and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee
Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively
Helen E. Holcomb
First Vice President, Federal Reserve Bank of Dallas
Brian F. Madigan
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel
Nathan Sheets
Economist

Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Bank Supervision and
Regulation, Board of Governors
Robert deV. Frierson1
Deputy Secretary, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director
for Management, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
William Nelson
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Nellie Liang, David Reifschneider, and
William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Seth B. Carpenter
Associate Director, Division of Monetary Affairs,
Board of Governors
Christopher J. Erceg
Deputy Associate Director, Division of International
Finance, Board of Governors
Egon Zakrajšek
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Brian J. Gross
Special Assistant to the Board, Office of Board
Members, Board of Governors
1

Attended Tuesday’s session only.

Minutes of Federal Open Market Committee Meetings

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Jennifer E. Roush
Senior Economist, Division of Monetary Affairs,
Board of Governors
Kurt F. Lewis
Economist, Division of Monetary Affairs,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Kimberley E. Braun
Records Project Manager, Division of Monetary
Affairs, Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Esther L. George
First Vice President, Federal Reserve Bank
of Kansas City
Loretta J. Mester, Harvey Rosenblum, and
John C. Williams
Executive Vice Presidents, Federal Reserve Banks of
Philadelphia, Dallas, and San Francisco, respectively
David Altig, Richard P. Dzina, Daniel G. Sullivan, and
John A. Weinberg
Senior Vice Presidents, Federal Reserve Banks
of Atlanta, New York, Chicago, and Richmond,
respectively
Warren Weber
Senior Research Officer, Federal Reserve Bank
of Minneapolis

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Committee met on March 16, 2010. The Manager
also reported on System open market operations in
Treasury securities and in agency debt and agency
mortgage-backed securities (MBS) during the intermeeting period. By unanimous vote, the Committee
ratified those transactions. There were no open market operations in foreign currencies for the System’s
account over the intermeeting period.
By unanimous vote, the Committee decided to
extend the reciprocal currency (“swap”) arrange-

201

ments with the Bank of Canada and the Banco de
Mexico for an additional year, beginning in midDecember 2010; these arrangements are associated
with the Federal Reserve’s participation in the North
American Framework Agreement of 1994. The
arrangement with the Bank of Canada is in the
amount of $2 billion equivalent, and the arrangement with the Banco de Mexico is in the amount of
$3 billion equivalent. The vote to renew the System’s
participation in these swap arrangements was taken
at this meeting because of a provision in the arrangements that requires each party to provide six months’
prior notice of an intention to terminate its
participation.
The staff also briefed the Committee on recent progress in the development of reserve draining tools. The
Desk was preparing to conduct small-scale reverse
repurchase operations to ensure its ability to use
agency MBS collateral. It also continued to work
toward expansion of the set of counterparties for
reverse repurchase operations. The staff noted that
the Board had recently approved changes to Regulation D that would be necessary for the establishment
of a term deposit facility.
The staff next gave a presentation on potential
longer-run strategies for managing the SOMA. At
previous meetings, Committee participants had
expressed support for steps to reduce the size of the
Federal Reserve’s balance sheet over time and return
the composition of the SOMA to only Treasury securities. The staff discussed the potential portfolio
paths and macroeconomic consequences of a number
of different strategies for accomplishing these objectives. To date, the Desk had been reinvesting the proceeds of all maturing Treasury securities in newly
issued Treasury securities, but it had not been reinvesting principal and interest payments on maturing
agency debt and agency MBS, nor had it been selling
securities. One strategy considered in the staff presentation was a continuation of the current practice,
which would normalize the balance sheet very gradually. In addition, the staff presented information on a
number of other strategies that included sales of
SOMA holdings of agency debt and MBS and under
which the proceeds of maturing Treasury securities
would not be reinvested; these strategies differed by
the date and circumstances under which sales would
be initiated, by the average pace of sales, and by the
degree to which the timing and pace of such sales
would be adjusted in response to financial and economic developments.

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Meeting participants agreed broadly on key objectives of a longer-run strategy for asset sales and
redemptions. The strategy should be consistent with
the achievement of the Committee’s objectives of
maximum employment and price stability. In addition, the strategy should normalize the size and composition of the balance sheet over time. Reducing the
size of the balance sheet would decrease the associated reserve balances to amounts consistent with
more normal operations of money markets and monetary policy. Returning the portfolio to its historical
composition of essentially all Treasury securities
would minimize the extent to which the Federal
Reserve portfolio might be affecting the allocation of
credit among private borrowers and sectors of the
economy.
Most participants expressed a preference for strategies that would eventually entail sales of agency debt
and MBS in order to return the size and composition
of the Federal Reserve’s balance sheet to a more normal configuration more quickly than would be
accomplished by simply letting MBS and agency
securities run off. They agreed that sales of agency
debt and MBS should be implemented in accordance
with a framework communicated in advance and be
conducted at a gradual pace that potentially could be
adjusted in response to changes in economic and
financial conditions.
Participants expressed a range of views on some of
the details of a strategy for asset sales. Most participants favored deferring asset sales for some time. A
majority preferred beginning asset sales some time
after the first increase in the Federal Open Market
Committee’s (FOMC) target for short-term interest
rates. Such an approach would postpone any asset
sales until the economic recovery was well established
and would maintain short-term interest rates as the
Committee’s key monetary policy tool. Other participants favored a strategy in which the Committee
would soon announce a general schedule for future
asset sales, with a date for the initiation of sales that
would not necessarily be linked to the increase in the
Committee’s interest rate target. A few preferred to
begin sales relatively soon. Earlier sales would normalize the size and composition of the balance sheet
sooner and would unwind at least part of the unconventional policy stimulus put in place during the crisis before conventional policy firming got under way.
Some participants saw advantages to varying the
FOMC’s holdings of longer-term assets systematically in response to economic and financial developments. However, others thought that a pre-

announced pace of sales that was unlikely to vary
much would provide a high degree of certainty about
sales, helping to limit disruptions in financial
markets.
The views of participants also differed to some extent
regarding the appropriate pace of asset sales. Most
preferred that the agency debt and MBS held in the
portfolio be sold at a gradual pace that would complete the sales about five years after they began. One
possibility would be for the pace to be relatively slow
initially but to increase over time, allowing markets to
adjust gradually. A couple of participants thought
faster sales, conducted over about three years, would
be appropriate and felt that such a pace would not
put undue strain on financial markets. In their view, a
relatively brisk pace of sales would reduce the chance
that the elevated size of the Federal Reserve’s balance
sheet and the associated high level of reserve balances could raise inflation expectations and inflation
beyond levels consistent with price stability or could
generate excessive growth of credit when the
economy and banking system recover more fully.
Participants saw both advantages and disadvantages
to not rolling over Treasury securities as they mature.
On the one hand, redeeming Treasury securities
would contribute to a more expeditious normalization of the size of the balance sheet and the quantity
of reserves. On the other hand, such redemptions
could put upward pressure on interest rates and
would tend to work against the objective of returning
the SOMA to an all-Treasuries composition.
No decisions about the Committee’s longer-run strategy for asset sales and redemptions were made at this
meeting. For the time being, participants agreed that
the Desk should continue the interim approach of
allowing all maturing agency debt and all prepayments of agency MBS to be redeemed without
replacement while rolling over all maturing Treasury
securities. Participants agreed to give further consideration to their longer-run strategy at a later date.

Staff Review of the Economic Situation
The information reviewed at the April 27–28 meeting
suggested that, on balance, the economic recovery
was proceeding at a moderate pace and that the deterioration in the labor market was likely coming to an
end. Consumer spending continued to post solid
gains in the first three months of the year, and business investment in equipment and software appeared
to have increased significantly further in the first

Minutes of Federal Open Market Committee Meetings

quarter. In addition, growth of manufacturing output remained brisk, and gains became more broadly
based across industries. However, residential construction, while having edged up, was still depressed,
construction of nonresidential buildings remained on
a steep downward trajectory, and state and local governments continued to retrench. Consumer price
inflation remained low.
The labor market showed signs of a nascent recovery
in recent months. Private nonfarm payroll employment increased over the first quarter of 2010—the
first quarterly increase since the onset of the recession. The average workweek also rose last quarter
and data from the household survey pointed to a
firming in labor market conditions. The unemployment rate held steady at 9.7 percent throughout the
first quarter, and the labor force participation rate
increased over the past few months following sharp
declines over the second half of last year. The number of new job losers as a percentage of household
employment continued to drop, and the fraction of
workers on part-time schedules for economic reasons
moved down since the end of last year. Nonetheless,
finding a job remained very difficult, and the average
duration of unemployment spells increased further.

203

the crisis. Furthermore, although banks indicated a
somewhat greater willingness to lend to consumers in
recent months, terms and standards on consumer
loans remained restrictive. Additionally, consumer
sentiment dropped back in early April and was little
changed, on net, since the beginning of the year.
Starts of new single-family homes edged up, on net,
over February and March, but much of this increase
likely reflected delayed projects getting under way as
weather conditions returned to normal. Home sales
strengthened noticeably, as sales of new single-family
homes jumped and sales of existing single-family
homes rose as well. However, both new home sales
and existing home sales were likely boosted, at least
in part, by the anticipated expiration of the homebuyer tax credit. Interest rates for conforming
30-year fixed-rate mortgages changed little in recent
months and remained at levels that were very low by
historical standards.

Industrial production continued to expand at a brisk
pace during the first quarter. Recent production
gains remained broadly based across industries, as
both foreign demand and a mild restocking of inventories contributed positively to output growth.
Capacity utilization stood significantly above the
trough recorded last June but was still well below its
long-run average. Light motor vehicle production
stepped up in March, and assemblies in the first
quarter were above their fourth-quarter average as
automakers cautiously began to rebuild dealers’
inventories. Production in high-tech industries
increased solidly, and available indicators pointed
toward further expansion in this sector in the near
term. On balance, indicators of near-term manufacturing activity remained quite positive.

Real spending on equipment and software continued
to rebound in the first quarter. Investment in hightech equipment and transportation advanced further,
and real spending for equipment other than high-tech
and transportation appeared to turn up sharply after
falling for more than a year, suggesting that the
recovery in equipment and software investment
became more broadly based. The recovery in equipment and software spending was consistent with the
strengthening in many indicators of business activity.
In contrast, the nonresidential construction sector
continued to contract. Real outlays on structures outside drilling and mining fell steeply last year, and
recent data on nominal expenditures through February suggested a further decline in the first quarter.
The weakness was widespread across categories and
likely reflected elevated vacancy rates, low levels of
property prices, and difficulties in obtaining financing for new projects. Real spending on drilling and
mining structures picked up strongly over the second
half of last year in response to the rebound in oil and
natural gas prices.

Consumer spending continued to rise at a solid pace
through March, with recent gains pronounced for
most non-auto goods and food services. Despite signs
of improvement recently, the determinants of spending remained subdued. While wages and salaries
picked up early this year, real disposable income was
flat in February after a slight decline in January;
housing wealth was still well below its level prior to

Available data suggested that the pace of inventory
liquidation moderated further in the first quarter
after slowing sharply in the fourth quarter of last
year. Inventories appeared to approach comfortable
levels relative to sales in the aggregate, although
inventory positions across industries varied. Months’
supply remained elevated for equipment, materials,
and, to a lesser degree, construction supplies. By con-

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97th Annual Report | 2010

trast, inventories of consumer goods, business supplies, and high-tech goods appeared low relative to
demand.
Consumer price inflation was low in recent months;
both headline and core personal consumption expenditures (PCE) prices were estimated to have risen
slightly in March after remaining unchanged in February. On a 12-month change basis, core PCE prices
slowed over the year ending in March, with deceleration widespread across categories of expenditures. In
contrast, the corresponding change in the headline
index moved up noticeably, as energy prices
rebounded. Survey measures of long-term inflation
expectations were fairly stable in recent months at
levels slightly lower than those posted a year ago.
Meanwhile, measures of inflation compensation
based on Treasury inflation-protected securities
(TIPS) edged up slightly. Cost pressures from rising
commodity prices showed through to prices at early
stages of processing, and the producer price index for
core intermediate materials continued to rise rapidly
through March. However, measures of labor costs
decelerated sharply last year, as compensation per
hour in the nonfarm business sector increased only
slightly over the four quarters of 2009.
The U.S. international trade deficit widened in February, as a rise in nominal imports outpaced a small
increase in exports. Increased exports of industrial
supplies, capital goods, and automotive products
were partly offset by declines in agricultural goods
and consumer goods. The February rise in imports
reversed a similarly sized decrease in January.
Imports of oil accounted for more than one-third of
the January decline, reflecting lower volumes, but
they accounted for only about one-tenth of the February increase, as volumes rebounded but prices fell.
Imports of capital goods rose as strong computer
imports more than offset falling aircraft purchases,
and imports of industrial supplies and consumer
goods also moved up.
Recent indicators in the advanced foreign economies
suggested a continued divergence in the pace of
recovery, with a strong performance in Canada, a
moderate expansion in Japan, and a more subdued
rebound in Europe. Fiscal strains in Greece intensified during the intermeeting period, and in midApril, euro-area member states announced a plan to
provide financing aid to Greece in coordination with
the International Monetary Fund. However, at the
time of the April FOMC meeting, no official agreement had been reached concerning the scale, compo-

sition, and implementation of such an aid package.
Economic activity in emerging markets continued to
expand robustly in the first quarter. Despite the
strength of exports, merchandise trade balances
declined for some countries where strong domestic
demand caused imports to outpace exports. In
China, real gross domestic product (GDP) increased
at a higher-than-expected annual rate in the first
quarter as the economic recovery remained broad
based, with industrial production, investment, and
domestic demand continuing to grow briskly. In
Latin America, indicators suggested that economic
activity in Mexico and Brazil expanded further in the
first quarter. Foreign inflation was boosted by
increases in the prices of oil and other commodities,
but core inflation generally remained subdued.

Staff Review of the Financial Situation
The decision by the FOMC at the March meeting to
keep the target range for the federal funds rate
unchanged and to retain the “extended period” language in the statement was largely anticipated by
market participants. However, some market participants reportedly interpreted the retention of the
“extended period” language as pointing to a longer
period of low rates than previously expected, and
Eurodollar futures rates temporarily declined a bit in
response.
On balance over the intermeeting period, the
expected path of policy edged down slightly. Yields
on 2-year and 10-year nominal Treasury securities
posted small mixed changes amid some volatility that
reportedly reflected evolving views about the U.S. fiscal outlook, prospects for U.S. economic growth, and
the fiscal situation in peripheral European countries.
Inflation compensation—the difference between
nominal Treasury yields and yields on TIPS—rose
some over the period, but survey measures of longerterm inflation expectations were about unchanged.
Overall, conditions in short-term funding markets
remained generally stable during the intermeeting
period. Spreads between London interbank offered
rates (Libor) and overnight index swap (OIS) rates
were about unchanged at levels near those that prevailed in late 2007, although they began to edge up in
the final days of the intermeeting period. Spreads in
the commercial paper market were little changed.
Equity indexes rose, on balance, over the intermeeting period, with bank shares outperforming the
broader market. Stock prices were supported by
somewhat better-than-expected macroeconomic data

Minutes of Federal Open Market Committee Meetings

and a favorable response by investors to the initial
batch of first-quarter earnings reports, especially
those of banking institutions. Option-implied volatility on the S&P 500 index generally declined over the
period but jumped at end of April on renewed concerns regarding the fiscal situation in Greece. The gap
between the staff’s estimate of the expected real
equity return over the next 10 years for S&P 500
firms and the real 10-year Treasury yield—a rough
measure of the equity risk premium—remained well
above its average over the past decade. Yields on
investment-grade corporate bonds edged down, leaving their spreads to comparable-maturity Treasury
securities a bit lower, at levels around those that prevailed in late 2007. Consistent with more-favorable
investor sentiment toward risky assets, yields and
spreads on speculative-grade corporate bonds
declined, and secondary market prices of syndicated
leveraged loans rose further.
Overall, net debt financing by nonfinancial firms was
positive in March. Issuance of nonfinancial bonds
surged, and net issuance of commercial paper
rebounded appreciably. Net equity issuance by nonfinancial firms was negative again in the first quarter
as the solid pace of gross public issuance was more
than offset by equity retirements from both cashfinanced mergers and share repurchases. Financial
firms issued a significant volume of debt securities in
the first quarter and also raised a moderate amount
of gross funds in the equity market, a pattern that
appeared to continue in the first half of April. Credit
quality in the commercial real estate sector continued
to deteriorate as the delinquency rate for securitized
commercial mortgages increased again in March. The
decline in outstanding commercial mortgage debt in
the fourth quarter of last year was the largest on
record. Nonetheless, indexes of prices for credit
default swaps on commercial mortgage-backed securities ticked up noticeably over the period, in line
with the overall reduction in financial market risk
premiums.
The conclusion of purchases under the Federal
Reserve’s agency MBS program had only a modest
market effect. Over the intermeeting period, spreads
on agency MBS retraced much of the increase seen
around the time of the program’s conclusion, ending
the period roughly unchanged. The factors contributing to the recent narrowing of MBS and mortgage
spreads included the low level of mortgage originations, which damped the supply of new MBS, and
Fannie Mae’s and Freddie Mac’s increased purchases
of mortgages through their buyouts of delinquent

205

loans. Consumer credit continued to trend lower in
recent months, pushed down by a steep decline in
revolving credit. Spreads on high-quality credit card
and auto loan asset-backed securities (ABS) edged
down over the period, with little upward pressure evident from the end of the portion of the Term AssetBacked Securities Loan Facility supporting ABS.
Nonetheless, fewer ABS were issued in the first quarter than in the fourth quarter, reflecting continued
weakness in loan originations. Delinquency rates on
consumer loans edged down further in February but
remained very elevated. Spreads of interest rates on
credit cards over yields on two-year Treasury securities continued to drift upward, while interest rates on
new auto loans at dealerships and their spreads over
yields on five-year Treasury securities extended their
previous decline.
After adjusting to remove the effects of banks’ adoption of Financial Accounting Standards 166 and 167,
bank credit contracted again in March, as both loans
and securities holdings declined.2 The contraction in
commercial and industrial loans remained pronounced. The drop in commercial real estate loans
persisted, reflecting weak fundamentals that limited
originations as well as charge-offs of existing loans.
Residential real estate loans also decreased further in
March, as did credit card loans and other consumer
loans.
M2 fell in March, reflecting a slowing in the expansion of liquid deposits along with a further contraction in small time deposits and a steep runoff in retail
money market mutual funds. Currency grew at a
moderate pace, likely as a result of continued
demand for U.S. banknotes from abroad coupled
with solid domestic demand. The monetary base contracted as the effect on reserves of purchases under
the Federal Reserve’s large-scale asset purchase programs was more than offset by a further contraction
in credit outstanding under liquidity and credit facilities and an increase in the Treasury’s balances at the
Federal Reserve.
2

The new accounting standards make it more difficult for U.S.
banks to hold assets off balance sheet. Banks adopted the standards in the fourth quarter of 2009 and the first quarter of
2010. The cumulative effects of the resulting asset consolidation
were incorporated in the bank credit data published on the Federal Reserve’s H.8 Statistical Release “Assets and Liabilities of
Commercial Banks in the United States” as of March 31, 2010.
While all major loan categories were affected to some degree by
banks’ adoption of Financial Accounting Standards 166 and
167, the largest effect was on credit card loans on commercial
bank balance sheets; banks also consolidated significant
amounts of other consumer loans, commercial and industrial
loans, and residential real estate loans.

