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Annual Report

2005
www.clevelandfed.org

F E D E R A L R E S E R V E B A N K O F C L E V E L A N D 2005 A N N U A L R E P O R T

Federal Reserve Bank of Cleveland

Federal Reserve Bank of Cleveland
2005

www.clevelandfed.org

Annual Report

The Federal Reserve System is responsible for

This Annual Report was prepared by the

Acknowledgments

formulating and implementing U.S. monetary policy.

Public Information and Research departments

Manager, Communications Support

It also supervises banks and bank holding companies

of the Federal Reserve Bank of Cleveland.

Michael Galka

and provides financial services to depository institutions
For additional copies, contact the Research Library,

and the federal government.

Federal Reserve Bank of Cleveland, P.O. Box 6387,
The Federal Reserve Bank of Cleveland is one of

Cleveland, OH 44101, or call (216) 579-2052.

12 regional Reserve Banks in the United States that,

Editor
Amy Koehnen

Designer
Lori Boehm

together with the Board of Governors in Washington,

The Annual Report is also available electronically

Portrait Photography

D.C., comprise the Federal Reserve System.

through the Cleveland Fed’s home page,

Bill Pappas Photography, Inc.

www.clevelandfed.org.

Stock Photography provided by

The Federal Reserve Bank of Cleveland, including its

Corbis, Fotosearch, Getty Images,
The Granger Collection, The Image
Finders, Inmagine, Jupiterimages,
and the Ohio Historical Society

branch offices in Cincinnati and Pittsburgh and its
check-processing center in Columbus, serves the
Fourth Federal Reserve District (Ohio, western
Pennsylvania, the northern panhandle of West Virginia,
and eastern Kentucky).
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.

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

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

Pittsburgh
717 Grant Street
Pittsburgh, PA 15129
(412) 261-7800

Contents

President’s Foreword

Altered States: A Perspective on
75 Years of State Income Growth

Operational Highlights:
Even the Treasury Needs a Bank

Management’s Report on
Responsibility for Financial Reporting

Report of Independent Accountants

Report of Independent Auditors

Comparative Financial Statements

Notes to Financial Statements

Officers and Consultants

Boards of Directors

Business Advisory Councils

Shrinking the World

The Electronic Age

Issued in 1876, Alexander Graham Bell’s patent for
the telephone has been called the most valuable ever
issued, revolutionizing the daily lives of ordinary
people. In 1935, the first telephone call was made
around the world. Although the two men spoke
from adjoining rooms in New York, their voices
circled the globe.

The 1990s to the present are widely considered to
be the electronic age: In 1998, Americans averaged
2,300 phone calls a year, and in 2003, computer and
Internet capabilities were added to cell phones. One
in five people under the age of 30 say the Internet is
their main source of information.

President’s Foreword

rade and innovation have profoundly influenced patterns of economic development

throughout the ages. The Federal Reserve Bank of Cleveland addressed this topic at some
length in our 2003 Annual Report. We noted that although trade and technological change
invariably favor some industries, skills, and locations more than others, they are ultimately
the only sources of rising living standards for all Americans.
During the past several decades, we have witnessed an intense period of globalization and
technological change. These forces have affected the United States not only on a national
level but on a state level as well. The states, in turn, are focused on how they might
influence their own economic development paths.
The fact is that per capita income differences among the states have declined significantly
over time, primarily because the poorest states have improved their relative positions
by so much. Income convergence among the states makes sense: People and businesses
are free to locate wherever they wish, and the declining costs of transportation and
communication foster mobility. But this convergence is far from complete.
This year’s Annual Report essay examines factors that might account for differences
in the evolution of states’ income growth. In seeking to understand why some states
appear to be faring much better than others, we conclude that innovation and workforce
skills make the difference.

2005 Annual Report w page 3

I am proud of the significant strides that our Bank has made in achieving its strategic objectives in 2005:
leadership in thought and deed, external focus, and operational excellence. In the Operational Highlights
section of this report, we focus on some of these achievements: converting a steadily increasing number
of paper checks to Automated Clearinghouse (ACH) debits and Check 21 clearings; becoming one of the
nation’s largest providers of Treasury services; and leading the effort to consolidate savings bond and
TreasuryDirect operations into the Federal Reserve’s Pittsburgh and Minneapolis offices.

(l–r): Charles E. Bunch, deputy chairman; R. Chris Moore, first vice president and chief operating officer; Sandra Pianalto,
president and chief executive officer; and Robert W. Mahoney, chairman.

page 4 w Federal Reserve Bank of Cleveland

The completion of the Bank’s Learning Center and Money Museum exemplifies all three of our strategic
objectives. The center was designed to educate students and visitors of all ages about what gives money
value and how the Federal Reserve supports the integrity of money, banking, and the payments system.
I hope that all of our constituents in the Fourth District and beyond will take the opportunity to visit this
wonderful new facility located in our Bank’s main lobby.
The Bank’s success last year was sustained by the guidance and support of our boards of directors in the
Cleveland, Cincinnati, and Pittsburgh offices and by the members of our advisory councils.
I am especially grateful for the exemplary service of our outgoing chairman of the board, Robert W.
Mahoney (retired chairman and chief executive officer, Diebold, Incorporated). Mr. Mahoney has led our
board during the past three years and has served as a director since 2000. His wise counsel and skilled
leadership have guided us through many important changes, both internal and external.
Thanks also go to another longtime director, Phillip R. Cox (president and CEO, Cox Financial Corporation).
Mr. Cox joined the Cincinnati board in 1994 and served two terms there before joining the Cleveland board
in 2000. He has been an energetic contributor, member, and chair of several board committees.
I also offer sincere thanks to V. Daniel Radford (executive secretary–treasurer, Cincinnati AFL–CIO Labor
Council) for six years of dedicated service on our Cincinnati board and to Martin G. McGuinn (chairman and
CEO, Mellon Financial Corporation), who has served with distinction as our Federal Advisory Council
representative for the past three years and as chairman of the council in 2005.
Finally, I offer my profound thanks to the officers and staff of the Federal Reserve Bank of Cleveland.
Their contributions in every area of our organization are both inspiring to me personally and essential to
our Bank’s capacity to change and grow. I know that we will not only meet our future challenges, but that
we will achieve new levels of success thanks to our employees’ skills, energy, pride, and resourcefulness.
Look to the Federal Reserve Bank of Cleveland for a continued focus on the community, region, and nation.
This focus helps us to serve our customers well, to inform economic discourse, and to partner with other
organizations that are committed—as we are—to promoting economic prosperity for all of our citizens.

Sandra Pianalto
President and Chief Executive Officer

2005 Annual Report w page 5

Farmer with Horse-Drawn Plow, 1930s

Still a Dominant Force

Farming was one of the top three occupations in the
Fourth District in 1930. The Rural Electrification
Act of 1936 brought electric power to many isolated
U.S. farms for the first time.

While both the number of farmers and the
percentage of Ohio residents who are farmers
have decreased since the mid-twentieth century,
average farm size and output have increased.

Altered States: A Perspective on
75 Years of State Income Growth

ll of us, it seems, would like to increase our incomes. If elected officials represent

our interests, then it follows that these officials would like to help their citizens do just
that. Yet boosting collective income levels is a difficult goal to achieve. There are no simple,
one-size-fits-all solutions for raising income growth. Still, governments can—and do—
try to improve the fortunes of their citizens through initiatives like providing public
education systems, recruiting businesses to locate in their region, and assisting in the
development and growth of new technologies. In this Annual Report, we ask: Why do
residents of some states have higher incomes than residents of other states? Why have
these income differences persisted for the past 75 years?
To answer these questions, we analyze the patterns of per capita income growth across the
48 contiguous U.S. states from the 1930s to 2004. We find that, over the long run, factors
like innovation and a skilled labor force appear to make a big difference in explaining why
some states have grown more than others.

2005 Annual Report w page 7

Since our research does not examine specific policies
for state taxation, spending, and regulation, we do
not offer advice on any specific policies designed to
raise state per capita incomes: Individual policies

THEN AND NOW: The 1930s and the 21st Century
U.S. incomes have risen dramatically over the
decades, and how people spend their money has
changed as well. Today, the percent of household

should be evaluated on cost–benefit criteria. Never-

consumption devoted to transportation expenditures

theless, our findings suggest directions that public

(18 percent) is nearly double that of the 1930s, as

policy makers might consider pursuing as they
chart their economic development strategies.
This essay begins by providing some facts about

lower auto prices, innovations in consumer credit,
and rising incomes have made multiple-vehicle
ownership widespread. Our food expenditures, on
the other hand, have dropped from 34 percent of
the U.S. household budget to just 13 percent; low-cost

state incomes from 1930 to 2004, and we consider

production techniques, refrigeration, and distribution

these facts in terms of economic growth models.

improvements have made this drop possible.

Next, we discuss our own research and how it
identifies factors that help to explain the paths of

Homeownership rates are also on the rise, increasing
from roughly 48 percent in 1930 to 69 percent in 2004.

state incomes over this time period. Finally, we

These rising rates were spurred by increasing incomes,

address state economic development strategies in

the availability of less-expensive suburban land and

light of what we have learned from our research.

housing, and financing innovations.
U.S. demographics have changed, too. While the
population of the entire United States grew 139 percent
from 1930 to 2004, the Fourth Federal Reserve District
did not keep pace: West Virginia grew at a meager
5 percent, Pennsylvania at 28 percent, and Kentucky
at 58 percent. Ohio’s 72 percent growth—the strongest
in the District—was still no match for the national
average (by comparison, California exploded by
528 percent). In 1930, all four states in the Fourth District
were within the top 15 most densely populated states.
Although each District state has fallen from its 1930
ranking, Ohio and Pennsylvania still ranked high in
the 2004 list.

page 8 w Federal Reserve Bank of Cleveland

State Incomes
We begin with an analysis of the patterns of per

Figure 1

capita income growth across U.S. states. All states

Income Growth

have seen their incomes grow in real (inflation-

100

adjusted) terms over the past few generations.
over the past 75 years: Even accounting for rising
prices, the 2004 median of state per capita incomes
is more than six times higher than it was in 1930.1
Much of that growth occurred in the expansion
that accompanied World War II. The longer-run

50
Real per Capita Income,
Thousands of Dollars

Figure 1 shows the income-level growth in all states

picture also reveals that the slower growth linked

1
1930

to most recessions is short-lived and that per capita

1940

1960

1970

1980

1990

2000

Year

income levels rose faster than inflation in 59 of the

Highest state
90th percentile
Median state

past 75 years.
States that had lower incomes in 1930 have tended

1950

10th percentile
Lowest state

Source: Authors’ calculations.

to grow at a faster pace than those whose incomes
were greater at that time. For example, the poorest

Figure 2

state—Mississippi—had a per capita income that

Income Convergence

was roughly one-fifth of the highest-income state at
of the lowest-income state—still Mississippi—was
only a little less than half of the highest-income
state, Connecticut. The progressively smaller gaps
among state incomes since the 1930s result in a
decline in the standard deviation (a statistic that
reveals how tightly state incomes are clustered
around the average), as seen in figure 2. This
decline is known as convergence—the notion that,
over time, the per capita income of states (or
countries) will become closer to average.

.45
Standard Deviation of Real
per Capita Income (natural log)

the time, New York. By 2003, the per capita income

.40
.35
.30
.25
.20
.15
.10
.05
.00
1930

1940

1950

1960

1970

1980

1990

2000

Year
Source: Authors’ calculations.

Within the Fourth Federal Reserve District, the
lower-income states of 1930 have also experienced
more rapid growth.2 Kentucky, which had the
lowest per capita income of the Fourth District
1 The median is the value below and above which there is an equal number of values or, in this case, where exactly half of the states have higher incomes and half have lower incomes.
2 The Fourth Federal Reserve District includes the entire state of Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

2005 Annual Report w page 9

states, experienced the fastest income growth.

