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ffcfc-28; FEDERAL RESERVE
S E A S C ii
A>0GO«riiTABILITY ACT OF 1993
uc .'it I .Ry
of S t. Louis

JUN g T

HEARING
BEFORE THE

COMMITTEE ON BANKING, FINANCE AND
URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRD CONGRESS
FIRST SESSION

OCTOBER 27, 1993

Printed for the use of the Committee on Banking, Finance and Urban Affairs

Serial No. 103-86

U.S. G O V E R N M E N T PRINTING OFFICE
73-435 CC

W A S H I N G T O N : 1994

For sale by the U.S. Government Printing O ffice
Superintendent o f Documents, Congressional Sales O ffice, W ashington, DC 20402




ISBN 0 -1 6 -0 4 4 2 8 6 -9

HOUSE COM
MITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY B. GONZALEZ. Texas. Chairman
STEPHEN L. NEAL, North Carolina
JAMES A. LEACH, Iowa
JOHN J. La FALCE, New York
BILL MCCOLLUM, Florida
BRUCE F. VENTO, Minnesota
MARGE ROUKEMA, New Jereey
CHARLES E. SCHUMER, New York
DOUG BEREUTER, Nebraska
BARNEY FRANK, Massachusetts
THOMAS J. RIDGE, Pennsylvania
PAUL E. KANJORSKI, Pennsylvania
TOBY ROTH, Wisconsin
JOSEPH P. KENNEDY II, Massachusetts
ALFRED A. (AL) McCANDLESS, California
FLOYD H. FLAKE, New York
RICHARD H. BAKER, Louisiana
KWEISI MFUME, Maryland
JIM NUSSLE, Iowa
MAXINE WATERS, California
CRAIG THOMAS, Wyoming
LARRY LaROCCO, Idaho
SAM JOHNSON, Texas
BILL ORTON, Utah
DEBORAH PRYCE, Ohio
JIM BACCHUS, Florida
JOHN LINDER, Georgia
HERBERT C. KLEIN, New Jersey
JOE KNOLLENBERG, Michigan
CAROLYN B. MALONEY, New York
RICK LAZIO, New York
PETER DEUTSCH, Florida
ROD GRAMS, Minnesota
SPENCER BACHUS, Alabama
LUIS V. GUTIERREZ, Illinois
BOBBY L. RUSH, Illinois
MIKE HUFFINGTON, California
LUCILLE ROYBAL-ALLARD, California
MICHAEL CASTLE, Delaware
THOMAS M. BARRETT, Wisconsin
PETER KING, New York
ELIZABETH FURSE, Oregon
NYDIA M. VELAZQUEZ, New York
BERNARD SANDERS, Vermont
ALBERT R WYNN, Maryland
CLEO FIELDS, Louisiana
MELVIN WATT, North Carolina
MAURICE HINCHEY, New York
CALVIN M. DOOLEY, California
RON KLINK, Pennsylvania
ERIC FINGERHUT, Ohio




(II)

CONTENTS
Page

Hearing held on:
October 27, 1993 ................................................................................................
Appendix:
October 27, 1993 ................................................................................................

1
53

WITNESSES
W ednesday, October 27, 1993
Angell, Wayne D., Governor of the Federal Reserve Board .................................
Borden, John P., President, National Organization of Clearing Houses ...........
Bowsher, Charles, Comptroller General of the United States, General
Accounting Office ..................................................................................................
Carreker, J.D., Chairman, J.D. Carreker & Associates, Inc.................................
LaufTer, James R., Chairman, President, and CEO, the First National Bank
of Herminie; President, Independent Bankers of America ...............................
McDonough, William J., President, Federal Reserve Bank of New York ..........
Wentworth, Howard B., Senior Vice President, Philadelphia National Bank ....

15
31
5
35
38
19
41

APPENDIX
Prepared statements:
Gonzalez, Hon. Hemy B. (First panel) ...........................................................
Gonzalez, Hon. Henry B. (Second panel) ........................................................
Leach, Hon. James A..........................................................................................
Angell, Wayne D.................................................................................................
Borden, John P....................................................................................................
Bowsher, Charles ...............................................................................................
Carreker, J.D.......................................................................................................
LaufTer, James R.................................................................................................
McDonough, William J .......................................................................................
Wentworth, Howard B........................................................................................

54
58
61
81
99
64
108
123
92
130

Additional Material S ubmitted for the R ecord
Chairman Gonzalez requests to have minutes from the Reserve Banks in
what turned out to be the Bank Audit Act of 1978 ...........................................
John Borden requests the Federal Reserve’s documents of approval process
for the payer group sort under the Freedom of Information Act ....................
Written statement oi Tom C. Frost, San Antonio, T X ..........................................
Written statement of E. Gerald Corrigan ..............................................................




(HI)

132
134
150
157




H.R. 28; FEDERAL RESERVE ACCOUNTABILITY
ACT OF 1993
WEDNESDAY, OCTOBER 27, 1993
House of Representatives,
Committee on Banking , Finance and U rban A ffairs,

Washington, DC.

The committee met, pursuant to notice, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry B. Gonzalez [chairman
of the committee] presiding.
Present: Chairman Gonzalez, Representatives Neal, Waters,
Klein, Hinchey, Leach, Roukema, McCandless, Nussle, Pryce,
Knollenberg, Lazio, Grams, and Huffington.
The Chairman. The committee will please come to order.
The Banking Committee begins the 4th day of hearings on issues
involved in H.R. 28, the Federal Reserve System Accountability Act
of 1993.
I welcome Charles Bowsher, the Comptroller General of the Gen­
eral Accounting Office, and look forward to his testimony. He will
tell us about the legal limitations the GAO faces in examining Fed­
eral Reserve operations.
In testimony during these hearings on October 13, Federal Re­
serve Chairman Alan Greenspan told us, and I quote, “GAO, in the
1978 act, could audit all aspects of the Federal Reserve System
with the exclusion of those which refer to the question of the delib­
erations related to monetary policy,” end of quote.
Was he trying to mislead us?
Let me tell you some areas of Federal Reserve operations that
the GAO cannot investigate. Most people do not know that when
the Federal Reserve changes the money supply, it does so from its
New York Federal Reserve Bank in an auction separate from the
U.S. Treasury auctions used to borrow money for government
operations.
Each morning, around 10 a.m., the Federal Reserve Bank of New
York holds a 30-minute auction with approved bank and nonbank
dealers in order to change the monetary base of the United States.
By buying or selling securities, usually very short-term repurchase
agreements, the Fed takes money out of circulation or puts money
back into circulation. There is little information on this auction. We
know there is no market clearing price as was recently introduced
for Treasury auctions. Thus, accepted bids or offers are transacted
at different prices.
Is this the most efficient way to run this market? Why are the
bids and offers not published? Is there any possibility of exploiting
inside information, especially since participants can meet at the




(1)

2

Federal Reserve Bank shortly before the auctions? Can the GAO
send in a team of experts to uncover the answers?
The second example concerns the Federal Reserve's intervention
in foreign currency markets. We know from the minutes of the
1962 FOMC meetings that the Federal Reserve gave itself a fund
for intervention without adequately notifying the Congress or the
public. That fund is now $30.1 billion. The Treasury, on the other
hand, has a fund similar to that of the Fed, called the Exchange
Stabilization Fund, but its budget is approved by the Congress.
According to a description published by the Federal Reserve
Bank of New York in the 1970’s, the Federal Reserve uses commer­
cial banks to initiate some of the transactions involved. For exam­
ple, an intervention by the Federal Reserve to sell German marks
to increase the relative price of U.S. dollars includes the sale of
marks to commercial banks, a request for a swap transaction to the
Bundesbank, and a 2-day settlement period.
Can the GAO send in a team of experts to discern the propriety
of these procedures?
I believe the answer to both situations is, of course, no.
Is it out-of-bounds for the Congress, therefore, the American pub­
lic, to learn about these transactions?
Again, this has nothing to do with the FOMC deliberations or
micromanagement of daily Federal Reserve operations. The Fed
just wants to keep the curtains closed and keep any outside eyes
from reviewing how well—or how bad—its biggest policies are im­
plemented. Who knows whether the Fed’s engine needs a tuneup
if no one will let the mechanic look under the hood?
Now, let’s discuss another gray area where the GAO would be
appropriate. Earlier this year, I was informed that New York Fed­
eral Reserve Bank personnel were accepting hospitality at expen­
sive restaurants ana gifts from the very banks they have authority
to regulate. On May 18, 1993, I received this astounding reply from
E. Gerald Corrigan, the former president of the New York Federal
Reserve Bank, and I quote:
“Our review indicates that in the limited number of instances
where bank officers have been guests at meals hosted by regulated
institutions at what would be considered an expensive restaurant,
they have been acting within bank guidelines, and their conduct
does not call into question the ethical standards of the Federal Re­
serve Bank of New York,” end of quote.
That certainly says something about the ethical standards of the
New York Federal Reserve Bank because such gifts would be ille­
gal for government agencies using appropriated iunds.
President Corrigan also rationalized the acceptance of tickets for
sporting events from regulated banking institutions when he said,
and I quote:
“There were a literal handful of instances involving attendance
at sporting events in which bank officers were guests of acquaint­
ances who worked at regulated institutions,” enaof quote.
But with no outside review, we don’t know how many cases there
were. Maybe this is like the rough notes of FOMC meetings that
turned out to be quite extensive tape recordings and transcripts.
The question I have for the Comptroller General is whether the
GAO can investigate the receipts of hospitality from regulated




3

banks by Federal Reserve employees if the employees say, “We
were discussing monetary policy during our free meals provided by
the XYZ Bank in an expensive restaurant”?
As I understand it, in this case, the Federal Reserve must give
its permission for any GAO examination. Doesn’t the public have
the right to monitor possible conflicts of interest? Are the Fed’s em­
ployees then invested with infallible comportment, merely because
they are sacrosanct officials of the Federal Reserve?
Finally, the reason GAO has such limitations is because the Fed
conducted an elaborate campaign to prohibit any audit bill from
passing and succeeded for many years. In fact, it was not even ap­
proved by the Banking Committee, but by another committee, in
1978.
I am happy to have the Comptroller General here today to dis­
cuss the GAO limitations in examining the Federal Reserve.
Mr. Bowsher, please introduce your associates after I have given
a chance for our minority leader, Mr. Leach, to say a few words or
place his remarks in the record.
Mr. Leach.
Mr. Leach. Thank you, Mr. Chairman. I have a lengthy state­
ment. I would like to read about half of it and place the rest in the
record.
The Chairman. Sure.
Mr. Leach. Mr. Chairman, as you know, I have previously stated
my support for relatively modest reforms to remove certain inde­
fensibly undemocratic elements of the Federal Reserve System. I
am also sympathetic to a greater degree of accountability for Fed
decisionmaking which might include a somewhat more timely re­
lease of FOMC policy directives.
However, I have reservations about the potentially more draco­
nian action of expanding GAO investigation, some call it audit au­
thority, to the monetary policy functions of the Fed.
In this regard, lest there be any misunderstanding, it should be
noted that in the government the term “audit” has two distinct
meanings. The GAO conducts financial audits—so called dollars
and cents audits of balance sheets; and performance audits—or re­
views of programs and the implementation of laws. Performance
audits are akin to audits of the decisionmaking process.
The issue of GAO audit or review of the Fed's conduct of mone­
tary policy is not an issue of first impression. Indeed, beginning in
the early 1950’s, the more general issue of GAO audit of the Fed­
eral Reserve, including the monetary policy function, was widely
debated on Capitol Hill.
The eventual outcome of this 25-year debate was passage of the
Federal Banking Agency Audit Act in 1978. That act, for the first
time, authorized the GAO to conduct both financial and perform­
ance audits of the Fed, exclusive of the monetary policy fixnction.
The monetary policy function was excluded from the purview of
GAO review at that time in recognition of the special political vul­
nerability of a central bank because of the opposition that may be
generated, particularly when it imposes monetary restraint.
There was also—and I believe still is—an awareness of the ex­
treme sensitivity of the confidential nature of information provided




by foreign central banks and governments—information critically
needed in the formulation and implementation of monetary policy.
It is not unreasonable to assume that public knowledge that an
arm of Congress, the GAO, had review powers and access to such
information would have a chilling effect on the Fed’s relationships
with foreign governments and central banks.
Indeed, 2 years ago, when this committee subpoenaed all records
held by the Federal Reserve relating to the BCCI scandal—an ac­
tion I supported—this issue was raised, albeit in the context of
bank supervision.
In that case, the covered records included confidential documents
supplied to the Fed by the Bank of England. The Bank of England
was prohibited by British law from releasing these documents to its
own Parliament and indicated that if the Fed were compelled to
produce them pursuant to this committee’s subpoena, it would de­
cline to share such information with the Fed in the future.
The formulation of monetary policy is a decisionmaking process
that involves confidential interchanges with a host of foreign gov­
ernments and central banks. Just as information sources are not
infrequently protected for reasons of political security and certain
foreign policy agencies of our government, an analogously compel­
ling argument exists that in a world of economic competition and
friction certain financial and economic information provided to the
Fed should be protected for reasons of national economic security.
It is conceivable that even the hint of a possibility of the release
of such information could jeopardize existing relationships among
foreign monetary authorities, the Fed, and the U.S. Treasury, thus,
aggravating our Nation’s international finance relationships.
Confidentiality may be the best protection for financial economic
security and the best protection for taxpayers who would bear the
brunt of any losses resulting from the compromise of policies
caused by the untimely disclosure.
Let me just conclude by saying, I would like to reemphasize that
the fundamental question in the issue of GAO auditing of the Fed’s
monetary policy function involves an understanding, or misunder­
standing, of the word “audit.” Unfortunately, the word “audit” car­
ries connotations that are misleading.
The common usage of the term, in everyday life, is an accounting
of the income and outflow of dollars. In this sense, there is already
100 percent audit of the Federal Reserve.
But what we are talking about here is a fundamental review of
the information and decisionmaking process which raises implica­
tions more of data sources and timeliness than it does of dollars
and cents.
As this committee well understands, the Fed makes a profit
every year, over $16 billion in 1992, that goes to the Treasury. To
the degree that market sensitive information is released in an un­
timely manner that profit is jeopardized. The greater protection
provided the Federal Reserve System, the better off the taxpayer.
I thank the Chairman.
[The prepared statement of Mr. James Leach can be found in the
appendix.]
The Chairman . Thank you very much.