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97th Annual Report | 2010

Until the intensification of the Greek crisis near the
end of the intermeeting period, equity indexes were
higher in nearly all countries, and emerging-market
risk spreads had generally declined. These moves
appeared to reflect growing confidence that the
global recovery was gaining momentum, particularly
in emerging market economies. However, sovereign
debt spreads in Greece, Portugal, and other peripheral European countries widened in the days leading
up to the April FOMC meeting, as investor anxiety
about the fiscal situation in those countries increased.
Downgrades to the credit ratings of Greece and Portugal weighed on investor sentiment, and global markets retraced some of their earlier gains.
Over the intermeeting period, the Bank of Japan
doubled the size of its three-month fixed-rate funds
facility, the Bank of Canada dropped its conditional
commitment to keeping rates steady through the first
half of the year, and the Reserve Bank of Australia
raised its policy rate. The trade-weighted value of the
dollar changed little, on net; gains against the euro
and yen were offset by declines against many emerging market currencies.

Staff Economic Outlook
The economic forecast prepared by the staff for the
April FOMC meeting was similar to that developed
for the March meeting. The staff continued to project that the accommodative stance of monetary
policy, together with a further attenuation of financial stress, the waning of adverse effects of earlier
declines in wealth, and improving household and
business confidence, would support a moderate
recovery in economic activity and a gradual decline
in the unemployment rate over the next two years.
The staff forecast for both real GDP growth and the
unemployment rate through the end of 2011 was
roughly in line with previous projections.
Recent data on core consumer prices led the staff to
mark down slightly its forecast for core PCE inflation. The staff continued to anticipate that downward pressure on inflation from the substantial
amount of projected resource slack would be tempered by stable inflation expectations. With energy
price increases expected to slow next year, total PCE
inflation was seen as likely to fall back in line with
core inflation by the end of 2011, as in previous
projections.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks—provided projections of economic
growth, the unemployment rate, and consumer price
inflation for each year from 2010 through 2012 and
over a longer horizon. Longer-run projections represent each participant’s assessment of the rate to
which each variable would be expected to converge
over time under appropriate monetary policy and in
the absence of further shocks. Participants’ forecasts
through 2012 and over the longer run are described
in the Summary of Economic Projections, which is
attached as an addendum to these minutes.
In their discussion of the economic situation and
outlook, meeting participants agreed that the incoming data and information received from business contacts indicated that economic activity continued to
strengthen and the labor market was beginning to
improve. Although some of the recent data on economic activity had been better than anticipated, most
participants saw the incoming information as broadly
in line with their earlier projections for moderate
growth; accordingly, their views on the economic outlook had not changed appreciably. Participants
expected the economic recovery to continue, but,
consistent with experience following previous financial crises, most anticipated that the pickup in output
would be rather slow relative to past recoveries from
deep recessions. A moderate pace of expansion, in
turn, would imply only a modest improvement in the
labor market this year, with the unemployment rate
declining gradually. Most participants again projected that the economy would grow somewhat faster
in 2011 and 2012, generating a more pronounced
decline in the unemployment rate. In light of stable
longer-term inflation expectations and the likely continuation of substantial resource slack, policymakers
anticipated that both overall and core inflation would
remain subdued through 2012, with measured inflation somewhat below rates that policymakers considered to be consistent over the longer run with the
Federal Reserve’s dual mandate.
Participants expected that economic growth would
continue: Recent data pointed to significant gains in
retail sales, business spending on equipment and soft-

Minutes of Federal Open Market Committee Meetings

ware had picked up substantially, and reports from
business contacts and regional surveys indicated that
production was increasing briskly in many sectors.
Participants agreed that the growth in real GDP
appeared to reflect a strengthening of private final
demand and not just fiscal stimulus and a slower
pace of inventory decumulation; this welcome development lessened policymakers’ concerns about the
economy’s ability to maintain a self-sustaining recovery without government support. Businesses
appeared to be gaining confidence in the economic
recovery, and narrowing credit spreads in private
debt markets were allowing low policy rates to be
reflected more fully in the cost of capital. At the
same time, rising stock prices and the apparent stabilization of house prices were helping to repair household balance sheets. As a result, consumers and firms
were beginning to satisfy demands for durable goods
and capital equipment that had been postponed during the economic downturn. Many participants
noted that employment had increased in recent
months, and that they expected a further firming of
labor market conditions going forward. A stronger
labor market could continue to boost consumer and
business confidence and so contribute to further
gains in spending.
Although these developments were positive, participants noted several factors that likely would continue
to restrain expansion in economic activity and posed
some downside risks. The recent increase in consumer spending appeared to be supported importantly by pent-up demands and possibly by other
temporary factors, such as unusually large income
tax refunds. With the personal saving rate having
dropped back to a relatively low level, it seemed
unlikely that consumer spending would be the major
factor driving growth as the recovery progressed.
Moreover, the recovery in the housing market
appeared to have stalled in recent months despite
various forms of government support. Although residential real estate values seemed to be stabilizing and
in some areas had reportedly moved higher, housing
sales and starts had leveled off in recent months at
depressed levels. Some participants saw the possibility of elevated foreclosures adding to the already very
large inventory of vacant homes as posing a downside risk to home prices, thereby limiting the extent of
the pickup in residential investment for a while.
In the business sector, prospects for nonresidential
construction outside the energy sector remained
weak. Commercial real estate activity continued to
fall in most parts of the country as a result of dete-

207

riorating fundamentals, including declining occupancy and rental rates and tight credit conditions.
However, a number of participants noted that investment in equipment and software had been strengthening, and they relayed anecdotal information from
their business contacts that suggested continued
growth in orders for capital equipment.
Business investment was expected to be supported by
improved conditions in financial markets. Large
firms with access to capital markets appeared to be
having little difficulty in obtaining credit, and in
many cases they also had ample retained earnings
with which to fund their operations and investment.
However, many participants noted that while financial markets had improved, bank lending was still
contracting and credit remained tight for many borrowers. Smaller firms in particular reportedly continued to face substantial difficulty in obtaining bank
loans. Because such firms tend to be more dependent
on commercial banks for financing, participants saw
limited credit availability as a potential constraint on
future investment and hiring by small businesses,
which normally are a significant source of employment growth in recoveries. Some participants noted
that many small and regional banks were vulnerable
to deteriorating performance of commercial real
estate loans.
Economic conditions abroad, especially in several
emerging Asian economies, continued to strengthen
in recent months, contributing to gains in U.S.
exports. However, participants saw the escalation of
fiscal strains in Greece and spreading concerns about
other peripheral European countries as weighing on
financial conditions and confidence in the euro area.
If other European countries responded by intensifying their fiscal consolidation efforts, the result would
likely be slower growth in Europe and potentially a
weaker global economic recovery. Some participants
expressed concern that a crisis in Greece or in some
other peripheral European countries could have an
adverse effect on U.S. financial markets, which could
also slow the recovery in this country.
Developments in labor markets were positive over the
intermeeting period. Nonfarm payrolls posted a
modest gain in March, and the upturn in private
employment was widespread across industries. Nevertheless, participants remained concerned about
elevated unemployment, including high levels of
long-term unemployment and permanent separations, which were seen as potentially leading to the
loss of worker skills and greater needs for labor real-

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97th Annual Report | 2010

location that could slow employment growth going
forward. Moreover, information from business contacts generally underscored the degree to which
firms’ reluctance to add to payrolls or start large
capital projects reflected uncertainty about the economic outlook and future government policies. A
number of participants pointed out that the economic recovery could eventually lose traction without a substantial pickup in job creation.
Participants cited a wide array of evidence as indications that underlying inflation remained subdued.
The latest readings on core inflation—which exclude
the relatively volatile prices of food and energy—
were generally lower than they had anticipated. One
participant noted that core inflation had been held
down in recent quarters by unusually slow increases
in the price index for shelter, and that the recent
behavior of core inflation might be a misleading signal of the underlying inflation trend. However, a
number of participants pointed out that the recent
moderation in price changes was widespread across
many categories of spending and was evident in
measures that exclude the most extreme price movements in each period. In addition, survey measures of
longer-term inflation expectations remained fairly
stable, wage growth continued to be restrained, and
unit labor costs were still falling; reports from business contacts also suggested that pricing power
remained limited. Against this backdrop, most participants anticipated that substantial resource slack
and stable longer-term inflation expectations would
likely keep inflation subdued for some time.
Participants’ assessments of the risks to the inflation
outlook were mixed. Some participants saw the risks
to inflation as tilted to the downside in the near term,
reflecting the quite elevated level of economic slack
and the possibility that inflation expectations could
begin to decline in response to the low level of actual
inflation. Others, however, saw the balance of risks as
pointing to potentially higher inflation and cited
pressures on commodity and energy prices associated
with expanding global economic activity as an upside
inflation risk; some also noted the possibility that
inflation expectations could rise as a result of the
public’s concerns about the extraordinary size of the
Federal Reserve’s balance sheet in a period of very
large federal budget deficits. While survey measures
of longer-term inflation expectations had been fairly
stable, some market-based measures of inflation
expectations and inflation risk suggested increased
concern among market participants about higher
inflation. To keep inflation expectations well

anchored, all participants agreed that it was important for policy to be responsive to changes in the economic outlook and for the Federal Reserve to continue to communicate clearly its ability and intent to
begin withdrawing monetary policy accommodation
at the appropriate time and pace.

Committee Policy Action
In the members’ discussion of monetary policy for
the period ahead, they agreed that no changes to the
Committee’s federal funds rate target range were
warranted at this meeting. On balance, the economic
outlook had changed little since the March meeting.
Even though the recovery appeared to be continuing
and was expected to strengthen gradually over time,
most members projected that economic slack would
continue to be quite elevated for some time, with
inflation remaining below rates that would be consistent in the longer run with the Federal Reserve’s dual
objectives. Based on this outlook, members agreed
that it would be appropriate to maintain the target
range of 0 to 1∕4 percent for the federal funds rate. In
addition, nearly all members judged that it was
appropriate to reiterate the expectation that economic conditions—including low levels of resource
utilization, subdued inflation trends, and stable inflation expectations—were likely to warrant exceptionally low levels of the federal funds rate for an
extended period. As at previous meetings, a few
members noted that at the current juncture, the risks
of an early start to policy tightening exceeded those
associated with a later start, because the scope for
more accommodative policy was limited by the effective lower bound on the federal funds rate, while the
Committee could be flexible in adjusting the magnitude and pace of tightening in response to evolving
economic circumstances. In light of the improved
functioning of financial markets, Committee members agreed that it would be appropriate for the statement to be released following the meeting to indicate
that the previously announced schedule for closing
the Term Asset-Backed Securities Loan Facility was
being maintained.
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 fos-

Minutes of Federal Open Market Committee Meetings

ter price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to 1∕4 percent. The Committee
directs the Desk to engage in dollar roll transactions as necessary to facilitate settlement of the
Federal Reserve’s agency MBS transactions. The
System Open Market Account Manager and the
Secretary will keep the Committee informed of
ongoing developments regarding the System’s
balance sheet that could affect the attainment
over time of the Committee’s objectives of
maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in March suggests that
economic activity has continued to strengthen
and that the labor market is beginning to
improve. Growth in household spending has
picked up recently but remains constrained by
high unemployment, modest income growth,
lower housing wealth, and tight credit. Business
spending on equipment and software has risen
significantly; however, investment in nonresidential structures is declining and employers remain
reluctant to add to payrolls. Housing starts have
edged up but remain at a depressed level. While
bank lending continues to contract, financial
market conditions remain supportive of economic growth. Although the pace of economic
recovery is likely to be moderate for a time, the
Committee anticipates a gradual return to
higher levels of resource utilization in a context
of price stability.
With substantial resource slack continuing to
restrain cost pressures and longer-term inflation
expectations stable, inflation is likely to be subdued for some time.
The Committee will maintain the target range
for the federal funds rate at 0 to 1∕4 percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels of the federal funds rate for an

209

extended period. The Committee will continue
to monitor the economic outlook and financial
developments and will employ its policy tools as
necessary to promote economic recovery and
price stability.
In light of improved functioning of financial
markets, the Federal Reserve has closed all but
one of the special liquidity facilities that it created to support markets during the crisis. The
only remaining such program, the Term AssetBacked Securities Loan Facility, is scheduled to
close on June 30 for loans backed by new-issue
commercial mortgage-backed securities; it closed
on March 31 for loans backed by all other types
of collateral.”
Voting for this action: Ben Bernanke, William C.
Dudley, James Bullard, Elizabeth Duke, Donald L.
Kohn, Sandra Pianalto, Eric Rosengren, Daniel K.
Tarullo, and Kevin Warsh.
Voting against this action: Thomas M. Hoenig.
Mr. Hoenig dissented because he believed it was no
longer advisable to indicate that economic and financial conditions were likely to warrant “exceptionally
low levels of the federal funds rate for an extended
period.” Mr. Hoenig was concerned that communicating such an expectation could lead to the buildup
of future financial imbalances and increase the risks
to longer-run macroeconomic and financial stability,
while limiting the Committee’s flexibility to begin
raising rates modestly in the near term. Mr. Hoenig
believed that the target for the federal funds rate
should be increased toward 1 percent this summer,
and that the Committee could then pause to further
assess the economic outlook. He believed this
approach would leave considerable policy accommodation in place to foster an expected gradual decline
in unemployment in the quarters ahead and would
reduce the risk of an increase in financial imbalances
and inflation pressures in coming years. It would also
mitigate the need to push the policy rate to higher
levels later in the expansionary phase of the economic cycle.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, June 22–23,
2010. The meeting adjourned at 12:50 p.m. on
April 28, 2010.

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97th Annual Report | 2010

Notation Vote

verge over time under appropriate monetary policy
and in the absence of further shocks.

By notation vote completed on April 5, 2010, the
Committee unanimously approved the minutes of the
FOMC meeting held on March 16, 2010.