Figure 3

West Virginia, whose per capita income was

State Manufacturing Employment

experienced noticeably slower growth than
Kentucky. Pennsylvania and Ohio, which had
significantly higher incomes than West Virginia
and Kentucky, have seen the slowest annual income
growth rates in the Fourth District since then.3
Does this mean that the economic policies of the
lower-income states in the 1930s supported faster
income growth than did the policies of the higherincome states? Not necessarily. Economic theory
leads us to expect a certain amount of convergence
among states.4 U.S. states share a common set

Percent Change of State Manufacturing
Employment (from 1930 to 2004)

low but still well above Kentucky’s in 1930,

10
Kentucky

5
0
-5

Average
Relationship

West Virginia

-10
Ohio

-15

100

Pennsylvania

150

200

250

Relative 1930 Personal Income
(Percent of Median State’s per Capita Income)
Source: Authors’ calculations.

of technologies, and labor and capital are free to
locate wherever the return for their services is
5

manufacturing—in the United States over the

highest. Over time, the movement of labor and

past 75 years reveals a clear pattern: States that

capital should reduce differences in the average

had lower incomes in 1930 have tended to see, for

amount of capital per worker in a state, a concept

example, a growing share of total manufacturing

known as capital equalization. Applying the basic

employment, while higher-income states have

economic model of total production and growth

typically seen a declining share (see figure 3). It

(see sidebar on Solow and the basics of economic

is exactly this kind of development pattern that

growth), this process should cause incomes to rise

should lead to an equalization of capital-per-worker

in the areas where incomes are lowest.

levels within the United States, almost regardless
of state policies.

Evidence shows that capital equalization, which
occurs through capital investments in existing

This trend suggests that the reason state incomes

plants as well as in the opening and closing of

have become more equalized is that states’ initial

facilities over time, has helped to reduce differences

levels of capital have become more equalized.

in state income levels. Businesses stand to gain the

In the process, living standards have improved

most when they add capital in places that start with

throughout the country. In this simplified version

very low relative capital levels (and, therefore,

of the growth process, the lower-income states

generally lower incomes). Just as the basic

could remain fairly passive and still see their

economic growth model predicts, the changing

fortunes improve.6

location of capital-intensive industries—like
3
4
5
6

Kentucky’s per capita income growth rate from 1930 to 2004 was 3.0 percent per year. West Virginia’s was 2.6, while Pennsylvania and Ohio each had a 2.2 percent annual growth rate.
For a basic review of the theory and data, see Gomme and Rupert (2004).
The simple version of economic theory neglects states’ fixed attributes that might also limit convergence, such as natural resources, access to the ocean, and climate.
Realistically, though, states could not sit on their hands. They would still need to build and maintain their public capital stocks just to keep in line with changing national practices.

page 10 w Federal Reserve Bank of Cleveland

Not So Fast
SOLOW AND THE BASICS OF ECONOMIC GROWTH
Good economic research is built on strong economic

The basic economic model would lead us to
expect almost complete convergence by now in

models. One of the most durable economic models

state incomes. Has this happened? One way to

of the past few decades—the Solow model—shows

measure the dispersion of state incomes around

us what we should expect to see as economies grow.

the average is with standard deviation; in a country

Fifty years ago, Robert Solow developed what would

with complete convergence, the standard deviation

become a Nobel Prize-winning model of economic

of state incomes would decline to zero. In fact, the

growth. Beginning with “A Contribution to the Theory

standard deviation of state incomes has declined

of Economic Growth” in 1956, he crafted a basic

considerably, reaching a minimum in 1976, at

model that is still considered a workhorse of
macroeconomics today.

roughly 31 percent of the 1930 level. Since then,
however, it has risen gradually (see figure 2), with

The Solow model shows what level of economic

the standard deviation of the 2004 state incomes

growth we can expect using a given amount of

at roughly 35 percent of the 1930 level. This means

capital and labor with a particular level of technology.
This is like thinking of the economy as a gradually
improving factory that produces one product using

that state incomes are now dispersed a bit more
widely around the state average than they were in

both people (labor) and machines (capital).

the mid-1970s.7

In this model, per capita income growth comes

This stalling out of gradual convergence is not

from a single direction—productivity gains—or, in

evident in all states. Over the past 25 years, lower-

other words, how our ability to generate per capita
income evolves. Productivity gains can be achieved
in two ways:
w By increasing the amount of capital for each worker
through saving and investment
w Through technical progress or innovation—finding

income states like Mississippi have actually
continued to close in on the median state. But a
comparison of state income levels in 2004 (figure 4)
shows that substantial income differences remain
between low- and high-income states. Why hasn’t

a better way to get things done with what you

convergence persisted across the nation? Statisti-

already have

cally, the reason is that the income levels reached

The Solow model has important implications for how

by our most prosperous states are moving farther

economies grow. It tells us that even if two regions

away from the median. For example, Connecticut

start off with different living standards and different

was the highest-income state in both 1976 and 2004:

amounts of capital and labor, their amounts of capital
per worker will converge. This implies that the regions’
per capita income levels will also converge.

In 1976, it was only 23 percent above the median,
whereas it was 47 percent above in 2004.

7 Romer (2000) provides an excellent summary of the basic model and how to calculate the expected rate of convergence.

2005 Annual Report w page 11

Figure 4

The basic economic growth model has no explana-

State Relative Incomes in 2004
-30

-20

-10

tion for this divergence of relatively high-income
20

economies sharing technologies should generally

MA
NJ

tend to converge. In this basic model, states have

MD
NY

identical rates of technical progress, and there is

no scope for government policies.8 To help explain

MN
CO

the per capita income differences we still observe

among states, the basic model must be expanded.

DE
CA

More sophisticated models direct us to recognize

WA
IL
WY

that companies and governments might be able

RI
NV

to stimulate technical progress through purposeful
action. In other words, rather than just relying

PA
NE

on labor and capital to move on their own, public

WI
MI

officials and private businesses might be able to

execute purposeful strategies that expand their

FL
OH
KS

abilities to produce goods and services. It is not
clear, however, which strategies will best support

IA
TX

the evolution of technical progress. We review

SD
OR

only the categories that might be particularly

MO
IN
ME

relevant within the United States: education
levels, taxes and public infrastructure, and patents

and technology.9

GA
NC
ND

Education Levels. The basic economic growth

AZ
OK
MT
AL

model does not account for human capital—the
accumulated investment in workforce skills. This

is important because during the past 75 years,

KY
SC

we have seen a tremendous rise in education

investment across the country: The share of the

UT
NM

U.S. population with college degrees has grown

from approximately 4 percent in 1930 to more

WV
MS

-30

-20

states. Rather, it has a strong prediction that

-10

than 27 percent today.

Relative Income
(Percent above or below State Average)
Source: Authors’ calculations.
8 Differing saving rates across states could account for some of this short-run divergence, but if savings move smoothly across state lines, then convergence should be even faster.
9 We did not examine the effects of state programs that offer specific tax breaks or subsidies to businesses in order to attract or retain them. Analysis by the Federal Reserve Bank of
Minneapolis (1995) suggests that while such programs benefit the recipients, they do not boost income at the state level.

page 12 w Federal Reserve Bank of Cleveland

WHAT CAN EDUCATIONAL ATTAINMENT TELL US?
Just as physical capital is a key determinant of how

More human capital means more productivity, even
without incorporating new technology. This may

much an economy can actually produce, human

not be the whole story, though. More human capital

capital is a key determinant of an economy’s

may also affect which technologies can be adopted.

productive potential. While true human capital can be

For example, computerization often requires

difficult to quantify, we can use levels of educational
attainment as a proxy.

workers to have at least basic programming skills.
More human capital may even advance the rate

By this measure, U.S. human capital has grown sharply

of technological innovation. Empirical studies on

since World War II. For instance, in 1940, less than

international income levels do find a substantial

25 percent of the U.S. population had completed
high school; today, that figure has more than tripled
to roughly 85 percent. In the same time span, the

relationship between education levels and income
growth, although education differences among

percent of college-educated Americans has shot up

countries still fall far short of explaining the

from less than 5 percent of the U.S. population to more

remaining income differences.10 Education differ-

than 25 percent.

ences, large at times, continue to persist and thus

Despite this general upward trend, there are still
noticeable differences in educational attainment

may be a factor within the United States as well.

across states, and this has implications for how these

Taxes and Public Infrastructure. What about

economies perform. Among all U.S. states, Massachusetts

taxes and public infrastructure? Taxes matter

has the highest proportion of college-educated adults

because they lower the amount of money potentially

at 36.7 percent and has one of the highest per capita

available for private investment, but spending on

incomes in the United States.

an improved public infrastructure can also help to

New Hampshire, Minnesota, Georgia, and Alabama

boost the economy’s productivity. These decisions

have seen some of the largest increases in their share

have potentially offsetting effects on income. In an

of college-educated citizens in the past 15 years,
although Alabama remains one of the states with a

international study, Kocherlakota and Yi find that

relatively low level of bachelor’s degree attainment

U.S. decisions on taxes and public capital have,

at 22.3 percent. West Virginia—a Fourth District state—

indeed, been roughly offsetting over a span of

has the smallest proportion of college-educated

many decades.11 This helps to explain the robust

citizens among all states. The other Fourth District
states are also below the median, with Kentucky at
21.0 percent, Ohio at 24.6 percent, and Pennsylvania

postwar economic growth, despite tax rates that
more than doubled during World War II and

at 25.3 percent. The State-Level Growth Analysis

remained far higher afterward. Public investment

section of the essay addresses the implications of

also rose dramatically. At the state and local levels,

these education patterns for income levels.

tax and public-spending variations certainly make
these factors a plausible source of state differences.

10 Bosworth and Collins (2003) provide recent research accounting for the role of international human-capital differences.
11 Kocherlakota and Yi (1997).

2005 Annual Report w page 13

State-Level Growth Analysis
Patents and Technology. Finally, it stands to

Even if factors such as human capital, patents,

reason that research and development activity

and taxes are likely to have an impact, it remains

might differ among the states, and this creates

to be seen just how important these factors are in

a channel through which per capita incomes

explaining the differences evident today in state

diverge. Just think about the tremendous effect

incomes. A recent research project completed at

of electrification—the spread of electricity to

the Federal Reserve Bank of Cleveland by Bauer,

nearly universal usage—on twentieth-century

Schweitzer, and Shane examines a variety of

society.

Advances of this scale cannot help but

factors that could influence the evolution of state

alter how the economy develops, and they may,

per capita incomes over time.14 They use a model

at least initially, be unevenly spread through the

grounded in growth theory to consider factors

economy. Smaller increments to our technological

that contributed to per capita income growth in

base, when cumulated over time, will also improve

the 48 contiguous U.S. states from 1939 to 2004.

living standards substantially. Consider the

This model estimates both the general pattern of

advances of the telephone:

convergence among states and the roles of a variety

s Early in the twentieth century, operator-assisted
rotary phones were still attached to big boxes
that housed the ringer.
s The mid-twentieth century saw the telephone

of growth factors like education, patents, taxes, and
infrastructure spending.
Part of the model’s accuracy stems from including
information on the relative income five years

become more compact, and modular connec-

earlier, which allows both past investments and

tions finally allowed phones to be plugged

past factors outside the model to boost (or lower)

directly into the wall.

state income levels. The model estimates imply that

s Small, fast, and functional cell phones began
replacing many standard phones in the later
part of the century and continue to evolve today.
Patents, the most consistent measure of new
technical advances, have been employed at each
stage of the telephone’s progress to protect the
many inventors’ intellectual property. Patent
statistics are typically regarded as an indicator of
a broad range of innovative activities rather than
as direct producers of income. Past research has
connected patent data to more general forms of
research and development activities that could
vary substantially from state to state.13

approximately 66 percent of that relative income
differential will remain after five years: High-income
states will, on average, remain higher-income, and
low-income states will remain lower-income.
However, the fact that this estimate is less than
100 percent of the income differential means that
the difference between the highest- and lowestincome states should decline each year unless
other factors intervene. Without these other
factors, income differentials should have shrunk
to less than a half of one percent of their starting
values over the 65-year period starting in 1939.
This pattern is consistent with the income

