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A “New Normal”? THE PROSPECTS FOR LONG-TERM GROWTH IN THE UNITED STATES  FEDERAL RESERVE BANK OF RICHMOND 2015 ANNUAL REPORT  MISSION  As a regional Reserve Bank, we serve the public by fostering the stability, integrity, and efficiency of our nation’s monetary, financial, and payments systems. VISION  To be an innovative policy and services leader for America’s economy. KEY FUNCTIONS  We contribute to the formulation of monetary policy. We supervise and regulate banks and financial holding companies headquartered in the Fifth Federal Reserve District. We process currency and electronic payments for banks and provide financial services to the U.S. Treasury. We also work with a wide variety of partners to strengthen communities in the Fifth District.  CONTENTS Message from the President. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    2  A “New Normal”? The Prospects for Long-Term Growth in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    4  Fifth District Economic Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    28  Boards, Councils, Officers, and Senior Professionals. . . . . . . . . . . .    33  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  47  FEATURE ESSAY  Financial Statements  FEDERAL RESERVE BANK OF RICHMOND  1  MESSAGE FROM THE PRESIDENT  Is Innovation Over?  PHOTO: MICHAEL BATTS  B  2  Jeffrey M. Lacker President  2015 ANNUAL REPORT  y many measures, the U.S. economy is performing quite well. Since the Great Recession ended in the summer of 2009, the unemployment rate has been cut in half, the economy has created more than 12 million jobs, and GDP growth has averaged a solid 2.1 percent annually. Yet it’s possible to paint a less rosy picture. Productivity growth has been slow, and the number of Americans working has declined significantly in recent years, due to both slowing population growth and a decline in the share of the population that is working. The current rate of GDP growth is well below the average annual rate of 3.4 percent we experienced between 1947 and 2007—and it appears unlikely to return to the previous trend any time soon. But does that mean we should be pessimistic about our economy’s future? Aaron Steelman and John Weinberg address this important question in this year’s feature essay, “A ‘New Normal’? The Prospects for Long-Term Growth in the United States.” In particular, they review two prominent arguments that the U.S. economy is likely to continue to grow substantially more slowly than in previous decades. One adherent to this view is Tyler Cowen of George Mason University. In a 2011 book, he argues that the United States has largely picked the “low-hanging fruit” that fueled rapid growth in previous eras. One such piece of fruit, according to Cowen, was the abundant supply of free land and natural resources, which attracted smart and ambitious workers from Europe. Another was the opportunity to dramatically raise the education level of the workforce. For much of the 20th century, the rapid increase in the number of Americans with high school and college degrees contributed to high productivity growth. But educational attainment appears to have stalled in recent years. Cowen also believes that the pace of innovation has slowed in recent decades, an argument that features prominently in research by Robert Gordon of Northwestern University as well. Gordon describes the years between 1920 and 1970 as the “Second Industrial Revolution,” a period of dramatic changes in technology and living standards. Electricity, indoor plumbing, and antibiotics, among other innovations, revolutionized both home and work life and led to rapid productivity gains. But the recent computer revolution, in Gordon’s view, has a more limited effect on how we live and work. Gordon also points to four significant headwinds facing the U.S. economy. Like Cowen, he views the slowdown in educational attainment as a  major drag on GDP and productivity growth. In addition, Gordon argues that rising income inequality, demographic changes such as the retirement of the baby boom generation, and rising public debt are likely to inhibit increases in living standards. Steelman and Weinberg offer the reader an overview of the economics of growth, which provides a framework for evaluating these ideas. The key takeaway is that longrun economic growth is driven primarily by technological change, which itself depends on the growth of knowledge and ideas. To put it more concretely, an economy can grow in the short term by adding more workers or more machines (or, in economic terms, more labor or more capital). But long-term growth depends on people developing new machines, and on workers learning new skills to operate those machines. What does this imply about the United States’ long-term prospects? On the one hand, if it is indeed true that the pace of innovation has slowed, then those prospects might be gloomy. But on the other hand, as Steelman and Weinberg note, there is plenty of reason for optimism. First, innovation is notoriously difficult, if not impossible, to predict; the fact that a future innovation on the scale of electric light is not immediately apparent does not mean that such an innovation won’t occur. Moreover, we shouldn’t discount the improvements in our quality of life that recent technological changes have afforded us, even if those improvements aren’t well captured by national statistics. Steelman and Weinberg also discuss several implications for policymakers, including trade policy and immigration reform. But the one that strikes me as most urgent is education, because data on wages and educational attainment suggest that we are failing to keep up with the economy’s demand for skilled workers.  What can we do to ensure our workforce has the skills necessary to perpetuate the United States’ economic growth? A full discussion of this issue is beyond the scope of Steelman and Weinberg’s essay, but the Richmond Fed’s review of the available research suggests several key strategies. First, we must do a better job of informing middle and high school students about what is required for success in college (as well as ensure that the K–12 education system is capable of providing them with those skills, although I know this is easier said than done). We can also do a better job of providing these students with information about multiple postsecondary educational options, so that students who are not prepared for or do not wish to attend college can take advantage of other opportunities to acquire valuable skills. At the same time, there is evidence that some students who are well-qualified for college overestimate the costs of attending; providing such students with targeted information could improve their decisionmaking. Finally, and perhaps most crucially, investment in high-quality early childhood education would yield exceptional returns and would help broaden opportunities for students of all backgrounds. I believe these strategies aimed at strengthening growth in human capital can not only bolster our nation’s prosperity over time but also can equip a broader range of our citizens with the skills they need to share in that prosperity.  Jeffrey M. Lacker President  FEDERAL RESERVE BANK OF RICHMOND  3  4  A “New Normal”? THE PROSPECTS FOR LONG-TERM GROWTH IN THE UNITED STATES  By Aaron Steelman and John A. Weinberg  Following the recession of 2007–09, annual U.S. economic growth rates have been below long-term trends. While there are plausible arguments that this sluggishness may continue for some time, there is good reason to think more rapid growth rates will return.  T  he United States, since the end of World War II, has generally been seen around the world as an eco-  nomic powerhouse. Indeed, that period has witnessed large gains in most Americans’ quality of life, as life spans have grown sharply, access to education has expanded markedly, and people regularly enjoy consumer items that would have once been considered luxuries or were simply unimagined when the hostilities in Europe and Asia ended and Americans got back to peacetime life. From 1947 through 2007, the economy grew at roughly 3.4 percent annually. While growth is often expressed in terms of total economic output, a growing population will bring with it some amount of overall growth.  FEDERAL RESERVE BANK OF RICHMOND  5  To measure improvement in average standards of living, growth of GDP per capita is  generally place themselves in the skep-  the standard yardstick. The post-war aver-  tics camp argue that the new normal had  age of 3.4 percent overall growth translated  already started, in a sense, prior to the Great  to an average growth rate per capita of  Recession—that, the U.S. economy was  about 2.1 percent. During that period, the  already experiencing lower productivity and  United States experienced a few significant  growth rates due to several important long-  recessions and several milder downturns.  term trends. As Tyler Cowen, an economist  Such fluctuations can be acutely felt by  at George Mason University, put it in his 2011  many people when they occur, but against  book The Great Stagnation, the United States  the longer-run performance, they look rela-  has “built social and economic institutions on  tively insignificant.  the expectation of a lot of low-hanging fruit,  Since the financial crisis and Great  but that fruit is mostly gone” and has been  Recession, though, many people’s perception  since roughly the early 1970s. 3 In particu-  of the strength of the U.S. economy and its  lar, he identifies three types of increasingly  prospects for the future have dimmed. These  scarce “fruit”: free land, technological  skeptics point to the slowed pace of growth:  breakthroughs, and smart but relatively  Since 2010, the U.S. economy has grown at  uneducated kids.4  a rate of roughly 2.1 percent annually, which  6  Some commentators who would  Regarding the first, until the begin-  translates to an average growth rate per  ning of the 20th century, free and fertile  capita of about 1.3 percent, both well below  American land was plentiful and not only  the post-World War II rates prior to the Great  “did the United States reap a huge bounty  Recession and, perhaps more notably, far  from the free land (often stolen from Native  below what has been seen in “catch-up” peri-  Americans, one should not forget), but  ods following previous significant downturns.  abundant resources helped the United  For instance, following the 1981–82 reces-  States attract many of the brightest and  sion, the U.S. economy rebounded sharply,  most ambitious workers from Europe,”  growing 7.8 percent in 1983 and 5.7 percent  Cowen writes. “Taking in these workers,  in 1984. Some observers believe we have  and letting them cultivate the land, was like  entered a period characterized by a “new  plucking low-hanging fruit.” Second, Cowen  normal” or even a “new mediocre”—and that  also sees technological innovation, and  it looks very different from what, on average,  especially breakthroughs, as slowing. “Life is  Americans enjoyed in the immediate decades  better and we have more stuff, but the pace  after the soldiers returned home from World  of change has slowed down compared to  War II. 1 Proponents of the new normal  what people saw two or three generations  hypothesis maintain that the United States  ago.” Third, in 1900, a very small percentage  is likely to grow at a substantially slower rate  of Americans graduated from high school,  than it did prior to the Great Recession, with  while estimates of high school completion  many predicting growth rates of roughly 1.5  today range from roughly 75 percent to 90  percent to 2 percent.  percent. “In other words,” Cowen writes,  2015 ANNUAL REPORT  2  Relatively Small Changes in Growth Rates Have Big Effects Over Time  T  here are many reasons why we might want to focus on long-run economic performance. But perhaps the most compelling one can be shown in the accompanying figure. In a sense, the faster the economy grows, the faster the future reaches us. Just like accounting for retirement, one can also account for where the economy will be in a given number of years using some basic actuarial principles. If an economy grows at 1 percent a year, it will take roughly 72 years for it to double in size in gross Small terms, a Changes little less than average Relatively inthe Growth  4  lifespan of an American today. In contrast, if you change that assumption to an annualized growth rate of 3 percent, an economy will be twice as large in only 24 years, about the time when many Americans have finished college and are getting settled into their careers. So while we are justifiably concerned about today, it’s useful to keep in mind that what might seem like relatively small changes in the longer-run growth path can have profound implications for our well-being and that of Have future generations. Rates Big Effects Over Time  18  3 Annualized Growth Rate (Percent) 2  Number of Years It Takes the Economy to Double in Size at Varying Annualized Growth Rates  24  36  1  72 0  10  20  30  40 Years  “earlier in the twentieth century a lot of  50  60  70  80  In a series of papers and his recently  potential geniuses didn’t get much educa-  published book The Rise and Fall of American  tion, but rather were literally ‘kept down on  Growth, Northwestern University economist  the farm.’ Taking a smart, motivated person  Robert J. Gordon also argues that the U.S.  out of an isolated environment and sending  economy is likely to grow slowly—and also,  that person to high school will bring big  like Cowen, traces this downward trajectory  productivity gains.” Cowen makes a similar  to roughly 1970. At the heart of Gordon’s  observation about college attendance. In  case are two ideas: first, that the pace of  1900, he notes, just one in 400 Americans  innovation has slowed, particularly compared  went to college, while about 40 percent  to the middle of the 20th century, and there  of 18–24-year-olds were enrolled in college  is little reason to believe that will change and,  in 2009, a number that was roughly the  second, there are four large additional “head-  same in 2015.  winds” facing the U.S. economy.  FEDERAL RESERVE BANK OF RICHMOND  7  Gordon describes the century following the Civil War as the period of great eco-  The U.S. experienced several short recessions during the 1950s and 1960s, but overall economic growth was relatively strong.  nomic liberation, where a large portion of the United States was freed from “an unremitting daily grind of painful manual labor, household drudgery, darkness, isolation, and early  American benefiting from the development  death.” He elaborates: “Manual outdoor jobs  of public waterworks, electricity, and anti-  were replaced by work in air-conditioned  biotics, and most seeing their workweeks  environments, housework was increasingly  become shorter and less physically onerous  performed by electric appliances, darkness  while their take-home pay increased. Leisure  was replaced by light, and isolation was  time and retirement, once abstract concepts,  replaced not just by travel, but also by color  became the norm. As a result, Gordon dubs  television images bringing the world into  the period 1920–70 as the “Second Industrial  the living room. Most important, a newborn  Revolution” or “IR #2”.  infant could expect to live not to age forty-  8  There has been innovation since 1970,  five, but to age seventy-two.” What is more,  Gordon concedes, but it can hardly be com-  these stark changes in Americans’ way of life  pared to IR #2. He argues that the effects  were broadly enjoyed, with virtually every  of the digital revolution, or “IR #3,” which  5  2015 ANNUAL REPORT  started with innovations that can be traced  employees grow. Gordon identifies two  to the late 1970s and early 1980s but did not  additional headwinds, which he thinks could  produce major changes in the way business  be barriers to growth, though they are hard  was done until the mid-1990s, have been “felt  to quantify: “globalization,” which could add  in a limited sphere of human activity, in con-  to growing income inequality, and global  trast to IR #2, which changed everything.”  warming and other environmental issues,  Moreover, the productivity gains produced  which could require significant resources  by IR #3 were most acutely felt for only  to address.7  about a decade, with advances coming much more slowly since 2004.  6  In addition to a slowing rate of innova-  All told, the slowing of innovation and the aforementioned headwinds suggest that the “outlook for future growth in the U.S.  tion, Gordon, as noted before, argues that  standard of living is not promising,” Gordon  the U.S. economy faces four big headwinds.  writes. He doubts that “the standard of living  First, there’s rising income inequality, which  of today’s youths will double that of their  has reduced the share of economic gains  parents, unlike the standard of living of each  going to the middle and working classes and  previous generation of Americans back to  with it their disposable income and purchas-  the late nineteenth century.”8  ing power. Second, growth in educational  In many ways, Cowen and Gordon have  attainment as measured by years of school-  framed the issues surrounding the prospects  ing completed has slowed and, among some  for long-term economic growth in the United  parts of the population, decreased since  States quite well. In the next two sections, we  1970. In addition, the quality of primary and  discuss the ways economists have studied  secondary education has become more  economic growth and its causes from the  stratified and the costs of higher education  1950s to the present. In sections four and  has increased. Such trends in education are  five, we evaluate the arguments made for rel-  themselves a contributor to the first head-  atively slow long-run economic growth and  wind, growing income inequality. Third, the  discuss possible policy implications.  United States is experiencing significant demographic changes, most significantly tional retirement age. That has reduced the  Accounting for Growth — The Neoclassical Model  number of hours worked per person. In addi-  In his speech accepting the Nobel Prize in  tion, labor force participation among people  December 1987, economist Robert Solow of  who have not yet reached retirement age  the Massachusetts Institute of Technology  has dropped. Fourth, federal, state, and local  noted that when he started thinking about  governments face mounting debt, in large  economic growth, prevailing “theory, like  measure due to the aging of the population,  much else in macroeconomics, was a product  as spending on “entitlement” programs such  of the depression of the 1930s and of the war  as Social Security and Medicare increases  that finally ended it. So was I. Nevertheless  and pension obligations to public-sector  it seemed to me that the story told by these  many baby boomers are reaching tradi-  FEDERAL RESERVE BANK OF RICHMOND  9  Technological innovation is a very important factor in both the neoclassical and endogenous growth models. This meant that an equilibrium growth path could be achieved only in rare circumstances. More often, the economy would be alternating between worsening periods of labor models felt wrong.” In particular, Solow  underutilization and long periods of growing  had in mind the work of the English econo-  labor shortage. Despite the severe effects of  mist Roy Harrod and the Russian-American  the Great Depression, American economic  economist Evsey Domar. The Harrod-Domar  history did not fit this pattern. Solow looked  model maintained that steady economic  to an alternative and in two papers in the  growth at a constant rate required the  1950s 11 developed what came to be known  national saving rate to be equal to the prod-  as either the “Solow growth model” 12 or the  uct of the capital-output ratio and the rate of  “neoclassical growth model.”  growth of the labor force.9 “Discomfort arose  10  The Harrod-Domar model assumed that  because they worked this out on the assump-  labor could not be substituted for capital in  tion that all three of the key ingredients …  production. Solow removed this assumption  were given constants, facts of nature,” Solow  and with it the “knife-edge notion of unsta-  wrote.10 But, in fact, all three are capable of  ble balance” went with it. His model was  changing at different rates at different times.  quite elegant in its simplicity. Output was  2015 ANNUAL REPORT  determined by three factors: capital, labor,  Growth theorists in the 1980s and 1990s  and technology. That measure of technol-  built on the neoclassical model but changed  ogy was later dubbed the “Solow residual”  an important assumption: In their models,  or “total factor productivity” (TFP) and  technological growth was endogenous rather  includes a variety of things beyond tech-  than exogenous. Endogenous technical  nological progress, strictly speaking. And  change is change that is determined within  the evolution of labor and technology was  the economic system, meaning that it is the  taken as given.  consequence of the decisions and actions of  The model has an important implica-  people in the economy. Still, it is important  tion for long-run per capita growth: Since  to note that both neoclassical growth theo-  capital suffers from diminishing returns,  rists and endogenous growth theorists focus  capital accumulation can drive growth only  on technology as one of the factors—if not  in the short run, and, with no technological  the principal factor—driving long-run eco-  improvements, per capita output stagnates  nomic growth. Indeed, while one of the signal  in the long run. So long-run growth (in  contributions of the neoclassical growth  output per worker) is due only to techno-  theorists was the development of tools that  logical progress, or TFP, and that progress  “enable us to measure the rate of technical  is exogenous, meaning it comes from forces  change,” Stiroh writes, the models of the  outside the economic system. Early measure-  endogenous “growth theorists provide an  ments done by Solow and others suggested  internal explanation for the sources of tech-  that a very large share of growth was not  nical change.” 