5

I am going to ask unanimous consent that all members present
and absent have an opportunity to place in the record any written
preliminary statement they may wish to make at the outset of this
nearing to appear in the transcript.
We will proceed and recognize General Bowsher.
If you will, introduce your associates.
STATEMENT OF CHARLES BOWSHER, COMPTROLLER GEN­
ERAL OF UNITED STATES, GENERAL ACCOUNTING OFFICE

Mr. Bowsher. Thank you very much, Mr. Chairman, members of
the committee.
I am accompanied today by Mr. Socolar, who is my Deputy; Mr.
Bothwell, who is in charge of all our banking and financial institu­
tions work; and Mr. Swaim, who has done most of our work at the
Fed in recent years.
We are pleased to be here today to discuss the limits of our audit
authority over the Federal Reserve System. My remarks principally
will concern the provisions of section 3 of H.R. 28 which would re­
move all restrictions on our authority to examine Federal Reserve
activities.
Currently, we lack audit authority over the Federal Reserve’s
monetary policy, foreign transactions, and the Federal Open Mar­
ket Committee operations.
In responding to the committee’s request, I will first describe our
existing authority and some of the work we have done under this
authority. I will then examine the implications of removing all re­
strictions on our authority, with specific reference to several topics
the committee asked us to address. Finally, I will discuss certain
safeguards that we feel would be appropriate to adopt if restric­
tions on our authority are to be removed.
The question of whether to lift the statutory constraints on our
authority to audit the Federal Reserve System ultimately depends
on what Congress wants us to do. Our access needs to be commen­
surate with the types of audits that the Congress expects us to
perform.
For just a little history here, we derive our Federal Reserve audit
authority from the Federal Banking Agency Audit Act of 1978. This
act was passed after we did a special congressionally mandated
study of the supervisory activities of all of the Federal bank regu­
latory agencies.
Before the act, our work at the Federal Reserve was mainly lim­
ited to audits of the fiscal agent functions performed by the Federal
Reserve banks for the Department of the Treasury. We did this
work under our authority to audit the Treasury.
Although the act significantly expanded our access to the Federal
Reserve System and other bank regulatory agencies, it precluded
us from auditing activities related to monetary policy, foreign
transactions, and the FOMC. The exact wording of the limitation
is set out in appendix 1 of my statement.
The act also prohibited us from disclosing certain information
identifying open financial institutions and customers. Appendix 2
describes these prohibitions in greater detail.
The act does not require us to perform any particular type of
audit. This means, as is true with most of our work, that our au-




6

dits are determined largely by specific congressional requests or by
our discretion under our basic legislative authority. As appropriate,
of course, we coordinate all of our activities with the Federal Re­
serve’s Office of Inspector General.
Notwithstanding the limitations on our authority, in the last 15
years since the act was passed, we have audited many aspects of
the Federal Reserve System in areas in which our access nas not
been restricted. And we mention several of those studies here. They
were basically in the area of bank supervision and regulation, in
the payment system activities, and in tne government securities ac­
tivities.
Our current work that involves the Federal Reserve, either exclu­
sively or as part of a study of all bank regulatory agencies includes:
One, studies of regulatory burden; two, implementation of major
provisions of the Federal Deposit Insurance Coiporation Improve­
ment Act of 1991; three, analysis of the risk and benefits of inter­
state banking; four, the regulation and supervision of derivative
products; five, an analysis of the banking industry activities in mu­
tual funds; six, loan loss reserving by banks; seven, review of ef­
forts to ensure a safe and sound international banking system
through coordination among national regulators; and, eight, analy­
sis of the expenses and revenues of the Federal Reserve System as
they affect the Federal budget.
As I have indicated, section 3 of H.R. 28 would remove all of the
restrictions on our authority to examine Federal Reserve activities.
This would provide us with full access to FOMC transactions; to
transactions for or with foreign central banks, governments, and
international financing organizations; and to deliberation, deci­
sions, and actions on monetary policy matters, including discount
window operations, member bank reserves, and open market
operations.
In considering the implications of removing restrictions, it is use­
ful to look more closely at the types of work we do. Our audit work
can be viewed as falling into two broad categories: financial audits
and performance audits.
I will just briefly describe financial audits, Mr. Chairman. And
I hope my full statement could be put in the record.
Financial audits are basically where the auditor goes in and
checks the flow of funds through the organization. You check the
internal controls, the systems; and according to the government au­
diting standards today, we are asking for more review of the con­
trols and the systems to see whether they are adequate or not. And
then the auditor gives a report at the end of that work.
Starting on page 10, section 3 of H.R. 28 proposes that all Fed­
eral Reserve banks, as well as the Board of Governors, be audited
annually by an independent public firm, not the GAO. In other
words, the way your legislation is set up, it would be an audit by
an outside public accounting firm.
I am inclined to believe that this outside review would be bene­
ficial for both the Federal Reserve and the general public. If the
restrictions on our access were removed, we would be better able
to assess the quality of those financial controls in auditing the
Federal Reserve’s system and make recommendations for
improvements.




7

Concerning performance audits, I would like to discuss access is­
sues by referring to the three areas we were asked to address in
our testimony. These issues are: One, the daily government securi­
ties auctions at the New York Federal Reserve Bank which the
Federal Reserve uses to manage the money supply; the Federal Re­
serve's interventions in foreign currency markets; and safeguards
in the auctions, and presumably foreign currency transactions as
well, against the Federal Reserve's releasing inside information.
Our access restrictions would be a major limitation to studying
any of these issues in a way that required us to analyze data on
actual transactions. Although it would be necessary for us to con­
sider the actual scope of a request before reaching a judgment in
any particular case, we must recognize that the restrictions in the
law are quite explicit. Therefore, with performance audits, as well
as with financial audits, the major question is really what Congress
wants us to do.
Now, if Congress decides to remove the existing restrictions on
our audit authority, we believe certain safeguards should be in­
cluded in the legislation. These safeguards, which are similar to
those that already exist under our present authority should: One,
prohibit us from disclosing the identity of foreign central banks or
governments; two, prohibit us from disclosing confidential docu­
ments and require safe keeping of confidential information; and,
three, specify delays in our access to certain types of confidential
information.
These safeguards are important because they make clear that re­
moving our audit restrictions will not necessarily jeopardize the
Federal Reserve’s independence.
I would like to say to the committee that we, in no way, want
to jeopardize the Federal Reserve’s independence.
For example, with these safeguards, we could not use our ex­
panded audit authority to undertake contemporaneous reviews of
the Federal Reserve’s monetary policy decisionmaking functions.
Also, immediate disclosure of information about Federal Reserve
decisions in a situation such as the stock market break of October
1987, might not be in the public interest because it could disrupt
the financial markets. Our role should be to make after the fact as­
sessments of the Federal Reserve’s performance, both in general
and in problem situations.
In summary, we have been able to do significant audits of the
Federal Reserve, despite the existing limitations on our authority.
Congress obviously must decide whether our audit authority should
be expanded.
However, if our audit authority is expanded, we believe measures
should be included to protect against release of confidential docu­
ments and to prevent undue interference with the Federal Re­
serve’s ongoing policymaking functions.
This concludes my prepared statement, Mr. Chairman. We would
be pleased to answer any questions.
[The prepared statement of Mr. Bowsher can be found in the
appendix.]
The Chairman. Thank you very much.




8

Is a private accounting firm in the best position to do an annual
financial audit of the Federal Reserve? Or is it more desirable for
the GAO to conduct the annual audit?
Should the Banking Committee consider allowing the GAO to re­
view any audits of the Federal Reserve by private accounting
firms?
Mr. Bowsher. You could do it either of those ways, I think, and
have a satisfactory result.
I think the big accounting firms could do the audit. We could do
it, although we are somewhat strapped for people now as we are
coming down in size. Just yesterday, the President, in announcing
his new National Performance Review, Summary of Government
Reform and Savings Act of 1993, called for audited financial state­
ments of 23 key Federal agencies. That is, the 23 largest agencies
in the Federal Government, which would comprise about 90 per­
cent of the Federal Government.
So there is going to be a big effort here in all of the Federal Gov­
ernment, if the Congress votes for that legislation. This would be
a big effort too. So I would think it might make sense to have the
independent CPA firm do the financial audit and then possibly
have us do some review of that as we do on many of the govern­
ment corporations.
The Chairman. Mr. Leach.
Mr. Leach . N o questions.

I appreciate your perspective, as we do in this committee very
often. Thank you.
Mr. Bowsher . Thank you.

The Chairman. Mr. Neal.
Mr. N eal. I think you have expressed these views before over the
years. They are not new, and I respect your opinion. And, in fact,
as you know, just yesterday in another hearing we were lauding
your operations, praising you for the good work that you do.
I don’t want to take a long time on this. I am just curious, what
is it that, especially in the open market operations, that would
trouble you to make you think that we—I guess I put it in terms
of sort of a cost benefit view of things. I mean as a clear benefit,
you said you don’t want to interfere with the independence of the
Fed. There is a well understood benefit in keeping the Fed inde­
pendent from political pressure, so it can try to take the long view
of things, which means that it can help keep inflation down, keep
interest rates down, and so on, that could be compromised, every­
one recognizes, if we do too much political meddling.
Now, the worry—the reason that an audit of the open market op­
erations was specifically prohibited in earlier legislation was that
we didn’t think that the benefit of getting into that area would out­
weigh the costs.
What makes you come to a different conclusion?
Mr. Bowsher. I don’t come to a different conclusion, Mr. Neal,
other than to say that sometimes having any process reviewed to
see whether it is being done fairly, efficiently, and things like that,
has some benefit.
But I have no knowledge of how that operation really works. So
I have no evidence to put forth to you that there is a big need here.




9

But in any operation of any large organization, sometimes it is
good to have a performance audit as to how well is it working.
Mr. N eal. I mean as a general principle, I can’t disagree with
you. I think that makes some sense. Again, I think here—well, let
me ask this question: How about our inspector general over there?
Is it your impression that----Mr. Bowsher. Well, you know, I read his last report, and he is
raising one issue that you might want to consider, and that is that,
according to the government auditing standards, independence is a
big issue; and he believes that independence would be enhanced if
the Financial Examination Program reported to the Board, where­
as now it reports to a division within the Federal Reserve.
And so I would think that the committee might want to look at
the issue that he has raised in his most recent report. And it is just
really the question of independence that they have in doing their
work.
Mr. N eal. You know, when I was chairman of the subcommittee
that had the oversight responsibility for the Fed, we heard from
the inspector general once a year; and we always made it very
clear, publicly, privately, and in every way, that the discussion off
the record was open and we wanted to hear from him, if he had
the slightest suspicion of any problem of any kind.
Mr. Bowsher. I think that is very good that you would do that.
Now the question is: How open of a door does the Financial Exam­
ination Program have to the----Mr. N eal. To the Board itself?
Mr. Bowsher. To the Board itself? And that is the issue that he
is raising in his report.
Mr. N eal. That is something that we ought to take a look at?
Mr. Bowsher. Yes.
Mr. N eal. I guess I am still just a little—my worry is, I have
seen what can happen when the Fed does not do its job right. We
went through this very costly period in our economy: Huge unem­
ployment, disruption, just incredible suffering that that caused.
Now we are moving in the right direction, got inflation down, in­
terest rates down. I am just worried about doing something to get
in there and foul it up.
So really, to me, it is a cost/benefit question. I don’t quite know
how to get at it. Because, I mean, as a general principle, I couldn’t
agree with you more, that we should have openness and no one is
perfect. You know, the idea of getting in there and taking a look
at things sounds very healthy. It is this other worry.
I guess the worry is about sort of going too far, especially if we
were to legislate it. Say we started the legislative ball rolling
around here and it just seems to me the temptation would be great
to just keep it moving in a way that would end up being harmful
to us.
Do you have any thoughts on that?
Mr. Bowsher. I don’t really have a lot of thoughts on it, Mr.
Neal. In other words, we would be willing to do the work as the
Congress wants it done. But I think it is up to you gentlemen and
ladies to make your policy decision on this issue.
Mr. N eal. Thank you, sir, very much.
The Chairman. Mr. Knollenberg.




10

Mr. K n ollen b erg. Thank you, Mr. Chairman.
I am a strong believer in the maxim that, if it ain’t broke, don’t
fix it. And I think I have made that clear at previous meetings of
this committee.
But could you outline any benefits there might be that may be
derived from having the GAO audit the FOMC? And aren’t there
some potential political risks in this process?
Maybe you have some thoughts that you might want to elaborate
on in regard to that.
Mr. Bowsher. The benefits, basically, would be just having an
independent check on the procedures and the systems that are
used and the policies that they have laid out being followed. That
is basically the way we do these performance audits.
So what you are doing is you are just checking to make sure that
things are working the way they should be in a manner that every­
body has agreed is what they want done.
Tne political concerns, I aon’t have any feeling on that one way
or the other. I would leave that up to your judgment.
Mr. K nollen b erg. I have no further questions.
Thank you.
The Chairman. Thank you.
Ms. Waters.
Ms. W aters. No questions.
The Chairman. Mr. McCandless.
Mr. M cCandless. Thank you, Mr. Chairman.
'' "
1
ad I have spent quite a bit of time together
I am going to go back to our discussions yesterday at the Govern­
ment Operations full committee as to the procedures that are fol­
lowed by GAO relative to the construction, the review, and the ulti­
mate release of a document, a report on subject X.
It was an interesting discussion, because there were checks and
balances through the process, as we discussed it, not only inter­
nally between your management reviewing the product, but also in
some cases, the product being reviewed by the office or the depart­
ment, in some cases, prior to release for purposes of maybe refining
it.
In the subject here today, we are talking about videotaping the
actual proceedings of an action. We are talking about immediate
release of a transcript of everything that has taken place and all
of the surrounding aspects of making everything public, except I
guess when somebody excuses themselves to go to the sand box.
This seems to be a contrary approach to the process of adminis­
tration of a public office. I would appreciate your thoughts on what
appears to me to be a total opposite in terms of how you function.
Mr. Bowsher. Well, the way we function is we----Mr. M cCandless . The comparison is what I am interested in.

Go ahead. I am sorry. I didn’t mean to interrupt you.
Mr. Bowsher. The way we function, Mr. McCandless, of course,
is two ways. When we do a review, about 50 percent of the time
on our major reports, we give a copy of the report to the agency
and ask for their official comments and we bind those comments
into the back of the report.




11

The other 50 percent of the time, for various reasons, we don't
get official comments, but we always have an exit interview, and
we try to take into consideration any of the issues that the audit,
you might say, raises in finalizing our report.
Now, as we discussed yesterday, sometimes, unfortunately, some
people will leak a report from the agency or sometimes if it gets
over here on the Hill—and we run into trouble when sometimes
that happens. If that was to happen in the Federal Reserve type
situation, it would be, I think, most unfortunate, as it is generally
in all of the other cases.
So one of the things we might want to do, if you wanted us to
do these kind of reviews, is to set up special processes to safeguard
the release of the reports; this would be one thing I might want to
consider with you.
Mr. M cCandless. Do you feel from your experience and the op­
eration of GAO that it is a good idea to have an agency operating
in a fishbowl while it is developing policy?
Mr. Bowsher. We have always generally been, in doing our

work, after the fact.
In other words, we have not been auditing, you know, right then
and there while a committee is making a decision or while the de­
fense officials are making their decisions on weapons systems or
forces.
And generally our process is to go in after the fact and to look
and see how it was done and to report on the process, you might
say.
Mr. M c Candless . Well, what I made reference to here is you are
also examining compliance with existing regulations and making
comments in your report relative to these issues.

So that is where I was focusing from a policy point of view: Is
it good government business to have such an organization operat­
ing in a fishbowl environment while in the process of making rath­
er substantial decisions on the future of the country's business?
Mr. Bowsher. Well, I think that is a major policy decision for
the Congress to make here. In other words, in some cases Congress
has generally come out on the side of openness and sunshine.
Other times you have made the decision that you thought, like
with National Security Council decisionmaking and things like
that, it was not. So I think that that is a policy decision for you
people to make. I think it is a very important one.
Mr. M cCandless. Good political answer. Thank you.
My time is up.
The Chairman. Thank you.
Mr. Grams.
Mr. Grams. I have no questions.
The Chairman. Mr. Huffington.
Mr. Huffington . N o questions. Thank you.

The Chairman. OK
Do you have any further questions?
Mr. N eal. May I ask one?
The Chairman. Yes. Certainly.
Mr. N eal. I would just like to ask one more question if I can.
I am just trying to get a little clearer fix on what is and what isn’t
done.




12

As I understand it, the Fed—all the regional banks are audited
internally, and then the Governors have an auditing system in ad­
dition to that. They audit the banks. Then the operations of the
Federal Reserve System itself are audited.
Other than the transactions between our Fed and foreign
banks—and the reason for that is that if we were to make public
those relations—the foreign banks simply wouldn’t do business
with us. I mean they are much more secretive than our banks. And
our Fed thinks it is valuable to have that information. And so the
practical matter is, if they thought that their relationships with us
were made public, then they would simply shut down their
operations.
The discount window operations aren’t audited because if you
make public the transactions between the discount window trans­
actions between the Fed and the bank, that would signal that that
bank was in trouble and you might cause a run on the bank.
So there is a pretty good reason for not making all that public.
And then the open market operations aren’t audited, and the ar­
gument has always been there that you don’t want to audit them
because that would start to compromise the independence of the
Fed and get into the conduct of monetary policy itself, because, as
a matter of fact, what they do, they buy and sell; and the only real
thing to look at is, I mean, to say, did you buy this on a certain
day? Well, sure, you either did or you didn’t. I mean there is noth­
ing to hide there. They did or they didn’t. So there is really not
much to get into except questions of policy.
Mr. Bowsher. Yes.
Mr. N eal. So as I understand it, these are the three main areas
where we don’t have audits, and everything else is well audited, if
I understand you correctly. And that is what I would like for you
to comment on.
So I don’t think that we ought to leave—my point here, to me,
is that it seems to me there are probably pretty good reasons that
almost anyone would agree to that we shouldn’t get into these
three areas. And we don’t want to leave this impression that some­
how this massive operation, all these banks and the regulatory op­
erations and so on, aren’t audited, because they are. That is what
I want you to comment on.
Mr. Bowsher. They are audited, Mr. Neal. And you described it
basically right. They just don’t pull it all together like you would
with an external financial audit. And that is the thing.
The one thing I should also say—and my colleague made a note
here for me—is that if you are going to have a financial audit, then
the outside auditor would have to be able to look at the necessary
transactions to give his opinion on the overall operations. But there
is no question that today, the Federal Reserve has certain compo­
nents of their operation, most of the large components, being au­
dited by their internal procedures.
Mr. N eal. Is there any reason to doubt the adequacy of those
procedures?
Mr. Bowsher. We have not done any work that would answer
that.




