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2013 Annual Report | Federal Reserve Bank of Philadelphia Message from the President 100 Years of Tradition and Transition n December 23, 2013, the Federal Reserve O System marked 100 years from the signing of the Federal Reserve Act by President Woodrow Wilson. This began a centennial period that will run through the 100th anniversary of when the 12 Federal Reserve Banks opened for business on November 16, 1914. That is why “100 Years of Tradition and Transition” is the subject of this year’s annual report. I have often described the Federal Reserve as a uniquely American form of a central bank — a decentralized central bank. To understand how it came to be, there is no better place to start than in Philadelphia, where just a few blocks from our Bank building you can find the vestiges of two earlier attempts at central banking from the time this city was the nation’s financial and political center. The cover article provides an overview of the 100-year history of the Federal Reserve System, including a comparison of our present structure with the two prior attempts. In this year’s essay, “A Limited Central Bank,” I take a step back and consider the Federal Reserve’s essential role more broadly and how the Fed might be improved to better fulfill that role. The annual report includes a message from First Vice President Blake Prichard on “A Century of Service” and “Bank Highlights” of our accomplishments Charles I. Plosser President and Chief Executive Officer during 2013. One of the past year’s highlights was the Policy Forum in December, which focused on 1 2 2013 Annual Report| Federal Reserve Bank of Philadelphia the “History of Central Banking in the United States.” We were extraordinarily pleased to have former Chairman Alan Greenspan and former Vice Chair Don Kohn, among others, participate in the daylong event. Our institution has been fortunate to have extraordinary citizens who have served on the Bank’s board of directors and advisory councils. As I look back at 2013, I especially thank Jeremy Nowak, president of J Nowak and Associates, LLC, who completed his second year as chairman and his sixth year as a director. I also thank Keith S. Campbell, chairman of Mannington Mills of Salem, NJ, and R. Scott Smith, retired chairman and CEO of Fulton Financial Corporation of Lancaster, PA, who also completed their terms as directors. James E. Nevels, founder and chairman of The Swarthmore Group, completed his second year as deputy chair and advanced to chairman in January 2014. Michael J. Angelakis, vice chairman and CFO of Comcast Corp., was appointed deputy chairman. Three other citizens joined the board in terms that began January 2014: William S. Aichele, chairman and CEO of Univest Corporation of Pennsylvania; Edward J. Graham, president and CEO of South Jersey Industries; and Brian M. McNeill, president and CEO of Southco Inc. The Economic Advisory Council includes representatives from diverse industries, manufacturers, and nonprofits in the Third District. In 2013, we welcomed Ernest Dianastasis, managing director and principal, Computer Aid, Inc.; Chris Gheysens, president and CEO, Wawa, Inc.; Patrick Magri, senior vice president of managed markets and policy, Merck & Co., Inc.; and Michael Pearson, president, Union Packaging, LLC, to serve three-year terms. The Community Depository Institutions Advisory Council (CDIAC) includes representatives from commercial banks, thrift institutions, and credit unions in the Third District. In 2013, members who joined were David E. Gillan, chairman and CEO of County Bank, Rehoboth Beach, DE; Thomas M. Petro, president and CEO of Fox Chase Bancorp, Inc., Hatboro, PA; and Gregory A. Smith, president and CEO of the Pennsylvania State Employees Credit Union (PSECU), Harrisburg, PA. In addition, Dennis D. Cirucci, president, CEO, and director of Alliance Bancorp, Inc. and Alliance Bank, continued to represent our District on the Federal Reserve Board’s CDIAC. I also thank Bharat Masrani, president and CEO of TD Bank, N.A., for his service as the Third District’s representative to the Federal Advisory Council, which meets quarterly with the Board of Governors in Washington, D.C. His term ended in 2013, and we welcomed Scott V. Fainor, president and CEO of National Penn Bancshares, Inc. and National Penn Bank, as our representative to the council for 2014. Finally, I offer my sincere thanks to the talented and dedicated employees at the Philadelphia Fed. The 100year history of our Bank is a story of the people who have contributed to its success through their public service to our many stakeholders. I especially would like to recognize Jeanne Rentezelas, who was promoted to senior vice president and general counsel during 2013. I would also be remiss if I did not acknowledge that this is the last annual report that will feature Loretta Mester as our Bank’s executive vice president and director of research. She has been the Bank’s director of research since 2000, and I have been extraordinarily fortunate to have Loretta as my chief policy advisor since 2006. While we will miss her here in Philadelphia, we are fortunate that she will remain a colleague and a friend in her new role as the 11th president and chief executive officer of the Federal Reserve Bank of Cleveland, effective June 1, 2014. Charles I. Plosser President and Chief Executive Officer May 2014 2013 Annual Report | Federal Reserve Bank of Philadelphia Message from the First Vice President A Century of Service he Federal Reserve Act enacted 100 years ago T century of why an effective central bank is essential to the established a central bank for the United States long-term health of our economy. economic stability, safe and sound practices at financial On December 23, 1913, the Federal Reserve Act became institutions, and efficient payment systems that support law, and nearly a year later on November 16, 1914, all economic activity. For those of us at the Fed, this is less 12 Reserve Banks simultaneously opened for business. of a celebration and more of a reflection on how our The Reserve Banks, under the supervision of the Board actions have forged a new understanding during the past of Governors in Washington, D.C., began to provide their and assured a framework that would promote Districts with a variety of services that have evolved over time. There were coins and currency to be provided to banks, checks to be cleared, and regional economies and communities to be understood. Everything we do today grew from the seed of these service obligations, adapting to a changing and growing economy, and building a legacy of service. Much has changed in the past century. Checks peaked and ebbed, and new payments emerged that were unimaginable, even 50 years ago. The number of banks has waxed and waned. Our economy was complex 100 years ago. Today, it is staggering in its complexity, with moving parts modeled by powerful computers and translated into discussions that form monetary policy. Today, as in the past 100 years, the Federal Reserve is an institution focused solely on the public interest, always promoting equal access to its services, striving to be efficient and effective in performing our mandate, and demanding the highest integrity in all that we do. I hope the learning over our first century translates into a deeper understanding of lessons learned to help us be even more effective in our second century of service to America. The “2013 Bank D. Blake Prichard First Vice President and Chief Operating Officer Highlights” on the pages that follow provide clear examples of how we continued to build on a century of service. 3 4 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Bank highlights Philadelphia Fed Policy Forum conomists and staff in the Philadelphia Fed’s Research Department hosted a number of conferences and workshops during 2013, including the 10th Philadelphia Fed Policy Forum, which focused on “The History of Central Banking in the United States.” E President Charles Plosser reflected on the history of central banking in the U.S. and noted that the Federal Reserve’s decentralized structure was influenced by the history of the First and Second Banks of the United States, two earlier attempts at central banking that were founded blocks away from today’s Bank. The biennial Policy Forum brought together more than 150 academics, policymakers, and market economists from several countries. Among the many key players who participated in the event were former Federal Reserve Chairman Alan Greenspan, former Vice Chairman Don Kohn, and noted author Allan H. Meltzer. Vidya Shenoy Wins System’s Top Bank Supervision Award idya Shenoy, manager in the Risk Assessment, V loan-level data each month Data Analysis, and Research (RADAR) unit, was on first-lien mortgages, honored in June as one of five winners of the home equity, credit cards, William Taylor Award, which is presented annually to and address matches System employees who display excellence in the field of from large bank holding bank supervision. Shenoy was honored for her leadership companies. Considered in delivering the new loan-level FR Y-14M consumer credit one of the most ambitious data that enabled successful completion of the consumer data collection efforts ever credit loss estimates for the Dodd-Frank Act stress testing. undertaken by the Fed, this initiative was launched and This loan-level data collection initiative involves gathering completed under tight, aggressive timelines. Vidya Shenoy with former Chairman Ben Bernanke Vidya Shenoy 2013 Vidya Shenoy, a nine-year Bank employee who is with the Risk Assessment, Data Analysis, and Research (RADAR) Group, received the Taylor Award for her extraordinary leadership in delivering the new loan-level Federal Reserve Y-14M consumer credit data that enabled successful completion of the consumer 2013 Annual Report | Federal Reserve Bank of Philadelphia The Bank Rolls Out The Federal Reserve and You Video to the Public fter four years in the making, The Federal Re- ulation, and the payments system. The video, available serve and You video was rolled out to the public on DVD and streaming on the Bank’s public website, was in April 2013 by the Bank’s Community Devel- designed as an informative and entertaining way to help A opment Studies and Education anyone interested in learning more about the Federal Department. The video offers a Reserve System. But its biggest impact is expected to be look inside the Federal Reserve felt in high school classrooms nationwide as a new educa- System and highlights the Fed’s tional resource for high school teachers. Andrew Hill, eco- role in the U.S. economy. More nomic education advisor in CDS&E, noted that more than than 70 video segments cover 15,000 DVDs were distributed and nearly 10,000 viewers topics including the history have seen the videos online in the first year. Keeping the of central banking in the U.S., video as a digital project will make it easier to update the mechanics of money and segments as needed, he said. banking, supervision and reg- The Secret Life of Money n March 2013, “The Secret Life of Money” made its debut on the I Discovery Channel. The documentary, hosted by Jacob Goldstein and David Kestenbaum from NPR’s “Planet Money,” explained how money is made, what gives it value, and how it ends up in your wallet. Highlights included interviews and footage recorded in the Bank’s actual vaults. Employees in the Cash Services Department specialize in handling huge amounts of cash each business day. They follow rigorous procedures as they process, distribute, and store currency in the Bank’s vault. All their work is done behind the scenes, so it has rarely been seen by the public, until now. The Bank’s staff worked closely with the film’s producer and crew to ensure the script and footage were accurate, without compromising Bank security. Filming was completed in 2011, and production extended into 2012, before the documentary aired in early 2013. Officials from the Bureau of Engraving and Printing, the U.S. Mint in Philadelphia, the U.S. Secret Service, and Dunbar armored carrier service also were featured in the documentary. 5 6 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Bank highlights GDPplus Spices Up an Old Standard 12 GDPplus ho can think of a more highly regard- W ed measure of economic activity than gross domestic product (GDP)? The 8 4 quarterly indicator, which seeks to distill all goods and services produced in the United States into a 0 single number, is known by everyone, from economists to news-hungry Americans. In November, the Bank’s Real-Time Data Research Center launched a new measurement using data from the U.S. Bureau -4 -8 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 of Economic Analysis (BEA) for estimates of GDP and The new measure was proposed by economic researchers gross domestic income (GDI). By using both GDP and GDI Borağan Aruoba, Francis Diebold, Jeremy Nalewaik, Frank data, GDPplus is designed to better estimate underlying Schorfheide, and Dongho Song in their work “Improving but unobserved economic activity. GDP Measurement: A Measurement-Error Perspective.” Aruoba, one of the paper’s authors, explained, “Econom- Tom Stark, assistant director and manager of the ic theory suggests that these two measures ought to be Real-Time Data Research Center, was instrumental identical, but in practice, they almost never are. What we in overseeing this initiative. “We think analysts and do in this project is to acknowledge that these two mea- policymakers will use GDPplus as well as the BEA’s sures are measures of the same underlying latent variable estimates of GDP and GDI to improve their understanding (true GDP) and use some statistical methods to obtain a of the dynamics of the U.S. economy,” Stark said. measure of this latent variable using these two measures.” Facilities Management Department Wins TOBY Award he Bank won The Outstanding Building of the Year (TOBY) award from the Building Owners and Managers T Association International (BOMA) in 2013. This competition selected the Bank as the top contender among the many facilities that were nominated in the “Government Building” category and that rivaled other government buildings in the region. The evaluation process for the award included a detailed look at all aspects of building operations and management, from green initiatives to tenant relations to community service. 2013 Annual Report | Federal Reserve Bank of Philadelphia The Bank Presents a Master Class on Diversity Metrics The Bank Partners with Cristo Rey Philadelphia High School he Bank entered into a new partnership to host four s part of the Bank’s Office of Diversity A and Inclusion (D&I) initiatives, 41 D&I practitioners gathered in Philadelphia T high school interns from the Cristo Rey Philadelphia High School to further outreach efforts to majority- minority and inner-city high for a special program: “A Master Class on Diver- schools. The four students sity and Inclusion Metrics: Measuring What Mat- worked part-time through ters.” Master teachers Dr. Rohini Anand, senior the school year in Human vice president and global chief diversity officer Resources and Financial for Sodexo, and her colleague, Chad Johnson, Management Services. director of diversity/EEO systems and analytics, These experiences not led the forum. Sodexo, a leading provider of only helped them develop quality of life services with 420,000 employees valuable skills but also in 80 countries, was ranked No. 1 in Diversity- exposed them to future Inc.’s 2013 business index of Top Companies for career opportunities within Diversity and Inclusion. the Bank. Bank Hosts the Conference of Presidents and the Conference of First Vice Presidents I n September, the Bank welcomed the Conference of Presidents, the Conference of First Vice Presidents, and the Financial Services Policy Committee, three Federal Reserve System leadership conferences. President Charles Plosser and First Vice President Blake Prichard, both cochairs of their respective conferences, hosted the gathering. The more than 30 Fed presidents, first vice presidents, and other officers had the opportunity to see Philadelphia’s historical roots of U.S. central banking as well as our nation’s Independence Hall and Congress Hall. 7 8 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Bank highlights Giving Back Year-Round Throughout the year, many Bank staff members roll up their sleeves to participate in one of the many volunteer initiatives sponsored by the Bank. Outreach to the community comes in all shapes and sizes, from a single day of service to ongoing weekly programs. In addition, many employees serve on the boards of area nonprofits. Bank employees volunteered time and talent through PhillyFedCARES in a variety of community service days. Events ranged from organizing the book inventory at a local elementary school library to reading stories to K–3 students as part of the National Education Association’s Read Across America Day. Another spring day was spent sprucing up a playground at a local city park. Bank employees, families, and friends also turned out for the 9-11 Heroes Run and fun walk in the fall. Some ran the 5K course while others walked it, and some cheered on the sidelines as part of the Bank’s continuing support to the local community. The Fed Completes the System-wide Transition from Lotus Notes to Outlook The Bank hosts the System’s Groupware Leadership Center (GLC), which provides e-mail services and other collaboration tools System-wide. In 2013, the GLC completed its work to migrate all employees in the Federal Reserve System to new e-mail and collaboration services. Patrick Turner, assistant vice president of GLC, was the program manager who directed the changeover, known as the Connect & Share project. 2013 Annual Report | Federal Reserve Bank of Philadelphia Cash Services Introduces New $100 Note The Bank’s Cash Services Department and the Public Affairs Department hosted a special event at the Franklin Institute that marked the release of the new $100 note in early October. The city of Philadelphia, Ben Franklin’s adopted hometown, was one of five locations nationwide selected by the Board of Governors and the U.S. Treasury to roll out the new “Benjamins.” Michelle Scipione and Jake Lofton appeared on morning television programs and then helped describe the new note and its security features to media members and the public at the museum. Windows into Our Past The project started more than a year ago as a simple idea: The Bank wanted a visual history of the past 100 years as a tribute to the contributions of Bank employees. The result was the Windows into Our Past display, a photo collage in the Bank’s Eastburn Court. The project was the brainchild of two Bank employees: Dianne Hallowell, Graphic Services, and Pat Lenar-Burns, Public Affairs, who worked with Bank volunteers in selecting the photographs. A similar “Centennial Wall” exhibit was installed in the third-floor lobby with photos and artifacts from our Bank’s 100 years. Also in the thirdfloor lobby, a series of original photos and architectural drawings pays tribute to 925 Chestnut Street, the Bank’s home from 1918 to 1976. 9 10 2013 Annual Report| Federal Reserve Bank of Philadelphia Image courtesy of the Woodrow Wilson Presidential Library and Museum, Staunton, VA The Signing of the Federal Reserve Act by Wilbur G. Kurtz Sr. 2013 Annual Report | Federal Reserve Bank of Philadelphia A Limited Central Bank By Charles I. Plosser s the Fed begins its 100th anniversary year, I believe it is entirely appropriate to reflect on its history and its future. At the same time, we need to reflect on what I believe is the Federal Reserve’s essential role and how it might be improved as an institution to better fulfill that role.1 A Douglass C. North was cowinner of the 1993 Nobel Prize that governments establish their central banks with limits in Economics for his work on the role that institutions that constrain the actions of the central bank to one play in economic growth. North argued that institu- degree or another. 