12 The National Academy of Engineering cites electrification as the most important technical advance of the twentieth century.
13 Griliches (1990) discusses the interpretation of patent statistics as a general economic indicator.
14 Bauer, Schweitzer, and Shane (2006).

page 14 w Federal Reserve Bank of Cleveland

INNOVATION IN THE FOURTH DISTRICT
The Fourth District has been the birthplace of many

the nation, as has been the case since 1917. On

of our nation’s inventions: the vacuum cleaner,

a positive note, the number of per capita patents

aluminum, and the Ferris wheel, to name a few.

originating in Fourth District states is higher than it

In 1999 alone, our region was granted 4,614 utility

was 10 years ago.

patents—that is, “patents for invention.” How does
our region stack up against the national average,

Individual companies play a large role in a region’s

and just who is receiving these Fourth District patents?

level of patent activity. In just the past five years,

In 1930, applicants from Kentucky, Ohio, Pennsylvania,

residents of Fourth District states; of these, almost

and West Virginia were awarded 7,673 total patents—

18 percent were assigned to just 10 companies.

more than 35,367 utility patents were awarded to

nearly 20 percent of all patents originating in the
United States. After 1930, the number of patents issued

Patents per Capita
700

but by 2004, the total granted was 7,216—nearly the

600

same number as was issued 75 years earlier. However,
the 2004 total amounted to only 7.7 percent of all
patents originating in the United States.
The share of the population involved in research
and development activities is better approximated
by looking at per capita patents. In 1930, Ohio had

Patents per Million People

to residents of Fourth District states fluctuated greatly,

500
400
300
200
100
0
1930

significantly more patents per person than the
United States as a whole. However, after significantly

1940

1950

1960

1970

1980

1990

2000

Year

outpacing the nation for decades, Ohio’s per capita

Ohio
Pennsylvania
United States

patents fell from 566 for every million residents in
1930 to 299 in 2004. Kentucky and West Virginia still

West Virginia
Kentucky

have significantly fewer patents per person than

Sources: U.S. Department of Commerce, Bureau of the Census; Annual Report of the
Commissioner of Patents (various years); www.uspto.gov/index.html; and
authors’ calculations.

Rank

Company*

Industry

Fourth District States’ Patent Total,
2000–2004

Procter & Gamble

Nondurable Household Products

1,463

General Electric Company

Diversified Industrials

1,245

SmithKline Beecham Corporation

Pharmaceuticals

604

Lexmark International, Inc.

Computer Hardware

558

The Goodyear Tire & Rubber Company

Tires

536

Lucent Technologies Inc.

Telecommunications Equipment

474

Delphi Technologies, Inc.

Automobile Parts

405

PPG Industries Ohio, Inc.

Specialty Chemicals

347

Air Products and Chemicals, Inc.

Specialty Chemicals

345

Rohm and Haas Company

Specialty Chemicals

324

Sources: www.uspto.gov/web/offices/ac/ido/oeip/taf/asgstc/oh_stc.htm; www.money.cnn.com; and authors’ calculations.
* Patent origin is determined by the residence of the first-named inventor listed on the patent grant.

2005 Annual Report w page 15

Figure 5

convergence predicted by the basic growth model

State Relative Incomes in 1939
-80

-60

-40

-20

100

with factor mobility and is also consistent with
past studies.15

DE
NV
CT

This estimated rate of convergence implies that
essentially no part of the 1939 state-income

NY
CA

distribution remains today. Yet considering the

NJ
MA

1939 state relative incomes, shown in figure 5, it

is evident that some states have retained their

IL
MD

relative status while others have moved substan-

tially. Connecticut, New Jersey, and Massachusetts

OH
WA

were all relatively high-income states, and they

PA
WY

ended 2004 as the three highest-income states.

OR
NH

Mississippi and Arkansas, the lowest-income states

in 1939, are still among the lowest-income states

IN
MN

today. On the other hand, Nevada’s relative income

has fallen, while Tennessee’s and Alabama’s incomes

WI
MO

have moved up considerably in the distribution.

ME
FL

Bauer, Schweitzer, and Shane identify several

VT
AZ

factors as statistically reliable indicators for

IA
UT

growth: education levels, patents, and industry

specializations.16 Figure 6 shows the model’s

VA
TX
NE
WV
KS

predicted 65-year impact of these factors on state
incomes in 2004 (see figure 4 to compare these

predicted incomes to the actual 2004 incomes).

Each factor is represented by a colored bar

OK
SD

specifying how much that factor boosted or reduced

the income prediction of each state. Take Ohio

as an example: Ohio’s history of above-average

TN
GA
KY

patent levels boosts its income prediction by almost

10 percent, while its slightly below-average levels

AL
AR
MS

-80

-60

-40

-20

of education and industry specialization have small
40

Relative Income (Percent above or below State Average)
1939

2004

100

negative effects on Ohio’s predicted income in 2004.
In cases where one of the factors offsets the others
(states with both positive and negative bars), the

Source: Authors’ calculations.
15 See Barro and Sala-i-Martin (1995) for examples and for citations to earlier work on the topic.
16 They also identify a statistically significant role for climate variables, although the effect of climate on income is not nearly as large a factor as the others.

page 16 w Federal Reserve Bank of Cleveland

predicted relative income is the sum of the positive

Figure 6

and negative effects, marked by the gold lines. This

Predicted Impact of Key Factors on 2004 State Incomes

means that although it looks like Ohio’s predicted

-40

-30

-20

-10

2004 income is almost 10 percent above average,

it is really only approximately 6 percent above.

NJ
MD
NY

Long-run variations in state education levels,

NH
MN

patents, and industry specializations explain much

of the 2004 income differences. If the predicted

VA
DE

rankings from the authors’ model were perfect,

CA
WA

the bars in figure 6 would steadily shift from the

bottom-left to the top-right. This is not the case,

WY
RI

but, in line with the model’s prediction, negative

bars are typically seen toward the bottom (lower-

PA
NE

income states), while positive bars are almost

WI
MI

exclusively seen toward the top. Also note that

the scale of the predicted effects is generally

FL
OH

smaller than the actual 2004 values (shown in

figure 4) but not by a large amount. Collectively,

IA
TX

this visual evidence shows that the model does

SD
OR

account for much of the current differences in

state income levels.

IN
ME
TN

The authors conclude from figure 6 that the

GA
NC

largest factor underlying relative income differ-

ences in 2004 is patents, followed by education

AZ
OK

then industry specialization. This is supported

by the predominance of the red bars and their

AL
LA

strong positive association with 2004 incomes.

KY
SC

Patent data are particularly informative, even

though most estimates of profits accruing to firms

UT
NM

that hold patents are not particularly high. Bauer,

AR
WV

Schweitzer, and Shane interpret the strong patent
result shown in figure 6 as income accruing to
places that are relatively innovative and produce
more patented inventions than other places.

-40

-30

-20

-10

Predicted Relative Income (Percent above or below State Average)
Patents

Industry Specialization

Education

Predicted Relative Income

Source: Authors’ calculations.

2005 Annual Report w page 17

Listing the states with the highest levels of patents

Industry specialization is yet another reliable

per capita at the end of the sample reveals why

indicator of state growth differences. For instance,

this variable works so well: Delaware ranks first,

states with larger-than-usual mining incomes tend

New Jersey second, and Connecticut third. In terms

to grow more slowly than states with other special-

of income, Connecticut is first and New Jersey is

ties. States with higher levels of manufacturing

third; both have shown surprising income growth.

also tend to grow more slowly, even though these

Most lower-income states have very low levels of

states initially had higher incomes. Indeed, both

patenting per capita. Delaware deviates from the

the familiar manufacturing centers, like Ohio and

pattern noticeably in that its income level is not

Indiana, and the new manufacturing centers of the

among the top states, but the overall correlation is

South, like Mississippi and Kentucky, are estimated

clear in the data.

to have lower income levels due to their industry
specializations. Today, the states with larger-than-

Bauer, Schweitzer, and Shane suggest that these
differences likely reflect higher (or lower) levels
of knowledge-building activities (which are

average service sectors are the ones estimated to
have experienced more income growth (see the
dark-blue bars in figure 6).

correlated with patents) within these states. In their
interpretation, something about Connecticut and

State tax differences and investments in infra-

New Jersey makes them more active in generating

structure (in the form of roads) play smaller roles

innovation, although the specific sources of these

in interstate income differences and typically are

advantages are not identified. For example, patents

statistically insignificant, as are banking deposits.

might be a proxy for success in commercialization

Climate differences are statistically valid for

of technology.

predicting income growth, with warmer and drier
states showing more income growth, yet the effects

The education factor in figure 6 comes from
combining high school and college completion

of the climate variables are substantially smaller
and more-erratic predictors of 2004 income levels.

statistics. Colorado, Connecticut, and Massachusetts
are the current education leaders; again, their

Overall, Bauer, Schweitzer, and Shane’s study

income levels stand out. Education is also a fairly

emphasizes the role of knowledge building—

reliable indicator of lower income levels and weak

through research and education—in aiding income

convergence, with West Virginia and Arkansas

growth. A separate study (see sidebar on dashboard

having the lowest education scores. It is important

indicators) analyzing the growth patterns of U.S.

to see that while patents and education levels are

metropolitan areas during the past 10 years

correlated, the statistical procedure used by the

corroborates this role: Although this study differs

authors indicates that these factors are distinct

considerably in its methodology, it agrees that

from one another.

patents and education are associated with higher
incomes in metropolitan areas.17

17 Eberts, Erickcek, and Kleinhenz (2006).

page 18 w Federal Reserve Bank of Cleveland

DASHBOARD INDICATORS
Not surprisingly, experts in many metropolitan areas

The skilled-workforce factor is consistent with both

have sharpened their focus on increasing regional

general education results and growth in the

growth prospects. A good example is “Dashboard

technology base in the Bauer–Schweitzer–Shane

Indicators for the Northeast Ohio Economy,” a

project (see the State-Level Growth Analysis section);

paper by Randall Eberts, George Erickcek, and

these two distinct measures are highly correlated in

Jack Kleinhenz. This study analyzes which local

recent metropolitan-level data and thus are

economic indicators have contributed to growth

combined into one measure. The “Dashboard” study

in terms of output, employment, per capita income,

estimates that the skilled-workforce factor is at least

and productivity in more than 100 metro areas.

twice as important as the other explanations of
income differences.

The authors’ research was supported by The Fund
for Our Economic Future, which seeks to advance a

The authors’ legacy-cost variable largely reflects the

regional economic development agenda that can

share of the workforce in manufacturing, which the

lead to long-term economic transformation.

Bauer–Schweitzer–Shane study also noted as a factor
that held back income growth. The additional factors

The “Dashboard” study considers a broad set of state-

that the authors identify as statistically significant

income-growth variables. Forty economic indicators

point to issues that local economic development

were combined into eight summary measures of

economists have observed as appearing to be new,

related variables: skilled workforce, assimilation center

potential growth sources.

(a set of variables focused on recent immigrants),
racial inclusion, legacy of place, income equality,

These two studies bring new empirical findings to

locational amenities, business dynamics, and urban/

the question of how communities can boost their

metro structure. The statistically derived factors

income levels. As is true with most growth models in

combine the effects of underlying variables that are

the national and international arenas, education

highly correlated among the metro areas.

levels stand out as important factors, but both of these
studies also help to direct attention to other factors

The authors then analyze these factors for their effect

that matter. As such, they help to push the focus of

on economic growth measures, including per capita

economic development beyond just the recruitment

income. The four factors that contribute to higher

and retention of capital investments.

income growth are—in order of importance—skilled
workforce (which includes patents), urbanization/
metro governance (which focuses on the governmental
structure), income equality, and locational amenities
(as evaluated in Places Rated Almanac).3 They also
find that the legacy-costs factor (which includes their
measures for industry specialization) is significantly
associated with lower income growth.