13
Mr. N eal . Do you agree that the reasons I gave for not having
auditing— especially auditing that would be made public— of these
three areas makes some sense?
Mr. Bowsher. They do. But I think also some people would want

to have those processes checked out every once in a while. I think
that is really the other part, to just see how well are they working.
After the fact, mostly.
In other words, as you say, when they are in a crisis stage with
some big problem, you dont want to have the auditors there at
that point in time. But at some point in time, periodically or some­
thing like that, it might be good to be checking the processes. That
is really your policy question, I think.
Mr. N eal. Well, you mean maybe with a timeline, 5 years or
something. Say you had a bank in trouble and it had to do discount
window operations with the Fed and you would say that it would
be—possibly could be important to go in and take a second look at
that after the fact—not after time—so that you might exacerbate
a bad financial situation, but with a time lag of, what? How long
a period of time would you say?
Mr. Bowsher. Some audits of discount window operations that
are related to bank supervisory activities we can do now, even with
the exclusions that are there.
What we can't look at is the foreign operations and the monetary
policy aspects.
The Chairman. The time of the gentleman has again expired. We
have some witnesses following.
Thank you very much, Mr. General and associates. We deeply
appreciate your helping. And we will be in sustained communica­
tion as we continue to travel along the road of H.R. 28.
Our next and second panel consists of Governor Wayne D.
Angell, the Governor of the Federal Reserve Board; and President
William J. McDonough, president of the Federal Reserve Bank of
New York.
I want to welcome Mr. William J. McDonough, Vice Chairman of
the Federal Open Market Committee and the president of the Fed­
eral Reserve Bank of New York and Governor Wayne D. Angell,
Federal Reserve Board.
I certainly want to hear your views on the GAO audit limitations
and whether or not you think they are justified.
Before turning to that, however, I have a very serious matter to
address. As you know, in H.R. 28, there are provisions that require
the release of any policy change within 1 week and a videotape of
FOMC discussions within 60 days.
You both know that I inquired of all of the Federal Reserve Bank
presidents and the Governors in my letter of October 22, 1992,
about minutes of FOMC meetings. Chairman Greenspan wrote the
following to me on December 24, 1992, and I quote:
“Members felt that making a tape or literal transcript public
would have an especially restrictive effect in discussions,” end of
quote.
For the hearing last week on October 19, 1993, I asked each Fed­
eral Reserve official to include in his or her testimony any knowl­
edge of notes or records made by others at FOMC meetings.




14

And even though you didn't appear, Vice Chairman McDonough,
you submitted testimony as follows—and I am going to quote from
it:
“I have no personal knowledge of any other notes or records that
others may have made at FOMC meetings,” end of quote.
Yesterday, I received a letter from Chairman Greenspan saying
that there have been tape recordings made at FOMC meetings
since 1976, that the FOMC has unedited transcript and staff notes
from transcripts existing back to 1983.
In addition, the meeting room for the FOMC has a complete
setup for tape recording including, and I quote:
“A green light on top of the meeting table near its head is lit
when the recording system is in use,” end of quote.
How could anyone not know what that green light meant and fail
to tell the Congress or report that there were no literal trans­
lations?
I also must say I have some trouble with Chairman Greenspan’s
statements, that he knew about the taping when he first assumed
office and he forgot when he learned about unedited transcripts.
I am going to quote:
“Indeed, until a staff member jogged my memory in the last few
days, I had been under the impression that I first learned only
about a year ago that transcripts were being retained,” end of
quote.
If I were sitting in front of a green light, as we do here, and it
lit up every time I talked, I think I would have been a little bit
more inquisitive about what was going on. It would jog my mem­
ory. I hope they didn’t think that when the green light went on it
meant raise interest rates.
Now that we know that Chairman Greenspan initiated a con­
ference call and informed the Governors and presidents about the
tape recordings, why did they give the testimony we received last
week on October 19?
I want to thank Governor Angell for testifying that he knew
about the transcripts several years ago. However, if that is the
case, why did you join in the misleading reply sent to me from
Chairman Greenspan on October 26, 1993?
This is a time in our Nation’s history when the public demands
accountability from its government officials. There are many citi­
zens who are losing their trust in government.
The less-than-truthful response to my requests by the senior offi­
cials of the Federal Reserve about minutes and their testimony last
week raises serious questions. Why all these discrepancies?
We held these hearings to encourage greater accountability of the
Federal Reserve. And sincerely believing that, in the end, it would
be helpful even to preserving and maintaining the rightful entitle­
ment to independence. The outrageous deception of the last few
days shows precisely why greater accountability is needed.
Now, as for the GAO audit, I can paint no better case for a GAO
audit than the outcome of the inquiry I made on the acceptance of
hospitality and gifts by the Federal Reserve of New York Bank offi­
cials from the very banks that they regulate.




15

Evidently, from the opening statement that you sent us, Mr.
McDonough, this practice has not ended. You have yet to establish
what you call a, quote, “paper trail,” end of quote.
I don’t think this is an adequate response when such hospitality
is illegal for other government employees. I would certainly expect
these practices to be curtailed, to establish an arm’s length rela­
tionship with those you regulate, just as other regulators nave al­
ways done.
I don’t think the American public, and particularly those that
have elected us to represent them as their agents, would be satis­
fied with less.
If it has seemed, through the years, that maybe they weren’t, the
impression I had all of these 32 years, is that they just didn’t see
any choice, they just didn’t see any hope that anything they could
do would matter, if their agents didn’t care enough either.
So, respectfully, I must say that the intent, the purpose of having
the agency the Congress has created for that purpose, to give us
some accountability of this great institution, is done with that
single-minded purpose of accountability.
I think that every one of our branches, whether it has been the
legislative—through our history, or the executive or the judiciary,
where it has power in accountability—our history shows we have
had rather difficult times for the public interests.
None of us, whether it is in the Congress, is exempt from the dic­
tum that if we have power, we must render accountability to the
best of the frail human abilities that we can summon. I have never
had any satisfaction in seeing anybody’s discomfort or anything,
and that is not the purpose. And I think my record, whether as
chairman of subcommittees that I have chaired all through, or as
full committee chairman at any time, reveals that I have, at any
time, been abusive or even discourteous to any witness who has
been kind enough and respectful enough to answer a request to ap­
pear as witnesses.
So thank you very much for your patience at hearing these pre­
liminary remarks.
And if there is no objection, I will introduce you as we listed you
and recognize Governor Angell first.
STATEMENT OF WAYNE D. ANGELL, GOVERNOR OF THE
FEDERAL RESERVE BOARD

Mr. A n g e ll. Mr. Chairman, thank you very much. Mr.
McDonough and I, of course, will want to respond directly and fully
to any questions you have on these matters that you have raised.
With your permission, I will go through the testimony. I will
leave out a few items in my statement so as to provide ample time
at the end to respond forthrightly and directly to your questions.
The Chairman. Certainly, Governor.
In fact, may I say that we want to thank you for submitting your
prepared statements. And they will appear, if there is no objection,
as you gave them to us in writing, following your oral presentation.
And you may proceed as you deem best, sir.
Mr. A n g e ll. Thank you, Mr. Chairman.
I am pleased to have this opportunity to speak on the General
Accounting Office’s authority to audit Federal Reserve operations




16

and the changes to that authority that would be made by H.R. 28.
President McDonough is addressing the scope of GAO audit author­
ity from the perspective of the Federal Reserve Bank of New York.
At the outset, I would like to dispel the notion I have frequently
heard that the Federal Reserve is not subject to GAO audit. In
1978, the Federal Banking Agency Audit Act gave the GAO broad
authority to audit most of the operations of both the Federal Re­
serve Board and the Federal Reserve banks.
Since then, the GAO has completed more than 100 reports on
various aspects of System operations, as well as numerous other re­
ports that involved us less directly. At present, the GAO has rough­
ly 25 audits of the Federal Reserve under way and maintains sev­
eral of its staff in residence at the Board and at selected Reserve
banks.
The GAO has free rein to audit the System, subject to explicit
exemptions for: Deliberations, decisions, or actions on monetary
policy matters including discount window credit operations, re­
serves of member banks, securities credit, interest on deposits, and
open market operations; transactions made under the direction of
the FOMC; transactions with, or for, foreign central banks and gov­
ernmental entities; and discussions or communications among or
between members of the Board and of officers and employees of the
Federal Reserve System related to these matters and transactions.
By excluding these areas, the act attempts to balance the need
for public accountability of the Federal Reserve through GAO au­
dits against the need to insulate the central bank’s monetary policy
functions from short-term political pressures and the need to en­
sure that foreign central banks and government entities can trans­
act business in U.S. financial markets through the Federal Reserve
on a confidential basis.
The precise line differentiating those Federal Reserve specific op­
erations and activities that are subject to GAO audit under the
Banking Agency Audit Act, and those that are exempt from audit
is difficult to draw in the abstract.
Over the years, since the passage of the act, the Federal Reserve
has worked with the GAO to define those limited areas that are not
subject to audit on a case-by-case basis in the context of individual
audits. In the future, we will continue to work with the GAO to ad­
dress its concerns consistent with the mandate of the act.
Expanding the GAO’s audit authority over the Federal Reserve
into the exempt areas would be contrary to the public interest.
Such an expansion could adversely affect Federal Reserve effective­
ness in the conduct of monetary policy.
As the Banking Agency Audit Act recognized, such a change
could reduce the central bank’s insulation from day-to-day political
pressures. Even what appears to be a very limited audit of the effi­
ciency of monetary policy operations could, in fact, turn into pres­
sure for a change in monetary policy itself. For example, the ques­
tion posed to Comptroller Bowsher in connection with these hear­
ings as to whether the magnitude of our open market operations
reflects unnecessary buying and selling of government securities
are monetary policy questions, not efficiency questions.




17

The number of transactions that the Open Market Desk com­
pletes in carrying out the FOMC’s directives correlates directly
with the substance of the policy in place.
GAO scrutiny of policy deliberations, discussions, and actions
could impede the process of formulating policy. A free discussion of
alternative policies and possible outcomes is essential to minimize
the chance of policy errors. The prospect of GAO review of forma­
tive discussions, background documents, and preliminary conclu­
sions could have an adverse effect on the free interchange and
consensus-building that leads to good policy.
Transactions made under the direction of the FOMC include for­
eign exchange operations. The efficacy of these operations is cru­
cially dependent on confidentiality. Important daily contacts and
exchanges of information with foreign monetary authorities are an
integral part of these operations. They now take place in a candid
and constructive atmosphere.
The possibility of a GAO audit of our foreign exchange operations
would reduce the willingness of foreign authorities to share infor­
mation with us and would thereby reduce the effectiveness and effi­
ciency of our operations which are frequently coordinated with for­
eign authorities.
This caution also applies to the exemption for transactions that
the Federal Reserve carries out as agent for foreign entities; how­
ever, there the principal issue is one of sensitive proprietary infor­
mation about foreign governments, foreign central banks, and
international financial organizations.
The benefits, if any, of broadening the GAO’s audit authority into
the areas of monetary policy and transactions with foreign official
entities would be small.
With regard to purely financial audits, the Federal Reserve Act
already requires that the Board conduct an annual financial exam­
ination of each Reserve bank. The Federal Reserve places great im­
portance on both the Reserve banks internal audit responsibilities
and the Board's responsibilities for examination of Federal Reserve
Banks, in part because it recognizes that its ability to police Fed­
eral Reserve Bank operations is critical to public and congressional
confidence in the Federal Reserve System.
The process of conducting annual financial audits is reviewed by
a public accounting firm to confirm that the methods and tech­
niques being employed are effective and that the program follows
generally accepted auditing standards applicable to the audit of
Federal Reserve Banks. These examinations are complemented by
extensive Board oversight and supervision of Federal Reserve Bank
activities, including Board operations reviews of Reserve bank ef­
fectiveness and efficiency, as well as by comprehensive audits con­
ducted by each Reserve Bank’s independent internal audit function.
Oversight and supervision of Federal Reserve Bank activities in­
clude review of Federal Reserve budgets and expenditures as well
as personnel and operating policies.
The Board’s annual financial examinations of Federal Reserve
Banks, operations reviews, and its oversight and supervision of
Federal Reserve Bank activities specifically includes examinations,
operations reviews, and oversight of open market and foreign
transactions.




18

The annual financial examinations include review of all accounts
for accuracy, compliance with internal controls, and confirmation
that balances reflected on the books agree with the records of
accountholders.
Operations reviews for effectiveness and efficiency of open mar­
ket and foreign operations are conducted by multidisciplinary
teams, including economists familiar with FOMC operations and
specialists in data and physical security, automation, communica­
tion, accounting, and secondary market trading and settlement.
These operations reviews also include the Federal Reserve Bank of
New York’s internal audit attentions to the open market account.
Further, a private accounting firm audits the Board’s balance
sheet, and the Board’s inspector general audits the effectiveness
and efficiency of Board programs and operations under the Inspec­
tor General Act of 1978 as amended.
The Board has continually reviewed its procedures for examina­
tions and oversight of Federal Reserve Bank activities. For exam­
ple, recently the Board has contracted for independent private au­
dits of two Federal Reserve Banks, Kansas City and Cleveland, in
order to provide an independent evaluation of the Reserve banks
control environments and the Board’s examination procedures and
to determine the feasibility of substituting, from time to time, out­
side audits for financial examinations by the Board’s examiners.
These audits have indicated that previous financial examinations
of these Reserve banks were at least as thorough as the outside
audits, that those Reserve banks were well controlled, and that
financial controls may be regarded as satisfactory from an audit
perspective.
Indeed, these audits have indicated that many policies are
uniquely applicable to Federal Reserve Banks and that, in these
areas, the Board’s examiners have a significant advantage in audit­
ing for Federal Reserve Bank compliance.
The Board is strongly committed to ensuring that its examina­
tions, both internal and external, oversight and supervision of Fed­
eral Reserve Banks, as well as its own internal audit function and
external audits, are as effective as possible and will continue to
review these fiinctions with an eye to ensuring their future
effectiveness.
Finally, and more broadly, Congress has, in effect, mandated its
own review of monetary policy by requiring semiannual reports to
Congress on monetary policy under the Full Employment and Bal­
anced Growth Act of 1978 and by holding hearings on various mon­
etary policy issues as they arise.
In addition, there is a vast and continuously updated body of lit­
erature and expert evaluation of U.S. monetary policy. In this envi­
ronment, the contribution that a GAO audit would make to the ac­
tive public discussion of the conduct of monetary policy is not likely
to outweigh the disadvantages of expanding GAO audit authority
in this area.
In sum, we believe that the Board’s supervision and oversight of
Federal Reserve Bank activities and the Board’s own audit func­
tions have served the public interest well, particularly in the area
of confidentiality of monetary policy information.