2 tions were deliberately devised to constrain interactions among parties both public and private. In the spirit of Yet, in recent years, we have seen many of the explicit North’s work, one theme of this essay will focus on the and implicit limits stretched. The Fed and many other fact that the institutional structure of the central bank central banks have taken extraordinary steps to address matters. The central bank’s goals and objectives, its a global financial crisis and the ensuing recession. These framework for implementing policy, and its governance steps have challenged the accepted boundaries of central structure all affect its performance. banking and have been both applauded and denounced. For example, the Fed has adopted unconventional large- Central banks have been around for a long time, but they scale asset purchases to increase accommodation after it have clearly evolved as economies and governments reduced its conventional policy tool — the federal funds have changed. Most countries today operate under a fiat rate — to near zero. These asset purchases have led to money regime, in which a nation’s currency has value the creation of trillions of dollars of reserves in the bank- because the government says it does. Central banks are ing system and have greatly expanded the Fed’s balance usually given the responsibility to protect and preserve sheet. But the Fed has done more than just purchase lots the value or purchasing power of the currency. In the of assets; it has altered the composition of its balance U.S., the Fed does so by buying or selling assets in order sheet through the types of assets it has purchased. I have to manage the growth of money and credit. The ability spoken on a number of occasions about my concerns that to buy and sell assets gives the Fed considerable power these actions to purchase specific (non-Treasury) assets to intervene in financial markets not only through the amounted to a form of credit allocation, which targets quantity of its transactions but also through the types of specific industries, sectors, or firms. These credit policies assets it can buy and sell. Thus, it is entirely appropriate cross the boundary from monetary policy and venture 3 11 12 2013 Annual Report| Federal Reserve Bank of Philadelphia into the realm of fiscal policy.4 I include in this category the U.S. and the world were operating under a classical the purchases of mortgage-backed securities (MBS) as gold standard. Therefore, price stability was not among well as emergency lending under Section 13(3) of the the stated goals in the original Federal Reserve Act. Federal Reserve Act, in support of the bailouts, most no- Indeed, the primary objective in the preamble was to tably of Bear Stearns and AIG. Regardless of the rationale provide an “elastic currency.” for these actions, one needs to consider the long-term repercussions that such actions may have on the central The gold standard had some desirable features. Domestic bank as an institution. and international legal commitments regarding convertibility were important disciplining devices that were As we contemplate what the Fed of the future should essential to the regime’s ability to deliver general price look like, I will discuss whether constraints on its goals stability. The gold standard was a de facto rule that most might help limit the range of objectives it could use to people understood, and it allowed markets to function justify its actions. I will also consider restrictions on the more efficiently because the price level was mostly types of assets it can purchase to limit its interference stable. with market allocations of scarce capital and generally to avoid engaging in actions that are best left to the fiscal But the international gold standard began to unravel authorities or the markets. I will also touch on gover- and was abandoned during World War I.5 After the war, nance and accountability of our institution and ways to efforts to reestablish parity proved disruptive and costly implement policies that limit discretion and improve in both economic and political terms. Attempts to rees- outcomes and accountability. tablish a gold standard ultimately fell apart in the 1930s. As a result, most of the world now operates under a fiat Goals and Objectives money regime, which has made price stability an import- The Federal Reserve’s goals and objectives have evolved ant priority for those central banks charged with ensuring over time. When the Fed was first established in 1913, the purchasing power of the currency. Congress established the current set of monetary policy ‘When the Fed was first established in 1913, the U.S. and the world were operating under a classical gold standard. Therefore, price stability was not among the stated goals in the original Federal Reserve Act.’ goals in 1978. The amended Federal Reserve Act specifies the Fed “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Since moderate long-term interest rates generally result when prices are stable and the economy is operating at full employment, many have interpreted these goals as a dual mandate with price stability and maximum employment as the focus. 2013 Annual Report | Federal Reserve Bank of Philadelphia Let me point out that the instructions from Congress call ment and high inflation. The economy paid the price in for the Federal Open Market Committee (FOMC) to stress the form of a deep recession, as the Fed sought to restore the “long run growth” of money and credit commensu- the credibility of its commitment to price stability. 13 rate with the economy’s “long run potential.” There are many other things that Congress could have specified, When establishing the longer-term goals and objectives but it chose not to do so. The act doesn’t talk about for any organization, and particularly one that serves managing short-term credit allocation across sectors; it the public, it is important that the goals be achievable. doesn’t mention inflating housing prices or other asset prices. It also doesn’t mention reducing short-term fluctuations in employment. Many discussions about the Fed’s man- ‘We need to better align the expectations of monetary policy with what it is actually capable of achieving.’ date seem to forget the emphasis on the long run. The public, and perhaps even some within the Fed, have come to accept as an axiom that monetary policy can and should Assigning unachievable goals to organizations is a recipe attempt to manage fluctuations in employment. Rather for failure. For the Fed, it could mean a loss of public con- than simply set a monetary environment “commensu- fidence. I fear that the public has come to expect too rate” with the “long run potential to increase produc- much from its central bank and too much from monetary tion,” these individuals seek policies that attempt to policy, in particular. We need to heed the words of anoth- manage fluctuations in employment over the short run. er Nobel Prize winner, Milton Friedman. In his 1967 presidential address to the American Economic Association, he The active pursuit of employment objectives has been and said, “…we are in danger of assigning to monetary policy continues to be problematic for the Fed. Most economists a larger role than it can perform, in danger of asking it to are dubious of the ability of monetary policy to predict- accomplish tasks that it cannot achieve, and as a result, ably and precisely control employment in the short run, in danger of preventing it from making the contribution and there is a strong consensus that, in the long run, that it is capable of making.”6 In the 1970s, we saw the monetary policy cannot determine employment. As the truth in Friedman’s earlier admonitions. I think that over FOMC noted in its statement on longer-run goals adopted the past 40 years, with the exception of the Paul Volcker in 2012, “the maximum level of employment is largely de- era, we failed to heed this warning. We have assigned an termined by nonmonetary factors that affect the structure ever-expanding role for monetary policy, and we expect and dynamics of the labor market.” In my view, focusing our central bank to solve all manner of economic woes on short-run control of employment weakens the credibil- for which it is ill-suited to address. We need to better ity and effectiveness of the Fed in achieving its price sta- align the expectations of monetary policy with what it is bility objective. We learned this lesson most dramatically actually capable of achieving. during the 1970s when, despite the extensive efforts to reduce unemployment, the Fed essentially failed, and the The so-called dual mandate has contributed to this ex- nation experienced a prolonged period of high unemploy- pansionary view of the powers of monetary policy. Even 14 2013 Annual Report| Federal Reserve Bank of Philadelphia can be justified by shifting the focus or rationale for action from ‘…we are in danger of assigning to goal to goal. monetary policy a larger role than it I have concluded that it would be can perform, in danger of asking it to appropriate to redefine the Fed’s accomplish tasks that it cannot achieve, solely, or at least primarily, on and as a result, in danger of preventing it from making the contribution that it is capable of making.’ – Milton Friedman 1967 monetary policy goals to focus price stability. I base this on two facts: Monetary policy has very limited ability to influence real variables, such as employment. And, in a regime with fiat currency, only the central bank can ensure price stability. Indeed, it is the one goal that the central bank can achieve over the longer run. Governance and Central Bank Independence Even with a narrow mandate to focus on price stability, the institution must be well designed if it is to be successful. To meet even this narrow mandate, the central bank must have though the 2012 statement of objectives acknowledged a fair amount of independence from the political pro- that it is inappropriate to set a fixed goal for employ- cess so that it can set policy for the long run without the ment and that maximum employment is influenced by pressure to print money as a substitute for tough fiscal many factors, the FOMC’s recent policy statements have choices. Good governance requires a healthy degree of increasingly given the impression that it wants to achieve separation between those responsible for taxes and ex- an employment goal as quickly as possible. penditures and those responsible for printing money. 7 I believe that the aggressive pursuit of broad and The original design of the Fed’s governance recognized the expansive objectives is quite risky and could have very importance of this independence. Consider its decentral- undesirable repercussions down the road, including ized, public-private structure, with Governors appointed undermining the public’s confidence in the institution, its by the U.S. President and confirmed by the Senate, and legitimacy, and its independence. To put this in different Fed presidents chosen by their boards of directors. This terms, assigning multiple objectives for the central bank design helps ensure a diversity of views and a more decen- opens the door to highly discretionary policies, which tralized governance structure that reduces the potential 2013 Annual Report | Federal Reserve Bank of Philadelphia for abuses and capture by special interests or political A third way to constrain central bank actions is to direct agendas. It also reinforces the independence of monetary the monetary authority to conduct policy in a systematic, policymaking, which leads to better economic outcomes. rule-like manner.9 It is often difficult for policymakers to 15 choose a systematic, rule-like approach that would tie Implementing Policy and Limiting Discretion their hands and thus limit their discretionary authority. Such independence in a democracy also necessitates that Yet, research has discussed the benefits of rule-like be- the central bank remain accountable. Its activities also havior for some time. Rules are transparent and there- need to be constrained in a manner that limits its dis- fore allow for simpler and more effective communication cretionary authority. As I have already argued, a narrow of policy decisions. Moreover, a large body of research mandate is an important limiting factor on an expansion- emphasizes the important role expectations play in deter- ist view of the role and scope for monetary policy. mining economic outcomes. When policy is set systematically, the public and financial market participants can What other sorts of constraints are appropriate on the form better expectations about policy. Policy is no longer activities of central banks? I believe that monetary policy a source of instability or uncertainty. While choosing an and fiscal policy should have clear boundaries. Indepen- appropriate rule is important, research shows that in a dence is what Congress can and should grant the Fed, wide variety of models simple, robust monetary policy but, in exchange for such independence, the central bank rules can produce outcomes close to those delivered by should be constrained from conducting fiscal policy. As I each model’s optimal policy rule. 8 have already mentioned, the Fed has ventured into the realm of fiscal policy by its purchase programs of assets that target specific industries and individual firms. One way to circumscribe the ‘a narrow mandate is an important range of activities a central bank can undertake is limiting factor on an expansionist to limit the assets it can buy and hold. In its System Open Market Account, the Fed is allowed to hold only U.S. government securi- view of the role and scope for monetary policy.’ ties and securities that are direct obligations of or fully guaranteed by agencies of the United States. But these restrictions still allowed the Fed to Systematic policy can also help preserve a central bank’s purchase large amounts of agency mortgage-backed independence. When the public has a better under- securities in its effort to boost the housing sector. My standing of policymakers’ intentions, it is able to hold the preference would be to limit Fed purchases to Treasury central bank more accountable for its actions. And the securities and return the Fed’s balance sheet to an rule-like behavior helps to keep policy focused on the all-Treasury portfolio. This would limit the ability of the central bank’s objectives, limiting discretionary actions Fed to engage in credit policies that target specific indus- that may wander toward other agendas and goals. tries. As I’ve already noted, such programs to allocate credit rightfully belong in the realm of the fiscal authori- Congress is not the appropriate body to determine the ties — not the central bank. form of such a rule. However, Congress could direct the 16 2013 Annual Report| Federal Reserve Bank of Philadelphia monetary authority to communicate the broad guidelines The Fed plays an important role as the lender of last re- the authority will use to conduct policy. One way this sort, offering liquidity to solvent firms in times of extreme might work is to require the Fed to publicly describe how financial stress to forestall contagion and mitigate systemic it will systematically conduct policy in normal times — risk. This liquidity is intended to help ensure that solvent this might be incorporated into the semiannual Monetary institutions facing temporary liquidity problems remain Policy Report submitted to Congress. This would hold solvent and that there is sufficient liquidity in the banking the Fed accountable. If the FOMC chooses to deviate system to meet the demand for currency. In this sense, from the guidelines, it must then explain why and how it liquidity lending is simply providing an “elastic currency.” intends to return to its prescribed guidelines. Thus, the role of lender of last resort is not to prop up My sense is that the recent difficulty the Fed has faced insolvent institutions. However, in some cases during the in trying to offer clear and transparent guidance on its crisis, the Fed played a role in the resolution of particular current and future policy path stems from the fact that insolvent firms that were deemed systemically important policymakers still desire to maintain discretion in setting financial firms. Subsequently, the Dodd-Frank Wall Street monetary policy. Effective forward guidance, however, Reform and Consumer Protection Act has limited some requires commitment to behave in a particular way in the of the lending actions the Fed can take with individual future. But discretion is the antithesis of commitment firms under Section 13(3). Nonetheless, by taking these and undermines the effectiveness of forward guidance. actions, the Fed has created expectations — perhaps Given this tension, few should be surprised that the Fed unrealistic ones — about what the Fed can and should do has struggled with its communications. to combat financial instability. What is the answer? I see three: Simplify the goals. Just as it is true for monetary policy, it is important to be Constrain the tools. Make decisions more systematically. clear about the Fed’s responsibilities for promoting finan- All three steps can lead to clearer communications and a cial stability. It is unrealistic to expect the central bank to better understanding on the part of the public. Creating a alleviate all systemic risk in financial markets. Expanding stronger policymaking framework will ultimately produce the Fed’s regulatory responsibilities too broadly increas- better economic outcomes. es the chances that there will be short-run conflicts between its monetary policy goals and its supervisory Financial Stability and Monetary Policy and regulatory goals. This should be avoided, as it could Before concluding, I would like to say a few words about price stability. undermine the credibility of the Fed’s commitment to the role that the central bank plays in promoting financial stability. Since the financial crisis, there has been Similarly, the central bank should set boundaries and an expansion of the Fed’s responsibilities for controlling guidelines for its lending policy that it can credibly macroprudential and systemic risk. Some have even commit to follow. If the set of institutions having regular called for an expansion of the monetary policy mandate access to the Fed’s credit facilities is expanded too far, it to include an explicit goal for financial stability. I think will create moral hazard and distort the market mecha- this would be a mistake. nism for allocating credit. This can end up undermining the very financial stability that it is supposed to promote. 2013 Annual Report | Federal Reserve Bank of Philadelphia Emergencies can and do arise. If the Fed is asked by the fiscal authorities to intervene by allocating credit to particular firms or sectors of the economy, then the Treasury should take these assets off of the Fed’s balance sheet in exchange for Treasury securities. In 2009, I advocated that we establish a new accord between the Treasury and the Federal Reserve that protects the Fed in just such a way.10 Such an arrangement would be similar to the Treasury-Fed Accord of 1951 that freed ‘What is the answer? I see three: • Simplify the goals. • Constrain the tools. • Make decisions more systematically.’ the Fed from keeping the interest rate on longterm Treasury debt below 2.5 percent. It would help ensure that when credit policies put taxpayer funds at risk, they are the responsibility of the fiscal authority — not the Fed. A new accord would also return control of the Fed’s balance sheet to the Fed so that it can conduct independent monetary policy. And third, by taking a highly discretionary approach to monetary policy, policymakers increase the risks of finan- Many observers think financial instability is endemic to cial instability by making monetary policy uncertain. Such the financial industry, and therefore, it must be controlled uncertainty can lead markets to make unwise investment through regulation and oversight. However, financial decisions — witness the complaints of those who took instability can also be a consequence of governments and positions expecting the Fed to follow through with the their policies, even those intended to reduce instability. I taper decision in September 2013. can think of three ways in which central bank policies can increase the risks of financial instability. First, by rescuing The Fed and other policymakers need to think more firms or creating the expectation that creditors will be about the way their policies might contribute to finan- rescued, policymakers either implicitly or explicitly create cial instability. I believe that it is important that the Fed moral hazard and excessive risking-taking by financial take steps to conduct its own policies and to help other firms. For this moral hazard to exist, it doesn’t matter if regulators reduce the contributions of such policies to the taxpayer or the private sector provides the funds. financial instability. The more limited role for the central What matters is that creditors are protected, in part, if bank I have described here can contribute to such efforts. not entirely. Conclusion Second, by running credit policies, such as buying huge The financial crisis and its aftermath have been challeng- volumes of mortgage-backed securities that distort mar- ing times for global economies and their institutions. The ket signals or the allocation of capital, policymakers can extraordinary actions taken by the Fed to combat the sow the seeds of financial instability because of the distor- crisis and the ensuing recession and to support recovery tions that they create, which in time must be corrected. have expanded the roles assigned to monetary policy. 17 18 2013 Annual Report| Federal Reserve Bank of Philadelphia The public has come to expect too much from its central • And fourth, limit the boundaries of its lender-of- bank. To remedy this situation, I believe it would be ap- last-resort credit extension and ensure that it is propriate to set four limits on the central bank: conducted in a systematic fashion. • • • First, limit the Fed’s monetary policy goals to a These steps would yield a more limited central bank. In narrow mandate in which price stability is the sole, doing so, they would help preserve the central bank’s or at least the primary, objective. independence, thereby improving the effectiveness of Second, limit the types of assets that the Fed can monetary policy, and, at the same time, they would make hold on its balance sheet to Treasury securities. it easier for the public to hold the Fed accountable for its Third, limit the Fed’s discretion in monetary policy decisions. These changes to the institution would policymaking by requiring a systematic, rule-like strengthen the Fed for its next 100 years. approach. Endnotes 1 This essay is based on a speech by the author, “A Limited Central Bank,” presented at the Cato Institute’s 31st Annual Monetary Conference, November 14, 2013, in Washington, D.C. The views expressed here are the author’s and not necessarily those of the Federal Reserve System or the Federal Open Market Committee. 