1 The Fund for Our Economic Future (2006).
2 For example, “legacy of place” combines the number of government units in the metropolitan area, a crime index, a climate index, the percent of houses built before 1940, and the total number
of layoffs and hires within the economy (a measure of how dynamically an economy is adapting to either positive or negative shocks). For descriptions of the other factors, please refer to
Eberts, Erickcek, and Kleinhenz’s report, which can be found at www.clevelandfed.org/Research/Workpaper/2006/index.cfm.
3 Savageau (1999).
2005 Annual Report w page 19

Lessons for the States
Does the rising importance of knowledge in the
economy necessarily mean that industries like
manufacturing—a prominent one in the Fourth

A SHIFT IN FOURTH DISTRICT OCCUPATIONS
Goods-producing industries such as steel and
farming have historically been the lifeblood of the

District—no longer have a place? After all, the

Fourth District economy. But since the 1930s, shifts in

results show that a manufacturing concentration

the labor force have caused this region to reevaluate

negatively affects a state’s income, at least when the

its place in the national economy.

model holds the state’s other characteristics—most

In 1930, the Fourth District’s three largest occupations—

importantly its income history—constant. As it

laborer, operative worker, and farmer—accounted

turns out, in the 1930s, manufacturing and high

for nearly 30 percent of its labor force. While these

state income levels tended to go together.18 But
in the model estimates, the negative effect of
manufacturing and the general pattern of income
convergence have largely eliminated the income
advantage that manufacturing once had. The
negative estimates for the industry-specialization

occupations remain significant to the Fourth District’s
vitality, they accounted for just over 10 percent of its
labor force in 2004, and farmer dropped from the
third-most-common job to the forty-ninth.
At the same time, health-care occupations have
seen a significant increase, with nurses, hospital
attendants, and medical technicians accounting for

factor likely reflect the importance of circumstances

nearly 5 percent of employment today, versus only

that have particularly affected manufacturers over

about 1/2 percent in 1930. This trend in occupational

this 75-year period.19

employment shows a movement in Fourth District

Statistically speaking, little correlation remains

to the trend in the rest of the country.

states toward a more service-based economy, similar

today between a state’s manufacturing share
and its income level. This leaves us close to the
premise that manufacturing’s expected return
to investment should be equalized across the
economy. In this case, there is no reason for states
to avoid manufacturing, but there is also no reason
to favor it over other economic activities.

18 The correlation in 1930 was 0.57.
19 International trade may have played an increasingly important role in manufacturing activity’s value to a state’s income during our sample period, but we did not examine
this proposition directly.

page 20 w Federal Reserve Bank of Cleveland

The results suggest a possible exception for at least

much growth, unless the companies also relocated

some manufacturing companies: the exceptional

their research activities. Furthermore, any realistic

innovators. Many states with high levels of patents

plan should take into account the activities of other

over the past 10 years generate a large fraction of

areas: Not every region can be the preeminent

their patents in companies with a manufacturing

center of the latest hot technology.

link to the state, even if their manufacturing
facilities are now often located elsewhere. Several

To be effective, all policies require careful thought

of the companies listed as top producers of patents

and planning. Research evaluating specific policy

in Fourth District states between 2000 and 2004

options will necessarily be more focused on the

are global companies with relatively few local

details that make policies successful. We intend

manufacturing sites. Innovative companies like

to follow up this work with additional research

this appear to offer benefits to their states

on how the identified factors can be boosted in a

potentially beyond the direct value of their

state or region. Indeed, conferences hosted by

activities, even though these benefits are often

the Federal Reserve Bank of Cleveland on the

thought of as supplemental.

economics of education policy over the past
two years have been focused on reaching a better

Innovation and education certainly stand out in

understanding of the economic policy issues of

the Bauer–Schweitzer–Shane study; and past

education reform.

research has also pointed in this direction, although
the scale of the factors was less certain.20 However,
it is one thing to establish that being a center of
innovation or having a large number of highly
educated residents—or both—promotes faster
income growth. It’s another to determine which
state and local policies can be most effective.

Caveats aside, the evidence provided by the
growing study of expanded growth models suggests
pursuing policies that increase the knowledge base
of the region. This may sound like the mantra of the
Internet age, but the results presented here show
that innovation has been pivotal to income growth
at the state level since the 1930s.

Policy initiatives should be evaluated on cost–benefit
criteria, and states can differ in their abilities to
get the most out of any policy initiative. For these
reasons, growth-promoting strategies should not
be blindly pursued. For example, subsidizing
companies that register their patents in particular
states or localities would probably not promote

20 For example, see Glaeser and Saiz (2004).

2005 Annual Report w page 21

References

Barro, R., and X. Sala-i-Martin. 1995. Economic Growth. New York: McGraw-Hill.

Bauer, Paul, Mark Schweitzer, and Scott Shane. 2006. “State Growth Empirics,” Working Paper Series 06-06. Cleveland:
Federal Reserve Bank of Cleveland.

Bosworth, Barry, and Susan Collins. 2003. “The Empirics of Growth: An Update,” Brookings Papers on Economic Activity 2: 133–206.

Burstein, Melvin L., and Arthur J. Rolnick. 1995. “Congress Should End the Economic War Among the States,” Federal Reserve Bank
of Minneapolis, The Region (March).

Eberts, Randall, George Erickcek, and Jack Kleinhenz. 2006. “Dashboard Indicators for the Northeast Ohio Economy,” Working Paper Series
06-05. Cleveland: Federal Reserve Bank of Cleveland.

The Fund for Our Economic Future. 2006. www.futurefundneo.org/page9066.cfm, accessed March 7, 2006.

Glaeser, E., and A. Saiz. 2004. “The Rise of the Skilled City,” Brookings–Wharton Papers on Urban Affairs, 47–105.

Gomme, Paul, and Peter Rupert. 2004. “Income Growth and Disparity in the United States, 1929–2003,” Federal Reserve Bank of Cleveland,

Economic Commentary (August 15).

Griliches, Zvi. 1990. “Patent Statistics as Economic Indicators: A Survey,” Journal of Economic Literature 28 (4): 1661–707.

Kocherlakota, Narayana, and Kei-Mu Yi. 1997. “Is There Endogenous Long-Run Growth? Evidence from the United States and the United
Kingdom,” Journal of Money, Credit, and Banking 29(2): 235–60.

National Academy of Engineering. 2006. www.nas.edu/greatachievements/index.html, accessed March 7, 2006.

Romer, David. 2000. Advanced Macroeconomics. New York: McGraw-Hill.

Savageau, D. 1999. Places Rated Almanac. Chicago: Wiley.

Solow, Robert. 1956. “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics 70: 65–94.

page 22 w Federal Reserve Bank of Cleveland

A Depressing Reality

The Rise of Universal Education

Before the Great Depression, education was one
of the top priorities in America. But by 1933, two
hundred thousand teachers were unemployed,
2.2 million children were out of school, and two
thousand rural schools had failed to open. Even
if children were fortunate enough to go to school,
class and racial barriers prevented many of them
from going to college.

Enrollment in prekindergarten through eighth grade
at private and public schools rose to 40.0 million
children in 2004. Private- and public-college
enrollment of undergraduates and grad students
hit a record level in 2004 at 17.4 million, and the
share of bachelor’s degrees obtained by African
Americans, Caucasians, and Hispanics have all
increased over the years.

Operational Highlights:
Even the Treasury Needs a Bank

Hamilton’s Treasury
When Alexander Hamilton reported to
work as the first Secretary of the U.S.
Treasury on September 14, 1789, he faced
daunting fiscal challenges: The new
nation’s public credit was in shambles,
with the outstanding public debt trading at
significant discounts; soldiers in the federal
army—in fact, all federal employees—
needed their paychecks; and the federal
government had no liquid bank balances,
relying instead on loans from the Bank of
New York and the Bank of North America
Alexander Hamilton,
first Secretary of the U.S. Treasury

page 24 w Federal Reserve Bank of Cleveland

to begin operations.

Much of Hamilton’s attention in that first year
was, naturally, focused on policy matters, such
as whether the federal government should assume
the Revolutionary War debts of the states and
whether the nation needed a national bank.
But Hamilton also devoted considerable
attention to the day-to-day financial business of
the government. In that first year, the federal
government’s revenues consisted almost entirely
of the $4.4 million earned in customs receipts, of
which 55 percent was spent on debt service and
another 15 percent on the military. But how could
the federal government reliably and efficiently
collect revenues from all customs and land sales
across a land mass of 900,000 square miles, an area
larger than any European state of the period save
the Russian Empire? How could the Treasury

First Bank of the United States, Philadelphia, 1799

combine funds from borrowings, note issues, and
taxes to meet its daily obligations? And how could
the Treasury assure the many creditors of the new

With 27 employees, the Treasury was the largest

nation, foreign and domestic, that the obligations

department in the new government, but it did not

owed them would be paid in full and on time?

have sufficient national reach or commercial

Hamilton addressed those challenges by running
the Treasury the way he knew how—like a business
enterprise. Hamilton was among the few founding
fathers with substantial commercial business
experience, having worked for several years in a
thriving St. Croix trading enterprise before
coming to the American colonies in 1772. In his
state papers, Hamilton emphasized the importance
of paying the government’s bills on time, collecting

expertise to efficiently execute its day-to-day
operations. The Treasury needed a fiscal agent
with a national presence to make payments,
collect funds owed to the government, and
manage relationships with the government’s
creditors. The Bank of the United States—our
nation’s first central bank—began serving in 1791
as the Treasury’s first fiscal agent, a role that the
Federal Reserve System continues to play today.

revenues in an efficient manner, and maintaining
cordial relationships with creditors and other
stakeholders.1
1 Hamilton’s state papers, Report on Public Credit (January 9, 1790) and Report on a National Bank (December 13, 1790), are particularly instructive in this area.

2005 Annual Report w page 25

Savings bonds

Liberty Loan bonds

The Federal Reserve as Fiscal Agent
The Federal Reserve Act was signed into law in

The partnership between the Treasury and the

December 1913. Toward the end of 1914, the

Federal Reserve continued to grow in succeeding

12 Federal Reserve Banks opened for business,

decades, with the Reserve Banks assuming an

but they only gradually took on the fiscal agency

increasing share of the back-office duties involved

role. In 1915 and 1916, the Reserve Banks were

in day-to-day Treasury operations. Among the

designated as depositories to maintain the

Federal Reserve’s fiscal agency activities today are

Treasury’s bank account, facilitating nationwide

collecting and holding balances due the Treasury;

collection and disbursement of funds for the

making and receiving payments for the federal

federal government. In 1917, Reserve Banks began

government using checks, Automated Clearing-

handling an unprecedented volume of securities

house (ACH), and wire transfers; printing, issuing,

processing associated with the Liberty Loan bonds

and retiring U.S. savings bonds; managing the

and Victory Notes issued to finance U.S. involve-

relationship between the Treasury and its creditors,

ment in World War I. In 1921, the Treasury closed

i.e., purchasers of government securities; and

its network of regional offices, which dated to the

processing U.S. postal money orders. In 2005, the

mid-1840s. The duties of those offices to hold

Federal Reserve spent $376 billion, or nearly

collateral for government funds held on deposit

15 percent of its total spending, on Treasury support.

at commercial banks and to distribute the nation’s
currency and coin were transferred to the
Federal Reserve.

page 26 w Federal Reserve Bank of Cleveland

Using the Federal Reserve as its fiscal agent has

payments, certain types of check clearing that

provided the Treasury with an alternative to

used to take two or three weeks can now be done

operating a national financial institution of its own.

overnight, lowering the cost of clearing and of

Like Alexander Hamilton, who moved most of the

after-the-fact exceptions processing. By using the

Treasury’s payment processing to the Bank of the

Internet, consumers can conduct business with the

United States, today’s Treasury has outsourced

Treasury and federal agencies 24/7.

much of its daily payment and debt-processing
activities to the Federal Reserve.