19

In this regard, Mr. Chairman, vou have asked about the security
checks on personnel involved in the monetary policy process and in­
cidents of so-called insider trading by Federal Reserve officials.
Attendees at FOMC meetings are now required to have “secret”
or higher clearances. And, over the years, there have been only
three known incidents where monetary policy information may
have been used for private gain.
I have fully explained these incidents in the written testimony,
Mr. Chairman. And I will be happy to respond to questions on
these incidents as well as on the entire subject matter of these
hearings and the particular questions that you posed at the
beginning.
We believe that the paucity and nature of the three incidents de­
scribed over the 80-year history of the Federal Reserve System is
strong evidence of the integrity of the Federal Reserve monetary
policy process.
Further, it is doubtful that any of these incidents would have
been prevented by a broadened GAO audit authority.
For these reasons, and the reasons previously stated, we believe
the enactment of the provisions of H.R. 28 that would expand the
GAO’s audit authority by removing the current exemption from
monetary policy matters; transactions made under the direction of
the FOMC; and transactions, with or for, foreign official entities
would be counter to the public interest.
Thank you, Mr. Chairman.
The Chairman. Thank you, sir.
[The prepared statement of Mr. Angell can be found in the
appendix.]
Mr. McDonough.
STATEMENT OF WILLIAM J. McDONOUGH, PRESIDENT,
FEDERAL RESERVE BANK OF NEW YORK

Mr. McDonough. Thank you, Mr. Chairman.
I believe that, as an American citizen, it is always an honor to
appear before a congressional committee, and I welcome the oppor­
tunity to appear before you today to provide my views on H.R. 28.
I will focus on the implications of the proposal for the actions
taken by the Federal Reserve Bank of New York in implementing
FOMC decisions and carrying out activities for a foreign account.
I would like to comment on the scope of the current exemption
and to make clear to the committee my appreciation and respect
for the audit process.
Also, I would like to take this opportunity to note steps that can
be taken to ensure further the effectiveness of GAO audits of the
bank, within the GAO’s current authority.
In my opinion, that authority provides sufficient scope to address
many of the concerns you have asked me to discuss today.
I believe that the elimination of the current exemption would
interfere with the Fed’s ability to formulate and execute an optimal
monetary policy. It would introduce the unmistakable potential for
political influence; every movement and nuance of policy would
then have to be examined in light of that potential.
At the core of my concern is the fact that the process by which
we implement monetary policy is inextricably entwined with the




20

policy itself. For example, questions regarding the volume of open
market operations on the surface may appear to be questions of ef­
ficiency. In fact, they relate to the policy intent to avoid undue vol­
atility in the markets. The idea that the process of executing open
market operations may be audited without imposing judgments
about the policy itself is, I believe, simply not realistic. The poten­
tial for damage clearly would outweigh any possible benefit to the
public from GAO audits of monetaiy policy operations.
I feel equally strongly, Mr. Chairman, about the impairment of
our policy implementation if the exclusion were to be lifted on the
foreign side. Foreign exchange intervention is conducted not only
in coniunction with the Treasury, through the Exchange Stabiliza­
tion Fund, which is exempt from GAO audit, but also frequently
with or on behalf of foreign central banks and monetary authori­
ties.
We hold a very large amount, over $300 billion at present, of
marketable U.S. Government securities representing dollar re­
serves of these official foreign entities. I cannot presume to gauge
the response of all of these central bank Governors and finance
ministers; but I can tell you with absolute certainty that there is
some number of them, and perhaps a large number, who would
question the appropriateness of their reserve activity being scruti­
nized by the GAO and the Congress. This would almost certainly
be damaging to the relationships that are so central to inter­
national monetary cooperation and, perhaps, to the role of the dol­
lar. Certainly, it would impair the ability of the U.S. monetary au­
thorities to conduct their foreign exchange intervention policies on
a coordinated basis with the same effectiveness and efficiency we
enjoy today.
Having said that, I want to reiterate that I do not have some sort
of reflexive distaste for auditors or the audit process. To the con­
trary, as someone who has had managerial responsibility for large
organizations in both the public and private sectors, I have a
keen appreciation for the role of auditors and the improvements
they bring to the table in the form of operational quality and
effectiveness.
A number of years ago, Mr. Chairman, the Board of Directors of
the World Bank thought that they would like to create an expert
panel to evaluate their use of outside auditors; and my interest in
auditing and presumed expertise in the matter led them to select
me as the chairman of the panel.
I view auditors as an important asset for management. There is
a long tradition at the Fed of recognizing the value of independent
oversight. Indeed, I believe we subject ourselves to an extraor­
dinarily rigorous series of performance and operational appraisals.
Within each Reserve bank there is an independent audit function
that reports directly to the board of directors and performs com­
prehensive audits of all aspects of that bank’s work.
At the New York Fed, we have had a constructive and positive
relationship with the GAO for almost 15 years. We supply the GAO
permanent space in the bank and have assigned staff as liaison in
order to assist them in the orderly completion of their tasks. In ad­
dition, we take seriously their findings and are responsive to their
suggestions for improvements. While I do not want to wax too po-




21

etic and imply that we love the result of each and every audit—
they probably wouldn’t be doing their job very well if we did—I do
want to make clear that we have a great appreciation for the role
of auditors.
The conduct of bank personnel with responsibility for monetary
policy matters is subject to the bank’s rules of conduct, stringent
standards regarding outside financial interests and potential con­
flicts stemming from family and other personal relationships.
The GAO always has had full audit authority over Reserve
bank’s personnel policies and practices, disclosure statements, and
the like and, thus, has been able to assure itself and Congress of
the ethical standards and practices of all of our employees.
We are not, however, resting on our laurels. There are always
ways to enhance the effectiveness of operations, and audits by GAO
can contribute significantly to that process. I plan to call Comptrol­
ler General Bowsher from time to time—we talked just the other
day—to offer suggestions as to how the GAO might be even more
useful to the Bank.
I now would like to respond to matters raised in Chairman Gon­
zalez’ October 21 letter to me regarding our policy on meals and
entertainment and our ethics officer.
As I have noted, there is no limitation on the GAO that prevents
its looking at our meals and entertainment practices or policy.
Moreover, we do not impart information on monetary policy or our
foreign account relationships to any outsiders, at luncheons or any
other time. To the contrary, we use meetings with knowledgeable
people to gain information about market conditions, and that is
helpful in our monetary policy deliberations.
The chairman asked a question regarding the cost of meals at ex­
pensive restaurants hosted by regulated institutions, which was
mentioned in a letter which you cited this morning, Mr. Chairman,
by Mr. Corrigan to you. Because others paid for these approxi­
mately two dozen meals that were identified as having occurred
over a period of IV2 years, we do not have that cost information.
We are, however, very sensitive to the appearances of such things,
and our internal rules specifically caution against accepting inap­
propriate entertainment, lavish meals, or frequent meals from a
particular institution.
Further, we concluded that we do not have an adequate audit
trail. Therefore, we are about to issue a policy requiring that all
business meals paid by regulated institutions or vendors be docu­
mented as to restaurant, purpose, and attendees. The purpose of
that is to provide an audit trail for us, the Board of Governors, and
the GAO going forward.
Mr. Chairman, I would wish to assure you and the committee
that in my days of private life, I don’t know of any institution that
had such an audit trail. We, in the course of evaluating it, said,
how do we know who has been having a meal with whom? So we
are creating a form that will require that information.
Finally, as the Chairman noted, we recently named an ethics of­
ficer. That does not mean this role was not being performed pre­
viously within the bank. That function was fulfilled by the bank’s
first vice president, its general counsel and the personnel officers.




22

We concluded that we would focus these responsibilities in a sin­
gle individual, a senior vice president of the bank. Since his ap­
pointment as ethics officer, he has responded to inquiries from
members of the bank’s staff regarding ethics and conflict of interest
questions. He also has participated in redrafting our rules of con­
duct, which should be concluded by year end, and other documents
which will be helpful to the bank s staff in their compliance with
these rules. We regard his efforts as a continuation and refinement
of the policies we have already put in place.
As far as I am concerned, GAO staff has access to those policies
and procedures. And lest I confuse anybody by what I mean by pro­
cedures, in other words, what actually happens, not just looking at
the policy. And I look forward to receiving GAO’s input on them.
I appreciate this opportunity to participate in this hearing, and
I look forward to answering any further questions, Mr. Chairman,
you or the committee members may have.
Thank you.
[The prepared statement of Mr. McDonough can be found in the
appendix.]
The Chairman. Thank you very much. I appreciate your state­
ment about sensitivity to appearances. That is very true.
Many years ago, in another world, when I grew up and knew
such things as melon patches and the like, I learned a lesson from
a neighbor, a friend of my grandfather, who came from Kentucky.
And there was an incident that somebody had snitched some mel­
ons. And I will never forget Mr. Heddy saying, well, if you want
to avoid suspicion, don’t stoop in the middle of the melon patch to
tie your shoestrings. It is so apt. It is true.
And as you referred to, there is a vast difference between the pri­
vate and the public sector. You have been involved in each one of
those sectors. And there is quite a difference. And learning to ap­
preciate a difference sometimes is the biggest challenge an elected
or appointed public official learns. It is not as easy as it sounds.
The standards of success in the private sector are not quite as ac­
ceptable in the public area. So I appreciate that remark.
Now, I gather from that statement that GAO has no restrictions
on reviewing such things as the meals.
Mr. McDonough. No. None whatsoever.
The Chairman. OK. But then you also say something that kind
of troubles me and may give rise to the fact that maybe you are
trying to tie a shoestring there, and that is you say to gather infor­
mation about market conditions, meals with bank personnel.
Now, is it ever necessary to have meals involving that character
of discussion paid for by regulated institutions?
I mean, you may have some reason, but I am asking.
Mr. McDonough. Well, one of the things that we try to do, Mr.
Chairman, is, as often as we possibly can—and at some expense to
our bottom line—recognizing that, since the days of the campfire,
man, as a social animal, tends to perhaps talk more fully when din­
ing or lunching or breakfasting we have them in as frequently as
we can to the Federal Reserve Bank itself so the occasion is taking
place on our premises.
I do think that, on occasion, if a regulated institution, in a res­
taurant of appropriate, reasonably modest price level, asks our peo-




23

pie to perhaps even reciprocate for a meal that they have had at
the Federal Reserve Bank of New York, that they may accept that
invitation.
It is very important for us to know what is going on in the mar­
ket so that we can implement monetary policy with the greatest
amount of knowledge. I think it is fair to say that we are close to
notorious for being very good at listening and very chary in saying
anything. I think the ideal sort of person to have a conversation
with us is somebody who likes to talk a lot and not to listen much,
because we have to be so careful about not inadvertently sharing
anything that would be inappropriate in the area of policy, and we
tend to be very, very quiet and not forthcoming, deliberately.
So I do think that a reasonable amount of accepting meals is ac­
ceptable, we tell the people, you should certainly not do it fre­
quently with the same institution. You should be very careful.
New York City is an area where, as you know, the cost of living
is quite high. And so we are very much pointing the people away
from restaurants that would appear not to be the kind of place that
Federal Reserve officials ought to be appearing, especially as the
guests of regulated institutions.
The Chairman. Well, time is catching up on us. I am a little
troubled, though, if you say that you do invite private sector to the
Fed for meals, then how is it accounted for? But I am not going
to split hairs on that.
I just want to say before I close out, Governor, the 1978 Bank
Auditing Act did not come from this committee. This committee
was thwarted. As a matter of fact, it wasn’t until we had the catas­
trophe that we have been dealing with since 1988, 1989, that it be­
came obvious that the Congress had done everything to please the
unseasoned demands of not only bankers, but S&Ls and everybody
else. It did everything they ever asked for, and look where it got.
On the other hand, it was obstruction when 1978 came because
Chairman Ben Rosenthal of the Subcommittee on Monetary Affairs
over in the Government Operations Committee, was the one that
also brought to bear—Nelson Bunker Hunt and his brother, in
their failed attempt to comer the silver market, which incidentally
used over $25 billion worth of bank resources and credit. And it
took him to do it from a subcommittee of the Government Oper­
ations Committee, not the House Banking Committee.
Because every effort was made—I know, because I have been on
it for 32 years, and I can go back to the initial attempts in the
1960’s, and the Fed came and lobbied. And, in fact, I will place in
the record the minutes from one of the Reserve banks in which
they were trying to figure out how to obstruct Rosenthal in what
turned out to be the Bank Audit Act of 1978.
I just wanted to make that clear, that it didn’t come with any
help or any encouragement from the Federal Reserve Board.
Mr. Leach.
Mr. Leach. Well, I thank the Chairman. And I must say that
there are several anecdotal instances raised by the Chair and then
some larger public policy issues. I think we are all concerned about
basic ethics and appearances.




24

On the food policy of the Fed, though, I think it has to be under­
stood as a very small potatoes issue. We are talking about the mon­
etary policy of the Fed here.
In terms of the instance that the chairman raised on the silver
issue, though, my own sense is it is one of the greatest mistakes
in terms of individual decisionmaking of the Fed, and the chairman
implied coverup or lack of cooperation with an investigation.
I think the basic decisionmaking of a private sector speculator
that was, in effect, protected through the banking system with the
backup of the Fed was deeply wrong headed.
And having said that, there is no reason that this Congress
should not have the right to assess or reassess that kind of policy.
But, again, that is a circumstance that I share on both issues with
the chairman.
But that means that some portion of the Fed's monetary should
be open to pervasive performance audits which, after all, truly
leads in the direction of politicizing of the Fed.
And here, I think there are some analogies. Governor Angell
mentioned the sensitivity of certain information-gathering from for­
eign governments, which I think is valid. In this issue of defini­
tions, the word “audit” has a very positive kind of implication. But
we are really talking about performance review of policy. And here
Congress has a number of techniques at our disposal, including the
semiannual requirements that the Chairman appear before Con­
gress and other techniques, many of which are public.
In terms of information-gathering I think there are analogies to
the national security front where Congress has always agreed that
there are certain kinds of information, for national security rea­
sons, that ought to be confidential, at least for a period of time.
While the Chairman of the Joint Chiefs of Staff needs to know
that we have a second strike capacity at sea, he or she doesn't need
to know the precise location of any submarine at any point in time.
Congress also needs to know the direction of policy but doesn't nec­
essarily need to know all market sensitive information.
Increasingly, market sensitive information is of an insider vari­
ety and affects markets for market participants. We will be opening
ourselves up to a lot of efforts literally of economic espionage with­
in the Congress if this information is transferred to an arm of the
Congress.
By economic espionage, I mean foreign as well as American par­
ticipants, that could be of a difficult nature.
So I, for one, am not overly inclined toward intrusive perform­
ance audits. I think that the review of your policy is what we need
to know. With regard to the review of all of the market decision­
making of the Fed, I think the country is better protected by a lit­
tle bit of confidentiality.
In order for that confidentiality to be respected, the Fed does
have to recognize that there are times now and again that people
will differ with decisions that are made and that the Fed has got
to realize that there will be some accountability that will be
expected.
But I personally think that Congress ought to approach this
issue with a great deal of chariness.