5 For more about Douglass C. North and his cowinner Robert W. Fogel and the 1993 Nobel Memorial Prize in Economic Sciences, see Nobel Media, “The Prize in Economics 1993 - Press Release,” (1993), www. nobelprize.org/nobel_prizes/economic-sciences/laureates/1993/press. html (accessed November 11, 2013). See also Douglass C. North, “Institutions,” Journal of Economic Perspectives, 5:1 (1991), pp. 97–112. 6 Countries can and do pursue different means of setting the value of their currency, including pegging their monetary policy to that of another country, but I will not concern myself with such issues in these comments. 8 2 3 See Charles Plosser, “Ensuring Sound Monetary Policy in the Aftermath of Crisis,” speech to the U.S. Monetary Policy Forum, The Initiative on Global Markets, sponsored by the University of Chicago Booth School of Business, New York, NY, February 27, 2009, and Charles Plosser, “Fiscal Policy and Monetary Policy: Restoring the Boundaries,” a speech to the same group, February 24, 2012. 4 See Ben S. Bernanke, “A Century of U.S. Central Banking: Goals, Frameworks, Accountability,” speech to the National Bureau of Economic Research, Cambridge, MA, July 10, 2013; and Jeffrey M. Lacker, “Global Interdependence and Central Banking,” speech to the Global Interdependence Center, Philadelphia, November 1, 2013. See Milton Friedman, “The Role of Monetary Policy,” American Economic Review, 58:1 (March 1968), pp. 1–17. See Daniel L. Thornton, “The Dual Mandate: Has the Fed Changed Its Objective?” Federal Reserve Bank of St. Louis Review, 94 (March/April 2012), pp. 117–33. 7 See Plosser (2009) and Plosser (2012). See Charles Plosser, “The Benefits of Systematic Monetary Policy,” speech given to the National Association for Business Economics, Washington Economic Policy Conference, Washington, D.C., March 3, 2008. Also see Finn E. Kydland and Edward C. Prescott, “Rules Rather Than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (June 1977), pp. 473–91. 9 10 See Plosser (2009). 2013 Annual Report | Federal Reserve Bank of Philadelphia Federal Reserve System 100 Years of Tradition and Transition the 20th century. When the Knickerbocker Trust Company in New York City failed in 1907, it triggered runs on other trust companies, as well as hundreds of bank failures, a decrease in the money supply, and a deep recession. In response, Congress set up the National Monetary Commission in 1908. The commission submitted a report to Congress four years later that proposed a plan to create a National Reserve Association of the United States. The actual plan was never implemented; however, it sparked a debate advocating a new central bank for the United States: the Federal Reserve System. Incoming President Wilson favored adding a central governmental board to oversee the reserve banks. Among the many proposals introduced to Congress in 1913, Representative Carter Glass sponsored the key bill passed by the House and finally by the Senate on December 19, 1913. Four days later, President Woodrow Wilson signed the bill into law, creating the Federal Reserve System. n 1913, Albert Einstein was working on his theory of gravity, Richard Nixon was born, and Franklin D. Roosevelt was sworn in as Assistant Secretary of the Navy. It was also the year Woodrow Wilson took the oath of office as the 28th President of the United States, intent on advocating progressive reform and change. One of his biggest reforms came on December 23, 1913, when he signed the Federal Reserve Act into law. This landmark legislation created the Federal Reserve System, the nation’s central bank. I In part, the Federal Reserve Act established the Reserve Bank Organization Committee, in which the Secretary of the Treasury, the Secretary of Agriculture, and the Comptroller of the Currency would divide the nation into no fewer than eight and no more than 12 Federal Reserve Districts. The committee was also charged with deciding which cities would host a Federal Reserve Bank, how the geographic boundaries of each Federal Reserve District would be defined, and how the Reserve Banks would be organized and supervised. A Need for Stability Between January and mid-February 1914, the committee held meetings in 18 cities across the nation. Local business- Why was a central bank needed? After the charter of the Second Bank of the United States expired in 1836, the United States endured a series of financial crises throughout the 19th century and into the first decade of men, bankers, farmers, and others made a case explaining why their city or state should be chosen as a Reserve Bank location. In April 1914, the committee submitted a report 19 20 2013 Annual Report| Federal Reserve Bank of Philadelphia to Congress listing the cities it had selected for the Reserve Banks, the same cities that host Reserve Banks today. The Federal Reserve Act also provided an operating structure for the Reserve System: It created a Federal Reserve Board in Washington, D.C., designed to oversee the operations of the Reserve Banks. The Board consisted of seven members, including the Secretary of the Treasury and the Comptroller of the Currency as ex officio members, as well as five members appointed by the President of the United States and confirmed by the Senate. On November 16, 1914, all 12 regional Reserve Banks opened for business. Like the First Bank and the Second Panics and Crises The Knickerbocker Trust Company, the second largest of its kind in New York, failed in October 1907, which led to runs on other trust companies. Knickerbocker did not have enough cash on hand to meet depositors’ demand. Since there was no deposit insurance in 1907 and no lender of last resort to turn to, the run triggered a panic that launched hundreds of bank failures, a significant decrease in the money supply, and a deep recession. Financier J.P. Morgan formed a syndicate with his fellow bankers to put sufficient liquidity into the economy to quell the panic. Congress then set up a federal commission to study the economy, which eventually led to the creation of the Federal Reserve System in 1913. But before the Federal Reserve System was established, the United States faced another crisis in July 1914. European investors, who owned more than 20 percent of American railroad stocks, started to sell these assets to secure a flow of gold to Europe to help pay for World War I. This sell-off put a serious drain on the U.S. gold supply, weakening the gold-backed dollar and making it hard for the U.S. to maintain the gold standard. Although Treasury Secretary William McAdoo tried to push for the Federal Reserve Banks to open early, his attempt was thwarted. So he moved to close Wall Street “to hamper British sales of American securities.” The stock market closed on July 31, 1914, and reopened on December 12. MINNEAPOLIS 9 CHICAGO 7 4 CLEVELAND BOSTON 1 2 NEW YORK 3 PHILADELPHIA 12 SAN FRANCISCO KANSAS CITY 10 8 ST. LOUIS 5 RICHMOND 6 ATLANTA DALLAS 11 The Federal Reserve Act is passed by Congress and signed by President Woodrow Wilson. 1913 The 12 Federal Reserve Banks open for business. 1914 The Philadelphia Fed opens in its first headquarters at 406–408 Chestnut Street. Charles J. Rhoads is named the first governor of the Federal Reserve Bank of Philadelphia. World War I creates difficult economic conditions, but the Federal Reserve System takes an active role in marketing war debt to the banks and general public to raise funds for the war effort. 1914 1914 1914-18 2013 Annual Report | Federal Reserve Bank of Philadelphia Bank of the United States, the Fed was initially given a 20-year charter. However, the McFadden Act of 1927 removed the 20-year limit. This helped the Federal Reserve avoid the political battle over rechartering, which had ended both previous attempts at a central bank. 21 Works of Glass (1858-1946) Carter Glass, the son of a newspaperman, was born in Lynchburg, VA. After attending school and working as Off to a Rough Start a printer’s apprentice, reporter, editor, and owner of a With the nation’s economy still unsettled, the Roaring Twenties were largely remembered as a period of economic prosperity and a rising stock market, despite three recessions. Middle class and wealthier households benefited from the boom, but not everyone shared in the prosperity. During the decade, crop prices collapsed, and as a result, many farmers defaulted on their mortgages. However, the Fed continued an accommodative monetary policy throughout 1927. Then in 1928, the Fed finally raised interest rates, but this proved to be too little too late. It further aggravated the economic situation by slowing down an already faltering economy. By 1929, the stock market crash deepened the crisis and triggered the Great Depression. newspaper, he was elected to the state senate in 1899 and served as a delegate to Virginia’s constitutional convention. After he was elected to the U.S. House of Representatives in 1902, he was appointed to the Committee on Banking and Currency. During the Panic of 1907, Glass saw the need to reduce, if not eliminate, the number of bank panics and financial crises as well as develop the need for a more elastic currency. Glass was Secretary of the Treasury from 1918 to 1920 and served in the Senate. One of his biggest accomplishments was his work on the bill that would become President Herbert Hoover attempted to stimulate the economy by urging Congress to pass the Reconstruction Finance Corporation (RFC) Act of 1932. The RFC was established to make loans to banks and other financial Ellis P. Passmore is named governor of the Philadelphia Fed. The Philadelphia Fed moves to a larger building at 925 Chestnut Street. 1918 1918 the Federal Reserve Act of 1913. George W. Norris is named governor of the Philadelphia Fed. During his tenure, he oversees the System’s first open market operations in 1923 and issues discounts and advances to avert monetary panic during the stock market crash in 1929. 1920 Carter Glass The McFadden Act is passed and creates significant changes for the Fed. The Black Tuesday Wall Street Crash sends the world into an economic panic. 1927 1929 22 2013 Annual Report| Federal Reserve Bank of Philadelphia institutions and to lend funds to railroads, many of which could not meet their bond payments. off workers. As incomes dwindled, many households defaulted on loans, and bankruptcies escalated. However, many people criticized Hoover, saying his actions weren’t fast enough and didn’t go far enough to stem the rise of bank failures and growing unemployment. Voters decided it was time for a change. Hoover lost the presidential election in November 1932, and voters sent Franklin D. Roosevelt to the White House. Although other factors, including the collapse of international trade, contributed to the severe economic distress in the United States, the breakdown of the banking system was credited with being the major cause of the Depression. Between 1930 and 1933, 9,000 banks failed in the United States. These bank failures limited money supply, which, in turn, led to a decline in spending on goods and services. Firms lowered their prices and laid Trust in banks evaporated. People withdrew their savings from banks and began hoarding cash. Bank reserves plunged, which resulted in tighter credit. In March 1933, Roosevelt declared a bank holiday, in which all U.S. banks were closed for four business days. After Congress passed the Emergency Banking Act on March 9, the Federal Reserve agreed to supply an unlimited amount of emergency money to the banks that reopened. This commitment by the Fed essentially created an early form of deposit insurance. These measures went a long way toward restoring the public’s confidence in banks. By the end of March 1933, two-thirds of the money that had been withdrawn in earlier bank runs and panics had been redeposited in the nation’s banks. In March 1933, Roosevelt declared a bank holiday, in which all U.S. banks were closed for four business days. However, the Fed did not respond aggressively; it continued its tight monetary policy for too long, and prices started to fall, leading to widespread deflation. When banks did close their doors, people lost their savings and credit became scarce. Congress passed many important pieces of legislation in response to the Great Depression. The Banking Act of 1933 created the Federal Deposit Insurance Corpora- The Great Depression: U.S. unemployment reaches 25%, international trade drops more than 50%, thousands of banks and other businesses fail, and tax revenue to the federal government drops dramatically. Congress passes the GlassSteagall Act to stem deflation, expand the Fed’s ability to offer rediscounts, and separate the activities of commercial banks and securities firms. 1929-39 1933 The Gold Reserve Act passes, requiring all gold and gold certificates held by the Federal Reserve to be surrendered to and vested in the U.S. Department of the Treasury. 1934 The Banking Act of 1935 calls for changes in the Federal Reserve’s structure, including the Federal Open Market Committee. 1935 2013 Annual Report | Federal Reserve Bank of Philadelphia tion (FDIC) as a temporary government agency with the authority to provide deposit insurance to banks, initially insuring bank deposits up to $2,500. This act, known as the Glass-Steagall Act, separated investment banking from commercial banking and established the Federal Open Market Committee (FOMC). Although the Federal Reserve Banks had set up an Open Market Investment Committee in 1923, the Reserve Banks were not obligated to carry out the committee’s recommendations. The 1933 law also gave the Federal Reserve Board the responsibility for supervising bank holding companies. The Banking Act of 1935 made the FDIC a permanent government agency and increased the maximum amount of insured deposits to $5,000. This law also further defined the FOMC, giving the Committee its current structure: the seven Governors on the Board of Governors and five of the 12 Reserve Bank presidents. One of the voting members is always the president of the New York Fed; the other four presidents serve one-year terms on a rotating basis. The Reserve Banks are required to carry out the directions of the FOMC, whose open market operations are centralized at the Open Market Trading Desk at the New York Fed. The 1935 law also changed the title of Reserve Bank heads from governor to president and removed the Comptroller of the Currency and the Secretary of the Treasury from their positions on the Federal Reserve Board. John S. Sinclair is named president (he is the first to assume this title) of the Philadelphia Fed. World War II rages throughout Europe, North Africa, and the South Pacific. Going to War World War II carried the American economy out of the Great Depression. Producing armaments and other goods for the war kept the economy buzzing in the early to mid-1940s. During this period, the Federal Reserve acted at the Treasury’s request to keep rates low to help finance the war. After 1945, when the war was over, the Treasury wanted the Fed to continue to keep interest rates low. But the Federal Reserve Act did not specifically set goals for monetary policy, stating instead that the Fed was required to furnish an “elastic currency.” In 1946, Congress passed the Employment Act, which defines the goals of monetary policy to include promoting “maximum employment, production, and purchasing power.” In 1950, the Treasury pressed the Fed to maintain low rates at the start of the Korean War. However, the central bank was reluctant to do so. Finally, in 1951, the two parties signed the Treasury-Fed Accord, which acknowledged the Fed’s independence in setting monetary policy. The economy entered another recession in the mid1950s. Once recovery was underway, the Fed raised interest rates above 3 percent to restrain inflation. But its actions were not fast enough to keep inflation from Alfred H. Williams is named president of the Philadelphia Fed. 1936 1939-45 1941 The Treasury-Federal Reserve Accord declares the Fed’s independence in conducting monetary policy. 1951 23 24 2013 Annual Report| Federal Reserve Bank of Philadelphia reaching nearly 4 percent. When a second recession began in mid-1957 and unemployment rose dramatically, the Fed responded with a sharp drop in interest rates to spur spending and employment. Looking Out for the Consumer In the 1960s and 1970s, Congress passed several important consumer protection laws, including the Truth in Lending Act in 1968, which requires lenders to disclose the cost of borrowing to consumers; the Equal Credit Opportunity Act in 1974, which combats discrimination in consumer and business lending; and the Electronic Fund Transfer Act in 1978, which provides protection for consumers in their electronic financial transactions. In 1977, Congress passed the Community Reinvestment Act, which encourages banks to meet the credit needs of all segments in their communities. This act also established a community affairs function at the Board of Governors and at each Reserve Bank. Congress also passed the Full Employment and Balanced Growth Act of 1978, otherwise known as the Humphrey-Hawkins Act. This law expanded the goals of the Employment Act of 1946 and required the Federal Reserve’s chairman to testify to Congress twice each year about the Fed’s objectives and plans for monetary policy. Karl R. Bopp is named president of the Philadelphia Fed, becoming one of the first professional economists to lead a Reserve Bank. David P. Eastburn is named president of the Philadelphia Fed. High inflation and high unemployment plagued the country during the 1970s; inflation climbed to about 6 percent at the start of the decade. With inflation still above 4 percent by mid-1971, President Richard Nixon imposed wage and price controls, which suppressed inflation for a time. The Fed tightened monetary policy when inflation rebounded following the end of the wage and price controls and a jump in oil prices during 1973–74. Inflation rose to 12 percent in 1974, ushering in another recession. The Fed eased monetary policy in 1974, and the federal funds rate fell below 5 percent in early 1976. Since the Fed was slow to raise short-term interest rates during the rest of the decade, the Fed’s monetary policy remained expansionary, and the Fed’s stated anti-inflation policy lost credibility. Although the economy expanded during the 1970s, oil prices jumped several times when oil-producing states tightened supplies. Inflation climbed to 14 percent in 1979 when the revolution in Iran reduced oil supplies to the U.S. President Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve Board of Governors in 1979, and Volcker took decisive actions to curb inflation. Rather than targeting a short-term interest rate, the Federal The Community Reinvestment Act (CRA) is passed. 1958 1970 1977 The Full Employment and Balanced Growth Act (commonly known as the Humphrey-Hawkins Act) passes, requiring the Federal Reserve to provide Congress with a semiannual report on the Fed’s objectives and plans for monetary policy. 1978 25 2013 Annual Report | Federal Reserve Bank of Philadelphia Reserve under Volcker focused on controlling the growth of the money supply. This led to higher interest rates, but it succeeded in reducing inflation and lowering interest rates over time. The Changing Fed The Depository Institutions Deregulation and Monetary Control Act of 1980 (MCA) changed the way the Fed provides services. The law mandated that the Federal Reserve offer payment services not only to member banks but also to any depository institution that wanted to use them and to charge all institutions (both member and nonmember banks) an amount sufficient to cover the cost of providing the service; the law also granted depository institutions equal access to discount window lending. In return, the MCA requires all banks to maintain reserves with the Fed. In the 1980s and 1990s, more deregulation came to the banking industry. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allowed banks to set up branches in other states. The Financial Services Modernization Act of 1999, also called the Gramm-LeachBliley Act, repealed the requirement that investment and commercial banking be separate, a provision that was originally set forth in the Glass-Steagall Act of 1933. After the world ushered in a new millennium, the terrorist attacks of September 11, 2001, forever changed life in America. In the days and weeks that followed, the Fed maintained financial stability and kept the economy moving by pumping liquidity into U.S. financial markets. The Fed kept the payments system and banking operations as close to normal as possible. The attacks also generated new payment systems since all air transportation was grounded for several days after 9/11. The Fed couldn’t move checks from one part of the country to another by air, so it stepped in to keep the financial system operational. The Fed credited the accounts of the banks receiving check payments and waited to debit the accounts of the paying banks until planes began flying again. The Fed asked Congress to enact a law that would allow a substitute check to be legally acceptable for collection and payment. And in 2003, Congress passed the Check Clearing for the 21st Century Act, commonly called Check 21. This legislation, which went into effect in October 2004, reduced the time it took banks to clear checks: An electronic image was sent instead of the actual paper check. In 2007, the Fed had to face yet another financial crisis and ensuing deep recession. This time, the Fed didn’t waste time in taking extraordinary steps: It lowered TM Edward G. Boehne is named president of the Philadelphia Fed. During his tenure, many Third District banks are taken over by larger rivals and the Federal Deposit Insurance Corporation Improvement Act is passed in 1991. Anthony Santomero is named president of the Philadelphia Fed. During his tenure, he oversees the launch of both the Payment Cards Center and the Money in Motion exhibit. 