16 Similarly, Harvard University  driven by capital accumulation but by TFP.  economist Elhanan Helpman, himself a major  Indeed, Solow concluded that during the first  contributor to the endogenous growth litera-  part of the 20th century in the United States,  ture, notes that “there is convincing evidence  about 80 percent of non-farm output growth  that total factor productivity plays a major  was due to TFP.  role” in accounting for cross-country varia-  13  A line of the neoclassical growth liter-  tions in per capita income and patterns of  ature in the late 1960s attempted to better  economic growth. But while careful growth  understand and measure the factors of pro-  accounting can help us understand the  duction. As New York Fed economist Kevin  relative “contribution of inputs and the con-  J. Stiroh has put it, economists working in  tribution of total factor productivity, it does  this period “sought to develop better mea-  not unveil the causes of economic growth.” 17  sures of investment, capital, labor, and other omitted inputs in order to reduce the magarea of research enriched the neoclassical  Explaining Growth — The New Growth Theory  growth model and pioneering work was done  Among the implications of the neoclassical  by Dale Jorgenson and Zvi Griliches, then of  growth model is that economic convergence  the University of California, Berkeley and the  between countries would occur over time,  University of Chicago, respectively.  with poorer countries catching up with richer  nitude of the unexplained residual.” 14 That  15  FEDERAL RESERVE BANK OF RICHMOND  11  The Origins of Modern Economic Growth  I  n 1651, Englishman Thomas Hobbes famously described life as “solitary, poor, nasty, brutish, and short.” 55 In many ways, he was right—certainly from today’s perspective. But within about 100 years from the time of Hobbes’ statement, the Industrial Revolution had started and then continued, in most economic historians’ view, until about 1820 and 1840. The Industrial Revolution changed the world forever. From 1820 to present, GDP per person in Western Europe and the United States rose by more than a factor of 20, to about $26,000, estimates Stanford University economist Charles Jones. 56 But what gave rise to the Industrial Revolution and the massive increases in wellbeing it spawned? And is it true that economic growth, as has often been asserted, was virtually non-existent prior to it? The answer to the first question is: It’s complicated. The answer to the second is: Probably not. The Industrial Revolution, it seems pretty clear, was the result of innovation—in short, of ideas. As Northwestern University economic historian Joel Mokyr has argued, “The effective deployment of that knowledge, scientific or otherwise, in the service of production is the primary—if not the only—cause for the rapid growth of Western economies in the past centuries.”57 But that begs the question: Why? After all, people have been coming up with ideas forever. Mokyr points to the Enlightenment of the late 17th centuries and 18th centuries. The ideas of this period, he argues, bridge the Scientific Revolution of Galileo, Descartes, and Newton with the Industrial Revolution of the mills and factories of Great Britain and continental Europe. In particular, the Enlightenment notions that economic growth and social progress can be achieved through knowledge—and that those things are desirable— were crucial to their actual attainment. 58 But it wasn’t enough. Also necessary was what Mokyr calls the doctrine of “economic reasonableness,”  12  2015 ANNUAL REPORT  itself a product of the Enlightenment, and that was characterized by greater openness to trade, improved infrastructure, legal predictability and stability, and less distortionary taxation. Above all, it “redefined the role of the public sphere in the economic game, pointing to the delicate balance between those who lubricate the wheels of economic activity and those who manipulate them for their own profit. It recognized the possibility of what we might call today coordination failures and suggested policies to rectify them.”59 Mokyr’s story of why the Industrial Revolution occurred when it did is not the only plausible one offered by economic historians. But it has the virtue of also offering a plausible explanation of why economic growth was not, in fact, unheard of prior to the late 18th and early 19th centuries and also not confined to Great Britain. The latter idea was once controversial, as mentioned previously, but is less so today. Work by economists such as Roger Fouquet of the London School of Economics and Political Science and Stephen Broadberry of the University of Oxford, among others, seems to demonstrate that there was intermittent and localized growth in the Middle Ages, such as in the Netherlands in the 16th and 17th centuries and in Italy in the 14th century.60 Indeed, that growth very likely made it possible for people to move to urban areas and into nonagricultural occupations. But none of the regions that experienced such progress previously ever switched from trade-based growth to technology-based growth. Trade-based growth remained vulnerable to setbacks and shocks, both natural, such as disease and disaster, and manmade, such as legal and institutional changes that hampered the expansion of commerce. In short, not only does the argument that ideas are a primary driver of economic growth seem compelling, so too does the argument that ideas helped make ideas-based growth possible.  countries. However, that is not observed in  learning by doing, and the sharing of ideas  the data. While the cross-country variation  among people working on similar problems.  in per capita wealth has been shrinking  Lucas echoed Jacobs’ argument that much  somewhat in recent decades, as some of the  of economic life is “creative” in a way that  poorest countries in the world have made  is similar to how we think of art or science  significant relative gains, there can be no  being creative. “New York City’s garment  doubt that the gap between what is gen-  district, financial district, diamond district,  erally considered the developed world and  advertising district and many more are as  the developing world remains very large.  much intellectual centers as Columbia or  This observation motivated economists Paul  New York University,” Lucas wrote. “The  Romer, now of New York University, and  specific ideas exchanged in these centers  Robert Lucas, of the University of Chicago,  differ, of course, from those exchanged in  to, as Romer has put it, “drop the two central  academic circles but the process is much the  assumptions of the neoclassical model: that  same. To an outsider, it even looks the same:  technological change is exogenous and that  A collection of people doing pretty much the  the same technological opportunities are  same thing, each emphasizing his own origi-  available in all countries in the world.” 18  nality and uniqueness.” Indeed, Lucas argued  Lucas argued that if the same technol-  that the principal factor that can explain the  ogy were available everywhere, resources,  dominant role of cities in economic life—why  such as human capital, would not tend to  people and businesses cluster in relatively  move from where they are scarce to where  small geographic areas where land and hous-  they are plentiful and substantial differences  ing is relatively expensive—are the benefits of  in the level and growth of income would  external human capital. 21  not persist. Yet both things are true. Lucas’  Lucas’ work was complementary to work  theory is that there are “external effects” of  being done by Romer in a series of papers  human capital. Economists had long argued  at roughly the same time. 22 Romer suggests  that improvements in a worker’s human cap-  that the evidence about growth that most  ital had “internal effects”—meaning benefits  economists have generally agreed to be  from building human capital accrued to the  true can be distilled to five facts. (1) There  worker (and perhaps his or her family). But  are many firms in a market economy. (2)  Lucas, building on the work of sociologist  Discoveries differ from other inputs in the  19  and urban theorist Jane Jacobs,  20  posited  sense that many people can use them at  that there were spillover effects associated  the same time. (3) It is possible to replicate  with human capital. As Lucas succinctly  physical activities. (4) Technological advance  noted: “Most of what we know we learn from  comes from things that people do. (5) Many  other people.”  individuals and firms have market power and  Some of what we know comes through relatively formal channels, such as schooling.  earn monopoly rents on discoveries. 23 According to Romer, the neoclassi-  But some of it comes through less formal  cal model captured facts 1, 2, and 3 but  channels, meaning through observation,  left 4 and 5 largely unaddressed. Some  FEDERAL RESERVE BANK OF RICHMOND  13  endogenous growth models, such as his own,  thus growth. Economist Daron Acemoglu of  “try to take the next step and accommodate  the Massachusetts Institute of Technology  fact 4.” At the heart of Romer’s work is the  describes innovation-friendly regimes as  importance of ideas and their role in innova-  “inclusive,” meaning they have secure prop-  tion and productivity improvements, which  erty rights, level playing fields, few barriers  he argues is the prime driver of economic  to entry for businesses and occupations, and  growth. Initially, it can be difficult to differen-  basic public services and infrastructure. In  tiate what Lucas refers to as the economy’s  addition, they have stable governments char-  “stock of knowledge” from Romer’s focus on  acterized by a broad distribution of political  ideas. But there is an important difference  power so that authority can’t be exercised in  in how they model the generation of new  an arbitrary way. 25  ideas or knowledge. In Lucas’ formulation,  inherently nonrivalrous, meaning they can  economic decisions people make with regard  be used and built upon by multiple people  to investment in physical and human capital.  simultaneously. Commenting on Romer’s  People make their decisions in a competitive  work, Stanford University economist Charles  environment, taking the current state of tech-  Jones provides a useful example: “If you add  nology as given. But in the process of doing  one computer, you make one worker more  so, new things are learned about the produc-  productive. If you add a new idea—think  tion of goods and services, which advances  of the computer code for the first spread-  the technological frontier.  sheet or word processor or even the internet  By contrast, Romer focuses on the  itself—you can make any number of workers  technological change that arises because  more productive.”26 Moreover, in a world of  of intentional actions of people responding  relatively fast transmission of ideas across  to market incentives. That is, technology  space, ideas are no longer country or region  advances because people seek to profit from  specific. They can be “imported” from any  new ways of producing goods and services.  part of the world fairly easily and cheaply.  To be sure, there are some people who come  Romer then goes on to address  up with technological breakthroughs with-  fact 5, the existence of monopoly rents.  out any commercial applications in mind.  Endogenous growth theorists working within  But even in those cases, those innovations  the “Schumpeterian” framework, especially,  spur related innovations that do have market  have incorporated market power into their  value. “Our initial understanding of electro-  models. 27 These economists trace their  magnetism arose from research conducted  work to Joseph Schumpeter, who noted  in academic institutions, but magnetic tape  the importance of technology in the 1930s  and home videocassette recorders resulted  and 1940s. He is best known for his book  from private attempts by private firms to  Capitalism, Socialism, and Democracy, and in  earn a profit,” Romer notes.  14  Particularly importantly, ideas are  technological progress is a byproduct of the  24  In this regard,  particular his description of the “gale of cre-  a country’s institutions are crucial to provid-  ative destruction” as a “process of industrial  ing the proper incentives for innovation and  mutation that incessantly revolutionizes the  2015 ANNUAL REPORT  As people work together on projects, sharing ideas, there are often spillover effects that enhance growth. as in the neoclassical model.” But like other theories of endogenous growth, “the causal explanation that it provides for economic growth is quite different from that of the economic structure from within, incessantly  neoclassical model.” In short, neoclassical  destroying the old one, incessantly creating  theory “can be seen as a special case of  a new one.”28 They address the possibility  modern endogenous growth theory, the  that current innovators not only can exert  special limiting case in which the marginal  positive knowledge spillovers on subsequent  productivity of efforts to innovate has fallen  innovators, but can also drive out previous  to zero.”30  technologies (through what amounts to a process of creative destruction) and for short periods of time effectively earn monopoly rents.  29  Economists Philippe Aghion of  Thinking About the Future Thus far, we have looked at the argument  Harvard University and Peter Howitt of  some economists have recently made that  Brown University argue that Schumpeterian  economic growth in the United States is  models are generally “consistent with the  likely to remain below historical trends for  empirical evidence on growth accounting,  some time, provided a brief overview of the  FEDERAL RESERVE BANK OF RICHMOND  15  neoclassical growth theory that was devel-  That is true in nearly every aspect of life. But  oped in the 1950s, and then looked at how  it is perhaps particularly true when it comes  the neoclassical model has been built upon  to predicting innovation, which as we know  by endogenous growth theorists in the 1980s  comes in fits and starts and is hard to forecast.  and beyond. Given what we know from both  Gordon’s colleague at Northwestern,  theory and evidence, how should we evalu-  economic historian Joel Mokyr, argues that  ate the “new normal” hypothesis regarding  there are many areas of science in which sig-  sluggish future U.S. growth?  nificant discoveries seem promising, among  Gordon presents a plausible outlook. It is true that TFP growth associated with  nanochemistry, and genetic engineering.  the digital revolution—or, again, as he puts  And while it is true that there is no automatic  it, IR #3—appears to have been relatively  mechanism that turns better science into  short lived relative to TFP growth associ-  improved technology, “there is one reason  ated with IR #1 and IR #2. During IR #2, 1920  to believe that in the near future it will do so  to 1970, the annualized rate of TFP growth  better and more efficiently than ever before.  was 1.89. From 1970 to 1994, that number  The reason is access.” Meaning, searching  slipped to 0.57. It rebounded to 1.03 from  for vast amounts of information has become  1994 to 2004, but then fell to 0.40 from  fast, easy, and nearly costless for research-  2004 to 2014. His interpretation for the rise  ers. Not only is the era of “Big Data” here but  from 1994 to 2004 and the drop thereafter  the ability to parse through the most arcane  is fairly straightforward: The introduction of  of data is no longer burdensome for people  the personal computer in the 1980s did not  working on the frontiers of knowledge.  generate major productivity gains until the  On the question of whether all the  “invention of the Internet, web browsing,  low-hanging fruit has been picked, Mokyr  search engines, and e-commerce produced a  argues that the analogy is flawed. As he puts  pervasive change in every aspect of business  it, science “builds taller and taller ladders, so  practice.”31 However, those changes have  we can reach the upper branches, and then  largely been exploited and we are unlikely  the branches above them.” In other words,  to see major additional changes from those  when a technological solution for a prob-  technologies—and the prospect for new  lem is found it often creates a new problem,  technological development that was as rev-  which creates a new problem, and so on.  olutionary as what we saw in the middle of  “Each solution perturbs some other com-  the 20th century is unlikely. Yes, we will see  ponent in the system and sows the seed of  more ingenuous apps for our mobile devices  more needs; the ‘demand’ for new technol-  but, as he frequently quips in public lectures,  ogy is thus self-sustaining.”32  “What would you rather have: your iPhone or indoor plumbing?” Arguably the biggest problem with  16  them molecular microbiology, astronomy,  Acemoglu is in general agreement with Mokyr on this point. The “macropicture is clear: there is little evidence we are running  Gordon’s analysis is that trying to predict  out of innovations,” he writes. “This is not  the future is inevitably fraught with trouble.  only because there are literally millions of  2015 ANNUAL REPORT  ideas that can be recombined into new ones  importance of recent innovations to human  to generate new processes and products,  well-being. Princeton University economist  but also because every innovation poses  Angus Deaton has made this point in an ele-  new problems and opens the way for yet  gant essay that is worth quoting at length:  more innovations.” In addition, he argues that in societies with good governance, market  I...challenge the proposition that the information  signals are sent to innovators to guide their  revolution and its associated devices do little  work toward areas where societal benefits  for human well-being. Many have documented  are large. As an example, he points to the U.S. pharmaceutical industry, where the production of drugs aimed to address problems faced by aging baby boomers has increased and the quality has improved. 33  the importance of spending time and socializing with friends and family, but this is exactly the feature of everyday life that the new communication methods work to enhance. All of us can remain in touch with our children and friends throughout every day, videoconferenc-  Insofar as there is a threat to technologi-  ing is essentially free, and we can cultivate close  cal advance, it is arguably not from a secular  relationships with people who live thousands of  drying up of ideas but rather a shift from  miles away. When my parents said good-bye  inclusive institutions that encourage and  to relatives and friends who left Scotland to  reward ingenuity and provide social stability toward extractive institutions that do just the opposite. 34 Still, while it is no doubt true that there are improvements to institutions that  look for better lives in Canada and Australia, they never expected to see or talk to them again, except perhaps for a brief and astronomically expensive phone call when someone died. Today, we often do not even know where  U.S. policymakers should consider (which  people are physically located when we work  we will address in the next section), there is  with them, talk to them, or play with them. We  little reason to think that the United States is  can also enjoy the great human achievements  heading from a system of broadly inclusive  of the past and the present, cheaply accessing  institutions to broadly extractive institutions. Also, while there are still far too many people in the world who live under regimes whose institutions, in the main, could be described  literature, music, and movies at any time and in any place. That these joys are not captured in growth statistics tells us about the growth statistics, not about the technology. If they are belittled by those who do not use them, it  as extractive, the broad trend is toward more  tells us only to pay no attention to those who  liberalization across the globe, thus unleash-  purport to use their own preference to pass  ing the potential of their citizens—people  judgments on the pleasures of others. 35  whose ideas will benefit not only them and their neighbors but people thousands of miles away. What’s more, even if we accept Gordon’s  Relatedly, Deaton notes that broader societal trends are making life better for millions of people. Whether these can be tied  hypothesis that technological growth is  to technological improvements is tenuous in  slowing and is likely to remain sluggish,  some cases, less so in others. For instance,  as measured by TFP, that doesn’t neces-  violence has fallen. From 2005 to 2014,  sarily mean that we should discount the  the violent crime rate in the United States  FEDERAL RESERVE BANK OF RICHMOND  17  fell 22.1 percent. 36 That is clearly important  and that some could have adverse economic  for those who otherwise would have been  consequences for segments of the popula-  victims of violence, but it is also important  tion. Insofar as the latter is true, policymakers  for those who potentially could be subject  may wish to consider ways to compensate  to violence, as they are able to live with less  those who are made worse off.  fear and insecurity. Arguably, technological advances have improved policing of crime as well as the collection and processing of  Implications for Policy  evidence that in the past would have been  Perhaps the first thing that policymakers  of little use to investigators, benefiting  ought to acknowledge when confronting  victims of crimes and those falsely accused.  