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FEDERAL RESERVE BANK OF CLEVELAND
2003
ANNUAL REPORT

www.clevelandfed.org

FEDERAL RESERVE BANK OF CLEVELAND
2 0 0 3 A n n ua l Re p o r t

2 0 0 3 Annual Report
The Federal Reserve System is responsible for formulating and

The Federal Reserve Bank of Cleveland, including its branch offices

This annual report was prepared by the Corporate Communications

implementing U.S. monetary policy. It also supervises banks

in Cincinnati and Pittsburgh and its check processing center in

and bank holding companies, and provides financial services to

Columbus, serves the Fourth Federal Reserve District (Ohio,

and Community Affairs Department and the Research Department
of the Federal Reserve Bank of Cleveland.

depository institutions and the federal government.

western Pennsylvania, the northern panhandle of West Virginia,
and eastern Kentucky).

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve
Banks in the United States that, together with the Board of Governors
in Washington, DC, comprise the Federal Reserve System.

Acknowledgments
Manager, Communications Support:
Michael Galka

For additional copies, contact the Research Library,
Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH 44101,
or call (216) 579-2052.

Editor: Deborah Ring
Design: Lori Boehm

It is the policy of the Federal Reserve Bank of Cleveland to provide
equal employment opportunity for all employees and applicants without
regard to race, color, religion, sex, national origin, age, or disability.

The annual report is also available electronically through the
Cleveland Fed’s home page, www.clevelandfed.org.

Portrait Photography:
Bill Pappas

Cleveland

Cincinnati

Pittsburgh

Columbus

1455 East 6th Street
Cleveland, OH 44114
(216) 579-2000

150 East 4th Street
Cincinnati, OH 45202
(513) 721-4787

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Pittsburgh, PA 15219
(412) 261-7800

965 Kingsmill Parkway
Columbus, OH 43229
(614) 846-7494

Federal Reserve Bank of Cleveland

Table of Contents

2003 Annual Report

President’s Foreword

3



6



23



29



30



31



32



Comparative Financial Statements

34



Notes to Financial Statements

41



Officers and Consultants

42



Boards of Directors

44



Innovation, Growth, and Economic
Policy in an Environment of Change
Operational Highlights
Management’s Report on
Responsibility for Financial Reporting
Report of Independent Accountants
on Financial Reporting
Report of Independent Accountants
on Financial Statements

Business Advisory Council and
Community Bank Advisory Council

Annual Report

2003

3

President’s Foreword

W

hat is the source of economic prosperity? In today’s

environment, where the slow pace of job creation tops the
national agenda, it is tempting to answer that high-paying
jobs lead to economic success. And in a region known for its
industrial prowess, wouldn’t those be manufacturing jobs?
But that response begs the very question we seek to answer:
how to get the most value from our resources over time.
The essay that follows examines the legacy and lessons of economic development during the last several hundred years, spanning agrarian, industrial,
mass-production, and postindustrial economic systems. We conclude that
education and flexibility are most important to stimulating innovation and
economic growth. In an economic order marked by a growing and more
diverse set of nations, invention is our greatest strength and flexibility our
most valuable asset. Economic success comes from responding to the changes
that innovation necessitates.

Federal Reserve Bank of Cleveland

4

R. Chris Moore, first vice president; Robert W. Mahoney, chairman; and Sandra Pianalto, president.

The Federal Reserve Bank of Cleveland has not been immune to the challenge of change, but
we are learning to embrace the opportunities those challenges present. In the “Operational
Highlights” section of this report, we look at some of the ways that innovation and new
technologies are transforming the payments system, and how these developments have
altered the way we do business.
The trend that is sweeping our payments system is the substitution of electronics for paper.
As the Federal Reserve System rationalizes and modernizes its check processing infrastructure,
it is constructing a platform to capture checks earlier in the payments stream and convert
them into electronic check images. The Federal Reserve is also facilitating electronic bill
payment and presentment, helping investors to purchase U.S. savings bonds online, and
speeding collections electronically for the U.S. Treasury.
The Federal Reserve Bank of Cleveland plays an important role in these projects, and to do
so, we are hiring people with higher education and different skills than we did even a decade
ago. We rely more on teams, and we benefit from putting better information into the hands
of each employee. We value learning and the continuous improvement it brings.

Annual Report

2003

5

Our Bank achieved many milestones last year—and that success would not have been
possible without the guidance and support of our boards of directors in the Cleveland,
Cincinnati, and Pittsburgh offices and the members of our advisory councils.
I am especially appreciative of the leadership of Robert W. Mahoney (retired chairman and
chief executive officer, Diebold, Incorporated), who serves the Bank as chairman of the
board. Mr. Mahoney also led the search committee that selected R. Chris Moore as our
Bank’s first vice president and chief operating officer. I also offer thanks to Cheryl L. Krueger
(president and chief executive officer, Cheryl&Co.), who completed her second term of
service on the Cleveland board in 2003. Ms. Krueger’s valuable service to the Bank dates
to 1995, when she began serving on our Business Advisory Council.
Finally, it is with heartfelt thanks that I recognize the officers and staff of the Federal Reserve
Bank of Cleveland. In response to the whirlwind changes taking place in our industry, we are,
together, reshaping the strategic direction of our organization to reflect a future of challenge,
opportunity, and possibility. During this year—my first as the Bank’s president—your
unwavering support and continued dedication to our shared mission inspire me daily.

President
and Chief Executive Officer

Innovation,
Growth,
and

Economic Policy
in an

Environment of Change

Annual Report

2003

7

W

hat is the source of economic prosperity?

This is the question that motivates all economic study—and it
is more than just academic inquiry. Economics, ultimately, is
about advocating policy. Whether we are atop the world stage
or around the kitchen table, each of us is a policymaker trying
to maximize our well-being using our limited means. The
search for greater prosperity—what economist and historian
Joel Mokyr aptly calls “the lever of riches”— is ubiquitous.
The idea of economic prosperity has a particular urgency here in the
Fourth Federal Reserve District, where manufacturing jobs are giving
way to the unrelenting pressures of an expanding service sector,
foreign competition, and their own spectacular productivity growth.
Indeed, our region has a ringside seat for the competitive struggle
that will determine our nation’s potential: the importance of innovation in spurring and sustaining growth, and the government’s role
in promoting the most conducive environment for that growth.
In this report, we explore innovation as the engine of economic prosperity and
argue that the greatest strength we possess is our ability to induce and embrace
change, from the integration of new technologies to new peoples and cultures.
Indeed, if we hope to remain an ongoing, vital player in the global economy,
flexibility is likely to be our most valuable asset.

Federal Reserve Bank of Cleveland

8

“If you’re not
competing,
you’re dead.”

In 1776, Adam Smith challenged the mercantilists’
us-versus-them view in his monumental work, An
Inquiry into the Nature and Causes of the Wealth
of Nations. The mercantilist prescription of promoting
exports and discouraging imports elevated the interests
of the producer at the expense of the consumer, Smith
argued, yet “consumption is the sole end and purpose

Arnold Palmer

of all production.” No nation can hope to raise the
prosperity of its citizens by encouraging them to
produce what they could buy more cheaply elsewhere.

The Economics of Us and Them

But how can an environment as seemingly destructive

Competition for precious resources is always and every-

as the marketplace be the basis for prosperity? The

where. It is the struggle that defines all life: Limited

answer, said Smith, is specialization and trade:

resources meet unlimited desires. And so we compete

If [they] can supply us with a commodity cheaper
than we ourselves can make it, better buy it of them
with some part of the produce of our own industry,
employed in a way in which we have some advantage.

with one another, person with person, business with
business, and nation with nation. At first glance, the
marketplace appears destructive— that is, the elevation
of one cannot be accomplished without a proportionate

Two important ideas here deserve emphasis. First, we

cost borne by another. This is the economics of us

gain from the marketplace by allocating our efforts to

versus them, and it is this view that each of us sees

areas where we get the most bang for our buck. In other

from our individual vantage point. This perspective is

words, we want to produce those things that require the

limited, though, and tends to breed misunderstanding

smallest sacrifice compared to others. When we each

about competition and social welfare. Unfortunately,

focus our abilities on our “comparative advantage,” and

it is also the perspective that has motivated an array of

then trade with those offering something different, both

economic “remedies” that, more often than not, have

parties advance their welfare beyond what they could

inhibited economic progress.

have attained in isolation.1 The logic that both parties

The predominant economic theory of the eighteenth

are made better off by trade is obvious: If each enters

century, mercantilism, was based on such a view. The

into the trade voluntarily, it is because what they offer

mercantilists held that a nation’s wealth lies in its stock-

is less valuable to them than what they receive in return.

piles of precious metals. One road to economic prosperity

The second key insight— a point the mercantilists

is god given— some nations are simply endowed with

missed— is that trade is symbiotic. If we wish to buy,

a richer store of precious metals that need only be dug

we must also sell. We simply cannot do one without

from the ground. But a nation might also create its own

the other. This truth holds for nations just as it does

prosperity by accumulating precious metals through

for each of us individually, though it is often lost on

trade. At the heart of mercantilist economic policy are

us. It is hard to look beyond the “us versus them” of

commercial controls aimed at promoting exports and

competition. When we see the production of a particular

suppressing imports.

1

David Ricardo (1817) is generally credited with the formal development of the idea of
comparative advantage.

Annual Report

2003

9

product moving to another location, perhaps even another

The mathematician Stanislaw Ulam once challenged

nation, we are tempted to extrapolate that trend in isola-

Nobel laureate Paul Samuelson to name “one proposi-

tion and wonder: What will become of us if all the jobs

tion in all of the social sciences that is both true and

go away? But employment opportunities don’t go away—

non-trivial.” Several years later, Samuelson thought of

they reappear in another form. We cannot buy if we do

the correct response: comparative advantage. “That it

not sell “from the produce of our own.” In the market-

is logically true need not be argued before a mathemati-

place, the prosperity of each trading partner is inextrica-

cian; that it is not trivial is attested by the thousands of

bly linked. This is the economics of us and them, and

important and intelligent men who have never been able

it is the mechanism by which competition elevates

to grasp the doctrine for themselves or to believe it after

overall prosperity.

it was explained to them.”2

Not everyone among “us,” however, will share equally
will be casualties along the way. Those who carry the

The Arithmetic of the Dismal Scientists:
Early Growth Theory

heaviest burdens—workers whose skills are at odds

Adam Smith gave us a crucial analytical framework,

with economic reorganization—will find little comfort

a model of the marketplace based on individual self-

in the knowledge they are paying its inevitable and

interest which, intentionally or not, promoted economic

necessary costs. What is certain, though, is that the

prosperity. The lever of riches was not, as the mercan-

benefits flowing to the gainers will more than offset the

tilists had claimed, to be found in the accumulation of

losses of the ravaged. How we choose to compensate

money, but in our ability to lower the costs of production

those who are in direct conflict with the changes brought

and create new trade relationships. But Smith’s was the

by competitive forces and how we reengage them in

era of the first great industrial revolution. Jethro Tull

the marketplace is a great and thorny challenge for

had invented his planting drill, Samuel Crompton his

economic policymakers.

spinning “mule,” and James Watt the steam engine,

in the gains of competitive trade with “them.” There

Economists today accept almost without debate that
specialization and trade define the benefits of a market
economy. Still, more than two centuries after Smith
described the process, it remains one of the most

while in America, Eli Whitney would soon develop the
cotton gin. New gadgetry was rearranging the nature of
work, altering trade patterns, and ushering in an era of
prosperity that had been unimaginable.

mistrusted—if not vilified— economic notions among

But if Adam Smith’s vision for the world was hopeful,

noneconomists. Consider the recent controversy when

it would soon be dashed by the first generation of

N. Gregory Mankiw, chairman of the president’s Council

economists to follow him, notably the Reverend Thomas

of Economic Advisers, repeated this widely held view

Robert Malthus. These early-nineteenth-century econo-

among economists: “Outsourcing of professional services

mists investigated the dynamics of Smith’s model and

is a prominent example of a new type of trade....When

found in it one inescapable conclusion: While prosperity

a good or service is produced at lower cost in another

may originate in specialization and trade, it would

country, it makes sense to import it rather than to

eventually be brought to a crashing end by unchecked

produce it domestically. This allows the United States
to devote its resources to more productive purposes.”
2

Samuelson (1969).

Federal Reserve Bank of Cleveland

10

population growth. The undoing of prosperity is found
in Malthus’s “law” of diminishing returns, which he
applied to land, but it could just as easily be applied
to any economic resource. As more land is cultivated,

Charles Darwin, Cleveland Public Library/Photograph Collection;
Thomas Robert Malthus, Private Collection/Roger-Viollet, Paris/Bridgeman Art Library

Malthus argued, the productive capacity of each additional plot is necessarily less than the previous plot and,
eventually, the expanding number of ravenous mouths
will overtake food production. In this view, widespread
poverty, misery, and suffering are inescapable.
Indeed, too much of the world continues to languish at
or near the level of starvation the classical economists
predicted would be the inevitable long-run state of the
human race. But in the nineteenth century, a small
number of nations were dramatically distancing themselves from that dismal fate in what economists now
call the “great divergence.” Something was propelling
these nations, including the United States, forward at
an undreamed-of pace.

Figure 1: The Great Divergence
GDP per capita
(1990 international dollars)

25,500
20,500
15,500

Charles Darwin’s inspiration for his theory of evolution
may have come from the social sciences rather than biology.
In 1838, four years after Thomas Malthus’s death, Darwin,
pursuing a “systematic inquiry” into the factors driving the
origin of new species, read the works of Malthus, noting:
…the Struggle for Existence amongst all organic beings
throughout the world, which inevitably follows from the
high geometrical ratio of their increase, will be considered.
This is the doctrine of Malthus, applied to the whole animal
and vegetable kingdoms. As many more individuals of
each species are born than can possibly survive; and as,
consequently, there is a frequently recurring struggle for
existence, it follows that any being, if it vary however
slightly in any manner profitable to itself, under the
complex and sometimes varying conditions of life, will
have a better chance of surviving, and thus be “naturally
selected.” From the strong principle of inheritance,
any selected variety will tend to propagate its new
and modified form.
—Origin of the Species

10,500
5,500
500
1700

Innovation, Extinction, and Growth:
Evolution Meets the Dismal Science

1750

1800

1850

1900

1950

United States

Former Soviet Union

Japan

China

Western Europe

India

2000

In the nineteenth century, the United States joined Western Europe in
distancing itself economically from the rest of the world. This prosperity
gap accelerated during the Industrial Revolution, and today, these advanced
economies enjoy per capita incomes six to 10 times that of other nations.
Source: Maddison (2001).