1981 2000 Charles I. Plosser is named president of the Philadelphia Fed. During his tenure, he leads the Bank through the global financial crisis of 2008 and the ensuing Great Recession. The Federal Reserve System reaches a milestone: a century of service. 2006 2013 26 2013 Annual Report| Federal Reserve Bank of Philadelphia Comparing U.S. Central Banks 1791-1811 1816-1836 1913-Present First Bank of the United States Second Bank of the United States Federal Reserve System Supervisory Duties No No Yes Monetary Policy No, but it was large enough to affect credit conditions nationwide. No, but it was large enough to affect credit conditions nationwide. Yes, but in the early years, the Fed did not conduct monetary policy as we know it today. Branches Yes Yes Yes 20-Year Charter Yes, charter not renewed Yes, charter not renewed Yes, the Fed originally had a 20-year charter, but the McFadden Act of 1927 gave the central bank permanency. Issues Currency Yes Yes Yes Stockholders Yes, 20% was held by government; 80% by the public. Yes, 20% was held by government; 80% by the public. Yes, but only member banks hold stock, not the public. Stock Publicly traded, held by foreign and domestic investors Publicly traded, held by foreign and domestic investors Federal Reserve System members of national banks and state-chartered banks receive nontradable stock in their District Reserve Bank; stock pays a fixed dividend of 6%. Commercial Bank Operations Yes, it accepted deposits from and made loans to the public. Yes, it accepted deposits from and made loans to the public. No, the Fed is a “bankers’ bank”; it makes loans only to banks and holds their deposits called reserves. Competition with State Banks None Yes None Services to Federal Government Served as the federal government’s fiscal agent, received its revenues, held its deposits, and made its payments Served as the federal government’s fiscal agent, received its revenues, held its deposits, and made its payments Serves as the federal government’s fiscal agent, receives its revenues, holds its deposits, and makes its payments 2013 Annual Report | Federal Reserve Bank of Philadelphia short-term interest rates to near zero, established special lending programs, expanded traditional overnight loans through the discount window to 90 days, and supported the functioning of credit markets through open market purchases of long-term securities for the Fed’s portfolio. In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which resulted in three significant changes for the Federal Reserve. Living History First, Congress expanded the Fed’s regulatory role by adding savings and loan holding companies to the Fed’s supervisory activities. The Fed was also given supervisory authority over systemically important nonbank financial companies. Congress also created the Financial Stability Oversight Council to conduct surveillance and monitor risks to the financial system. Second, Congress limited the Fed’s role under Section 13(3) of the Federal Reserve Act as lender of last resort in unusual and exigent circumstances. During the financial crisis, the Fed used this authority to make $182 billion in loans to the American International Group (AIG) to prevent it from filing for bankruptcy, which would have destabilized the global financial system because of AIG’s size. Finally, Congress transferred the Fed’s authority to write regulations for most federal consumer protection laws to the newly created Consumer Financial Protection Bureau (CFPB). Although Dodd-Frank funded the CFPB through the Fed, the new bureau is independent of the Fed in terms of its decision-making authority. While rule-making authority for most consumer protection laws was transferred to the CFPB, the Fed and federal agencies still had the authority to write regulations for certain federal laws, including the Community Reinvestment Act (CRA), the National Flood Insurance Act, and the Expedited Funds Availability Act. And the Fed continues to be the consumer compliance regulator for state member banks with assets of less than $10 On December 16, 2013, more than 80 Federal Reserve Board officials gathered in Washington, D.C., to commemorate the signing of the Federal Reserve Act. Four Federal Reserve System Chairs whose service has spanned 35 years were on hand; from left to right, Janet Yellen (2014–ongoing), the first woman to be appointed Chair; Alan Greenspan (1987–2006), Ben Bernanke (2006–14), and Paul Volcker (1979–87). billion. It also conducts limited consumer examinations of state member banks with assets of more than $10 billion to ensure compliance with laws that the bureau doesn’t cover in its examinations. These changes were only the latest the Fed has undergone in the past 100 years. Yet, the economy and the banking industry have also been shaped by changing times. The financial services industry as a whole would be all but unrecognizable to our forebears a hundred years ago. Unlike its predecessors, the Fed has weathered the political storms of its day. It insulated itself from partisan politics, but it is clearly accountable to Congress and the American people. Its decentralized structure has kept it close to the economy on Main Streets throughout America. And that has made it ready to tackle the challenges to come as the Fed enters its second century of service as the nation’s central bank. For more information on the history of central banking, see the ongoing series published by the Federal Reserve Bank of Philadelphia (www.philadelphiafed.org/publications/economiceducation/). For more on the Federal Reserve System’s centennial, see www.philadelphiafed.org/about-the-fed/ centennial/. 27 28 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Board of Directors Jeremy Nowak (a, d) Chairman President of J Nowak and Associates, LLC Philadelphia, PA James E. Nevels (a, c, d) Deputy Chairman Founder and Chairman, The Swarthmore Group Philadelphia, PA Michael J. Angelakis (a, b) Vice Chairman and CFO, Comcast Corporation Philadelphia, PA Keith S. Campbell (a, b, d) Chairman, Mannington Mills, Inc. Salem, NJ Patrick T. Harker (a, c) President of the University of Delaware Newark, DE David R. Hunsicker (b) Chairman, President, and CEO, New Tripoli Bank New Tripoli, PA Frederick C. “Ted” Peters II (a, b) Chairman and CEO, Bryn Mawr Trust Company Bryn Mawr, PA R. Scott Smith Jr. (a, c) Chairman and CEO, Fulton Financial Corporation Lancaster, PA Rosemary Turner (c), not pictured President of the United Parcel Service’s Chesapeake District Philadelphia, PA (a) Executive Committee (b) Audit Committee (c) Management & Budget Committee (d) Nominating & Governance Committee Left to right: Michael J. Angelakis, Jeremy Nowak, and James E. Nevels 2013 Annual Report | Federal Reserve Bank of Philadelphia Left to right: Patrick T. Harker and R. Scott Smith Jr. 29 Left to right: Keith S. Campbell, David R. Hunsicker, and Frederick C. “Ted” Peters II 30 2013 Annual Report| Federal Reserve Bank of Philadelphia Economic Advisory Council Left to right: Kevin Flemming, Cheryl Feldman, Patrick Magri, Michael Araten, M. Shawn Puccio, Chris Gheysens, Ernest J. Dianastasis, Thomas J. Doll, William Polacek, and Edward Graham. Not pictured: Teresa Bryce Bazemore, Michael Pearson Michael Araten President and CEO Rodon Group and K’NEX Brands Hatfield, PA Teresa Bryce Bazemore President Radian Guaranty, Inc. Philadelphia, PA Ernest J. Dianastasis Managing Director ComputerAid, Inc. Wilmington, DE Thomas J. Doll President, COO, and CFO Subaru of America, Inc. Cherry Hill, NJ Cheryl Feldman Executive Director District 1199C Training & Upgrading Fund Philadelphia, PA Patrick Magri Senior Vice President, Managed Markets & Policy Merck & Co., Inc. North Wales, PA Kevin Flemming President Integrity Personnel Allentown, PA Michael Pearson President Union Packaging, LLC Yeadon, PA Chris Gheysens President & CEO Wawa, Inc. Wawa, PA William Polacek President and CEO JWF Industries Johnstown, PA Edward Graham Chairman, President, and CEO South Jersey Industries Folsom, NJ M. Shawn Puccio Senior Vice President of Finance Saint-Gobain Corporation Valley Forge, PA 2013 Annual Report | Federal Reserve Bank of Philadelphia Community Depository Institutions Advisory Council Left to right: Gregory A. Smith, Gerard P. Cuddy, Evelyn F. Smalls, Stephen Cimo, Gerald L. Reeves, Glenn L. Wilson, Dennis D. Circucci, Thomas M. Petro, and David E. Gillan. Not pictured: Lynda Messick, Vito S. Pantilione, Richard A. Grafmyre Stephen Cimo President and CEO Delaware State Police Federal Credit Union Georgetown, DE Dennis D. Cirucci President, CEO, and Director Alliance Bancorp Inc. of Pennsylvania and Alliance Bank Broomall, PA Gerard P. Cuddy President and CEO Beneficial Bank Philadelphia, PA David E. Gillan Chairman and CEO County Bank Rehoboth, DE Richard A. Grafmyre President and CEO Jersey Shore State Bank Jersey Shore, PA Gerald L. Reeves President, CEO, and Director Sturdy Savings Bank Stone Harbor, NJ Lynda Messick President and CEO Community Bank Delaware Lewes, DE Evelyn F. Smalls President and CEO United Bank of Philadelphia Philadelphia, PA Vito S. Pantilione President and CEO Parke Bank Sewell, NJ Gregory A. Smith President and CEO Pennsylvania State Employees Credit Union Harrisburg, PA Thomas M. Petro President and CEO Fox Chase Bancorp, Inc. Hatboro, PA Glenn L. Wilson President and CEO AmeriServ Financial, Inc. Johnstown, PA 31 32 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Annual Report | Federal Reserve Bank of Philadelphia Management Committee Charles I. Plosser President and Chief Executive Officer Loretta J. Mester Executive Vice President and Director of Research D. Blake Prichard First Vice President and Chief Operating Officer Donna L. Franco Senior Vice President and Chief Financial Officer William W. Lang Executive Vice President and Lending Officer Supervision, Regulation & Credit Terry E. Harris Senior Vice President and Chief Information Officer Information Technology Services Mary Ann Hood Senior Vice President and EEO Officer, Human Resources Director, Office of Diversity and Inclusion Arun K. Jain Senior Vice President Treasury and Financial Services Milissa M. Tadeo Senior Vice President Corporate Affairs Herbert E. Taylor Vice President and Corporate Secretary Office of the Secretary Jeanne R. Rentezelas Senior Vice President and General Counsel Legal other Bank Officers Richard Sheaffer Senior Vice President and General Auditor Audit John D. Ackley Vice President Cash Services Roc Armenter Vice President and Economist Research Mitchell Berlin Vice President and Economist Research Donna L. Brenner Vice President Enterprise Risk Management Jennifer E. Cardy Vice President Financial Management Services Larry Cordell Vice President Supervision, Regulation & Credit Michael Dotsey Vice President and Senior Economic Policy Advisor Research Patrick M. Regan Vice President Information Technology Services Michael T. Doyle Assistant Vice President Treasury Payments Anthony T. Scafide Jr. Assistant Vice President Financial Institutions Relations Michelle M. Scipione Vice President Treasury Services Suzanne W. Furr Assistant Vice President and Assistant General Auditor Audit Stephen J. Smith Assistant Vice President and Counsel Legal Stephen G. Hart Assistant Vice President Human Resources H. Robert Tillman Assistant Vice President Supervision, Regulation & Credit Christopher Henderson Assistant Vice President Supervision, Regulation & Credit Gail L. Todd Assistant Vice President and Credit Officer Supervision, Regulation & Credit Stanley Sienkiewicz Vice President, Research Support Research Keith Sill Vice President and Director Real-Time Data Research Center Research Theresa Y. Singleton Vice President and Community Affairs Officer Community Development Studies and Education Vish P. Viswanathan Vice President and Discount Officer Supervision, Regulation & Credit Constance H. Wallgren Vice President and Chief Examinations Officer Supervision, Regulation & Credit James S. Ely Vice President Public Affairs James K. Welch Vice President Law Enforcement and Facilities Management Gregory Fanelli Vice President Information Technology Services Joanne M. Branigan Assistant Vice President Supervision, Regulation & Credit Charles Kirkland Vice President Financial Statistics Brian Calderwood Assistant Vice President Groupware Leadership Center Robert Hunt Vice President and Director Payment Cards Center Paul Calem Assistant Vice President Supervision, Regulation & Credit Alice Menzano Vice President Groupware Leadership Center Kori Ann Connelly Assistant Vice President and Counsel Legal Leonard Nakamura Vice President and Economist Research A. Reed Raymond III Vice President and Chief Administrative Officer Supervision, Regulation & Credit Maryann T. Connelly Assistant Vice President and Counsel Legal Frank J. Doto Assistant Vice President Supervision, Regulation & Credit Includes promotions through January 2014 Christopher Ivanoski Assistant Vice President Facilities–Plant Operations John P. Kelly Assistant Vice President Enterprise Risk Management Thomas Lombardo Assistant Vice President and Assistant Secretary Financial Institutions Relations Keith Morales Assistant Vice President and Information Security Officer Information Technology Services Robert F. Mucerino Assistant Vice President Treasury Services John J. Munera III Assistant Vice President Supervision, Regulation & Credit Robin P. Myers Assistant Vice President Supervision, Regulation & Credit Camille M. Ochman Assistant Vice President Cash Services Wanda Preston Assistant Vice President Supervision, Regulation & Credit Chellappan Ramasamy Assistant Vice President Supervision, Regulation & Credit Gregory A. Ramick Assistant Vice President Cash Services Patrick F. Turner Assistant Vice President Groupware Leadership Center William T. Wisser Assistant Vice President Supervision, Regulation & Credit Julia Cheney Officer and Assistant Director Payment Cards Center Michael Costello Business Technology Officer Supervision, Regulation & Credit Heather Derbyshire Officer Financial Statistics Dawn Karlyn Officer Treasury Services James Lofton Officer Cash Services Pattie Scafide Officer Financial Management Services Kim Taylor Officer Human Resources Luke Tilley Officer and Economic Advisor Corporate Affairs Linda Van Valkenburg Officer Information Technology Services 33 34 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Annual Report | Federal Reserve Bank of Philadelphia Statement of Auditor Independence he Board of Governors engaged Deloitte & Touche LLP (D&T) to audit the 2013 combined and individual T financial statements of the Reserve Banks and those of the consolidated LLC entities.1 In 2013, D&T also conducted audits of internal controls over financial reporting for each of the Reserve Banks. Fees for D&T’s services totaled $7 million, of which $1 million was for the audits of the consolidated LLC entities. To ensure auditor independence, the Board requires that D&T be independent in all matters relating to the audits. Specifically, D&T may not perform services for the Reserve Banks or others that would place it in a position of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit independence. In 2013, the Bank did not engage D&T for any non-audit services. In addition, D&T audited the Office of Employee Benefits of the Federal Reserve System (OEB), the Retirement Plan for Employees of the Federal Reserve System (System Plan), and the Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The System Plan and the Thrift Plan provide retirement benefits to employees of the Board, the Federal Reserve Banks, and the OEB. 1 35 36 2013 Annual Report| Federal Reserve Bank of Philadelphia 2013 Annual Report | Federal Reserve Bank of Philadelphia Financial Statement contents Management’s Report on Internal Control Over Financial Reporting 38 Independent Auditors’ Report 39 Abbreviations 42 Financial Statements: Statements of Condition as of December 31, 2013 and December 31, 2012 43 Statements of Income and Comprehensive Income for the years ended December 31, 2013 and December 31, 2012 44 Statements of Changes in Capital for the years ended December 31, 2013 and December 31, 2012 45 Notes to Financial Statements 46 37 2013 Annual Report| Federal Reserve Bank of Philadelphia O management’s Report on Internal control over financial reporting FP 38 2013 Annual Report | Federal Reserve Bank of Philadelphia Independent Auditors’ Report Deloitte & Touche LLP 1700 Market Street Philadelphia, PA 19102-3984 USA Tel: +1 215 246 2300 Fax: +1 215 569 2441 www.deloitte.com INDEPENDENT AUDITORS’ REPORT To the Board of Governors of the Federal Reserve System and the Board of Directors of the Federal Reserve Bank of Philadelphia: We have audited the accompanying financial statements of the Federal Reserve Bank of Philadelphia (“FRB Philadelphia”), which are comprised of the statements of condition as of December 31, 2013 and 2012, and the related statements of income and comprehensive income, and of changes in capital for the years then ended, and the related notes to the financial statements. We also have audited the FRB Philadelphia’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s Responsibility The FRB Philadelphia’s management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles established by the Board of Governors of the Federal Reserve System (the “Board”) as described in Note 3 to the financial statements. The Board has determined that this basis of accounting is an acceptable basis for the preparation of the FRB Philadelphia’s financial statements in the circumstances. The FRB Philadelphia’s management is also responsible for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. The FRB Philadelphia’s management is also responsible for its assertion of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Auditors’ Responsibility Our responsibility is to express an opinion on these financial statements and an opinion on the FRB Philadelphia's internal control over financial reporting based on our audits. We conducted our audits of the financial statements in accordance with auditing standards generally accepted in the United States of America and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”) and we conducted our audit of internal control over financial reporting in accordance with attestation standards established by the American Institute of Certified Public Accountants and in accordance with the auditing standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement and whether effective internal control over financial reporting was maintained in all material respects. An audit of the financial statements involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers Member of Deloitte Touche Tohmatsu Limited 39 40 2013 Annual Report| Federal Reserve Bank of Philadelphia Independent Auditors’ Report — page 2 internal control relevant to the FRB Philadelphia’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances. An audit of the financial statements also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. An audit of internal control over financial reporting involves obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. Definition of Internal Control Over Financial Reporting The FRB Philadelphia’s internal control over financial reporting is a process designed by, or under the supervision of, the FRB Philadelphia’s principal executive and principal financial officers, or persons performing similar functions, and effected by the FRB Philadelphia’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the accounting principles established by the Board. The FRB Philadelphia’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the FRB Philadelphia; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the accounting principles established by the Board, and that receipts and expenditures of the FRB Philadelphia are being made only in accordance with authorizations of management and directors of the FRB Philadelphia; and (3) provide reasonable assurance regarding prevention or timely detection and correction of unauthorized acquisition, use, or disposition of the FRB Philadelphia’s assets that could have a material effect on the financial statements. Inherent Limitations of Internal Control Over Financial Reporting Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected and corrected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Opinions In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the FRB Philadelphia as of December 31, 2013 and 2012, and the results of its operations for the years then ended in accordance with the basis of accounting described in Note 3 to the financial statements. Also, in our opinion, the FRB Philadelphia maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. 