FOMC participants’ forecasts for economic activity
and inflation were broadly similar to their previous
projections, which were made in conjunction with the
January 2010 FOMC meeting. As depicted in
figure 1, the economic recovery was expected to be
gradual, with real gross domestic product (GDP)
expanding at a rate only moderately above the participants’ assessment of its longer-run sustainable
growth rate and unemployment declining slowly over
the next few years. Most participants also anticipated
that inflation would remain subdued over this period.
As indicated in table 1, participants generally made
modest upward revisions to their projections for real
GDP growth in 2010. Beyond 2010, however, the
contours of participants’ projections for economic
activity and inflation were little changed. Participants
continued to expect the pace of the economic recovery to be restrained by household and business uncertainty, only gradual improvement in labor market
conditions, and slow easing of credit conditions in
the banking sector. Participants generally expected
that it would take some time for the economy to converge fully to its longer-run path—characterized by a
sustainable rate of output growth and by rates of
employment and inflation consistent with participants’ interpretation of the Federal Reserve’s dual
objectives—but only a minority anticipated that the
convergence process would take more than five to six

Brian F. Madigan
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the April 27–28, 2010, FOMC
meeting, the members of the Board of Governors
and the presidents of the Federal Reserve Banks, all
of whom participate in deliberations of the FOMC,
submitted projections for output growth, unemployment, and inflation for the years 2010 to 2012 and
over the longer run. The projections were based on
information available through the end of the meeting
and on each participant’s assumptions about factors
likely to affect economic outcomes, including his or
her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that the participant deems most
likely to foster outcomes for economic activity and
inflation that best satisfy his or her interpretation of
the Federal Reserve’s dual objectives of maximum
employment and stable prices. Longer-run projections represent each participant’s assessment of the
rate to which each variable would be expected to con-

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, April 2010
Percent
Central tendency1

Range2

Variable

Change in real GDP
January projection
Unemployment rate
January projection
PCE inflation
January projection
Core PCE inflation3
January projection

2010

2011

2012

Longer run

2010

2011

2012

Longer run

3.2 to 3.7
2.8 to 3.5
9.1 to 9.5
9.5 to 9.7
1.2 to 1.5
1.4 to 1.7
0.9 to 1.2
1.1 to 1.7

3.4 to 4.5
3.4 to 4.5
8.1 to 8.5
8.2 to 8.5
1.1 to 1.9
1.1 to 2.0
1.0 to 1.5
1.0 to 1.9

3.5 to 4.5
3.5 to 4.5
6.6 to 7.5
6.6 to 7.5
1.2 to 2.0
1.3 to 2.0
1.2 to 1.6
1.2 to 1.9

2.5 to 2.8
2.5 to 2.8
5.0 to 5.3
5.0 to 5.2
1.7 to 2.0
1.7 to 2.0

2.7 to 4.0
2.3 to 4.0
8.6 to 9.7
8.6 to 10.0
1.1 to 2.0
1.2 to 2.0
0.7 to 1.6
1.0 to 2.0

3.0 to 4.6
2.7 to 4.7
7.2 to 8.7
7.2 to 8.8
0.9 to 2.4
1.0 to 2.4
0.6 to 2.4
0.9 to 2.4

2.8 to 5.0
3.0 to 5.0
6.4 to 7.7
6.1 to 7.6
0.7 to 2.2
0.8 to 2.0
0.6 to 2.2
0.8 to 2.0

2.4 to 3.0
2.4 to 3.0
5.0 to 6.3
4.9 to 6.3
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are 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 (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The January projections were made in
conjunction with the meeting of the Federal Open Market Committee on January 26–27, 2010.
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 consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

Minutes of Federal Open Market Committee Meetings

Figure 1. Central tendencies and ranges of economic projections, 2010–12 and over the longer run

211

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97th Annual Report | 2010

years. As in January, most participants judged the
risks to their growth outlook as balanced, and most
also saw balanced risks surrounding their inflation
projections. Participants in general continued to
judge the uncertainty surrounding their projections
for economic activity and inflation as unusually high
relative to historical norms.
The Outlook
Participants’ projections for real GDP growth in 2010
had a central tendency of 3.2 to 3.7 percent, a little
higher than in January. Readings on consumer
spending and business outlays for equipment and
software were seen as broadly consistent with a moderate pace of economic recovery. The labor market
appeared to be starting to improve, but job growth
was expected to be modest. Participants pointed to a
number of factors that would support the continued
expansion of economic activity, including accommodative monetary policy and the improved condition
of financial markets and institutions. Several participants also noted that fiscal policy was currently providing substantial support to real activity. However,
they expected less impetus to GDP growth from this
factor later in the year and anticipated that budgetary pressures would probably continue to weigh on
spending at the state and local levels. Many participants thought that the expansion was likely to be
restrained by firms’ caution in hiring and spending in
light of the considerable uncertainty regarding the
economic outlook, and by limited access to credit by
small businesses and consumers.
Looking further ahead, participants’ projections were
for real GDP growth to pick up somewhat in 2011
and 2012; the projections for growth in both years
had a central tendency of about 3½ to 4½ percent.
As in January, participants generally expected the
ongoing recovery in household wealth and gradual
improvements in credit availability to bolster consumer spending. As the recovery became more firmly
established, businesses were seen as likely to boost
their outlays on equipment and software and to
increase production in order to rebuild their inventories. Nevertheless, participants indicated several factors that would likely restrain the pace of expansion,
including a higher household saving rate as households repair balance sheets, significant uncertainty
on the part of households and businesses about the
outlook for the economy, and a slow recovery in non-

residential construction. Moreover, although financial conditions had improved noticeably in recent
months, ongoing strains in the commercial real estate
sector were expected to pose risks to the balance
sheets of banking institutions for some time. Terms
and standards on bank loans remained restrictive,
and participants anticipated only a gradual easing of
credit conditions for many households and smaller
firms. In the absence of further shocks, participants
generally expected that real GDP growth would converge over time to an annual rate of 2.5 to 2.8 percent, the longer-run pace that appeared to be sustainable in view of expected trends in the labor force and
improvements in labor productivity.
Participants anticipated that labor market conditions
would improve slowly over the next several years. The
central tendency of their projections for the average
unemployment rate in the fourth quarter of 2010 was
9.1 to 9.5 percent, only modestly below the levels of
late last year. In line with their outlook for moderate
output growth, participants generally expected that
the unemployment rate would decline only to about
6.6 to 7.5 percent by the end of 2012, remaining well
above their assessments of its longer-run sustainable
rate. Although some participants noted concerns that
substantial ongoing structural adjustments in product and labor markets would reduce the sustainable
level of employment, participants’ longer-term
unemployment projections had a central tendency of
5.0 to 5.3 percent, essentially the same as in January.
Most participants revised down slightly their nearterm projections for inflation, and participants generally anticipated that inflation would remain subdued
over the next several years. The central tendency of
their projections for personal consumption expenditures (PCE) inflation was 1.2 to 1.5 percent for 2010,
1.1 to 1.9 percent for 2011, and 1.2 to 2.0 percent for
2012. Many participants anticipated that increases in
food and energy prices would lead headline PCE
inflation to run slightly above core PCE inflation
over the next few years. Most expected that inflation
would rise gradually toward their individual assessments of the measured rate of inflation judged to be
most consistent with the Federal Reserve’s dual mandate. As in January, the central tendency of projections of the longer-run inflation rate was 1.7 to
2.0 percent. A majority of participants anticipated
that inflation in 2012 would still be below their

Minutes of Federal Open Market Committee Meetings

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2010

2011

2012

±1.1
±0.5
±0.9

±1.7
±1.2
±1.0

±1.8
±1.5
±1.1

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1990 through 2009 that were released in the spring by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

assessments of the mandate-consistent inflation rate,
while the remainder expected that inflation would be
at or slightly above its longer-run value by that time.
Uncertainty and Risks
Most participants continued to see their projections
of future economic activity and unemployment as
subject to greater-than-average uncertainty.3 Participants generally perceived the risks to their projections as roughly balanced, although a few indicated
that they now viewed the risks to economic growth as
tilted to the upside. Many participants pointed to
stronger incoming data as suggesting that the economic recovery was more firmly established than had
been the case in January, but they emphasized that
predicting macroeconomic outcomes in the wake of a
financial crisis and a severe recession was particularly
difficult. In addition, participants cited uncertainties
regarding the likely persistence of both the recent
pickup in the growth of consumer spending and
rapid labor productivity growth and noted the risk
that severe strains in the commercial real estate sector
could continue to impair bank balance sheets, thus
limiting credit availability and restraining growth of
output and employment.

3

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1990 to 2009. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in economic forecasts and
explains the approach used to assess the uncertainty and risk
attending participants’ projections.

213

Most participants continued to see the uncertainty
surrounding their inflation projections as elevated.
However, a few judged that uncertainty in the outlook for inflation was about in line with typical levels,
and one viewed the uncertainty surrounding the
inflation outlook as lower than average. Nearly all
participants judged the risks to the inflation outlook
as roughly balanced; however, two saw these risks as
tilted to the upside, while two regarded the risks as
weighted to the downside. Several participants noted
that inflation expectations were well anchored, likely
mitigating the tendency for inflation to decline in
response to continued slack in resource utilization.
Others cited the risk that expected and actual inflation could increase, especially if extraordinarily
accommodative monetary policy measures were not
unwound in a timely fashion.
Diversity of Views
Figures 2.A and 2.B provide further details on the
diversity of participants’ views regarding the likely
outcomes for real GDP growth and the unemployment rate. The distributions of participants’ projections for real GDP growth this year and next year
were slightly narrower than the distributions of their
projections in January, but the distribution of projections for real GDP growth in 2012 was little changed.
As in earlier projections, the dispersion in participants’ forecasts for output growth appeared to reflect
the diversity of their assessments regarding the current degree of underlying momentum in economic
activity, the evolution of consumer and business sentiment, the likely pace of easing of bank lending
standards and terms, and other factors. Regarding
participants’ unemployment rate projections, the distribution for 2010 shifted down somewhat, but the
distributions of their unemployment rate projections
for 2011 and 2012 did not change appreciably. The
distributions of participants’ estimates of the longerrun sustainable rates of output growth and unemployment were essentially the same as in January.
Corresponding information about the diversity of
participants’ views regarding the inflation outlook is
provided in figures 2.C and 2.D . For overall and core
PCE inflation, the distributions of participants’ projections for 2010 shifted a bit lower relative to the distributions in January. The distributions of overall
and core inflation for 2011 and 2012, however, were
little changed and remained fairly wide. The dispersion in participants’ projections over the next few
years was mainly due to differences in their judgments regarding the determinants of inflation,
including their estimates of prevailing resource slack

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97th Annual Report | 2010

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2010–12 and over the longer run

215

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97th Annual Report | 2010

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2010–12

217

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97th Annual Report | 2010

and their assessments of the extent to which such
slack affects actual and expected inflation. In contrast, the relatively tight distribution of participants’
projections for longer-run inflation illustrates their

substantial agreement about the measured rate of
inflation that is most consistent with the Federal
Reserve’s dual objectives of maximum employment
and stable prices.

Minutes of Federal Open Market Committee Meetings

219

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policy-makers 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 gross domestic product (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 would imply a probability of about 70 percent that actual GDP would expand within a range of
1.9 to 4.1 percent in the current year, 1.3 to 4.7 percent in the second year, and 1.2 to 4.8 percent in the
third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.1 to 2.9 percent in the current year, 1.0 to 3.0 percent in the second year, and 0.9 to 3.1 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, are weighted to the 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.

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97th Annual Report | 2010

Meeting Held on June 22–23, 2010
A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
June 22, 2010, at 2:00 p.m. and continued on
Wednesday, June 23, 2010, at 9:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren

Thomas A. Connors, William B. English, Jeff Fuhrer,
Steven B. Kamin, Simon Potter, Lawrence Slifman,
Christopher J. Waller, and David W. Wilcox
Associate Economists
Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Bank Supervision and
Regulation, Board of Governors
Robert deV. Frierson1
Deputy Secretary, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director
for Management, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors

Kevin Warsh

Linda Robertson2
Assistant to the Board, Office of Board Members,
Board of Governors

Charles L. Evans, Richard W. Fisher,
Narayana Kocherlakota, and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee

Nellie Liang, David Reifschneider, and
William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors

Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively

William Nelson
Senior Associate Director, Division of Monetary
Affairs, Board of Governors

Daniel K. Tarullo

Brian F. Madigan
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Thomas Baxter
Deputy General Counsel
Richard M. Ashton
Assistant General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist

Seth B. Carpenter
Associate Director, Division of Monetary Affairs,
Board of Governors
Christopher J. Erceg
Deputy Associate Director, Division of International
Finance, Board of Governors
Michael G. Palumbo and Joyce K. Zickler
Deputy Associate Directors, Division of Research and
Statistics, Board of Governors
Brian J. Gross
Special Assistant to the Board, Office of Board
Members, Board of Governors
Fabio M. Natalucci
Assistant Director, Division of Monetary Affairs,
Board of Governors
1
2

Attended Tuesday’s session only.
Attended Wednesday’s session only.

Minutes of Federal Open Market Committee Meetings

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Beth Anne Wilson
Section Chief, Division of International Finance,
Board of Governors
John C. Driscoll and Jennifer E. Roush
Senior Economists, Division of Monetary Affairs,
Board of Governors
Andrea L. Kusko
Senior Economist, Division of Research and
Statistics, Board of Governors
John W. Schindler
Senior Economist, Division of International Finance,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Valerie Hinojosa and Randall A. Williams
Records Management Analysts, Division of Monetary
Affairs, Board of Governors
Patrick K. Barron and John F. Moore
First Vice Presidents, Federal Reserve Banks
of Atlanta and San Francisco, respectively
Loretta J. Mester, Harvey Rosenblum, and
John C. Williams
Executive Vice Presidents, Federal Reserve Banks of
Philadelphia, Dallas, and San Francisco, respectively
David Altig, Richard P. Dzina, Arthur Rolnick, and
Mark E. Schweitzer
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, New York, Minneapolis, and Cleveland,
respectively
Daniel Aaronson, Todd E. Clark, and
Andreas L. Hornstein
Vice Presidents, Federal Reserve Banks of Chicago,
Kansas City, and Richmond, respectively
Joshua L. Frost
Assistant Vice President, Federal Reserve Bank
of New York

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Committee met on April 27–28, 2010. He also briefed
the Committee on the System’s progress in developing tools for managing the supply of reserves, includ-

221

ing reverse repurchase agreements and the Term
Deposit Facility. In preparation for possible future
reserve draining operations, in June the Federal
Reserve conducted the first of several small-value
auctions to test the Term Deposit Facility. In addition, the Manager reported on System open market
operations during the intermeeting period. By unanimous vote, the Committee ratified those transactions.
There were no open market operations in foreign currencies for the System’s account over the intermeeting period.
In his presentation to the Committee, the Manager
noted that “fails to deliver” in the mortgage-backed
securities (MBS) market had reached very high levels
in recent months. Under these conditions, dealers
had experienced difficulty in arranging delivery of a
small amount—including about $9 billion of securities with 5.5 percent coupons issued by Fannie
Mae—of the $1.25 trillion of MBS that the Desk at
the Federal Reserve Bank of New York had purchased between January 2009 and March 2010. The
Desk had postponed settlement of some of these
transactions through the use of dollar rolls. The
Manager discussed alternative methods of settling
the outstanding transactions and recommended that
the Committee authorize the Desk to engage in coupon swap transactions to facilitate the settlement of
these purchases. The Manager noted that a coupon
swap is a common transaction in the market for MBS
in which the two counterparties exchange securities
at market prices. By engaging in a coupon swap, the
Federal Reserve would effectively sell the scarce securities that it had not yet received and purchase
instead securities that are more readily available in
the market. After discussing various approaches,
meeting participants agreed that coupon swaps were
an appropriate method to achieve settlement of outstanding transactions.
As background for the Committee’s continuing consideration of its portfolio management policies, the
Manager gave a presentation on alternative strategies
for reinvesting the proceeds from maturing Treasury
securities. Under current practice, the Desk reinvests
the proceeds of maturing Treasury coupon securities
in new Treasury securities that are issued on the date
the older securities mature, allocating the investments
across the new securities in proportion to the issuance amounts. The Manager presented two alternatives to the status quo. First, the Committee could
consider halting all reinvestment of the proceeds of
maturing securities. Such a strategy would shrink the
size of the Federal Reserve’s balance sheet and

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97th Annual Report | 2010

reduce the quantity of reserve balances in the banking system gradually over time. Second, the Committee could reinvest the proceeds of maturing securities
only in new issues of Treasury securities with relatively short maturities—bills only, or bills as well as
coupon issues with terms of three years or less. This
strategy would maintain the size of the Federal
Reserve’s balance sheet but would reduce somewhat
the average maturity of the portfolio and increase its
liquidity. One participant favored halting all reinvestment, and many saw benefits to eventually adopting
an approach of reinvesting in bills and shorter-term
coupon issues to shift the maturity composition of
the portfolio toward the structure that had prevailed
prior to the financial crisis. However, the Committee
made no change to its reinvestment policy at this
meeting.
Continuing a discussion from previous meetings, participants again addressed issues regarding asset sales.
Participants continued to agree that gradual sales of
MBS should be undertaken, at some point, to speed
the return to a Treasury-securities-only portfolio. A
few participants supported beginning such sales fairly
soon; they noted that, given the evident demand in
the market for safe, longer-term assets, modest sales
of MBS might not put much, if any, upward pressure
on long-term interest rates or be disruptive to the
functioning of financial markets. However, many
participants still saw asset sales as potentially tightening financial conditions to some extent. Most participants continued to judge it appropriate to defer asset
sales for some time; several noted the modest weakening in the economic outlook since the Committee’s
last meeting as an additional reason to do so. A
majority of participants continued to anticipate that
asset sales would start after the Committee had
begun to firm policy by increasing short-term interest
rates; such an approach would postpone asset sales
until the economic recovery was well established and
maintain short-term interest rates as the Committee’s
key monetary policy tool. A few participants suggested selling MBS and using the proceeds to purchase Treasury securities of comparable duration,
arguing that doing so would hasten the move toward
a Treasury-securities-only portfolio without tightening financial conditions. Participants agreed that it
would be important to maintain flexibility regarding
the appropriate timing and pace of asset sales, given
the uncertainties associated with the unprecedented
size and composition of the Federal Reserve’s balance sheet and its effects on financial conditions.
Overall, participants emphasized that any decision to
engage in asset sales would need to be communicated

well in advance of the initiation of such transactions,
and that sales should be conducted at a gradual pace
and potentially be adjusted in response to developments in economic and financial conditions.