The idea is that systems evolve as a result of innovation—
which, if it is advantageous, supplants the obsolescent
technology. The competition for limited resources favors
the better technology and, as it flourishes, the economic
“species” improves.

2003

Annual Report

11

The Process of Growth:
Innovation and Creative Destruction

Growth theory made another great leap forward in the

During the first half of the twentieth century, the

by economist Robert Solow, who would go on to win

question of how economies grow over time, known

a Nobel Prize. In his 1956 paper, Solow demonstrated

as growth theory, was pushed to the back burner of

that an economy’s long-run growth is unaffected by its

economic inquiry, subjugated by the exigencies of the

rate of saving and investment. The idea was similar to

world’s economic depression. Stabilization theory

that posited by the classical economists and came to

became the rallying cry of most economists, and it was

be known as the “neoclassical growth model.” In a 1957

exemplified by British economist John Maynard Keynes’s

paper, Solow went on to show that nearly 90 percent

scornful denigration of the long-run perspective of growth

of the rise in U.S. prosperity during the first half of the

theorists when he said that “in the long run, we are

twentieth century came from technological growth, and

all dead.” To Keynes, the important questions did not

not, as most economists had assumed, from the mere

concern the long march of economic progress, but the

accumulation of machinery. 5

1950s with the publication of two influential papers

unnerving fluctuations that characterize that march—

Figure 2: Accounting for Growth

bility of market economies and threaten to mire our
economies in chronic underemployment, if not bring
them down altogether.
While Keynes was refocusing economists’ attention
away from growth theory and toward stabilization
theory, the Austrian-born Harvard economist Joseph
Schumpeter argued that the two theories are inextricably
connected. In Schumpeter’s view, the ebb and flow of
economic activity and national joblessness that Keynes

10-year growth rate of real GDP (percent)

fluctuations he believed demonstrate the inherent insta-

7
6
5
4
3
2
1
0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

had aimed to control are an integral—indeed, necessary—
part of growth. Growth, he argued, is about innovation,
or “putting productive resources to uses hitherto untried
in practice, and withdrawing them from the uses they
have served so far.” 3 Schumpeter included in his set
of growth-driving innovations the introduction of new
products, new methods of production, new trade

Technology

Labor

Capital

In the typical growth accounting exercise, economic growth is separated into three
sources: labor, capital, and a hard-to-measure factor that connects workers to their
machinery—technology. By this measure, technology has accounted for one-third
of U.S. growth over the past 10 years.
Sources: Federal Reserve Bank of Cleveland; for standard parameter assumptions,
see Edward C. Prescott, “Theory Ahead of Business Cycle Measurement,” Federal
Reserve Bank of Minneapolis, Quarterly Review, Fall 1986, 9–22.

relationships, the discovery of raw materials, and the

Using Solow’s framework and the accumulated evidence

reorganization of business and economy activity. Each

of several centuries, growth theorists now suspect that

innovation, he believed, would be accompanied by

technological development is not the result of random

temporary periods of joblessness and business stress

inspiration, but instead arises from the same competitive,

as it “reconstruct[s] each time the economic system

seemingly destructive, forces that produce all goods. The

4

roots of this idea can also be traced back to Schumpeter:

on a more efficient plan.” He called this process
creative destruction.
3
4

Schumpeter (1928).
Schumpeter (1934).

5

Subsequent “growth accounting” exercises, like the influential work of Edward F. Denison (1974)
in the 1960s through the 1980s, have lowered that estimate, but the fact remains that technology—
the introduction of innovations—is an essential component of long-run growth.

Federal Reserve Bank of Cleveland

12

It is quite wrong…to say, as so many economists do,
that capitalist enterprise was one, and technological
progress a second, distinct factor in the observed development of output; they were essentially one and the
same thing or, as we may also put it, the former was
the propelling force of the latter.6
The theory that technology responds to market incentives—that an economy manufactures technology as

Innovation, Diffusion, and Economic Stress
History has revealed that major economic innovations
take many years to fully diffuse throughout an economy,
and the course is hardly steady. At first, new technology
is slow to take hold. Businesses are heavily invested in
the older technology, and the applications of the new
technology—seen through the eyes of entrepreneurs,
who tend to view production through the lens of the

it does other goods—is called endogenous growth.

old technology—appear limited. Moreover, the new

Innovation begets growth, which begets yet more
innovation. But what is the nature of the process that
spawns innovation, and is there anything that economic
policymakers can do to promote it? These questions are
being addressed by today’s growth theorists in the hope
that we might yet understand the lever of riches.7

technology may require a critical level of diffusion
before it is truly effective; for instance, a telephone
isn’t a particularly useful tool until a sufficiently large
number of people own phones. And of course, the
initial innovation is just the beginning, as supporting
technologies are developed and diffused. Technological
revolution “constitute[s] a social process that involves
more than the sum of our individual struggles with
inanimate nature. People are adjusting not only to

Figure 3: Patents and Technological Revolution

changes in technology, but to changes that others are

0.07

making to technology.”8

Patents issued per capita

0.06
0.05

The process of growth through innovation, erratic and

First Industrial Revolution
1840s–1860s

Great Depression

uneven, produces some unpleasant side effects. At the
inception of the new technology, productivity gains

0.04

are difficult to come by, and productivity may actually

0.03

decline for some time because of the awkward process
of learning and assimilation. Here again we find the

0.02
Second Industrial Revolution
1860s–1930s

0.01

IT Revolution
1974–?

insights of Schumpeter: Some of the economy’s existing
capital will be made obsolete nearly overnight, and skills

0
1810

that once were valuable will no longer be needed. From
1830

1850

1870

1890

1910 1930

1950

1970

1990

Charles H. Duell, commissioner of the U.S. Patent Office in 1899, is often credited
with the statement that “Everything that can be invented has been invented.”
Although it seems doubtful the commissioner actually made this remark, it is easy
to underestimate the pace of innovation. Since the early 1970s, the number of
patents per capita has accelerated to a new record, roughly doubling the pace of
the 1960s and 1970s.
Sources: U.S. Department of Commerce, Patent and Trademark Office;
and Greenwood (1999).

livery workers to milkmen, elevator operators to wireless
operators, railroad conductors to cobblers, gas station
attendants to blacksmiths, our economic history is
littered with jobs that are now largely obsolete. Workers
will need to be retrained and production processes
overhauled, and, for a time, unemployment will rise.
The process of creative destruction is also likely to
create a temporary gap in the distribution of prosperity.9

6
7

Schumpeter (1942).
Notably, economist Paul Romer (1990, 1994, 1996) of Stanford University.

8
9

Howitt (1994).
See Galor and Tsiddon (1997) and Greenwood (1999).

2003

Annual Report

13

Figure 4: The Changing Character of American Jobs
100
90
80

Innovation and Social Organization:
Has Technology Liberated Women?
In 1900, about 5 percent of married women worked outside
the home. By 1960, that figure had risen to about 30 percent,
and in 1990, nearly 60 percent of all married women participated in the labor market. What accounts for this major social
change? It seems to be the result of a confluence of events:
the breakdown of social stereotypes, social legislation, the
narrowing wage gap between the sexes, and—perhaps most
underappreciated—women’s liberation from home work as a
result of innovation in home technology. This is one example
of the social reorganization that often accompanies major technological breakthroughs.
Economists Jeremy Greenwood, Ananth Seshadri, and
Mehmet Yorukoglu (2003) argue that a variety of labor-saving
devices—from home electronics in the 1920s and 1930s to
the introduction of microwave ovens more recently—have dramatically lowered the time required for household chores,
allowing women greater freedom to choose paid employment.

Percent of all jobs

70
60
50
40
30
20
10
0
1850

1900

Craftsmen, operatives
All other
Managers, clerks, sales

1950

2000

Arts, science, teaching
Farming, general labor

The nature of American work has undergone dramatic change over time.
While some jobs have remained relatively constant, many have fallen into
economic obscurity, such as railroad conductors, porters, ushers, charwomen,
elevator operators, postmasters, and midwives. In the last 50 years, the share
of craftsmen and operatives has declined, replaced by occupations in the arts
and sciences (including teachers), and managers, clerks, and salespeople.
Source: Steven Ruggles and Matthew Sobek, et al., Integrated Public Use
Microdata Series: Version 3.0 (Minneapolis, MN: Historical Census Projects,
University of Minnesota, 2003).

Some will be so heavily invested in the old technology
that the new process will seem like more of a threat
than a benefit. The same will be true for the workforce.
Collectively, then, there will be many people who have
little interest in or ability to embrace the new tools and

Home and Market Work of Married Women

techniques. But over time, those who readily adapt to

70

successful innovations will find their incomes growing

60

faster than those who cling to obsolete technologies and

50

business practices. Eventually, the superiority of the new

40

technology will become so great that its widespread
adoption is imperative. The next generation masters the

30

skills associated with the newer methods, and income
20

inequality falls as the technology is diffused across

10
0
1900

industries and occupations.
1910

1920

1930

1940

Labor force participation (percent)

1950

1960

1970

1980

1990

Home work (hours)

Sources: Labor force participation rates are from Matthew Sobek, “A Century of
Work: Gender, Labor Force Participation, and Occupational Attainment in the United States,
1880–1990,” PhD diss., University of Minnesota, 1997; hours of home work is from Stanley
Lebergott, Pursuing Happiness, American Consumers in the Twentieth Century (Princeton,
NJ: Princeton University Press, 1993), table 8.1.

The economy is now being transformed by another great
innovation, the microprocessor. This, and the vast
number of innovations the microprocessor has spawned—
called the information technology revolution—is
dramatically lowering the cost of information. The cost

Federal Reserve Bank of Cleveland

14

per computation has declined so rapidly over the past
few decades that mechanical devices have replaced
human action in innumerable daily tasks.
Technology may be the reason for the surging U.S.

Smarter, Luckier, or Better Technology?
What Accounts for the Improvement in
U.S. Economic Stability?

productivity of the 1990s, and it may sustain us for

One of the most remarkable developments of the last quartercentury has been the U.S. economy’s increased stability: The
variability of U.S. output has been cut in half during the last
20 years or so.

tion in IT software and services, greater diffusion of

The puzzle of our recent economic stability has prompted
three explanations—improved management of the economy
by policymakers, good luck, and structural changes, including
improved technology. All three probably deserve some
measure of the credit, and each has its proponents.10

quite some time. We may yet see a second wave of high
productivity growth, brought about by still more innovainformation technology in lagging sectors of the economy,
and further cost advantages from the global production
of technologies.11 Sharply lower communications costs
have accelerated the exchange of ideas in a way not
seen since the invention of the telegraph. It is no
exaggeration to say that information technology has
expanded the marketplace to every location on the
globe. Markets that had been isolated since before
World War II are now opening, and we stand before a

Economists Margaret McConnell and Gabriel Perez-Quiros
(2000) say that, beginning in 1984, increased economic
stability was associated with lower volatility in the durable
goods sector of the economy, which, in turn, roughly coincided
with a reduction in durable goods inventories. One reason
for the improvement in inventory management may have
been the widespread adoption of new technologies that have
allowed firms to better manage their stock of goods relative
to their sales.

great opportunity that would have seemed impossible
only a decade ago.
How this transformation will unfold is unknown, but we
have learned from earlier periods in world history that,
although the potential gains to our economic well-being
are considerable, they are likely to be uneven. Several
studies contend that technology has produced greater
inequality in earnings in the United States, as the
demand for workers who can adopt the technology rises

U.S. Economic Stability since 1984

relative to those who are less able to do so.12 In some

4

places, the transformation will put great stress on the

Quarterly percent change

3

existing economic order. The more dramatically the new

2

technology promises to raise our future standard of living,

1

the more disrupting it will be to current businesses
and employees.

0

From the scribe guilds of the fifteenth century that

–1

resisted the introduction of Gutenberg’s printing press,

Range = +
- one standard deviation

–2

to the attempts by canal operators to block the expansion
–3
1954

1959

1964

1969

1974

1979

1984

1989

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

10 See Bernanke (2004).

1994

1999

of the railroads, in every century, in every nation, in
every industry, those who have a stake in the old ways
11 Mann (2003) is one who predicts a second wave of IT-induced productivity growth. Oliner and
Sichel (2000) document IT-related productivity growth during the 1990s. Baily (2001) provides
a comprehensive overview of the issue.
12 See, for example, Autor, Katz, and Krueger (1998).