policy issues aimed at boosting innovation  Reducing violent crime is an area where  and economic growth is that there are factors  there remains room for further progress,  related to long-term economic growth that  with the potential for considerable improve-  are largely beyond their control. One of them  ment in people’s lives.  is the domestic birth rate. A fact that seems  On balance, there is reason to be  as they get richer, the fertility rate declines.  technological innovation. There is also reason  In 2013, University of Chicago economist  to celebrate recent innovations that may  Gary Becker estimated that more than 80  not immediately appear as fundamentally  countries have fewer births annually than are  transforming as, say, the development and  required to replace the number of individuals  widespread use of automobiles during the  who die each year, including every country  middle part of the 20th century, but that  in Western Europe, China, Japan, Russia, and  have still brought great gains to millions of  Canada.38 In the United States, the fertility  Americans and billions of people worldwide,  rate was only slightly above the replacement  gains that arguably are not fully captured  rate. The United Nations predicts that many  in many standard measures of well-being. It  of these countries will have smaller popula-  would be rash to attempt to predict with pre-  tions in 2050 than they do today.39  cision the pace at which future innovation will  Such trends have significant economic  take place or how important those innova-  implications. As noted in the introduction to  tions will be, but it would also be premature  this essay, Gordon argues that demographic  to say that America’s best days are behind  trends are one of the four major “headwinds”  us and that future generations will not live  that the U.S. economy faces. In particular, the  much better than we do today.  37  In the next  declining fertility rate (accompanied by lower  section, we will raise several policy issues  overall labor force participation) will make it  that might be addressed to help provide an  more difficult to fund entitlement programs  environment in which innovation can con-  such as Social Security and Medicare, which  tinue to occur and economic growth can be  depend on payroll taxes to distribute benefits.  robust. We acknowledge that some of these ideas may be difficult to achieve politically  18  to hold true across nearly all countries is that  sanguine about the prospects for future  2015 ANNUAL REPORT  In the neoclassical model, declining population has a very clear and direct effect  on output. As the amount of labor falls, so  long-distance communication has improved  does output. In endogenous growth models,  and become cheaper. Policies that would  population has the same direct effect on  increase the level of skills by making it easier  labor input, but many also feature an indirect  for workers to come to the United States  effect. Growth in such models is largely a  would benefit the immigrants themselves  function of ideas, and the more people in a  and native-born Americans, on average.42  country, the more ideas they will create. As Charles Jones argues:  Closely tied to the issue of immigration is that of trade. Since at least the publication of The Wealth of Nations by Adam Smith in  First, just as the total output of any good  1776,43 economists have generally been sup-  depends on the total number of workers produc-  portive of liberal trade policies. Such policies  ing the good, more researchers produce more  permit countries to specialize in the produc-  ideas. A larger population means more Mozarts  tion of goods where they have a comparative  and Newtons, and more Wright brothers, Sam Waltons, and William Shockleys. Second, the nonrivalry of knowledge means that per capita output depends on the total stock of ideas, not on ideas per person. Each person in the econ-  advantage, as classical economist David Ricardo noted,44 leading to an increase in output per worker. But Romer points out that the benefits of trade extend beyond increas-  omy benefits from the new ideas created by  ing the efficiency of the production of goods  the Isaac Newtons and William Shockleys of the  that already exist. Trade also introduces new  world, and this benefit is not degraded by the  or improved types of goods and services  presence of a larger population.40  from abroad.45  So how might policymakers address  Princeton University and Elhanan Helpman  Similarly, economist Gene Grossman of the issue of declining fertility rates in the  posit a theory of integration and growth,  United States? As noted above, this seems  where trade may help the process of tech-  to be an issue that is largely out of their  nological dissemination if foreign exporters  control, at least directly. One could imagine  suggest ways that their goods can be used  schemes that would subsidize births but, as  more productively or foreign importers indi-  Becker, who viewed population growth as  cate how local products can be made more  a net positive, argued, those programs can  attractive to consumers in their country. In  be expensive and hard to administer.41 An  addition, exposure to international compe-  obvious alternative to domestic population  tition may mitigate redundancy in industrial  growth is to look abroad and effectively  research. “Whereas a firm that develops a  import ideas through more liberalized  product for a protected domestic market  immigration policies. Consistent with Lucas’  need only make use of technologies that are  theory of economic growth, people can be  new to the local economy,” they write, “one  more productive when placed in close prox-  that hopes to compete in the international  imity to others, jointly working on projects,  marketplace will be forced to generate ideas  than in isolation, though arguably the impor-  that are truly innovative on a global scale.”46  tance of proximity has declined somewhat as  The United States ought to act on the  FEDERAL RESERVE BANK OF RICHMOND  19  presumption that just as competition within a  For those who are unsure whether college  country improves efficiency and its citizens’  is right for them, the choice to go can be  welfare, so too does trade between coun-  costly in terms of foregone earnings and also  tries. Thus, policymakers ought to be wary  bring with it substantial debt, while at the  of imposing barriers that would impede such  same time yielding little in improved earn-  transactions and make most people worse  ings if they do not complete their degree.  off than they otherwise would be.47  People who have some college but have not  Education is also clearly important to  more than their peers with only a high school  States. The building of human capital, as we  degree. This is particularly important when  have seen, brings with it gains to the person  we consider that the college dropout rate is  who has acquired skills as well as the econ-  roughly 40 percent.  omy as a whole. In addition, universities tend  It should also be noted that the high  to be incubators for ideas, some that have no  school dropout rate nationwide is roughly 20  obvious immediate commercial application  percent, but in many of our major cities that  and others that do. How to “fix” America’s  number rises above 50 percent. What’s more,  educational system, particularly at the ele-  many of those students often go to school in  mentary and secondary levels, is a perennial  fear for their safety and, if they do graduate,  topic of debate and, while there is merit in  do not have the same skills, on average, as  focusing on specific proposals that deal with,  their peers in suburban or private schools.  say, how to construct curricula, we would like  This feeds inequality and raises a host of  to discuss a few broader principles.  troubling questions about social equity.  First, it appears that there are significant  Improving access to good educational  returns to early childhood education. Skills  opportunities for students in urban areas in  that are acquired early in life tend to build on  principle should be an example of “low-hang-  each other over time.  48  Second, we ought to  ing fruit.” How we harvest that fruit, however,  take a broad view of what we mean when we  has proven to be a difficult issue to address.  use the term “skills.” Some of these may not  The pursuit of better solutions will, and  be easily measurable through standardized  should, continue, not only because it may  tests but seem to have important long-run  improve aggregate economic performance  effects. For instance, noncognitive skills such  but also because it is important to bettering  as following instructions, patience, and work  the lives of some of our country’s most dis-  ethic can lay the foundation for mastering  advantaged citizens. 50  more complex cognitive skills later in life.  20  attained a degree earn only about 15 percent  the future of economic growth in the United  49  The cumulative effects of economic reg-  Third, we ought not take a one-size-fits-all  ulation appear to be exerting a drag on the  approach to education. It is true that, on  U.S. economy. While some regulations—for  average, a college degree brings with it sig-  instance, those that require firms to effec-  nificant monetary returns over the course of  tively internalize the costs they impose on  a person’s life. But that does not mean that  others—arguably promote both efficiency  all students should be guided toward college.  and equity, many regulations serve little  2015 ANNUAL REPORT  Human capital accumulation occurs both in and out of the classroom and benefits individuals and the economy overall.  particular. It is true that monetary policymakers need to be attentive to the forces shaping long-run growth. Different underlying rates of growth imply differences in the general  aggregate economic purpose but instead  level of interest rates—rates will tend to be  deliver concentrated benefits for certain  lower in a more slowly growing economy.  groups, often by helping to protect them  Accordingly, expectations about average  from competition. Robert Gordon dubs  growth rates going forward will be one of  these barriers to entry as “regressive reg-  the factors that influence policymakers’  ulation” and identifies excessive monopoly  assessments of the appropriate setting of  privileges granted under intellectual property  their short-term interest rate instrument. But  law, protection of incumbent service pro-  in terms of the influence of monetary policy  viders through occupational licensing, and  on growth, the most important contribution  artificial scarcity through land-use regulation  is to provide an environment of macroeco-  as areas ripe for reform. 52  nomic stability that is friendly to innovation  51  The policy considerations discussed  and growth. Similarly, the Federal Reserve’s  here lie mostly beyond the responsibility  role in the regulation of financial interme-  of the central bank, and monetary policy in  diation—in particular, permitting firms to  FEDERAL RESERVE BANK OF RICHMOND  21  borrow, lend, and innovate, while guarding  would have thought that the rest of the  against excessive risk-taking—is important to  20th century would have produced such  the maintenance of a sound financial sector,  massive gains for such a huge swath of the  without which economic growth is difficult.  population? n  53  In sum, there can be little doubt that the U.S. economy does face some significant challenges. However, the “new normal” is far from a given. The prospects for continued innovations that improve measured as well as unmeasured standards of living remain stronger than the skeptics maintain. And there are policy areas that, if addressed thoughtfully, likely could yield improvement in economic performance and human welfare. 54 It might be hard for many people to imagine the U.S. economy growing like it did in, say, the 1950s, but how many Americans in 1930  22  2015 ANNUAL REPORT  Aaron Steelman is director of publications and John A.Weinberg is senior vice president and special advisor to the president at the Federal Reserve Bank of Richmond. The authors would like to thank Kartik Athreya, Huberto Ennis, Andreas Hornstein, and Alexander Wolman for helpful comments. The views expressed are those of the authors and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.  REFERENCES  Acemoglu, Daron. 2013. “The World Our Grandchildren Will Inherit.” In In 100 Years: Leading Economists Predict the Future, edited by Ignacio Palacios-Huerta, 1–35. Cambridge, Mass.: MIT Press.  Fouquet, Roger, and Stephen Broadberry. 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July 29, 2015. “World Population Prospects: 2015 Revision.” New York: United Nations.  ENDNOTES  1  See El-Erian (2010) and Lagarde (2014).  21  2  See Jorgenson, Ho, and Samuels (2014).  22	 See Romer (1986), Romer (1987), and Romer (1990).  3  Cowen (2011, 7).  23	 Romer (1994a, 11–17).  4  It should be noted that in his 2013 book Average Is Over, Cowen considers himself more optimistic about U.S. economic growth over the long run, though he worries that the distribution of its benefits will be highly uneven depending on the relative skill levels of workers.  24	 Romer (1990, S72).  5  Gordon (2016, 1).  6  Gordon (2016, 566–579).  7  Gordon (2016, 605–639).  8  Gordon (2016, 21–22).  9  While called the Harrod-Domar model, the model is the product of independent work by each of the authors, in particular Harrod (1939) and Domar (1946).  10  Solow (1988, 307–308).  11  Solow (1956) and Solow (1957).  12  The Solow growth model is sometimes referred to as the “Solow-Swan growth model,” as Australian economist Trevor Swan developed similar ideas roughly contemporaneously (Swan 1956).  13  Solow (1957, 314–316).  14  Stiroh (2001, 41).  15  Jorgenson and Griliches (1967).  16  Stiroh (2001, 2).  17  Helpman (2004, 26–33).  18  Romer (1994a, 4).  19  As Lucas, Romer, and others were developing endogenous growth models, in which human capital played an important role, economists Gregory Mankiw, David Romer, and David Weil of Harvard University, the University of California, Berkeley, and Brown University, respectively, sought to augment the neoclassical model by including accumulation of human capital as well as physical capital and argued that this change produced results that were consistent with many of the implications of the neoclassical model. See Mankiw, Romer, and Weil (1992).  20	 Jacobs (1969) and Jacobs (1984).  Lucas (1988, 35–38).  25	 Acemoglu (2013, 15–16). 26	 Jones (2015a, 1). 27	 Two foundational papers in Schumpeterian growth theory are Grossman and Helpman (1991b) and Aghion and Howitt (1992). For a useful overview of Schumpeterian growth models, see Aghion, Akcigit, and Howitt (2014). Solow is less enthusiastic about Schumpeter’s contributions. He writes that Schumpeter is viewed as a patron saint among some endogenous growth theorists and that he should be treated as such: “paraded around one day each year and more or less ignored the rest of the time (Solow 1994, 52).” 28	 Schumpeter (1942, 83). 29	 In Schumpeterian growth models, the legal protection of intellectual property rights (IPR), which too can be seen as a form of temporary monopoly power, is generally considered crucial to induce innovation because it permits innovators to reap financial benefits from their work. Daron Acemoglu of the Massachusetts Institute of Technology and Ufuk Akcigit, now of the University of Chicago, for instance, have developed a dynamic framework to study the interactions between IPR and competition. They argue “that protection given to companies with significant technological leads over their rivals also dynamically incentivizes companies with more limited technological leads—as further innovation will not only increase their productivity but also grant them additional IPR protection. This new effect implies that optimal IPR policy should be state dependent and provide greater protection to companies with significant technological leads and only limited IPR protection for those without (Acemoglu and Akcigit 2012, 38–39).” As we shall see later in this essay, though, some economists and policy analysts believe that IPR protection is excessively restrictive and liberalization would be good for growth. Notably, Michele Boldrin of Washington University and David Levine of the University of California, Los Angeles believe that IPR, on net, are harmful to economic growth and should be eliminated. See Boldrin and Levine (2002) and Boldrin and Levine (2009). 30	 Aghion and Howitt (2007, 80).  FEDERAL RESERVE BANK OF RICHMOND  25  31  in which technological change is not necessarily dependent on the presence of genius producing sharp one-time gains but instead on continuous acceleration. See Kremer (1993).  Gordon (2016, 575–576).  32	 Mokyr (2013). 33	 Acemoglu (2013, 25–26). 34	 For a cross-country examination of institutional characteristics—such as the rule of law, predictable and relatively modest regulation, and efficient provision of public services—and their importance for economic development and growth, see La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1999). 35	 Deaton (2013, 41). 36	 Federal Bureau of Investigation (2015). 37	 It is worth noting that it is possible that some technological advances—what might be thought of as new and often general purpose technologies, as opposed to incremental innovations—might actually slow economic growth for a period as firms learn how to make use of those technologies, but then contribute to faster economic growth over time as they are incorporated into production practices. See Hornstein and Krusell (1996). 38	 Becker (2013). 39	 United Nations (2015). 40	 Jones (2005, 1073). This line of argument has a long pedigree. In 1968, a time when many social scientists were worried about overpopulation causing enormous societal problems, Columbia University economist Edmund Phelps argued: “One can hardly imagine, I think, how poor we would be today were it not for the rapid population growth of the past to which we owe the enormous number of technological advances enjoyed today. …If I could re-do the history of the world, halving population size each year from the beginning of time on some random basis, I would not do it for fear of losing Mozart in the process (Phelps 1968, 511–512).” Similarly, University of Maryland economist Julian Simon argued that people were the “ultimate resource” in numerous popular writings and, most comprehensively, in The Ultimate Resource 2 (Simon 1998). Michael Kremer, a development economist at Harvard University, has looked empirically at the relationship of population growth and technological progress from the prehistoric period to 1900. He concludes that technological growth has been higher when population has been larger, including in places that were isolated physically from other parts of the world, such as during the period between the melting of the polar ice caps, which eliminated land bridges, and Europeans’ reestablishment of contact with North America. He also develops a model  26  2015 ANNUAL REPORT  41  Becker (2013).  42	 There is also a strong case for liberalizing immigration policies for lower-skilled workers, both on ethical and efficiency grounds, but that argument is beyond the scope of this essay. 43	 Smith (1776). 44	 Ricardo (1817). 45	 Romer (1994b, 25). 46	 Grossman and Helpman (1994, 40). It should be noted that Grossman and Helpman have also constructed examples where closing off trade might also increase a country’s long-run growth rate. For example, a country that has a relative abundance of natural resources and unskilled labor may be induced by trade to specialize in activities that make use of those activities and forego humancapital-intensive activities that would result in the development of new technologies, thus reducing the pace of non-agricultural output. See Grossman and Helpman (1991a, 237–257). But they add: “These arguments should not be taken to imply that illiberal trade policies would generally be beneficial to a country that sees slower growth as a result of openness to trade. A country that lacks the size and technological experience to support a world class R&D effort, or one that has the endowments appropriate to activities like agriculture or mining, typically will gain from specializing in the production of goods that do not require the latest technologies (Grossman and Helpman 1994, 41).” 47	 It is true that liberal trade policies do produce some net losers. For instance, those people formerly employed in industries that are now partly or largely located in other countries may be worse off due to international trade. But rather than trying to restrict the free flow of ideas and goods—and thereby blunt the substantial economic benefits that result—a more desirable alternative, insofar as any action is taken, would be to provide financial compensation for those who have been economically harmed. Economist Earl Grinols, now of Baylor University, provides an overview of the merits of different policies that would achieve that end in Grinols (1996). 48	 Heckman (2008). 49	 Bowles, Gintis, and Groves (2008).  50	 Students in urban areas also are disproportionately likely to be raised in single-parent homes or homes with significant dysfunction. There is compelling evidence that this, too, contributes to lower lifetime earnings as well as, for example, higher incarceration rates. See Schwartz (2005) and Lerman and Wilcox (2014). Policymakers ought to focus on what can be done to address such problems—including, perhaps most of all, the elimination of policies that inadvertently foster them. Gordon (2016, 644–646) offers some thought-provoking suggestions in this regard. 