2013 Annual Report | Federal Reserve Bank of Philadelphia Independent Auditors’ Report — page 3 Basis of Accounting We draw attention to Note 3 to the financial statements, which describes the basis of accounting. The FRB Philadelphia has prepared these financial statements in conformity with accounting principles established by the Board, as set forth in the Financial Accounting Manual for Federal Reserve Banks, which is a basis of accounting other than accounting principles generally accepted in the United States of America. The effects on such financial statements of the differences between the accounting principles established by the Board and accounting principles generally accepted in the United States of America are also described in Note 3 to the financial statements. Our opinion is not modified with respect to this matter. March 14, 2014 41 42 2013 Annual Report| Federal Reserve Bank of Philadelphia Abbreviations ACH Automated clearinghouse ASC Accounting Standards Codification ASU Accounting Standards Update BEP Benefit Equalization Retirement Plan Bureau Bureau of Consumer Financial Protection FAM Financial Accounting Manual for Federal Reserve Banks FASB Financial Accounting Standards Board FOMC Federal Open Market Committee FRBNY Federal Reserve Bank of New York GAAP Accounting principles generally accepted in the United States of America GSE Government-sponsored enterprise IMF International Monetary Fund MBS Mortgage-backed securities OFR Office of Financial Research SDR Special drawing rights SERP Supplemental Retirement Plan for Select Officers of the Federal Reserve Banks SOMA System Open Market Account TBA To be announced TDF Term Deposit Facility 2013 Annual Report | Federal Reserve Bank of Philadelphia 43 STATEMENTS OF CONDITION As of December 31, 2013 and December 31, 2012 (in millions) 2013 2012 ASSETS Gold certificates $ 397 $ 437 Special drawing rights certificates 210 210 Coin 123 141 Loans to depository institutions - 2 System Open Market Account: Treasury securities, net (of which $497 and $302 is lent as of December 31, 2013 and 2012, respectively) 68,363 59,808 Government-sponsored enterprise debt securities, net (of which $32 and $23 is lent as of December 31, 2013 and 2012, respectively) 1,713 2,627 Federal agency and government-sponsored enterprise mortgage-backed securities, net 44,442 31,416 Foreign currency denominated investments, net 1,835 2,157 Central bank liquidity swaps 21 771 Accrued interest receivable 685 635 Other investments - 1 Bank premises and equipment, net 87 87 Other assets 28 27 Total assets $ 117,904 $ 98,319 LIABILITIES AND CAPITAL Federal Reserve notes outstanding, net $ 36,063 $ 43,262 System Open Market Account: Securities sold under agreements to repurchase 9,154 3,543 Other liabilities 39 105 Deposits: Depository institutions 48,568 30,547 Other deposits 21 17 Interest payable to depository institutions 2 4 Accrued benefit costs 104 115 Accrued remittances to Treasury 84 29 Interdistrict settlement account 19,721 16,451 Other liabilities 12 14 Total liabilities 113,768 Capital paid-in 2,068 Surplus (including accumulated other comprehensive loss of $14 and $33 at December 31, 2013 and 2012, respectively) 2,068 Total capital Total liabilities and capital $ 117,904 The accompanying notes are an integral part of these financial statements. 4,136 94,087 2,116 2,116 4,232 $ 98,319 44 2013 Annual Report| Federal Reserve Bank of Philadelphia STATEMENTS OF INCOME AND COMPREHENSIVE INCOME For the years ended December 31, 2013 and December 31, 2012 (in millions) 2013 2012 INTEREST INCOME System Open Market Account: Treasury securities, net $ 1,549 $ Government-sponsored enterprise debt securities, net 66 Federal agency and government-sponsored enterprise mortgage-backed securities, net 1,098 Foreign currency denominated assets, net 8 Central bank liquidity swaps 2 Other investments - Total interest income 2,723 INTEREST EXPENSE System Open Market Account: Securities sold under agreements to repurchase 2 Deposits: Depository institutions 99 Term Deposit Facility 1 Total interest expense 1,550 88 1,051 12 21 1 2,723 5 91 1 102 97 Net interest income 2,621 NON-INTEREST INCOME (LOSS) System Open Market Account: Treasury securities gains, net - Federal agency and government-sponsored enterprise mortgage-backed securities gains, net 1 Foreign currency translation losses, net (98) Compensation received for service costs provided 4 Reimbursable services to government agencies 39 Other 4 2,626 Total non-interest (loss) income (50) OPERATING EXPENSES Salaries and benefits 124 Occupancy 16 Equipment 7 Other 51 Assessments: Board of Governors operating expenses and currency costs 81 Bureau of Consumer Financial Protection 43 397 Total operating expenses Net income before providing for remittances to Treasury Earnings remittances to Treasury 322 288 2,249 2,189 2,735 2,812 442 8 (96) 2 39 2 112 14 9 46 76 31 Net income (loss) Change in prior service costs related to benefit plans Change in actuarial gains (losses) related to benefit plans 60 (77) - 19 1 (9) Total other comprehensive income (loss) 19 (8) Comprehensive income (loss) $ 79 The accompanying notes are an integral part of these financial statements. $ (85) 2013 Annual Report | Federal Reserve Bank of Philadelphia STATEMENTS OF CHANGES IN CAPITAL For the years ended December 31, 2013 and December 31, 2012 (in millions, except share data) Surplus Accumulated other Capital Net income comprehensive paid-in retained income (loss) Total surplus Balance at December 31, 2011 (46,662,518 shares) $ 2,333 Net change in capital stock redeemed (4,338,127 shares) $ 2,358 $ 2,333 Comprehensive income: Net loss - (77) - (77) Other comprehensive loss - - (8) (8) Dividends on capital stock - (132) - (132) (77) (8) (132) Net change in capital (434) Balance at December 31, 2012 (42,324,391 shares) $ 2,116 (209) $ 2,149 (48) $ (8) (33) (217) $ 2,116 (48) Comprehensive income: Net income - 60 - 60 Other comprehensive income - - 19 19 Dividends on capital stock - (127) - (127) 60 19 (127) (48) Balance at December 31, 2013 (41,365,761 shares) $ 2,068 The accompanying notes are an integral part of these financial statements. (67) $ 2,082 $ - $ 4,232 - Net change in capital - - $ 4,666 (217) (217) - (25) - Net change in capital stock redeemed (958,630 shares) (217) $ Total capital 19 (14) (48) $ 2,068 (96) $ 4,136 45 46 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements 1. Structure The Federal Reserve Bank of Philadelphia (Bank) is part of the Federal Reserve System (System) and is one of the 12 Federal 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 serves the Third Federal Reserve District, which includes Delaware and portions of New Jersey and Pennsylvania. In accordance with the Federal Reserve Act, supervision and control of the Bank is exercised by a board of directors. The Federal Reserve Act specifies the composition of the board of directors for each of the Reserve Banks. Each board is composed of nine members serving three-year terms: three directors, including those designated as chairman and deputy chairman, are appointed by the Board of Governors of the Federal Reserve System (Board of Governors) to represent the public, 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. 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. In addition to the 12 Reserve Banks, the System also consists, in part, of the 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 Reserve Banks perform a variety of services and operations. These functions include participating in formulating and conducting monetary policy; participating in the payment system, including large-dollar transfers of funds, automated clearinghouse (ACH) operations, and check collection; distributing coin and currency; performing fiscal agency functions for the U.S. Department of the Treasury (Treasury), certain federal agencies, and other entities; serving as the federal government’s bank; providing short-term loans to depository institutions; providing loans to participants in programs or facilities with broad-based eligibility in unusual and exigent circumstances; serving consumers and communities by providing educational materials and information regarding financial consumer protection rights and laws and information on community development programs and activities; and supervising bank holding companies, state member banks, savings and loan holding companies, U.S. offices of foreign banking organizations, and designated financial market utilities pursuant to authority delegated by the Board of Governors. Certain services are provided to foreign and international monetary authorities, primarily by the FRBNY. The FOMC, in conducting monetary policy, establishes policy regarding domestic open market operations, oversees these operations, and issues authorizations and directives to the FRBNY to execute transactions. The FOMC authorizes and directs the FRBNY to conduct operations in domestic markets, including the direct purchase and sale of Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities (MBS); the purchase of these securities under agreements to resell; and the sale of these securities under agreements to 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements repurchase. The FRBNY holds the resulting securities and agreements in a portfolio known as the System Open Market Account (SOMA). The FRBNY is authorized and directed to lend the Treasury securities and GSE debt securities that are held in the SOMA. To counter disorderly conditions in foreign exchange markets or to meet other needs specified by the FOMC to carry out the System’s central bank responsibilities, the FOMC has authorized and directed the FRBNY to execute spot and forward foreign exchange transactions in 14 foreign currencies, to hold balances in those currencies, and to invest such foreign currency holdings, while maintaining adequate liquidity. The FOMC has also authorized the FRBNY to maintain reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico in the maximum amounts of $2 billion and $3 billion, respectively, and to warehouse foreign currencies for the Treasury and the Exchange Stabilization Fund in the maximum amount of $5 billion. Because of the global character of bank funding markets, the System has at times coordinated with other central banks to provide liquidity. The FOMC authorized and directed the FRBNY to establish temporary U.S. dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. In addition, as a contingency measure, the FOMC authorized and directed the FRBNY to establish temporary foreign currency liquidity swap arrangements with these five central banks to allow for the System to access liquidity, if necessary, in any of the foreign central banks’ currencies. On October 31, 2013, the Federal Reserve and five other central banks agreed to convert their existing temporary liquidity swap arrangements to standing agreements which will remain in effect until further notice. Although the Reserve Banks are separate legal entities, they collaborate on the delivery of certain services to achieve greater efficiency and effectiveness. This collaboration takes the form of centralized operations and product or function 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 Banks. In some cases, costs incurred by a Reserve Bank for services provided to other Reserve Banks are not shared; in other cases, the Reserve Banks are reimbursed for costs incurred in providing services to other Reserve Banks. Major services provided by the Bank on behalf of the System for which the costs were not reimbursed by the other Reserve Banks include Collateral Management System, Groupware Leadership Center, and Video Conferencing Network. 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 accounting standard-setting bodies. The Board of Governors has developed specialized accounting principles and practices that it considers to be appropriate for the nature and function of a central bank. These accounting principles and practices are documented in the Financial Accounting Manual for Federal Reserve Banks (FAM), which is issued by the Board of Governors. The Reserve Banks are required to adopt and apply accounting policies and practices that are consistent with the FAM. The financial statements have been prepared in accordance with the FAM. Limited differences exist between the accounting principles and practices in the FAM and accounting principles generally accepted in the United States of America (GAAP), due to the unique nature of the Bank’s powers and responsibilities as part of the nation’s central bank and given the System’s unique responsibility to conduct monetary policy. The primary 47 48 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements differences are the presentation of all SOMA securities holdings at amortized cost, adjusted for credit impairment, if any, and the recording of all SOMA securities on a settlement-date basis. Amortized cost, rather than the fair value presentation, more appropriately reflects the Bank’s securities holdings given the System’s unique responsibility to conduct monetary policy. Although the application of fair value measurements to the securities holdings may result in values substantially greater or less than their carrying values, these unrealized changes in value have no direct effect on the quantity of reserves available to the banking system or on the ability of the Reserve Banks, as the central bank, to meet their financial obligations and responsibilities. Both the domestic and foreign components of the SOMA portfolio may involve transactions that result in gains or losses when holdings are sold before maturity. Decisions regarding securities and foreign currency transactions, including their purchase and sale, are motivated by monetary policy objectives rather than profit. Accordingly, fair values, earnings, and gains or losses resulting from the sale of such securities and currencies are incidental to open market operations and do not motivate decisions related to policy or open market activities. Accounting for these securities on a settlement-date basis, rather than the trade-date basis required by GAAP, better reflects the timing of the transaction’s effect on the quantity of reserves in the banking system. The cost bases of Treasury securities, GSE debt securities, and foreign government debt instruments are adjusted for amortization of premiums or accretion of discounts on a straight-line basis, rather than using the interest method required by GAAP. In addition, the Bank does not present a Statement of Cash Flows as required by GAAP because the liquidity and cash position of the Bank are not a primary concern given the Reserve Banks’ unique powers and responsibilities as a central bank. Other information regarding the Bank’s activities is provided in, or may be derived from, the Statements of Condition, Income and Comprehensive Income, and Changes in Capital, and the accompanying notes to the financial statements. Other than those described above, there are no significant differences between the policies outlined in the FAM and GAAP. Preparing the financial statements in conformity with the FAM requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. In 2013, the description of certain line items presented in the Statements of Income and Comprehensive Income and the Statements of Condition have been revised to better reflect the nature of these items. Amounts related to these line items were not changed from the prior year, only the nomenclature for the line item was revised, as further noted below: • • • The line item, “Accrued interest on Federal Reserve notes” has been revised in the Statements of Condition to “Accrued remittances to Treasury.” The line item, “Net income before interest on Federal Reserve notes expense remitted to Treasury” has been revised in the Statements of Income and Comprehensive Income to “Net income before providing for remittances to Treasury.” The line item, “Interest on Federal Reserve notes expense remitted to Treasury” has been revised in the Statements of Income and Comprehensive Income to “Earnings remittances to Treasury.” Certain amounts relating to the prior year have been reclassified in the Statements of Condition to conform to the cur- 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements rent year presentation. The amount reported as “System Open Market Account: Accrued interest receivable” for the year ended December 31, 2012 ($635 million) was previously reported as a component of “System Open Market Account: Foreign currency denominated assets, net” ($9 million) and “Accrued interest receivable” ($626 million). Significant accounts and accounting policies are explained below. a. Consolidation The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) established the Bureau of Consumer Financial Protection (Bureau) as an independent bureau within the System that has supervisory authority over some institutions previously supervised by the Reserve Banks in connection with those institutions’ compliance with consumer protection statutes. Section 1017 of the Dodd-Frank Act provides that the financial statements of the Bureau are not to be consolidated with those of the Board of Governors or the System. The Board of Governors funds the Bureau through assessments on the Reserve Banks as required by the Dodd-Frank Act. Section 152 of the Dodd-Frank Act established the Office of Financial Research (OFR) within the Treasury and required the Board of Governors to fund the OFR for the twoyear period ended July 21, 2012. The Reserve Banks reviewed the law and evaluated the design of and their relationships to the Bureau and the OFR and determined that neither should be consolidated in the Bank’s financial statements. b. Gold and Special Drawing Rights Certificates The Secretary of the Treasury is authorized to issue gold certificates to the Reserve Banks. Upon authorization, the Reserve Banks acquire gold certificates by crediting equivalent amounts in dollars to the account established for the Treasury. The gold certificates held by the Reserve Banks are required to be backed by the gold owned by the Treasury. The Treasury may reacquire the gold certificates at any time, and the Reserve Banks must deliver them to the Treasury. At such time, the Treasury’s account is charged, and the Reserve Banks’ gold certificate accounts are reduced. The value of gold for purposes of backing the gold certificates is set by law at $42 2/9 per fine troy ounce. Gold certificates are recorded by the Banks at original cost. The Board of Governors allocates the gold certificates among the Reserve Banks once a year based on each Reserve Bank’s average Federal Reserve notes outstanding during the preceding twelve months. Special drawing rights (SDR) are issued by the International Monetary Fund (IMF) to its members in proportion to each member’s quota in the IMF 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 U.S. participation in the SDR system, the Secretary of the Treasury is authorized to issue SDR certificates to the Reserve Banks. When SDR certificates are issued to the Reserve Banks, equivalent amounts in U.S. dollars are credited to the account established for the Treasury and the Reserve Banks’ SDR certificate accounts are increased. The Reserve Banks are required to purchase SDR certificates, at the direction of the Treasury, for the purpose of financing SDR acquisitions or for financing exchange-stabilization operations. At the time SDR certificate transactions occur, the Board of Governors allocates the SDR certificates among the Reserve Banks based upon each Reserve Bank’s Federal Reserve notes outstanding at the end of the preceding calendar year. SDR certificates are recorded by the Banks at original cost. There were no SDR certificate transactions during the years ended December 31, 2013 and 2012. c. Coin The amount reported as coin in the Statements of Condition represents the face value of all United States coin held by the Bank. The Bank buys coin at face value from the U.S. Mint in order to fill depository institution orders. 