2003

Annual Report

15

impede the new, either by direct assault, or indirectly
in the name of preserving a particular way of life.13
Many social systems are resistant to change, making
them infertile ground for breeding and adopting new
ideas. Certainly, some thoughtful resistance to innovation
makes sense. Like Darwin’s genetic mutations, not every
innovation is necessarily life enhancing, and it should
prove itself in the competitive struggle with the existing
regime. But “[u]nlike natural selection, however, in
cultural evolution there is a feedback effect; a high level
of resistance will not only obstruct the adoption of new
ideas but also discourage their emergence altogether,
thus throttling the supply of the raw material of which
change is made.” 14
The usual justifications for resisting new technologies
are diverse and predictable. New practices are frequently
characterized as too risky, a corruption of social values
or environmental harmony, destructive to human
creativity, indeed, a threat to humanity itself. Historically,
the political order controls the speed and direction of
change by using controls on wages and prices, trade
restrictions and protectionist measures, regulatory
constraints on business expansions and contractions,
and other strategies to preserve the status quo.
But the colossal failure of state-managed economic
systems in the second half of the twentieth century is
not just a warning about the dangers of replacing the
values of the marketplace with the values of the state.
It is also a warning about the fate of societies that cannot
adjust to the shifting preferences and technologies that
guide precious resources to their most beneficial use.
For this reason, state-directed industrial policies, no
matter how well intended or initially successful, tend to

Luddite Rioters, Private Collection/Bridgeman Art Library

Resistance to Technology: The Luddites
New technology cannot help but make older technology
obsolete—and the old technology will undoubtedly have a
constituency with a vested interest in preserving it. In the first
century, the emperor Tiberius, who had an interest in Roman
glass manufacturing, is said to have ordered the inventor of
“unbreakable” glass to be strangled. Fourteenth-century tailors
in Cologne were prohibited from using machines that pressed
pin heads. And the ribbon loom, originally invented in Germany
in the late sixteenth century, was killed by political pressure—
only to be reinvented 25 years later in the Netherlands.15
The Luddite movement was a notorious uprising that protested
technological change. The Luddites began in 1811 as a band
of artisans in the wool and cotton industries in Nottingham,
England. Distraught over wage reductions, the use of unapprenticed workmen, and the emerging use of machines, the
artisans vandalized mills across the English countryside.
Operating under its mythical leader and namesake, Ned Ludd,
the group sought to defend its livelihood by targeting the
symbols of industrial change—the machinery and factories
of England’s early industrialists.
The Luddites gained widespread support throughout Nottingham
and other shires. Their brutal and violent response to the new
industrialists was met with the same, as the British government
set troops against the rioters. Although the Luddites were
ultimately overcome, antitechnology sentiment grew stronger
in Victorian Britain, and the torch of technological leadership
was passed to the American continent, where there was
considerably less resistance to new technology.

have a detrimental effect on growth. Once in place, they
are hard to remove, and this creates inflexibility in the
distribution of resources. We handcuff our futures to an
economic structure that must, in time, become obsolete.
13 For a detailed historical account of resistance to innovation, see Mokyr (1992). Parente and
Prescott (1994) provide a theoretical treatment of barriers to technology adoption.
14 Mokyr (1992).

15 Examples are from Mokyr (1990, 1992).

Federal Reserve Bank of Cleveland

16

“It is not the strongest of the species
that survive, nor the most intelligent,
but the one most responsive to change.”
Charles Darwin
The Wealth of Nations:
What Accounts for the Success
of the American Economy?

It was an era of great upheaval that changed many of

Classical economists believed the unusually strong

workers who could read, compute, and interact with

growth experienced in America during the early

complex production processes, putting pressure on our

nineteenth century was a function of our great

educational institutions to turn out employees who

expanse of land relative to our small population.

could contribute more than brute force to the new

In time, as the population expanded and the law

economic order. Mass education became imperative,

of diminishing returns took hold, it seemed likely

and the nation responded.

that America’s growth rate would fall back to match
that of the European continent. But it did not. So
if we are to believe modern growth theorists—that
innovation is the origin of long-term growth—why
has the United States been a more fertile environment
for innovation than elsewhere? Some have suggested
that much of America’s economic success lies in
what it did not do. During the industrial revolution
of the late nineteenth and early twentieth centuries,
America resisted many of the antitechnology forces
that prevented other nations from realizing the full
advantage of new technology.16

our social institutions, including our system of public
education. Industrial capitalism placed a premium on

The same constellation of factors may be propelling the
nation today as we rapidly assimilate information technologies into the economy. The successful adoption of
new technology in America is often attributed to the
nation’s relatively unencumbered regulatory environment, more flexible labor markets, and, again, our
educational system. In the United States, our emphasis
on post–high school education has been general, not
vocational, allowing greater flexibility for workers who
face a changing work environment. We teach how to
learn rather than what to learn. One estimate suggests
the difference in education strategy between the United

And so the nation was transformed from a rural

States and Europe may account for as much as three-

giant to an industrial giant, but to say it was a

quarters of the growth differential between the two over

difficult transition would be a gross understatement.

the past decade, with the remainder attributable to

Factories absorbed a rapidly increasing share of our

regulatory and labor “rigidities.” 17

nation’s resources, and rural workers migrated to the
industrializing urban centers in huge numbers.

16 Mokyr (1992).

17 See Krueger and Kumar (2003). The role of general versus technical education is discussed in
Bertocchi and Spagat (2001).

2003

Annual Report

17

The Rise and Fall
and Rise of Regional Economies
Can modern growth theory help us to understand our
own region? Of course. Our natural infrastructure
includes easy access to the lakes, rivers, and canals

The Founding Fathers on
Manufacturing and Public Education

that moved products east, and, for a time, the greatest
network of rail lines connecting resources to the rest of

To America’s founding fathers, the public promotion of
education was a matter of good government. For a democracy
to be successful, its citizenry needed to be intellectually up to
the challenge—and it would be from these enlightened citizens
that our elected leaders would be drawn. Yet it may have been
economic necessity that ultimately provided the motivation for
our public education system. The study of practical subjects
prepared the ground for the emergence of manufacturing,
and it was an important—and perhaps underappreciated—
force in our nation’s industrialization. By the mid-nineteenth
century, the United States had the highest rate of school
enrollment of any nation, and its curriculum and egalitarianism
became a model that other nations would follow.

the nation. Our geography, combined with a frontier
spirit, worked to the region’s advantage at a time when
new technologies enabled industrial mass production
and transportation. Although these advantages initially
started the ball rolling, they have not proved to be a
continual source of economic prosperity. While our
region’s relative share of the national population peaked
in the early 1960s, its relative productivity growth peaked
some 30 years earlier, and the seeds of that gradual
decline may have been sowed in the 1920s, when our
region’s network of innovators became “industrycentric,”
focusing on technologies that served a particular industrial need rather than general technology that would
spawn new businesses.18

Figure 5: Population and Productivity in Northeast Ohio
U.S. Educational Achievement since 1910

1.3

1.25

1.2

1.20

1.1

1.15

1.0

1.10

0.9

1.05

0.8

1.00

0.7

0.95

0.6

0.90

70
60

Percent

Percent of adult population

80

50
40
30
20
10
0
1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

0.5
1879

0.85

1899

1919

1939

Share of U.S. population (percent)
High school diploma
or some college

At least four
years of college

Source: U.S. Department of Education, National Center for Education Statistics,
Digest of Education Statistics, 2002.

1959

1979

1999

a

Relative productivity (ratio, U.S.=1)

Northeast Ohio, traditionally known for durable goods manufacturing, peaked as a share
of the national population in the early 1960s. But the seeds of that decline may have
begun considerably earlier: According to one estimate, the region’s relative productivity
may have peaked just before World War II.
a. Value added per production worker, relative to U.S. average.
Source: Fogarty, Garofalo, and Hammack (2002).
18 See Forgarty, Garofalo, and Hammack (2002).

Ratio, U.S.=1

90

Federal Reserve Bank of Cleveland

18

The key to maintaining a region’s economic vibrancy,

high-ability individuals—those with the capacity to

like that of a nation, is to be found in its ability to

apply the technology most effectively. These workers

sustain a community of innovators. Although there is

migrate to sectors of the economy that offer the greatest

no foolproof cookbook to follow, modern growth theory

potential for advancing the technology, and the growing

nevertheless suggests some appealing recipes. Some

concentration of workers creates an environment of

of the qualities that may help an economy to nurture

continuous innovation—that is, the intellectual synergy

innovation are a commitment to the rule of law, stable

necessary for even more growth-sustaining innovation.19

government and economic institutions, openness to

The American melting pot, our great social and ethnic

trade, and a willingness to integrate our economy with

diversity, is not only about adding more mouths to a

an expanding international marketplace. To these we

fixed stock of resources, as it has been portrayed since

add the following ingredients.

Thomas Malthus, but may itself contribute to our fertile
ground for innovation. With such diversity in people

Diversity

and cultures, we cannot help but see old problems in

We must think about the elements that make the ground

new ways.

fertile for new ideas—or perhaps more accurately, for
new idea makers. Many economists believe communities
of innovators are attracted as much as they are bred.
The process goes something like this: A major techno-

In a similar spirit, Richard Florida (2002) of Carnegie
Mellon University suggests that communities need to
create an environment that is attractive to what he calls
the “creative class,” which may include scientists and

logical breakthrough creates a wage premium for

artists, lawyers and musicians, teachers and poets—

Percent of population

any group of people whose product is ideas. Certainly,

Figure 6: Immigrants in America

lifestyle amenities are important to attracting a commu-

16

nity of innovators. But perhaps even more important is a

14

community’s openness to new ideas and different per-

12

spectives. Whereas in the current language of regional
economic development, the term “brain drain” refers to

10

the migration of younger, highly educated residents to

8

other communities, “innovation drain” characterizes the

6

loss of creative people whose ideas are the engine of

4

economic growth.

2

Ending the Manufacturing versus Services Debate

0
1850

1900

Africa, Oceania,
and other North American

Latin
America

1960

Asia

2000

Europe

America has seen a resurgence of immigrants in the workforce, especially during the
1990s, when foreign-born workers made up nearly half of the net increase in the U.S.
labor force. In 2000, just over 10 percent of the U.S. population was foreign born,
almost twice its 1960 level. Moreover, the geographic origins of immigrants have
shifted considerably, with Asian and Latin America immigrants replacing people of
European origin as the predominant share of our foreign-born population.

What Adam Smith tried to teach us in The Wealth of
Nations is that economic strength does not lie in what
a nation produces, but how effectively it’s produced.
Our present attachment to the industrial economy, from
which many presume our national wealth flows, closely
parallels our attachment to farming during the first half

Source: Mosisa (2002).
19 These “agglomeration effects” can be traced to the work of Cambridge economist
Alfred Marshall (1920).

2003

Annual Report

19

of the last century. In that world, as we may have

Education, Government, and Institutions

forgotten, most presumed wealth came from the ground.

Are there any policies that can help to facilitate

Manufacturers, the proponents of agriculture claimed,

innovation? At the top of virtually every economist’s

were merely the benefactors of agricultural wealth, not

list is education. During the last century—what Claudia

the creators of it. Without farming and mining and

Goldin (2002) calls the “human capital century”—the

forestry, there would be nothing to manufacture! This

United States led the world in raising the educational

idea was powerfully expressed during the last industrial

level of its citizens. The virtues of the U.S. mass educa-

revolution by the great Populist orator, William Jennings

tional system, that “it was publicly funded, managed by

Bryan. Speaking at the Democratic Convention of 1896,

numerous small, fiscally independent districts, open

Bryan thundered:

and forgiving, academic yet practical in its curriculum,

[T]he great cities rest upon our broad and fertile
prairies. Burn down your cities and leave our farms,
and your cities will spring up again as if by magic; but
destroy our farms and the grass will grow in the streets
of every city in the country.
This idea is simple and intuitive—and we now know it
is wrong. Seventy years ago, 26 percent of our nation
worked on farms—about 10 percentage points higher
than the number currently working in U.S. manufacturing. Within 30 years, that share had fallen to just below
7 percent of all jobs, and 30 years after that, agricultural
workers represented only about 2 1/2 percent of all jobs.
Indeed, the rise of U.S. manufacturing was driven, in
part, by the continual, unrelenting pressure of the
marketplace to make our food better and cheaper.
Today, we hear the same story turned on its head:
Manufacturing, some say, is the origin of wealth. The
service economy, for all its fanfare, is little more than
one hand scratching the other, and wouldn’t be possible
without the wealth generated by industry. Of course, the
importance of manufacturing employment is waning—
that has been a persistent and defining characteristic of
the manufacturing economy since 1960. But manufacturing and service output have been expanding, with
each sector depending on the other in ways that are
changing over time. It is not one versus the other, but

secular in control, and gender-neutral in its admission…
increased social mobility and enhanced economic
growth.”20 The success of a country’s educational
system is still a critical determinant of how quickly
and effectively workers can assimilate new, growthenhancing technologies.21
But education by itself may not be enough if a nation
inhibits its citizens’ incentives to gain from their
educational capital. In 1999, economists Robert Hall
and Charles Jones investigated why some nations create
prosperity so much more successfully than others. The
authors concluded that it is a consequence of “social
infrastructure,” the incentives that a nation’s institutions
and government policies provide, which take the form of
the protection of property rights, the embrace of trade,
and capital and labor flexibility.
In other words, having a comparative advantage in ideas
requires a highly educated workforce—but knowing this
is not a sufficient condition for achieving it. Policymakers
must carefully evaluate the public returns to a variety of
competing investments that may include roads, sports
complexes, industrial site development, business
location incentives, and education. Sound public policy
justifies reallocating funds to high-return activities, as
well as experimenting with different ways of delivering
services if traditional organizational structures do not

one and the other that leads to greater prosperity.

20 Goldin (2002).
21 Benhabib and Spiegel (1994) model and estimate these effects across countries.

Federal Reserve Bank of Cleveland

20

yield the desired outcomes. States spend resources to

conducive to innovation and change. To do so requires

attract businesses from “them” to “us,” an activity that,

that we lengthen the horizon over which we hope to

overall, does little good for society. What if more of

effect change. Nations, regions, and cities can live for

these resources were devoted to building human capital?

quite some time off their past successes, addressing
what they perceive to be their immediate needs. They

Nobel laureate James Heckman (2003) argues that

can protect their established industries, they can dis-

education generally delivers the greatest returns to public

courage newcomers, and they can squabble over how

investment, and that social returns to early childhood

to divide what assets they still have. In the meantime,

development yield the highest returns of all. But money

innovation will migrate to a more accepting environment

alone is not always the answer: Public funds for K–12

and take root—disruptions and all.

education have increased considerably during the past
several decades, but educational outcomes have hardly

Change comes hard, and change takes time, but cumula-

22

changed. Innovation and the willingness to try new

tive change raises living standards in the only way it

methods might yield better results.

can, step by step. It is easy for citizens to resist change,
but harder for their children and grandchildren to live

The Long Run May Be Closer than We Think

At the turn of the nineteenth century, the United States
was one of a select group of nations that were able to
distance themselves from the subsistence threshold
that characterized many of the world’s economies.
Membership in that elite group has not been exclusive,
as some nations that were slow to prosper are now
finally doing so. And of course, membership among the
world’s most economically elite nations is not necessarily
permanent—some nations that were once prosperous
are no longer so.23
One of the most important policy implications of the
new theory of endogenous growth is that we must think
more holistically about our economic environment. That
is, we must think not in terms of specific industries or
projects, but in terms of whether the economic climate is
22 See Hanushek (2002).
23 See Dowrick and DeLong (2003).

if they raise living standards by only 1/2 percentage point
each year, will raise prosperity by 25 percent within
44 years, roughly the working life of the average person.
Small gains can offer such great long-run rewards.