25

Anyway, I might just briefly ask if that seems relevant to you as
an observation or irrelevant?
Governor Angell.
Mr. A n g e ll. Mr. Leach, I must say that there are times that I
think presidents and other officers and directors of Reserve banks
think that the Federal Reserve Board examination process is in­
deed intrusive. But we have a responsibility to do that, and Re­
serve banks understand that.
I have no other comments to make on your references.
Mr. Leach. Mr. McDonough.
Mr. McDonough. They seem to make a great deal of sense to
me, Mr. Leach.
I have no other comment.
Mr. Leach. All right. Thank you.
Thank you, Mr. Chairman.
The Chairman. Mr. Neal.
Mr. Neal. Well, again, I must say I wonder why—I think about
some of the points I was trying to make earlier; you made them
much better and much more thoroughly.
Most anything of any significance that we are dealing with here
is being auditea, it looks to me like. And the things that are not
being audited are not being audited because there are good reasons
in terms of the impact on policy to not audit.
I don't know why we—I mean so far in these hearings we have
steered away from why we have a Federal Reserve and what the
most sensible policy is. I mean, the American public today, the
working people of America, are able to buy houses at 7, 7.5 percent
interest. They are able to buy cars—I noticed the other day the in­
terest on cars is 6 to 7 percent. The banking system has been saved
from a huge catastrophe a couple of years ago. Most people were
saying we thought we were going to have to bail out the banking
system.
The Federal Government is able to borrow to—at much lower
rates than it was a few years ago, but all because the Fed has done
the job that we have asked it to do fairly well in recent years. That
is, it has brought down the rate of inflation.
Now, that is where the focus ought to be. Is the Fed doing the
job that we want it to do, which is to control inflation and, thereby,
create the conditions that will most enhance economic growth, jobs
for our people, low interest rates, savings, investment, productivity
growth, competitiveness in international trade. These are the key
questions.
And all this other stuff about whether someone had a meal
there—I mean, I don't want you to do anything, frankly, that looks
the least bit unseemly, because I think it detracts—it gives—it
opens up the opportunity to detract from this primary goal.
So, of course, I wince when I hear the least thing. But, frankly,
I have to say I think the Fed has operated in a pristine sort of en­
vironment. I am not aware of any hint of any scandal. In fact, I
think you have conducted your affairs very appropriately and, on
the most important question, have devoted your focus to bringing
down inflation; and that has benefited the American people
enormously.




26

Now, I have to point out that that inflation was caused by the
Fed, also, a few years ago; and we ought to understand that and
not repeat it. We wouldn’t have had to go through the pain that
grinding inflation out of the system has imposed on the American
people if the Fed hadn’t created that inflation in the first place.
But the Fed has realized it and has brought it under control, and
that has enormously benefited the American people. So that is the
main issue.
And this other—of course, to do that and to be able to maintain
the independence that is necessary to do that, the Fed must con­
duct its other business in an exemplary fashion. I think you have
done that.
I asked the Comptroller General, a little while ago, if he had any
reason to believe that there was anything inappropriate going on
over at the Fed. He said he didn’t. And we have an inspector gen­
eral—he may not have been in the room when I said I used to
Chair the subcommittee that deals with the Fed. We used to tell
the inspector general, we wanted to know anything, just the least
thing—and I am still sure that that is the policy. We want to know
the least thing that is wrong, everything, anything that possibly is
inappropriate going on over there, we want to know about it and
we want to stop it.
So I am not aware of there being any such thing. And I commend
you for it. And I hope the focus—I hope we are able to put the
focus on the key question and not some of this other stuff.
I thank you.
The Chairman. Mr. Knollenberg.
Mr. K nollen b erg. Thank you, Mr. Chairman.
I concur with my colleague who just commented on your effec­
tiveness over those 80 years, with just the three examples, I think,
that were given as to problems perhaps that were created for you.
You both have been very clear about your opposition to eliminat­
ing the exemption. In fact, of the two, I think, President
McDonough, you are maybe a little more pronounced in saying that
if we made the elimination, it would introduce the unmistakable
>otential for political influence—I am just reading your comments
rom the page—and every movement and nuance of the policv
would then have to be examined. And, of course, you mentioned,
Governor, that it would be contrary to the public interest.
My question, first for the Governor, would be: Could you provide
a couple of specific examples of how a GAO audit would—of the
FOMC—would negatively impact monetary policy, something that
you seem to have had a pretty good handle on?
Just give me a couple of examples, if you would. And you can
share those, if you will.
Mr. A n g e ll. Yes. Mr. Congressman, the audit process cannot
work well at all if you say, well, you can do this aspect of the open
market operations and you can do this aspect of foreign exchange,
and yet you can’t do that aspect.
We understand that to do a full balance sheet audit requires ad­
ditional information. The information that would be required would
be information dealing with the process of policy formation and the
carrying out of the policy and making certain that those that are
doing the operations do it precisely as it was developed.

f




27

Our monetary policy process is really a strategy that we are de­
veloping. Macroeconomics and finance is always a changing study.
We never get to the place where we have final answers in regard
to how people in the financial marketplace will behave because ex­
pectations are involved.
Mr. K nollenberg. It is a dynamic kind of thing.
Mr. A n g e ll. It is a dynamic kind of thing.
So the policy process is one in which we are looking at strategies
and the Federal Open Market Committee has developed these
strategies. To have someone come in and audit that and say, well,
are you accountable for that, and knowing precisely what your ob­
jective was and how it came out would, we believe, have a quieting,
an inhibiting impact upon the policy process.
The Federal Open Market Committee is a very unique kind of
engagement. It is one in which all participants understand that
ideas are raised. Someone is willing to say at the table: Well,
maybe this might happen, and raising such questions about what
might happen may have—mav not be the most probable event, but
the reason we have 12 people involved as voting members is we
want to make certain that every perspective is being heard.
The audit process from the GAO reporting directly to you rather
than our reporting through the Humphrey-Hawkins hearings to
you, in a sense, removes us from the full accountability and can
have attention directed elsewhere. What is this going to look like
in regard to some auditing procedure? We believe that the impor­
tance of policy considerations for this country and, indeed, for the
entire world, goes so far that we need to be sure that the process
continues to work as best it can.
Mr. K nollenberg. Would you concur in that? Or do you have
another idea?
Mr. McDonough. I do concur in it. And I think that the imple­
mentation of policy by the Open Market Desk, which perhaps, as
you know, I used to run before I became president of the New York
Fed, is so completely intertwined with the policy formulation that
I don’t think it is possible to divide the two.
What the desk manager is doing in consultation with others
when he—now she—decides to enter the market on a certain day
and do a certain thing fully reflects all the nuances and the discus­
sions of the last FOMC meeting. The two are just as closely tied
as you can imagine.
Mr. K nollenberg. Gentlemen, thank you very kindly. I see my
time has expired.
Thank you, Mr. Chairman.
The Chairman. Mr. Hinchey.
Mr. Hinchey. Thank you, Mr. Chairman.
Gentlemen, I think everyone would agree that there is great
value in maintaining the independence of the Federal System. But,
nevertheless, within that, within the context of that independence,
there must also be accountability. I think that our chairman is at­
tempting to establish a new balance between that independence
and accountability through the introduction of the Federal Reserve
System Accountability Act of 1993. And that is the focus of these
hearings, to a large extent.




28

Now, in the context of that focus and of these hearings particu­
larly, there has been some question about the availability of infor­
mation and, indeed, the actual accumulation of information that oc­
curs during the meetings of the FOMC.
And I think that some of the members of the committee have
been concerned because there seems to be some discrepancies in
the messages that we have been getting from various members
over the course of the last—over the course of these hearings.
For example, Mr. McDonough, in your written statement that
was submitted to the committee, you said as follows: I have no per­
sonal knowledge of any other notes or records that others may have
made at FOMC meetings.
Now, we have learned that, of course, there are these recordings
that are made. Each meeting is tape-recorded and there are also
rough notes that are taken.
Now, when you said, I have no personal knowledge of any other
notes or records that others may have made at FOMC meetings,
what was the relationship between that statement and the fact
that actual tape recordings are made?
Mr. McDonough. Thank you, Congressman Hinchey. I am de­
lighted that you asked that question because it gives me an oppor­
tunity to answer what was asked by the Chair earlier.
I did not attend, as you perhaps remember, the hearings on Octo­
ber 19 because I was asked by Chairman Greenspan to represent
the Federal Reserve at a meeting in Moscow. My going permitted
Governor LaWare to be here on the 19th.
When I submitted my written testimony, which I had written
and actually finished on the morning of the 15th and dispatched
it by fax to the committee, I was not aware at the time that the
recordings were ever made or that these rough transcripts existed.
Consequently, when I wrote the statement and sent it, it was a
completely accurate statement.
In the course of the afternoon of October 15, I learned from
Chairman Greenspan that the tapes and the rough transcripts ex­
isted. Since he said on that occasion that he was going to acquaint
the committee at the meeting on the 19th with the existence of the
tape and the rough transcripts, I decided that it was not necessary,
as I was literally heading home in order to pack my bags to go to
Moscow, to change the testimony—change the submission, because
I knew that the record would be established in an accurate manner
the following Tuesday.
Mr. Hinchey. Well, I don’t want to be too sharp about this, but
I think it is an important question. And I think we ought to try
to put it to rest for all time if we can.
Let me ask you this, Mr. McDonough: How long have you been
in your present position with the Fed?
Mr. M cDonough. Three months.
Mr. Hinchey. Three months. How many meetings have you
attended?
Mr. McDonough. As a member of the Federal Open Market
Committee, I have attended two.
Mr. Hinchey. Just two. Were you aware of that green light that
apparently flashes on when the recording system is in operation?




29
Mr. McDonough. I was aware of the green light. And part of my
youth was spent as a naval officer, and I was the chief engineer
of a ship. So I ought to ask the question of what is the light about,
and I thought that the purpose of the light was to say that the
sound system was working. I had no idea that it had any other
significance.
Mr. Hinchey. The sound system meaning the microphones at the
various----Mr. McDonough. Yes. It is a big room, rather as you have here.
Governor Angell and I, with our Midwestern and plains States ten­
ors, are easily heard. Some others are not, so we have a system so
that people can be heard around the table. That is what I thought
it was.
Mr. Hinchey. These kinds of questions arise for a number of rea­
sons, not the least of which is the fact that Mr. Greenspan has in­
dicated that, although at one point apparently he knew about the
recordings when he made a statement that said that he wasn’t
aware of the recordings, he had forgotten of their existence; and we
are trying to rationalize those two statements in the context of par­
ticularly of this ocular proof, if you will, that the system is actually
working. And that has given rise to some concern about the infor­
mation that we are receiving in the course of these hearings.
Now, under the Freedom of Information Act, is it your view that
those transcripts are available?
Mr. McDonough. Congressman Hinchey, I really don’t know. I
am not an attorney, and I don’t claim sufficient expertise on the
Freedom of Information Act. I really can’t give a sensible, meaning­
ful answer to your question.
Mr. Hinchey. Who could answer that question for the FOMC? I
think this is a question that you ought to be asking someone who
could provide you with that kind of information.
Mr. McDonough. I would assume the general counsel would be.
He, being the senior attorney of the Federal Reserve System and
of the Board of Governors, would be the appropriate person for the
FOMC to ask.
Mr. Hinchey. Would you be kind enough to instruct the attorney
to provide us with the official view with regard to the Freedom of
Information Act as it relates to the availability of these transcripts
and rough notes?
Mr. M cDonough . May I pass that to Governor Angell?

Mr. A n g e ll. Yes. The general counsel will be giving the advice.
And I see no reason for the general counsel’s advice not to be made
available. So we will provide you with that information.
[Governor Angell subsequently supplied the following informa­
tion:]
I am advised by counsel that the deliberative portions of the transcripts, which
we believe represent most of each document, would be exempt from public disclosure
under exemption 5 of the Freedom of Information Act. That exemption permits, but
does not require, an agency to withhold from public disclosure material that reflects
the process by which an agency arrives at its decisions or policies. The exemption
is based on tne belief that disclosure of these deliberative processes would inhibit
frank and open discussion to the detriment of the quality of decisionmaking within
the government. In this regard, in 1976, the U.S. District Court for the District of
Columbia addressed the availability to the public under FOIA of the FOMC’s Memo­
randa of Discussion, which were very detailed records of the discussion at FOMC
meetings. In its March 9 opinion, the court ruled that the FOMC was only required

73-435 0 - 9 4 - 2



30
to disclose to the public under FOIA the reasonably segregable factual portions of
the Memoranda. Thus, the deliberative portions of these materials were not
released.

Mr. A n g e ll. May I, however, refer back to what Alan Greenspan
said when he said he forgot? He said he forgot about the tran­
scripts. He never forgot about the recording. I mean the Chairman
knew from the beginning about the recording, the tape recording
going on. And then those are recorded over after the minutes have
been completed.
He never forgot—he didn’t say he forgot about those recordings,
with that green light right in front of him. He just forgot about the
fact that there was a rough transcript made up and from which the
minutes were prepared. And that is what you see he was referring
to.
Mr. Hinchey . S o he didn’t forget about the fact that the record­
ing was made, he just forgot about the purpose for which the re­
cording was being made, forgot that the recording was being made
in order to bring about transcripts?
Mr. A n g e ll. You know, Congressman Hinchey, we at the Fed­

eral Reserve, do have sort of a single-minded purposefulness, as
Congressman Neal suggested. We—the weight of being the world’s
reserve currency and doing it exactly right does dominate our
thinking----Mr. Hinchey. I am sure.
Mr. A n g e ll. And you get used to a green light. You get used to—
I mean that is there. But certainly, I want you to know that I have
never known anyone who is so scrupulous, in regard to what comes
out of his mouth and its accuracy—and there are many of those
around at Federal Reserve that feel that way.
And I want you to know that in my view, Chairman Greenspan
is one of those world’s most accurate people; and he would never,
ever want someone to believe what wasn’t the case.
Mr. Hinchey. I have no difficulty in believing that whatsoever.
In fact, that was my belief prior to this most recent experience. It
is just that, in the existence of that belief, we have some evidence
which seemed to be to the contrary. And what we are trying to do
is to clear it up.
Mr. A n g e ll. I understand.
The Chairman. Thank you, gentlemen, very much, for your time
and your cooperation.
We have our third panel----Mr. A n g e ll. Mr. Chairman.
The Chairman. Yes, Governor.
Mr. A n g e ll. I would like to also affirm something that you said.
Mr. Chairman, we at the Federal Reserve have opportunities to ap­
pear on many occasions. And I agree, and I think everyone at the
Federal Reserve that appears before you agrees, that this is a com­
mittee in which courteousness does prevail. And I want you to
know how much we appreciate the atmosphere that you develop
which enables us to be as forthright and forthcoming so that every­
one in this Nation has confidence in all we do.
I wanted to give you a particular thanks from one person to an­
other in regard to the courtesy that you provide to us.
The Chairman. Thank you.




31

Mr. McDonough. Mr. Chairman, may we make that two persons
to another.
The Chairman. Thank you.
Mr. N eal. I had also written Chairman Greenspan on this tran­
script matter, and I got a response back from him which I would
like to make a part of the record, if I may.
The Chairman. Without objection.
Mr. N eal. Thank you.
The Chairman. Thank you very much, gentlemen. And thank
you for your generous words.
Our third and final panel invited to discuss that part of H.R. 28
that authorizes a reform commission to study a number of topics.
The panel will focus on one of those topics, which is the desirabil­
ity of further privatizing check clearing now handled by the Fed­
eral Reserve.
We have first, Mr. John P. Borden, president of the National Or­
ganization of Clearing Houses; Mr. J.D. Carreker, chairman of J.D.
Carreker and Associates, Inc.; Mr. Howard P. Wentworth, senior
vice president, Philadelphia National Bank; and Mr. James R.
Lauffer, chairman, president, and CEO of the First National Bank
of Herminie, Pennsylvania, and president of the Independent
Bankers Association of Amtfrica.
Gentlemen, thank you very much for your answering our invita­
tion and taking the time to be with us. Unless there is some time
constraint on some of the other panelists, is there any objection to
my recognizing you in the order that I introduced you?
If not, Mr. Borden.
STATEMENT OF JOHN P. BORDEN, PRESIDENT, NATIONAL
ORGANIZATION OF CLEARING HOUSES

Mr. Borden. Good morning, Mr. Chairman and members of the
committee.
I am John Borden. I am president of the Greater Kansas City
Clearing House Association in Kansas City, Missouri, and presi­
dent and CEO of the Mid-America Payments Exchange. The Great­
er Kansas City Clearing House Association provides check-clearing
services for approximately 100 financial institutions in the Kansas
City area. The Mid-America Payments Exchange is the largest of
the 29 automated clearing houses in the United States.
I am here today on behalf of the National Organization of Clear­
ing Houses, which is called NOCH; and I serve as president of that
organization.
NOCH was founded in 1989 to promote and support the impor­
tant role of clearing houses in the U.S. payments system. In addi­
tion to serving financial institutions in Kansas City, NOCH’s mem­
ber clearing houses serve the regional check-clearing needs for fi­
nancial institutions in Arizona, California, Connecticut, Illinois,
New York State, Oregon, Pennsylvania, Puerto Rico, and Texas.
Our members also include the two national private check-clearing organizations. With this testimony, NOCH will provide its per­
spective on the role of the Federal Reserve System in providing
check-clearing services. Our sole purpose here today is to promote
the goal of a competitive check-clearing system.