Staff Review of the Economic Situation
The information reviewed at the June 22–23 meeting
suggested that the economic recovery was proceeding
at a moderate pace in the second quarter. Businesses
continued to increase employment and lengthen
workweeks in April and May, but the unemployment
rate remained elevated. Industrial production registered strong and widespread gains, and business
investment in equipment and software rose rapidly.
Consumer spending appeared to have moved up further in April and May. However, housing starts
dropped in May, and nonresidential construction
remained depressed. Falling energy prices held down
headline consumer prices in April and May while
core consumer prices edged up.
Labor demand continued to firm in recent months.
While the change in total nonfarm payroll employment in May was boosted significantly by the hiring
of temporary workers for the decennial census, private employment posted only a small increase. This
increase, however, followed sizable gains in March
and April, and the average workweek of all privatesector employees increased over the March-to-May
period. As a result, aggregate hours worked by
employees on private nonfarm payrolls rose substantially through May. The unemployment rate moved
up in April but dropped back in May to 9.7 percent,
its first-quarter average. The labor force participation
rate was, on average, higher in recent months than in
the first quarter, as rising employment was accompanied by an increasing number of jobseekers.
Although the number of workers who were employed
part time for economic reasons leveled off in recent
months, the proportion of unemployed workers who
were jobless for more than 26 weeks continued to
move up. Initial claims for unemployment insurance
were little changed over the intermeeting period,
remaining at a still-elevated level.
Industrial production rose at a robust rate in April
and May, with production increases broadly based
across industries. Firming domestic demand, rising
exports, and business inventory restocking appeared
to have provided upward impetus to factory production. In April and May, production in hightechnology industries again rose strongly, with substantial gains in the output of semiconductors and

Minutes of Federal Open Market Committee Meetings

further solid increases in the production of computers and communications equipment. The production
of other types of business equipment continued to
rebound, and the output of construction supplies
advanced further. Production of light motor vehicles
turned up in May; nonetheless, dealers’ inventories
remained lean. Capacity utilization in manufacturing
rose in May to a rate noticeably above the low
reached in mid-2009, but it was still substantially
below its longer-run average.
The rise in consumer spending slowed in recent
months after a brisk increase in the first quarter.
Although sales of light motor vehicles continued to
trend higher, nominal sales of non-auto consumer
goods and food services were little changed in April
and May. The moderation in spending appeared, on
balance, to be aligning the pace of consumption with
recent trends in income, wealth, and consumer sentiment. Real disposable personal income moved up at a
solid rate in March and April, reflecting increases in
employment and hours worked as well as slightly
higher real wages, but home values declined in recent
months and equity prices moved down since the
April meeting. Measures of consumer sentiment
improved in May and early June but were still at relatively low levels.
The anticipated expiration of the homebuyer tax
credit appeared to have pulled home sales forward,
boosting their level in recent months. Sales of existing single-family homes rose strongly in April, and,
although they moved down in May, these sales were
still above their level earlier in the year. Purchases of
new single-family homes also jumped in April, but
then fell steeply in May. On net, the upswing in the
volume of real estate transactions in recent months
was likely to boost the brokers’ commissions component of residential investment in the second quarter.
However, starts of new single-family homes, which
had trended higher in the first four months of the
year, declined sharply in May. In addition, the number of permits for new homes, which tends to lead
starts, fell for a second month in May. House prices
declined somewhat in recent months, reversing some
of the modest increases that occurred in the spring
and summer of 2009. After changing little on net
during the preceding year, interest rates for 30-year
fixed-rate conforming mortgages moved lower in
May and June.
Real spending on equipment and software increased
further early in the second quarter. Business outlays
for computing equipment and software continued to

223

rise at a brisk pace through April, and shipments of
aircraft to domestic carriers rebounded. Orders and
shipments of nondefense capital goods excluding
transportation and high-tech equipment stayed on a
noticeable uptrend, on net, in March and April, with
the increases broadly based by type of equipment.
The recovery in equipment and software spending
was consistent with the relatively strong gains in production in recent months, improved financial conditions over the first part of the year, and the positive
readings from surveys on business conditions and
earnings reports for producers of capital goods. Business outlays for nonresidential construction appeared
to be contracting further, on balance, in March and
April, although the rate of decline seemed to be moderating. Outlays for new power plants and for manufacturing facilities firmed, and investment in drilling
and mining structures continued to rise strongly.
However, spending on office and commercial structures was still falling steeply through April, with the
weakness likely related to high vacancy rates, falling
property prices, and the light volume of sales.
Businesses appeared to have begun to restock their
inventories. Real nonfarm inventory investment
turned positive in the first quarter, and data for April
pointed to further modest accumulation. Ratios of
inventories to sales for most industries looked to be
within comfortable ranges.
Consumer price inflation remained low in April and
May. The core consumer price index rose only
slightly over the period, and the year-over-year
change in the index was lower than earlier this year.
Core goods prices continued to decline, on net, and
prices of non-energy services remained soft. The
headline consumer price index edged down in both
months, as the drop in the price of crude oil since
April led consumer energy prices to retrace a portion
of the run-up that occurred during the nine months
ending in January. At earlier stages of processing,
producer prices of core intermediate materials rose
moderately in May after five months of large
increases. Inflation compensation based on Treasury
inflation-protected securities decreased recently in
response to low readings on inflation and falling oil
prices. Survey measures of both short- and long-term
inflation expectations remained relatively stable.
Unit labor costs continued to be restrained by weakness in hourly compensation and further gains in
productivity. Revised estimates of labor compensation indicated that hourly compensation in the nonfarm business sector was about flat, on net, during

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97th Annual Report | 2010

the fourth quarter of 2009 and the first quarter of
2010. The employment cost index showed a moderate
rise over the period, boosted by a sizable increase in
benefit costs in the first quarter. The year-over-year
increase in average hourly earnings of all employees
was also moderate through May. Output per hour in
the nonfarm business sector, which rose rapidly in
2009, posted a more moderate but still-solid gain in
the first quarter of 2010.
The U.S. international trade deficit widened slightly
in April, as nominal exports fell a bit more than
nominal imports. The April declines in both exports
and imports followed robust increases in March. The
April fall in exports reflected declines in exports of
consumer goods, primarily due to a drop in pharmaceuticals, and in agricultural goods. Exports of
industrial supplies moved up while exports of capital
goods were flat after increasing strongly in March.
Imports in April were pulled down by lower imports
of consumer goods, which more than offset sharply
higher imports of capital goods, particularly computing equipment. Imports of automotive products and
non-oil industrial supplies declined slightly, and
imports of petroleum products were flat following a
large increase in March.
Incoming data suggested that economic activity
abroad continued to expand at a strong pace in the
first half of the year. Among the advanced foreign
economies, growth of real gross domestic product
(GDP) in the first quarter was particularly strong in
Canada and Japan, and recent indicators for those
countries pointed to continued solid increases in the
second quarter. In contrast, the rise in economic
activity in the euro area was subdued, as favorable
readings for the manufacturing sector were counterbalanced by weakness in domestic demand. Since the
time of the April meeting of the Federal Open Market Committee (FOMC), concerns about the fiscal
situation of several euro-area countries intensified
sharply. In response, European authorities
announced a number of policy measures, including
acceleration of fiscal consolidation plans in some
countries, finalization of an International Monetary
Fund (IMF) and European Union (EU) assistance
package for Greece, and the introduction of a
broader €500 billion financial assistance program
that could be complemented by bilateral IMF lending. The European Central Bank (ECB) also
announced further measures to improve liquidity
conditions in impaired markets, including a program
to purchase sovereign and private debt.

Economic activity in emerging market economies
continued to expand briskly in the first half of this
year. Growth of economic activity was particularly
robust in emerging Asia, driven in part by strong
increases in industrial production and exports associated with solid gains in final demand as well as the
turn in the inventory cycle. The rise of real GDP in
Latin America appeared to have stalled in the first
quarter, but this development reflected a contraction
in Mexico that more-favorable monthly indicators
suggested should prove temporary. In contrast, the
increase in Brazilian real GDP was very strong. Consumer price inflation in the foreign economies in
aggregate was buoyed by higher food and energy
prices in the first quarter, while core inflation generally remained subdued. More recent information suggested some moderation in foreign inflation in the
second quarter.

Staff Review of the Financial Situation
The FOMC’s decision at its April meeting to maintain the 0 to ¼ percent target range for the federal
funds rate and the wording of the accompanying
statement were largely in line with expectations and
prompted little market reaction. Economic data
releases were mixed, on balance, over the intermeeting period, but market participants were especially
attentive to incoming information on the labor market—most notably, the private payroll figures in the
employment report for May, which were considerably
weaker than investors expected. Those data, combined with heightened concerns about the global economic outlook stemming in part from Europe’s sovereign debt problems, contributed to a downward
revision in the expected path of policy implied by
money market futures rates.
In the market for Treasury coupon securities, 2- and
10-year nominal yields fell considerably over the
intermeeting period. Market participants pointed to
flight-to-quality flows and greater concern about the
economic outlook as factors boosting the demand
for Treasury securities. The drop in Treasury yields
was accompanied by a small widening of swap
spreads.
Conditions in short-term funding markets deteriorated somewhat, particularly for European financial
institutions. Spreads of the term London interbank
offered rate, or Libor, over rates on overnight index
swaps widened noticeably, with the availability of
funding at maturities longer than one week report-

Minutes of Federal Open Market Committee Meetings

edly quite limited. Market participants also reduced
holdings of commercial paper sponsored by entities
thought to have exposures to peripheral European
financial institutions and governments. Even so,
spreads of high-grade unsecured financial commercial paper to nonfinancial commercial paper widened
only modestly over the intermeeting period. In
secured funding markets, spreads on asset-backed
commercial paper also widened modestly, while rates
on repurchase agreements involving Treasury and
agency collateral changed little. In the inaugural
Senior Credit Officer Opinion Survey on Dealer
Financing Terms, which was conducted by the Federal Reserve between May 24 and June 4, dealers generally reported that the terms on which they provided
credit remained tight relative to those at the end of
2006. However, they noted some loosening of terms
for both securities financing and over-the-counter
derivatives transactions, on net, over the previous
three months for certain classes of clients—including
hedge funds, institutional investors, and nonfinancial
corporations—and intensified efforts by those clients
to negotiate more-favorable terms. At the same time,
they reported a pickup in demand for financing
across several collateral types over the past three
months.
Broad U.S. stock price indexes fell over the intermeeting period, in part reflecting deepening concerns
about the European fiscal situation and its potential
for adverse spillovers to global economic growth.
Option-implied volatility on the S&P 500 index
spiked in mid-May, to more than double its value at
the time of the April FOMC meeting, but largely
reversed its run-up by the time of the June meeting.
The spread between the staff’s estimate of the
expected real return on equities over the next 10 years
and an estimate of the expected real return on a
10-year Treasury note—a measure of the equity risk
premium—increased from its already elevated level.
Investors’ attitudes toward financial institutions deteriorated somewhat, as the equity of financial firms
underperformed the broader market amid uncertainty about the implications of developments in
Europe and the potential effects of financial regulatory reform. Yields on investment- and speculativegrade corporate bonds moved higher over the intermeeting period, and high-yield bond mutual funds
recorded substantial net outflows. Spreads on corporate bonds widened, although they remained within
the range prevailing since last summer. Secondarymarket bid prices on syndicated leveraged loans fell,
while bid-asked spreads in that market widened.

225

Net debt financing by nonfinancial corporations
increased in April and May relative to its pace in the
first quarter. Gross bond issuance by investmentgrade nonfinancial corporations in the United States
remained solid, on average, over those two months;
nonfinancial commercial paper outstanding increased
as well. High-yield corporate bond issuance in the
United States briefly paused in May, reflecting the
market’s pullback from risky assets, although
speculative-grade U.S. firms continued to issue bonds
abroad and a few placed issues domestically in the
first half of June. Gross equity issuance fell a bit, on
net, in April and May, likely due in part to recent
declines in equity prices and elevated market volatility. Measures of the credit quality of nonfinancial
firms generally continued to improve, and firstquarter profits for firms in the S&P 500 jumped substantially, primarily reflecting an upturn in financial
sector profits from quite depressed levels. The outlook in commercial real estate markets stayed weak;
prices of commercial properties fell a bit further in
the first quarter, and the volume of commercial property sales remained light. The delinquency rate for
securitized commercial mortgages continued to climb
in May, and indexes of prices of credit default swaps
on commercial mortgages declined, on net, over the
intermeeting period.
Consumer credit contracted again in recent months,
as revolving credit continued on a steep downtrend.
Issuance of consumer credit asset-backed securities
(ABS) increased in May, although the pace was still
well below that observed before the onset of the
financial crisis. Credit card ABS issuance remained
subdued, partly reflecting regulatory changes that
made financing credit card receivables via securitization less desirable. In primary markets, spreads of
credit card interest rates over those on Treasury securities remained extremely high in April, while interest
rate spreads on auto loans stayed near their average
level of the past decade. Consumer credit quality
improved further, with delinquency rates on credit
cards and auto loans moving down a bit in April.
Bank credit declined, on average, in April and May at
about the same pace as in the first quarter. Commercial and industrial loans, after dropping rapidly in
April, decreased at a slower pace in May. While commercial real estate and home equity loans fell at a
slightly faster rate than in recent quarters, the contraction in closed-end residential loans abated, partly
because of a reduced pace of sales to Fannie Mae
and Freddie Mac. Consumer loans declined again,
on average, in April and May. The amount of Treas-

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97th Annual Report | 2010

ury and agency securities held by large domestic
banks and foreign-related institutions declined in
May, contributing to a sizable drop in banks’ securities holdings.
On a seasonally adjusted basis, M2 contracted in
April but surged in May, with much of the month-tomonth variation apparently associated with the
effects of federal tax payments and refunds. Averaging across the two months, M2 expanded moderately
after having been about unchanged in the first quarter; liquid deposits accounted for most of the net
change.
The threat to global economic growth and financial
stability posed by the fiscal situation in some European nations sparked widespread flight-to-quality
flows over most of the intermeeting period. This
retreat led to a broad appreciation of the dollar as
well as declines in equity prices abroad and in yields
on benchmark sovereign bonds. However, investor
sentiment improved near the end of the period, leading to a partial reversal in some of these movements,
despite Moody’s downgrade of Greece to belowinvestment-grade status in mid-June. On net, the dollar ended the intermeeting period up, most headline
equity indexes fell, and benchmark government bond
yields declined. Strains in euro-area bank funding
markets reemerged during the period. In response,
the ECB announced some changes to its liquidity
operations that would provide greater market access
to term funding in euros.3 Difficulties also appeared
in corporate debt markets as both nonfinancial and
financial corporate debt issuance dropped substantially in May. In addition, pressures in dollar funding
markets reappeared for foreign financial institutions,
especially those thought to have significant exposure
to Greece and other peripheral euro-area countries.
To help contain these pressures and to prevent their
spread to other institutions and regions, the Federal
Reserve reestablished dollar liquidity swap arrangements with the ECB, the Bank of England, the Bank
of Japan, the Bank of Canada, and the Swiss
National Bank.
Yields on the sovereign obligations of peripheral
European countries declined noticeably following a
May 10 announcement of a framework established
by the EU for providing financial aid to euro-area
governments and of the ECB’s intention to purchase
euro-area sovereign debt. However, yields remained
3

The ECB reinstituted a six-month lending operation and
switched its three-month lending operations from fixed-quantity
auctions to full-allotment offerings at a fixed rate of 1 percent.

high even after these announcements and moved up
subsequently, notwithstanding the ECB’s purchases
of government debt. Amid a weakening outlook for
economic growth in Europe, central banks in several
emerging European economies began to decrease
policy rates. By contrast, brighter economic prospects in Canada and China prompted the Bank of
Canada to raise its target for the overnight rate to
50 basis points at its June meeting and Chinese
authorities to raise banks’ reserve requirement further in May. In addition, the People’s Bank of China
announced late in the period that it would allow the
renminbi to move more flexibly, and the currency
appreciated slightly immediately following the
announcement.

Staff Economic Outlook
In the economic forecast prepared for the June
FOMC meeting, the staff continued to anticipate a
moderate recovery in economic activity through
2011, supported by accommodative monetary policy,
an attenuation of financial stress, and strengthening
consumer and business confidence. While the recent
data on production and spending were broadly in line
with the staff’s expectations, the pace of the expansion over the next year and a half was expected to be
somewhat slower than previously predicted. The
intensifying concerns among investors about the
implications of the fiscal difficulties faced by some
European countries contributed to an increase in the
foreign exchange value of the dollar and a drop in
equity prices, which seemed likely to damp somewhat
the expansion of domestic demand. The implications
of these less-favorable factors for U.S. economic
activity appeared likely to be only partly offset by
lower interest rates on Treasury securities, other
highly rated securities, and mortgages, as well as by a
lower price for crude oil. The staff still expected that
the pace of economic activity through 2011 would be
sufficient to reduce the existing margins of economic
slack, although the anticipated decline in the unemployment rate was somewhat slower than in the previous projection.
The staff’s forecasts for headline and core inflation
were also reduced slightly. The changes were a
response to the lower prices of oil and other commodities, the appreciation of the dollar, and the
greater amount of economic slack in the forecast.
Despite these developments, inflation expectations
had remained stable, likely limiting movements in
inflation. On balance, core inflation was expected to
continue at a subdued rate over the projection period.

Minutes of Federal Open Market Committee Meetings

As in earlier forecasts, headline inflation was projected to move into line with the core rate by 2011.