Figure 7: Relative Economic Prosperity
3.4

Per capita GDP, relative to world average
(international dollars, world average=1)

Productivity in the United States has increased generation after generation, creating ever-rising standards
of living. Our knowledge-based skills in a business
environment…have enabled our workforce to create
ever-greater value added—irrespective of what goods
and services we have chosen to produce at home and
what and how much we have chosen to import.
—Alan Greenspan, Federal Reserve Chairman, 2004

with the consequences. Policies put in place today, even

1.50
1.25
1.00
0.75
0.50
0.25
0
E. Europe

Former
Latin
Soviet Union America
1913

1950

Japan

China

Africa

2001

While some of the world's economies have advanced far beyond the average,
membership in this group is not exclusive or permanent. Former Soviet countries
and Latin America enjoyed a relatively high standard of living in the middle half
of the last century, but have since seen that advantage decline. Japan, on the
other hand, has greatly elevated itself relative to the average in the latter half of
the century, while China has recently begun to improve its economic standing.
Source: Maddison (2003).

2003

Annual Report

21
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Benhabib, Jess, and Mark M. Spiegel. 1994. “The Role of Human Capital
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Maddison, Angus. 2001. The World Economy: A Millennial Perspective.
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Bernanke, Ben S. 2004. “The Great Moderation.” Remarks at the meetings
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Bertocchi, Graziella, and Michael Spagat. 2001. “The Evolution of Modern
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Dowrick, Steven, and J. Bradford DeLong. 2003. “Globalization and
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Florida, Richard. 2002. The Rise of the Creative Class: And How It's
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Greenspan, Alan. 2004. “The Critical Role of Education in the Nation’s
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2003

Annual Report

23

Operational Highlights

A

s the nation’s central bank, the Federal Reserve’s

chief objectives are to promote sustained, long-term economic
growth and to foster a sound and efficient financial system.
This charge is particularly salient today, as our payments
system undergoes significant change: Market demands and
new technologies are spurring the rapid development of new
electronic delivery channels. As a result, the Federal Reserve
is making investments in research and technology to both
modernize paper payments and ensure the stability and
effectiveness of electronic payments.
The U.S. payments system has witnessed a surge of innovation in
recent years—and a great deal of that innovation is occurring right
here in the Fourth Federal Reserve District. The Federal Reserve Bank
of Cleveland, which has long been known for its hard work, creativity,
and ability to get the job done, is partnering with the U.S. Treasury,
industry groups, and financial institutions on projects throughout the
Federal Reserve System that are helping to improve the infrastructure
of our payments system and bringing electronic payments to market.

Federal Reserve Bank of Cleveland

24

Modernizing the Check Factory
Although paper checks may be on the decline, they’re
certainly not a thing of the past. Consumers continue
to favor checks because they are convenient, familiar,
universally accepted, and offer simple record keeping.
According to the most recent Federal Reserve estimates,
roughly 40 billion checks—60 percent of all noncash
payments—are still written in the United States
each year.
But the work of processing checks is costly and labor
intensive. For that reason, the Federal Reserve has
sought out ways to improve the efficiency of its check
operations—to modernize its factory, so to speak.
In 2003, the Federal Reserve completed its four-year
Check Modernization initiative, which overhauled the
systems and infrastructure for processing checks. The
Cleveland Bank’s Retail Payments Office, working in
partnership with the Federal Reserve Bank of Atlanta,
led the development and implementation of this
ambitious project, which was completed on time
and within budget.
Check Modernization has standardized check processing
across Federal Reserve offices nationwide, implemented
common software for processing and researching check
adjustments, delivered Web-based services to financial
institutions, and created a national archive and retrieval
system for check images. The Cleveland Office is home
to one of two national check image archive sites, where
the Bank stores approximately 250 million images every
month for financial institutions across the country.
In addition to the operational efficiencies and flexibility
afforded by Check Modernization, the improvements
will allow the Fed to develop and roll out new products
more quickly and cost-effectively.

Responding to a Changing
Market for Check Services
While the Check Modernization initiative has dramatically
improved the Fed’s infrastructure for check payment processing
and the quality of service it provides to depository institutions,
market forces cannot be ignored: The use of checks is
declining, and that has had a significant impact on Federal
Reserve operations. For this reason, the Federal Reserve
System announced in early 2003 that it would reduce the
number of check processing locations nationwide from
45 to 32. Additionally, the System will reduce the number
of sites that perform check adjustments to 12 regional
locations. The move will allow the Fed to continue providing
high-quality check services while maintaining efficient,
cost-effective operations.
What does this mean for the Fourth Federal Reserve
District? In late 2003, the Cleveland Office took on the check
processing volume of its Pittsburgh branch, which no longer
performs check activities. Throughout 2004, the Bank’s check
operations in Cincinnati will absorb the work of three check
offices in Indianapolis, Louisville, and Charleston, making
it one of the largest check processing sites in the System. In
addition, the Cleveland Office will take on check adjustments
from five offices in our District and others.
As we make these changes, financial institutions can be
assured that the Federal Reserve Bank of Cleveland will
continue its tradition of high-quality check services and
superior customer service.

2003

Annual Report

25

Clearing the Way

More and more consumers are choosing to pay bills

The nation’s check collection system is also getting

online because of the convenience, cost savings, and

a boost from a law enacted in late 2003, the Check

improved security of internet payments. It makes

Clearing for the 21st Century Act—“Check 21” for

sense, then, for companies to take advantage of the

short. The legislation, which will become effective

same benefits by actually presenting bills electronically

in October 2004, promises to foster innovation and

and eliminating the paper bills that consumers receive

efficiency in the payments system by reducing some

each month.

of the impediments to check truncation.

In 2003, the Cleveland Fed continued to champion

Under the new law, financial institutions will be able

the Electronic Billing Information Delivery System

to collect and return checks by using digital images

(EBIDS), which aims to deliver summary electronic

and electronic check information to create substitute

bills to consumers through their financial institutions

paper checks that will be the legal equivalent of the

using the Fed’s ACH network. The Cleveland Bank

original check.

is taking a leadership role in moving the EBIDS

For banks, Check 21 will mean greater efficiency,
lower check handling and transportation costs, and
the ability to broaden deposit options for customers.
Plus, financial institutions will be able to take full
advantage of electronic check collection and return
capabilities, giving customers an attractive alternative
to the current paper-based system.

concept into a national pilot program, working in
partnership with NACHA (the rules-making body
for ACH payments), industry groups, financial
institutions, and private companies. EBIDS is expected
to complement banks’ existing online banking and
ACH applications by delivering bill content and
supporting the adoption of electronic payments.

The Cleveland Fed, working on behalf of the System’s
Retail Payments Office, is once again taking a leadership

The Retail Payments Mix

role by preparing for the requirements of Check 21,
designing a new suite of products and services, and
overseeing the project’s implementation.

8%
Transforming Electronic Payments
Even as the Federal Reserve works to make traditional
paper payments as efficient as possible, it’s clear that

21%

electronic payments are driving today’s financial services:

59%

Electronic payments have increased nearly fivefold over
the past two decades. That’s why we’re putting as much
brain power into the future of electronic payments as

12%

we are improving existing paper payments. The Fed—
and the Cleveland Reserve Bank in particular—is at
the center of several exciting initiatives that are paving
the way for new payment vehicles.

Check
Debit card
Credit card
ACH

Federal Reserve Bank of Cleveland

26

By eliminating the cost and hassle of paperwork, EBIDS

parts of that goal are ensuring the efficient operation of

promises to be a win–win solution for everyone involved.

the current savings bond and TreasuryDirect businesses,

Consumers can receive and pay more of their bills at a

and the transition to an electronic environment for

single banking site, and they can easily control the

government transactions with the public.

timing and amount of payment. Financial institutions

The Federal Reserve Bank of Cleveland has long operated

retain their primary role as payments providers, and

the largest, most efficient, and most innovative site

gain added support for their existing internet banking

for processing savings bonds on behalf of the Treasury’s

business. Finally, billers benefit from the reduced costs
of processing bills and remittances. Although the EBIDS
pilot will focus on consumer bill presentment, industry
groups expect the service to have significant businessto-business applications in the future.

Bureau of Public Debt. In late 2003, the Treasury
announced it would reduce the number of Federal
Reserve sites providing Treasury retail securities services
from nine to two. The Cleveland Fed’s Pittsburgh Office
was chosen to be one of only two Reserve Banks
doing this work. The multiyear transition—which

Helping Government Work Better

the Cleveland Bank is leading on the System’s behalf—

One of the Fed’s chief responsibilities is to act as

will require the Pittsburgh Office to reestablish its

the fiscal agent for the U.S. government. Like most

TreasuryDirect functions and expand its savings

organizations, the U.S. Treasury Department has set

bond operation.

ambitious goals to reduce its costs and improve the
efficiency of government financial operations. Two key

Electronic Billing Information Delivery Service
Consumer views bill and pays using internet banking service

Consumer

Biller
Payment
(ACH credit)

Payment
(ACH credit)

Summary bill

Summary bill
ACH
Biller‘s bank

Consumer‘s bank

2003

Annual Report

27

The Treasury’s decision was based on its long-term

federal agencies sponsored by the Financial Management

goal to move to an electronic processing environment—

Service. In 2003, use of Pay.gov continued to rise: By

with the new Web-based TreasuryDirect system at the

year-end, it supported 17 federal agencies and processed

center. This new system represents a different way of

nearly half a million transactions (totaling $3.8 billion),

doing business for the Bureau of Public Debt: It allows

an increase of nearly 200 percent over 2002.

investors to purchase savings bonds (and eventually
marketable securities) online and hold them as bookentry securities. The system is expected to decrease the
number of paper transactions processed and provide
greater convenience and flexibility for investors.

In addition to its work on Pay.gov, the Cleveland Reserve
Bank has partnered with the Treasury’s Financial
Management Service to develop and implement a second
electronic payments initiative, Paper Check Conversion.
The service, known as PCC, converts paper checks

When you think of your interactions with government

presented at the point of sale at government and military

agencies, “convenient” and “efficient” may not be the

locations worldwide into electronic debits. It is an inno-

words that immediately come to mind. But thanks in

vative, highly automated system that improves the

part to the Government Paperwork Elimination Act—

collection, reconciliation, and reporting processes for

a federal law that requires agencies to accept forms

federal agencies.

electronically—that’s beginning to change. That act
is one component of a governmentwide move to
“electronify” services.

PCC is deployed at military bases overseas and at
government agencies in the United States. In 2003,
Federal Reserve staff responded to the Treasury’s request

For several years, the Federal Reserve Bank of

for rapid deployment at several military bases in the

Cleveland has worked closely with the Treasury’s

Middle East during the months preceding the war in

Financial Management Service, which is responsible

Iraq—an effort recognized by both the Assistant Secretary

for government payments and collections, to help

of the Army and the Assistant Secretary of the Treasury.

reengineer the government’s collections process. One

By the end of 2003, Paper Check Conversion supported

result, Pay.gov, gives individuals and corporations a fast,

40 agencies at 170 locations around the world,

safe, and convenient way to complete and submit forms

processing more than 740,000 transactions totaling

to government agencies and make payments online.

$391 million.

For example, the Federal Trade Commission uses
Pay.gov to collect fees from telemarketers who purchase

Where To?

the national Do Not Call list, and the National Park

The pace of change and innovation in financial services

Service uses the system to process camping permits and

isn’t likely to slow down any time soon—and that’s a

collect fees.

good thing. The innovation that’s taking place in our

The Pay.gov project is a model for how the Fed works

industry today means growth and prosperity tomorrow.

collaboratively to foster innovation and efficiency in the

By embracing change and remaining open to the possi-

payments system: Over the course of several years, the

bilities that technology is bringing us, we all benefit.

Cleveland Bank has partnered with the Treasury, on

Although our environment may be uncertain, one thing

whose behalf it works, and with more than a dozen

is for sure: The Federal Reserve remains committed to
ensuring the safety, soundness, and efficiency of the
nation’s payments system today and in the future.

The firm engaged by the Board of Governors for the audits of the individual and combined financial
statements of the Reserve Banks for 2003 was PricewaterhouseCoopers LLP (PwC). Fees for these
services totaled $1.4 million. To ensure auditor independence, the Board of Governors requires that
PwC be independent in all matters relating to the audit. Specifically, PwC 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. In 2003, the Bank did not engage PwC for advisory services.

Annual Report

2003

29
Management’s Report on Responsibility for Financial Reporting
March 8, 2004

To the Board of Directors of the Federal Reserve Bank of Cleveland:

The management of the Federal Reserve Bank of Cleveland (“Bank”) is responsible for the preparation and
fair presentation of the Statement of Financial Condition, Statement of Income, and Statement of Changes
in Capital as of December 31, 2003 (“Financial Statements” ). The Financial Statements have been prepared
in conformity with the accounting principles, policies, and practices established by the Board of Governors
of the Federal Reserve System and as set forth in the Financial Accounting Manual for the Federal Reserve
Banks (“Manual”), and as such, include amounts, some of which are based on judgments and estimates of
management. To our knowledge, the Financial Statements are, in all material respects, fairly presented in
conformity with the accounting principles, policies and practices documented in the Manual and include all
disclosures necessary for such fair presentation.
The management of the Bank is responsible for maintaining an effective process of internal controls over
financial reporting including the safeguarding of assets as they relate to the Financial Statements. Such internal
controls are designed to provide reasonable assurance to management and to the Board of Directors regarding
the preparation of reliable Financial Statements. This process of internal controls contains self-monitoring
mechanisms including, but not limited to, divisions of responsibility and a code of conduct. Once identified,
any material deficiencies in the process of internal controls are reported to management and appropriate
corrective measures are implemented.
Even an effective process of internal controls, no matter how well designed, has inherent limitations,
including the possibility of human error, and therefore can provide only reasonable assurance with respect
to the preparation of reliable financial statements.
The management of the Bank assessed its process of internal controls over financial reporting including the
safeguarding of assets reflected in the Financial Statements, based upon the criteria established in the
“Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on this assessment, we believe that the Bank maintained an effective
process of internal controls over financial reporting including the safeguarding of assets as they relate to
the Financial Statements.