Straight-through processing illustrates one of
the most remarkable accomplishments of the

Technology and Consolidation
The Treasury’s relationship with the Federal
Reserve Banks is a “dynamic partnership based
on common goals of delivery of high quality service
and efficiency of operations.”2 The Treasury and

Treasury/Federal Reserve collaboration: the
transition from a system dominated by paper
processing to one with a large electronic component. The Federal Reserve Bank of Cleveland
has played an important role in that evolution.

the Reserve Banks have used technology and
consolidation to cut costs and improve the
delivery of services to millions of U.S. citizens.
Services such as Treasury securities and savings
bond processing, which, as recently as 1990, were
provided by all 35 main offices and branches in

Transactions Converted from Paper to Electronics
Category

1970

2005

Federal payments
made electronically

79%

Savings bond applications
received electronically

65%

the Federal Reserve System, have now been
consolidated into just two locations. Treasury
Reserve check-processing locations until 1990,

The Cleveland Bank’s Role in
Supporting the U.S. Treasury

have also been consolidated into two offices.

In the 1980s, the Federal Reserve Bank of

check services, which were handled in 45 Federal

Cleveland’s role in providing fiscal agency services
The Treasury and the Federal Reserve have
migrated to straight-through processing of some
activities, using the Internet, telecommunications,
and data processing technology as more efficient
and cost-effective substitutes for manual processing.

to the Treasury was much like those of the other
11 Reserve Banks. However, by 2005, the Cleveland
Reserve Bank had become one of the largest
providers of Treasury services in terms of staff
levels, comprising 27 percent of the System’s total.

By using ACH to convert checks to electronic

2 Bureau of the Public Debt. 2003. Public Debt Strategic Plan 2003–2008. www.publicdebt.treas.gov/oa/oastrategicplan.pdf, accessed April 3, 2006.

2005 Annual Report w page 27

A number of factors contributed to the Cleveland
Bank’s role in providing Treasury services:
s Transfer of activities from the Treasury to the
Federal Reserve, such as the processing of
redeemed bonds, which was moved from the

CASH AND CHECK OPERATIONS
Fiscal agency functions were not the only Federal
Reserve operations to be affected by consolidations
in recent years. In 2004, the Federal Reserve Bank of
Cleveland’s Cincinnati office began processing
cash for financial institutions in the Federal Reserve’s

Treasury’s office in Parkersburg, West Virginia,

Louisville territory. In 2006, the Bank’s Cleveland office

to the Federal Reserve Bank of Cleveland’s

is scheduled to absorb the cash activities of the

Pittsburgh Branch in 1999

Federal Reserve office in Buffalo, New York.

s Consolidation of Treasury services once

Check-processing volume in the Fourth District has

performed in all Federal Reserve Districts into

grown from an average of 6.3 million checks per day

progressively fewer offices, such as the consoli-

in 2002—before consolidation began—to 7.6 million

dation of Treasury securities and savings bond
servicing into the Pittsburgh and Minneapolis
Federal Reserve offices in 2005
s Treasury efforts to move services from commercial banks and other private-sector providers
into the Federal Reserve, such as the Over-

in 2005, despite a 38 percent decline in overall check
volume in the Federal Reserve System. The Cleveland
Bank’s Cincinnati office, in addition to serving its own
territory, now clears checks for territories once served
by the Charleston, Indianapolis, and Louisville Federal
Reserve offices. In mid-2005, the Cleveland office
absorbed the check-processing operation of the
Federal Reserve’s Detroit office, and in early 2006,

the-Counter Paper Check Conversion to ACH

Cleveland and Cincinnati will absorb all check

program that is now centralized in the

processing from the Cleveland Bank’s Columbus office.

Cleveland office
s Initiatives chosen by the U.S. Treasury to be
sourced from the Federal Reserve, especially
those that were placed in the Fourth District for
production and day-to-day management, such

Federal Reserve check-processing operations are
also being impacted by Check 21, which became
effective in October 2004. The volume of checks
being converted to images or to substitute checks rose
rapidly throughout 2005. By year’s end, such checks
represented approximately 5 percent of the number,

as the Pay.gov program, which Web-enables

and roughly 20 percent of the dollar value, of checks

and makes electronic many Treasury and other

processed by the Federal Reserve.

federal collection transactions that were once
done with paper

page 28 w Federal Reserve Bank of Cleveland

Treasury Retail Securities
The Treasury Retail Securities Department, housed

The eGovernment function also administers the

in Cleveland’s Pittsburgh Branch, led the System’s

Pay.gov program, which involves collections

effort to consolidate savings bond and Treasury-

management for 87 federal agencies, which

Direct operations into the Federal Reserve’s

themselves manage 208 separate federal programs.

Pittsburgh and Minneapolis offices. The Treasury

Pay.gov handles payments received over the Web;

expects the consolidation to result in $30 million

the hosting of electronic versions of paper forms,

in annual savings for U.S. taxpayers.

which can be completed on the Web; and the

In 2005, the Pittsburgh office processed 5.7 million
savings bond applications, printed and mailed
32 million bonds, and redeemed 48 million bonds.
Also, as part of its fiscal agency activities, Pittsburgh
managed the Treasury’s book-entry and payroll

electronic presentment of bills for federal services,
which can be executed there. Pay.gov offers
consumers and businesses electronic access to
information and transaction processing, while
reducing the Treasury’s operating costs.

savings bond programs and its TreasuryDirect

The U.S. Treasury anticipates that $30 billion

bond and note-purchasing program.

in transactions will move across Pay.gov in 2006,
including $24 billion associated with the Customs

eGovernment

and Border Protection Service.

The eGovernment function, housed in Cleveland,
is responsible for the conversion of paper checks—

Principles That Stand the Test of Time

received over the counter and at government-

Alexander Hamilton could not possibly have fore-

contracted lockbox operations—to ACH debits and

seen the way technology would transform Treasury

Check 21 clearings. These paper-check-conversion

operations or the role that the Federal Reserve

programs reduce the Treasury’s clearing costs and

System would play in that transformation. But

its exposure to risk from bounced checks.

Hamilton would no doubt recognize the business

The programs have grown significantly in the
past year: The Cleveland office currently receives

principles that guided the process: timeliness,
efficiency, and customer service.

over-the-counter check images from a total of
463 government sites on six continents and
U.S. Navy ships at sea. In 2005, the Cleveland
office handled 1.9 million over-the-counter
payments worth $1.75 billion. Lockbox papercheck conversion, launched in 2005, involved
415,000 transactions worth $456 million.

2005 Annual Report w page 29

Financial Statements

The firm engaged by the Board of Governors for the audits of the
individual and combined financial statements of the Reserve Banks for
2005 was PricewaterhouseCoopers LLP (PwC). Fees for these services
totaled $4.6 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 2005, the Bank did not
engage PwC for any material advisory services.

Management’s Report on
Responsibility for Financial Reporting

March 2, 2006
To the Board of Directors of the Federal Reserve Bank of Cleveland:
The management of the Federal Reserve Bank of Cleveland (“FRBC”) 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, 2005 (the “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 FRBC 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 FRBC 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 FRBC 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

2005 Annual Report w page 31

Report of Independent Accountants

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 of December 31, 2005, 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. 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 of December 31, 2005 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 8, 2006
Cleveland, Ohio

page 32 w Federal Reserve Bank of Cleveland

Report of Independent Auditors

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, 2005 and 2004, 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, 2005 and 2004, and results of its operations for the years then ended,
on the basis of accounting described in Note 3.

March 8, 2006
Cleveland, Ohio

2005 Annual Report w page 33

Comparative Financial Statements

Statements of Condition

(in millions)
December 31, 2005

December 31, 2004

Assets

Gold certificates

Special drawing rights certificates

453

104

Coin
Items in process of collection
U.S. government securities, net
Investments denominated in foreign currencies

452
104

820

814

31,692

31,004

1,712

1,757

Accrued interest receivable

247

217

Interdistrict settlement account

833

—

Bank premises and equipment, net

185

183

Interest on Federal Reserve notes due from U.S. Treasury

—

234

Other assets

Total assets

36,174

34,902

31,457

29,103

Liabilities and Capital

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

1,289

1,315

658

1,272

581

505

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

—

Interdistrict settlement account

—

495

Accrued benefit costs

Other liabilities

34,146

32,772

Capital paid-in

1,014

1,065

Surplus

1,014

1,065

2,028

2,130

Total liabilities
Capital:

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

page 34 w Federal Reserve Bank of Cleveland

36,174

34,902

Statements of Income

(in millions)
For the year ended
December 31, 2005

For the year ended
December 31, 2004

Interest income:
Interest on U.S. government securities

1,191

Interest on investments denominated in foreign currencies

963

1,216

985

1,182

972

Income from services

—

Compensation received for check services provided

—

Reimbursable services to government agencies

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

Foreign currency (losses)/gains, net

(243)

Other income

101

Total other operating income (loss)

(123)

208

106

103

Occupancy expense

Equipment expense

Assessments by the Board of Governors

Other expenses

246

222

Operating expenses:
Salaries and other benefits

Total operating expenses
Net income prior to distribution

813

958

Distribution of net income:
Dividends paid to member banks
Transferred (from)/to surplus

(51)

338

Payments to U.S. Treasury as interest on
Federal Reserve notes

799

575

Total distribution

Statements of Changes in Capital

813

958

(in millions)
For the years ended December 31, 2005 and December 31, 2004

Capital
Paid-in

Balance at January 1, 2004 (14.5 million shares)

Transferred to surplus

Net change in capital stock redeemed (1.0 million shares)
$

1,065

727

338

338
$

Transferred from surplus
Balance at December 31, 2005 (20.3 million shares)

—

Net change in capital stock issued (6.8 million shares)
Balance at December 31, 2004 (21.3 million shares)

727

Total
Capital

Surplus

338

—
$

1,065

1,454
338

2,130

—

(51)

—

(51)

1,014

2,028

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

2005 Annual Report w page 35

Notes to Financial Statements
1. STRUCTURE
The Federal Reserve Bank of Cleveland (“Bank”) is part of
the Federal Reserve System (“System”) and one of the twelve
Reserve Banks (“Reserve Banks”) created by Congress under
the Federal Reserve Act of 1913 (“Federal Reserve Act”), which
established the central bank of the United States. The Reserve
Banks are chartered by the federal government and possess a
unique set of governmental, corporate, and central bank characteristics. 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.
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. Banks that are members of the System
include all national banks and any state-chartered banks that
apply and are approved for membership in the System. 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.
The System also consists, in part, of the Board of Governors
of the Federal Reserve System (“Board of Governors”) and
the Federal Open Market Committee (“FOMC”). The Board
of Governors, an independent federal agency, is charged by
the Federal Reserve Act with a number of specific duties,
including general supervision over the Reserve Banks. 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.
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 system including largedollar transfers of funds, automated clearinghouse (“ACH”)
operations, and check processing; distributing coin and currency;
performing fiscal agency functions for the U.S. Treasury and
certain federal agencies; serving as the federal government’s bank;
providing short-term loans to depository institutions; serving the
consumer and the community by providing educational materials
and information regarding consumer laws; supervising bank
holding companies, state member banks, and U.S. offices of foreign
banking organizations; and administering other regulations of
the Board of Governors. The System also provides certain
services to foreign central banks, governments, and international
official institutions.
The FOMC, in the conduct of monetary policy, establishes
policy regarding domestic open market operations, oversees
these operations, and annually issues authorizations and
directives to the FRBNY for its execution of transactions. FRBNY
is authorized to conduct operations in domestic markets,
including direct purchase and sale of U. S. government securities,
the purchase of securities under agreements to resell, the sale
page 36 w Federal Reserve Bank of Cleveland

of securities under agreements to repurchase, and the lending of
U.S. government securities. FRBNY executes these open market
transactions and holds the resulting securities, with the exception
of securities purchased under agreements to resell, 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 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. The FRBNY is authorized
by the FOMC to hold balances of, and to execute spot and
forward foreign exchange (“F/X”) and securities contracts for
nine foreign currencies and to invest such foreign currency
holdings ensuring adequate liquidity is maintained. In addition,
FRBNY is authorized to maintain reciprocal currency arrangements (“F/X swaps”) with two central banks, and “warehouse”
foreign currencies for the U.S. Treasury and Exchange Stabilization Fund (“ESF”) through the Reserve Banks. In connection with
its foreign currency activities, FRBNY 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.
Although Reserve Banks are separate legal entities, in the
interests of greater efficiency and effectiveness, they collaborate
in the delivery of certain operations and services. The collaboration takes the form of centralized competency centers, operations
sites, and product or service offices that have responsibility for
the delivery of certain services on behalf of the Reserve Banks.
Various operational and management models are used and are
supported by service agreements between the Reserve Bank
providing the service and the other eleven Reserve Banks. In
some cases, costs incurred by a Reserve Bank for services
provided to other Reserve Banks are not shared; in other cases,
Reserve Banks are billed for services provided to them by another
Reserve Bank.
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, FedImage, Savings Bonds
technology, National Check Adjustments, Check 21, National
Check Restructure, Cash Automation and Materials Handling
Software, Check Automation Services, National Billing
Operations, and Audit Application Competency Center.
Beginning in 2005, the Reserve Banks adopted a new management
model for providing check services to depository institutions.
Under this new model, the Federal Reserve Bank of Atlanta
(“FRBA”) has the overall responsibility for managing the Reserve
Banks’ provision of check services and recognizes total System
check revenue on its Statements of Income. FRBA compensates
the other eleven Reserve Banks for the costs incurred to provide
check services. This compensation is reported as “Compensation received for check services provided” in the Statements of
Income. If the management model had been in place in 2004, the
Bank would have reported $58 million as compensation received
for check services provided and $61 million in check revenue
would have been reported by FRB Atlanta rather than the Bank.