49 50 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements d. Loans Loans to depository institutions are reported at their outstanding principal balances and interest income is recognized on an accrual basis. Loans are impaired when current information and events indicate that it is probable that the Bank will not receive the principal and interest that are due in accordance with the contractual terms of the loan agreement. Impaired loans are evaluated to determine whether an allowance for loan loss is required. The Bank has developed procedures for assessing the adequacy of any allowance for loan losses using all available information to identify incurred losses. This assessment includes monitoring information obtained from banking supervisors, borrowers, and other sources to assess the credit condition of the borrowers and, as appropriate, evaluating collateral values. Generally, the Bank would discontinue recognizing interest income on impaired loans until the borrower’s repayment performance demonstrates principal and interest would be received in accordance with the terms of the loan agreement. If the Bank discontinues recording interest on an impaired loan, cash payments are first applied to principal until the loan balance is reduced to zero; subsequent payments are applied as recoveries of amounts previously deemed uncollectible, if any, and then as interest income. e. Securities Purchased Under Agreements to Resell, Securities Sold Under Agreements to Repurchase, and Securities Lending The FRBNY may engage in purchases of securities with primary dealers under agreements to resell (repurchase transactions). These repurchase transactions are settled through a tri-party arrangement. In a tri-party arrangement, two commercial custodial banks manage the collateral clearing, settlement, pricing, and pledging, and provide cash and securities custodial services for and on behalf of the FRBNY and counterparty. The collateral pledged must exceed the principal amount of the transaction by a margin determined by the FRBNY for each class and maturity of acceptable collateral. Collateral designated by the FRBNY as acceptable under repurchase transactions primarily includes Treasury securities (including Treasury Inflation-Protected Securities and Separate Trading of Registered Interest and Principal of Securities Treasury securities); direct obligations of several federal and GSE-related agencies, including Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Federal Home Loan Banks; and pass-through federal agency and GSE MBS. The repurchase transactions are accounted for as financing transactions with the associated interest income recognized over the life of the transaction. These transactions are reported at their contractual amounts as “System Open Market Account: Securities purchased under agreements to resell” and the related accrued interest receivable is reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. The FRBNY may engage in sales of securities under agreements to repurchase (reverse repurchase transactions) with primary dealers and with the set of expanded counterparties which includes banks, savings associations, GSEs, and domestic money market funds. These reverse repurchase transactions, when arranged as open market operations, are settled through a tri-party arrangement, similar to repurchase transactions. Reverse repurchase transactions may also be executed with foreign official and international account holders as part of a service offering. Reverse repurchase agreements are collateralized by a pledge of an amount of Treasury securities, GSE debt securities, and federal agency and GSE MBS that are held in the SOMA. Reverse repurchase transactions are accounted for as financing transactions, and the associated interest expense is recognized over the life of the transaction. These transactions are reported at their contractual amounts as “System Open Market Account: Securities sold under agreements to repurchase” and the related accrued interest payable is reported as a component of “Other liabilities” in the Statements of Condition. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements Treasury securities and GSE debt securities held in the SOMA may be lent to primary dealers, typically overnight, to facilitate the effective functioning of the domestic securities markets. The amortized cost basis of securities lent continues to be reported as “Treasury securities, net” and “Government-sponsored enterprise debt securities, net,” as appropriate, in the Statements of Condition. Securities lending transactions are fully collateralized by Treasury securities that have fair values in excess of the securities lent. The FRBNY charges the primary dealer a fee for borrowing securities, and these fees are reported as a component of “Non-interest income (loss): Other” in the Statements of Income and Comprehensive Income. Activity related to securities purchased under agreements to resell, securities sold under agreements to repurchase, and securities lending is allocated to each of the Reserve Banks on a percentage basis derived from an annual settlement of the interdistrict settlement account that occurs in the second quarter of each year. f. Treasury Securities; Government-Sponsored Enterprise Debt Securities; Federal Agency and Government-Sponsored Enterprise Mortgage-Backed Securities; Foreign Currency Denominated Assets; and Warehousing Agreements Interest income on Treasury securities, GSE debt securities, and foreign currency denominated assets included in the SOMA is accrued on a straight-line basis. Interest income on federal agency and GSE MBS is accrued using the interest method and includes amortization of premiums, accretion of discounts, and gains or losses associated with principal paydowns. Premiums and discounts related to federal agency and GSE MBS are amortized or accreted over the term of the security to stated maturity, and the amortization of premiums and accretion of discounts are accelerated when principal payments are received. Gains and losses resulting from sales of securities are determined by specific issue based on average cost. Treasury securities, GSE debt securities, and federal agency and GSE MBS are reported net of premiums and discounts in the Statements of Condition and interest income on those securities is reported net of the amortization of premiums and accretion of discounts in the Statements of Income and Comprehensive Income. In addition to outright purchases of federal agency and GSE MBS that are held in the SOMA, the FRBNY enters into dollar roll transactions (dollar rolls), which primarily involve an initial transaction to purchase or sell “to be announced” (TBA) MBS for delivery in the current month combined with a simultaneous agreement to sell or purchase TBA MBS on a specified future date. During the years ended December 31, 2013 and 2012, the FRBNY executed dollar rolls primarily to facilitate settlement of outstanding purchases of federal agency and GSE MBS. The FRBNY accounts for dollar rolls as purchases or sales on a settlement-date basis. In addition, TBA MBS transactions may be paired off or assigned prior to settlement. Net gains (losses) resulting from these MBS transactions are reported as “Non-interest income (loss): System Open Market Account: Federal agency and government-sponsored enterprise mortgage-backed securities gains (losses), net” in the Statements of Income and Comprehensive Income. Foreign currency denominated assets, which can include foreign currency deposits, securities purchased under agreements to resell, and government debt instruments, are revalued daily at current foreign currency market exchange rates in order to report these assets in U.S. dollars. Foreign currency translation gains and losses that result from the daily revaluation of foreign currency denominated assets are reported as “Non-interest income (loss): System Open Market Account: Foreign currency translation gains (losses), net” in the Statements of Income and Comprehensive Income. Because the FRBNY enters into commitments to buy Treasury securities, federal agency and GSE MBS, and foreign gov- 51 52 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements ernment debt instruments and records the related securities on a settlement-date basis in accordance with the FAM, the related outstanding commitments are not reflected in the Statements of Condition. Activity related to Treasury securities, GSE debt securities, and federal agency and GSE MBS, including the premiums, discounts, and realized gains and losses, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement of the interdistrict settlement account that occurs in the second quarter of each year. Activity related to foreign currency denominated assets, including the premiums, discounts, and realized and unrealized gains and losses, is allocated to each Reserve Bank based on the ratio of each Reserve Bank’s capital and surplus to the Reserve Banks’ aggregate capital and surplus at the preceding December 31. Warehousing is an arrangement under which the FOMC has approved the exchange, at the request of the Treasury, of U.S. dollars for foreign currencies held by the Treasury over a limited period. The purpose of the warehousing facility is to supplement the U.S. dollar resources of the Treasury for financing purchases of foreign currencies and related international operations. Warehousing agreements are valued daily at current market exchange rates. Activity related to these agreements is allocated to each Reserve Bank based on the ratio of each Reserve Bank’s capital and surplus to the Reserve Banks’ aggregate capital and surplus at the preceding December 31. g. Central Bank Liquidity Swaps Central bank liquidity swaps, which are transacted between the FRBNY and a foreign central bank, can be structured as either U.S. dollar or foreign currency liquidity swap arrangements. Central bank liquidity swaps activity, including the related income and expense, is allocated to each Reserve Bank based on the ratio of each Reserve Bank’s capital and surplus to the Reserve Banks’ aggregate capital and surplus at the preceding December 31. The foreign currency amounts associated with these central bank liquidity swap arrangements are revalued daily at current foreign currency market exchange rates. U.S. dollar liquidity swaps At the initiation of each U.S. dollar liquidity swap transaction, the foreign central bank transfers a specified amount of its currency to a restricted account for the FRBNY in exchange for U.S. dollars at the prevailing market exchange rate. Concurrent with this transaction, the FRBNY and the foreign central bank agree to a second transaction that obligates the foreign central bank to return the U.S. dollars and the FRBNY to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. The Bank’s allocated portion of the foreign currency amounts that the FRBNY acquires are reported as “System Open Market Account: Central bank liquidity swaps” in the Statements of Condition. Because the swap transaction will be unwound at the same U.S. dollar amount and exchange rate that were used in the initial transaction, the recorded value of the foreign currency amounts is not affected by changes in the market exchange rate. The foreign central bank compensates the FRBNY based on the amount outstanding and the rate under the swap agreement. The Bank’s allocated portion of the amount of compensation received during the term of the swap transaction is reported as “Interest income: System Open Market Account: Central bank liquidity swaps” in the Statements of Income and Comprehensive Income. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements Foreign currency liquidity swaps The structure of foreign currency liquidity swap transactions involves the transfer by the FRBNY, at the prevailing market exchange rate, of a specified amount of U.S. dollars to an account for the foreign central bank in exchange for its currency. The foreign currency amount received would be reported as a liability by the Bank. h. Bank Premises, Equipment, and Software Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straightline basis over the estimated useful lives of the assets, which range from 2 to 50 years. Major alterations, renovations, and improvements are capitalized at cost as additions to the asset accounts and are depreciated over the remaining useful life of the asset or, if appropriate, over the unique useful life of the alteration, renovation, or improvement. Maintenance, repairs, and minor replacements are charged to operating expense in the year incurred. Costs incurred to acquire software are capitalized based on the purchase price. Costs incurred during the application development stage to develop internal-use software are capitalized based on the cost of direct services and materials associated with designing, coding, installing, and testing the software. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software applications, which generally range from two to five years. Maintenance costs related to software are charged to operating expense in the year incurred. Capitalized assets, including software, buildings, leasehold improvements, furniture, and equipment, are impaired and an adjustment is recorded when events or changes in circumstances indicate that the carrying amount of assets or asset groups is not recoverable and significantly exceeds the assets’ fair value. i. Interdistrict Settlement Account At the close of business each day, each Reserve Bank aggregates the payments due to or from other Reserve Banks. These payments result from transactions between the Reserve Banks and transactions that involve depository institution accounts held by other Reserve Banks, such as Fedwire funds and securities transfers and check and ACH transactions. The cumulative net amount due to or from the other Reserve Banks is reflected in the “Interdistrict settlement account” in the Statements of Condition. An annual settlement of the interdistrict settlement account occurs in the second quarter of each year. As a result of the annual settlement, the balance in each Bank’s interdistrict settlement account is adjusted by an amount equal to the average balance in the account during the previous twelve-month period ended March 31. An equal and offsetting adjustment is made to each Bank’s allocated portion of SOMA assets and liabilities. j. Federal Reserve Notes Federal Reserve notes are the circulating currency of the United States. These notes, which are identified as issued to a specific Reserve Bank, must be fully collateralized. All of the Bank’s assets are eligible to be pledged as collateral. The collateral value is equal to the book value of the collateral tendered with the exception of securities, for which the collateral value is equal to the par value of the securities tendered. The par value of securities sold under agreements to repurchase is deducted from the eligible collateral value. 53 54 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements The Board of Governors may, at any time, call upon a Reserve Bank for additional security to adequately collateralize outstanding 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 issued to 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, Federal Reserve notes are obligations of the United States government. “Federal Reserve notes outstanding, net” in the Statements of Condition represents the Bank’s Federal Reserve notes outstanding, reduced by the Bank’s currency holdings of $5,920 million and $4,304 million at December 31, 2013 and 2012, respectively. At December 31, 2013 and 2012, all Federal Reserve notes outstanding, reduced by the Reserve Bank’s currency holdings, were fully collateralized. At December 31, 2013, all gold certificates, all special drawing rights certificates, and $1,182 billion of domestic securities held in the SOMA were pledged as collateral. At December 31, 2013, no investments denominated in foreign currencies were pledged as collateral. k. Deposits Depository Institutions Depository institutions’ deposits represent the reserve and service-related balances in the accounts that depository institutions hold at the Bank. The interest rates paid on required reserve balances and excess balances are determined by the Board of Governors, based on an FOMC-established target range for the federal funds rate. Interest payable is reported as a component of “Interest payable to depository institutions” in the Statements of Condition. The Term Deposit Facility (TDF) consists of deposits with specific maturities held by eligible institutions at the Reserve Banks. The Reserve Banks pay interest on these deposits at interest rates determined by auction. Interest payable is reported as a component of “Interest payable to depository institutions” in the Statements of Condition. There were no deposits held by the Bank under the TDF at December 31, 2013 and 2012. Other Other deposits include the Bank’s allocated portion of foreign central bank and foreign government deposits held at the FRBNY. Other deposits also include cash collateral and GSE deposits held by the Bank. l. 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 six 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. A member bank is liable for Reserve Bank liabilities up to twice the par value of stock subscribed by it. By law, each Reserve Bank is required to pay each member bank an annual dividend of six percent on the paid-in capital stock. This cumulative dividend is paid semiannually. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements m. Surplus The Board of Governors requires the Reserve Banks to maintain a surplus equal to the amount of capital paid-in. On a daily basis, surplus is adjusted to equate the balance to capital paid-in. Accumulated other comprehensive income is reported as a component of “Surplus” in the Statements of Condition and the Statements of Changes in Capital. Additional information regarding the classifications of accumulated other comprehensive income is provided in Notes 9 and 10. n. Remittances to Treasury The Board of Governors requires the Reserve Banks to transfer excess earnings to the Treasury as interest on Federal Reserve notes after providing for the costs of operations, payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in. Currently, remittances to Treasury are made on a weekly basis. This amount is reported as “Earnings remittances to Treasury” in the Statements of Income and Comprehensive Income. The amount due to the Treasury is reported as “Accrued remittances to Treasury” in the Statements of Condition. See Note 12 for additional information on interest on Federal Reserve notes. If earnings during the year are not sufficient to provide for the costs of operations, payment of dividends, and equating surplus and capital paid-in, remittances to the Treasury are suspended. A deferred asset is recorded that represents the amount of net earnings a Reserve Bank will need to realize before remittances to the Treasury resume. This deferred asset is periodically reviewed for impairment. o. Income and Costs Related to Treasury Services When directed by the Secretary of the Treasury, the Bank is required by the Federal Reserve Act to serve as fiscal agent and depositary of the United States Government. By statute, the Treasury has appropriations to pay for these services. During the years ended December 31, 2013 and 2012, the Bank was reimbursed for substantially all services provided to the Treasury as its fiscal agent. The Bank seeks reimbursement from the Treasury and other government agencies on behalf of all Reserve Banks of costs of performing fiscal agency functions. Each Reserve Bank transfers its Treasury reimbursement receivable to the Bank. The reimbursement receivable is reported in “Other assets” and totaled $2 million and $1 million at December 31, 2013 and 2012, respectively. The cost of unreimbursed Treasury services is reported in “Other expense” and was immaterial at December 31, 2013 and 2012. p. Compensation Received for Service Costs Provided The Federal Reserve Bank of Atlanta has overall responsibility for managing the Reserve Banks’ provision of check and ACH services to depository institutions, the FRBNY has overall responsibility for managing the Reserve Banks’ provision of Fedwire funds and securities services, and the Federal Reserve Bank of Chicago has overall responsibility for managing the Reserve Banks’ provision of electronic access services to depository institutions. The Reserve Bank that has overall responsibility for managing these services recognizes the related total System revenue in its Statements of Income and Comprehensive Income. The Bank is compensated for costs incurred to provide these services by the Reserve Banks responsible for managing these services and reports this compensation as “Non-interest income (loss): Compensation received for service costs provided” in its Statements of Income and Comprehensive Income. 55 56 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements q. Assessments The Board of Governors assesses the Reserve Banks to fund its operations, the operations of the Bureau and, for a twoyear period following the July 21, 2010 effective date of the Dodd-Frank Act, the OFR. These assessments are allocated to each Reserve Bank based on each Reserve Bank’s capital and surplus balances. The Board of Governors also assesses each Reserve Bank for expenses related to producing, issuing, and retiring 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 prior year. The Dodd-Frank Act requires that, after the transfer date of July 21, 2011, the Board of Governors fund the Bureau in an amount not to exceed a fixed percentage of the total operating expenses of the System as reported in the Board of Governors’ 2009 annual report, which totaled $4.98 billion. The fixed percentage of total operating expenses of the System for the years ended December 31, 2013 and 2012 was 12 percent ($597.6 million) and 11 percent ($547.8 million), respectively. After 2013, the amount will be adjusted in accordance with the provisions of the Dodd-Frank Act. The Bank’s assessment for Bureau funding is reported as “Assessments: Bureau of Consumer Financial Protection” in the Statements of Income and Comprehensive Income. The Board of Governors assessed the Reserve Banks to fund the operations of the OFR for the two-year period ended July 21, 2012, following enactment of the Dodd-Frank Act; thereafter, the OFR is funded by fees assessed on bank holding companies and nonbank financial companies that meet the criteria specified in the Dodd-Frank Act. r. 