President
and Chief Executive Officer
Federal Reserve Bank of Cleveland

First Vice President
and Chief Operating Officer
Federal Reserve Bank of Cleveland

Senior Vice President
and Chief Financial Officer
Federal Reserve Bank of Cleveland

Federal Reserve Bank of Cleveland

30
Report of Independent Accountants on Financial Reporting
PricewaterhouseCoopers LLP

To the Board of Directors of the Federal Reserve Bank of Cleveland:
We have examined management’s assertion, included in the accompanying Management Assertion, that the
Federal Reserve Bank of Cleveland (“FRB Cleveland”) maintained effective internal control over financial
reporting and the safeguarding of assets as they relate to the financial statements as of December 31, 2003,
based on criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. FRB Cleveland’s management is responsible for
maintaining effective internal control over financial reporting and safeguarding of assets as they relate to
the financial statements. Our responsibility is to express an opinion on management’s assertion based on
our examination.
Our examination was conducted in accordance with attestation standards established by the American Institute
of Certified Public Accountants and, accordingly, included obtaining an understanding of internal control over
financial reporting, testing and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the circumstances. We believe that our
examination provides a reasonable basis for our opinion.
Because of inherent limitations in any internal control, misstatements due to error or fraud may occur and not
be detected. Also, projections of any evaluation of internal control over financial reporting to future periods are
subject to the risk that the internal control may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assertion that FRB Cleveland maintained effective internal control over financial
reporting and over the safeguarding of assets as they relate to the financial statements as of December 31, 2003
is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
This report is intended solely for the information and use of management and the Board of Directors and Audit
Committee of FRB Cleveland and any organization with legally defined oversight responsibilities and is not
intended to be and should not be used by anyone other than these specified parties.

March 1, 2004

2003

Annual Report

31
Report of Independent Accountants on Financial Statements
PricewaterhouseCoopers LLP

To the Board of Governors of the Federal Reserve System and
the Board of Directors of the Federal Reserve Bank of Cleveland:
We have audited the accompanying statements of condition of the Federal Reserve Bank of Cleveland
(the “Bank”) as of December 31, 2003 and 2002, and the related statements of income and changes in capital
for the years then ended, which have been prepared in conformity with the accounting principles, policies, and
practices established by the Board of Governors of the Federal Reserve System. These financial statements are
the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 3, these financial statements were prepared in conformity with the accounting principles,
policies, and practices established by the Board of Governors of the Federal Reserve System. These principles,
policies, and practices, which were designed to meet the specialized accounting and reporting needs of the
Federal Reserve System, are set forth in the Financial Accounting Manual for Federal Reserve Banks and
constitute a comprehensive basis of accounting other than accounting principles generally accepted in the
United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial
position of the Bank as of December 31, 2003 and 2002, and results of its operations for the years then ended,
on the basis of accounting described in Note 3.

March 1, 2004

Federal Reserve Bank of Cleveland

32
Comparative Financial Statements

S TAT E M E N T S O F C O N D I T I O N
(in millions)

As of December 31, 2003

As of December 31, 2002

ASSETS
Gold certificates

$

Special drawing rights certificates
Coin
Items in process of collection

477

$

522

104

104

33

43

595

764

31,655

35,264

1,665

1,531

Accrued interest receivable

237

301

Bank premises and equipment, net

180

182

69

64

U.S. government and federal agency securities, net
Investments denominated in foreign currencies

Other assets
Total assets

$

35,015

$

38,775

$

28,375

$

28,170

LIABILITIES AND CAPITAL
Liabilities:
Federal Reserve notes outstanding, net
Securities sold under agreements to repurchase

1,202

1,164

1,260

1,393

4

4

521

685

Deposits:
Depository institutions
Other deposits
Deferred credit items
Interest on Federal Reserve notes due U.S. Treasury

24

71

2,103

5,818

Accrued benefit costs

61

58

Other liabilities

11

8

Interdistrict settlement account

Total liabilities

$

33,561

$

37,371

Capital:
Capital paid-in

727

702

Surplus

727

702

Total capital
Total liabilities and capital
The accompanying notes are an integral part of these financial statements.

1,454
$

35,015

1,404
$

38,775

Annual Report

2003

33
S TAT E M E N T S O F I N C O M E
For the year ended
December 31, 2003

(in millions)

For the year ended
December 31, 2002

Interest income:
Interest on U.S. government and federal agency securities

$

1,097

Interest on investments denominated in foreign currencies

$

1,410

22

24

1,119

1,434

11

1

1,108

1,433

Income from services

56

66

Reimbursable services to government agencies

32

26

227

194

—

4

4

4

Total interest income
Interest expense:
Interest expense on securities sold under agreements to repurchase
Net interest income
Other operating income:

Foreign currency gains, net
U.S. government securities gains, net
Other income
Total other operating income

$

319

$

294

Operating expenses:
Salaries and other benefits

93

86

Occupancy expense

13

11

Equipment expense

13

13

Assessments by Board of Governors

52

40

Other expenses

49

46

220

196

Total operating expenses
Net income prior to distribution

$

1,207

$

1,531

$

42

$

42

Distribution of net income:
Dividends paid to member banks
Transferred to surplus
Payments to U.S. Treasury as interest on Federal Reserve notes
Total distribution

$

25

37

1,140

1,452

1,207

$

1,531

S TAT E M E N T S O F C H A N G E S I N CA P I TA L (in millions)
For the years ended December 31, 2003 and December 31, 2002
Capital
Paid-in
Balance at January 1, 2002 (13.3 million shares)

$

665

Total
Capital

Surplus
$

665

$

1,330

Net income transferred to surplus

—

37

37

Net change in capital stock issued (0.7 million shares)

37

—

37

Balance at December 31, 2002 (14 million shares)

$

Net income transferred to surplus

$

—

Net change in capital stock issued (0.5 million shares)
Balance at December 31, 2003 (14.5 million shares)

702

The accompanying notes are an integral part of these financial statements.

727

$

25

25
$

702

25

—
$

727

1,404
25

$

1,454

Federal Reserve Bank of Cleveland

34
Notes to Financial Statements
1. STRUCTURE
The Federal Reserve Bank of Cleveland (“Bank”) is part of the Federal
Reserve System (“System”) created by Congress under the Federal
Reserve Act of 1913 (“Federal Reserve Act”) which established the
central bank of the United States. The System consists of the Board of
Governors of the Federal Reserve System (“Board of Governors”) and
twelve Federal Reserve Banks (“Reserve Banks”). The Reserve Banks
are chartered by the federal government and possess a unique set of
governmental, corporate, and central bank characteristics. The Bank
and its branches in Cincinnati and Pittsburgh serve the Fourth Federal
Reserve District, which includes Ohio and portions of Kentucky,
Pennsylvania, and West Virginia. Other major elements of the System
are the Federal Open Market Committee (“FOMC”) and the Federal
Advisory Council. The FOMC is composed of members of the Board
of Governors, the president of the Federal Reserve Bank of New York
(“FRBNY”) and, on a rotating basis, four other Reserve Bank presidents.
Banks that are members of the System include all national banks and
any state-chartered bank that applies and is approved for membership
in the System.
B OARD OF DIRECTORS
In accordance with the Federal Reserve Act, supervision and control
of the Bank are exercised by a Board of Directors. The Federal Reserve
Act specifies the composition of the Board of Directors for each of the
Reserve Banks. Each board is composed of nine members serving
three-year terms: three directors, including those designated as Chairman
and Deputy Chairman, are appointed by the Board of Governors, and
six directors are elected by member banks. Of the six elected by member
banks, three represent the public and three represent member banks.
Member banks are divided into three classes according to size. Member
banks in each class elect one director representing member banks and
one representing the public. In any election of directors, each member
bank receives one vote, regardless of the number of shares of Reserve
Bank stock it holds.
2. OPERATIONS AND SERVICES
The System performs a variety of services and operations. Functions
include: formulating and conducting monetary policy; participating
actively in the payments mechanism, including large-dollar transfers
of funds, automated clearinghouse (“ACH”) operations and check
processing; distributing coin and currency; performing fiscal agency
functions for the U.S. Treasury and certain federal agencies; serving as
the federal government’s bank; providing short-term loans to depository
institutions; serving the consumer and the community by providing
educational materials and information regarding consumer laws;
supervising bank holding companies and state member banks; and
administering other regulations of the Board of Governors. The Board
of Governors’ operating costs are funded through assessments on
the Reserve Banks.
In performing fiscal agency functions for the U.S. Treasury, the Bank
provides U.S. securities direct purchase and savings bonds processing
services. In December 2003, the U.S. Treasury selected the Bank as one
of two future consolidation sites for these services. An implementation
plan is expected to be announced in March 2004. At this time, the
Bank has not developed a detailed estimate of the financial effect of
the consolidation.

The FOMC establishes policy regarding open market operations,
oversees these operations, and issues authorizations and directives to
the FRBNY for its execution of transactions. Authorized transaction
types include direct purchase and sale of securities, matched salepurchase transactions, the purchase of securities under agreements to
resell, the sale of securities under agreements to repurchase, and the
lending of U.S. government securities. The FRBNY is also authorized
by the FOMC to hold balances of, and to execute spot and forward
foreign exchange (“F/X”) and securities contracts in nine foreign
currencies, maintain reciprocal currency arrangements (“F/X swaps”)
with various central banks, and “warehouse” foreign currencies for the
U.S. Treasury and Exchange Stabilization Fund (“ESF”) through the
Reserve Banks.
3. SIGNIFICANT ACCOUNTING POLICIES
Accounting principles for entities with the unique powers and responsibilities of the nation’s central bank have not been formulated by the
Financial Accounting Standards Board. The Board of Governors has
developed specialized accounting principles and practices that it believes
are appropriate for the significantly different nature and function of a
central bank as compared with the private sector. These accounting
principles and practices are documented in the Financial Accounting
Manual for Federal Reserve Banks (“Financial Accounting Manual”),
which is issued by the Board of Governors. All Reserve Banks are
required to adopt and apply accounting policies and practices that
are consistent with the Financial Accounting Manual.
The financial statements have been prepared in accordance with the
Financial Accounting Manual. Differences exist between the accounting
principles and practices of the System and accounting principles generally
accepted in the United States of America (“GAAP”). The primary
differences are the presentation of all security holdings at amortized
cost, rather than at the fair value presentation requirements of GAAP,
and the accounting for matched sale-purchase transactions as separate
sales and purchases, rather than secured borrowings with pledged
collateral, as is generally required by GAAP. In addition, the Bank has
elected not to present a Statement of Cash Flows. The Statement of
Cash Flows has not been included because the liquidity and cash position
of the Bank are not of primary concern to the users of these financial
statements. Other information regarding the Bank’s activities is provided
in, or may be derived from, the Statements of Condition, Income, and
Changes in Capital. A Statement of Cash Flows, therefore, would not
provide any additional useful information. There are no other significant
differences between the policies outlined in the Financial Accounting
Manual and GAAP.
Each Reserve Bank provides services on behalf of the System for which
costs are not shared. Major services provided on behalf of the System by
the Bank, for which the costs were not redistributed to the other Reserve
Banks, include: Retail Payments Office, Check Standardization Project,
National Check Restructure, FedImage, Cash Automation and Materials
Handling Software, Savings Bonds, including software and architecture,
National Billing Operations, National Information Center, Audit
Application Competency Center, and Electronic Access Products,
including Pay.Gov, Paper Check and Check to ACH conversions.