32

I respectfully request, Mr. Chairman, that my written testimony
be included in the record.
The Chairman. Certainly. Without objection.
And likewise, with each one of the witnesses that gave us written
testimony.
Mr. Borden . Thank you, sir.

NOCH does not believe that it is necessary to establish a con­
gressional commission charged with evaluating the fair market
value of the Federal Reserve's check collection operations.
Instead, NOCH believes that Congress should focus its attention
on achieving the goal of balanced competition as envisioned by the
Monetaiy Control Act.
NOCH also believes that to pursue this goal properly, a combina­
tion of active congressional oversight, through existing means, and
greater public involvement in the review of Federal Reserve pay­
ments system practices is both appropriate and necessary.
It is clear to NOCH that the current check collection environ­
ment does not reflect the intent of Congress as expressed in the
Monetary Control Act. The Federal Reserve System accounts for
roughly 50 percent of all check-clearing volume, whereas no single
competitor of the Federal Reserve accounts for more than about 3
percent.
Complicating the private sector’s ability to compete with the Fed,
is its dual role as not only competitor but also as regulator. None­
theless, NOCH believes that the goal of a competitively balanced
market in check collection services is obtainable.
Given the unique role of the Federal Reserve System, it is no
surprise that there is friction between the private sector and the
Federal Reserve. This friction goes back to the establishment of the
Fed in 1913 but really blossomed following the passage of the Mon­
etary Control Act in 1980.
With the passage of this act, the Federal Reserve's check collec­
tion role changed fundamentally from serving member banks exclu­
sively to that of serving the entire population of financial institu­
tions seeking check services, and it involved competing directly
with the private sector.
This change in competitive balance led Congress, largely through
the General Accounting Office, to become actively involved in deter­
mining whether the act was resulting in the intended level playing
field. I refer you to the GAO's May 1989 report to this committee
and its counterpart in the Senate, which is titled: “Check Collec­
tion: Competitive Fairness is an Elusive Goal.”
Since the release of that report, the Federal Reserve has taken
some positive steps to address specific recommendations made by
GAO. Specifically, the Federal Reserve has amended regulation CU
mandating same-day settlement for checks without the imposition
of fees.
Until these amendments, only the Federal Reserve could present
checks to any depository institution in the United States and de­
mand immediate payment without the payment of presentment
fees.
While the Federal Reserve has taken specific steps to address the
GAO's recommendations, the current environment strongly sug­
gests that the Federal Reserve has neither thoroughly addressed



33

the competitive fairness issue, nor has it adequately enforced exist­
ing competitiveness policies in its approval of check collection serv­
ices and prices.
If this posture is allowed to continue, the balancing of competi­
tive opportunities that is promised by such actions as same-day
settlement will be lost.
An example; The Federal Reserve recently implemented changes
to its Payments System Risk Reduction Program, which included
a change in the schedule by which check transactions are posted
to a financial institution’s reserve account. Because of this change,
credits for checks cleared through the Federal Reserve are avail­
able to the collecting institution much earlier than was possible—
or than is possible with checks collected privately. This is an im­
portant distinction since the Federal Reserve is preparing to price
for “daylight overdrafts.” Since the timing of proceeds of checks and
all other payment transactions will be very important, it is impera­
tive that we look at this particular matter.
The impact of this change represents a perfect example as to the
Fed’s dual role as regulator and payment services provider operat­
ing to the detriment of the private sector.
In this case we see that the Federal Reserve is seeing risks in
the check collection process which we do not see is there for them;
and in their attempt to reduce this risk, they have established a
competitive advantage.
No one relying on the U.S. payment system stands to realize any
benefit if one group, particularly the Federal Reserve, is perceived
as dominant in a strictly one-sided game. Sooner or later in this
situation, the private sector simply might decide to stay home.
Therefore, the perception that competition in the payment sys­
tems is one sided cannot be permitted to continue. The perception
and indeed the reality must be that the competitive playing field
is level and that the officiating is fair and just. In NOCH’s view,
that was the intent of the Monetary Control Act.
Public comment is already required by the Federal Reserve’s own
policies governing the approval of changes in fees and services that
would have significant longer run effects on the Nation’s payment
system.
Frequently, however, changes to a price or a service by an indi­
vidual Federal Reserve Bank have received Federal Reserve Board
approval without the benefit of public comment. That is that the
Federal Reserve’s interpretation is that a particular change would
have a very limited effect on local providers only. It is true that a
particular price or service might, in one region, only have a limited
impact on competition in that region with those local service
providers.
However, subsequent adoption of that change in other Federal
Reserve districts, on a national or multiregional basis, may under­
mine the competitive position of other service providers. Thus, we
believe that all changes to Federal Reserve price services have the
potential that might result in significant longer run effects on the
Nation’s payment system and, therefore, should be issued for public
comment.
A good example of this is the controversial service, that was ap­
proved without the benefit of public comment, a relatively new



34

service known as “payer service group sort.” This service is now in
effect in over 11 Federal Reserve offices and relies on a completely
different pricing mechanism than any other Federal Reserve check
collection service.
I would like to add that not only does the Federal Reserve ap­
prove many controversial services without the benefit of advanced
public comment but even when the comment seeks more informa­
tion about the service and its approval process, the response from
the Federal Reserve can be less than forthcoming.
For example, when NOCH filed a request for more information
about the approval process for the payer group sort under the Free­
dom of Information Act, the information received was less than
satisfactory.
Mr. Chairman, with your permission, I would like to submit for
the record a copy of the Federal Reserve’s document of approval for
this service which was received in response to our request.
The Chairman. Without objection, it is so ordered, sir.
[The information referred to can be found in the appendix.]
Mr. Borden. Thank you. A quick review of this document would
reveal that there is a substantial amount of information that has
been deleted as “not for public consumption.” I find it extremely
difficult to understand how a simple and basic information request
can result in a response where the Federal Reserve feels compelled
to delete so much information.
The message here should be clear: All proposed changes to Fed­
eral Reserve prices and services should be issued for public com­
ment. Providing the public with opportunity to review changes to
Federal Reserve prices and services not only elevates the Federal
Reserve Board above any reasonable suspicion of conferring com­
petitive advantage upon the Federal Reserve System but also per­
mits the private sector providers the opportunity to respond with
potential effects that might be felt in the region or regions which
they serve.
Public comment would greatly enhance the ability of the public
and the Federal Reserve to fully review the competitive impact of
those proposals.
However, numerous questions still continue to surround the Fed
in its role, and market dominance in the post-Monetaiy Control Act
environment strongly suggests that this role must be mrther evalu­
ated by a knowledgeable, nonbiased third party.
Given the GAO’s substantial involvement with this* issue, NOCH
would recommend to this committee that the GAO conduct a thor­
ough reevaluation of the Federal Reserve’s role in the payment sys­
tem. Given changes in the competitive environment that have
occurred since the May 1989 report, this would be particularly
appropriate.
NOCH also believes that Congress should establish an ongoing
process to measure progress toward the ultimate goal of achieving
full competitive balance in check collection services.
We recommend that GAO follow up this comprehensive report I
have just described with an annual progress report until such time
as the Congress may conclude that the competitive environment
has reached the stage envisioned by the Monetary Control Act.




35

Congress may, therefore, assure the public that continuous
progress is being made toward this goal. To this end, NOCH offers
whatever assistance is requested of it to support GAO’s reporting
initiative.
Mr. Chairman, on behalf of the National Organization of Clear­
ing Houses, I appreciate this opportunity to share our views and
would be happy to answer questions at the appropriate time.
[The prepared statement of Mr. Borden can be found in the
appendix.]
The Chairman. Thank you very much, sir.
Those bells you heard and those two lights indicate we have a
recorded vote. But if, Mr. Carreker, you could convey your testi­
mony or message in, I would say, 5 to 7 minutes, we would still
have time to go and record our vote and come back and pick up.
Mr. Neal. Mr. Chairman, would you let me say one thing briefly
before we go?
The Chairman . Yes, sir.
Mr. N eal. A couple of sentences. I just want to say that I have

worked—mostly my staff worked with Mr. Borden earlier on this
problem, and I personally found it so complicated that I could not
figure out who I thought was right. And I just want to commend
you for your bill in this area, because I think you are on the right
track. I don’t personally think there is any reason why the private
sector can’t do this. I just don’t know exactly how to do it. And I
think you are exactly on the right track, and I appreciate your
doing it.
The Chairman. Thank you. I know that you are chairman of the
Monetary Subcommittee.
Mr. N eal. Yes. But he contacted us because of our role there.
The Fed has all—they have the power. You know, a guy—he can’t
deal with them. You know what I mean? And I couldn t.
So anyway, if we are going to get this done, I think something
along the lines of your suggestion. Whether this is exactly the right
thing, I don’t know. Maybe we will learn. But you are certainly on
the right track here. And it is a private sector sort of activity, it
seems to me; so why not get the private sector to do it.
I thank you very much for letting me say that. I wanted to say
that because I am not going to be able to come back. And I thank
you very much.
The Chairman. I understand. Thank you very much.
I tell you what, Mr. Carreker. Why don’t we see how you proceed.
I am not going to place any limitation on you.
STATEMENT OF J.D. CARREKER, CHAIRMAN, J.D. CARREKER &
ASSOCIATES, INC.

Mr. Carreker. Thank you, Mr. Chairman and members of the
committee.
I am Denny Carreker, chairman of J.D. Carreker & Associates.
We are a management consulting firm. And for approximately the
last 25 years or so, I have been working with the top 250 banks
in the United States on matters related to the banking system, and
check presentments most recently.
Our client base includes most of the country’s top 100 banks,
their regional clearing houses, and banking industry associations.



36

It has also included Federal Reserve Banks and the staff of the
Federal Reserve Board of Governors.
It is in my capacity as executive director of ECCHO, the Elec­
tronic Check Clearing House Organization, that I have been invited
to address the committee.
ECCHO is a nonprofit national organization dedicated to facili­
tating the private sector’s implementation of electronic check pre­
sentment. As I will describe later, electronic check presentment is
changing the payment systems in the United States and the rel­
ative roles of the private sector and the Federal Reserve.
ECCHO now has 58 members who account for more than 60 per­
cent of the total domestic deposits for the largest banks—100 larg­
est banks in the United States.
ECCHO has become the central focus for many of the important
changes currently taking place in the Nation’s payment system.
The committee has asked me to address two questions. First: Is
it feasible to privatize the Federal Reserve’s check-clearing func­
tions? And, second: What is the fair market value of the Federal
Reserve’s check-clearing operation?
First, regarding feasibility, not only is gradual privatization of
the Federal Reserve’s check-clearing functions feasible and desir­
able, it is already occurring. It is ECCHO’s belief that the Federal
Reserve should encourage the prevailing privatization trend and
the success of private sector initiatives.
Doing this would involve addressing a fundamental issue and
that is the basic conflict of interest in the Federal Reserve’s dual
role as both regulator of and competitor in the check collection sys­
tem. In this dual role, the Federal Reserve can unilaterally and
without accountability undertake regulatory, service policy, and
service pricing initiatives to maintain market share and recover
costs in direct competition with the private sector.
There was a time when, thanks to nonpar banking, widespread
unit banking, and manual check operations, and uncertain trans­
portation that the Federal Reserve’s operating role was necessary.
That is not the case today.
Three main changes are contributing to the privatization trend.
The first is consolidation of the banking industry; the second is the
emergence of electronic check presentment; and the third is the in­
creasing extent to which the payment information needs of banks’
customers are directing the payment system.
Collectively, these three changes are changing the relationship
between the Federal Reserve and its necessity to play an operating
role. I would like to elaborate on each of these briefly.
First, consolidation. As banks consolidate, the nature of checkclearing volumes changes. Intrabank checks increase while inter­
bank cnecks, or transit checks, decrease. The Federal Reserve’s
check-clearing role is in transit checks. As a result, consolidation
continues to diminish the Federal Reserve’s check volumes and,
correspondingly, the required role of the Federal Reserve in the
check collection system.
The second change I referred to is electronic check presentment
or ECP. The essence of electronic check presentment is that it cap­
tures the checks’ information on the bottom of the check, the MICR
[magnetic ink character recognition] data, and transmits that infor-




37

mation electronically, separating the physical handling require­
ments of checks from the transmission of the data that is needed
to affect most of the payment operation.
It is important to note that the Federal Reserve’s role with elec­
tronic check presentment will be changing. The private sector has
already developed electronic check presentment software, written
the rules and agreements designed to implement requirements, de­
velop national standards and formats, definitions, and borne the
expense and risk connected with all of these efforts. The private
sector is adapting ECP service and delivering mechanisms to serve
the thousands of small banks that cannot support their own checkclearing operations and helping these small banks reduce their
check risks and the risks of their customers.
On the other hand, the Federal Reserve, while explicitly endors­
ing the concept of ECP is planning to invest in a different approach
to ECP that will compete with the private sector's investment and
has already complicated and delayed the private sector's develop­
ment of electronic check presentment standards.
There is no reason for the Federal Reserve to duplicate the pri­
vate sector's ECP efforts. Additionally, competitive ECP activity by
the Federal Reserve at this juncture will unnecessarily complicate
the work of the private sector, potentially introducing new systemic
risk and delaying ECP’s benefits for banks and their customers.
The third change I referred to is the greater customer respon­
siveness required of the payment system. During the decades that
have led to this point in time that the Federal Reserve played its
operating role, the check was pretty much a commodity. Pieces of
paper were handed from one group to the next to the next.
With electronic check presentment and the future of the elec­
tronic check payment system that will be evolving in this country,
it is important to understand the risk exposure of the various cus­
tomers in the United States that utilize the payment system. The
Federal Reserve does not have an awareness of these customer re­
quirements, since it appropriately does not play a role in interfac­
ing directly with corporations and consumers.
The second question I have been asked to address is the fair
market value of the Federal Reserve check-clearing operations. The
value of the operations are directly tied to the timing in which, and
the scope of which, operations would be taken from the Federal Re­
serve. It is our belief that the operational transition from the pre­
dominantly Federal Reserve role to a private sector role should
take place over a significant period of time and that the settlement
functionality that the Federal Reserve is currently performing
should continue to stay with the Federal Reserve.
ECCHO recommends that Congress establish a Payment System
Advisory Board, comprised of payment system experts drawn from
private sector, Federal Reserve staff and other parties as appro­
priate.
The Payment System Advisory Board would advise Congress or
its agents on new Federal Reserve pricing initiatives, major Fed­
eral Reserve investments in check collection, changes in the scope
of Federal Reserve services, and Reserve compliance with congres­
sional mandates.