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 various accounting standard-setting bodies.
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 and the financial statements have been prepared in
accordance with the Financial Accounting Manual.
Differences exist between the accounting principles and practices
in the Financial Accounting Manual and those generally accepted
in the United States (“GAAP”) primarily due to the unique nature
of the Bank’s powers and responsibilities as part of the nation’s
central bank. The primary difference is the presentation of all
security holdings at amortized cost, rather than using the fair
value presentation requirements in accordance with GAAP.
Amortized cost more appropriately reflects the Bank’s security
holdings given its unique responsibility to conduct monetary
policy. While the application of current market prices to the
securities holdings may result in values substantially above or
below their carrying values, these unrealized changes in value
would have no direct affect on the quantity of reserves available
to the banking system or on the prospects for future Bank
earnings or capital. Both the domestic and foreign components
of the SOMA portfolio may involve transactions that result in
gains or losses when holdings are sold prior to maturity.
Decisions regarding security and foreign currency 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
securities and currencies are incidental to the open market
operations and do not motivate its activities or policy decisions.
In addition, the Bank has elected not to present a Statement of
Cash Flows because the liquidity and cash position of the Bank
are not a primary concern given the Bank’s unique powers and
responsibilities. A Statement of Cash Flows, therefore, would
not provide any additional meaningful information. Other information regarding the Bank’s activities is provided in, or may be
derived from, the Statements of Condition, Income, and Changes
in Capital. There are no other significant differences between the
policies outlined in the Financial Accounting Manual and GAAP.
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. Certain
amounts relating to the prior year have been reclassified to
conform to the current-year presentation. Unique accounts and
significant accounting policies are explained below.
a. Gold and Special Drawing Rights Certificates
The Secretary of the U.S. Treasury is authorized to issue gold
and special drawing rights (“SDR”) certificates to the Reserve
Banks.

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 the average Federal Reserve notes
outstanding in each Reserve Bank.
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 2005 or 2004.
b. Loans to Depository Institutions
All depository institutions that maintain reservable transaction
accounts or nonpersonal time deposits, as defined in regulations
issued by the Board of Governors, have borrowing privileges at
the discretion of the Reserve Bank. 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 Board of Directors
of the Reserve Bank, subject to review by the Board of Governors.
There were no outstanding loans to depository institutions at
December 31, 2005 and 2004.
c. U.S. Government Securities and
Investments Denominated in Foreign Currencies
U.S. government 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. Gains and
losses resulting from sales of securities are determined by
specific issues based on average cost. Foreign-currencydenominated 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 (losses), net.”
Activity related to U.S. government securities, including the
related premiums, discounts, and realized and unrealized gains
and losses, is allocated to each Reserve Bank on a percentage
basis derived from an annual settlement of interdistrict clearings that occurs in April of each year. The settlement equalizes
2005 Annual Report w page 37

Reserve Bank gold certificate holdings to Federal Reserve notes
outstanding in each District. Activity related to investments in
foreign-currency-denominated assets is allocated to each Reserve
Bank based on the ratio of each Reserve Bank’s capital and
surplus to aggregate capital and surplus at the preceding
December 31.
d. U.S. Government Securities Sold Under
Agreements to Repurchase and Securities Lending
Securities sold under agreements to repurchase are accounted
for as financing transactions and the associated interest expense
is recognized over the life of the transaction. These transactions
are carried in the Statements of Condition at their contractual
amounts and the related accrued interest is reported as a
component of “Other liabilities.”
U.S. government securities held in the SOMA are lent to U.S.
government securities dealers and to banks participating in
U.S. government securities clearing arrangements in order to
facilitate the effective functioning of the domestic securities
market. Securities-lending transactions are fully collateralized
by other U.S. government securities and the collateral taken is in
excess of the market value of the securities loaned. The FRBNY
charges the dealer or bank a fee for borrowing securities and the
fees are reported as a component of “Other income” in the
Statements of Income.
Activity related to U.S. government securities sold under agreements to repurchase and securities lending is allocated to each
Reserve Bank on a percentage basis derived from the annual
settlement of interdistrict clearings. Securities purchased under
agreements to resell are allocated to FRBNY and not to the
other Banks.
e. Foreign Currency Swaps and Warehousing
F/X swap arrangements are contractual agreements between two
parties to exchange specified currencies, at a specified price, on
a specified date. 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 the
foreign currencies it may need to intervene to support the dollar
and give the counterparty temporary access to dollars it may
need to support its own currency. Drawings under the F/X
swap arrangements can be initiated by either FRBNY or the
counterparty (the drawer) and must be agreed to by the drawee.
The F/X swaps are structured so that the party initiating the
transaction bears the exchange rate risk upon maturity. FRBNY
will generally invest the foreign currency received under an
F/X swap in interest-bearing instruments.
Warehousing is an arrangement under which the FOMC agrees
to exchange, at the request of the U.S. Treasury, U.S. dollars
for foreign currencies held by the U.S. 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 U.S. Treasury and
ESF for financing purchases of foreign currencies and related
international operations.
Foreign currency swaps and warehousing agreements are
revalued daily at current market exchange rates. Activity related
to these agreements, with the exception of the unrealized gains
and losses resulting from the daily revaluation, is allocated to
each Reserve Bank based on the ratio of each Reserve Bank’s
capital and surplus to aggregate capital and surplus at the
preceding December 31. Unrealized gains and losses resulting
from the daily revaluation are allocated to FRBNY and not to the
other Reserve Banks.

page 38 w Federal Reserve Bank of Cleveland

f. 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 one to
fifty years. Major alterations, renovations, and improvements
are capitalized at cost as additions to the asset accounts and
are amortized over the remaining useful life of the asset.
Maintenance, repairs, and minor replacements are charged
to operating expense in the year incurred. Capitalized assets
including software, building, leasehold improvements, furniture,
and equipment are impaired when it is determined that the net
realizable value is significantly less than book value and is
not recoverable.
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 straightline basis over the estimated useful lives of the software
applications, which range from one to five years.
g. Interdistrict Settlement Account
At the close of business each day, each Reserve Bank assembles
the payments due to or from other Reserve Banks as a result of
the day’s transactions that involve depository institution accounts
held by other Districts. Such transactions may include funds
settlement, check clearing, and ACH operations. The cumulative
net amount due to or from the other Reserve Banks is reflected
in the “Interdistrict settlement account” in the Statements of
Condition.
h. 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.
Assets eligible to be pledged as collateral security include all
Bank assets. 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 deducted.
The Board of Governors may, at any time, call upon a Reserve
Bank for additional security to adequately collateralize the
Federal Reserve notes. To satisfy the obligation to provide
sufficient collateral for outstanding Federal Reserve notes, the
Reserve Banks have entered into an agreement that provides
for certain assets of the Reserve Banks to be jointly pledged as
collateral for the Federal Reserve notes of all Reserve Banks. In
the event that this collateral is insufficient, the Federal Reserve
Act provides that Federal Reserve notes become a first and
paramount lien on all the assets of the Reserve Banks. Finally,
as obligations of the United States, Federal Reserve notes are
backed by the full faith and credit of the United States
government.

The “Federal Reserve notes outstanding, net” account represents
the Bank’s Federal Reserve notes outstanding, reduced by the
currency issued to the Bank but not in circulation, of $5,081 million
and $5,408 million at December 31, 2005 and 2004, respectively.
i. Items in Process of Collection and Deferred Credit Items
The balance in the “Items in process of collection” line in the
Statements of Condition primarily represents amounts
attributable to checks that have been deposited for collection
by the payee depository institution and, as of the balance sheet
date, have not yet been collected from the payor depository
institution. Deferred credit items are the counterpart liability to
items in process of collection, and the amounts in this account
arise from deferring credit for deposited items until the amounts
are collected. The balances in both accounts can fluctuate and
vary significantly from day to day.
j. 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.
These shares are nonvoting with a par value of $100 and may not
be transferred or hypothecated. As a member bank’s capital and
surplus changes, its holdings of Reserve Bank stock must be
adjusted. Currently, only one-half of the subscription is paid-in
and the remainder is subject to call. By law, each Bank is
required to pay each member bank 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.
k. 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 an increase in capital paid-in at a
Reserve Bank, payments to the U.S. Treasury are suspended
and earnings are retained until the surplus is equal to the
capital paid-in. Weekly payments to the U.S. Treasury may
vary significantly.
In the event of a decrease in capital paid-in, the excess surplus,
after equating capital paid-in and surplus at December 31, is
distributed to the U.S. Treasury in the following year. This
amount is reported as a component of “Payments to U.S.
Treasury as interest on Federal Reserve notes.”
l. Income and Costs related to U.S. 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.

m. Assessments by the Board of Governors
The Board of Governors assesses the Reserve Banks to fund its
operations based on each Reserve Bank’s capital and surplus
balances. The Board of Governors also assesses each Reserve
Bank for the expenses incurred for the U.S. Treasury to issue and
retire Federal Reserve notes based on each Reserve Bank’s share
of the number of notes comprising the System’s net liability for
Federal Reserve notes on December 31 of the previous year.
n. 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,
2005 and 2004, and are reported as a component of “Occupancy
expense.”
o. Restructuring Charges
In 2003, the System began the restructuring of several
operations, primarily check, cash, and U.S. Treasury 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. These restructuring activities continued in
2004 and 2005.
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 in
connection with the restructuring activities for all Reserve Banks
are recorded on the books of the FRBNY and those associated
with enhanced post-retirement benefits are discussed in footnote 9.
4. U.S. GOVERNMENT SECURITIES, SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE, AND SECURITIES LENDING
The FRBNY, on behalf of the Reserve Banks, holds securities
bought outright in the SOMA. The Bank’s allocated share of
SOMA balances was approximately 4.225 percent and
4.273 percent at December 31, 2005 and 2004, respectively.
The Bank’s allocated share of U.S. Government securities, net,
held in the SOMA at December 31, was as follows (in millions):
2005

Par value:
U.S. government:
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated to Bank

11,460
16,058
3,921
31,439
372
(119)
31,692

2004

11,237
15,418
4,017
30,672
402
(70)
31,004

The total of the U.S. government securities, net held in the SOMA
was $750,202 million and $725,584 million at December 31, 2005
and 2004, respectively.
At December 31, 2005 and 2004, the total contract amount of
securities sold under agreements to repurchase was $30,505
million and $30,783 million, respectively, of which $1,289 million
and $1,315 million, were allocated to the Bank. The total par
value of the SOMA securities pledged for securities sold under
agreements to repurchase at December 31, 2005 and 2004 was
$30,559 million and $30,808 million, respectively, of which
$1,291 million and $1,316 million was allocated to the Bank.