2003

Annual Report

35

The preparation of the financial statements in conformity with the
Financial Accounting Manual requires management to make certain
estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of income and
expenses during the reporting period. Actual results could differ from
those estimates. Unique accounts and significant accounting policies
are explained below.
a. GOLD CERTIFICATES
The Secretary of the Treasury is authorized to issue gold certificates
to the Reserve Banks to monetize gold held by the U.S. Treasury.
Payment for the gold certificates by the Reserve Banks is made by
crediting equivalent amounts in dollars into the account established
for the U.S. Treasury. These gold certificates held by the Reserve
Banks are required to be backed by the gold of the U.S. Treasury.
The U.S. Treasury may reacquire the gold certificates at any time and
the Reserve Banks must deliver them to the U.S. Treasury. At such
time, the U.S. Treasury’s account is charged, and the Reserve Banks’
gold certificate accounts are lowered. The value of gold for purposes
of backing the gold certificates is set by law at $42 2/9 a fine troy
ounce. The Board of Governors allocates the gold certificates among
Reserve Banks once a year based on average Federal Reserve notes
outstanding in each District.
b. SPECIAL DRAWING RIGHTS CERTIFICATES
Special drawing rights (“SDRs”) are issued by the International
Monetary Fund (“Fund”) to its members in proportion to each
member’s quota in the Fund at the time of issuance. SDRs serve as a
supplement to international monetary reserves and may be transferred
from one national monetary authority to another. Under the law
providing for United States participation in the SDR system, the
Secretary of the U.S. Treasury is authorized to issue SDR certificates,
somewhat like gold certificates, to the Reserve Banks. At such time,
equivalent amounts in dollars are credited to the account established
for the U.S. Treasury, and the Reserve Banks’ SDR certificate accounts
are increased. The Reserve Banks are required to purchase SDR
certificates, at the direction of the U.S. Treasury, for the purpose of
financing SDR acquisitions or for financing exchange stabilization
operations. At the time SDR transactions occur, the Board of
Governors allocates SDR certificate transactions among Reserve
Banks based upon Federal Reserve notes outstanding in each District
at the end of the preceding year. There were no SDR transactions in
2003 or 2002.
c. LOANS TO DEPOSITORY INSTITUTIONS
The Depository Institutions Deregulation and Monetary Control
Act of 1980 provides that all depository institutions that maintain
reservable transaction accounts or nonpersonal time deposits, as
defined in Regulation D issued by the Board of Governors, have
borrowing privileges at the discretion of the Reserve Banks. Borrowers
execute certain lending agreements and deposit sufficient collateral
before credit is extended. Loans are evaluated for collectibility. If loans
were ever deemed to be uncollectible, an appropriate reserve would
be established. Interest is accrued using the applicable discount rate
established at least every fourteen days by the Boards of Directors
of the Reserve Banks, subject to review by the Board of Governors.
There were no outstanding loans to depository institutions at
December 31, 2003 and 2002, respectively.

d. U.S. GOVERNMENT AND FEDERAL
AGENCY SECURITIES AND INVESTMENTS
DENOMINATED IN FOREIGN CURRENCIES
The FOMC has designated the FRBNY to execute open market
transactions on its behalf and to hold the resulting securities in the
portfolio known as the System Open Market Account (“SOMA”).
In addition to authorizing and directing operations in the domestic
securities market, the FOMC authorizes and directs the FRBNY to
execute operations in foreign markets for major currencies in order to
counter disorderly conditions in exchange markets or to meet other
needs specified by the FOMC in carrying out the System’s central
bank responsibilities. Such authorizations are reviewed and approved
annually by the FOMC.
In December 2002, the FRBNY replaced matched sale-purchase
(“MSP”) transactions with securities sold under agreements to
repurchase. MSP transactions, accounted for as separate sale and
purchase transactions, are transactions in which the FRBNY sells a
security and buys it back at the rate specified at the commencement
of the transaction. Securities sold under agreements to repurchase are
treated as secured borrowing transactions with the associated interest
expense recognized over the life of the transaction.
The FRBNY has sole authorization by the FOMC to lend U.S.
government securities held in the SOMA to U.S. government securities
dealers and to banks participating in U.S. government securities
clearing arrangements on behalf of the System, in order to facilitate
the effective functioning of the domestic securities market. These
securities-lending transactions are fully collateralized by other U.S.
government securities. FOMC policy requires the FRBNY to take
possession of collateral in excess of the market values of the securities
loaned. The market values of the collateral and the securities loaned
are monitored by the FRBNY on a daily basis, with additional
collateral obtained as necessary. The securities loaned continue to
be accounted for in the SOMA.
F/X contracts are contractual agreements between two parties to
exchange specified currencies, at a specified price, on a specified
date. Spot foreign contracts normally settle two days after the trade
date, whereas the settlement date on forward contracts is negotiated
between the contracting parties, but will extend beyond two days from
the trade date. The FRBNY generally enters into spot contracts, with
any forward contracts generally limited to the second leg of a
swap/warehousing transaction.
The FRBNY, on behalf of the Reserve Banks, maintains renewable,
short-term F/X swap arrangements with two authorized foreign
central banks. The parties agree to exchange their currencies up to
a pre-arranged maximum amount and for an agreed-upon period of
time (up to twelve months), at an agreed-upon interest rate. These
arrangements give the FOMC temporary access to foreign currencies
it may need for intervention operations to support the dollar and give
the partner foreign central bank temporary access to dollars it may
need to support its own currency. Drawings under the F/X swap
arrangements can be initiated by either the FRBNY or the partner
foreign central bank and must be agreed to by the drawee. The F/X
swaps are structured so that the party initiating the transaction (the
drawer) bears the exchange rate risk upon maturity. The FRBNY will
generally invest the foreign currency received under an F/X swap in
interest-bearing instruments.

Federal Reserve Bank of Cleveland

36

Warehousing is an arrangement under which the FOMC agrees to
exchange, at the request of the Treasury, U.S. dollars for foreign
currencies held by the Treasury or ESF over a limited period of time.
The purpose of the warehousing facility is to supplement the U.S.
dollar resources of the Treasury and ESF for financing purchases of
foreign currencies and related international operations.
In connection with its foreign currency activities, the FRBNY, on
behalf of the Reserve Banks, may enter into contracts that contain
varying degrees of off-balance-sheet market risk, because they
represent contractual commitments involving future settlement and
counter-party credit risk. The FRBNY controls credit risk by obtaining
credit approvals, establishing transaction limits, and performing daily
monitoring procedures.
While the application of current market prices to the securities currently
held in the SOMA portfolio and investments denominated in foreign
currencies may result in values substantially above or below their
carrying values, these unrealized changes in value would have no direct
effect on the quantity of reserves available to the banking system or
on the prospects for future Reserve Bank earnings or capital. Both the
domestic and foreign components of the SOMA portfolio from time
to time involve transactions that may result in gains or losses when
holdings are sold prior to maturity. Decisions regarding the securities
and foreign currencies transactions, including their purchase and
sale, are motivated by monetary policy objectives rather than profit.
Accordingly, market values, earnings, and any gains or losses resulting
from the sale of such currencies and securities are incidental to the
open market operations and do not motivate its activities or policy
decisions.
U.S. government and federal agency securities and investments
denominated in foreign currencies comprising the SOMA are recorded
at cost, on a settlement-date basis, and adjusted for amortization of
premiums or accretion of discounts on a straight-line basis. Interest
income is accrued on a straight-line basis and is reported as “Interest
on U.S. government and federal agency securities” or “Interest on
investments denominated in foreign currencies,” as appropriate.
Income earned on securities lending transactions is reported as a
component of “Other income.” Gains and losses resulting from sales
of securities are determined by specific issues based on average cost.
Gains and losses on the sales of U.S. government and federal agency
securities are reported as U.S. government securities gains, net.
Foreign-currency-denominated assets are revalued daily at current
foreign currency market exchange rates in order to report these assets
in U.S. dollars. Realized and unrealized gains and losses on investments
denominated in foreign currencies are reported as Foreign currency
gains, net. Foreign currencies held through F/X swaps, when initiated
by the counter-party, and warehousing arrangements are revalued
daily with the unrealized gain or loss reported by the FRBNY as a
component of “Other assets” or “Other liabilities,” as appropriate.
Balances of U.S. government and federal agency securities bought
outright, securities sold under agreements to repurchase, securities
loaned, investments denominated in foreign currency, interest income
and expense, securities lending fee income, amortization of premiums
and discounts on securities bought outright, gains and losses on sales
of securities, and realized and unrealized gains and losses on investments denominated in foreign currencies, excluding those held under
an F/X swap arrangement, are allocated to each Reserve Bank.
Securities purchased under agreements to resell and unrealized gains
and losses on the revaluation of foreign currency holdings under
F/X swaps and warehousing arrangements are allocated to the
FRBNY and not to other Reserve Banks.

In 2003, additional interest income of $61 million representing one
day’s interest on the SOMA portfolio was accrued to reflect a change
in interest accrual methods, of which $3 million was allocated to
the Bank. Interest accruals and the amortization of premiums and
discounts are now recognized beginning the day that a security is
purchased and ending the day before the security matures or is sold.
Previously, accruals and amortization began the day after the security
was purchased and ended on the day that the security matured or was
sold. The effect of this change was not material; therefore, it was
included in the 2003 interest income.
e. BANK PREMISES, EQUIPMENT, AND SOFTWARE
Bank premises and equipment are stated at cost less accumulated
depreciation. Depreciation is calculated on a straight-line basis over
estimated useful lives of assets ranging from two to fifty years. Major
alterations, renovations, and improvements are capitalized at cost as
additions to the asset accounts. Maintenance, repairs, and minor
replacements are charged to operations in the year incurred. Costs
incurred for software, either developed internally or acquired for
internal use, during the application development stage are capitalized
based on the cost of direct services and materials associated with
designing, coding, installing, or testing software. Capitalized software
costs are amortized on a straight-line basis over the estimated useful
lives of the software applications, which range from two to five years.
f. INTERDISTRICT SETTLEMENT ACCOUNT
At the close of business each day, all Reserve Banks and branches
assemble the payments due to or from other Reserve Banks and
branches as a result of transactions involving accounts residing in
other Districts that occurred during the day’s operations. Such
transactions may include funds settlement, check clearing and ACH
operations, and allocations of shared expenses. The cumulative net
amount due to or from other Reserve Banks is reported as the
“Interdistrict settlement account.”
g. FEDERAL RESERVE NOTES
Federal Reserve notes are the circulating currency of the United States.
These notes are issued through the various Federal Reserve agents
(the Chairman of the Board of Directors of each Reserve Bank) to
the Reserve Banks upon deposit with such agents of certain classes of
collateral security, typically U.S. government securities. These notes
are identified as issued to a specific Reserve Bank. The Federal Reserve
Act provides that the collateral security tendered by the Reserve Bank
to the Federal Reserve agent must be equal to the sum of the notes
applied for by such Reserve Bank. In 2003, the Federal Reserve Act
was amended to expand the assets eligible to be pledged as collateral
security to include all Federal Reserve Bank assets. Prior to the
amendment, only gold certificates, special drawing rights certificates,
U.S. government and federal agency securities, securities purchased
under agreements to resell, loans to depository institutions, and
investments denominated in foreign currencies could be pledged
as collateral. The collateral value is equal to the book value of the
collateral tendered, with the exception of securities, whose collateral
value is equal to the par value of the securities tendered. The par
value of securities pledged for securities sold under agreements to
repurchase is similarly deducted. The Board of Governors may, at
any time, call upon a Reserve Bank for additional security to
adequately collateralize the Federal Reserve notes. The Reserve
Banks have entered into an agreement that provides for certain assets
of the Reserve Banks to be jointly pledged as collateral for the Federal
Reserve notes of all Reserve Banks in order to satisfy their obligation
of providing sufficient collateral for outstanding Federal Reserve notes.
In the event that this collateral is insufficient, the Federal Reserve Act

2003

Annual Report

37

provides that Federal Reserve notes become a first and paramount
lien on all the assets of the Reserve Banks. Finally, as obligations of
the United States, Federal Reserve notes are backed by the full faith
and credit of the United States government.
The “Federal Reserve notes outstanding, net” account represents the
Bank’s Federal Reserve notes outstanding reduced by its currency
holdings of $4,740 million, and $4,417 million at December 31, 2003
and 2002, respectively.
h. CAPITAL PAID-IN
The Federal Reserve Act requires that each member bank subscribe to
the capital stock of the Reserve Bank in an amount equal to 6 percent
of the capital and surplus of the member bank. As a member bank’s
capital and surplus changes, its holdings of the Reserve Bank’s stock
must be adjusted. Member banks are those state-chartered banks that
apply and are approved for membership in the System and all national
banks. Currently, only one-half of the subscription is paid-in and the
remainder is subject to call. These shares are nonvoting with a par
value of $100. They may not be transferred or hypothecated. By
law, each member bank is entitled to receive an annual dividend of
6 percent on the paid-in capital stock. This cumulative dividend is
paid semiannually. A member bank is liable for Reserve Bank liabilities
up to twice the par value of stock subscribed by it.
i. SURPLUS
The Board of Governors requires Reserve Banks to maintain a
surplus equal to the amount of capital paid-in as of December 31.
This amount is intended to provide additional capital and reduce
the possibility that the Reserve Banks would be required to call on
member banks for additional capital. Pursuant to Section 16 of the
Federal Reserve Act, Reserve Banks are required by the Board of
Governors to transfer to the U.S. Treasury as interest on Federal
Reserve notes excess earnings, after providing for the costs of
operations, payment of dividends, and reservation of an amount
necessary to equate surplus with capital paid-in.
In the event of losses or a substantial increase in capital, payments
to the U.S. Treasury are suspended until such losses are recovered
through subsequent earnings. Weekly payments to the U.S. Treasury
may vary significantly.
j. INCOME AND COSTS RELATED TO
TREASURY SERVICES
The Bank is required by the Federal Reserve Act to serve as fiscal
agent and depository of the United States. By statute, the Department
of the Treasury is permitted, but not required, to pay for these services.
k. TAXES
The Reserve Banks are exempt from federal, state, and local taxes,
except for taxes on real property. The Bank’s real property taxes were
$2 million for each of the years ended December 31, 2003 and 2002,
and are reported as a component of “Occupancy expense.”
l. RECENT ACCOUNTING DEVELOPMENTS
In May 2003, the Financial Accounting Standards Board issued
SFAS No. 150, “Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity.” SFAS No. 150, which
will become applicable for the Bank in 2004, establishes standards
for how an issuer classifies and measures certain financial instruments
with characteristics of both liabilities and equity and imposes certain
additional disclosure requirements. When adopted, there may be
situations in which the Bank has not yet processed a member bank’s

application to redeem its Reserve Bank stock. In those situations,
this standard requires that the portion of the capital paid-in that is
mandatorily redeemable be reclassified as debt.
m. 2003 RESTRUCTURING CHARGES
In 2003, the System restructured several operations, primarily in the
check and cash services. The restructuring included streamlining the
management and support structures, reducing staff, decreasing the
number of processing locations, and increasing processing capacity
in the remaining locations.
Footnote 10 describes the restructuring and provides information
about the Bank’s costs and liabilities associated with employee
separations and contract terminations. The costs associated with
the write-down of certain Bank assets are discussed in footnote 6.
Costs and liabilities associated with enhanced pension benefits for
all Reserve Banks are recorded on the books of the FRBNY as
discussed in footnote 8 and those associated with the Bank’s
enhanced postretirement benefits are disclosed in footnote 9.
4. U.S. GOVERNMENT AND
FEDERAL AGENCY SECURITIES
Securities bought outright are held in the SOMA at the FRBNY.
An undivided interest in SOMA activity and the related premiums,
discounts, and income, with the exception of securities purchased under
agreements to resell, is allocated to each Reserve Bank on a percentage
basis derived from an annual settlement of interdistrict clearings. The
settlement, performed in April of each year, equalizes Reserve Bank gold
certificate holdings to Federal Reserve notes outstanding. The Bank’s
allocated share of SOMA balances was approximately 4.686 percent
and 5.517 percent at December 31, 2003 and 2002, respectively.
The Bank’s allocated share of securities held in the SOMA at
December 31, that were bought outright, was as follows (in millions):
2003
Par value:
Federal agency
U.S. government:
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated to Bank

$

—

2002
$

11,472
15,152
4,614
31,238
459

12,507
16,436
5,784
34,728
594

(42)
$

31,655

1

(58)
$

35,264

The total of SOMA securities bought outright was $675,569 million
and $639,125 million at December 31, 2003 and 2002, respectively.
As noted in footnote 3, the FRBNY replaced MSP transactions with
securities sold under agreements to repurchase in December 2002.
At December 31, 2003 and 2002, securities sold under agreements
to repurchase with a contract amount of $25,652 million and
$21,091 million, respectively, were outstanding, of which $1,202 million
and $1,164 million were allocated to the Bank. At December 31, 2003
and 2002, securities sold under agreements to repurchase with a par
value of $25,658 million and $21,098 million, respectively, were
outstanding, of which $1,202 million and $1,164 million were
allocated to the Bank.