38

The Payment System Advisory Board would hold an annual
meeting and provide Congress with an annual report on these is­
sues. ECCHO believes that the General Accounting Office could
play a useful role in this regard.
In summary, the committee’s attention to this issue is particu­
larly timely. It comes at a time when the private sector checkclearing banks are particularly well positioned to provide even bet­
ter check-clearing services more cost-effectively than ever, with
greater corporate and consumer value than ever and with even bet­
ter service for small banks.
Congress can, with little or no impact on the quality or safety of
the check collection system, encourage current private sector initia­
tives, the prevailing trend toward privatization of the checkclearing business and the gradual elimination of the Federal Re­
serve’s conflict of interest.
To ensure the continuity and security of the payment system
during this transition and beyond, Congress should form a Pay­
ment System Advisory Board consisting of Federal Reserve and pri­
vate sector parties. ECCHO is pleased to offer its services in any
way in the establishment of this Board.
Thank you, Mr. Chairman.
The Chairman. Thank you, sir.
We will stand in recess until after the vote.
[The prepared statement of Mr. Carreker can be found in the
appendix.]
[Recess].
The Chairman. Mr. Lauffer.
STATEMENT OF JAMES R. LAUFFER, CHAIRMAN, PRESIDENT,
AND CEO, THE FIRST NATIONAL BANK OF HERMINIE; PRESI­
DENT, INDEPENDENT BANKERS OF AMERICA

Mr. L auffer. Yes, Mr. Chairman.
Jim Lauffer, chairman and president and CEO of the First Na­
tional Bank of Herminie in Irwin, Pennsylvania. I am also presi­
dent of the Independent Bankers Association of America.
We appreciate this opportunity to testify on your bill, the Federal
Reserve Accountability Act of 1993. You have asked us to comment
on that part of the bill which directs a new commission to study
the benefits and efficiencies that would result from reducing or
eliminating the Federal Reserve’s role in check clearing. While my
written statement discusses other issues, I will limit my oral re­
marks to what you have asked for on the commission.
IBAA believes that the legislation should call for a study that
would, or could, ignore crucial factors that must go into consider­
ation of whether the Federal Reserve should divest check-clearing
services. It only requires the commission to take into account the
economic benefits to be derived from and the efficiencies to be
achieved as a result of the divestment. This would or could result
in a biased study, since it does not clearly require the commission
to consider any of the disadvantages of reducing or eliminating the
Federal Reserve’s check-clearing role.
The bill should require the commission to consider the indirect
cost to the public if reasonably priced check clearing is no longer
available to financial institutions serving small and rural commu­




39

nities; the adverse effects of these communities, if they lose access
to prompt and efficient payment services; and the value of having
the services retained by the Federal Reserve.
Individuals and small businesses throughout the Nation expect
reasonably priced banking services: Checking accounts, interestbearing checking accounts, and savings accounts. The availability
of the Federal Reserve services gives community banks—collec­
tively the largest private sector market for the Federal Reserve set­
tlement and clearing services—access to affordable correspondent
services designed to meet the needs of their customers in rural
America.
For many community banks, particularly in the rural areas, the
Federal Reserve is the only provider offering check-clearing serv­
ices. The Federal Reserve ensures that all financial institutions,
approximately 30,000, have universal access to its services.
In the last 3 to 4 years, several private entities have formed or
expanded to provide national correspondent services, including
check clearing. Although these services are available on a national
basis, they are not universally available to all institutions.
In 1992, Huntington Bancshares and two nonbank partners
formed the National Clearinghouse Association, a nationwide
check-clearing network. Its membership requirements effectively
exclude small institutions by establishing a $200 million minimum
capital level for their participants. That $200 million would equate
to about a $2 billion asset-sized bank. And there are 10,000 banks
in this country that are under $150 million in assets and under $15
million in capital. So effectively, in their system, they would be
frozen out.
I would like to make a comment that is not in my statement con­
cerning Huntington Bancshares. Lee Hoskins, who was president of
the Federal Reserve Bank of Cleveland for a number of years, left
about a year ago. Now I would suspect—we are in the Cleveland
district, so I know Lee. And he went to Huntington Bancshares,
and within months, came up with a decision to spend millions of
dollars on this clearing house.
Now, I ask you, Mr. Chairman, a president of the Federal Re­
serve Bank of Cleveland for a number of years, if he thought that
the Federal Reserve pricing system was too low and uncompetitive,
why would he go to an institution and form something to compete
against the Fed immediately? I would just like to add that to my
comments.
The Visa Automated Clearing House has identified the top 100
ACH originators as its niche. Community banks need not apply.
The top 100 banks again. And there are 10,000, 11,000 banks in
this countiy.
Electronic Check Clearing House Organization was formed in
1990 to provide private sector national electronic check present­
ment. The ECCHO membership includes many of the country’s 50
largest banks. I think it was mentioned 58 is what they have.
Late last year, ECCHO added a new associate membership cat­
egory to attract members that might not otherwise be available to
afford regular membership. Unless it has recently changed, the an­
nual cost of associate membership is $10,000. This effectively ex­
cludes smaller banks.




40

These examples indicate that the private sector has neither the
capacity to absorb the Federal Reserve’s check volume, about 30
percent of the total—I heard 50, our figures show 30—nor the will­
ingness to provide the services to all segments of the industry.
I have heard it said that you will do it through your correspond­
ent bank. In most major banks, a lot of maior banks have gotten
out of the correspondent business. In fact, the Independent Bank­
ers Association of America has helped establish 16 bankers’ banks,
including 1 in your State of Texas, to handle correspondent services
because the big banks have gotten out of correspondent services. So
unless there is a high-pront margin in check clearing, smaller
banks are not going to have access to that service.
If the Federal Reserve abandons these services to the private sec­
tor, community banks would likely experience increased operating
costs. In today’s environment, community banks would have to
pass these on to the consumers, or they would have to make less
profit.
I think the commission should study that. In other words, if it
costs me $10,000 to get into the clearing house, that will be
$10,000 off my profit; that would be $3,400, at a 34-percent tax
rate, that the government would not receive, unless I pushed the
cost on to my customers.
In addition to ensuring that all financial institutions have uni­
versal access to check-clearing services, the Federal Reserve is the
catalyst for improvements in the payments system, including
check-clearing operations.
Unlike any private sector provider, the Federal Reserve has re­
sponsibility for regulation and improvement of the payments sys­
tem. The Expedited Funds Availability Act of 1987 strengthened
this requirement. As a result, the Federal Reserve has a nation­
wide—number one, nationwide, two, long-term perspective, not just
a short-term, regional or niche perspective as so many in the pri­
vate sector do.
The IBAA understands that the Federal Reserve is strongly com­
mitted to remaining in the check-clearing business and improving
the efficiency of the Nation’s check-clearing system. The Federal
Reserve’s 7-year research and development effort in check image
technology and the development of electronic check exchange serv­
ice are prime examples. The Federal Reserve’s leadership role in
both of these areas prompted software and hardware vendors to de­
velop systems much sooner than private sector markets would
have. The Federal Reserve cannot continue to improve our pay­
ments system if it no longer offers services in that system.
Any study must factor in the benefits of the Federal Reserve’s
dual role as regulator and service provider committed to serve all
financial institutions.
Some may contend that community bankers should not worry
about this proposed study since, after all, it is just a study. We dis­
agree. Studies, particularly biased studies, can lead to dangerous
legislative proposals.
For example, section 1001 of the 1989 savings and loan legisla­
tion directed the Treasury to study the Federal deposit insurance
system. That section focused on ways to cut back on deposit insur­
ance to reduce loss to the government. It failed to require the




41

Treasury to study any benefits of keeping deposit insurance, in
keeping it where it was.
The result was a Treasury recommendation that deposit insur­
ance coverage be greatly curtailed.
Mr. Chairman, I know you favored those recommendations, and
we strongly opposed them. But certainly we can agree that the bat­
tle over deposit insurance coverage that grew out of the Treasury
study was hard fought and highly significant.
The fact that the 1989 law did not require the Treasury to con­
sider any positive aspects of deposit insurance put a tremendous
burden on those of us who opposed deposit insurance cutbacks. Be­
cause of that experience, we will continue to closely scrutinize pro­
posals to “just study” topics of concern to community banks and
fight to eliminate bias.
We ask, Mr. Chairman, at the least, on your appointment—the
appointments to this commission—that there be members from
rural America who have an understanding of how these changes in
the pavments system would impact their banks on main street and
rural America.
We thank you for the opportunity to testify, and we would be
glad to answer any questions.
The Chairman. Thank you very much.
[The prepared statement of Mr. LaufTer can be found in the
appendix.]
Mr. Wentworth.
STATEMENT OF HOWARD B. WENTWORTH, SENIOR VICE
PRESIDENT, PHILADELPHIA NATIONAL BANK

Mr. W entw orth. Mr. Chairman and committee members, my
name is Howard Wentworth, senior vice president with CoreStates
Financial.
CoreStates Financial is a multibank, Philidelphia-based holding
company with assets over $23 billion. We are one of the Nation’s
largest correspondent banks and, as a result, are in direct competi­
tion with the Federal Reserve for priced services. We are also the
Federal Reserve Bank of Philadelphia’s largest customer.
I would like to thank the committee for the opportunity to com­
ment on the issue of privatization of Federal Reserve price services.
As documented in the 1989 General Accounting Office report,
“Check Collection: Competitive Fairness is an Elusive Goal,” the
Federal Reserve is engaged in almost $800 million a vear business
of providing priced services, activities that the Federal Reserve pro­
vides for a fee, such as check collection, wire transfer, and so forth,
in direct competition with banks and other service providers.
At the same time the Federal Reserve also regulates its competi­
tors. The dual roles of regulator and service provider effectively sti­
fle private sector competition for price services. Competition is cur­
tailed in several ways.
The Federal Reserve enjoys legal advantages that no private sec­
tor provider can match. Among these are the ability to present to
any paying bank as late as 2 p.m., the ability to compete on a na­
tional basis, and the ability to spread costs over a variety of prod­
ucts, including some products where the Federal Reserve enjoys a
virtual monopoly position.




42

As the manager of the payment system, the Federal Reserve ex­
ercises its tactical rulemaking abilities, granted under regulation
CC, in ways that frequently appear to have, as their primary moti­
vation, improvement of the Federal Reserve’s competitive position
at the expense of the private sector providers. A recent example
would be the establishment, by the Federal Reserve, of a 6:30 p.m.
deadline for the settlement of same-day settlement presentments.
The late deadline, which applies only to private sector present­
ments, compares to a deadline as early as 11 a.m. for Federal Re­
serve presentments. The early deadline reduces Federal Reserve
risk, while the late deadline increases private sector risks and
costs.
Although the time under which payment can be delayed may ap­
pear to be unimportant, the distinction could effectively negate the
cost avoidance opportunities for some of the very banks that sameday settlement was supposed to benefit.
Finally, it is important to appreciate that banks view the Federal
Reserve primarily as a regulator. As a result, banks frequently are
reluctant to challenge Federal Reserve actions related to price serv­
ices because of their concerns related to the Fed’s regulatory role.
The net effect is that the dual powers that Congress has granted
to the Federal Reserve sets up a governmental agency with unfair
competitive advantages over the private sector. Although it is now
seen as a cliche, it is nevertheless true that the FAA doesn’t fly air­
planes since it would place them in the conflicting roles of regu­
lator and operator. This is a truth that the current Federal Reserve
structure does not reflect.
Privatization of the Federal Reserve price services functions is
the most effective way to resolve the actual and perceived conflicts
of interest which the government has created in allowing the Fed­
eral Reserve to function in its dual roles.
Three approaches to privatization of the Federal Reserve’s price
services functions should be considered.
One, the Federal Reserve should sell their operating units on a
regional basis to private sector providers.
Two, priced service activities could be spun off from the Federal
Reserve on a local basis. The new charter would be to operate as
a private company with profits to be paid to the Treasury. This ap­
proach would result in approximately 46 separate companies being
created. Each new company would be subject to the same regula­
tions as the private sector providers.
And, three, the Federal Reserve could return to its historic role
as a processor of last resort providing those services that the pri­
vate sector elects not to deliver.
Each of the three alternatives provides benefits and challenges.
Additional work would be required to install any one or a combina­
tion of the above solutions. However, each would appear to success­
fully eliminate the conflict in the dual roles of the Federal Reserve
without jeopardizing the safety and soundness of the payment
system.
Thank you for your attention. I would be pleased to answer any
questions.
The Chairman. Thank you very much.




43

[The prepared statement of Mr. Wentworth can be found in the
appendix.]
The Chairman. Well, let’s see now. Mr. Borden, if I understood
correctly, you don’t favor the creation of a congressional study
committee?
Mr. Borden. Mr. Chairman, we feel that a committee approach
or a GAO approach would both end up with going for the same
goal.
It was our position that the GAO, having had some previous ex­
posure and experience in looking at this question with the Fed,
might have a headstart on that process.
The Chairman. Well, Mr. Lauffer, you heard the other testimony
and also Mr. Borden’s. As I interpret it, you are suggesting that
private enterprise would not satisfactorily provide the check-clearing services, particularly, the smaller and either what you call com­
munity or rural.
But now the thrust of your presentation with respect to the study
was not so much against the creation of a committee as to what
the parameters should be prefixed for that committee to work
within.
But I don’t interpret yours to be in opposition to an inquiry or
a study or the creation of the committee as such.
Am I correct?
Mr. L au ffer. Well, as long as there were representatives on
there that would take into consideration the rural banks.
You see, with the big clearing houses, volume is the name of the
game. And they already stated—how much volume do you have
now in the total market, 85 percent or something. It doesn’t pay
them to provide services to the smaller banks with that low vol­
ume. And that is why Fed has always been a good provider that
we know is going to be there.
Correspondent banks, the issue is, OK, get it through your cor­
respondent. A lot of correspondent banks have gone out of all kind
of business. Like I said, we helped 16 bankers banks around the
country in 16 States because the correspondents said to the little
banks, forget it, we don’t need your business, there is not enough
volume in it, whether it has been safekeeping or a number of
things.
We have a bank in Pittsburgh that had a data center, that has,
I forget how many participants, hundreds, maybe 1,000, that they
were always going to be in that business and their correspondent
banks joined. Well, they sold it 6 months ago.
And so you have the big banks always moving to where the profit
is going to be the greatest, and that is fine. That is what they
should be doing in a free enterprise system. But if we do something
to take away the rural bank’s only way of clearing, or they have
to pay a correspondent or pay $10,000 a year just to belong, be­
cause as I said in the statement, the Huntington one, they required
$200 million in capital; thereby, they are not interested in the
10,000 other banks. They are only interested in the top 100 that
produce the volume.
That is just how it is going to come down, because that is how
a profit margin is going to come down. Sure, they might provide
them but at what cost to the individual banks? And what cost to




44

the consumers? Because it is just like the nationwide banking
trend.
As they consolidate, you find them closing branches in rural
areas because it doesn’t pay them to have one that far—it is too
far to move the material. Material can move electronically now, but
the cost to a $10 million bank or a $30 million bank or a $50 mil­
lion bank would be unreal.
My other point that I think is a good point, if Lee Hoskins, who
was president of Fed Cleveland for a number of years, thought that
the Fed’s pricing was noncompetitive in the market, why would you
go to a large bank and form this to compete against the Fed?
I can't find a rational reason why that would happen. Because
these other three gentlemen are saying that the Fed has a competi­
tive edge, they have a competitive advantage. I mean here is a man
who worked for Fed and then started one of the biggest deals that
we have in the Nation right now.
Mr. W entw orth. Mr. Chairman----The Chairman. Either he should have stuck to being the Fed
president, or he knows something we don't know. And maybe per­
haps we can have some comment from the respective witnesses.
Mr. Wentworth.
Mr. W entw orth. Yes. Thank you, sir.
As a point of clarification, CoreStates is not a member of the Na­
tional Association of Clearing Houses; however, I am familiar with
their operations.
I believe the record will indicate that the $200 million require­
ment was established by the Federal Reserve as part of the nego­
tiations that went on between Huntington Bank and the other
partners in order to get the settlement facilities that were nec­
essary for that organization’s operation. So that limiting member­
ship was never an objective of the organization. It was a require­
ment placed by the Fed.
Second, I think it is interesting that we have heard testimony
about the withdrawal of correspondent banks from the marketplace
or of major banks from the marketplace.
I think that is absolutely accurate. But the root cause of that
withdrawal is the predatory pricing of the Federal Reserve as they
move to try to offset the other elements that are happening simul­
taneously within the marketplace such as the consolidation of
banks.
The statements that addressed the reduction in transit activity
are exactly right. As transit volume declines, the Federal Reserve
has moved to retain its market share by ratcheting down prices, as
they have the ability to do that and have exercised their ability to
do that.
The profit incentives that are left for banks has been eliminated
so that there is a cause and effect here and an interrelationship be­
tween all of these activities.
Mr. Carreker. I would like to make just two points. First, back
when the Monetary Control Act came about, the Federal Reserve
started losing volume significantly because it, for the first time,
was having to price its services; and its volume levels were such
that, since the check operations are veiy volume oriented, its cost
of services were too high.