Participants’ Views of Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks—provided projections of economic
growth, the unemployment rate, and consumer price
inflation for each year from 2010 through 2012 and
over a longer horizon. Longer-run projections represent each participant’s assessment of the rate to
which each variable would be expected to converge
over time under appropriate monetary policy and in
the absence of further shocks. Participants’ forecasts
through 2012 and over the longer run are described
in the Summary of Economic Projections, which is
attached as an addendum to these minutes.
In their discussion of the economic situation and
outlook, meeting participants generally saw the
incoming data and information received from business contacts as consistent with a continued, moderate recovery in economic activity. Participants noted
that the labor market was improving gradually,
household spending was increasing, and business
spending on equipment and software had risen significantly. With private final demand having strengthened, inventory adjustments and fiscal stimulus were
no longer the main factors supporting economic
expansion. In light of stable inflation expectations
and incoming data indicating low rates of inflation,
policymakers continued to anticipate that both overall and core inflation would remain subdued through
2012. However, financial markets were generally seen
as recently having become less supportive of economic growth, largely reflecting international spillovers from European fiscal strains. In part as a result
of the change in financial conditions, most participants revised down slightly their outlook for economic growth, and about one-half of the participants
judged the balance of risks to growth as having
moved to the downside. Most participants continued
to see the risks to inflation as balanced. A number of
participants expressed the view that, over the next
several years, both employment and inflation would
likely be below levels they consider to be consistent
with their dual mandate, but they anticipated that,
with appropriate monetary policy, both would rise
over time to levels consistent with the Federal
Reserve’s objectives.

227

Financial markets had become somewhat less supportive of economic growth since the April meeting,
with the developments in Europe cited as a leading
cause of greater global financial market tensions.
Risk spreads for many corporate borrowers had widened noticeably, equity prices had fallen appreciably,
and the dollar had risen in value against a broad basket of other currencies. Participants saw these
changes as likely to weigh to some degree on household and business spending over coming quarters.
Participants also noted ongoing difficulties in financing commercial real estate. Nonetheless, reports suggested that more-creditworthy business borrowers
were still able to obtain funding in the open markets
on fairly attractive terms, and a couple of participants noted that credit from the banking sector,
which had been contracting for some time, was showing some tentative signs of stabilizing. Moreover, several participants observed that the decline in yields
on Treasury securities resulting from the global flight
to quality was positive for the domestic economy; in
particular, the associated decline in mortgage rates
was seen as potentially helpful in supporting the
housing sector.
Supporting the view of a continued recovery, incoming data and anecdotal reports pointed to strength in
a number of business sectors, particularly manufacturing and transportation. Policymakers noted that
firms’ investment in equipment and software had
advanced rapidly of late, and they anticipated that
such spending would continue to rise, though perhaps at a somewhat slower pace. Business contacts
suggested that investment spending had been supported by the replacement and upgrading of existing
capital, making up for some spending that had been
postponed in the downturn, and this component of
investment demand was seen as unlikely to remain
robust. In addition, inventory accumulation, which
had been a significant contributor to recent gains in
production, appeared likely to provide less impetus to
growth in coming quarters. Participants also noted
that several uncertainties, including those related to
legislative changes and to developments in global
financial markets, were generating a heightened level
of caution that could lead some firms to delay hiring
and planned investment outlays.
Participants commented that household spending
continued to advance, with notable increases in auto
sales and expenditures on other durable goods.
Going forward, consumption spending was expected
to continue to post moderate gains, with the effects
of income growth and improved confidence as the

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97th Annual Report | 2010

economy recovers more than offsetting the effects of
lower stock prices and housing wealth. However, continued labor market weakness could weigh on consumer sentiment, and households were still repairing
their balance sheets; both factors could restrain consumer spending going forward. Although readings
from the housing sector had been strong through
mid-spring, participants noted that the strength likely
reflected the effects of the temporary tax credits for
homebuyers. Indeed, data for the most recent month
suggested that, with the expiration of those provisions, home sales and starts had stepped down
noticeably and could remain weak in the near term;
with lower demand and a continuing supply of foreclosed houses coming to market, participants judged
that house prices were likely to remain flat or decline
somewhat further in the near term.
Meeting participants interpreted the data on the
labor market as consistent with their outlook for
gradual recovery. Employers were adding hours to
the workweek and hiring temporary workers, suggesting a pickup in labor demand; however, the most
recent data on employment had been disappointing,
and new claims for unemployment insurance
remained elevated. Reportedly, employers were still
cautious about adding to payrolls, given uncertainties
about the outlook for the economy and government
policies. Participants expected the pace of hiring to
remain low for some time. Indeed, the unemployment
rate was generally expected to remain noticeably
above its long-run sustainable level for several years,
and participants expressed concern about the
extended duration of unemployment spells for a large
number of workers. Participants also noted a risk
that continued rapid growth in productivity, though
clearly beneficial in the longer term, could in the near
term act to moderate growth in the demand for labor
and thus slow the pace at which the unemployment
rate normalizes.
A broad set of indicators suggested that underlying
inflation remained subdued and was, on net, trending
lower. The latest readings on core inflation—which
excludes the relatively volatile prices of food and
energy—had slowed, and other measures of the
underlying trajectory of inflation, such as median
and trimmed-mean measures, also had moved down
this year. Crude oil prices declined somewhat over
the intermeeting period, a factor that was likely to
damp headline inflation at the consumer level in
coming months. Other commodity prices were moderating, and nominal wages appeared to be rising
only slowly. Some participants indicated that they

viewed the substantial slack in labor and resource
markets as likely to reduce inflation. The financial
strains in Europe had led to an increase in the foreign
exchange value of the dollar, and the resulting downward pressure on import prices also was expected to
weigh on consumer prices for a time. However, inflation expectations were seen by most participants as
well anchored, which would tend to curb any tendency for actual inflation to decline. On balance,
meeting participants revised down modestly their
outlook for inflation over the next couple of years;
they generally expected inflation to be quite low in
the near term and to trend slightly higher over time.
Some participants judged the risks to the outlook for
inflation as tilted to the downside, particularly in the
near term, in light of the large amount of resource
slack already prevailing in the economy, the significant downside risks to the outlook for real activity,
and the possibility that inflation expectations could
begin to decline in response to low actual inflation. A
few participants cited some risk of deflation. Other
participants, however, thought that inflation was
unlikely to fall appreciably further given the stability
of inflation expectations in recent years and very
accommodative monetary policy. Over the medium
term, participants saw both upside and downside
risks to inflation. Several participants noted that a
continuation of lower-than-expected inflation and
high unemployment could eventually lead to a downward movement in inflation expectations that would
reinforce disinflationary pressures. By contrast, a few
participants noted the possibility that a potentially
unsustainable fiscal position and the size of the Federal Reserve’s balance sheet could boost inflation
expectations and actual inflation over time.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, members agreed that it would be appropriate
to maintain the target range of 0 to 1∕4 percent for
the federal funds rate. The economic outlook had
softened somewhat and a number of members saw
the risks to the outlook as having shifted to the
downside. Nonetheless, all saw the economic expansion as likely to be strong enough to continue raising
resource utilization, albeit more slowly than they had
previously anticipated. In addition, they saw inflation
as likely to stabilize near recent low readings in coming quarters and then gradually rise toward more
desirable levels. In sum, the changes to the outlook
were viewed as relatively modest and as not warranting policy accommodation beyond that already in

Minutes of Federal Open Market Committee Meetings

place. However, members noted that in addition to
continuing to develop and test instruments to exit
from the period of unusually accommodative monetary policy, the Committee would need to consider
whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.
Given the slightly softer cast of recent data and the
shift to less accommodative financial conditions,
members agreed that some changes to the statement’s
characterization of the economic and financial situation were necessary. Nearly all members judged that
it was appropriate to reiterate the expectation that
economic conditions—including low levels of
resource utilization, subdued inflation trends, and
stable inflation expectations—were likely to warrant
exceptionally low levels of the federal funds rate for
an extended period. One member, however, believed
that continuing to communicate an expectation in the
Committee’s statement that the federal funds rate
would remain at an exceptionally low level for an
extended period would create conditions that could
lead to macroeconomic and financial imbalances.
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 seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to 1∕4 percent. The Committee
directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate
settlement of the Federal Reserve’s agency MBS
transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System’s balance sheet that could
affect the attainment over time of the Committee’s objectives of maximum employment and
price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in April suggests that
the economic recovery is proceeding and that the

229

labor market is improving gradually. Household
spending is increasing but remains constrained
by high unemployment, modest income growth,
lower housing wealth, and tight credit. Business
spending on equipment and software has risen
significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing
starts remain at a depressed level. Financial conditions have become less supportive of economic
growth on balance, largely reflecting developments abroad. Bank lending has continued to
contract in recent months. Nonetheless, the
Committee anticipates a gradual return to
higher levels of resource utilization in a context
of price stability, although the pace of economic
recovery is likely to be moderate for a time.
Prices of energy and other commodities have
declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost
pressures and longer-term inflation expectations
stable, inflation is likely to be subdued for some
time.
The Committee will maintain the target range
for the federal funds rate at 0 to 1∕4 percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels of the federal funds rate for an
extended period.
The Committee will continue to monitor the
economic outlook and financial developments
and will employ its policy tools as necessary to
promote economic recovery and price stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, James Bullard, Elizabeth Duke, Donald L.
Kohn, Sandra Pianalto, Eric Rosengren, Daniel K.
Tarullo, and Kevin Warsh.
Voting against this action: Thomas M. Hoenig.
Mr. Hoenig dissented because he believed that, as the
economy completed its first year of modest recovery,
it was no longer advisable to indicate that economic
and financial conditions were likely to warrant
“exceptionally low levels of the federal funds rate for
an extended period.” Although risks to the forecast
remained, Mr. Hoenig was concerned that communi-

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cating such an expectation would limit the Committee’s flexibility to begin raising rates modestly in a
timely fashion and could result in a buildup of future
financial imbalances and increase the risks to longerrun macroeconomic and financial stability.
By unanimous vote, the Committee selected William
B. English to serve as Secretary and Economist, and
James A. Clouse to serve as Associate Economist,
effective July 23, 2010, until the selection of their successors at the first regularly scheduled meeting of the
Committee in 2011.
It was agreed that the next meeting of the Committee
would be held on Tuesday, August 10, 2010. The
meeting adjourned at 12:10 p.m. on June 23, 2010.

Conference Call
On May 9, 2010, the Committee met by conference
call to discuss developments in global financial markets and possible policy responses. Over the previous
several months, market concerns about the ability of
Greece and some other euro-area countries to contain their sizable budget deficits and finance their
debt had increased. By early May, financial strains
had intensified, reflecting investors’ uncertainty
about whether fiscally stronger euro-area governments would provide financial support to the weakest
members, the extent of the drag on euro-area economies that could result from efforts at fiscal consolidation, and the degree of exposure of major European
banks and financial institutions to vulnerable countries. Conditions in short-term funding markets in
Europe had also deteriorated, and global financial
markets more generally had been volatile and less
supportive of economic growth.
The Chairman indicated that European authorities
were considering a number of measures to promote
fiscal sustainability and to provide increased liquidity
and support to money markets and markets for
European sovereign debt. In connection with the possible implementation of these measures, some major
central banks had requested that dollar liquidity
swap lines with the Federal Reserve be reestablished.
These swap lines would enhance the ability of these
central banks to provide support for dollar funding
markets in their jurisdictions. The terms and conditions of the swap lines would generally be similar to
those in place prior to their expiration earlier in the
year.

The Committee discussed considerations surrounding the possible reestablishment of dollar liquidity
swap lines. Participants agreed that such arrangements could be helpful in limiting the strains in dollar funding markets and the adverse implications of
recent developments for the U.S. economy. Participants observed that, in current circumstances, the
dollar swap lines should be made available to a
smaller number of major foreign central banks than
previously. In order to promote the transparency of
these arrangements, participants agreed that it would
be appropriate for the Federal Reserve to publish the
swap contracts and to release on a weekly basis the
amounts of draws under the swap lines by central
bank counterparty. It was recognized that the Committee would need to consider the implications of
swap lines for bank reserves and overall management
of the Federal Reserve’s balance sheet. Participants
noted the importance of appropriate consultation
with U.S. government officials and emphasized that a
reestablishment of the lines should be contingent on
strong and effective actions by authorities in Europe
to address fiscal sustainability and support financial
markets.
At the conclusion of the discussion, the Committee
voted unanimously to approve the following
resolution:
“The Committee authorizes the Chairman to
agree to establish swap lines with the European
Central Bank, the Bank of England, the Swiss
National Bank, the Bank of Japan, and the
Bank of Canada, as discussed by the Committee
today.”
Secretary’s note: Later on May 9, 2010, the Federal Reserve, in coordination with the Bank of
Canada, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank,
announced that U.S. dollar liquidity swap facilities
had been reestablished with those central banks.
The arrangements with the Bank of England, the
ECB, and the Swiss National Bank provide these
central banks with the capacity to conduct tenders
of U.S. dollars in their local markets at fixed rates
for full allotment, similar to arrangements that
had been in place previously. The arrangement
with the Bank of Canada would support drawings
of up to $30 billion, as was the case previously. On
May 10, the Federal Reserve and the Bank of
Japan (BOJ) announced that a temporary U.S.

Minutes of Federal Open Market Committee Meetings

231

the Federal Reserve’s dual objectives of maximum
employment and stable prices. Longer-run projections represent each participant’s assessment of the
rate to which each variable would be expected to converge over time under appropriate monetary policy
and in the absence of further shocks.

dollar liquidity swap arrangement had been established that would provide the BOJ with the capacity to conduct tenders of U.S. dollars at fixed rates
for full allotment.

Notation Vote
By notation vote completed on May 17, 2010, the
Committee unanimously approved the minutes of the
FOMC meeting held on April 27–28, 2010.

FOMC participants’ forecasts for economic activity
and inflation suggested that they expected the recovery to continue and inflation to remain subdued, but
with, on balance, slightly weaker real activity and a
bit lower inflation than in the projections they made
in conjunction with the April 2010 FOMC meeting.
As depicted in figure 1, the economic recovery was
anticipated to be gradual, with real gross domestic
product (GDP) expanding at a pace only moderately
above the participants’ assessment of its longer-run
sustainable growth rate and the unemployment rate
slowly trending lower over the next few years. Most
participants also anticipated that inflation would
remain relatively low over the forecast period. As
indicated in table 1, participants generally made modest downward revisions to their projections for real
GDP growth for the years 2010 to 2012, as well as
modest upward revisions to their projections for the
unemployment rate for the same period. Participants
also revised down a little their projections for inflation over the forecast period. Several participants
noted that these revisions were largely the result of
the incoming economic data and the anticipated
effects of developments abroad on U.S. financial
markets and the economy. Overall, participants con-

Brian F. Madigan
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the June 22–23, 2010, FOMC
meeting, the members of the Board of Governors
and the presidents of the Federal Reserve Banks, all
of whom participate in deliberations of the FOMC,
submitted projections for output growth, unemployment, and inflation for the years 2010 to 2012 and
over the longer run. The projections were based on
information available through the end of the meeting
and on each participant’s assumptions about factors
likely to affect economic outcomes, including his or
her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that the participant deems most
likely to foster outcomes for economic activity and
inflation that best satisfy his or her interpretation of

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, June 2010
Percent
Central tendency1

Range2

Variable

Change in real GDP
April projection
Unemployment rate
April projection
PCE inflation
April projection
Core PCE inflation3
April projection

2010

2011

2012

Longer run

2010

2011

2012

Longer run

3.0 to 3.5
3.2 to 3.7
9.2 to 9.5
9.1 to 9.5
1.0 to 1.1
1.2 to 1.5
0.8 to 1.0
0.9 to 1.2

3.5 to 4.2
3.4 to 4.5
8.3 to 8.7
8.1 to 8.5
1.1 to 1.6
1.1 to 1.9
0.9 to 1.3
1.0 to 1.5

3.5 to 4.5
3.5 to 4.5
7.1 to 7.5
6.6 to 7.5
1.0 to 1.7
1.2 to 2.0
1.0 to 1.5
1.2 to 1.6

2.5 to 2.8
2.5 to 2.8
5.0 to 5.3
5.0 to 5.3
1.7 to 2.0
1.7 to 2.0

2.9 to 3.8
2.7 to 4.0
9.0 to 9.9
8.6 to 9.7
0.9 to 1.8
1.1 to 2.0
0.7 to 1.5
0.7 to 1.6

2.9 to 4.5
3.0 to 4.6
7.6 to 8.9
7.2 to 8.7
0.8 to 2.4
0.9 to 2.4
0.6 to 2.4
0.6 to 2.4

2.8 to 5.0
2.8 to 5.0
6.8 to 7.9
6.4 to 7.7
0.5 to 2.2
0.7 to 2.2
0.4 to 2.2
0.6 to 2.2

2.4 to 3.0
2.4 to 3.0
5.0 to 6.3
5.0 to 6.3
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are 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 (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The April projections were made in conjunction
with the meeting of the Federal Open Market Committee on April 27–28, 2010.
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 consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