2005 Annual Report w page 39

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, 2005, was as follows
(in millions):

Maturities of Securities Held

Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total

U.S.
Securities Sold
Government Under Agreements
Securities
to Repurchase
(Par value) (Contract amount)

1,732
7,277
7,870
8,903
2,395
3,262
31,439

1,289
—
—
—
—
—
1,289

At December 31, 2005 and 2004, U.S. government securities with
par values of $3,776 million and $6,609 million, respectively, were
loaned from the SOMA, of which $160 million and $282 million,
respectively, were allocated to the Bank.
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.
The Bank’s allocated share of investments denominated in foreign
currencies was approximately 9.043 percent and 8.220 percent at
December 31, 2005 and 2004, respectively.
The Bank’s allocated share of investments denominated in
foreign currencies, including accrued interest, valued at current
foreign currency market exchange rates at December 31, was as
follows (in millions):
2005

European Union Euro:
Foreign currency deposits
Securities purchased under
agreements to resell
Government debt instruments
Japanese Yen:
Foreign currency deposits
Government debt instruments
Total

491

2004

500

174
322

176
324

237
488
1,712

127
630
1,757

Total System investments denominated in foreign currencies
were $18,928 million and $21,368 million at December 31, 2005
and 2004, respectively.
The maturity distribution of investments denominated in foreign
currencies which were allocated to the Bank at December 31,
2005, was as follows (in millions):
Maturities of Investments
Denominated in Foreign Currencies

European
Euro

Japanese
Yen

Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total

306
233
189
258
1
—
987

237 $
61
91
336
—
—
725 $

Total

543
294
280
594
1
—
1,712

At December 31, 2005 and 2004, there were no open or outstanding
foreign exchange contracts.

page 40 w Federal Reserve Bank of Cleveland

At December 31, 2005 and 2004, 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):
Useful
Life Range
(in Years)

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

N/A
1–43
1–20
N/A
1–9

2005

$
$
$

8
170
49
3
70
300
(115)
185
11

2004

$
$
$

7
163
48
6
68
292
(109)
183
11

The Bank leases space to outside tenants with lease terms
ranging from one to nine years. Rental income from such leases
was $1 million for each of the years ended December 31, 2005
and 2004. Future minimum lease payments under noncancelable
agreements in existence at December 31, 2005, were (in millions):
2006
2007
2008
2009
2010
Thereafter

1
1
1
1
1
3
8

The Bank has capitalized software assets, net of amortization,
of $39 million for each of the years ended December 31, 2005 and
2004. Amortization expense was $12 million and $8 million for the
years ended December 31, 2005 and 2004, respectively. Capitalized software assets are reported as a component of “Other
assets” and related amortization is reported as a component of
“Other expenses.” Obsolete software assets of $1 million were
written off for each of the years ended December 31, 2005 and
2004. The majority of the write offs were reimbursed by the
Department of the Treasury.
Assets impaired as a result of the Bank’s restructuring plan, as
discussed in footnote 10, include building, leasehold improvements, furniture, and equipment. Asset impairment losses of
$2 million for the period ending December 31, 2004, were determined using fair values based on quoted market values or other
valuation techniques and are reported as a component of “Other
expenses.” The Bank had no impairment losses in 2005.
7. COMMITMENTS AND CONTINGENCIES
At December 31, 2005, the Bank was obligated under noncancelable leases for premises and equipment with terms ranging
from one to approximately two 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, 2005 and 2004. 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, 2005, were not material.
At December 31, 2005, the Bank, acting on its own behalf, had
other commitments and long-term obligations extending through
the year 2010 with a remaining amount of $14 million. As of
December 31, 2005, commitments of $50 million were recognized.
Purchases of $22 million and $18 million were made against
these commitments during 2005 and 2004, respectively. These
commitments represent Electronic Treasury Financial Services,
facilities-related expenditures, and Cash and Check transportation and have variable and fixed components. The variable
portion of the commitments is primarily for Cash and Check
transportation. The fixed payments for the next five years under
these commitments are (in millions):
2006
2007
2008
2009
2010

Fixed Commitment
$
6.6
2.1
2.0
0.3
0.1

At December 31, 2005, the Bank, acting on behalf of the Reserve
Banks, had contractual commitments extending through the year
2012 totaling $41 million. As of December 31, 2005, commitments
of $54 million were recognized. Purchases of $16 million and
$7 million were made against these commitments during 2005 and
2004, respectively. It is estimated that the Bank’s allocated share
of these commitments will be $8 million. These commitments
represent Check software and hardware license and maintenance
fees and have only fixed components. The fixed payments for the
next five years under these commitments are (in millions):
2006
2007
2008
2009
2010

Fixed Commitment
$
12.7
12.3
10.0
5.9
0.1

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 System. No separate accounting is
maintained of assets contributed by the participating employers.
The FRBNY acts as a sponsor of the System Plan and the
costs associated with the Plan are not redistributed to other
participating employers. The Bank’s benefit obligation and net
pension costs for the BEP and the SERP at December 31, 2005
and 2004, 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 $4 million and $3 million for the years ended December
31, 2005 and 2004, respectively, and are reported as a component
of “Salaries and other benefits.” The Bank matches employee
contributions based on a specified formula. For the years ended
December 31, 2005 and 2004, the Bank matched 80 percent on the
first 6 percent of employee contributions for employees with less
than five years of service and 100 percent on the first 6 percent of
employee contributions for employees with five or more years of
service.
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.
Following is a reconciliation of beginning and ending balances of
the benefit obligation (in millions):
2005

Under the Insurance Agreement of the Federal Reserve Banks,
each Reserve Bank 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, 2005 or 2004.
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 three 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”). Employees at certain compensation
levels participate in the Benefit Equalization Retirement
Plan (“BEP”) and certain Bank officers participate in the
Supplemental Employee Retirement Plan (“SERP”).

Accumulated postretirement benefit
obligation at January 1
Service cost-benefits earned during
the period
Interest cost of accumulated
benefit obligation
Actuarial (gain) loss
Special termination (gain) loss
Contributions by plan participants
Benefits paid
Plan amendments
Accumulated postretirement benefit
obligation at December 31

66.3

2004

56.1

1.6

1.8

3.1
(9.0)
—
0.3
(3.1)
—

4.1
20.2
0.1
0.2
(2.8)
(13.4)

59.2

66.3

At December 31, 2005 and 2004, the weighted-average discount
rate assumptions used in developing the postretirement benefit
obligation were 5.50 percent and 5.75 percent, respectively.
Discount rates reflect yields available on high quality corporate
bonds that would generate the cash flows necessary to pay the
plan’s benefits when due.

2005 Annual Report w page 41

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):
2005

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 (loss)
Accrued postretirement benefit costs

$
$

—
—
2.8
0.3
(3.1)
—
59.2
10.2
(13.7)
55.7

2004

—
—
2.6
0.2
(2.8)
—

$
$

66.3
12.5
(23.1)
55.7

Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs.”
For measurement purposes, the assumed health care cost trend
rates at December 31 are as follows:
Health care cost trend rate assumed for next year
Rate to which the cost trend rate is assumed
to decline (the ultimate trend rate)
Year that the rate reaches the ultimate trend rate

2005

2004

9.00%

5.00%
2011

4.75%
2011

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, 2005 (in
millions):
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

0.8

One Percentage
Point Decrease

(0.6)

7.9

(6.5)

The following is a summary of the components of net periodic
postretirement benefit costs for the years ended December 31
(in millions):
2005

Service cost–benefits earned
during the period
Interest cost of accumulated
benefit obligation
Amortization of prior service cost
Recognized net actuarial loss
Total periodic expense
Curtailment (gain)
Special termination loss
Net periodic postretirement benefit costs

1.6

3.1
(2.3)
0.4
2.8
—
—
2.8

2004

1.8

4.1
(0.6)
0.8
6.1
(1.1)
0.1
5.1

Net postretirement benefit costs are actuarially determined using
a January 1 measurement date. At January 1, 2005 and 2004, the
weighted-average discount rate assumptions used to determine
net periodic postretirement benefit costs were 5.75 percent and
6.25 percent, respectively.
Net periodic postretirement benefit costs are reported as a
component of “Salaries and other benefits.”
A plan amendment that modified the credited service period
eligibility requirements created curtailment gains in 2004. The
recognition of special termination losses is primarily the result
of enhanced retirement benefits provided to employees during the
restructuring described in footnote 10.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a prescription drug benefit under
page 42 w Federal Reserve Bank of Cleveland

Medicare (“Medicare Part D”) and a federal subsidy to sponsors
of retiree health care benefit plans that provide benefits that are
at least actuarially equivalent to Medicare Part D. The benefits
provided by the Bank’s plan to certain participants are at least
actuarially equivalent to the Medicare Part D prescription drug
benefit. The estimated effects of the subsidy, retroactive to
January 1, 2004, are reflected in actuarial loss in the accumulated
postretirement benefit obligation and net periodic postretirement
benefit costs.
Following is a summary of expected benefit payments
(in millions):
Without Subsidy

2006
2007
2008
2009
2010
2011–2015
Total

3.0
3.1
3.3
3.4
3.5
20.2
36.5

With Subsidy

2.7
2.8
2.9
3.0
3.1
17.7
32.2

Postemployment Benefits
The Bank offers benefits to former or inactive employees.
Postemployment benefit costs are actuarially determined using
a December 31, 2005, measurement date and include the cost
of medical and dental insurance, survivor income, disability
benefits, and self-insured workers’ compensation expenses.
The accrued postemployment benefit costs recognized by the
Bank at December 31, 2005 and 2004, were $8.7 million and
$8.6 million, respectively. This cost is included as a component
of “Accrued benefit costs.” Net periodic postemployment benefit
costs included in 2005 and 2004 operating expenses were
$1 million and $3 million, respectively and are recorded as a
component of “Salaries and other benefits.”
10. BUSINESS 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.
In 2004 and 2005, additional consolidation and restructuring
initiatives were announced in the Check operations, Check
Automation Services, and Marketing. These actions resulted in
the following business restructuring charges (in millions):
Total
Accrued
Estimated Liability
Total
Costs 12/31/2004 Charges

Employee
separation

1.1

1.2

— $

Accrued
Total Liability
Paid 12/31/2005

0.3

0.9

Employee separation costs are primarily severance costs related
to identified staff reductions of approximately 70, including 16
staff reductions related to restructuring announced in 2004.
These costs 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.”
Restructuring 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.
Future costs associated with the announced restructuring plans
are not material.
The Bank anticipates substantially completing its announced
plans by March 2006.

National Road, 1941

Superhighways: An American Icon

Concrete began to surpass brick and dirt as the
preferred road-surface material in 1912, but it
wasn’t until the Federal Highway Act of 1938
that an interstate highway system was considered,
proposed by President Roosevelt as a way of providing jobs. The goal of the act was to study the feasibility of a national, six-route, toll-road network.

The Dwight D. Eisenhower System of Interstate
and Defense Highways has over 40,000 miles
of interstates, which represent 1 percent of
our nation’s total road length, yet carry over
20 percent of its traffic. There is hardly one aspect
of American society that has not been affected by
the interstates.

Officers and Consultants
Sandra Pianalto
President and Chief Executive Officer

R. Chris Moore
First Vice President and Chief Operating Officer

Andrew C. Burkle, Jr.