51  Mancur Olson explains this dynamic in The Logic of Collective Action: Public Goods and the Theory of Groups (Olson 1965).  52	 Gordon (2016, 649). Brink Lindsey of the Cato Institute makes a similar argument but includes restrictions on high-skilled immigration under the “regressive regulation” rubric as well: “[A]ll these entry barriers undermine economic growth by restricting vital inputs to innovation. Copyright and patent protections restrict the recombination of ideas that is the essence of innovation by making some ideas artificially inaccessible. Immigration laws restrict the inflow of highly skilled individuals who are disproportionately entrepreneurial and innovative. Occupational licensing restricts the formation of new businesses, which frequently are the vessels of new products or new production methods. And zoning restricts urban density, a vital catalyst for the innovative recombination of ideas (Lindsey 2015a, 28).” 53	 Using data from 80 countries during 1960–89, economists Robert G. King and Ross Levine, then of the University of Virginia and the World Bank, respectively, provided evidence that the level of financial development is strongly associated with real per capita GDP growth, the rate of physical capital accumulation, and efficiency improvements in the use of physical capital. See King and Levine (1993). 54	 For a thoughtful discussion of many other policy areas where reform might be helpful to long-term growth, see Lindsey (2015b). 55	 Hobbes (1651). 56	 Jones (2015b, 4). 57	 Mokyr (2005, 287). 58	 Mokyr (2005, 288–290). 59	 Mokyr (2005, 336–337). 60	 See Fouquet and Broadberry (2015) and Goldstone (2002).  FEDERAL RESERVE BANK OF RICHMOND  27  FIFTH DISTRICT ECONOMIC REPORT  Fifth District Expansion Continued in 2015 Introduction Overall, 2015 was a year of economic expan-  notable contributor to the 1.3 percent con-  sion in the Fifth District. Labor markets  traction was the natural resource and mining  tightened in most areas, with the notable  industry, which shed 5,500 jobs (19.1 percent)  exception of West Virginia, where job losses  over the year.  were largely related to the state’s energy  In the District overall, every industry  sector. The tightening labor markets in the  reported a year-over-year employment gain  rest of the District resulted in firms reporting  with the most jobs—72,300 (3.3 percent)—  upward pressure on labor costs and increased  added in the professional and business  difficulty finding qualified workers. An area of  services industry. The professional and  the economy with the most pronounced labor  business services industry was the largest con-  challenges was construction, where activity  tributor to the net job gain in North Carolina,  picked up in both residential and commercial  South Carolina, and Virginia. In both D.C. and  real estate. Reports on manufacturing and  Maryland, the industry was the second-largest  transportation were a little more mixed across  contributor behind leisure and hospitality. In  the year; some firms benefited from the lower  West Virginia, the professional and business  commodity prices and the appreciating dollar,  services industry contracted on a year-over-  although export activity declined. Retail and  year basis, as did most industries in that state.  non-retail service sector firms continued to  The unemployment rate in the Fifth  experience improved sales to a generally  District declined from 5.6 percent to 5.1  more confident consumer.  percent in 2015, closely mirroring the improvement in the national rate that  Labor Markets  28  declined from 5.6 percent to 5.0 percent over the year. Unemployment rates declined  Labor markets in the Fifth District generally  in every District jurisdiction over the year.  strengthened over the year. Total employment  The largest improvement occurred in  in the District grew 2.0 percent (284,000  South Carolina, where the rate fell 1.1 per-  jobs) in 2015 as every jurisdiction except West  centage points to 5.5 percent. The District  Virginia added jobs. South Carolina reported  of Columbia ended 2015 with the highest  the largest year-over-year growth in the  unemployment rate in the Fifth District,  District of 2.8 percent, which outpaced the  despite decreasing 0.9 percentage point  national rate of 2.0 percent. Job growth in  over the year. Meanwhile, the labor force in  North Carolina and Virginia met or exceeded  the District rose steadily over the course of  the national expansion, while the District of  2015 but grew more slowly than the civilian  Columbia and Maryland posted slower growth  population and, as a result, the labor force  (1.0 percent and 1.6 percent, respectively). In  participation rate declined from 62.6 percent  West Virginia, employment declined; the most  to 62.5 percent.  2015 ANNUAL REPORT  Employment Growth by Industry Percent Change from 2014  2.0 2.0  Total  2.2  Natural Resources & Construction 0.2  Manufacturing  2.7  1.0 1.7  Trade, Transportation & Utilities  2.3  1.1  Information  0.1  Every industry in the Fifth District reported a year-over-year employment gain in December 2015, led by 3.7 percent growth in the leisure and hospitality industry.  1.9  Financial Activities  1.7 3.2 3.3  Professional & Business Services Educational & Health Services  3.2  1.9 3.0  Leisure & Hospitality 1.2  Other Services Government  0.2  2.4  United States Fifth District  0.4  0  3.7  1  2  3  4  Year-Over-Year Percent Change, Seasonally Adjusted Source: Bureau of Labor Statistics, Haver Analytics  Anecdotes from across the Fifth District  Business Conditions  indicated a tightening labor market, with cer-  Reports on manufacturing activity were  tain exceptions such as coal mining in West  mixed during 2015. The Federal Reserve  Virginia. Demand for workers at all skill levels  Bank of Richmond maintains a composite  reportedly expanded in 2015, particularly  manufacturing index based on the Bank’s  in information technology, manufacturing,  Fifth District Survey of Manufacturing  and construction. Certain occupations were  Activity. It is a diffusion index, meaning that  also cited regularly throughout the year,  a positive reading indicates that the share of  including: health care workers, engineers,  firms reporting expansion exceeds the share  truck drivers, accountants, and hospital-  of firms reporting contraction. The diffusion  ity workers. Over the course of the year,  index spent most of the year close to zero,  the accounts of upward wage pressures  although the summer months were a bit  increased, particularly for those positions  stronger. Toward the end of the year, not only  that were in the most demand.  did the index indicate slowing activity, but  FEDERAL RESERVE BANK OF RICHMOND  29  several manufacturers commented that slow-  District. This trend could be manifesting itself  ing global demand and the appreciating dollar  in the softer readings for the November and  had negatively impacted business activity.  December shopper traffic index.  That sentiment was not expressed universally,  Non-retail services firms reported steady  however, as other manufacturers indicated a  improvements over the year. The survey  pickup in activity over the same period, partic-  measure of revenues for those businesses  ularly manufacturers of metals, automobiles,  remained above zero throughout the year,  and auto parts. Further, in every month of the  with particularly high index values in July and  year, the survey measure of raw materials price  August. Anecdotes from services firms during  growth was lower than in the same month of  those months indicated a boost from tourism  2014, which was consistent with persistent  as well as strength in software, transportation,  reports of low commodity prices from man-  and temporary employment services. Similar  ufacturing contacts. The survey’s index for  to retail firms, non-retail services experienced  number of employees and the index for wages  a slowdown in the last two months of the year.  were consistently positive in 2015.  There were a few comments about sluggish  Data on Fifth District port activity were consistent with the reports of slowing exports of manufactured goods. Export activity out  activity in wholesale trade, real estate services and construction, legal services, and tourism. Like the manufacturing sector, the survey  of the Charleston, S.C., port, for example,  measures of employment and wages also indi-  started the year strong but slowed some in  cated continued improvement in the service  the fall and winter months. In fact, District  sector. The non-retail services employment  exports of most goods categories declined  index maintained a value well above zero for  from the prior year, with the notable exception  the majority of the year, while the retail index  of transportation equipment, which includes  started the year strong, although it dipped  automobile and aerospace vehicles and  below zero a few times in 2015, commonly  parts. The Norfolk, Va., port reported export  during the fall months. The indexes for wages  declines beginning in the spring of 2015 and  were consistently positive throughout the  the Baltimore, Md., port continued to report  year. Moreover, the retail index for wages hit a  declining exports. Import activity, on the other  10-year peak in October 2015.  hand, grew fairly steadily over the year across Fifth District ports. According to the Federal Reserve Bank of  30  Real Estate  Richmond Service Sector Survey, retail activity  In 2015, Fifth District housing markets con-  strengthened throughout most of the year. The  tinued the slow and steady improvement  survey index for retail revenues was relatively  that has characterized the industry for a few  high by historical standards until the last two  years. According to CoreLogic Information  months of the year. On the other hand, com-  Solutions, District house prices grew 2.8  ments from retailers in the District indicated  percent over the course of the year. Home  a continued trend toward online shopping,  values appreciated in every District juris-  particularly around the holidays, which nega-  diction except Maryland, with the strongest  tively affected brick-and-mortar retailers in the  growth coming from the 6.6 percent price  2015 ANNUAL REPORT  Ten Largest Fifth District Export Categories in 2015 Percent Change from 2014  Transportation equipment Chemicals Machinery Computers & electronic products  Export levels for all of the largest categories were down compared to 2014 levels except for transportation equipment, which was up 8.2 percent from the prior year.  Plastics & rubber products Electronic equipment, appliances & components Food Paper Textile mills Fabricated metal products -20.0%  -15.0%  -10.0%  -5.0%  0.0%  5.0%  10.0%  Source: The Census Bureau via WISER, Haver Analytics  growth in South Carolina. In the second half  strengthened as well, with several comments  of 2015, North Carolina’s house price index  citing continued expansion in multifamily  exceeded its pre-recession high, becoming  construction. Permitting activity, although  the second jurisdiction in the Fifth District to  volatile, generally supported the anecdotal  do so (D.C. crossed that threshold in January  information. The total number of housing per-  2013). Reports from real estate agents gen-  mits issued in 2015 exceeded the prior year by  erally noted rising home sales and prices,  5.5 percent. Permits for single-family homes,  reduced days on market, and low inventory  which account for about 70 percent of total  levels. One exception was Maryland, where  permits in the Fifth District, grew 7.1 percent  many contacts still reported sluggish activity.  while multifamily permitting grew 2.0 percent.  Meanwhile, distressed inventory levels shrank  Commercial real estate activity varied  as the number of mortgages in foreclosure or  by location but generally expanded in 2015  with payments more than 90 days late con-  as well. Particular strength was noted in the  tinued to decline in 2015 across the District.  construction of multifamily housing, indus-  Residential construction activity picked  trial space (particularly data centers and  up in 2015 after many years of lagging the  warehouses), hotels, health care facilities, and  improvement in other housing indicators.  grocery-anchored retail projects. Reports  However, there were reports of constraints  from the office segment were more mixed,  on growth such as lot shortages, regulatory  with some mention of high inventory levels  delays, and difficulty finding construc-  and a decreased need for square footage,  tion workers. Activity in rental markets  while other markets reported rising rents and  FEDERAL RESERVE BANK OF RICHMOND  31  increased absorption. Similarly to residen-  the commercial and industrial (9.6 percent)  tial construction, builders noted increased  and construction and development (8.8 per-  difficulty finding labor, which drove up costs  cent) loan segments had the highest median  in some areas.  year-over-year growth rates. The District’s largest balance sheet concentration, in terms  Banking Conditions  of capital, remained in commercial real estate. In conjunction with growing loan portfo-  Despite the challenges of adapting to an  lios, credit quality also improved. Fifth District  evolving banking environment, Fifth District  credit quality indicators improved with  banks continued to grow during 2015 while  banks’ median ratio of nonperforming loans  exhibiting stable profitability and improving  as a percentage of total loans at 1.0 percent,  credit quality.  declining to their lowest level since 2008,  Though the challenges of a continued  with improvements centered in the real estate  low-rate environment and costs associated  sector. Improvements in credit quality allowed  with technological innovations and new regu-  provision levels to fall to their lowest in over a  latory requirements has inhibited widespread  decade, with 15 percent of Fifth District banks  profitability from rebounding back to pre-fi-  reporting negative provisions, providing a  nancial crisis levels, Fifth District earnings  boost to earnings.  over the course of 2015 remained stable with median return on average assets (ROAAs) of 0.70 percent. Despite the low interest rate  Conclusion  environment weighing on banks’ net interest  Overall, economic activity in the District  margins, a little over half of the District banks  strengthened in 2015. Labor markets con-  showed improving ROAAs year over year.  tinued to tighten, retail and non-retail  Overall, 92.7 percent of Fifth District banks  services firms indicated improved activity,  were profitable at year-end 2015. Retained  and residential and commercial real estate  earnings contributed to capital growth, which  activity—including construction—expanded.  increased year over year by 4.6 percent.  As was the case across much of the country,  In response to environmental challenges,  the strongest headwind came in the form of  some banks across the nation and in the Fifth  slowing global demand that most notably  District chose alternative strategies to boost  impacted the manufacturing and transporta-  earnings and growth by adding more risk to  tion sectors. Low energy prices were also a  the balance sheet and/or engaging in merger  challenge for certain firms in manufacturing  and acquisition activity. As of fourth quarter  and transportation; in the Fifth District, the  2015, Fifth District banks grew both organi-  slowdown in energy-related activity man-  cally and through mergers and acquisitions  ifested itself primarily through softening  at a median asset growth pace of 4.5 per-  economic indicators for West Virginia.  cent. This asset growth consisted mainly of loan growth. Median loan growth in the Fifth District and the nation stood at 5.9 percent and 6.3 percent, respectively. In the District,  32  2015 ANNUAL REPORT  Economic (nonbanking) data accurate as of March 14, 2016.  Boards, Councils, Officers, and Senior Professionals  Federal Reserve Bank of Richmond Board of Directors. . . . . . . . . . . . . . .    35  Baltimore Branch Board of Directors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    36  Charlotte Branch Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    37  . . . . . . . . . . . . . . .  38  Community Depository Institutions Advisory Council.  Community Investment Council. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    39  Payments Advisory Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    40  Management Committee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	42 Officers and Senior Professionals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	43 Federal Reserve Information Technology (FRIT) Management Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    44  FRIT Officers and Senior Professionals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    45  FEDERAL RESERVE BANK OF RICHMOND  33  FEDERAL RESERVE BANK OF RICHMOND BOARD OF DIRECTORS  COMMUNITY DEPOSITORY INSTITUTIONS ADVISORY COUNCIL  The Bank’s board of directors oversees management of the Bank and its Fifth District offices, provides timely business and economic information, participates in the formulation of national monetary and credit policies, and serves as a link between the Federal Reserve System and the private sector. Six directors are elected by banks in the Fifth District that are members of the Federal Reserve System, and three are appointed by the Board of Governors. Directors who are not bankers appoint the Bank’s president and first vice president with approval from the Board of Governors. The Bank’s board of directors annually appoints the Fifth District’s representative to the Federal Advisory Council, which consists of one member from each of the 12 Federal Reserve Districts. The council meets four times a year with the Board of Governors to consult on business conditions and issues related to the banking industry.  Created in 2011, the Bank’s Community Depository Institutions Advisory Council advises the Bank’s management and the Board of Governors on the economy, lending conditions, and other issues from the perspective of banks, thrifts, and credit unions with total assets under $10 billion. The council’s members are appointed by the Bank’s president.  BALTIMORE AND CHARLOTTE BRANCHES BOARDS OF DIRECTORS The Bank’s Baltimore and Charlotte branches have separate boards that oversee operations at their respective locations and, like the Richmond Board, contribute to policymaking and provide timely business and economic information about the District. Four directors on each of these boards are appointed by the Richmond directors, and three are appointed by the Board of Governors.  COMMUNITY INVESTMENT COUNCIL Established in 2011, the Community Investment Council advises the Bank’s management about emerging issues and trends in communities across the Fifth District, including low- and moderate-income neighborhoods in urban and rural areas. The council’s members are appointed by the Bank’s president. PAYMENTS ADVISORY COUNCIL Created in 1978, the Payments Advisory Council serves as a forum for communication with financial institutions about financial services provided by the Federal Reserve. The council helps the Bank respond to the evolving needs of its banking constituency. Council members are appointed by the Bank’s first vice president.  Listings of boards and councils include members and titles as of December 31, 2015, unless otherwise noted.  THANK YOU Thank you to those directors who have completed their service: Wilbur E. Johnson and Brad E. Schwartz of the Richmond Board; Anita G. Newcomb and Stephen R. Sleigh of the Baltimore Board; and Robert R. Hill, Jr., and Lucia Z. Griffith of the Charlotte Board. The Bank also welcomes five new directors: Catherine A. Meloy and Susan K. Still have joined the Richmond Board; Kenneth R. Banks and Laura L. Gamble have joined the Baltimore Board; and Deborah Aguiar-Vélez has joined the Charlotte Board.  34  2015 ANNUAL REPORT  Board of Directors, Federal Reserve Bank of Richmond  First row, from the left: C. Richard Miller, Charles R. Patton, Margaret G. Lewis Second row: Kathy J. Warden, Russell C. Lindner, Robert R. Hill, Jr., Brad E. Schwartz, Thomas C. Nelson, Wilbur E. Johnson  CHAIRMAN  Russell C. Lindner  Executive Chairman and Chief Executive Officer The Forge Company Washington, D.C. DEPUTY CHAIRMAN  Margaret G. Lewis Retired President HCA Capital Division Richmond, Virginia  Robert R. Hill, Jr.  Chief Executive Officer South State Corporation and South State Bank Columbia, South Carolina  Wilbur E. Johnson  Managing Partner Young Clement Rivers, LLP Charleston, South Carolina  C. Richard Miller, Jr.  President and Chief Executive Officer Woodsboro Bank Woodsboro, Maryland  Kathy J. Warden  Corporate Vice President and President, Information Systems Northrop Grumman Corporation McLean, Virginia  Thomas C. Nelson  Chairman, President, and Chief Operating Officer National Gypsum Company Charlotte, North Carolina  Charles R. Patton  President and Chief Operating Officer Appalachian Power Company Charleston, West Virginia  FEDERAL ADVISORY COUNCIL REPRESENTATIVE  Kelly S. King  Chairman and Chief Executive Officer BB&T Corporation Winston-Salem, North Carolina  Brad E. Schwartz  Chief Executive Officer Monarch Financial Holdings, Inc. and Monarch Bank Chesapeake, Virginia  FEDERAL RESERVE BANK OF RICHMOND  35  Board of Directors, Baltimore Branch  First row, from the left: Mary Ann Scully, Austin J. Slater, Jr. Second row: Christopher J. Estes, Samuel L. Ross, Anita G. Newcomb, Susan J. Ganz Not pictured: Stephen R. Sleigh CHAIRMAN  Samuel L. Ross  Anita G. Newcomb  Christopher J. Estes  Mary Ann Scully  Chief Executive Officer Bon Secours Baltimore Health System Baltimore, Maryland  President and Chief Executive Officer National Housing Conference Washington, D.C.  