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97th Annual Report | 2010

Figure 1. Central tendencies and ranges of economic projections, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

tinued to expect the pace of the economic recovery to
be held back by a number of factors, including
household and business uncertainty, persistent weakness in real estate markets, only gradual improvement
in labor market conditions, waning fiscal stimulus,
and slow easing of credit conditions in the banking
sector. Participants generally anticipated that, in light
of the severity of the economic downturn, it would
take some time for the economy to converge fully to
its longer-run path as characterized by sustainable
rates of output growth, unemployment, and inflation
consistent with participants’ interpretation of the
Federal Reserve’s dual objectives; most expected the
convergence process to take no more than five to six
years. About one-half of the participants now judged
the risks to the growth outlook to be tilted to the
downside, while most continued to see balanced risks
surrounding their inflation projections. Participants
generally continued to judge the uncertainty surrounding their projections for both economic activity
and inflation to be unusually high relative to historical norms.
The Outlook
Participants’ projections for real GDP growth in 2010
had a central tendency of 3.0 to 3.5 percent, slightly
lower than in April. Participants noted that the economic recovery was proceeding. Consumer spending
was increasing, supported by rising disposable
income as labor markets gradually improved. Business outlays on equipment and software were also rising, driven by replacement spending, the low cost of
capital, and increased production. Participants
pointed to a number of factors that would provide
ongoing support to economic activity, including
accommodative monetary policy and still generally
supportive conditions in financial markets. Fiscal
policy was also seen as currently contributing to economic growth, although participants expected that
the effects of fiscal stimulus would diminish going
forward and also anticipated that budgetary pressures would continue to weigh on spending at the
state and local levels. Participants noted that financial
conditions had tightened somewhat because of developments abroad. The effects of a stronger dollar, a
lower stock market, and wider corporate credit
spreads were expected to be offset only partially by
lower oil and commodity prices and a decline in
Treasury yields. Many participants anticipated that
the economic expansion would be held back by
firms’ caution in hiring and spending in light of the
considerable uncertainty regarding the economic outlook, by households’ focus on repairing balance
sheets weakened by equity and house price declines,

233

and by tight credit conditions for small businesses
and households.
Looking further ahead, the central tendencies of participants’ projections for real GDP growth were
3.5 to 4.2 percent in 2011 and 3.5 to 4.5 percent in
2012. Participants generally expected a rebound in
spending on housing, consumer durables, and business capital equipment as household income and balance sheets strengthen, credit becomes more widely
available, and the recovery is seen by households and
firms as more firmly established. Nevertheless, participants cited several factors that could restrain the
pace of expansion over the next two years, including
a rising household saving rate as households seek to
make further progress in repairing balance sheets,
persistent uncertainty on the part of households and
businesses about the strength of the recovery, spillovers from fiscal strains abroad to U.S. financial markets and the U.S. economy, and continued weakness
in residential construction. Moreover, despite
improvements in the condition of banking institutions, strains in the commercial real estate sector were
seen as posing risks to the balance sheets of such
institutions for some time. Terms and standards on
bank loans continued to be restrictive, and participants anticipated only a gradual loosening of credit
conditions for many households and smaller firms. In
the absence of further shocks, participants generally
expected that real GDP growth would eventually
settle down at an annual rate of 2.5 to 2.8 percent, a
pace that appeared to be sustainable in view of
expected long-run trends in the labor force and labor
productivity.
Participants anticipated that labor market conditions
would improve slowly over the next several years. The
central tendency of their projections for the average
unemployment rate in the fourth quarter of 2010 was
9.2 to 9.5 percent. Consistent with their expectations
of a gradual economic recovery, participants generally anticipated that the unemployment rate would
decline to 7.1 to 7.5 percent by the end of 2012,
remaining well above their assessments of its longerrun sustainable rate. Although a few participants
were concerned about a possible decrease in the sustainable level of employment resulting from ongoing
structural adjustments in product and labor markets,
participants’ longer-term unemployment projections
had a central tendency of 5.0 to 5.3 percent, the same
as in April.
Participants noted that prices of energy and other
commodities declined somewhat in recent months,

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97th Annual Report | 2010

and underlying inflation trended lower. They generally expected inflation to remain subdued over the
next several years. Indeed, most of the participants
marked down a bit their projections for inflation over
the forecast period: The central tendency of their
projections for personal consumption expenditures
(PCE) inflation was 1.0 to 1.1 percent for 2010, 1.1 to
1.6 percent for 2011, and 1.0 to 1.7 percent for 2012,
generally about 1∕4 percentage point lower than in
April. The central tendencies of participants’ projections for core PCE inflation followed a broadly similar path, although headline PCE inflation was
expected to run slightly above core PCE inflation
over the forecast period, reflecting somewhat more
rapid increases in food and energy prices. Most participants anticipated that, with appropriate monetary
policy, inflation would rise gradually toward the
inflation rate that they individually consider most
consistent with the Federal Reserve’s dual mandate
for maximum employment and stable prices. The central tendency of participants’ projections of the
longer-run, mandate-consistent inflation rate was
1.7 to 2.0 percent, unchanged from April. A majority
of participants anticipated that inflation in 2011 and
2012 would continue to be below their assessments of
the mandate-consistent inflation rate.
Uncertainty and Risks
Most participants judged that their projections of
future economic activity and unemployment continued to be subject to greater-than-average uncertainty,
while a few viewed the uncertainty surrounding their
outlook for growth and unemployment as in line with
typical levels.4 About one-half of the participants
saw the risks to their growth outlook as tilted to the
downside; in contrast, in April a large majority of
participants saw the risks to growth as balanced. In
the current survey, a substantial number of participants also viewed the risks to unemployment as tilted
to the upside. The remaining participants saw the
risks to the projections for economic growth and
unemployment as roughly balanced. Participants
pointed to developments abroad and their possible
ramifications for U.S. financial markets and the U.S.
economy as suggesting somewhat greater uncertainty
about the path of economic growth. In addition,
some participants cited the unusual rise in the unem4

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1990 to 2009. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in economic forecasts and
explains the approach used to assess the uncertainty and risk
attending participants’ projections.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2010

2011

2012

±1.0
±0.4
±0.9

±1.6
±1.2
±1.0

±1.8
±1.5
±1.1

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1990 through 2009 that were released in the summer by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

ployment rate last year, which was associated with
rapid growth in labor productivity, as contributing to
increased uncertainty regarding the outlook for
employment and economic activity. Participants who
judged that the risks to their growth outlook were
tilted to the downside pointed to recent developments
abroad and the risk of further contagion, together
with the potential for an increase in risk aversion
among investors, as important factors contributing
to their assessment. Participants noted that problems
in the commercial real estate market and the effects
of financial regulatory reform could lead to greater
constraints on credit availability, thereby restraining
growth of output and employment. However, some
participants viewed the downside risks to the growth
outlook as roughly balanced by upside risks; they
saw the possibility that monetary policy might
remain accommodative for too long as one reason
that growth could prove stronger than expected.
As in April, most participants continued to see the
uncertainty surrounding their inflation projections as
above average. Still, a few judged that uncertainty in
the outlook for inflation was about in line with or
lower than typical levels. Most participants judged
the risks to the inflation outlook as roughly balanced. As factors accounting for elevated uncertainty
regarding the outlook for inflation, participants
pointed to the extraordinary degree of monetary
policy accommodation, the uncertain timing of the
exit from accommodation, and the unusually large
gap between expected inflation, as measured by surveys of households and businesses, and current infla-

Minutes of Federal Open Market Committee Meetings

tion. Participants noted that, despite the downward
trend in underlying inflation in recent months, inflation expectations continued to be well anchored.
Nonetheless, the possibility that inflation expectations might start to decline in response to persistently
low levels of actual inflation and the potential effects
of continued weakness of the economy on price
trends were seen by a few participants as posing some
downside risks to the inflation outlook.
Diversity of Views
Figures 2.A and 2.B provide further details on the
diversity of participants’ views regarding the likely
outcomes for real GDP growth and the unemployment rate. The distribution of participants’ projections for real GDP growth this year was slightly narrower than the distribution in April, but the distributions for real GDP growth in 2011 and 2012 were
about unchanged. As in earlier projections, the dispersion in forecasts for output growth appeared to
reflect the diversity of their assessments regarding the
current degree of underlying momentum in economic
activity, the evolution of consumer and business sentiment, the degree of support to economic growth
provided by financial markets, the effects of monetary policy accommodation, and other factors.
Regarding participants’ projections for the unem-

235

ployment rate, the distributions shifted somewhat
higher for the years 2010 to 2012. The distributions
of their estimates of the longer-run sustainable rates
of output growth and unemployment were little
changed from April.
Corresponding information about the diversity of
participants’ views regarding the inflation outlook is
provided in figures 2.C and 2.D . The distributions of
projections for overall and core PCE inflation for
2010 shifted lower relative to the distributions in
April, and the distributions were noticeably more
tightly concentrated. The distributions of overall and
core inflation for 2011 and 2012, however, were generally little changed and remained fairly wide. The
dispersion in participants’ projections over the next
few years was mainly due to differences in their judgments regarding the determinants of inflation,
including their estimates of prevailing resource slack
and their assessments of the extent to which such
slack affects actual and expected inflation. In contrast, the relatively tight distribution of participants’
projections for longer-run inflation illustrates their
substantial agreement about the measured rate of
inflation that is most consistent with the Federal
Reserve’s dual objectives of maximum employment
and stable prices.

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97th Annual Report | 2010

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2010–12 and over the longer run

237

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97th Annual Report | 2010

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2010–12 and over the longer run

Minutes of Federal Open Market Committee Meetings

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2010–12

239

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97th Annual Report | 2010

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers 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 gross domestic product (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 would imply a probability of about 70 percent that actual GDP would expand within a range of
2.0 to 4.0 percent in the current year, 1.4 to 4.6 percent in the second year, and 1.2 to 4.8 percent in the
third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.1 to 2.9 percent in the current year, 1.0 to 3.0 percent in the second year, and 0.9 to 3.1 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, are weighted to the 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 Federal Open Market Committee Meetings

Meeting Held on August 10, 2010

Nathan Sheets
Economist

A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
August 10, 2010, at 8:00 a.m.

James A. Clouse, Thomas A. Connors,
Steven B. Kamin, Lawrence Slifman,
Mark S. Sniderman, and David W. Wilcox
Associate Economists

Present
Ben Bernanke,
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Christine Cumming, Charles L. Evans,
Richard W. Fisher, Narayana Kocherlakota,
and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee
Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively
William B. English
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Thomas C. Baxter
Deputy General Counsel
Richard M. Ashton
Assistant General Counsel

241

Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Bank Supervision and
Regulation, Board of Governors
Robert deV. Frierson
Deputy Secretary, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director
for Management, Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
David Reifschneider and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Stephen A. Meyer
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Stephen D. Oliner
Senior Adviser, Division of Research and Statistics,
Board of Governors
Brian J. Gross
Special Assistant to the Board, Office of Board
Members, Board of Governors
Eric M. Engen
Assistant Director, Division of Research and
Statistics, Board of Governors

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97th Annual Report | 2010

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
John C. Driscoll and Jennifer E. Roush
Senior Economists, Division of Monetary Affairs,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Kimberley E. Braun
Records Project Manager, Division of Monetary
Affairs, Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
David Sapenero
First Vice President, Federal Reserve Bank
of St. Louis
Loretta J. Mester and Robert H. Rasche
Executive Vice Presidents, Federal Reserve Banks
of Philadelphia and St. Louis, respectively
David Altig, Ron Feldman, Craig S. Hakkio,
Glenn D. Rudebusch, Daniel G. Sullivan,
and Geoff Tootell
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Minneapolis, Kansas City, San Francisco,
Chicago, and Boston, respectively
Linda Goldberg
Vice President, Federal Reserve Bank of New York
Annmarie S. Rowe-Straker
Assistant Vice President, Federal Reserve Bank
of New York
Pia Orrenius
Research Officer, Federal Reserve Bank of Dallas
Robert L. Hetzel
Senior Economist, Federal Reserve Bank
of Richmond

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Committee met on June 22–23, 2010. He also
reported on System open market operations during
the intermeeting period, noting that the Desk at the
Federal Reserve Bank of New York had engaged in
coupon swap transactions in agency mortgagebacked securities (MBS) to substantially reduce the

number of the Committee’s earlier agency MBS purchases that remained to be settled. In addition, the
Manager briefed the Committee on the System’s
progress in developing tools for possible future
reserve draining operations. The Federal Reserve successfully conducted two more small-value auctions of
term deposits to confirm operational readiness for
such auctions at the Federal Reserve and at the
depository institutions that chose to participate. The
Manager noted that the staff was developing plans
for additional small-value tests of the Term Deposit
Facility. In early August, the Federal Reserve successfully executed a few small-value term reverse repurchase operations, including the first the Federal
Reserve conducted using agency MBS as collateral,
to ensure operational readiness for such transactions
at the Federal Reserve, the clearing banks, and the
primary dealers. There were no open market operations in foreign currencies for the System’s account
over the intermeeting period. By unanimous vote, the
Committee ratified the Desk’s transactions over the
intermeeting period.
The Manager also noted the staff’s projection that, if
mortgage rates were to remain near their levels at the
time of the meeting, repayments of principal on the
agency MBS held in the SOMA likely would reduce
the face value of those holdings by roughly $340 billion from August 2010 through the end of 2011. The
level of repayments would be expected to increase
further if mortgage rates were to decline from those
levels. In addition, about $55 billion of agency debt
held in the SOMA portfolio would mature over the
same time frame.

Staff Review of the Economic Situation
The information reviewed at the August 10 meeting
indicated that the pace of the economic recovery
slowed in recent months and that inflation remained
subdued. In addition, revised data for 2007 through
2009 from the Bureau of Economic Analysis showed
that the recent recession was deeper than previously
thought, and, as a result, the level of real gross
domestic product (GDP) at the end of 2009 was
noticeably lower than estimated earlier. Private
employment increased slowly in June and July, and
industrial production was little changed in June after
a large increase in May. Consumer spending continued to rise at a modest rate in June, and business outlays for equipment and software moved up further.
However, housing activity dropped back, and nonresidential construction remained weak. Additionally,
the trade deficit widened sharply in May. A further

Minutes of Federal Open Market Committee Meetings

decline in energy prices and unchanged prices for
core goods and services led to a fall in headline consumer prices in June.
Private nonfarm employment expanded slowly in
recent months. The average monthly gain in private
payroll employment during the three months ending
in July was small, considerably less than the average
increase over the preceding three months. However,
average weekly hours of all employees continued to
recover. The net addition of jobs in manufacturing
and related industries, and in nonbusiness services
such as health and education, continued to contribute importantly to the net increase in private employment. Employment in construction and financial
activities fell further. The unemployment rate moved
down in June from its level earlier in the year, and
was unchanged in July, as declining civilian employment was accompanied by decreases in labor force
participation. Initial claims for unemployment insurance remained at an elevated level over the intermeeting period.
Industrial production was little changed in June after
three months of strong increases. The output of utilities was boosted by unseasonably hot weather while
manufacturing production declined. The drop in
manufacturing output included a reduction in motor
vehicle assemblies, but they were scheduled to
increase noticeably in July. The June decrease in factory output also reflected weaker production in
industries producing non-automotive consumer
goods and construction and business supplies. The
output of high-technology items and other business
equipment continued to rise. Capacity utilization in
manufacturing in June stood well above its mid-2009
low, but it was still substantially short of its longerrun average.
Revised data indicated that consumer spending fell
more sharply in 2008 and in the first half of 2009,
and subsequently recovered more slowly, than previously estimated. Real personal consumption expenditures (PCE) rose gradually during the second quarter.
Sales of light motor vehicles continued to move up,
on balance, with the level of sales in July slightly
higher than the second-quarter average. Real disposable personal income increased at a noticeably
stronger pace than spending in recent months, and
the personal saving rate moved up further from the
upwardly revised level reported in the revisions to the
national income and product accounts. Indicators of
household net worth—such as stock prices and house
prices—were little changed, on net, over the inter-

243

meeting period. Consumer confidence fell back in
July, with households expressing greater concern
about their personal finances and the outlook for the
recovery.
The housing market, which had been supported earlier in the year by activity associated with the homebuyer tax credits, was quite soft for a second consecutive month in June. Sales of new single-family
homes rebounded some in June after their sharp drop
in May, but they remained at a depressed level. Sales
of existing homes fell for a second month in June,
and the index of pending home sales suggested
another decline in July. Starts of new single-family
houses, which had dropped steeply in May, edged
down in June to the lowest level since the spring of
2009. The low number of new permits issued in June
appeared to signal that little improvement in new
homebuilding was likely in July. House prices were
largely stable, on balance, in recent months. The
interest rate on 30-year fixed-rate conforming mortgages fell further during July, reaching a record low
for the 39-year history of the series.
Real business spending on equipment and software
rose strongly again in the second quarter, with
increases widespread across the categories of spending. New orders for nondefense capital goods excluding aircraft remained on a solid uptrend, although
their three-month change for the period ending in
June was less rapid than earlier in the year. Survey
indicators of business conditions and sentiment softened in July but remained consistent with further
gains in production and capital spending in the near
term. Business investment in nonresidential structures turned up in the second quarter, with spending
boosted by the rise in outlays for drilling and mining
structures. The decline in spending for other types of
nonresidential buildings appeared to be slowing, and
there were a few signs that financial conditions in
commercial real estate markets, though still difficult,
were stabilizing. In the second quarter, businesses
appeared to add to inventories at a faster rate. However, ratios of inventories to sales for most industries
did not point to any sizable overhangs.
Inflation remained subdued in recent months. Headline consumer prices declined in May and June
because of sizable drops in consumer energy prices.
At the same time, the core PCE price index moved up
only slightly, and the year-over-year increase in the
index in June was lower than earlier in the year. In
recent months, prices of core consumer goods continued to decline while prices of non-energy services

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rose moderately. At earlier stages of production, producer prices of core intermediate materials fell back
in June; in contrast, most indexes of spot commodity
prices moved up during July. Inflation compensation
based on Treasury inflation-protected securities
moved down further over the intermeeting period,
partly in response to softer-than-expected data on
economic activity, but survey measures of short- and
long-term inflation expectations were largely stable.

many countries began to decelerate. In contrast,
Mexican indicators suggested that economic activity
rebounded in the second quarter after contracting in
the first quarter. Headline inflation rates generally
declined abroad, reflecting prior declines in oil and
other commodity prices.