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, 2013 and 2012 and are reported as a component of “Operating expenses: Occupancy” in the Statements of Income and Comprehensive Income. s. Restructuring Charges The Reserve Banks recognize restructuring charges for exit or disposal costs incurred as part of the closure of business activities in a particular location, the relocation of business activities from one location to another, or a fundamental reorganization that affects the nature of operations. Restructuring charges may include costs associated with employee separations, contract terminations, and asset impairments. Expenses are recognized in the period in which the Bank commits to a formalized restructuring plan or executes the specific actions contemplated in the plan and all criteria for financial statement recognition have been met. Note 11 describes the Bank’s restructuring initiatives and provides information about the costs and liabilities associated with employee separations and contract terminations. t. Recently Issued Accounting Standards In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This update indefinitely deferred the requirements of ASU 2011-05, which required an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective net income line items. Subsequently, in February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements of Accumulated Other Comprehensive Income, which established an effective date for the requirements of ASU 2011-05 related to reporting of significant reclassification adjustments from accumulated other comprehensive income. This update improves the transparency of changes in other comprehensive income and items reclassified out of accumulated other comprehensive income in the financial statements. These presentation requirements of ASU 2011-05 and the required disclosures in ASU 2013-02 are effective for the Bank for the year ending December 31, 2013, and are reflected in the Bank’s 2013 financial statements and Note 10. 4. Loans Loans to Depository Institutions The Bank offers primary, secondary, and seasonal loans to eligible borrowers, and each program has its own interest rate. Interest is accrued using the applicable interest rate established at least every 14 days by the Bank’s board of directors, subject to review and determination by the Board of Governors. Primary and secondary loans are extended on a shortterm basis, typically overnight, whereas seasonal loans may be extended for a period of up to nine months. Primary, secondary, and seasonal loans are collateralized to the satisfaction of the Bank to reduce credit risk. Assets eligible to collateralize these loans include consumer, business, and real estate loans; Treasury securities; GSE debt securities; foreign sovereign debt; municipal, corporate, and state and local government obligations; asset-backed securities; corporate bonds; commercial paper; and bank-issued assets, such as certificates of deposit, bank notes, and deposit notes. Collateral is assigned a lending value that is deemed appropriate by the Bank, which is typically fair value reduced by a margin. Loans to depository institutions are monitored daily to ensure that borrowers continue to meet eligibility requirements for these programs. If a borrower no longer qualifies for these programs, the Bank will generally request full repayment of the outstanding loan or, for primary or seasonal loans, may convert the loan to a secondary credit loan. Collateral levels are reviewed daily against outstanding obligations, and borrowers that no longer have sufficient collateral to support outstanding loans are required to provide additional collateral or to make partial or full repayment. The Bank had no loans outstanding as of December 31, 2013. Loans to depository institutions were $2 million as of December 31, 2012 with a remaining maturity within 15 days. At December 31, 2013 and 2012, the Bank did not have any loans that were impaired, restructured, past due, or on nonaccrual status, and no allowance for loan losses was required. There were no impaired loans during the years ended December 31, 2013 and 2012. 5. System Open Market Account a. Domestic Securities Holdings The FRBNY conducts domestic open market operations and, on behalf of the Reserve Banks, holds the resulting securities in the SOMA. During the years ended December 31, 2013 and 2012, the FRBNY continued the purchase of Treasury securities and federal agency and GSE MBS under the large-scale asset purchase programs authorized by the FOMC. In September 2011, the FOMC announced that the Federal Reserve would reinvest principal payments from the SOMA portfolio holdings of GSE debt securities and federal agency and GSE MBS in federal agency and GSE MBS. In June 2012, the FOMC announced 57 58 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements that it would continue the existing policy of reinvesting principal payments from the SOMA portfolio holdings of GSE debt securities and federal agency and GSE MBS in federal agency and GSE MBS. In September 2012, the FOMC announced that the Federal Reserve would purchase additional federal agency and GSE MBS at a pace of $40 billion per month. In December 2012, the FOMC announced that the Federal Reserve would purchase longer-term Treasury securities initially at a pace of $45 billion per month after its program to extend the average maturity of its holdings of Treasury securities was completed at the end of 2012. In December 2012, the FOMC announced that the Federal Reserve would continue the policy of rolling over maturing Treasury securities into new issues at auction. During the year ended December 31, 2012, the FRBNY also continued the purchase and sale of SOMA portfolio holdings under the maturity extension programs authorized by the FOMC. In September 2011, the FOMC announced that the Federal Reserve would extend the average maturity of the SOMA portfolio holdings of securities by purchasing $400 billion par value of Treasury securities with maturities of six to thirty years and selling or redeeming an equal par amount of Treasury securities with remaining maturities of three years or less by the end of June 2012. In June 2012, the FOMC announced that the Federal Reserve would continue through the end of 2012 its program to extend the average maturity of securities by purchasing $267 billion par value of Treasury securities with maturities of six to thirty years and selling or redeeming an equal par amount of Treasury securities with maturities of three and a quarter years or less by the end of 2012. The Bank’s allocated share of activity related to domestic open market operations was 2.897 percent and 3.306 percent at December 31, 2013 and 2012, respectively. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements The Bank’s allocated share of Treasury securities, GSE debt securities, and federal agency and GSE MBS, net, excluding accrued interest, held in the SOMA at December 31 was as follows (in millions): Par Notes $ Bonds 2013 Unamortized premiums 42,518 $ 21,480 Unaccreted discounts 967 $ 3,724 Total Treasury securities $ 63,998 $ 4,691 GSE debt securities $ 1,658 $ 55 Federal agency and GSE MBS $ 43,176 $ 1,297 Par Notes Bonds $ Total amortized cost (165) $ 43,320 (161) 25,043 $ (326) $ - $ (31) $ 68,363 $ 1,713 $ 44,442 2012 Unamortized premiums 36,707 $ 18,372 Unaccreted discounts 1,075 $ 3,681 Total Treasury securities $ 55,079 $ 4,756 GSE debt securities $ 2,538 $ 89 Federal agency and GSE MBS $ 30,633 $ 806 Total amortized cost (23) $ 37,759 (4) 22,049 $ (27) $ - $ (23) $ 59,808 $ 2,627 $ 31,416 The FRBNY enters into transactions for the purchase of securities under agreements to resell and transactions to sell securities under agreements to repurchase as part of its monetary policy activities. In addition, transactions to sell securities under agreements to repurchase are entered into as part of a service offering to foreign official and international account holders. There were no material transactions related to securities purchased under agreements to resell during the years ended December 31, 2013 and 2012. Financial information related to securities sold under agreements to repurchase for the years ended December 31 was as follows (in millions): Allocated to the Bank Total SOMA 2013 2012 2013 2012 Contract amount outstanding, end of year $ 9,154 $ 3,543 $ 315,924 $ 107,188 Average daily amount outstanding, during the year 2,997 3,069 99,681 91,898 Maximum balance outstanding, during the year 9,154 4,051 315,924 122,541 Securities pledged (par value), end of year 8,995 3,092 310,452 93,547 Securities pledged (market value), end of year 9,124 3,543 314,901 107,188 59 60 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements The remaining maturity distribution of Treasury securities, GSE debt securities, federal agency and GSE MBS bought outright, and securities sold under agreements to repurchase that were allocated to the Bank at December 31, 2013 and 2012 was as follows (in millions): Within 15 days 16 days to 90 days 91 days to 1 year Over 1 year Over 5 years to 5 years to 10 years Over 10 years Total December 31, 2013: Treasury securities (par value) $ - $ 9 $ 5 $ 22,117 $ 25,054 $ 16,813 $ 63,998 GSE debt securities (par value) 67 219 251 1,051 2 68 1,658 Federal agency and GSE MBS (par value)1 - - - - 74 43,102 43,176 Securities sold under agreements to repurchase (contract amount) 9,154 - - - - - 9,154 December 31, 2012: Treasury securities (par value) $ - $ - $ 1 $ 12,512 $ 28,509 $ 14,057 $ 55,079 GSE debt securities (par value) 52 92 502 1,746 68 78 2,538 Federal agency and GSE MBS (par value)1 - - - - 78 30,555 30,633 Securities sold under agreements to repurchase (contract amount) 3,543 - - - - - 3,543 1 The par amount shown for federal agency and GSE MBS is the remaining principal balance of the securities. Federal agency and GSE MBS are reported at stated maturity in the table above. The estimated weighted average life of these securities, which differs from the stated maturity primarily because it factors in scheduled payments and prepayment assumptions, was approximately 6.5 and 3.3 years as of December 31, 2013 and 2012, respectively. The amortized cost and par value of Treasury securities and GSE debt securities that were loaned from the SOMA at December 31 was as follows (in millions): Allocated to the Bank Total SOMA 2013 2012 2013 2012 Treasury securities (amortized cost) Treasury securities (par value) GSE debt securities (amortized cost) GSE debt securities (par value) $ 497 $ 448 32 31 302 $ 17,153 $ 9,139 280 15,447 8,460 23 1,099 697 22 1,055 676 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements The FRBNY enters into commitments to buy and sell Treasury securities and records the related securities on a settlement-date basis. As of December 31, 2013, there were no outstanding commitments. The FRBNY enters into commitments to buy and sell federal agency and GSE MBS and records the related securities on a settlement-date basis. As of December 31, 2013, the total purchase price of the federal agency and GSE MBS under outstanding purchase commitments was $59,350 million, of which $479 million was related to dollar rolls. The total purchase price of outstanding purchase commitments allocated to the Bank was $1,720 million, of which $14 million was related to dollar rolls. As of December 31, 2013, there were no outstanding sales commitments for federal agency and GSE MBS. These commitments, which had contractual settlement dates extending through February 2014, are for the purchase of TBA MBS for which the number and identity of the pools that will be delivered to fulfill the commitment are unknown at the time of the trade. These commitments are subject to varying degrees of off-balance-sheet market risk and counterparty credit risk that result from their future settlement. The FRBNY requires the posting of cash collateral for commitments as part of the risk management practices used to mitigate the counterparty credit risk. Other investments consist of cash and short-term investments related to the federal agency and GSE MBS portfolio. Other liabilities, which are related to federal agency and GSE MBS purchases and sales, includes the FRBNY’s obligation to return cash margin posted by counterparties as collateral under commitments to purchase and sell federal agency and GSE MBS. In addition, other liabilities includes obligations that arise from the failure of a seller to deliver securities to the FRBNY on the settlement date. Although the FRBNY has ownership of and records its investments in the MBS as of the contractual settlement date, it is not obligated to make payment until the securities are delivered, and the amount included in other liabilities represents the FRBNY’s obligation to pay for the securities when delivered. The amount of other investments and other liabilities allocated to the Bank and held in the SOMA at December 31 was as follows (in millions): Allocated to the Bank 2013 Other investments $ - Total SOMA 2012 $ 1 2013 $ 2 2012 $ 23 Other liabilities: Cash margin $ 38 $ 102 $ 1,320 $ 3,092 Obligations from MBS transaction fails 1 3 11 85 Total other liabilities $ 39 $ 105 $ 1,331 $ 3,177 Accrued interest receivable on domestic securities holdings was $23,405 million and $18,924 million as of December 31, 2013 and 2012, respectively, of which $678 million and $626 million, respectively, was allocated to the Bank. These amounts are reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. 61 62 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements Information about transactions related to Treasury securities, GSE debt securities, and federal agency and GSE MBS during the years ended December 31, 2013 and 2012, is summarized as follows (in millions): Allocated to the Bank Federal Total Treasury GSE debt agency and Bills Notes Bonds securities securities GSE MBS Balance at December 31, 2011 $ 631 $ 44,942 $ 14,385 $ 59,958 $ 3,694 $ 29,058 Purchases1 4,011 13,316 8,818 26,145 - 14,387 Sales1 - (16,949) (391) (17,340) - Realized gains, net2 - 400 42 442 - Principal payments and maturities (4,620) (2,263) - (6,883) (910) (10,804) Amortization of premiums and accretion of discounts, net - (183) (251) (434) (38) (174) Inflation adjustment on inflation-indexed securities - 21 35 56 - Annual reallocation adjustment4 (22) (1,525) (589) (2,136) (119) (1,051) Balance at December 31, 2012 $ Purchases1 Sales1 Realized gains, net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities Annual reallocation adjustment4 - $ 37,759 $ 22,049 $ 59,808 $ 2,627 $ 31,416 - 10,822 6,235 17,057 - 26,256 - - - - - - - - - - - - - - (586) (8,303) - (181) (286) (467) (24) (211) - 8 19 27 - (5,088) (2,974) (8,062) - (304) (4,716) Balance at December 31, 2013 $ - $ 43,320 $ 25,043 $ 68,363 $ 1,713 $ 44,442 Year-ended December 31, 2012 Supplemental information - par value of transactions: Purchases3 $ 4,011 $ 12,815 $ 6,852 $ 23,678 $ - $ 13,777 Sales3 - (16,443) (303) (16,746) - Year-ended December 31, 2013 Supplemental information - par value of transactions: Purchases3 $ - $ 10,744 $ 5,572 $ 16,316 $ - $ 25,424 Sales3 - - - - - Purchases and sales may include payments and receipts related to principal, premiums, discounts, and inflation compensation adjustments to the basis of inflation-indexed securities. The amount reported as sales includes the realized gains and losses on such transactions. Purchases and sales exclude MBS TBA transactions that are settled on a net basis. 1 Realized gains, net offset the amount of realized gains and losses included in the reported sales amount. 3 Includes inflation compensation. 2 Reflects the annual adjustment to the Bank’s allocated portion of the related SOMA securities that results from the annual settlement of the interdistrict settlement account, as discussed in Note 3i. 4 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements Total SOMA Bills Notes Bonds Total Treasury securities Federal GSE debt agency and securities GSE MBS Balance at December 31, 2011 $ 18,423 $ 1,311,917 $ 419,937 $ 1,750,277 $ 107,828 $ 848,258 Purchases1 118,886 397,999 263,991 780,876 - 431,487 Sales1 - (507,420) (11,727) (519,147) - Realized gains, net2 - 12,003 1,252 13,255 - Principal payments and maturities (137,314) (67,463) - (204,777) (27,211) (324,181) Amortization of premiums and accretion of discounts, net 5 (5,460) (7,531) (12,986) (1,138) (5,243) Inflation adjustment on inflation-indexed securities - 643 1,047 1,690 - Balance at December 31, 2012 $ Purchases1 Sales1 Realized gains, net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities - $ 1,142,219 $ 666,969 $ 1,809,188 $ 79,479 $ 950,321 - 358,656 206,208 564,864 - 864,537 - - - - - - - - - - - (21) - (21) (19,562) (273,990) - - (6,024) (9,503) 285 645 (15,527) (795) (7,008) 930 - - Balance at December 31, 2013 $ - $ 1,495,115 $ 864,319 $ 2,359,434 $ 59,122 $ 1,533,860 Year-ended December 31, 2012 Supplemental information - par value of transactions: Purchases3 $ 118,892 $ 383,106 $ 205,115 $ 707,113 $ - $ 413,160 Sales3 - (492,234) (9,094) (501,328) - Year-ended December 31, 2013 Supplemental information - par value of transactions: Purchases3 $ - $ 356,766 $ 184,956 $ 541,722 $ - $ 837,490 Sales3 - - - - - Purchases and sales may include payments and receipts related to principal, premiums, discounts, and inflation compensation adjustments to the basis of inflation-indexed securities. The amount reported as sales includes the realized gains and losses on such transactions. Purchases and sales exclude MBS TBA transactions that are settled on a net basis. 2 Realized gains, net offset the amount of realized gains and losses included in the reported sales amount. 3 Includes inflation compensation. 1 63 64 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements b. Foreign Currency Denominated Investments The FRBNY conducts foreign currency operations and, on behalf of the Reserve Banks, holds the resulting foreign currency denominated assets in the SOMA. The FRBNY holds foreign currency deposits with foreign central banks and the Bank for International Settlements and invests in foreign government debt instruments of Germany, France, and Japan. These foreign government debt instruments are guaranteed as to principal and interest by the issuing foreign governments. In addition, the FRBNY enters into transactions to purchase Euro-denominated government debt securities under agreements to resell for which the accepted collateral is the debt instruments issued by the governments of Belgium, France, Germany, Italy, the Netherlands, and Spain. The Bank’s allocated share of activity related to foreign currency operations was 7.735 percent and 8.674 percent at December 31, 2013 and 2012, respectively. Information about foreign currency denominated investments valued at amortized cost and foreign currency market exchange rates at December 31 was as follows (in millions): Allocated to Bank 2013 2012 Total SOMA 2013 2012 Euro: Foreign currency deposits $ 582 $ 774 $ 7,530 $ Securities purchased under agreements to resell 197 57 2,549 German government debt instruments 185 185 2,396 French government debt instruments 186 210 2,397 Japanese yen: Foreign currency deposits 227 308 2,927 Japanese government debt instruments 458 623 5,925 Total $ 1,835 $ 2,157 $ 23,724 8,925 659 2,133 2,421 3,553 7,182 $ 24,873 Accrued interest receivable on foreign currency denominated assets was $88 million and $99 million as of December 31, 2013 and 2012, respectively, of which $7 million and $9 million, respectively, was allocated to the Bank. These amounts are reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements The remaining maturity distribution of foreign currency denominated investments that were allocated to the Bank at December 31, 2013 and 2012, was as follows (in millions): Within 15 days 16 days to 90 days 91 days to 1 year Over 1 year to 5 years Total December 31, 2013: Euro $ 544 $ 140 $ 167 $ 299 $ Japanese yen 241 29 145 270 1,150 685 Total $ 785 $ 169 $ 312 $ 569 $ December 31, 2012: Euro $ 572 $ 149 $ 187 $ 318 $ Japanese yen 330 43 185 373 1,835 2,157 Total $ 902 $ 192 $ 372 $ 691 $ 1,226 931 There were no foreign exchange contracts related to open market operations outstanding as of December 31, 2013. The FRBNY enters into commitments to buy foreign government debt instruments and records the related securities on a settlement-date basis. As of December 31, 2013, there were no outstanding commitments to purchase foreign government debt instruments. During 2013, there were purchases, sales, and maturities of foreign government debt instruments of $3,539 million, $0, and $3,431 million, respectively, of which $279 million, $0, and $270 million, respectively, were allocated to the Bank. In connection with its foreign currency activities, the FRBNY may enter into transactions that are subject to varying degrees of off-balance-sheet market risk and counterparty credit risk that result from their future settlement. The FRBNY controls these risks by obtaining credit approvals, establishing transaction limits, receiving collateral in some cases, and performing daily monitoring procedures. At December 31, 2013 and 2012, there was no balance outstanding under the authorized warehousing facility. There were no transactions related to the authorized reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico during the years ended December 31, 2013 and 2012. c. Central Bank Liquidity Swaps U.S. Dollar Liquidity Swaps The Bank’s allocated share of U.S. dollar liquidity swaps was approximately 7.735 percent and 8.674 percent at December 31, 2013 and 2012, respectively. The total foreign currency held under U.S. dollar liquidity swaps in the SOMA at December 31, 2013 and 2012, was $272 million and $8,889 million, respectively, of which $21 million and $771 million, respectively, was allocated to the Bank. 65 66 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements The remaining maturity distribution of U.S. dollar liquidity swaps that were allocated to the Bank at December 31 was as follows (in millions): 2013 Within 15 days Euro Total 2012 16 days to 90 days Total Within 15 days 16 days to 90 days Total $ 9 $ 12 $ 21 $ 151 $ 620 $ 771 $ 9 $ 12 $ 21 $ 151 $ 620 $ 771 Foreign Currency Liquidity Swaps There were no transactions related to the foreign currency liquidity swaps during the years ended December 31, 2013 and 2012. d. Fair Value of SOMA Assets The fair value amounts below are presented solely for informational purposes. Although the fair value of SOMA security holdings can be substantially greater than or less than the recorded value at any point in time, these unrealized gains or losses have no effect on the ability of the Reserve Banks, as the central bank, to meet their financial obligations and responsibilities. The fair value of the Treasury securities, GSE debt securities, federal agency and GSE MBS, and foreign government debt instruments in the SOMA’s holdings is subject to market risk, arising from movements in market variables such as interest rates and credit risk. The fair value of federal agency and GSE MBS is also affected by the expected rate of prepayments of mortgage loans underlying the securities. The fair value of foreign government debt instruments is also affected by currency risk. Based on evaluations performed as of December 31, 2013, there are no credit impairments of SOMA securities holdings. 