Federal Reserve Bank of Cleveland

38

The maturity distribution of U.S. government securities bought outright
and securities sold under agreements to repurchase, that were allocated
to the Bank at December 31, 2003, was as follows (in millions):

Maturities of Securities Held
Within 15 days
16 to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total

Securities
Sold Under
U.S. Government
Agreements
Securities
to Repurchase
(Par value) (Contract amount)
$
2,237
$
1,202
6,529
—
7,688
—
8,765
—
2,404
—
3,615
—
$ 31,238
$
1,202

At December 31, 2003 and 2002, U.S. government securities with par
values of $4,426 million and $1,841 million, respectively, were loaned
from the SOMA, of which $207 million and $102 million were allocated
to the Bank.

The maturity distribution of investments denominated in foreign
currencies which were allocated to the Bank at December 31, 2003,
was as follows (in millions):
Maturities of Investments Denominated in Foreign Currencies
Within 1 year
$
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total
$

At December 31, 2003 and 2002, there were no outstanding F/X swaps
or material open foreign exchange contracts.
At December 31, 2003 and 2002, the warehousing facility was
$5,000 million, with no balance outstanding.
6. BANK PREMISES, EQUIPMENT, AND SOFTWARE
A summary of bank premises and equipment at December 31 is as
follows (in millions):
2003

5. INVESTMENTS DENOMINATED
IN FOREIGN CURRENCIES
The FRBNY, on behalf of the Reserve Banks, holds foreign currency
deposits with foreign central banks and the Bank for International
Settlements, and invests in foreign government debt instruments.
Foreign government debt instruments held include both securities
bought outright and securities purchased under agreements to resell.
These investments are guaranteed as to principal and interest by the
foreign governments.
Each Reserve Bank is allocated a share of foreign-currency-denominated
assets, the related interest income, and realized and unrealized foreign
currency gains and losses, with the exception of unrealized gains and
losses on F/X swaps and warehousing transactions. This allocation
is based on the ratio of each Reserve Bank’s capital and surplus to
aggregate capital and surplus at the preceding December 31. The
Bank’s allocated share of investments denominated in foreign
currencies was approximately 8.381 percent and 9.053 percent at
December 31, 2003 and 2002, respectively.
The Bank’s allocated share of investments denominated in foreign
currencies, valued at current foreign currency market exchange rates at
December 31, was as follows (in millions):
2003
European Union Euro:
Foreign currency deposits
Government debt instruments including
agreements to resell
Japanese Yen:
Foreign currency deposits
Government debt instruments including
agreements to resell
Accrued interest
Total

2002

Bank premises and equipment:
Land
Buildings
Building machinery and equipment
Construction in progress
Furniture and equipment
Subtotal

$

$

Accumulated depreciation
Bank premises and equipment, net
Depreciation expense,
for the years ended

7
151
46
4
69
277

2002
$

$

7
150
45
2
71
275

(97)

(93)

$

180

$

182

$

11

$

11

The Bank leases unused space to outside tenants. Those leases have
terms ranging from one to 12 years. Rental income from such leases
was $1 million for each of the years ended December 31, 2003 and
2002. Future minimum lease payments under noncancelable agreements
in existence at December 31, 2003, were (in millions):
2004
2005
2006
2007
2008
Thereafter

$

$
$

$

576

$

1
1
1
1
1
4
9

505

343

299

123

162

615
8
1,665

558
7
1,531

$

1,529
108
28
—
1,665

Total investments denominated in foreign currencies were $19,868
million and $16,913 million at December 31, 2003 and 2002, respectively.

The Bank has capitalized software assets, net of amortization, of $40
million and $32 million at December 31, 2003 and 2002, respectively.
Amortization expense was $6 million and $1 million for the years ended
December 31, 2003 and 2002, respectively.
Assets impaired as a result of the Bank’s restructuring plan, as discussed
in footnote 10, and the Bank’s decision to discontinue an ongoing
technology project include software, building, leasehold improvements,
furniture, and equipment. Asset impairment losses of $2 million for
the period ending December 31, 2003 were determined using fair values
based on quoted market values or other valuation techniques and are
reported as a component of “Other expenses.”

2003

Annual Report

39

7. COMMITMENTS AND CONTINGENCIES
At December 31, 2003, the Bank was obligated under noncancelable
leases for premises and equipment with terms ranging from one to
approximately four years. These leases provide for increased rental
payments based upon increases in real estate taxes, operating costs,
or selected price indices.
Rental expense under operating leases for certain operating facilities,
warehouses, and data processing and office equipment (including taxes,
insurance and maintenance when included in rent), net of sublease
rentals, was $1 million for each of the years ended December 31, 2003
and 2002. Certain of the Bank’s leases have options to renew.
Future minimum rental payments under noncancelable operating leases
and capital leases, net of sublease rentals, with terms of one year or
more, at December 31, 2003, were (in thousands):
2004
2005
2006
2007
2008
Thereafter

Operating
$
144
147
151
102
—
—
$
544

At December 31, 2003, the Bank had other commitments and long-term
obligations in excess of one year totaling $26 million, $17 million of
which had been recognized.
In addition, at December 31, 2003, the Bank, acting on behalf of the
Reserve Banks, had contractual commitments through the year 2008
totaling $58 million, $50 million of which had been recognized. These
contracts represent equipment, maintenance, software, and other
miscellaneous costs for Check operations and the Check Modernization
project that will be allocated annually to other Reserve Banks. It is
estimated that the Bank’s allocated share will be $2 million.
Under the Insurance Agreement of the Federal Reserve Banks dated as
of March 2, 1999, each of the Reserve Banks has agreed to bear, on a
per incident basis, a pro rata share of losses in excess of one percent of
the capital paid-in of the claiming Reserve Bank, up to 50 percent of the
total capital paid-in of all Reserve Banks. Losses are borne in the ratio
that a Reserve Bank’s capital paid-in bears to the total capital paid-in of
all Reserve Banks at the beginning of the calendar year in which the loss
is shared. No claims were outstanding under such agreement at
December 31, 2003 or 2002.
The Bank is involved in certain legal actions and claims arising in
the ordinary course of business. Although it is difficult to predict the
ultimate outcome of these actions, in management’s opinion, based on
discussions with counsel, the aforementioned litigation and claims will
be resolved without material adverse effect on the financial position or
results of operations of the Bank.

8. RETIREMENT AND THRIFT PLANS
RETIREMENT PLANS
The Bank currently offers two defined benefit retirement plans to
its employees, based on length of service and level of compensation.
Substantially all of the Bank’s employees participate in the Retirement
Plan for Employees of the Federal Reserve System (“System Plan”)
and the Benefit Equalization Retirement Plan (“BEP”). In addition,
certain Bank officers participate in the Supplemental Employee
Retirement Plan (“SERP”).
The System Plan is a multi-employer plan with contributions fully
funded by participating employers. Participating employers are the
Federal Reserve Banks, the Board of Governors of the Federal Reserve
System, and the Office of Employee Benefits of the Federal Reserve
Employee Benefits System. No separate accounting is maintained of
assets contributed by the participating employers. The FRBNY acts as
a sponsor of the Plan for the System and the costs associated with the
Plan are not redistributed to the Bank. The Bank’s projected benefit
obligation and net pension costs for the BEP and the SERP at
December 31, 2003 and 2002, and for the years then ended, are
not material.
THRIFT PLAN
Employees of the Bank may also participate in the defined contribution
Thrift Plan for Employees of the Federal Reserve System (“Thrift Plan”).
The Bank’s Thrift Plan contributions totaled $3 million for each of the
years ended December 31, 2003 and 2002, and are reported as a
component of “Salaries and other benefits.”
9. POSTRETIREMENT BENEFITS OTHER THAN
PENSIONS AND POSTEMPLOYMENT BENEFITS
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
In addition to the Bank’s retirement plans, employees who have met
certain age and length of service requirements are eligible for both
medical benefits and life insurance coverage during retirement.
The Bank funds benefits payable under the medical and life insurance
plans as due and, accordingly, has no plan assets. Net postretirement
benefit costs are actuarially determined using a January 1 measurement
date.
Following is a reconciliation of beginning and ending balances of the
benefit obligation (in millions):
2003
Accumulated postretirement
benefit obligation at January 1
Service cost-benefits earned
during the period
Interest cost of accumulated
benefit obligation
Actuarial loss
Contributions by plan participants
Benefits paid
Accumulated postretirement
benefit obligation at December 31

$

$

44.5

2002
$

40.8

1.3

1.1

2.9
9.9
0.2
(2.7)

2.8
1.6
0.2
(2.0)

56.1

$

44.5

Federal Reserve Bank of Cleveland

40

Following is a reconciliation of the beginning and ending balance of
the plan assets, the unfunded postretirement benefit obligation, and
the accrued postretirement benefit costs (in millions):
Fair value of plan assets at January 1
Actual return on plan assets
Contributions by the employer
Contributions by plan participants
Benefits paid
Fair value of plan assets at December 31
Unfunded postretirement
benefit obligation
Unrecognized prior service cost
Unrecognized net actuarial gain (loss)
Accrued postretirement benefit costs

$

$
$

$

2003
—
—
2.5
0.2
(2.7)
—
56.1
0.8
(3.7)
53.2

$

$
$

$

2002
—
—
1.8
0.2
(2.0)
—
44.5
0.9
6.3
51.7

Accrued postretirement benefit costs are reported as a component of
“Accrued benefit costs.”
At December 31, 2003 and 2002, the weighted average discount rate
assumptions used in developing the benefit obligation were 6.25 percent
and 6.75 percent, respectively.
For measurement purposes, a 10.00 percent annual rate of increase
in the cost of covered health care benefits was assumed for 2004.
Ultimately, the health care cost trend rate is expected to decrease
gradually to 5.00 percent by 2011 and remain at that level thereafter.
Assumed health care cost trend rates have a significant effect on the
amounts reported for health care plans. A one percentage point change
in assumed health care cost trend rates would have the following effects
for the year ended December 31, 2003 (in millions):

described in footnote 10. Because the special termination benefits are
less than $50 thousand, the amount is not displayed in the tables above.
Following the guidance of the Financial Accounting Standards Board,
the Bank elected to defer recognition of the financial effects of the
Medicare Prescription Drug Improvement and Modernization Act of
2003 until further guidance is issued. Neither the accumulated
postretirement benefit obligation at December 31, 2003 nor the net
periodic postretirement benefit cost for the year then ended reflect the
effect of the Act on the plan.
POSTEMPLOYMENT BENEFITS
The Bank offers benefits to former or inactive employees. Postemployment benefit costs are actuarially determined and include the cost of
medical and dental insurance, survivor income, disability benefits, and
self-insured workers’ compensation expenses. Costs were projected
using the same discount rate and health care trend rates as were used
for projecting postretirement costs. The accrued postemployment benefit
costs recognized by the Bank were $7 million for each of the years ended
December 31, 2003 and 2002. This cost is included as a component of
“Accrued benefit costs.” Net periodic postemployment benefit costs
included in 2003 and 2002 operating expenses were $1 million for each
of the years ended December 31, 2003 and 2002.
10. RESTRUCTURING CHARGES
In 2003, the Bank announced plans for restructuring to streamline
operations and reduce costs, including consolidation of Check
operations and staff reductions in various functions of the Bank.
These actions resulted in the following business restructuring charges:
Major categories of expense (in millions):
Total
Estimated
Costs

One Percentage One Percentage
Point Increase

Effect on aggregate of service and
interest cost components of net
periodic postretirement benefit costs
Effect on accumulated postretirement
benefit obligation

$

9.6

Point Decrease

$

0.9

(7.5)
(0.7)

The following is a summary of the components of net periodic postretirement benefit costs for the years ended December 31 (in millions):
2003
Service cost-benefits earned
during the period
Interest cost of accumulated
benefit obligation
Amortization of prior service cost
Recognized net actuarial gain
Net periodic postretirement
benefit costs

$

1.3

2002
$

3.0
(0.1)
(0.1)
$

4.1

1.1
2.8
(0.1)
(0.2)

$

3.6

Employee separation
Contract termination
Other
Total

$

$

1
—
2
3

Accrued
Liability
Total
12/31/02 Charges

$

$

—
—
—
—

$

1
—
2
$ 3

Accrued
Total Liability
Paid 12/31/03

$ —
—
(2)
$ (2)

$

1
—
—
$ 1

Employee separation costs are primarily severance costs related to
reductions of approximately forty-four staff and are reported as a
component of “Salaries and other benefits.” Contract termination
costs include the charges resulting from terminating existing lease and
other contracts and are shown as a component of “Other expenses.”
Other costs, primarily related to the management of the System Check
project, are also shown as a component of “Other expenses.”
Costs associated with the write-downs of certain Bank assets, including
software, buildings, leasehold improvements, furniture, and equipment
are discussed in footnote 6. Costs associated with enhanced pension
benefits for all Reserve Banks are recorded on the books of the
FRBNY as discussed in footnote 8. Costs associated with enhanced
postretirement benefits are disclosed in footnote 9.