Staff Review of the Financial Situation

Nominal hourly labor compensation—as measured
by compensation per hour in the nonfarm business
sector and the employment cost index—rose modestly during the year ending in the second quarter.
Average hourly earnings of all employees rose slowly
over the 12 months ending in July. Output per hour
in the nonfarm business sector declined in the second
quarter after rising rapidly in the preceding three
quarters. On net, unit labor costs remained well
below their level one year earlier.

The decision taken by the Federal Open Market
Committee (FOMC) at its June meeting to maintain
the 0 to 1∕4 percent target range for the federal funds
rate was about in line with investor expectations and
elicited little market reaction; the same was true of
the wording of the accompanying statement. Over
the intermeeting period, investors appeared to mark
down the path for monetary policy in response to
weaker-than-expected economic data releases and
Federal Reserve communications that were read as
suggesting that policymakers’ concerns about the
economic outlook had increased.

The U.S. international trade deficit widened sharply
in May, as a significant increase in exports was more
than offset by a surge in imports. The corresponding
decline in real net exports made a significant negative
contribution to U.S. GDP growth in the second quarter. The increase in exports was broadly based, with
particular strength in exports of capital equipment.
Imports of capital goods also were strong, as were
imports of consumer goods and automotive products. In contrast, imports of petroleum products fell
in May, held back by both lower prices and reduced
volumes.

Reflecting the same factors, yields on nominal Treasury coupon securities fell noticeably on net. Treasury
auctions were generally well received, with bid-tocover ratios mostly exceeding historical averages.
Yields on investment- and speculative-grade corporate bonds decreased, and their spreads relative to
yields on comparable-maturity Treasury securities
declined moderately. Secondary-market bid prices on
syndicated leveraged loans rose a bit, while bid-asked
spreads in that market edged down.

Available data suggested that aggregate GDP growth
in foreign economies remained strong in the second
quarter. Recent indicators of economic activity for
the euro area showed little imprint of the fiscal
stresses that emerged in the spring. Industrial production continued to grow in May, with particularly
solid gains in Germany and France, and purchasing
managers indexes and economic sentiment turned up
in July. In Japan, exports continued to support economic growth, even as indicators of household
spending remained weak. Machinery orders declined
in May, however, and industrial production moved
down in June, suggesting some deceleration in economic activity. In the emerging market economies
(EMEs), incoming data generally pointed to a moderation of economic growth, albeit to a still-solid
pace, with a notable slowing in China in the second
quarter. In other EMEs, purchasing managers
indexes generally still pointed to expansions in manufacturing activity, though industrial production in

Conditions in short-term funding markets improved
somewhat over the intermeeting period. Spreads of
term London interbank offered rates (Libor) over
rates on overnight index swaps moved down at most
horizons, and liquidity in term funding markets
reportedly increased. Spreads on unsecured commercial paper were little changed. In secured funding
markets, spreads on asset-backed commercial paper
moved down, while rates and haircuts on collateral
for repurchase agreements involving Treasury and
agency collateral held steady.
Broad U.S. equity price indexes increased slightly, on
net, as generally positive corporate earnings news and
an easing of investors’ worries about the potential
effects of fiscal strains in Europe were partly offset by
concerns about the strength of the economic recovery. Most firms in the S&P 500 reported secondquarter earnings that exceeded analysts’ forecasts.
Option-implied volatility on the S&P 500 index
declined but remained somewhat elevated by histori-

Minutes of Federal Open Market Committee Meetings

cal standards. The spread between the staff’s estimate
of the expected real return on equities over the next
10 years and an estimate of the expected real return
on a 10-year Treasury note—a rough measure of the
equity risk premium—was little changed at an
elevated level. Financial stock prices moved about in
line with broader indexes, and credit default swap
spreads for large financial institutions narrowed
moderately.
Gross bond issuance by U.S. investment-grade nonfinancial corporations rebounded in July from relatively subdued levels in May and June. Nonfinancial
commercial paper outstanding also increased. Issuance of syndicated leveraged loans rose in the second
quarter, but terms on such deals reportedly tightened
somewhat. Measures of the credit quality of nonfinancial firms remained solid. Gross equity issuance
was moderate in June and July.

245

straight quarter, that a small net fraction of respondents had eased standards for C&I loans over the
previous three months. Commercial real estate loans
continued to decline steeply in June and July, and
residential real estate loans also decreased. Consumer
loans at commercial banks were about flat, on balance, as reductions in credit card loans about offset
an increase in nonrevolving consumer loans. Securities holdings by banks increased substantially in
recent weeks.
M2 was little changed in July after expanding slightly
in the second quarter. Its subdued growth in recent
months likely reflected a continued unwinding of
earlier safe-haven flows as well as the very low rates
of return on some components of M2, particularly
small time deposits and retail money market mutual
funds.

Consumer credit contracted again in the second
quarter, as revolving credit continued to decline and
nonrevolving credit edged down. Issuance of consumer asset-backed securities slowed a bit in July,
reflecting, in part, typical seasonal patterns. Consumer credit quality continued to show improvement.
Delinquency and charge-off rates for most types of
consumer loans moved down in recent months,
although these rates remained elevated. Spreads of
credit card interest rates over those on Treasury securities stayed elevated in May, while interest rate
spreads on auto loans remained near their average
level over the past decade.

In foreign exchange markets, the value of the dollar
declined on balance over the intermeeting period,
likely reflecting some reversal of flight-to-safety
flows, better-than-expected European economic data,
and the softer economic outlook for the United
States. The release of the results of the European
Union stress-test exercise, including data on European banks’ exposures to sovereign debt, appeared to
ease concerns about the potential for severe financial
dislocations in Europe. Investors also seemed to take
comfort from several oversubscribed auctions of government debt by Spain, Portugal, Ireland, and
Greece. Accordingly, risk spreads on these governments’ bonds, though elevated, generally declined,
and European banks’ access to dollar funding
improved somewhat. The lack of any disruption to
market functioning following the expiration, on
July 1, of the European Central Bank’s first one-year
refinancing operation also supported investor sentiment. Market indicators of expectations for future
overnight rates in the euro area shifted up during the
period. No changes were made to policy interest rates
in the euro area, the United Kingdom, or Japan. The
Bank of Canada tightened policy a step further during the period, raising its target for the overnight rate
25 basis points to 3∕4 percent.

Commercial banks’ core loans—the sum of commercial and industrial (C&I), real estate, and consumer
loans—continued to contract in June and July. However, the recent runoff in core loans was appreciably
smaller than the declines posted earlier in the year,
reflecting a more modest contraction in C&I loans.
The July Senior Loan Officer Opinion Survey on
Bank Lending Practices showed, for the second

Notwithstanding the improved investor sentiment
toward Europe, data releases pointing to lower-thanexpected growth in economic activity in the United
States and China may have weighed on global sovereign bond yields, which declined on net in Canada,
Germany, the United Kingdom, and Japan. Equity
prices, while up in Europe over the intermeeting
period, were little changed in Canada and down in

Prices of commercial real estate appeared to have
increased in the second quarter, though the number
of transactions was small. Nonetheless, commercial
real estate markets remained under pressure. Delinquency rates for securitized commercial mortgages
continued to rise in June, and commercial mortgage
debt was estimated to have contracted by a sizable
amount again in the second quarter. However, investor demand for high-quality commercial mortgagebacked securities (CMBS) reportedly was robust,
although issuance of CMBS remained muted.

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97th Annual Report | 2010

Japan. By contrast, share prices rose in emerging
markets and flows into emerging market equity funds
continued to be strong. The central banks of a number of EMEs, including Brazil, Chile, India, Malaysia, South Korea, Taiwan, and Thailand, increased
policy interest rates.

Staff Economic Outlook
In the economic forecast prepared for the August
FOMC meeting, the staff lowered its projection for
the increase in real economic activity during the second half of 2010 but continued to anticipate a moderate strengthening of the expansion in 2011. The
softer tone of incoming economic data suggested
that the pace of the expansion would be slower over
the near term than previously projected. Financial
conditions, however, became somewhat more supportive of economic growth. Interest rates on Treasury securities, corporate bonds, and mortgages
moved down further over the intermeeting period;
the dollar reversed its April to June appreciation; and
equity prices edged higher. Over the medium term,
the recovery in economic activity was expected to
receive support from accommodative monetary
policy, further improvement in financial conditions,
and greater household and business confidence. Over
the forecast period, the increase in real GDP was projected to be sufficient to slowly reduce economic
slack, although resource slack was still anticipated to
remain quite elevated at the end of 2011.
Overall inflation was projected to remain subdued
over the next year and a half. The staff’s forecasts for
headline and core inflation in 2010 were revised up
slightly in response to the higher prices of oil and
other commodities and the depreciation of the dollar. Even so, the wide margin of economic slack was
projected to contribute to some slowing in core inflation in 2011, though the extent of that slowing would
be tempered by stable inflation expectations.

Participants’ Views on Current Conditions
and the Economic Outlook
In their discussion of the economic situation and
outlook, meeting participants generally characterized
the economic information received during the intermeeting period as indicating a slowing in the pace of
recovery in output and employment in recent
months. Real GDP growth was noticeably weaker in
the second quarter of 2010 than most had anticipated, and monthly data suggested that the pace of

recovery remained sluggish going into the third quarter. Private payrolls and consumer spending had risen
less than expected. Business spending on equipment
and software had increased strongly but reportedly
was concentrated in replacements and upgrades that
had been postponed during the economic downturn.
Investment in nonresidential structures continued to
be weak. Housing starts and sales remained at
depressed levels, falling back after the expiration of
the temporary homebuyer tax credits. The incoming
data suggested that economic growth abroad had
been somewhat stronger than anticipated and
remained solid, boosting U.S. exports and supporting
a pickup in U.S. manufacturing output and employment, though a surprising surge in imports in the second quarter widened the U.S. trade deficit. Conditions in financial markets had become somewhat
more supportive of growth over the intermeeting
period, in part reflecting perceptions of diminished
risk of financial dislocations in Europe: Mediumand longer-term interest rates had fallen, some risk
spreads had narrowed, and the decline in equity
prices that had occurred in the months before the
Committee’s June meeting had been partly reversed.
Moreover, participants saw some indications that
credit conditions for households and smaller businesses were beginning to improve, albeit gradually.
Thus, while they saw growth as likely to be more
modest in the near term, participants continued to
anticipate that growth would pick up in 2011.
Revised national income and product account data
showed that the contraction in aggregate output during the recent recession had been larger than previously reported. In particular, consumer spending had
contracted more over the course of 2008 and the first
half of 2009, and recovered less rapidly, than previously estimated, even as households’ after-tax
incomes had increased more than shown by the earlier data. In combination, these revisions indicated
that the personal saving rate had been higher and had
risen somewhat more during the past three years than
previously thought. Participants recognized that the
implications of these new data for the outlook were
unclear. On the one hand, the revised data might
indicate that households have made greater progress
in repairing their balance sheets than had been realized, potentially allowing stronger growth in consumer spending as the recovery proceeds. On the
other hand, the revised data might signify that households are seeking to raise their net worth more substantially than previously understood, or to build
greater precautionary balances in what they perceive

Minutes of Federal Open Market Committee Meetings

to be a more uncertain economic environment, with
the result that growth in consumer spending could
remain restrained for some time.
Many participants noted that the protracted downturn in house prices and in residential investment
seemed to have ended, although ups and downs in
housing starts and home sales associated with the
temporary tax credit for homebuyers made it difficult
to be certain. A few commented that home sales and
prices appeared to be edging up in their Districts.
While recognizing that the housing sector likely had
bottomed out, participants observed that large inventories of vacant and unsold homes, along with continuing foreclosures that would increase the number
of houses for sale, likely would continue to damp
residential construction, indicating that a sustained
upturn from very low levels was not imminent.
Business investment in equipment and software had
grown at a robust pace, but growth in new orders for
nondefense capital goods, though volatile from
month to month, appeared to have stepped down.
Many participants noted that capital investment was
heavily concentrated in replacement investment and
upgrades that firms had postponed during the economic downturn. A number of participants reported
that business contacts again indicated that their
uncertainty about the fiscal and regulatory environment made them reluctant to expand capacity. Other
participants cited business surveys and reports from
business contacts indicating that slow growth in sales
and uncertainty about the strength and durability of
the recovery likely were more important factors.
Except in the extractive industries (drilling and mining), investment in nonresidential structures had continued to decline. The near-term outlook for commercial real estate investment remained weak despite
a decline in vacancy rates in some markets.
Participants agreed that credit conditions did not
appear to be an important restraint on investment
spending by larger firms that have access to the capital markets. Such firms were able to borrow readily
and at relatively low rates; moreover, many businesses
held substantial cash balances. In addition, survey
results suggested that a sizable fraction of banks had
eased loan terms, and a few had eased lending standards, on C&I loans. Some participants observed
that small businesses continued to find credit hard to
obtain. However, several participants noted recent
survey evidence indicating that most small firms that
requested credit were able to borrow, and that relatively few small firms thought that access to credit

247

was their most important problem. Standards for
commercial real estate loans and residential mortgages remained very tight, and banks did not appear
to be easing standards on such loans. Some limited
easing of lending standards was noted for consumer
loans, but credit availability remained a constraint
and consumer credit continued to contract. However,
several participants noted that with credit quality
improving, some bankers were more actively seeking
loan growth, though the same bankers also indicated
that the demand for loans remained weak.
Many participants noted that European countries’
efforts to address their fiscal imbalances, and the
release of the results of the stress test of European
banks along with information about their exposures
to sovereign debt, had reduced investor concern
about downside risks in Europe. These factors
appeared to have supported improvements in financial markets both here and abroad. Moreover, growth
in Europe and Asia apparently remained solid,
boosting U.S. exports. Nonetheless, a continuation of
strong foreign growth would require a pickup in private demand abroad to offset a decline in policy
stimulus and a smaller boost from inventory investment. Several participants noted that the same shift
in the sources of demand would need to take place in
the United States: Waning fiscal stimulus on the part
of the federal government and continuing retrenchment in spending by state and local governments
would weigh on the economic recovery, and recent
data raised questions as to whether private demand
would strengthen enough to increase resource
utilization.
The incoming data on the labor market were weaker
than meeting participants had anticipated. Privatesector payrolls grew sluggishly in recent months. The
unemployment rate declined a bit, but that reflected a
decrease in labor force participation rather than an
increase in employment. Policymakers discussed a
variety of factors that appeared to be contributing to
the slow pace of job growth. A number of participants reported that business contacts again indicated
that uncertainty about future taxes, regulations, and
health-care costs made them reluctant to expand
their workforces. Instead, businesses had continued
to meet growth in demand for their products largely
through productivity gains and by increasing existing
employees’ hours. Several participants suggested that
structural factors such as mismatches between unemployed workers’ skills and the needs of employers
with job openings, or unemployed workers’ inability
to move to a new locale, were contributing to the

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elevated level and long average duration of unemployment. Other participants, while agreeing that
such factors could restrain job growth and contribute
to high rates of unemployment, noted that employment was lower than a year earlier and that job openings were only slightly above their lowest level in
10 years, indicating that few firms saw a need to add
employees. Most participants viewed weak demand
for firms’ outputs as the primary problem; they saw
substantial scope for stronger aggregate demand for
goods and services to spur employment in a wide
range of industries.
Weighing the available information, participants
again expected the recovery to continue and to gather
strength in 2011. Nonetheless, most saw the incoming
data as indicating that the economy was operating
farther below its potential than they had thought,
that the pace of recovery had slowed in recent
months, and that growth would be more modest during the second half of 2010 than they had anticipated
at the time of the Committee’s June meeting. Some
policymakers whose forecasts for growth had been in
the low end of the range of participants’ earlier projections viewed the recent data as consistent with
their earlier forecasts for a weak recovery. A few participants, observing that month-to-month data
releases are noisy and subject to revision, did not see
the recent data as clearly indicating a change in the
outlook. Many policymakers judged that downside
risks to the U.S. recovery had become somewhat
larger; a few saw the incoming data as suggesting a
greater risk that private demand for goods and services might not grow enough to offset waning fiscal
stimulus and a smaller impetus from inventory
restocking. In contrast, most saw a reduced risk of
financial turmoil in Europe and attendant spillovers
to U.S. financial markets.
Policymakers generally saw the inflation outlook as
little changed. They observed that a range of measures continued to indicate subdued underlying inflation and that growth in wages and compensation
remained quite moderate. Many said they expected
underlying inflation to stay, for some time, below levels they judged most consistent with the dual mandate to promote maximum employment and price
stability. Participants viewed the risk of deflation as
quite small, but a number judged that the risk of further disinflation had increased somewhat despite the
stability of longer-run inflation expectations. One
noted that survey measures of longer-run inflation
expectations had remained positive in Japan throughout that country’s bout of deflation. A few saw the

continuation of exceptionally accommodative monetary policy in the United States as posing some
upside risk to inflation expectations and actual inflation in the medium run.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, Committee members agreed that it would be
appropriate to maintain the target range of 0 to
1∕4 percent for the federal funds rate. Members still
saw the economic expansion continuing, and most
believed that inflation was likely to stabilize near
recent low readings in coming quarters and then
gradually rise toward levels they consider more consistent with the Committee’s dual mandate for maximum employment and price stability. Nonetheless,
members generally judged that the economic outlook
had softened somewhat more than they had anticipated, particularly for the near term, and some saw
increased downside risks to the outlook for both
growth and inflation. Some members expressed a
concern that in this context any further adverse
shocks could have disproportionate effects, resulting
in a significant slowing in growth going forward.
While no member saw an appreciable risk of deflation, some judged that the risk of further near-term
disinflation had increased somewhat. More broadly,
members generally saw both employment and inflation as likely to fall short of levels consistent with the
dual mandate for longer than had been anticipated.
Against this backdrop, the Committee discussed the
implications for financial conditions and the economic outlook of continuing its policy of not reinvesting principal repayments received on MBS or
maturing agency debt. The decline in mortgage rates
since spring was generating increased mortgage refinancing activity that would accelerate repayments of
principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities
as the Federal Reserve’s holdings ran off, making
longer-term interest rates somewhat higher than they
would be otherwise. Most members thought that the
resulting tightening of financial conditions would be
inappropriate, given the economic outlook. However,
members noted that the magnitude of the tightening
was uncertain, and a few thought that the economic
effects of reinvesting principal from agency debt and
MBS likely would be quite small. Most members
judged, in light of current conditions in the MBS
market and the Committee’s desire to normalize the
composition of the Federal Reserve’s portfolio, that
it would be better to reinvest in longer-term Treasury