2013 Annual Report | Federal Reserve Bank of Philadelphia 67 Notes to Financial Statements The following table presents the amortized cost and fair value of and cumulative unrealized gains (losses) on the Treasury securities, GSE debt securities, and federal agency and GSE MBS, net held in the SOMA at December 31 (in millions): Allocated to the Bank 2013 2012 Cumulative Cumulative Amortized unrealized Amortized unrealized cost Fair value gains (losses) cost Fair value gains Treasury securities: Notes Bonds Total Treasury securities GSE debt securities Federal agency and GSE MBS $ 43,320 $ 43,432 $ 25,043 24,406 112 $ (637) 37,759 $ 22,049 40,105 25,162 $ 2,346 3,113 $ 68,363 $ 67,838 $ (525) 59,808 $ 65,267 $ 5,459 1,713 44,442 90 (1,109) 2,627 31,416 2,810 32,859 93,851 $ 100,936 1,803 43,333 $ Total domestic SOMA portfolio securities holdings $ 114,518 $ 112,974 $ (1,544) $ Memorandum - Commitments for: Purchases of Treasury securities $ - $ - $ - $ Purchases of Federal agency and GSE MBS 1,720 1,713 (7) Sales of Federal agency and GSE MBS - - - - $ 3,908 - $ 7,085 - $ 3,914 183 1,443 - 6 - - Total SOMA 2013 2012 Cumulative Cumulative Amortized unrealized Amortized unrealized cost Fair value gains (losses) cost Fair value gains Treasury securities: Notes $ 1,495,115 $ 1,499,000 $ 3,885 $ 1,142,219 $ 1,213,177 $ 70,958 Bonds 864,319 842,336 (21,983) 666,969 761,138 94,169 Total Treasury securities $ 2,359,434 $ 2,341,336 $ (18,098) $ 1,809,188 $ 1,974,315 GSE debt securities 59,122 62,236 3,114 Federal agency and GSE MBS 1,533,860 1,495,572 (38,288) 79,479 950,321 $ 165,127 85,004 5,525 993,990 43,669 Total domestic SOMA portfolio securities holdings $ 3,952,416 $ 3,899,144 $ (53,272) $ 2,838,988 $ 3,053,309 Memorandum - Commitments for: Purchases of Treasury securities $ - $ - $ - $ - $ - Purchases of Federal agency and GSE MBS 59,350 59,129 (221) 118,215 118,397 Sales of Federal agency and GSE MBS - - - - - $ 214,321 $ - 182 - 68 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements The fair value of Treasury securities and GSE debt securities was determined using pricing services that provide market consensus prices based on indicative quotes from various market participants. The fair value of federal agency and GSE MBS was determined using a pricing service that utilizes a model-based approach that considers observable inputs for similar securities. At December 31, 2013 and 2012, the fair value of foreign currency denominated investments was $23,802 million and $25,042 million, respectively, of which $1,841 million and $2,172 million, respectively, was allocated to the Bank. The fair value of government debt instruments was determined using pricing services that provide market consensus prices based on indicative quotes from various market participants. The fair value of foreign currency deposits and securities purchased under agreements to resell was determined by reference to market interest rates. The cost basis of securities purchased under agreements to resell, securities sold under agreements to repurchase, and other investments held in the SOMA approximate fair value. The following table provides additional information on the amortized cost and fair values of the federal agency and GSE MBS portfolio at December 31 (in millions): 2013 2012 Distribution of MBS holdings by coupon rate Amortized cost Fair value Amortized cost Fair value Allocated to the Bank: 2.0% $ 411 $ 392 $ 28 $ 2.5% 3,588 3,432 1,242 3.0% 15,119 14,032 5,310 3.5% 10,132 9,804 5,937 4.0% 6,672 6,696 4,554 4.5% 5,384 5,664 8,677 5.0% 2,413 2,549 4,136 5.5% 623 658 1,321 6.0% 88 93 186 6.5% 12 13 25 Total $ 44,442 $ 43,333 $ 31,416 $ Total SOMA: 2.0% $ 14,191 $ 13,529 $ 845 $ 2.5% 123,832 118,458 37,562 3.0% 521,809 484,275 160,613 3.5% 349,689 338,357 179,587 4.0% 230,256 231,113 137,758 4.5% 185,825 195,481 262,484 5.0% 83,290 87,968 125,107 5.5% 21,496 22,718 39,970 6.0% 3,052 3,225 5,642 6.5% 420 448 753 Total $ 1,533,860 $ 1,495,572 $ 950,321 28 1,248 5,347 6,108 4,825 9,328 4,371 1,382 195 27 32,859 846 37,766 161,757 184,752 145,955 282,181 132,214 41,819 5,888 812 $ 993,990 2013 Annual Report | Federal Reserve Bank of Philadelphia 69 Notes to Financial Statements Because SOMA securities are recorded at amortized cost, the change in the cumulative unrealized gains (losses) is not reported in the Statements of Income and Comprehensive Income. The following tables present the realized gains (losses) and the change in the cumulative unrealized gains (losses), presented as “Fair Value changes unrealized gains (losses),” of the domestic securities holdings during the years ended December 31, 2013 and 2012 (in millions): Allocated to Bank 2013 2012 Total portfolio Fair value changes Total portfolio Fair value changes holdings realized unrealized holdings realized unrealized gains1 losses gains1 losses Treasury securities GSE debt securities Federal agency and GSE MBS $ - $ - 1 (5,286) $ (71) (2,396) 442 $ - 8 Total $ 1 $ (7,753) $ 450 $ (53) (30) (116) (199) Total SOMA 2013 2012 Total portfolio Fair value changes Total portfolio Fair value changes holdings realized unrealized holdings realized unrealized gains1 losses gains1 losses Treasury securities GSE debt securities Federal agency and GSE MBS $ - $ (183,225) $ - (2,411) 51 (81,957) Total $ 51 $ (267,593) $ 13,255 $ - 241 (1,142) (885) (3,568) 13,496 (5,595) $ Total portfolio holdings realized gains (losses) are reported in “Non-interest income (loss): System Open Market Account” in the Statements of Income and Comprehensive Income. 1 The amount of change in unrealized gains position, net, related to foreign currency denominated assets was a decrease of $90 million and an increase of $3 million for the years ended December 31, 2013 and 2012, respectively, of which $7 million and $206 thousand, respectively, were allocated to the Bank. Accounting Standards Codification (ASC) Topic 820 (ASC 820) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that distinguishes between assumptions developed using market data obtained from independent sources (observable inputs) and the Bank’s assumptions developed using the best information available in the circumstances (unobservable inputs). The three levels established by ASC 820 are described as follows: 70 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements • Level 1 – Valuation is based on quoted prices for identical instruments traded in active markets. • Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. • Level 3 – Valuation is based on model-based techniques that use significant inputs and assumptions not observable in the market. These unobservable inputs and assumptions reflect the Bank’s estimates of inputs and assumptions that market participants would use in pricing the assets and liabilities. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. Treasury securities, GSE debt securities, Federal agency and GSE MBS, and foreign government debt instruments are classified as Level 2 within the ASC 820 hierarchy because the fair values are based on indicative quotes and other observable inputs obtained from independent pricing services. The fair value hierarchy level of SOMA financial assets is not necessarily an indication of the risk associated with those assets. 6. Bank Premises, Equipment, and Software Bank premises and equipment at December 31 were as follows (in millions): 2013 2012 Bank premises and equipment: Land and land improvements $ 8 $ Buildings 113 Building machinery and equipment 25 Construction in progress 1 Furniture and equipment 53 Subtotal 200 (113) 8 107 23 2 55 195 Accumulated depreciation (108) Bank premises and equipment, net $ 87 $ 87 Depreciation expense, for the years ended December 31 $ 10 $ 9 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements The Bank leases space to outside tenants with remaining lease terms ranging from 4 to 11 years. Rental income from such leases was $2 million for each of the years ended December 31, 2013 and 2012 and is reported as a component of “Non-interest income: Other” in the Statements of Income and Comprehensive Income. Future minimum lease payments that the Bank will receive under noncancelable lease agreements in existence at December 31, 2013, are as follows (in millions): 2014 2015 2016 2017 2018 Thereafter Total $ 2 2 2 2 2 7 $ 17 The Bank had capitalized software assets, net of amortization, of $6 million and $7 million at December 31, 2013 and 2012, respectively. Amortization expense was $2 million for each of the years ended December 31, 2013 and 2012. Capitalized software assets are reported as a component of “Other assets” in the Statements of Condition and the related amortization is reported as a component of “Operating expenses: Other” in the Statements of Income and Comprehensive Income. 7. Commitments and Contingencies In conducting its operations, the Bank enters into contractual commitments, normally with fixed expiration dates or termination provisions, at specific rates and for specific purposes. At December 31, 2013, the Bank was obligated under noncancelable leases for premises and equipment with remaining terms ranging from 2 to approximately 6 years. These leases provide for increased lease payments based upon increases in real estate taxes, operating costs, or selected price indexes. 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, 2013 and 2012. Certain of the Bank’s leases have options to renew. The Bank has no capital leases. Future minimum lease payments under noncancelable operating leases, net of sublease rentals, with remaining terms of one year or more, at December 31, 2013, are as follows (in thousands): Operating leases 2014 2015 2016 2017 2018 Thereafter Future minimum lease payments $ 554 484 469 480 492 41 $ 2,520 71 72 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements At December 31, 2013, there were no material unrecorded unconditional purchase commitments or obligations in excess of one year. Under the Insurance Agreement of the Reserve Banks, each of the Reserve Banks has agreed to bear, on a per-incident basis, a share of certain losses in excess of 1 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 of a Reserve Bank’s capital paid-in 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 the agreement at December 31, 2013 and 2012. 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 legal actions 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 employees of the Reserve Banks, Board of Governors, and Office of Employee Benefits of the Federal Reserve System participate in the Retirement Plan for Employees of the Federal Reserve System (System Plan). Under the Dodd-Frank Act, newly hired Bureau employees are eligible to participate in the System Plan. In addition, employees at certain compensation levels participate in the Benefit Equalization Retirement Plan (BEP) and certain Reserve Bank officers participate in the Supplemental Retirement Plan for Select Officers of the Federal Reserve Banks (SERP). The FRBNY, on behalf of the System, recognizes the net asset or net liability and costs associated with the System Plan in its consolidated financial statements. During the years ended December 31, 2013 and 2012, certain costs associated with the System Plan were reimbursed by the Bureau. The Bank’s projected benefit obligation, funded status, and net pension expenses for the BEP and the SERP at December 31, 2013 and 2012, and for the years then ended, were not material. Thrift Plan Employees of the Bank participate in the defined contribution Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The Bank matches 100 percent of the first six percent of employee contributions from the date of hire and provides an automatic employer contribution of one percent of eligible pay. The Bank’s Thrift Plan contributions totaled $5 million for each of the years ended December 31, 2013 and 2012 and are reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements 9. Postretirement Benefits Other Than Retirement Plans and Postemployment Benefits Postretirement Benefits Other Than Retirement Plans In addition to the Bank’s retirement plans, employees who have met certain age and length-of-service requirements are eligible for both medical and life insurance benefits 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 the beginning and ending balances of the benefit obligation (in millions): 2013 2012 Accumulated postretirement benefit obligation at January 1 $ 103.6 $ Service cost benefits earned during the period 3.3 Interest cost on accumulated benefit obligation 3.9 Net actuarial (gain) loss (16.3) Contributions by plan participants 1.9 Benefits paid (5.9) Medicare Part D subsidies 0.4 Plan amendments 0.4 Accumulated postretirement benefit obligation at December 31 $ 91.3 $ 89.5 2.8 4.1 10.9 1.9 (6.0) 0.4 103.6 At December 31, 2013 and 2012, the weighted-average discount rate assumptions used in developing the postretirement benefit obligation were 4.79 percent and 3.75 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. Beginning in 2013, the System Plan discount rate assumption setting convention changed from rounding the rate to the nearest 25 basis points to using an unrounded rate. 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): 2013 2012 Fair value of plan assets at January 1 $ - $ Contributions by the employer 3.6 Contributions by plan participants 1.9 Benefits paid (5.9) Medicare Part D subsidies 0.4 3.7 1.9 (6.0) 0.4 Fair value of plan assets at December 31 $ - $ Unfunded obligation and accrued postretirement benefit cost $ 91.3 $ Amounts included in accumulated other comprehensive loss are shown below: Prior service cost $ (1.2) $ Net actuarial loss (13.2) - (1.2) (32.3) (33.5) Total accumulated other comprehensive loss $ (14.4) $ 103.6 73 74 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs” in the Statements of Condition. For measurement purposes, the assumed health-care cost trend rates at December 31 are as follows: 2013 2012 Health-care cost trend rate assumed for next year 7.00 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate 2019 2018 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, 2013 (in millions): One percentage point increase One percentage point decrease Effect on aggregate of service and interest cost components of net periodic postretirement benefit costs $ 0.1 $ Effect on accumulated postretirement benefit obligation 0.7 (0.4) (4.9) The following is a summary of the components of net periodic postretirement benefit expense for the years ended December 31 (in millions): 2013 Service cost-benefits earned during the period $ Interest cost on accumulated benefit obligation Amortization of prior service cost Amortization of net actuarial loss Net periodic postretirement benefit expense $ 2012 3.3 $ 3.9 0.4 2.9 10.5 $ 2.7 4.1 0.6 2.2 9.6 Estimated amounts that will be amortized from accumulated other comprehensive loss into net periodic postretirement benefit expense in 2014 are shown below: Prior service cost $ Net actuarial loss Total $ 0.6 0.6 1.2 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements Net postretirement benefit costs are actuarially determined using a January 1 measurement date. At January 1, 2013 and 2012, the weighted-average discount rate assumptions used to determine net periodic postretirement benefit costs were 3.75 percent and 4.50 percent, respectively. Net periodic postretirement benefit expense is reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a prescription drug benefit under 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 under 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 are reflected in actuarial loss in the accumulated postretirement benefit obligation and net periodic postretirement benefit expense. Federal Medicare Part D subsidy receipts were $331 thousand and $350 thousand in the years ended December 31, 2013 and 2012, respectively. Expected receipts in 2014, related to benefits paid in the years ended December 31, 2013 and 2012, are $292 thousand. Following is a summary of expected postretirement benefit payments (in millions): Without subsidy 2014 $ 2015 2016 2017 2018 2019 - 2023 Total $ With subsidy 4.7 $ 5.1 5.4 5.8 6.1 34.5 4.3 4.6 5.0 5.3 5.5 31.2 61.6 55.9 $ Postemployment Benefits The Bank offers benefits to former or inactive employees. Postemployment benefit costs are actuarially determined using a December 31 measurement date and include the cost of medical, dental, and vision insurance; survivor income; disability benefits; and self-insured workers’ compensation expenses. The accrued postemployment benefit costs recognized by the Bank at December 31, 2013 and 2012, were $7.2 million and $6.4 million, respectively. This cost is included as a component of “Accrued benefit costs” in the Statements of Condition. Net periodic postemployment benefit expense (credit) included in 2013 and 2012 operating expenses were $1.6 million and $(98) thousand, respectively, and are recorded as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income. 75 76 2013 Annual Report| Federal Reserve Bank of Philadelphia Notes to Financial Statements 10. Accumulated Other Comprehensive Income And Other Comprehensive Income Following is a reconciliation of beginning and ending balances of accumulated other comprehensive income (loss) as of December 31 (in millions): 2013 2012 Amount related to Amount related to postretirement postretirement benefits other than benefits other than retirement plans retirement plans Balance at January 1 $ (33.5) $ Change in funded status of benefit plans: Prior service costs arising during the year (0.4) Amortization of prior service cost 0.4 1 (25.4) 0.6 1 Change in prior service costs related to benefit plans - 0.6 Net actuarial gain (loss) arising during the year 16.2 (10.9) Amortization of net actuarial loss 2.9 1 2.2 1 Change in actuarial gain (losses) related to benefit plans 19.1 Change in funded status of benefit plans - other comprehensive income (loss) 19.1 Balance at December 31 $ (14.4) $ (8.7) (8.1) (33.5) Reclassification is reported as a component of “Operating Expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income. 1 Additional detail regarding the classification of accumulated other comprehensive loss is included in Note 9. 11. Business Restructuring Charges The Bank had no material business restructuring charges in 2013. The Bank had no business restructuring charges in 2012. In years prior to 2012, the Reserve Banks announced the acceleration of their check restructuring initiatives to align the check processing infrastructure and operations with declining check processing volumes. The new infrastructure consolidated paper and electronic check processing at the Federal Reserve Bank of Atlanta. The Bank’s liability balance for the check restructuring as of December 31, 2013 and 2012, and the related activity during the years then ended, were not material. 2013 Annual Report | Federal Reserve Bank of Philadelphia Notes to Financial Statements 12. Distribution of Comprehensive Income In accordance with Board policy, Reserve Banks remit excess earnings, after providing for dividends and the amount necessary to equate surplus with capital paid-in, to the U.S. Treasury as earnings remittances to Treasury. The following table presents the distribution of the Bank’s comprehensive income in accordance with the Board’s policy for the years ended December 31 (in millions): Dividends on capital stock Transfer from surplus - amount required to equate surplus with capital paid-in Earnings remittances to Treasury Total distribution 2013 2012 $ 127 $ (48) 2,189 132 (217) 2,812 $ 2,268 2,727 $ During each of the years ended December 31, 2013 and 2012, the Bank recorded a reduction in the amount of capital paid-in and a corresponding reduction of surplus, which is presented in the above table as “Transfer from surplus – amount required to equate surplus with capital paid-in. The reduction of surplus resulted in an equivalent increase in “Earnings remittances to Treasury” and a reduction in “Comprehensive loss” for each of the years ended December 31, 2013 and 2012. 13. Subsequent Events There were no subsequent events that require adjustments to or disclosures in the financial statements as of December 31, 2013. Subsequent events were evaluated through March 14, 2014, which is the date that the financial statements were available to be issued. 77 78 2013 Annual Report| Federal Reserve Bank of Philadelphia