Susan J. Ganz  Chief Executive Officer Lion Brothers Company, Inc. Owings Mills, Maryland  36  2015 ANNUAL REPORT  President A.G. Newcomb & Company Columbia, Maryland  Chairman, President, and Chief Executive Officer Howard Bancorp Ellicott City, Maryland  Austin J. Slater, Jr.  Chief Executive Officer Southern Maryland Electric Cooperative, Inc. Hughesville, Maryland  Stephen R. Sleigh Chief Executive Officer Sleigh Strategy, LLC Chevy Chase, Maryland  Board of Directors, Charlotte Branch  First row, from the left: Laura Y. Clark, Lucia Z. Griffith Second row: Elizabeth A. Fleming, Claude Z. Demby, Mark L. Williamson, Paul E. Szurek Not pictured: Michael C. Crapps CHAIRMAN  Elizabeth A. Fleming  President Converse College Spartanburg, South Carolina  Laura Y. Clark  Executive Director Renaissance West Community Initiative Charlotte, North Carolina  Claude Z. Demby  Vice President of Business Development Cree, Inc. Durham, North Carolina  Lucia Z. Griffith  Chief Executive Officer and Principal METROLandmarks Charlotte, North Carolina  Paul E. Szurek  Chief Financial Officer Biltmore Farms, LLC Asheville, North Carolina  Mark L. Williamson  President and Chief Executive Officer High Point Bank and Trust High Point, North Carolina  Michael C. Crapps  President and Chief Executive Officer First Community Bank Lexington, South Carolina  FEDERAL RESERVE BANK OF RICHMOND  37  Community Depository Institutions Advisory Council  From the left: Jan Roche, David Morrow, Robert A. DeAlmeida, Charles H. Majors, Michael L. Middleton, R. Arthur Seaver, Judy Tharp, Michael Walker  CHAIRMAN  Jan Roche*  Suzanne S. DeFerie  VICE CHAIRMAN  Michael P. Fitzgerald  President and Chief Executive Officer State Department Federal Credit Union Alexandria, Virginia  Michael L. Middleton  President and Chief Executive Officer Asheville Savings Bank and ASB Bancorp, Inc. Asheville, North Carolina  Chairman and Chief Executive Officer Community Bank of the Chesapeake Waldorf, Maryland  Chairman, President, and Chief Executive Officer Bank of Georgetown Washington, D.C.  Michael C. Crapps  Charles H. Majors  President and Chief Executive Officer First Community Bank Lexington, South Carolina  Robert A. DeAlmeida  President and Chief Executive Officer Hamilton Bank and Hamilton Bancorp, Inc. Towson, Maryland  Chairman and Chief Executive Officer American National Bank and American National Bankshares, Inc. Danville, Virginia  David Morrow  President and Chief Executive Officer CresCom Bank Charleston, South Carolina  R. Arthur Seaver  Chief Executive Officer Southern First Bank Greenville, South Carolina  Judy Tharp  President and Chief Executive Officer Piedmont Advantage Credit Union Winston-Salem, North Carolina  Brian Thomas  President and Chief Executive Officer Clear Mountain Bank Bruceton Mills, West Virginia  Michael Walker  President and Chief Executive Officer Benchmark Community Bank Kenbridge, Virginia  Frank W. Wilkinson  President and Chief Executive Officer First Century Bank Bluefield, West Virginia  *	In 2015, Jan Roche served as the Fifth District’s representative on the Community Depository Institutions Advisory Council at the Federal Reserve’s Board of Governors.  38  2015 ANNUAL REPORT  Community Investment Council  From the left: Charles Martin, Deborah Hooper, George Rothman, Mary Hunt, Earl Gohl, MaryAnn Black, Kent Spellman, Paul Phillips  CHAIRMAN  Mary Hunt  Senior Program Officer The Claude Worthington Benedum Foundation Pittsburgh, Pennsylvania  Tammy Besherse  Attorney South Carolina Appleseed Legal Justice Center Columbia, South Carolina  MaryAnn Black  Associate Vice President Office of Community and Government Local Relations Duke University Health System Durham, North Caolina  Tamea L. Franco  President and Chief Executive Officer Global Metal Finishing, Inc. Roanoke, Virginia  Earl Gohl  Paul Phillips  John Hamilton  George Rothman  Deborah Hooper  Kent Spellman  Charles Martin  Michel Zajur  Federal Co-Chair Appalachian Regional Commission Washington, D.C.  President and Chief Executive Officer Freedom First Federal Credit Union Roanoke, Virginia  President City First Enterprises Washington, D.C.  President and Chief Executive Officer Manna, Inc. Washington, D.C.  Chief Operating Officer Greensboro Partnership Greensboro, North Carolina  Executive Director WV Community Development Hub Stonewood, West Virginia  Administrative Vice President, Regional Community Reinvestment Officer M&T Bank Baltimore, Maryland  President and Chief Executive Officer Virginia Hispanic Chamber of Commerce Richmond, Virginia  FEDERAL RESERVE BANK OF RICHMOND  39  Payments Advisory Council  From the left: Steve Shuford, Tina Giorgio, E. Stephen Lilly, Martin W. Patterson, Terry Garner, Peter Davey, Karen Buck  CHAIRMAN  E. Stephen Lilly  Mitch Christensen  William E. Albert  R. Lee Clark  Executive Vice President, Operations TowneBank Suffolk, Virginia  Chief Information Officer and Executive Vice President, Operations Yadkin Bank Statesville, North Carolina  Ronald L. Bowling  John Kevin Cranford  Rodney Epps  Executive Vice President and Chief Operating Officer First Community Bancshares, Inc. Bluefield, Virginia  Senior Vice President First Century Bank Bluefield, West Virginia  President and Chief Executive Officer First Peoples Bank Mullens, West Virginia  Karen Buck  Head, Commercial and Payment Operations TD Bank Mount Laurel, New Jersey  Kim L. Bunn  Senior Vice President and Operations Executive Bank of America Jacksonville, Florida  Executive Vice President, Innovation and Payments Strategy Wells Fargo and Company Scottsdale, Arizona  Senior Vice President Branch Banking and Trust Charlotte, North Carolina  Robert E. Dael  Jeff W. Dick  President and Chief Executive Officer MainStreet Bank Fairfax, Virginia  Kristi A. Eller  Senior Vice President and Chief Operating Officer Industrial Bank of Washington Washington, D.C.  President and Chief Executive Officer MACHA — The Mid-Atlantic Payments Association Hanover, Maryland  Terry Garner  Peter Davey  Tina Giorgio  Vice President and Director, Enterprise Payments CapitalOne Bank Richmond, Virginia  Senior Vice President, Deposit Operations Southern First Bank Greenville, South Carolina  Senior Vice President Sandy Spring Bank Columbia, Maryland  Leton L. Harding, Jr.  Chief Executive Officer Powell Valley National Bank Wise, Virginia  40  2015 ANNUAL REPORT  Payments Advisory Council (continued)  From the left: Gayle Youngblood, John Kevin Cranford, Steve Stone, Jeff W. Dick, Woody Shuler, Kristi A. Eller, Jamin M. Hujik  Chad Harmon  Senior Vice President and Operations Manager South State Bank Orangeburg, South Carolina  Jamin M. Hujik  Rick Rhoads  Senior Vice President, E-Services State Employees’ Credit Union Raleigh, North Carolina  Susan G. Riel  Chris Tolomeo  Senior Vice President, Banking Services M&T Bank Amherst, New York  Executive Vice President CresCom Bank Charleston, South Carolina  Senior Executive Vice President and Chief Operating Officer EagleBank Bethesda, Maryland  Paul Trozzo  Scott Jennings  Steve Shuford  Samuel A. Vallandingham  Adrian S. Johnson  Woody Shuler  Senior Vice President and Chief Operating Officer Summit Community Bank Moorefield, West Virginia  Senior Vice President and Chief Financial Officer MECU of Baltimore, Inc. Baltimore, Maryland  Martin W. Patterson Senior Vice President, Banking Operations SunTrust Banks, Inc. Richmond, Virginia  Senior Vice President, Director of Treasury Management Paragon Bank Raleigh, North Carolina  Senior Vice President PNC Bank Pittsburgh, Pennsylvania  President The First State Bank Barboursville, West Virginia  David Willis  Vice President, Finance SRP Federal Credit Union North Augusta, South Carolina  Senior Vice President, Debit Card and Funds Services Navy Federal Credit Union Vienna, Virginia  Steve Stone  Gayle Youngblood  Executive Vice President United Bank Charleston, West Virginia  Note: The council’s membership year runs from June 1 to May 31, but this listing includes all members who served during 2015.  Assistant Vice President, Product Management State Employees Credit Union of Maryland Linthicum, Maryland  FEDERAL RESERVE BANK OF RICHMOND  41  Management Committee  From the left: Matthew A. Martin, Becky C. Bareford, Jennifer J. Burns, Mark L. Mullinix, Roland Costa, Janice E. Clatterbuck, Michael D. Stough, Jeffrey M. Lacker, Michelle H. Gluck, Kartik B. Athreya, David E. Beck  Jeffrey M. Lacker President  Mark L. Mullinix  First Vice President and Chief Operating Officer  Kartik B. Athreya  Executive Vice President and Director of Research  Becky C. Bareford  Senior Vice President, Human Resources and Finance  42  2015 ANNUAL REPORT  David E. Beck  Senior Vice President and Baltimore Regional Executive  Jennifer J. Burns  Executive Vice President, Supervision, Regulation, and Credit  Janice E. Clatterbuck Senior Vice President and Chief Information Officer  Roland Costa  Senior Vice President and Chief Technology Officer, Currency Technology  Michelle H. Gluck  Executive Vice President, General Counsel, and Chief Risk Officer  Matthew A. Martin  Senior Vice President and Charlotte Regional Executive  Michael D. Stough  Senior Vice President and General Auditor  Officers John A. Weinberg Senior Vice President and Special Advisor to the President Huberto M. Ennis Group Vice President Thomas A. Lubik Group Vice President Lisa T. Oliva Group Vice President Michael L. Wilder Group Vice President and Chief Financial Officer Hattie R.C. Barley Vice President Christy R. Cleare Vice President Todd E. Dixon Vice President Kevin W. Fergusson Vice President and Medical Director Joan T. Garton Vice President Richard B. Gilbert Vice President Rebecca Goldberg Vice President Howard S. Goldfine Vice President Anne C. Gossweiler Vice President Bruce E. Grinnell Vice President Chad K. Harper Vice President Mattison W. Harris Vice President Kathleen R. Houghtaling Vice President Cathy I. Howdyshell Vice President Gregory A. Johnson Vice President Malissa M. Ladd Vice President Rongerlis C. Levine Vice President Ann B. Macheras Vice President Andrew S. McAllister Vice President Diane H. McDorman Vice President James T. Nowlin Vice President  Senior Professionals P.A.L. Nunley Deputy General Counsel  Bennie R. Moore Assistant Vice President  RESEARCH  Kerri R. O’RourkeRobinson Vice President  Cheryl R. Moore Assistant Vice President  Borys M. Grochulski Senior Economist  Johnnie E. Moore Assistant Vice President  Robert L. Hetzel Senior Economist and Research Advisor  Alexander L. Wolman Vice President Ronald G. Barnes Assistant Vice President Niranjan Chandramowli Assistant Vice President Cary B. Crabtree Assistant Vice President Bary M. Dalton Assistant Vice President Jeffrey B. Deibel Assistant Vice President Jacqueline R. Draper Assistant Vice President Adam M. Drimer Assistant Vice President Kimberley D. Fuller Assistant Vice President Jeffrey R. Gerlach Assistant Vice President Keith R.G. Goodwin Assistant General Counsel Jennifer J. Hall Assistant General Counsel Ann S. Harrison Assistant Vice President James R. Hart Assistant Vice President John S. Insley, Jr. Assistant Vice President Pinkaj R. Klokkenga Assistant Vice President Diane R. Knapp Assistant Vice President  Dennis H. Ott, Jr. Assistant Vice President Christopher J. Palumbo Assistant Vice President Patricia A. Perry Assistant Vice President Melanie M. Rose Assistant Vice President Jason C. Schemmel Assistant Vice President Michael J. Seifert Assistant Vice President Brent M. Stanton Assistant Vice President Markus A. Summers Assistant Vice President Alexander T. Swartz Assistant Vice President  Steve V. Malone Assistant Vice President Randal C. Manspile Assistant Vice President Page W. Marchetti Assistant Vice President and Corporate Secretary Jonathan P. Martin Assistant Vice President Laura H. Mayer Assistant Vice President  Raymond E. Owens, III Senior Economist and Policy Advisor Gary Richardson Federal Reserve System Historian Pierre-Daniel G. Sarte Senior Advisor John R. Walter Senior Economist and Policy Advisor Zhu Wang Senior Economist Roy H. Webb Senior Economist and Policy Advisor  Sandra L. Tormoen Assistant Vice President James Trotta Assistant Vice President Lauren E. Ware Assistant Vice President H. Julie Yoo Assistant Vice President  BALTIMORE BRANCH  Steven T. Bareford Assistant Vice President  SUPERVISION, REGULATION, AND CREDIT  Eliana Balla Lead Financial Economist Craig S. Edwards Large Bank Principal Examiner D. Keith Maglinger Large Bank Principal Examiner Nada Mora Senior Financial Economist Hemangini R. Parekh Large Bank Principal Examiner  D. Keith Larkin Assistant Vice President Dan C. Lewis Assistant Vice President  Andreas L. Hornstein Senior Advisor  CHARLOTTE BRANCH  Stanley F. Poszywak Risk and Policy Team Leader  Lisa A. White Senior Vice President  Todd M. Ryan Risk and Policy Team Leader  Terry J. Wright Group Vice President, Operations  Steven D. Sanderford Large Bank Principal Examiner  Jeremy B. Caldwell Vice President Richard F. Westerkamp, Jr. Vice President Joshua R. Daulton Assistant Vice President Kelly J. Stewart Assistant Vice President  Phillip C. Watts Large Complex Banking Organization Central Point of Contact  Listings include officers, senior professionals, and titles as of December 31, 2015.  FEDERAL RESERVE BANK OF RICHMOND  43  Federal Reserve Information Technology (FRIT) Management Council  From the left: Christopher A. Tignor, Kathryn K. Smith, Matthew D. Larson, Robert I. Turner, Scott C. Furman, Lyn McDermid, David N. Alfano, Paul M. Maguire  Lyn McDermid  System Chief Information Officer  David N. Alfano  Senior Vice President and Chief Administrative Officer  Scott C. Furman  Senior Vice President, Treasury Services  44  2015 ANNUAL REPORT  Matthew D. Larson Senior Vice President, End User Services  Paul M. Maguire  Senior Vice President and Chief Technology Officer  Kathryn K. Smith  Senior Vice President and PMO Director  Christopher A. Tignor  Senior Vice President and Interim Chief Information Security Officer  Robert I. Turner  Senior Vice President and Chief Operating Officer  Federal Reserve Information Technology (FRIT) Officers  Senior Professionals  Jessie A. Bowen Senior Vice President  Carie L. Kelleher Vice President  Lisa H. Gravely Assistant Vice President  Jeffrey F. Crow Senior Vice President  S. Craig Minyard Vice President  Gary A. Helfrich Assistant Vice President  Donovan O. Harper, II Senior Vice President  Mahnaz Moosa Vice President  M. Polly Helm Assistant Vice President  Andy T. Hendrickson Senior Vice President  A. Vinton Myers, III Vice President  Peter B. Holleran Assistant Vice President  Gerald L. Moreno Senior Vice President  Gary M. Patton Vice President  M. Brannon Howle Assistant Vice President  Brian K. Murray Senior Vice President  R. Nathan Ragan Vice President  Bradley M. Joiner Assistant Vice President  Nicole E. Bennett Vice President  Victoria F. Riendeau Vice President  John T. Lines Assistant Vice President  Jane Y. Burk Vice President  Joyce M. Romito Vice President  Keith A. Malatesta Assistant Vice President  Gerry P. Collins Vice President  Joshua N. Snell Vice President  Garland H. McKenzie Assistant Vice President  Michael E. Cortese Vice President  Sherri L. Thorne Vice President  Ellen D. Mitchell Assistant Vice President  Kevin J. Craig Vice President  Jeannie L. Willette Vice President  James O’Connell Assistant Vice President  Albert M. D’Avanzo Vice President  Abigail T. Baker Assistant Vice President  Arthur J. Papa Assistant Vice President  Fay T. Donahue Vice President  Michael L. Bellanti Assistant Vice President  Heidi R. Patterson Assistant Vice President  Frank J. Doto Vice President  Cynthia S. Bullington Assistant Vice President  Irina V. Piven Assistant Vice President  Valerie A. Freund Vice President  Melissa E. Butler Assistant Vice President  Kevin A. Reed Assistant Vice President  Mark A. Hamilton Vice President  Reginal L. Bryant Assistant Vice President  Douglas R. Sampson Assistant Vice President  Kristopher K. Hogan Vice President  James A. Caulfield Assistant Vice President  Stephanie T. Shetterly Assistant Vice President  Christine M. Holzem Vice President  William C. Conway, II Assistant Vice President  Hunter R. Shomo Assistant Vice President  Tamera S. Hornsby-Fink Vice President  John F. Crabtree Assistant Vice President  Christopher T. Szymonik Assistant Vice President  Frederick B. Johnson Vice President  Michael S. Everett Assistant Vice President  Thomas J. Weber Assistant Vice President  Elise P. Ott Chief Application Integration Engineer Michael T. Shaughnessy Chief Application Integration Engineer Ian W. Beirnes Treasury Services Architect Jeffery S. Borneman Business Architect Pedro E. Fong Business Architect Devin D. Gordon Business Architect M. Scott Hannah Business Architect Robert B. Klank Business Architect Darren L. Knutson Business Architect Donald H. Larmee Business Architect Poorav K. Shah Business Architect  William H. Fenerty Assistant Vice President  Listings include officers, senior professionals, and titles as of December 31, 2015.  FEDERAL RESERVE BANK OF RICHMOND  45  46  2015 ANNUAL REPORT  Financial Statements  Statement of Auditor Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	48 Management’s Report on Internal Control Over Financial Reporting. . . . . 	49 Independent Auditors’ Report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	50 Financial Statements Statements of Condition as of December 31, 2015, and December 31, 2014. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	52 Statements of Income and Comprehensive Income for the years ended December 31, 2015, and December 31, 2014. . . . . . . . . . . . 	53 Statements of Changes in Capital for the years ended December 31, 2015, and December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . 	54 Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 	55  FEDERAL RESERVE BANK OF RICHMOND  47  N O T E S T O F I N A N C I A L S TAT E M E N T S  Statement of Auditor Independence The Federal Reserve Board engaged KPMG to audit the 2015 combined and individual financial statements of the Reserve Banks and Maiden Lane LLC.1 In 2015, KPMG also conducted audits of internal controls over financial reporting for each of the Reserve Banks. Fees for KPMG services totaled $6.7 million, of which $0.4 million was for the audit of Maiden Lane LLC. To ensure auditor independence, the Board requires that KPMG be independent in all matters relating to the audits. Specifically, KPMG 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 2015, the Bank did not engage KPMG for any non-audit services.  1  48  In addition, KPMG 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, the OEB, and the Consumer Financial Protection Bureau.  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  Management’s Report Management’s Report on Internal Control Over Financial Reporting March 8, 2016 To the Board of Directors: The management of the Federal Reserve Bank of Richmond (Bank) is responsible for the preparation and fair presentation of the Statements of Condition as of December 31, 2015 and 2014, and the Statements of Income and Comprehensive Income, and Statements of Changes in Capital for the years then ended (the financial statements). The financial statements have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System as set forth in the Financial Accounting Manual for Federal Reserve Banks (FAM), and, as such, include some amounts that are based on management judgments and estimates. To our knowledge, the financial statements are, in all material respects, fairly presented in conformity with the accounting principles, policies, and practices documented in the FAM and include all disclosures necessary for such fair presentation. The management of the Bank is responsible for establishing and maintaining effective internal control over financial reporting as it relates to the financial statements. The Bank’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with the FAM. The Bank’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Bank’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with FAM, and that the Bank’s receipts and expenditures are being made only in accordance with authorizations of its management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Bank’s assets that could have a material effect on its financial statements. Even effective internal control, no matter how well designed, has inherent limitations, including the possibility of human error, and therefore can provide only reasonable assurance with respect to the preparation of reliable financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The management of the Bank assessed its internal control over financial reporting based upon the criteria established in the Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, we believe that the Bank maintained effective internal control over financial reporting.  Federal Reserve Bank of Richmond   Jeffrey M. Lacker  President   Mark L. Mullinix First Vice President and Chief Operating Officer  Michael L. Wilder Group Vice President and Chief Financial Officer  FEDERAL RESERVE BANK OF RICHMOND  49  N O T E S T O F I N A N C I A L S TAT E M E N T S  Independent Auditors’ Report To the Board of Governors of the Federal Reserve System and the Board of Directors of the Federal Reserve Bank of Richmond:  We have audited the accompanying statement of condition of the Federal Reserve Bank of Richmond (“FRB Richmond”) as of December 31, 2015, and the related statements of income and comprehensive income and changes in capital for the year then ended. We also have audited the FRB Richmond’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The FRB Richmond’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the FRB Richmond’s internal control over financial reporting based on our audit. The accompanying financial statements of the FRB Richmond as of December 31, 2014, and for the year then ended were audited by other auditors whose report thereon dated March 11, 2015, expressed an unmodified opinion on those financial statements and contained an emphasis of matter paragraph that described the FRB Richmond’s basis of accounting discussed in Note 3 to the 2014 financial statements. We conducted our audit of the financial statements in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”) and in accordance with auditing standards generally accepted in the United States of America. We conducted our audit of internal control over financial reporting in accordance with the auditing standards of the PCAOB and in accordance with attestation standards established by the American Institute of Certified Public Accountants. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. The FRB Richmond’s internal control over financial reporting is a process designed 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 of Governors of the Federal Reserve System (the “Board”) as described in Note 3 of the financial statements and as set forth in the Financial Accounting Manual for Federal Reserve Banks (“FAM”). The FRB Richmond’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  50  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  Independent Auditors’ Report  FRB Richmond; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the FAM, and that receipts and expenditures of the FRB Richmond are being made only in accordance with authorizations of management and directors of the FRB Richmond; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the FRB Richmond’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As described in Note 3 to the financial statements, the FRB Richmond has prepared these financial statements in conformity with the accounting principles established by the Board, as set forth in the FAM, which is a basis of accounting other than U.S. generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the FRB Richmond as of December 31, 2015, and the results of its operations for the year then ended, on the basis of accounting described in Note 3. Also, in our opinion, the FRB Richmond maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  KPMG LLP Richmond, VA March 8, 2016  FEDERAL RESERVE BANK OF RICHMOND  51  N O T E S T O F I N A N C I A L S TAT E M E N T S  Statements of Condition (in millions) As of December 31,  2015  2014  Assets Gold certificates  $   783  $   824  Special drawing rights certificates  412  412  Coin  301  307  —  1  140,166  145,106  1,833  2,235  97,789  99,993  4,490  4,358  229  319  1,392  1,446  1  2  Loans   Note 4  System Open Market Account:   Note 5  	Treasury securities, net (of which $1,030 and $623 is lent as of December 31, 2015 and 2014, respectively) 	Government-sponsored enterprise debt securities, net (of which $8 and $35 is lent as of December 31, 2015 and 2014, respectively) 	Federal agency and government-sponsored enterprise mortgage-backed securities, net 	Foreign currency denominated investments, net 	Central bank liquidity swaps 	Accrued interest receivable 	Other assets  342  349  29,869  —  Other assets  115  115  Total assets  $  277,722  $  255,467  $  95,659  $  91,935  38,693  28,495  28  46  133,840  118,097  140  100  16  6  303  308  183  28  Interdistrict settlement account  —  3,289  Other liabilities  48  49  Total liabilities  268,910  242,353  Capital paid-in Surplus (including accumulated other comprehensive loss of $29 and $52 at December 31, 2015 and 2014, respectively)  6,582  6,557  2,230  6,557  Total capital  8,812  13,114  $  277,722  $  255,467  Bank premises and equipment, net   Note 6  Interdistrict settlement account  Liabilities and Capital Federal Reserve notes outstanding, net System Open Market Account:   Note 5  	Securities sold under agreements to repurchase 	Other liabilities Deposits: 	Depository institutions 	Other deposits Interest payable to depository institutions Accrued benefit costs   Notes 8 and 9  Accrued remittances to the Treasury  Total liabilities and capital The accompanying notes are an integral part of these financial statements.  52  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  Statements of Income and Comprehensive Income (in millions) For the years ended December 31,  Interest income System Open Market Account:  	Treasury securities, net 	Government-sponsored enterprise debt securities, net 	Federal agency and government-sponsored enterprise mortgage-backed securities, net 	Foreign currency denominated investments, net Total interest income  2014  $  3,465 73  $  3,622 92  2,681 7 6,226  2,950 16 6,680  13  7  401 1 415 5,811  297 1 305 6,375  Note 5  Interest expense System Open Market Account:  	Securities sold under agreements to repurchase Deposits: 	Depository institutions 	Term Deposit Facility Total interest expense Net interest income  Note 5  Non-interest loss System Open Market Account:  	Federal agency and government-sponsored enterprise mortgage-backed securities gains, net 	Foreign currency translation losses, net 	Other Compensation received for service costs provided Reimbursable services to government agencies Other Total non-interest loss Operating expenses Salaries and benefits Occupancy Equipment Other Assessments: 	Board of Governors operating expenses and currency costs 	Bureau of Consumer Financial Protection Total operating expenses Net income before providing for remittances to the Treasury Earnings remittances to the Treasury:  	Interest on Federal Reserve notes 	Required by the Federal Reserve Act, as amended by the FAST Act  Total earnings remittances to the Treasury Net (loss) income after providing for remittances to the Treasury Change in prior service costs related to benefit plans  Change in actuarial losses related to benefit plans  Total other comprehensive income (loss)  2015  Note 5  2 (303) 1 17 42 4 (237)  5 (606) 1 15 50 3 (532)  434 50 78 (196)  422 50 73 (181)  225 111 702 4,872  187 116 667 5,176  4,112 4,715 8,827 (3,955) (3) 26 23  3,974 — 3,974 1,202 (4) (22) (26)  Note 12  Note 3n  Note 9 Note 9  Comprehensive (loss) income  $  (3,932)  $  1,176  The accompanying notes are an integral part of these financial statements.  FEDERAL RESERVE BANK OF RICHMOND  53  N O T E S T O F I N A N C I A L S TAT E M E N T S  Statements of Changes in Capital (in millions, except share data) Surplus For the years ended December 31, 2015, and December 31, 2014  Balance at December 31, 2013 (114,722,758 shares)  Capital paid-in  5,736  $  5,762  821  —  	Net income  —  1,202  	Other comprehensive loss  —  —  Net change in capital stock issued (16,418,000 shares)  $  Net income retained  Accumulated other comprehensive income (loss)  $   (26)  Total surplus  $  Total capital  5,736  $ 11,472  —  —  821  —  1,202  1,202  Comprehensive income:  Dividends on capital stock Net change in capital Balance at December 31, 2014 (131,140,758 shares) Net change in capital stock issued (494,935 shares)  —  (26)  (26)  (26)  (355)  —  (355)  821  847  (26)  821  1,642  $  6,557  $  6,609  (52)  $  6,557  $  13,114  25  —  —  25  $  —  (355)  Comprehensive income: 	Net loss  —  (3,955)  —  	Other comprehensive income  —  23  23  23  —  (395)  —  (395)  (395)  25  (4,350)  23  (4,327)  (4,302)  Balance at December 31, 2015 (131,635,693 shares)  $  6,582  $  2,259  $   (29)  The accompanying notes are an integral part of these financial statements.  54  (3,955)  Dividends on capital stock Net change in capital  —  (3,955)  2015 ANNUAL REPORT  $  2,230  $  8,812  N O T E S T O F I N A N C I A L S TAT E M E N T S  Notes to Financial Statements  1  	STRUCTURE  The Federal Reserve Bank of Richmond (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 Fifth Federal Reserve District, which includes Maryland, North Carolina, South Carolina, Virginia, District of Columbia, and portions of West Virginia. 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 nationally-chartered 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 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 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 be prepared 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  FEDERAL RESERVE BANK OF RICHMOND  55  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 FRBNY holds these securities and obligations in the SOMA. 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 U.S. dollar liquidity and reciprocal foreign currency 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. The FRBNY holds amounts outstanding under these swap lines in the SOMA. These swap lines, which were originally established as temporary arrangements, were converted to standing arrangements on October 31, 2013, and will remain in place 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 Standard Cash Automation, Currency Technology Office, the Payroll Central Business Administration Function, Daylight Overdraft Reporting and Pricing, and the National Procurement Office. Costs are, however, redistributed to the other Reserve Banks for computing and support services the Bank provides for the System. The Bank’s total reimbursement for these services was $367 million and $348 million for the years ended December 31, 2015 and 2014, respectively, and is included in “Operating expenses: Other” on the Statements of Income and Comprehensive Income.  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 and associated disclosures 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 differences are the presentation of all SOMA securities holdings at amortized cost, adjusted for credit impairment, if any, the recording of all SOMA securities on a settlement-date basis, and the use of straight-line amortization for Treasury securities, GSE debt securities, and foreign currency denominated investments. Amortized cost, rather than the fair value presentation, more appropriately reflects the financial position associated with 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  56  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 Bank’s 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. 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. The Reserve Banks reviewed the law and evaluated the design of and their relationship to the Bureau and determined that it should not 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 12 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.  FEDERAL RESERVE BANK OF RICHMOND  57  N O T E S T O F I N A N C I A L S TAT E M E N T S  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.  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 typically settled through a tri-party arrangement. In the United States, there are two commercial custodial banks that provide these services. In a tri-party arrangement, a commercial custodial bank manages the collateral clearing, settlement, pricing, and pledging, and provides 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, Separate Trading of Registered Interest and Principal of Securities Treasury securities, and Treasury Floating Rate Notes); 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 with primary dealers and with a set of expanded counterparties that includes banks, savings associations, GSEs, and domestic money market funds (Primary dealer and expanded counterparties reverse repurchase agreements). These reverse repurchase transactions are designed to have a margin of zero and 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, or 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 “System Open Market Account: Other liabilities” in the Statements of Condition.  58  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 “System Open Market Account: Treasury securities, net” and “System Open Market Account: Governmentsponsored enterprise debt securities, net,” as appropriate, in the Statements of Condition. Securities lending transactions are fully collateralized by Treasury securities based on the fair values of the securities lent increased by a margin determined by the FRBNY. The FRBNY charges the primary dealer a fee for borrowing securities, and these fees are reported as a component of “Non-interest loss: System Open Market Account: 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 GovernmentSponsored Enterprise Mortgage-Backed Securities, and Foreign Currency Denominated Investments Interest income on Treasury securities, GSE debt securities, and foreign currency denominated investments included in the SOMA is accrued using the straight-line method. 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, 2015 and 2014, the FRBNY executed dollar rolls to facilitate settlement of outstanding purchases of federal agency and GSE MBS. The FRBNY accounts for dollar rolls as individual purchases and sales, on a settlement-date basis. Accounting for these transactions as purchases and sales, rather than as financing transactions, is appropriate because the purchase or sale component of the MBS TBA dollar roll is paired off or assigned prior to settlement and, as a result, there is no transfer and return of securities. The FRBNY also conducts small-value exercises from time to time for the purpose of testing operational readiness. Small-value exercises may include sales of federal agency and GSE MBS. Net gains resulting from MBS transactions are reported as a component of “Non-interest income: System Open Market Account: Federal agency and government-sponsored enterprise mortgage-backed securities gains, net” in the Statements of Income and Comprehensive Income. Foreign currency denominated investments, 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 investments are reported as “Non-interest loss: System Open Market Account: Foreign currency translation 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 government 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 investments, including the premiums, discounts, and realized and unrealized gains and losses, is allocated in the first quarter of each year 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.  FEDERAL RESERVE BANK OF RICHMOND  59  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 in the first quarter of each year 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. Foreign currency liquidity swaps Foreign currency liquidity swap transactions involve 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 amounts that the FRBNY receives are recorded as a liability.  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. Reserve Banks may transfer assets to other Reserve Banks or may lease property of other Reserve Banks. 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 and minor replacements related to software are charged to operating expense in the year incurred. Leased assets that meet the criteria of ASC 840, Leases are capitalized and amortized over the shorter of the useful life of the asset or the term of the lease. 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.  60  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  i. Interdistrict Settlement Account 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. 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 $10,988 million and $11,153 million at December 31, 2015 and 2014, respectively. At December 31, 2015 and 2014, all Federal Reserve notes outstanding, reduced by the Reserve Bank’s currency holdings, were fully collateralized. At December 31, 2015, all gold certificates, all special drawing rights certificates, and $1,363 billion of domestic securities held in the SOMA were pledged as collateral. At December 31, 2015, 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. Required reserve balances are those that a depository institution must hold to satisfy its reserve requirement. Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Excess reserves are those held by the depository institutions in excess of their required reserve balances. 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 expense on depository institutions’ deposits is accrued daily at the appropriate 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 expense on depository institutions’ deposits is accrued daily at the appropriate rate. 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, 2015 and 2014. Other Other deposits include the Bank’s allocated portion of foreign central bank and foreign government deposits held at the FRBNY.  FEDERAL RESERVE BANK OF RICHMOND  61  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 6 percent of the capital and surplus of the member bank. These shares are nonvoting, with a par value of $100, and may not be transferred or hypothecated. As a member bank’s capital and surplus changes, its holdings of Reserve Bank stock must be adjusted. Currently, only one-half of the subscription is paid in, and the remainder is subject to call. 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 was required to pay each member bank an annual dividend of 6 percent on the paid-in capital stock. This cumulative dividend is paid semiannually. The Fixing America’s Surface Transportation Act (FAST Act), which was enacted on December 4, 2015, amended section 7 of the Federal Reserve Act related to Reserve Bank surplus and the payment of dividends to member banks. The FAST Act changed the dividend rate for member banks with more than $10 billion of consolidated assets, effective January 1, 2016, to the smaller of 6 percent or the rate equal to the high yield of the 10-year Treasury note auctioned at the last auction held prior to the payment of the dividend. The FAST Act did not change the 6 percent dividend rate for member banks with $10 billion or less of total consolidated assets. The provisions of the FAST Act related to dividend payments did not affect the amounts reported by the Bank for the year ended December 31, 2015, but are expected to reduce the amount of dividend payments made to member banks in future years.  m. Surplus Before the enactment of the FAST Act, the Board of Governors required the Reserve Banks to maintain a surplus equal to the amount of capital paid-in. On a daily basis, surplus was adjusted to equate the balance to capital paid-in. Effective December 4, 2015, the FAST Act limits aggregate Reserve Bank surplus to $10 billion. Reserve Bank surplus is allocated among the Reserve Banks based on the ratio of each Bank’s capital paid-in to total Reserve Bank capital paid-in as of December 31 of each year. 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. Earnings Remittances to the Treasury Before the enactment of the FAST Act, the Board of Governors required the Reserve Banks to transfer excess earnings to the Treasury after providing for the costs of operations, payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in. The Federal Reserve Act, as amended by the FAST Act effective December 4, 2015, now requires that any amounts of the surplus funds of the Reserve Banks that exceed, or would exceed, the aggregate limitation of $10 billion shall be transferred to the Board of Governors for transfer to the Treasury. The Bank remits excess earnings to the Treasury after providing for the cost of operations, payment of dividends, and reservation of an amount necessary to maintain surplus at the Bank’s allocated portion of the $10 billion aggregate surplus limitation. Remittances to the Treasury are made on a weekly basis. The amount of the remittances to the Treasury that were required under the Board of Governor’s policy is reported as “Earnings remittances to the Treasury: Interest on Federal Reserve notes” in the Statements of Income and Comprehensive Income. The amount of remittances to the Treasury that are required by the FAST Act is reported as “Earnings remittances to the Treasury: Required by the Federal Reserve Act, as amended by the FAST Act” in the Statements of Income and Comprehensive Income. The amount due to the Treasury is reported as “Accrued remittances to the Treasury” in the Statements of Condition. See Note 12 for additional information on earnings remittances to the Treasury. Under the previous Board of Governor’s policy, if earnings during the year were not sufficient to provide for the costs of operations, payment of dividends, and equating surplus and capital paid-in, remittances to the Treasury were suspended, and under the FAST Act, if earnings during the year are not sufficient to provide for the costs of operations, payment of dividends, and maintaining surplus at an amount equal to the Bank’s allocated portion of the $10 billion aggregate surplus limitation, 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.  62  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  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, 2015 and 2014, the Bank was reimbursed for all services provided to the Treasury as its fiscal agent.  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 loss: Compensation received for service costs provided” in its Statements of Income and Comprehensive Income.  q. Assessments The Board of Governors assesses the Reserve Banks to fund its operations and the operations of the Bureau. 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 of its responsibilities to the Bureau on 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 Governor’s 2009 annual report, which totaled $4.98 billion. After 2013, the amount will be adjusted annually in accordance with the provisions of the Dodd-Frank Act. The percentage of total operating expenses of the System for the years ended December 31, 2015 and 2014 was 12.42 percent ($618.7 million) and 12.22 percent ($608.4 million), respectively. The Bank’s assessment for Bureau funding is reported as “Assessments: Bureau of Consumer Financial Protection” in the Statements of Income and Comprehensive Income.  