Net periodic postretirement benefit costs are reported as a component of
“Salaries and other benefits.”

Future costs associated with the restructuring that are not estimable
and are not recognized as liabilities will be incurred in 2004.

The recognition of a special termination loss is the result of enhanced
retirement benefits provided to employees during the restructuring

The Bank anticipates substantially completing its announced plans
by November 2004.

Annual Report

2003

41
Officers and Consultants

as of December 31, 2003

Sandra Pianalto

David E. Altig

Kelly A. Banks

President and Chief Executive Officer

Vice President and Associate Director of Research
Research

Assistant Vice President and Public Information Officer
Corporate Communications, Public Information

Douglas A. Banks

Tracy L. Conn

Vice President and Consumer Affairs Officer
Supervision and Regulation

Assistant Vice President
Supervision and Regulation

Terry N. Bennett

Stephen J. Geers

Vice President
Information Technology

Assistant Vice President
Regional Account Management

James A. Blake

Patrick Geyer

Senior Consultant
Retail Payments Office

Assistant Vice President
Cash Automation

Senior Vice President
Financial Management Services, Strategic Planning,
Information Technology, COSO

Raymond L. Brinkman

Kenneth J. Good

Vice President
Savings Bonds, EZ Clear

Assistant Vice President
Check Adjustments, Image Services System Operations

Robert W. Price

Michael F. Bryan

Felix Harshman

Vice President and Economist
Research

Assistant Vice President
Accounting, Budget

Ruth M. Clevenger

Joseph G. Haubrich

Vice President and Community Affairs Officer
Corporate Communications, Community Affairs

Consultant and Economist
Research

William D. Fosnight

Paul E. Kaboth

Vice President and Associate General Counsel
Legal

Assistant Vice President
Supervision and Regulation

Barbara B. Henshaw

Kenneth E. Kennard

Vice President
Cincinnati Location Officer, Protection, Business Continuity

Assistant Vice President
Protection

Suzanne M. Howe

Susan M. Kenney

Vice President
Treasury Services, Electronic Payments

Assistant Vice President
Treasury Services

Senior Vice President
Human Resources, Payroll, Internal Communications,
Quality Process, EEO Officer

David P. Jager

Dean A. Longo

Vice President
Cash, Treasury Services, Electronic Payments

Consultant
Information Technology

Andrew W. Watts

Stephen H. Jenkins

Martha Maher

Senior Vice President and General Counsel
Legal, Ethics Officer

Vice President
Supervision and Regulation

Assistant Vice President
Retail Payments Office

Jon C. Jeswald

William Mason

Vice President
Retail Payments Office

Assistant Vice President
Regional Sales and Support

Rayford P. Kalich

Mark S. Meder

Vice President
Accounting, Budget, Purchasing, Strategic Planning, COSO

Assistant Vice President
Supervision and Regulation

Stephen J. Ong

James W. Rakowsky

Vice President
Credit Risk Management, Data Services

Assistant Vice President
Facilities, Business Continuity

David E. Rich

John P. Robins

Senior Consultant
Information Technology

Consultant
Supervision and Regulation

Edward E. Richardson

Elizabeth J. Robinson

Vice President
Marketing, Sales, Product Management, Customer
Satisfaction, Electronic Delivery Services

Assistant Vice President
Human Resources

Terrence J. Roth

Assistant Vice President
Columbus Check Operations

R. Chris Moore
First Vice President and Chief Operating Officer

Andrew C. Burkle, Jr.
Senior Vice President
Supervision and Regulation, Credit Risk Management,
Data Services

Lawrence Cuy

Senior Vice President
Retail Payments Office, National Check Automation
and Operations, National Product Development

Susan G. Schueller
Senior Vice President and General Auditor
Audit

Samuel D. Smith
Senior Vice President
Cash, Treasury Services, Savings Bonds,
Facilities, Information Security, Protection,
Business Continuity, Electronic Payments

Mark S. Sniderman
Senior Vice President and Director of Research
Research, Corporate Communications, Community Affairs

Peggy A. Velimesis

Vice President
Retail Payments Office, Check Products

Robert B. Schaub
Vice President
Pittsburgh Location Officer, Protection, Business Continuity

Gregory L. Stefani
Vice President
Supervision and Regulation

Edward J. Stevens
Senior Consultant and Economist
Research

James B. Thomson
Vice President and Economist
Research

Joseph C. Thorp
Vice President
Facilities, Business Continuity

Anthony Turcinov
Vice President
Check Operations, Check Adjustments

Jeffrey R. Van Treese
Vice President
Cincinnati Check Operations

Darell R. Wittrup
Vice President
Accounting, Billing

Thomas Schaadt
Jerome J. Schwing
Assistant Vice President
Cincinnati Check Operations

James P. Slivka
Assistant Vice President
Audit Application Competency Center

Diana C. Starks
Assistant Vice President
Check Operations

Stacey C. Talley
Assistant Vice President and Corporate Secretary
Office of the Corporate Secretary

Henry P. Trolio
Assistant Vice President
Information Technology

Michael Vangelos
Assistant Vice President
Information Security

Lisa Vidacs
Assistant Vice President
Cleveland, Pittsburgh Cash Operations

Nadine M. Wallman
Assistant Vice President
Supervision and Regulation

Federal Reserve Bank of Cleveland

42
Board of Directors

as of December 31, 2003

Federal Reserve Banks each have a
board of nine directors. Directors
supervise the Bank’s budget and
operations, make recommendations
on the primary credit rate, and, with
the Board of Governors’ approval,
appoint the Bank’s president, first
vice president, and officers.
Class A directors are elected by
and represent the interests of
Fourth District member banks.
Class B directors also are elected
by member banks but represent

(Standing) Phillip R. Cox, Cheryl L. Krueger, Wayne R. Embry, Bick Weissenrieder; (seated) Stephen P. Wilson,
Robert W. Mahoney, Tanny Crane; (not pictured) John R. Cochran, Charles E. Bunch.

the public interests of agriculture,
commerce, industry, services, labor,

Cleveland

and consumers. Class C directors are

Robert W. Mahoney
Chairman

selected by the Board of Governors
and also represent these public
interests.
Directors serve for three years. Two
Class C directors are designated by
the Board of Governors as chairman

Retired Chairman and Chief Executive Officer
Diebold, Incorporated
Uniontown, Ohio

Charles E. Bunch
Deputy Chairman
President and Chief Operating Officer
PPG Industries, Inc.
Pittsburgh, Pennsylvania

John R. Cochran

Directorships generally are limited to

Chairman and Chief Executive Officer
FirstMerit Corporation
Akron, Ohio

two successive terms to ensure that

Phillip R. Cox

the individuals who serve the Federal

President and Chief Executive Officer
Cox Financial Corporation
Cincinnati, Ohio

and deputy chairman of the board.

Reserve System represent a diversity
of backgrounds and experience.

Tanny Crane

The Cincinnati and Pittsburgh branch

President and Chief Executive Officer
Crane Plastics Company, LP
Columbus, Ohio

offices each have a board of seven

Wayne R. Embry

directors who serve three-year terms.

Former President and Chief Operating Officer
Cleveland Cavaliers
Cleveland, Ohio

Board members are appointed by
the Cleveland Fed and the Board
of Governors.

Cheryl L. Krueger
President and Chief Executive Officer
Cheryl&Co.
Westerville, Ohio

Bick Weissenrieder
Chairman and Chief Executive Officer
Hocking Valley Bank
Athens, Ohio

Stephen P. Wilson
President and Chief Executive Officer
Lebanon Citizens National Bank
Lebanon, Ohio

Martin McGuinn
Federal Advisory Council Representative
Chairman and Chief Executive Officer
Mellon Financial Corporation
Pittsburgh, Pennsylvania

Annual Report

2003

43

Cincinnati
Dennis C. Cuneo
Chairman
Senior Vice President
Toyota Motor Manufacturing North America, Inc.
Erlanger, Kentucky

James H. Booth
President
Czar Coal Corporation
Lovely, Kentucky

Herbert T. Brown
Senior Vice President
Western and Southern Financial Group
Cincinnati, Ohio

Glenn D. Leveridge
President
Bank One, NA
Lexington, Kentucky

Charlotte W. Martin
President and CEO
Great Lakes Bankers Bank
Gahanna, Ohio

V. Daniel Radford
(Standing) James H. Booth, Charlotte W. Martin, V. Daniel Radford; (seated)
Herbert T. Brown, Glenn D. Leveridge; (not pictured) Charles Whitehead, Dennis C. Cuneo.

Executive Secretary-Treasurer
Cincinnati AFL-CIO Labor Council
Cincinnati, Ohio

Charles Whitehead
Retired President
Ashland Inc. Foundation
Covington, Kentucky

Pittsburgh
Roy W. Haley
Chairman
Chairman and Chief Executive Officer
WESCO International, Inc.
Pittsburgh, Pennsylvania

Robert O. Agbede
Chairman and Chief Executive Officer
Advanced Technology Systems, Inc.
Pittsburgh, Pennsylvania

Ronnie L. Bryant, CEcD FM
President and Chief Operating Officer
Pittsburgh Regional Alliance
Pittsburgh, Pennsylvania

Michael J. Hagan
President and Chief Executive Officer
Iron and Glass Bank
Pittsburgh, Pennsylvania

James Mitnick
Senior Vice President
Turner Construction Company
Pittsburgh, Pennsylvania

Kristine Molnar
(Standing) Roy W. Haley, Georgiana N. Riley, Ronnie L. Bryant, Michael J. Hagan;
(seated) Robert O. Agbede, James Mitnick; (not pictured) Kristine Molnar.

President and Chief Executive Officer
WesBanco Bank, Inc.
Wheeling, West Virginia

Georgiana N. Riley
President and Chief Executive Officer
TIGG Corporation
Bridgeville, Pennsylvania

Federal Reserve Bank of Cleveland

44
Business Advisory Council

Community Bank Advisory Council

William E. Adams

Marlene K. Barkheimer

Chairman and Chief Executive Officer
Adams Manufacturing Corporation
Portersville, Pennsylvania

President and Chief Executive Officer
Farmers State Bank
West Salem, Ohio

Barbara A. Bissett

Michael M. Cottle

Managing Member
Bissett Industries, Ltd.
Westlake, Ohio

President and Chief Executive Officer
First National Bank of Blanchester
Blanchester, Ohio

R. Douglas Cowan

Luther Deaton, Jr.

Chairman and Chief Executive Officer
Davey Tree Expert Company
Kent, Ohio

Chairman, President, and Chief Executive Officer
Central Bank and Trust Company
Lexington, Kentucky

D. Michael Hartley

Charles K. Graham

Chairman and Chief Executive Officer
Standard Bent Glass Corporation
Butler, Pennsylvania

President and Chief Executive Officer
Progressive Bank, NA
Wheeling, West Virginia

R. Duane Hord

Dorsey G. Hall II

President
Hord Livestock Company, Inc.
Bucyrus, Ohio

Chairman, President, and Chief Executive Officer
First National Bank of Lexington
Lexington, Kentucky

Peter C. Johnson, MD

G. Courtney Haning

Chairman and Chief Executive Officer
TissueInformatics.Inc
Pittsburgh, Pennsylvania

Chairman, President, and Chief Executive Officer
Peoples National Bank
New Lexington, Ohio

John M. Kahl

Dallas C. Hipple

Chief Executive Officer
Henkel Consumer Adhesives, Inc.
Avon, Ohio

President and Chief Executive Officer
Mars National Bank
Mars, Pennsylvania

P. C. Miller

G.W. Holden

President and Chief Executive Officer
Duramax Marine LLC
Hiram, Ohio

President and Chief Executive Officer
First National Bank
Pandora, Ohio

Frederick D. Pond

Orval H. Homan

President
Ridge Tool Company, Inc.
Elyria, Ohio

Chairman, President, and Chief Executive Officer
Minster Bank
Minster, Ohio

Jack H. Schron, Jr.

Edward J. McKeon

President and Chief Executive Officer
Jergens, Inc.
Cleveland, Ohio

President and Chief Executive Officer
Western Reserve Bank
Medina, Ohio

Charles G. Urtin
President and Chief Executive Officer
Irwin Bank and Trust Company
Irwin, Pennsylvania

2 0 0 3 Annual Report
The Federal Reserve System is responsible for formulating and

The Federal Reserve Bank of Cleveland, including its branch offices

This annual report was prepared by the Corporate Communications

implementing U.S. monetary policy. It also supervises banks

in Cincinnati and Pittsburgh and its check processing center in

and bank holding companies, and provides financial services to

Columbus, serves the Fourth Federal Reserve District (Ohio,

and Community Affairs Department and the Research Department
of the Federal Reserve Bank of Cleveland.

depository institutions and the federal government.

western Pennsylvania, the northern panhandle of West Virginia,
and eastern Kentucky).

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve
Banks in the United States that, together with the Board of Governors
in Washington, DC, comprise the Federal Reserve System.

Acknowledgments
Manager, Communications Support:
Michael Galka

For additional copies, contact the Research Library,
Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH 44101,
or call (216) 579-2052.

Editor: Deborah Ring
Design: Lori Boehm

It is the policy of the Federal Reserve Bank of Cleveland to provide
equal employment opportunity for all employees and applicants without
regard to race, color, religion, sex, national origin, age, or disability.

The annual report is also available electronically through the
Cleveland Fed’s home page, www.clevelandfed.org.

Portrait Photography:
Bill Pappas

Cleveland

Cincinnati

Pittsburgh

Columbus

1455 East 6th Street
Cleveland, OH 44114
(216) 579-2000

150 East 4th Street
Cincinnati, OH 45202
(513) 721-4787

717 Grant Street
Pittsburgh, PA 15219
(412) 261-7800

965 Kingsmill Parkway
Columbus, OH 43229
(614) 846-7494

FEDERAL RESERVE BANK OF CLEVELAND
2003
ANNUAL REPORT

www.clevelandfed.org

FEDERAL RESERVE BANK OF CLEVELAND
2 0 0 3 A n n ua l Re p o r t