(as of December 31, 2005)

David E. Altig
Vice President and Associate Director of Research
Research

Douglas A. Banks
Vice President and Consumer Affairs Officer
Supervision and Regulation

Senior Vice President
Supervision and Regulation, Credit Risk Management,
Statistics and Analysis

Raymond L. Brinkman

Lawrence Cuy

Michael F. Bryan

Vice President
Treasury Retail Securities

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

Vice President and Economist
Research

Robert W. Price

Vice President and Community Affairs Officer
Community Affairs

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 Retail Securities, Facilities, Information Security,
Protection, Business Continuity, eGovernment, Payments System Research

Mark S. Sniderman
Senior Vice President and Director of Research
Research, Economic Policy and Strategy

Peggy A. Velimesis
Senior Vice President
Human Resources, Payroll, Internal Communications,
Quality Process, EEO Officer

Andrew W. Watts
Senior Vice President and General Counsel
Legal, Ethics Officer

Ruth M. Clevenger

Cheryl L. Davis
Vice President and Corporate Secretary
Community Affairs, Public Information, Office of the Corporate Secretary

William D. Fosnight
Vice President and Associate General Counsel
Legal

Barbara B. Henshaw
Vice President
Cincinnati Location Officer, Protection, Business Continuity

Suzanne M. Howe
Vice President
eGovernment Operations, Treasury Electronic Check Processing

David P. Jager
Vice President
eGovernment

Stephen H. Jenkins
Vice President
Supervision and Regulation

Jon C. Jeswald
Vice President
Retail Payments Office

Rayford P. Kalich
Vice President
Accounting, Budget Procurement, Strategic Planning, Risk Management

Stephen J. Ong
Vice President
Credit Risk Management, Statistics and Analysis

Terrence J. Roth
Vice President
Retail Payments Office, Check Products

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

page 44 w Federal Reserve Bank of Cleveland

Officers and Consultants

(as of December 31, 2005)

Gregory L. Stefani

Dean A. Longo

Vice President
Supervision and Regulation

Consultant
Information Technology

James B. Thomson

Martha Maher

Vice President and Economist
Research

Assistant Vice President
Retail Payments Office

Anthony Turcinov

Mark S. Meder

Vice President
Check Operations, Check Adjustments

Assistant Vice President
Supervision and Regulation

Jeffrey R. Van Treese

James J. Miklich

Vice President
Cincinnati Check Operations

Assistant Vice President
Check Automation Services

Lisa M. Vidacs

Anthony V. Notaro

Vice President
Cash Operations

Assistant Vice President
Facilities

Darell R. Wittrup

James W. Rakowsky

Vice President
Accounting, System Billing

Assistant Vice President
Cleveland Facilities

Robin R. Ratliff
Kelly A. Banks
Assistant Vice President and Public Information Officer
Public Information, Communication Support, Learning Center

Tracy L. Conn
Assistant Vice President
Supervision and Regulation

Stephen J. Geers
Assistant Vice President
Check Consolidation

Patrick J. Geyer
Assistant Vice President
eGovernment Operations

Kenneth J. Good
Assistant Vice President
Check Adjustments, Image Services System Operations

Felix Harshman
Assistant Vice President
Accounting, Budget

Joseph G. Haubrich
Consultant and Economist
Research

Amy J. Heinl
Assistant Vice President
Treasury Retail Securities

Paul E. Kaboth
Assistant Vice President
Supervision and Regulation

Kenneth E. Kennard
Assistant Vice President
Protection

Susan M. Kenney
Assistant Vice President
eGovernment Technical Support, Pay.gov

Assistant Vice President and Assistant Corporate Secretary
Office of the Corporate Secretary

John P. Robins
Consultant
Supervision and Regulation

Elizabeth J. Robinson
Assistant Vice President
Human Resources

Thomas E. Schaadt
Assistant Vice President
Check Automation Services

Mark E. Schweitzer
Assistant Vice President and Economist
Research

Jerome J. Schwing
Assistant Vice President
Cincinnati Check Operations

James P. Slivka
Assistant Vice President
Information Systems Audit Function, Audit Application Competency Center

Diana C. Starks
Assistant Vice President
Information Technology Governance System Initiative

Henry P. Trolio
Assistant Vice President
Information Technology

Michael Vangelos
Assistant Vice President
Information Security, Business Continuity

Nadine M. Wallman
Assistant Vice President
Supervision and Regulation
2005 Annual Report w page 45

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 the public interests of
agriculture, commerce, industry, services, labor,
and consumers. Class C directors are 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 and deputy chairman of the board.
Directorships generally are limited to two successive
terms to ensure that the individuals who serve the
Federal Reserve System represent a diversity of
backgrounds and experience.
The Cincinnati and Pittsburgh branch offices
each have a board of seven directors who serve
three-year terms. Board members are appointed
by the Federal Reserve Bank of Cleveland and the
Board of Governors.

page 46 w Federal Reserve Bank of Cleveland

Cleveland Board of Directors

(as of December 31, 2005)

Robert W. Mahoney
Chairman

Martin G. McGuinn
Federal Advisory Council Representative

Retired Chairman and Chief Executive Officer
Diebold, Incorporated
North Canton, Ohio

Chairman and Chief Executive Officer
Mellon Financial Corporation
Pittsburgh, Pennsylvania

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

Phillip R. Cox
President and Chief Executive Officer
Cox Financial Corporation
Cincinnati, Ohio

Tanny Crane
President and Chief Executive Officer
Crane Group Company
Columbus, Ohio

V. Ann Hailey
Executive Vice President and Chief Financial Officer
Limited Brands
Columbus, Ohio

Henry L. Meyer III
Chairman and Chief Executive Officer
KeyCorp
Cleveland, Ohio

Les C. Vinney
President and Chief Executive Officer
STERIS Corporation
Mentor, 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

(l–r): Charles E. Bunch, Stephen P. Wilson, Bick Weissenrieder, V. Ann Hailey, Robert W. Mahoney, Henry L. Meyer III, Phillip R. Cox,
Tanny Crane, and Les C. Vinney.

2005 Annual Report w page 47

Cincinnati Board of Directors
James M. Anderson
Chairman
President and Chief Executive Officer
Cincinnati Children’s Hospital Medical Center
Cincinnati, Ohio

James H. Booth
President
Czar Coal Corporation
Lovely, Kentucky

Herbert R. Brown
Senior Vice President
Western & Southern Financial Group
Cincinnati, Ohio

(as of December 31, 2005)

Charlotte W. Martin
President and Chief Executive Officer
Great Lakes Bankers Bank
Gahanna, Ohio

V. Daniel Radford
Executive Secretary –Treasurer
Cincinnati AFL–CIO Labor Council
Cincinnati, Ohio

Charles Whitehead
Retired President
Ashland Inc. Foundation
Covington, Kentucky

Glenn D. Leveridge
President, Lexington Market
JPMorgan Chase Bank
Lexington, Kentucky

(l–r): Herbert R. Brown, James H. Booth, James M. Anderson, V. Daniel Radford, Charles Whitehead, Charlotte W. Martin, and
Glenn D. Leveridge.

page 48 w Federal Reserve Bank of Cleveland

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

Robert O. Agbede
President and Chief Executive Officer
ATS–Chester Engineers, Inc.
Pittsburgh, Pennsylvania

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

(as of December 31, 2005)

James I. Mitnick
Senior Vice President
Turner Construction Company
Pittsburgh, Pennsylvania

Kristine N. Molnar
Executive Vice President
WesBanco Bank, Inc.
Wheeling, West Virginia

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

(l–r): Robert O. Agbede, Georgiana N. Riley, James I. Mitnick, Roy W. Haley, Kristine N. Molnar, and Michael J. Hagan.

2005 Annual Report w page 49

Business Advisory Councils

(as of December 31, 2005)

Business Advisory Council members are a diverse group of Fourth District businesspeople who advise the president and
senior officers on current business conditions.
In 2005, the Bank’s Business Advisory Council expanded into three councils—in Cleveland, Cincinnati, and Pittsburgh—
to provide greater regional presence and outreach.
Each council meets with senior Bank leaders at least twice yearly. These meetings provide anecdotal information
that is useful in the consideration of monetary policy direction and economic research activities.

Cleveland

Cincinnati

Pittsburgh

Gerald E. Henn

Cynthia O. Booth

R. Yvonne Campos

Founder and President
Henn Corporation
Warren, Ohio

Christopher J. Hyland
Chief Financial Officer
Hyland Software, Inc.
Westlake, Ohio

Gary A. Lesjak

Chief Financial Officer
The Shamrock Companies Inc.
Westlake, Ohio

Rodger W. McKain

President
SOFCo-EFS Holdings LLC
Alliance, Ohio

Kevin M. McMullen
Chairman and CEO
OMNOVA Solutions Inc.
Fairlawn, Ohio

Michael J. Merle

Executive Vice President
Ray Fogg Building Methods, Inc.
Brooklyn Heights, Ohio

Frederick D. Pond

President and
Chief Executive Officer
COBCO Enterprises
Cincinnati, Ohio

Charles H. Brown

Vice President of Accounting
and Finance
Toyota Motor Manufacturing North America, Inc.
Erlanger, Kentucky

Ronald D. Brown

Chairman, President, and
Chief Executive Officer
Milacron Inc.
Cincinnati, Ohio

James E. Bushman

President and
Chief Executive Officer
Cast-Fab Technologies, Inc.
Cincinnati, Ohio

Frederick W.P. Buttrell
President
Comair, Inc.
Erlanger, Kentucky

Richard O. Coleman

President
Ridge Tool Company, Inc.
Elyria, Ohio

President and
Chief Executive Officer
GenStone Acquisition Company
Cincinnati, Ohio

Scott E. Rickert

Jerry A. Foster

President and Co-founder
Nanofilm, Corporate Headquarters
Valley View, Ohio

Jack H. Schron, Jr.

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

Steven J. Williams

President and
Chief Executive Officer
Elsons International, Inc.
Cleveland, Ohio

President
Diversified Tool & Development
Richmond, Kentucky

Edward R. Jackson

President and
Chief Executive Officer
Fierro Technologies, Inc.
Cincinnati, Ohio

Rebecca S. Mobley

Co-owner, Broker, and
Relocation Director
TurfTown Properties, Inc.
Lexington, Kentucky

Joseph L. Rippe

Partner
Rippe & Kingston, Co. psc
Cincinnati, Ohio
page 50 w Federal Reserve Bank of Cleveland

President
Campos, Inc.
Pittsburgh, Pennsylvania

Renee S. Frazier

Senior Vice President
and Executive Officer
VHA Pennsylvania
Pittsburgh, Pennsylvania

D. Michael Hartley

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

John L. Kalkreuth

President
Kalkreuth Roofing and Sheet Metal
Wheeling, West Virginia

Scott D. Leib

President
Applied System Associates, Inc.
Murrysville, Pennsylvania

Steven C. Price

Chief Executive Officer
TBG Consulting, Inc.
Pittsburgh, Pennsylvania

Stephen V. Snavely

Chief Executive Officer
Snavely Forest Products, Inc.
Pittsburgh, Pennsylvania

Robert G. Visalli

President and
Chief Executive Officer
Kerotest Manufacturing Corporation
Pittsburgh, Pennsylvania

Federal Reserve Bank of Cleveland
2005

www.clevelandfed.org

Annual Report

The Federal Reserve System is responsible for

This Annual Report was prepared by the

Acknowledgments

formulating and implementing U.S. monetary policy.

Public Information and Research departments

Manager, Communications Support

It also supervises banks and bank holding companies

of the Federal Reserve Bank of Cleveland.

Michael Galka

and provides financial services to depository institutions
For additional copies, contact the Research Library,

and the federal government.

Federal Reserve Bank of Cleveland, P.O. Box 6387,
The Federal Reserve Bank of Cleveland is one of

Cleveland, OH 44101, or call (216) 579-2052.

12 regional Reserve Banks in the United States that,

Editor
Amy Koehnen

Designer
Lori Boehm

together with the Board of Governors in Washington,

The Annual Report is also available electronically

Portrait Photography

D.C., comprise the Federal Reserve System.

through the Cleveland Fed’s home page,

Bill Pappas Photography, Inc.

www.clevelandfed.org.

Stock Photography provided by

The Federal Reserve Bank of Cleveland, including its

Corbis, Fotosearch, Getty Images,
The Granger Collection, The Image
Finders, Inmagine, Jupiterimages,
and the Ohio Historical Society

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

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

Pittsburgh
717 Grant Street
Pittsburgh, PA 15129
(412) 261-7800

Annual Report

2005
www.clevelandfed.org

F E D E R A L R E S E R V E B A N K O F C L E V E L A N D 2005 A N N U A L R E P O R T

Federal Reserve Bank of Cleveland

Full text of Annual Report of the Federal Reserve Bank of Cleveland : 2005 Annual Report

FRASER