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 and $1 million for the years ended December 31, 2015 and 2014, respectively, 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. In 2014, the Treasury announced plans to consolidate the provision of substantially all fiscal agent services for the U.S. Treasury at the Federal Reserve Bank of Cleveland, the Federal Reserve Bank of Kansas City, the FRBNY, and the Federal Reserve Bank of St. Louis. The implementation plan associated with this consolidation is expected to be completed in 2018.  FEDERAL RESERVE BANK OF RICHMOND  63  N O T E S T O F I N A N C I A L S TAT E M E N T S  Note 11 describes the Bank’s restructuring initiatives and provides information about the costs and liabilities associated with employee separations and contract terminations. Costs and liabilities associated with enhanced pension benefits in connection with the restructuring activities for all of the Reserve Banks are recorded on the books of the FRBNY. The Bank had no significant restructuring activities in 2015.  t. Recently Issued Accounting Standards In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014–08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This update changes the requirements for reporting discontinued operations, which may include a component of an entity or a group of components of an entity, or a business or nonprofit activity. This update is effective for the Bank for the year ended December 31, 2015, and did not have a material effect on the Bank’s financial statements. In May 2014, the FASB issued ASU 2014–09, Revenue from Contracts with Customers (Topic 606). This update was issued to create common revenue recognition guidance for U.S. GAAP and International Financial Reporting Standards. The guidance is applicable to all contracts for the transfer of goods or services regardless of industry or type of transaction. This update requires recognition of revenue in a manner that reflects the consideration that the entity expects to receive in return for the transfer of goods or services to customers. In August 2015, the FASB issued ASU 2015–14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the required effective date of this accounting by one year. This revenue recognition accounting guidance is effective for the Bank for the year ending December 31, 2019, although the Bank may elect to adopt guidance earlier. The Bank is continuing to evaluate the effect of this new guidance on the Bank’s financial statements. In June 2014, the FASB issued ASU 2014–11, Transfer and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This update requires certain changes in the accounting for repurchase-to-maturity transactions and repurchase financing transactions. Additionally, this update provides guidance for the disclosures for certain transfers of financial assets accounted for as sales, where the transferor retains substantially all of the exposure to economic return on the transferred financial asset; and repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. This update is effective for the Bank for the year ended December 31, 2015. The update did not have any effect on the Bank’s accounting for these transactions. The relevant required disclosures have been included in the Note 3e and Note 5 to the Bank’s financial statements. In April 2015, the FASB issued ASU 2015–05, Intangibles - Goodwill and Other - Internal Use Software (Subtopic 350–40). The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. Consequently, all software licenses within the scope of subtopic 350–40 will be accounted for consistent with other licenses of intangible assets. This update is effective for the Bank for the year ending December 31, 2016, and is not expected to have a material effect on the Bank’s financial statements. In July 2015, the FASB issued ASU 2015–12, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient (consensuses of the FASB Emerging Issues Task Force). Previously, plans were required to disclose (1) individual investments representing 5 percent or more of net assets available for benefits and (2) net appreciation or depreciation for investments by general type. The amendments in Part II of this update (1) eliminate the required disclosure related to individual investments and (2) removes the requirement to disaggregate net appreciation or depreciation for investments by general type. This update is effective for the Bank for the year ending December 31, 2016, and is not expected to have a material effect on the Bank’s financial statements.  64  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  In January 2016, the FASB issued ASU 2016–01, Financial Instruments – Overall (Subtopic 825–10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update eliminate the requirement to disclose methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. This update is effective for the Bank for the year ending December 31, 2019. The Bank is continuing to evaluate the effect of this new guidance on the Bank’s financial statements. In February 2016, the FASB issued ASU 2016–02, Leases (Topic 842). This update revises the model to assess how a lease should be classified and provides guidance for lessees, requiring lessees to present right-of-use assets and lease liabilities on the balance sheet. The update is effective for the Bank for the year ended December 31, 2020, although earlier adoption is permitted. The Bank is continuing to evaluate the effect of this new guidance on its financial statements.  4  	LOANS  Loans to Depository Institutions The Bank offers primary, secondary, and seasonal loans to eligible borrowers (depository institutions that maintain reservable transaction accounts or nonpersonal time deposits and have established discount window borrowing privileges). Each program has its own interest rate and 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 short-term 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, 2015. Loans to depository institutions were $1 million as of December 31, 2014, with a remaining maturity within 15 days. At December 31, 2015 and 2014, the Bank did not have any loans that were impaired, restructured, past due, or on non-accrual status, and no allowance for loan losses was required. There were no impaired loans during the years ended December 31, 2015 and 2014. Interest income attributable to loans to depository institutions was immaterial during the years ended December 31, 2015 and 2014.  FEDERAL RESERVE BANK OF RICHMOND  65  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 year ended December 31, 2014, the FRBNY continued the purchase of Treasury securities and federal agency and GSE MBS under the large-scale asset purchase programs as directed by the FOMC, although at a reduced pace than previous years. In October 2014, the FOMC concluded its asset purchase program while maintaining its existing policy of reinvesting principal payments from its holdings of GSE debt securities and federal agency and GSE MBS and of rolling over maturing Treasury securities at auction. During the year ended December 31, 2015, the FRBNY continued the reinvestments. The Bank’s allocated share of activity related to domestic open market operations was 5.431 percent and 5.589 percent at December 31, 2015 and 2014, respectively. 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): 2015 Par  Unamortized premiums  Unaccreted discounts  Total amortized cost  Treasury securities 	Notes  $   	Bonds  88,791  $   44,905  1,137  $   6,193  (352)  $   (508)  Total Treasury securities  $   133,696  $   7,330  $   GSE debt securities  $   1,789  $   44  $   Federal agency and GSE MBS  $   94,911  $   2,918  $   (860)  89,576 50,590  $   140,166  —  $   1,833  (40)  $   97,789  2014 Par  Unamortized premiums  Unaccreted discounts  Total amortized cost  Treasury securities 	Notes  $   	Bonds  91,378  $   46,189  1,547  $   6,965  (431)  $   (542)  Total Treasury securities  $   137,567  $   8,512  $   GSE debt securities  $   2,162  $   73  $   Federal agency and GSE MBS  $   97,073  $   2,975  $   (973)  92,494 52,612  $   145,106  —  $   2,235  (55)  $   99,993  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. Prior to December 17, 2015, these operations were for the purpose of further assessing the appropriate structure of such operations in supporting the implementation of monetary policy during normalization. From December 17, 2015 these operations have been undertaken as necessary to maintain the federal funds rate in a target range. 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.  66  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  There were no material transactions related to securities purchased under agreements to resell during the years ended December 31, 2015 and 2014. 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     2015  Total SOMA  2014  2015  2014  $  474,592  $  396,705  Primary dealers and expanded counterparties: Contract amount outstanding, end of year  $   Average daily amount outstanding, during the year  25,777  $   22,172  6,892  7,428  125,656  130,281  Maximum balance outstanding, during the year  25,777  22,172  474,592  396,705  Securities pledged (par value), end of year  23,787  20,413  437,961  365,235  Securities pledged (fair value), end of year  25,822  22,275  475,422  398,540  6,323  $  237,809  $  113,132  8,636  5,925  157,929  102,968  12,916  7,348  237,809  122,232  Foreign official and international accounts: Contract amount outstanding, end of year  $   Average daily amount outstanding, during the year Maximum balance outstanding, during the year  12,916  $   Securities pledged (par value), end of year  12,510  6,056  230,333  108,355  Securities pledged (fair value), end of year  12,917  6,323  237,825  113,132  $  712,401  $  509,837  $   $   Total contract amount outstanding, end of year  $   38,693  $   28,495  $   4  $   4  Supplemental information—interest expense: Primary dealers and expanded counterparties Foreign official and international accounts Total interest expense — securities sold under agreements to repurchase  9 $   13  3 $   7  84 164  $   248  68 44  $   112  Securities pledged as collateral, at December 31, 2015 and 2014, consisted solely of Treasury securities. The contract amount outstanding as of December 31, 2015 of securities sold under agreements to repurchase that were transacted with primary dealers and expanded counterparties had a term of one business day and matured on January 4, 2016. The contract amount outstanding as of December 31, 2015 of securities sold under agreements to repurchase that were transacted with foreign official and international accounts had a term of one business day and matured on January 4, 2016.  FEDERAL RESERVE BANK OF RICHMOND  67  N O T E S T O F I N A N C I A L S TAT E M E N T S  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, 2015 and 2014 was as follows (in millions):  Within 15 days  16 days to 90 days  91 days to 1 year  Over 1 year to 5 years  Over 5 years to 10 years  Over 10 years  Total  $   $   $   9,640  $  60,742  $  26,572  $  34,645  $  133,696  December 31, 2015: Treasury securities (par value)  —  2,097  GSE debt securities (par value)  —  200  710  751  —  128  1,789  Federal agency and GSE MBS (par value)1  —  —  —  25  490  94,396  94,911  38,693  —  —  —  —  —  38,693  197  $  62,202  $  38,376  $  36,792  $  137,567  Securities sold under agreements to repurchase (contract amount) December 31, 2014: Treasury securities (par value)  $   $   —  $   GSE debt securities (par value)  61  40  220  1,710  —  131  2,162  Federal agency and GSE MBS (par value)1  —  —  —  1  361  96,711  97,073  28,495  —  —  —  —  —  28,495  Securities sold under agreements to repurchase (contract amount) 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 5.7 years as of December 31, 2015 and 2014, respectively. The amortized cost and par value of Treasury securities and GSE debt securities that were loaned from the SOMA under securities lending agreements, at December 31 were as follows (in millions): Allocated to the Bank 2015  2015  2014  623  $ 18,960  $ 11,144  981  565  18,055  10,105  GSE debt securities (amortized cost)  8  35  146  633  GSE debt securities (par value)  7  34  137  616  Treasury securities (amortized cost) Treasury securities (par value)  68  Total SOMA  2015 ANNUAL REPORT  2014  $ 1,030  $   N O T E S T O F I N A N C I A L S TAT E M E N T S  Securities pledged as collateral by the counterparties in the securities lending arrangements at December 31, 2015 and 2014, consisted solely of Treasury securities. The securities lending agreements outstanding as of December 31, 2015 had a term of one business day and matured on January 4, 2016. 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, 2015, 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, 2015, the total purchase price of the federal agency and GSE MBS under outstanding purchase commitments was $22,187 million, none of which was related to dollar rolls. The total purchase price of outstanding purchase commitments allocated to the Bank was $1,205 million, none of which was related to dollar rolls. MBS commitments, which had contractual settlement dates extending through January 2016, are principally 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. As of December 31, 2015, there were no outstanding sales commitments for federal agency and GSE MBS. 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 MBS commitments as part of its risk management practices used to mitigate the counterparty credit risk. Other assets consists primarily of cash and short-term investments related to the federal agency and GSE MBS portfolio. Other liabilities, which are primarily 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 MBS 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 assets and other liabilities allocated to the Bank and held in the SOMA at December 31 was as follows (in millions): Allocated to the Bank 2015  Total SOMA  2014  2015  2014  Other assets: MBS portfolio related cash and short-term investments  $   Other Total other assets  1  $   —  2  $   —  13  $   1  28 1  $   1  $   2  $   14  $   29  $   27  $   44  $   486  $   793  Other liabilities: Cash margin Obligations from MBS transaction fails  1  2  16  30  Other  —  —  6  7  Total other liabilities  $   28  $   46  $   508  $   830  Accrued interest receivable on domestic securities holdings was $25,354 million and $25,561 million as of December 31, 2015 and 2014, respectively, of which $1,377 million and $1,429 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.  FEDERAL RESERVE BANK OF RICHMOND  69  N O T E S T O F I N A N C I A L S TAT E M E N T S  Information about transactions related to Treasury securities, GSE debt securities, and federal agency and GSE MBS during the years ended December 31, 2015 and 2014, is summarized as follows (in millions): Allocated to the Bank Federal agency and GSE MBS  Notes  Bonds  Total Treasury securities  $  92,968  $  53,744  $  146,712  3,676  $  95,377  9,712  5,030  14,742  —  27,038  Sales  —  —  —  —  (2)  Realized gains, net2  —  —  —  —  —  (28)  —  (28)  (1,098)  (11,630) (411)  Balance at December 31, 2013 Purchases1 1  Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities  Balance at December 31, 2014  $   (319)  (583)  (902)  (34)  28  75  103  —  (9,867)  Annual reallocation adjustment  3  GSE debt securities  (5,654)  (15,521)  —  (309)  $  92,494  $  52,612  $  145,106  2,235  $  99,993  149  41  190  —  19,537  Sales  —  —  —  —  (26)  Realized gains, net2  —  —  —  —  1  Purchases1 1  $   (10,379)  Principal payments and maturities  (162)  (29)  (191)  (316)  (18,256)  Amortization of premiums and accretion of discounts, net  (300)  (562)  (862)  (28)  (641)  Inflation adjustment on inflation-indexed securities  2 (2,607)  Annual reallocation adjustment  3  Balance at December 31, 2015  6  $  89,576  8  (1,478)  —  (4,085)  —  (58)  (2,819)  $  50,590  $  140,166  $   1,833  $  97,789  $   4,920  $  14,767  $   —  $  26,129  —  —  Year-ended December 31, 2014 Supplemental information—par value of transactions: Purchases4  $   Sales  9,847 —  —  (2)  Year-ended December 31, 2015 Supplemental information—par value of transactions: Purchases4 Sales  $   149 —  $   42 —  $   191 —  $   —  $  18,853  —  (24)  	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.  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.  3  	Includes inflation compensation.  4  70  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  Total SOMA  Notes  Bonds  Total Treasury securities  $ 1,495,115  $  864,319  $ 2,359,434  59,122  $ 1,533,860  165,306  85,826  251,132  —  466,384  Sales  —  —  —  —  (29)  Realized gains, net2  —  —  —  —  —  Balance at December 31, 2013 Purchases1 1  Principal payments and maturities  (475)  Amortization of premiums and accretion of discounts, net  (18,544)  (203,933)  (10,132)  (15,677)  (588)  (7,199)  1,327  1,827  941,340  $ 2,596,241  2,736  761  —  —  500 $ 1,654,901  Purchases  1  $   Federal agency and GSE MBS  (475)  (5,545)  Inflation adjustment on inflation-indexed securities Balance at December 31, 2014  —  GSE debt securities  Sales1  $  —  Realized gains, net  2  —  —  —  39,990  $ 1,789,083  3,497  —  356,976  —  —  $  —  —  (464) 16  Principal payments and maturities  (2,977)  (543)  (3,520)  (5,733)  (333,441)  Amortization of premiums and accretion of discounts, net  (5,485)  (10,253)  (15,738)  (509)  (11,721)  Inflation adjustment on inflation-indexed securities Balance at December 31, 2015  53  143  196  $ 1,649,228  $  931,448  $ 2,580,676  $   83,739  $  251,236  —  —  —  —  $   33,748  $ 1,800,449  $   —  $  450,633  Year-ended December 31, 2014 Supplemental information—par value of transactions: Purchases3  $  167,497  Sales  —  —  (29)  Year-ended December 31, 2015 Supplemental information—par value of transactions: Purchases3 Sales  $   2,747 —  $   766 —  $   3,513  $   —  — —  $  344,505 (435)  	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.  2  	Includes inflation compensation.  3  FEDERAL RESERVE BANK OF RICHMOND  71  N O T E S T O F I N A N C I A L S TAT E M E N T S  b. Foreign Currency Denominated Investments The FRBNY conducts foreign currency operations and, on behalf of the Reserve Banks, holds the resulting foreign currency denominated investments 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 backed by the full faith and credit of the issuing foreign governments. In addition, the FRBNY may enter 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, which are backed by the full faith and credit of those issuing governments. At December 31, 2015 and 2014, there were no securities purchased under agreements to resell outstanding and, consequently, no related foreign securities held as collateral. The Bank’s allocated share of activity related to foreign currency operations was 22.949 percent and 20.853 percent at December 31, 2015 and 2014, respectively. Information about foreign currency denominated investments valued at amortized cost and at foreign currency market exchange rates at December 31 was as follows (in millions): Allocated to the Bank  Total SOMA  2015  2014  2015  2014  $  1,427  $  1,446  $  6,218  $  6,936  Euro: Foreign currency deposits German government debt instruments  519  520  2,261  2,494  French government debt instruments  763  769  3,325  3,687  589  537  2,568  2,576  1,192  1,086  5,195  5,207  $  4,490  $  4,358  $  19,567  $  20,900  Japanese yen: Foreign currency deposits Japanese government debt instruments Total  Accrued interest receivable on foreign currency denominated investments was $64 million and $83 million as of December 31, 2015 and 2014, respectively, of which $15 million and $17 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.  72  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  The remaining maturity distribution of foreign currency denominated investments that were allocated to the Bank at December 31, 2015 and 2014, was as follows (in millions): Within 15 days  16 days to 90 days  91 days to 1 year  Over 1 year to 5 years  Over 5 years to 10 years  $  490  $  1,019  $  241  $  878  628  80  368  705  $  1,118  $  1,099  $  609  $  1,583  $   $  758  $  586  $  343  $  1,048  $   575  82  321  645  $  1,333  $  668  $  664  $  1,693  Total  December 31, 2015: Euro Japanese yen Total  $   81  $  2,709  —  1,781  81  $  4,490  December 31, 2014: Euro Japanese yen Total  $   —  $  2,735  —  1,623  —  $  4,358  There were no foreign exchange contracts related to foreign currency operations outstanding as of December 31, 2015. The FRBNY enters into commitments to buy foreign government debt instruments and records the related securities on a settlement-date basis. During 2015, there were purchases and maturities of foreign government debt instruments of $3,288 million and $3,155 million, respectively, of which $747 million and $714 million, respectively, were allocated to the Bank. There were no sales of foreign government debt instruments in 2015. 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 monitoring procedures. Foreign currency working balances held and foreign exchange contracts executed by the Bank to facilitate international payments and currency transactions made on behalf of foreign central banks and U.S. official institution customers were not material as of December 31, 2015 and 2014.  c. Central Bank Liquidity Swaps U.S. Dollar Liquidity Swaps The Bank’s allocated share of U.S. dollar liquidity swaps was 22.949 percent and 20.853 percent at December 31, 2015 and 2014, respectively. The total foreign currency held under U.S. dollar liquidity swaps in the SOMA at December 31, 2015 and 2014, was $997 million and $1,528 million, respectively, of which $229 million and $319 million, respectively, was allocated to the Bank. The remaining maturity distribution of U.S. dollar liquidity swaps that were allocated to the Bank at December 31 was as follows (in millions):  Euro Japanese yen Total  2015  2014  Within 15 days  Within 15 days  $  212  $   —  17  319  $  229  $  319  FEDERAL RESERVE BANK OF RICHMOND  73  N O T E S T O F I N A N C I A L S TAT E M E N T S  Foreign Currency Liquidity Swaps At December 31, 2015 and 2014, there was no balance outstanding related to foreign currency liquidity swaps.  