Minutes of Federal Open Market Committee Meetings

securities than in MBS. While reinvesting in Treasury
securities was seen as preferable given current market
conditions, reinvesting in MBS might become desirable if conditions were to change. A few members
worried that reinvesting principal from agency debt
and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s
readiness to resume large-scale asset purchases.
Another member argued that reinvesting repayments
of principal from agency debt and MBS, thereby
postponing a reduction in the size of the Federal
Reserve’s balance sheet, was likely to complicate the
eventual exit from the period of exceptionally accommodative monetary policy and could have adverse
macroeconomic consequences in future years.
All but one member concluded that it would be
appropriate to begin reinvesting principal received
from agency debt and MBS held in the SOMA by
purchasing longer-term Treasury securities in order
to keep constant the face value of securities held in
the SOMA and thus avoid the upward pressure on
longer-term interest rates that might result if those
holdings were allowed to decline. Several members
emphasized that in addition to continuing to develop
and test instruments to facilitate an eventual exit
from the period of unusually accommodative monetary policy, the Committee would need to consider
steps it could take to provide additional policy stimulus if the outlook were to weaken appreciably further.
Given the softer tone of recent data and the more
modest near-term outlook, members agreed that
some changes to the statement’s characterization of
the economic and financial situation were necessary.
All members but one judged that it was appropriate
to reiterate the expectation that economic conditions—including low levels of resource utilization,
subdued inflation trends, and stable inflation expectations—were likely to warrant exceptionally low levels of the federal funds rate for an extended period.
One member argued that the recovery was proceeding about as outlined earlier this year and that starting a gradual process of removing policy accommodation fairly soon would better foster the Committee’s long-run objectives of maximum employment
and price stability.
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:

249

“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 seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to 1∕4 percent. The Committee
directs the Desk to maintain the total face value
of domestic securities held in the System Open
Market Account at approximately $2 trillion by
reinvesting principal payments from agency debt
and agency mortgage-backed securities in
longer-term Treasury securities. The Committee
directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate
settlement of the Federal Reserve’s agency MBS
transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System’s balance sheet that could
affect the attainment over time of the Committee’s objectives of maximum employment and
price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in June indicates that
the pace of recovery in output and employment
has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income
growth, lower housing wealth, and tight credit.
Business spending on equipment and software is
rising; however, investment in nonresidential
structures continues to be weak and employers
remain reluctant to add to payrolls. Housing
starts remain at a depressed level. Bank lending
has continued to contract. Nonetheless, the
Committee anticipates a gradual return to
higher levels of resource utilization in a context
of price stability, although the pace of economic
recovery is likely to be more modest in the near
term than had been anticipated.
Measures of underlying inflation have trended
lower in recent quarters and, with substantial
resource slack continuing to restrain cost pressures and longer-term inflation expectations
stable, inflation is likely to be subdued for some
time.

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The Committee will maintain the target range
for the federal funds rate at 0 to 1∕4 percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels of the federal funds rate for an
extended period.
To help support the economic recovery in a context of price stability, the Committee will keep
constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency
mortgage-backed securities in longer-term
Treasury securities.1 The Committee will continue to roll over the Federal Reserve’s holdings
of Treasury securities as they mature.
The Committee will continue to monitor the
economic outlook and financial developments
and will employ its policy tools as necessary to
promote economic recovery and price stability.
1

The Open Market Desk will issue a technical note shortly
after the statement providing operational details on how it
will carry out these transactions.”

Voting for this action: Ben Bernanke, William C.
Dudley, James Bullard, Elizabeth Duke, Donald L.
Kohn, Sandra Pianalto, Eric Rosengren, Daniel K.
Tarullo, and Kevin Warsh.
Voting against this action: Thomas M. Hoenig.

Mr. Hoenig dissented because he thought it was not
appropriate to indicate that economic and financial
conditions were “likely to warrant exceptionally low
levels of the federal funds rate for an extended
period” or to reinvest principal payments from
agency debt and agency mortgage-backed securities
in longer-term Treasury securities. Mr. Hoenig felt
that the “extended period” expectation could limit
the Committee’s flexibility to begin raising rates
modestly in a timely fashion, and he believed that the
recovery, which had entered its second year and was
expected to continue at a moderate pace, did not
require support from additional accommodation in
monetary policy. Mr. Hoenig was also concerned that
these accommodative policy positions could result in
the buildup of future financial imbalances and
increase the risks to longer-run macroeconomic and
financial stability.
It was agreed that the next meeting of the Committee
would be held on Tuesday, September 21, 2010. The
meeting adjourned at 1:35 p.m. on August 10, 2010.

Notation Vote
By notation vote completed on July 13, 2010, the
Committee unanimously approved the minutes of the
FOMC meeting held on June 22–23, 2010.
William B. English
Secretary

Minutes of Federal Open Market Committee Meetings

Meeting Held on September 21, 2010
A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday, September 21, 2010, at 8:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Christine Cumming, Charles L. Evans,
Richard W. Fisher, Narayana Kocherlakota,
and Charles I. Plosser
Alternate Members of the Federal Open Market
Committee
Jeffrey M. Lacker, Dennis P. Lockhart, and
Janet L. Yellen
Presidents of the Federal Reserve Banks of
Richmond, Atlanta, and San Francisco, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist

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Alan D. Barkema, James A. Clouse,
Thomas A. Connors, Jeff Fuhrer, Steven B. Kamin,
Lawrence Slifman, Mark S. Sniderman,
Christopher J. Waller, and David W. Wilcox
Associate Economists
Brian Sack, Manager
System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director,
Board of Governors
Maryann F. Hunter
Deputy Director, Division of Banking Supervision
and Regulation, Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
David Reifschneider and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Eric M. Engen and Michael G. Palumbo
Deputy Associate Directors, Division of Research and
Statistics, Board of Governors
Brian J. Gross
Special Assistant to the Board, Office of Board
Members, Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Jennifer E. Roush
Senior Economist, Division of Monetary Affairs,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Gordon Werkema
First Vice President, Federal Reserve Bank
of Chicago
Harvey Rosenblum and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks
of Dallas and Chicago, respectively

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97th Annual Report | 2010

David Altig, John A. Weinberg, and Kei-Mu Yi
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Richmond, and Minneapolis, respectively
Chris Burke, John Fernald, James M. Nason
Vice Presidents, Federal Reserve Banks of New York,
San Francisco, and Philadelphia, respectively
Gauti B. Eggertsson
Research Officer, Federal Reserve Bank of New York
By unanimous vote, the Committee selected Deborah
J. Danker to serve as Deputy Secretary until the
selection of a successor at the first regularly scheduled meeting of the Committee in 2011.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Committee met on August 10, 2010. He also reported
on System open market operations during the intermeeting period, including the implementation of the
Committee’s decision at the August meeting to reinvest principal payments on agency debt and agency
mortgage-backed securities (MBS) in longer-term
Treasury securities. Following the August meeting,
the Open Market Desk at the Federal Reserve Bank
of New York announced that purchase operations
would follow a schedule that would be released in the
middle of each month, with the amounts calibrated
to offset the amount of principal payments from
agency debt and agency MBS expected to be received
from the middle of the month to the middle of the
following month. The Desk conducted 12 such
operations over the intermeeting period and purchased about $28 billion of Treasury securities, with
maturities concentrated in the 2- to 10-year sector of
the nominal Treasury curve, although purchases were
made across both the nominal and inflationprotected Treasury coupon yield curves. The Manager also briefed the Committee on progress in developing temporary reserve draining tools. Over the
intermeeting period, the Federal Reserve announced
a schedule for ongoing small-value auctions of term
deposits. The auctions, which will be held about every
other month, are intended to ensure the operational
readiness of the term deposit facility and to increase
the familiarity of eligible participants with the auction procedures. In addition, the Desk continued to
conduct small-scale tri-party reverse repurchase
operations using MBS collateral with the primary
dealers, and it published a list of money market

mutual funds that have been accepted as counterparties for reverse repurchase operations. The Manager
also discussed plans to publish a new set of criteria
that would allow a broader set of money market
funds to become eligible counterparties. There were
no open market operations in foreign currencies for
the System’s account over the intermeeting period.
By unanimous vote, the Committee ratified the
Desk’s transactions over the intermeeting period.

Staff Review of the Economic Situation
The information reviewed at the September 21 meeting indicated that the pace of the economic expansion slowed in recent months and that inflation
remained low. Private businesses increased employment modestly in August, but the length of the workweek was unchanged and the unemployment rate
remained elevated. Industrial production advanced at
a solid pace in July and rose further in August. Consumer spending continued to increase at a moderate
rate in July and appeared to move up again in
August. The rise in business outlays for equipment
and software looked to have moderated recently following outsized gains in the first half of the year.
Housing activity weakened further, and nonresidential construction remained depressed. After falling in
the previous three months, headline consumer prices
rose in July and August as energy prices retraced
some of their earlier decline while prices for core
goods and services edged up slightly.
The labor market situation continued to improve
only slowly. The average monthly increase in private
payroll employment over the three months ending in
August was small and was less than the average gain
earlier in the year. Moreover, average weekly hours of
all employees were little changed, on net, in recent
months after rising during the first half of the year.
The unemployment rate ticked up in August and
remained close to the level that has prevailed since
the beginning of this year. The labor force participation rate moved up a little in August but was still low.
Initial claims for unemployment insurance remained
at an elevated level over the intermeeting period. In
addition, other indicators of labor demand, such as
measures of hiring and job vacancies, did not
improve.
Industrial production increased solidly in July and
then rose more moderately in August. Manufacturing
production was boosted in July by a pickup in motor
vehicle assemblies as automakers replenished lean
stocks at dealers. However, the production of motor

Minutes of Federal Open Market Committee Meetings

vehicles was pared back in August. More broadly, the
output of high-technology items and other business
equipment expanded at a solid pace in July and
August. The output of utilities declined over the past
two months after it was boosted by unseasonably hot
weather in the preceding two months. Capacity utilization in manufacturing ticked up further in August
from its mid-2009 low, but it was still substantially
below its longer-run average.
Real personal consumption expenditures rose modestly in July, similar to the average increase over the
preceding two months. Data for retail sales and the
sales of light motor vehicles pointed to a moderate
gain in real consumer spending in August. Real disposable personal income declined a bit in July after
increasing at a solid pace in the second quarter. The
personal saving rate edged down in July but remained
near the high level registered in the second quarter.
Indicators of household net worth were mixed; home
prices moved down in July, while equity prices inched
up, on balance, over the intermeeting period. After
falling back in July, consumer confidence remained
downbeat in August and early September, with
households more pessimistic about the outlook for
their personal financial situations and general economic conditions.
Housing activity, which had been supported earlier in
the year by the availability of homebuyer tax credits,
softened further in July. Sales of new single-family
homes remained at a depressed level. Sales of existing
homes fell substantially in July, and the index of
pending home sales suggested that sales were muted
in August. Starts of new single-family houses in July
and August were below the low level seen in June,
and the number of new permits issued in August
appeared to signal that little improvement in new
homebuilding was likely in September. House prices
declined modestly in July after changing little, on net,
in recent months. The interest rate for 30-year fixedrate conforming mortgages remained essentially
unchanged over the intermeeting period at a historically low level.
Real business spending on equipment and software
appeared to have slowed in July after expanding rapidly over the preceding three quarters. Both new
orders and shipments of nondefense capital goods
excluding aircraft dipped in July. Moreover, survey
indicators of business conditions softened further in
August. Incoming construction data indicated that
business investment in nonresidential structures

253

decreased in the second quarter but at a slower pace
than over the preceding year. Increases in spending
for drilling and mining structures were more than offset by continued declines in outlays for other types of
nonresidential buildings. Despite some indications
that the difficult financial conditions in commercial
real estate markets might be stabilizing, credit was
still tight and vacancy rates for office and commercial
space remained high. In the second quarter, businesses appeared to build their inventories at a faster
pace than earlier in the year, but ratios of inventories
to sales for most industries did not point to any sizable overhangs.
Inflation remained subdued in recent months. Headline consumer prices rose in July and August as
energy prices rebounded after their decline over the
previous three months. At the same time, prices for
core goods and services moved up slightly. At earlier
stages of production, producer prices of core intermediate materials moved down, on net, during July
and August while most indexes of spot commodity
prices increased. Survey measures of short- and longterm inflation expectations were essentially
unchanged.
Unit labor costs at the end of the second quarter
remained below their level one year earlier, as labor
compensation continued to increase only slowly and
labor productivity stayed near its recent high level.
Hourly labor compensation—as measured by compensation per hour in the nonfarm business sector
and the employment cost index—rose modestly during the year ending in the second quarter. More
recently, the year-over-year change in average hourly
earnings of all employees in July and August
remained subdued. While output per hour in the
nonfarm business sector declined in the second quarter following large increases in the preceding three
quarters, productivity was still well above its level one
year earlier.
The U.S. international trade deficit narrowed in July
after widening in June. The rise in exports in July
more than offset their decline in June, as overseas
sales of capital goods rose sharply. Most other major
categories of exports were little changed in July,
although exports of automotive products posted
their first decline since May 2009. The narrowing of
the trade deficit in July also reflected a broad-based
decline in imports following their large increase in
June. Imports of consumer goods fell substantially in
July, while imports of industrial supplies, capital

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97th Annual Report | 2010

goods, and automotive products also moved down.
In contrast, imports of petroleum products remained
about flat in July.
Increases in foreign economic activity were robust,
on average, in the second quarter. In particular, gross
domestic product (GDP) grew strongly in the emerging market economies, even though gains in China
apparently moderated. Among the advanced foreign
economies, Europe posted a notable rise in economic
activity in the second quarter; rapid expansion in
Germany more than offset weaker outcomes in other
euro-area economies, particularly those experiencing
financial stress related to concerns about their fiscal
situations and potential vulnerabilities in their banking sectors. In Canada and Japan, the rise in real
GDP slowed noticeably in the second quarter. Recent
indicators of foreign economic activity for the third
quarter, including data on exports, production, and
purchasing managers indexes, generally pointed to a
slowing in the pace of expansion in economic activity
abroad. Headline inflation rates in foreign economies
generally were restrained in the second quarter by a
deceleration in food and energy prices, but prices
appeared to be rising a bit more rapidly of late.

Staff Review of the Financial Situation
The decision by the Federal Open Market Committee
(FOMC) at its August meeting to maintain the 0 to
1∕4 percent target range for the federal funds rate was
widely anticipated, but Treasury yields declined as
investors reportedly focused on the indication in the
accompanying statement that principal payments
from agency debt and MBS in the Federal Reserve’s
portfolio would be reinvested in longer-term Treasury
securities and also on the characterization of the economic outlook, which was seen as somewhat more
downbeat than expected. The expected path of the
federal funds rate moved down early in the intermeeting period in response to weaker-than-expected economic data. The Chairman’s Jackson Hole speech
was reportedly viewed by market participants as
more encouraging about economic prospects and as
providing more clarity about the policy options available to the FOMC, but it did not have a sustained
effect on policy expectations. The expected path of
the federal funds rate rose for a time following the
more-positive-than-expected data on manufacturing
activity and the labor market released in early September, but the path ended the intermeeting period
down on balance.

Yields on nominal Treasury coupon securities were
volatile and ended the period somewhat lower, particularly for intermediate- and longer-term maturities. In addition to Federal Reserve communications
and news about the economic outlook, market participants pointed to strong demand for long-duration
assets by institutional investors and speculation
about additional large-scale asset purchases by the
Federal Reserve as factors contributing to the drop in
longer-term yields. Five-year inflation compensation
based on Treasury inflation-protected securities
(TIPS) fell, while forward inflation compensation
5 to 10 years ahead edged up, on net, over the intermeeting period but remained at a lower level than in
the spring. Treasury auctions over the intermeeting
period were generally well received. Yields on
investment- and speculative-grade corporate bonds
moved roughly in line with those on comparablematurity Treasury securities, leaving risk spreads little
changed. Measures of liquidity in secondary markets
for corporate bonds remained stable. In the secondary market for syndicated leveraged loans, the average bid price moved up and bid-asked spreads edged
down.
Conditions