d. Fair Value of SOMA Assets and Liabilities The fair value amounts below are presented solely for informational purposes and are not intended to comply with the fair value disclosures required by FASB Accounting Standards Codification (ASC) Topic 820 (ASC 820), Fair Value Measurement. 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. Because SOMA securities are recorded at amortized cost, cumulative unrealized gains (losses) are not recognized in the Statements of Condition and the changes in cumulative unrealized gains (losses) are not recognized in the Statements of Income and Comprehensive Income. The fair value of the Treasury securities, GSE debt securities, federal agency and GSE MBS, and foreign government debt instruments held in the SOMA 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, 2015 and 2014, there are no credit impairments of SOMA securities holdings. The following table presents the amortized cost, fair value, and cumulative unrealized gains (losses) on the Treasury securities, GSE debt securities, and federal agency and GSE MBS held in the SOMA at December 31 (in millions): Allocated to the Bank 2015  2014  Amortized cost  Fair value  Notes  $  89,576  $  90,671  Bonds  50,590  54,667  Cumulative unrealized gains (losses)  Amortized cost  Fair value  1,095  $  92,494  $  94,085  4,077  52,612  58,848  Cumulative unrealized gains (losses)  Treasury securities:  Total Treasury securities  $   1,591 6,236  $  140,166  $  145,338  5,172  $  145,106  $  152,933  GSE debt securities  1,833  1,910  77  2,235  2,375  140  Federal agency and GSE MBS  97,789  98,321  532  99,993  101,752  1,759  $  239,788  $  245,569  $   5,781  $  247,334  $  257,060  $   9,726  $   $   $   —  $   $   $   —  Total domestic SOMA portfolio securities holdings  $   $   $   7,827  Memorandum— Commitments for: Purchases of Treasury securities  74  —  —  Purchases of Federal agency and GSE MBS  1,205  1,204  Sales of Federal agency and GSE MBS  —  —  2015 ANNUAL REPORT  (1) —  —  —  1,604  1,610  6  —  —  —  N O T E S T O F I N A N C I A L S TAT E M E N T S  Total SOMA 2015  2014  Amortized cost  Fair value  Notes  $ 1,649,228  $ 1,669,395  Bonds  931,448  1,006,514  $ 2,580,676  $ 2,675,909  33,748  Cumulative unrealized gains (losses)  Cumulative unrealized gains (losses)  Amortized cost  Fair value  20,167  $ 1,654,901  $ 1,683,377  75,066  941,340  1,052,916  111,576  95,233  $ 2,596,241  $ 2,736,293  $  140,052  35,165  1,417  39,990  42,499  2,509  1,800,449  1,810,256  9,807  1,789,083  1,820,544  31,461  $ 4,414,873  $ 4,521,330  $  106,457  $ 4,425,314  $ 4,599,336  $  174,022  $   $   $   $   $   $   Treasury securities:  Total Treasury securities GSE debt securities Federal agency and GSE MBS Total domestic SOMA portfolio securities holdings  $   $   $   28,476  Memorandum— Commitments for: Purchases of Treasury securities Purchases of Federal agency and GSE MBS Sales of Federal agency and GSE MBS  —  —  22,187  22,170  —  —  — (17) —  —  —  —  28,692  28,803  111  —  —  —  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. The cost bases of securities purchased under agreements to resell, securities sold under agreements to repurchase, central bank liquidity swaps and other investments held in the SOMA domestic portfolio approximate fair value. Due to the short-term nature of these agreements and the defined amount that will be received upon settlement, the cost basis is estimated to approximate fair value. At December 31, 2015 and 2014, the fair value of foreign currency denominated investments was $19,630 million and $20,996 million, respectively, of which $4,505 million and $4,378 million, respectively, was allocated to the Bank. The fair value of foreign 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.  FEDERAL RESERVE BANK OF RICHMOND  75  N O T E S T O F I N A N C I A L S TAT E M E N T S  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): 2015 Distribution of MBS holdings by coupon rate  2014  Amortized cost  Fair value  Amortized cost  Fair value  Allocated to the Bank: 2.0%  $  608  $  597  $   715  $   705  2.5%  6,329  6,247  6,406  6,342  3.0%  30,113  29,507  28,688  28,296  3.5%  31,469  31,607  26,900  27,352  4.0%  19,615  20,019  23,924  24,659  4.5%  6,296  6,737  8,712  9,381  5.0%  2,658  2,853  3,663  3,953  5.5%  605  651  851  918  6.0%  84  90  118  128  6.5%  12  13  16  18  Total  $  97,789  $  98,321  $   99,993  $   101,752  $  11,198  $  10,993  $   12,788  $   12,618  Total SOMA: 2.0%  76  2.5%  116,527  115,018  114,609  113,468  3.0%  554,430  543,270  513,289  506,280  3.5%  579,403  581,940  481,305  489,390  4.0%  361,149  368,576  428,047  441,204  4.5%  115,914  124,043  155,867  167,844  5.0%  48,931  52,523  65,544  70,719  5.5%  11,138  11,989  15,232  16,414  6.0%  1,542  1,666  2,110  2,287  6.5%  217  238  292  320  Total  $ 1,800,449  $ 1,810,256  $  1,789,083  $  1,820,544  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  The following tables present the realized gains (losses) and the change in the cumulative unrealized gains (losses) related to SOMA domestic securities holdings during the years ended December 31, 2015 and 2014 (in millions): Allocated to the Bank 2015 Realized gains1  Treasury securities  $   2014  Change in cumulative unrealized gains (losses) 2, 3  —  $  Realized gains 1  (2,359)  $   —  GSE debt securities  —  (60)  —  Federal agency and GSE MBS  2  (1,155)  5  Total  $   2  $  (3,574)  $   Change in cumulative unrealized gains (losses) 2, 3  $   9,173 (34) 4,056  5  $   13,195  Total SOMA 2015 Realized gains 1  Treasury securities  $   —  2014  Change in cumulative unrealized gains (losses) 2  $  (44,819)  Realized gains1  $   —  GSE debt securities  —  (1,092)  —  Federal agency and GSE MBS  43  (21,654)  81  Total  $   43  $  (67,565)  $   81  Change in cumulative unrealized gains (losses) 2  $   158,150 (605) 69,749  $   227,294  	Realized gains are reported in “Non-interest loss: System Open Market Account: Federal agency and government-sponsored enterprise mortgage-backed securities gains, net” in the Statements of Income and Comprehensive Income.  1  	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.  2  	The amount reported as change in cumulative unrealized gains (losses) allocated to the Bank is affected by the annual adjustment to the Bank’s allocated portion of the related SOMA securities, as discussed in Note 3f.  3  The amount of change in cumulative unrealized gains (losses) position, net, related to foreign currency denominated investments was a loss of $33 million and a gain of $18 million for the years ended December 31, 2015 and 2014, respectively, of which $7 million and $4 million, respectively, were allocated to the Bank. 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: •	 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. FEDERAL RESERVE BANK OF RICHMOND  77  N O T E S T O F I N A N C I A L S TAT E M E N T S  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): 2015  2014  Bank premises and equipment: Land and land improvements  $   48  Buildings Building machinery and equipment  $   48  250  247  87  86  Construction in progress  1  2  Furniture and equipment  381  373  767  756  (425)  (407)  Subtotal Accumulated depreciation Bank premises and equipment, net  $   342  $   349  Depreciation expense, for the years ended December 31  $   57  $   53  Bank premises and equipment at December 31 included the following amounts for capitalized leases (in millions): 2015  Leased premises and equipment under capital leases  $   Accumulated depreciation  78  2014  25  $   (21)  26 (20)  Leased premises and equipment under capital leases, net  $   4  $   6  Depreciation expense related to leased premises and equipment under capital leases, for the years ended December 31  $   4  $   6  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  The Bank leases space to outside tenants with remaining lease terms ranging from one to eight years. Rental income from such leases was $2 million and $1 million for the years ended December 31, 2015 and 2014, respectively, and is reported as a component of “Non-interest loss: 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, 2015, are as follows (in millions): 2016  $  2  2017  2  2018  1  2019  1  2020  1  Thereafter  3  Total  $  10  The Bank had capitalized software assets, net of amortization, of $32 million and $35 million at December 31, 2015 and 2014, respectively. Amortization expense was $17 million for each of the years ended December 31, 2015 and 2014. 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, 2015, the Bank was obligated under noncancelable leases for premises and equipment with remaining terms ranging from one to approximately four years. 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 $923 thousand and $380 thousand for the years ended December 31, 2015 and 2014, respectively. Certain of the Bank’s leases have options to renew. Future minimum lease payments under noncancelable operating leases, net of sublease rentals, with terms of one year or more, at December 31, 2015, were not material. At December 31, 2015, 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, 2015 and 2014. 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.  FEDERAL RESERVE BANK OF RICHMOND  79  N O T E S T O F I N A N C I A L S TAT E M E N T S  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 (OEB) participate in the Retirement Plan for Employees of the Federal Reserve System (System Plan).1 Under the Dodd-Frank Act, newly hired Bureau employees are eligible to participate in the System Plan and, during the years ended December 31, 2015 and 2014, certain costs associated with the System Plan were reimbursed by the Bureau. 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. The Bank reports the net cost related to the BEP and SERP as a component of “Operating expenses: Salaries and benefits” in its Statements of Income and Comprehensive Income and reports the net liability as a component of “Accrued benefit costs” in its Statements of Condition. The Bank’s projected benefit obligation, funded status, and net pension expenses for the BEP and the SERP at December 31, 2015 and 2014, 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 6 percent of employee contributions from the date of hire and provides an automatic employer contribution of 1 percent of eligible pay. The Bank’s Thrift Plan contributions totaled $18 million and $17 million for the years ended December 31, 2015 and 2014, respectively, and are reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income.  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 and plan participants fund benefits payable under the medical and life insurance plans as due and the plans have no assets.  	The OEB was established by the System to administer selected System benefit plans.  1  80  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  Following is a reconciliation of the beginning and ending balances of the benefit obligation (in millions): 2015  Accumulated postretirement benefit obligation at January 1  $  273.6  Service cost benefits earned during the period  $   13.8  Interest cost on accumulated benefit obligation Net actuarial (gain) loss Benefits paid  11.7  11.3  11.7 24.4  3.0  3.0  (12.2)  (11.1)  0.7  0.7  —  —  Medicare Part D subsidies Plan amendments $   233.2  (22.5)  Contributions by plan participants  Accumulated postretirement benefit obligation at December 31  2014  267.7  $   273.6  At December 31, 2015 and 2014, the weighted-average discount rate assumptions used in developing the postretirement benefit obligation were 4.31 percent and 3.96 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. The System Plan discount rate assumption setting convention uses an unrounded rate. Following is a reconciliation of the beginning and ending balance of the plan assets, and the unfunded postretirement benefit obligation and accrued postretirement benefit costs (in millions): 2015  Fair value of plan assets at January 1  $   Contributions by the employer  2014  —  $   8.5  Contributions by plan participants Benefits paid Medicare Part D subsidies  — 7.4  3.0  3.0  (12.2)  (11.1)  0.7  0.7  Fair value of plan assets at December 31  $   —  Unfunded obligation and accrued postretirement benefit cost  $  267.7  $   —  $  273.6  Amounts included in accumulated other comprehensive loss are shown below: Prior service cost  $  Net actuarial loss Total accumulated other comprehensive loss  2.3  $   (31.8) $  (29.5)  5.7 (58.1)  $   (52.4)  Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs” in the Statements of Condition.  FEDERAL RESERVE BANK OF RICHMOND  81  N O T E S T O F I N A N C I A L S TAT E M E N T S  For measurement purposes, the assumed health-care cost trend rates at December 31 are provided in the table below. The current health-care cost trend rate for next year is expected to decline ratably each year until achieving the ultimate trend rate in 2022: 2015  2014  Health-care cost trend rate assumed for next year  7.00%  6.60%  Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)  4.75%  4.75%  Year that the rate reaches the ultimate trend rate  2022  2019  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, 2015 (in millions): One percentage point increase  Effect on aggregate of service and interest cost components of net periodic postretirement benefit costs  $   Effect on accumulated postretirement benefit obligation  One percentage point decrease  5.2  $  (4.1)  41.8  (34.1)  The following is a summary of the components of net periodic postretirement benefit expense for the years ended December 31 (in millions): 2015  Service cost-benefits earned during the period  $  2014  13.8  $  11.7  Interest cost on accumulated benefit obligation  11.3  11.7  Amortization of prior service cost  (3.5)  (4.0)  Amortization of net actuarial loss  4.0  1.9  25.6  $  21.3  Net periodic postretirement benefit expense  $  Estimated amounts that will be amortized from accumulated other comprehensive loss into net periodic postretirement benefit expense in 2016 are shown below:  Prior service cost  $   Net actuarial loss Total  82  2015 ANNUAL REPORT  (1.8) 0.6  $   (1.2)  N O T E S T O F I N A N C I A L S TAT E M E N T S  Net postretirement benefit costs are actuarially determined using a January 1 measurement date. At January 1, 2015 and 2014, the weighted-average discount rate assumptions used to determine net periodic postretirement benefit costs were 3.96 percent and 4.79 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 gain in the accumulated postretirement benefit obligation and net periodic postretirement benefit expense. Federal Medicare Part D subsidy receipts were $557 thousand and $725 thousand in the years ended December 31, 2015 and 2014, respectively. Expected receipts in 2016, related to benefits paid in the years ended December 31, 2015 and 2014, are $207 thousand and $175 thousand, respectively. Following is a summary of expected postretirement benefit payments (in millions): Without subsidy  With subsidy  2016  $  10.0  2017  10.9  10.1  2018  11.7  10.9  2019  12.6  11.6  2020  13.5  12.4  2021–2025  83.3  76.3  $ 142.0  $ 130.6  Total  $   9.3  Postemployment Benefits The Bank offers benefits to former qualifying 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, 2015 and 2014, were $21 million and $23 million, respectively. This cost is included as a component of “Accrued benefit costs” in the Statements of Condition. Net periodic postemployment benefit expense included in 2015 and 2014 operating expenses were $1 million and $5 million, respectively, and are recorded as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income.  FEDERAL RESERVE BANK OF RICHMOND  83  N O T E S T O F I N A N C I A L S TAT E M E N T S  10 	ACCUMULATED OTHER COMPREHENSIVE INCOME AND OTHER COMPREHENSIVE INCOME  Following is a reconciliation of beginning and ending balances of accumulated other comprehensive loss as of December 31 (in millions):  Balance at January 1  2015  2014  Amount related to postretirement benefits other than retirement plans  Amount related to postretirement benefits other than retirement plans  $   (52)  $   (26)  Change in funded status of benefit plans: Amortization of prior service cost  (3) 1  (4) 1  Change in prior service costs related to benefit plans  (3)  (4)  Net actuarial gain (loss) arising during the year  22  (24)  4  21  Amortization of net actuarial loss Change in actuarial losses related to benefit plans Change in funded status of benefit plans— other comprehensive income (loss) Balance at December 31  $   1  26  (22)  23  (26)  (29)  $   (52)  	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.  84  2015 ANNUAL REPORT  N O T E S T O F I N A N C I A L S TAT E M E N T S  11  	BUSINESS RESTRUCTURING CHARGES  In 2014, the Treasury announced a plan to consolidate the number of Reserve Banks providing fiscal agent services to the Treasury from ten to four. As a result of this initiative, the Automated Standard Application for Payments operations and the International Treasury Services Operations performed by the Bank will be transitioned to the Federal Reserve Bank of Kansas City; the Intragovernmental Payments and Collections operations performed by the Bank will be transitioned to the Federal Reserve Bank of St. Louis; and the Direct Voucher Service operations performed by the Bank will be transitioned to the Federal Reserve Bank of Cleveland. The Bank had no significant business restructuring charges in 2015. Following is a summary of financial information related to the restructuring plans (in millions): 2014 restructuring plans  Information related to restructuring plans as of December 31, 2015: Total expected costs related to restructuring activity  $   Estimated future costs related to restructuring activity  2.6 0.3  Expected completion date  2017  Reconciliation of liability balances: Balance at December 31, 2013  $   Employee separation costs Payments Balance at December 31, 2014  — 4.4 (0.1)  $   Employee separation costs  4.3 0.5  Adjustments  (2.6)  Payments  (0.4)  Balance at December 31, 2015  $  1.8  Employee separation costs are primarily severance costs for identified staff reductions associated with the announced restructuring plans. Separation costs that are provided under terms of ongoing benefit arrangements are recorded based on the accumulated benefit earned by the employee. Separation costs that are provided under the terms of one-time benefit arrangements are generally measured based on the expected benefit as of the termination date and recorded ratably over the period to termination. Restructuring costs related to employee separations are reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Income and Comprehensive Income. Adjustments to the accrued liability are primarily due to changes in the estimated restructuring costs and are shown as a component of the appropriate expense category in the Statements of Income and Comprehensive Income. Costs associated with enhanced pension benefits for all Reserve Banks are recorded on the books of the FRBNY as discussed in Note 8.  FEDERAL RESERVE BANK OF RICHMOND  85  N O T E S T O F I N A N C I A L S TAT E M E N T S  12 	DISTRIBUTION OF COMPREHENSIVE INCOME The following table presents the distribution of the Bank’s comprehensive income for the years ended December 31 (in millions):  Dividends on capital stock Transfer (from) to surplus  2015  2014  $  395  $  355  (4,327)  821  Earnings remittances to the Treasury: Interest on Federal Reserve notes  4,112  3,974  Required by the Federal Reserve Act, as amended by the FAST Act  4,715  —  $ 4,895  $ 5,150  Total distribution  Before enactment of the FAST Act, the amount reported as transfer (from) to surplus represented the amount necessary to equate surplus with capital paid-in, in accordance with the Board of Governor’s policy. Subsequent to the enactment of the FAST Act, the amount reported as transfer (from) to surplus represents the amount necessary to maintain surplus at an amount equal to the Bank’s allocated portion of the aggregate surplus limitation. On December 28, 2015, the Reserve Banks reduced the aggregate surplus to the $10 billion limit in the FAST Act by remitting $19.3 billion to the Treasury. The Bank’s share of this remittance was $4.3 billion, which is reported as a component of “Earnings remittances to the Treasury: Required by the Federal Reserve Act, as amended by the FAST Act” in the Bank’s Statements of Income and Comprehensive Income, and in the table above.  13 	SUBSEQUENT EVENTS The FAST Act includes provisions that, effective on January 1, 2016, will change the rate of dividends paid to member banks by the Bank. See Note 3l for additional information on these FAST Act provisions. There were no other subsequent events that require adjustments to or disclosures in the financial statements as of December 31, 2015. Subsequent events were evaluated through March 8, 2016, which is the date that the financial statements were available to be issued.  86  2015 ANNUAL REPORT  The Federal Reserve Bank of Richmond 2015 Annual Report was produced by the Research Department, Publications Division.  MANAGING EDITOR: DESIGN:  Amanda Kramer  MillerCox Design, Inc.  PHOTOGRAPHY: PRINTING:  Michael Batts and Larry Cain  Federal Reserve Bank of Richmond  Special thanks to Gina Karp, Lisa Kenney, Joseph Mengedoth, Karl Rhodes, and Jessie Romero. The Annual Report also is available on the Bank’s website, www.richmondfed.org.  Fifth Federal Reserve District Offices RICHMOND  BALTIMORE  CHARLOTTE  701 East Byrd Street Richmond, Virginia 23219 (804) 697-8000  502 South Sharp Street Baltimore, Maryland 21201 (410) 576-3300  530 East Trade Street Charlotte, North Carolina 28202 (704) 358-2100  FEDERAL RESERVE BANK OF RICHMOND Richmond Baltimore Charlotte  www.richmondfed.org