45

The Federal Reserve, taking advantage of its national delivery
system and its ability to regulate implemented something called
“noon presentment” which forced all banks across the United
States to receive deposits from the Federal Reserve individually
until 2 p.m. so it changed the entire structure across the country.
And then it put in place a national transportation system that
made it possible for the Federal Reserve to intercept transit checks
in remote national locations around the country and to funnel those
into the Federal Reserve and out of the private sector.
As a result of that, a number of the clients that we work with
that had spent millions of dollars building large correspondent
bank operations found their volume going away to the Federal Re­
serve. As a result, their unit costs went up. As a result, when they
started looking at their ability to compete with the Fed, they exited
the business, resulting in the problem that Mr. Lauffer is referring
to.
It is a perfect example of how the Federal Reserve has, in fact,
used its regulatory authority to change the playing field and to
compete in a way that disrupts the ability of the private sector to
predict the return—reasonable return on investment that it can re­
alize from its check operations. That is the first point I wanted to
make.
The second point I wanted to make is that all of our discussions
have focused on the check collection system in the United States
as we thought of it historically. The check collection system in the
United States is undergoing a change like it has not seen since the
earlv sixties when MICR was invented.
Electronic check presentment and the advent of image tech­
nologies will position the United States to move forward in dra­
matically reducing fraud, which is growing exponentially, which
will allow it to reduce the processing costs dramatically, which will
allow it to compete much more effectively on a global basis around
the world.
To do that, the private sector, who is aware of the opportunities
to reduce costs, fraud, and deliver improved payment systems serv­
ices to corporate America, has to take the leadership and make the
investment necessary to move our payment system forward.
If the private sector constantly has fear that the Federal Reserve
can come in and regulate a playing field that disrupts their ability
to predict a return on that investment, they will withdraw. That
has occurred in the past, and it will occur again in the future.
This is a crucial time for the private sector to take leadership,
even the Fed acknowledged that; and that is why we feel it is so
important that a connectivity between the private sector and the
Fed, like never before, be established through this advisory board
so that the Fed can’t unilaterally move to try to optimize its cost
recovery market share and those kinds of things.
This is not the time for that kind of behavior.
The Chairman. Mr. Borden.
Mr. Borden. Mr. Chairman, I would like to comment on a few
things. And I think maybe an overall comment that while there are
several proposals coming from this table, I think that the general
spirit is in the same direction that there is something that needs
to be addressed. That does not mean that we need to attack the




46

role of the Fed in providing services to the independent community
banks, I don’t think that is the intention at all.
I think that the root comment that we are looking at here is that
if we have a competitive process that, as Mr. Carreker said, has
that level playing field aspect, then you would find a lot of the com­
petitive inequities that maybe are falling at the lap of the commu­
nity banks removed.
And to take that further, I would like to go into the automated
clearing house world where it is a little different than checks; but
there you have an organization like VISA who is an operator of an
ACH, just as the Fed is an operator of the ACH.
VISA, for years, has been working with the Fed to get a settle­
ment agreement in place. When they finally did get the settlement
agreement in place with the Fed, it was less than satisfactory.
And it definitely favored, as Mr. Wentworth said, the larger
organizations.
So we have the Fed, in effect, set a policy on the use of settle­
ment in several examples—one, a check clearing house and the
other an automated clearing house—that is biased toward the
larger player.
And in that regard, I think that the IBAA comments are right
on target. It is not that these organizations do not want to service
the independent or smaller bank at all. It is because they are con­
strained in what they are dealt by the Fed as to how they can oper­
ate that business.
And I would go further to say that in my clearing house and in
my ACH we have membership that goes down to the credit unions
which open 1 day a week, and you can’t get much smaller than
that in terms of being a financial institution, so that we have all
of these players that are in the same process together.
There are differences between the large ones and the small ones.
The small ones cannot afford to have certain kinds of services and
activities. They can’t afford the capital to buy the equipment. But
they have access throughout this process. And it is the access, I
think, that we are worried about. And if we have a competitive,
level playing field, the access will take care of itself.
Thank you.
The Chairman. Now, are you saying that Mr. Lauffer’s point
about the market for banking services and check clearing are not
functioning well for small banks, but that is because of Fed
policies.
Mr. Lauffer, what do you say about that?
Mr. L au ffer. I would disagree with that. I contend that the Fed
is the only national player across the Nation. If we were close to
Kansas City and able to use Mr. Borden’s clearing house, that
would be one thing. But you have banks in Montana, Wyoming,
and parts of Texas, as you well know, that aren’t close to a regional
situation. And I don’t think—I mean I have to rest part of my case
on the Huntington Bancshares and go back to what you said. The
gentleman must know something more than we know of that be­
cause, why would you start a venture and invest millions of dollars
and go after this big market if you didn’t think that you had a com­
petitive edge against the Federal Reserve from where you came?




47

It just, to my mind—and I have never asked Lee that question;
but since it came up here today, that is a good question to ask. If
there is no competitive advantage, I mean, why would you go out
and become CEO and go into something that is so unique as this,
and only few in the country, if you knew that the Federal Reserve
is going to undercut you, you wouldn’t make a profit?
You know, I rest with you saying somebody knows something we
don’t know.
The Chairman. Mr. Wentworth.
Mr. W entw orth. Sir, the National Clearing House Associates,
which is the organization that Huntington is linked with, is a notfor-profit corporation. It is an association of banks who have come
together without a profit motivation in order to reduce their clear­
ing costs. The Huntington involvement is an element called Chexs,
which is a for-profit company that provides settlement services ex­
clusively for the members of the national clearing house.
So to make a comparison of the motivation that Huntington had
vis-a-vis traditional correspondent check clearing house activities,
I would categorize as being inaccurate. Huntington does not proc­
ess checks, Huntington provides a settlement service, which is a
net settlement service, through the books of the Cleveland Fed.
The Chairman. Yes, Mr. Carreker.
Mr. Carreker. Mr. Chairman, relative to the comment that was

made about making payment system services available through re­
mote or rural banks. In Canada, the Federal Reserve equivalent
there does not perform check operations. Instead, what it has is,
in effect, a committee, if you will, that is an ongoing group where
the banks that have met certain qualifications to play the role of
intermediary bank come together with the policy regulatory author­
ity, which is the Fed equivalent up there, and the Fed, in effect,
interacts with those larger banks in Canada to ensure that the
payment system is sound, safe, and cost effective.
The banks, then, implement the operations and carry those out,
and while the largest banks are involved in that interaction with
the Federal Reserve equivalent, there are many banks in more
rural locations than we have here in the United States that are
served in the Canadian model. Similar models exist in other indus­
trialized countries.
So it is not a direct conclusion that a private sector approach
under the regulation and authority of the Federal Reserve cannot
deliver cost-effective services. It has in the past and it could do it
in the future. There would be many issues that would have to be
thought through and dealt with, but given the opportunity, that
could be done.
Mr. Lauffer. Mr. Chairman, I want to put something else in the
record here one of my colleagues gave me. We have asked the Fed
people a number of times about the $200 million capital limitation,
and they have denied saying that they ever set any capital limita­
tion. I don’t know who is right and who is wrong, but that is what
they have told us.
The Chairman. Well, we intend to follow through and we will
have another hearing at which time of course we would expect to
have the Fed, and that is why it was important for us to hear from




48

you first so that we would be able to follow through and pinpoint
some of these issues.
[The information referred to can be found in the appendix.]
The Chairman. But coming back, I am going to ask some of the
other witnesses, Mr. Carreker and Mr. Wentworth, to respond to
Mr. Lauffer’s speculation about the venture of this former reserve
president going into a business if the Fed is so preemptive in its
dual role as regulator and competitor.
Mr. Carreker. Well, there are many situations, I think, where
over time, as various payment systems, innovations have come
about where the Federal Reserve has been found to not be the costeffective solution, and to not be the best price in town. And I think
what the national clearing house organization has done is to iden­
tify a way for the private sector to come together and to create a
structure between banks that is less costly than going through the
Federal Reserve. That is innovative and tnat is a creative thing to
do.
I think the point that I really want to drive home, because of the
need for investment in the payment system today, is that the Fed­
eral Reserve can change the rules. They have done it in the past
and they are not some black cloaked outfit out to do damage or
anything like that, they simply have a conflict of interest. They are
required to maintain a certain market share and a certain cost re­
covery if they are going to stay in operation, and so they tend to
do the things necessary to accomplish that.
If you were an enterprising organization out to get a good return
on investment for your investors, you would not invest in things
when there was inordinate risk. And in the payment system of the
United States, when the Federal Reserve can unilaterally change
the rules, that deters investment. And that, to me, given the time
period that we are in in this country, is a very, very serious and
sad situation to be in. It needs to be dealt with.
The Chairman. Mr. Wentworth.
Mr. W entw orth. If I may, Mr. Chairman. I think representing
correspondents in general, which is a mantle I am taking unto my­
self, our position would be that service enhancements and quality
are assured as the result of competition, competition between the
private sector and the Federal Reserve.
I think the numbers from our market, the third Federal Reserve
district, perhaps are symbolic of the problem. The best numbers
that we have is that the Federal Reserve enjoys about a 55 percent
market share. We enjoy about a 35 percent market share, meaning
that all of the rest of the banks in the districts split up about 10
percent between them.
Should CoreStates decide for profit motivation reasons to with­
draw from this business, there will be no competition for price serv­
ices in the third district, and I cannot imagine any elements of the
banking industry that over time would benefit from that situation.
Mr. L auffer. Mr. Chairman, I am a little confused. I think I just
heard you said that this was an enterprising thing going on and
knowing that private enterprise, the private sector, could be more
competitive than the Fed on pricing; and then I know I heard that
the Fed has a competitive advantage on pricing. So I am not sure
what that leads to.




49

On one hand we are saying here that the private sector can go
out and do a better job and cut costs under Fed, and on the other
hand, we are hearing everybody say the Fed has competitive ad­
vantage now. It cannot go both ways.
I am sure it could go both ways, or in different factors, in dif­
ferent facets of Fed’s operation, but it cannot go both ways. You
cannot say the private sector will do a better job and cut costs and
the reason why you are going to let them do that is because they
are going to be able to cut costs, but then on the other hand say
we want to do this because the Fed has a competitive advantage.
The Chairman. It seems to me that the thrust of the statements
with respect to the Fed’s dual role or capacity, that is as a regu­
lator over the same entities and banks, and also the provider of
services was providing a backdrop in which competition could, at
any time, be susceptible to elimination. That is what it seems to
me.
I don’t know what your opinion is as to this very basic argument
for privatization or what is labeled here as an even playing field,
competitive playing field. Is it your interpretation that the Federal
Reserve Board does not indulge at times in a switch role, one from
the other, in this clearing process?
Mr. Lauffer. I am not sure I understand the question. I think
you are saying or are you saying that they may have a competitive
advantage in one area and they are subsidizing it from another
area? Is that what you are----The Chairman. Well, I was trying—I think the best thing to do
is ask Mr. Carreker and Mr. Wentworth or Mr. Borden because
they are from the private sector, to interpret what I was trying to
poorly evaluate as the thrust of their main reason for an enhance­
ment or encouragement of privatization based on a competitive and
fair playing field. And that is that the Fed, as a prime regulator
of banks, does not lose control of that power when it comes to the
providing of check-clearing services.
But I think the best thing would be to clarify that by having Mr.
Carreker, Mr. Wentworth, or Mr. Borden elaborate or extend a lit­
tle more on what they have already stated.
Mr. W entworth. Sir, the Monetary Control Act required the
Federal Reserve to act as if it were a private sector provider, and
to establish a kind of Chinese wall between its regulatory activities
and its price services activities. Events have proven that the Chi­
nese wall frequently appears to disappear when it is in the interest
of price services volumes.
The Federal Reserve prices are based upon its ability to change
payment rules to their exclusive advantage at the expense of all
the other alternatives. We can cite a number of examples where
the Federal Reserve has unilaterally made major changes in the
payment system in conflict with their own pricing policies having
to do with such things as competitive impact studies, where they
have stated that they would not make a major change in a pay­
ment system that would have an adverse effect on the competitive
environment without doing an extensive competitive impact study.
The fact is that these studies are frequently not done at all or
done in ways which provide no benefit at all to the process.




50

I think Mr. Carreker said earlier it is not our intention to pass
the image of the Federal Reserve as being ill-intended people. I be­
lieve that the basic policy that Congress has established which sets
up this dual role has left them in an untenable position. You can­
not be both a regulator and an operator, it just does not work.
The Chairman. Do you have any comment, Mr. Lauffer, in view
of that explanation?
Mr. L au ffer. I have a couple of comments. It has worked since
1912 or whatever it has been and, of course, the Constitution of
this country has worked a lot longer than that.
But one point I want to make to Mr. Wentworth; how much of
the market did you say you have in Philly or eastern Pennsylva­
nia?
Mr. W entw orth. We have 35 percent of the market’s share.
Mr. L au ffer. And Fed has 50?
Mr. W entw orth. Fifty-five.
Mr. L au ffer. I submit to you, Mr. Chairman, you take the Fed
out of the business in the Philadelphia district and this one bank
will have 85 percent of the market share.
Mr. W entw orth. And we are not recommending, sir, that that
be the result. What we are simply asking for is to have the Federal
Reserve operate on the same level playing field, if you will, as the
rest of us.
Privatization does not translate into a monopoly of a single pro­
vider, which is the end result of the current practices of the Fed­
eral Reserve. Privatization gives the opportunity to have multiple
players.
Mr. L auffer. Mr. Chairman, one other question or one other
statement. The Canadian illustration, I think, is a very poor illus­
tration in comparing our system to theirs. They have five or six
large banks with branches all over Canada. Very few community
banks. We are dealing with 10,000 banks in the United States.
So to compare that to the same system, you know, we get this
thrown in our face as community bankers all the time. We do not
need all you guys, England only has three banks, Canada only has
four. Well, we are serving somebody out there or we would not be
there, and all we want to make sure is that we do not get frozen
out of the payment system or priced out of the payment system, so
that we cannot afford the price, that it ups our cost and ups our
cost to our customers.
That is what we want to do, we want to make sure the Commis­
sion is not biased; that they are looking at where our banks are
and what we have to deal with and will these private sector provid­
ers provide us that service at a reasonable cost.
The Chairman . Yes, Mr. Carreker.
Mr. Carreker. I just would not, I don’t think anything should

happen that would in any way place in jeopardy the small banks
that serve the communities around the country, and I don’t believe
anybody here is suggesting that. I don’t even believe that anybody
on the panel is suggesting that the Federal Reserve be taken com­
pletely out of the payment system until such time as their operat­
ing role is conspicuously not necessaiy any more and other ration­
ale has been put in place that makes it cost-effective.




51

So I don't think that is what we are dealing with. I think what
we are dealing with is the fact the Federal Reserve does have a
basic conflict of interest. There is a basic issue there that is deter­
ring the ability of the U.S. payment system and the banks that
make it up to move forward in a manner that is important for this
country.
And I think that an advisory board or some group that can en­
sure that the initiatives between the Federal Reserve and the pri­
vate sector are well dealt with in a very visible and open way, be­
fore the Fed has a unilateral opportunity to continue to operate in
the dual role, is an important thing that needs to occur at this
time.
Mr. Lauffer. I would respond to that, Mr. Chairman, in saying
that I don’t have any problem with them being a regulatory body
plus being in check clearing. In fact, I think there is an advantage
there because the Fed’s ultimate goal is to keep this country, the
economy, and failures, and the whole thing on as even keel as it
can. Taking the volume outside their system takes them out of that
loop to know that there might be something,that should be dealt
with.
So I don’t look to, and I don’t think the community bankers look
to that being a problem at the Fed. The Fed regulates them plus
providing clearing or whatever services they do. It might be a prob­
lem for the big banks but I am not sure it is a problem for us.
The Chairman. I believe that the issue here is the wisdom or
lack thereof of the creation of an evaluative or study commission.
And we can conjure all kind of peers, but the basic premise is that
this is an area that needs clarification as to policy, where the na­
tional policymaking body, the Congress, has a responsibility.
So unless any one of you gentlemen has an additional remark or
question to raise, we will proceed on the basis that this has been
a most effective presentation and that we are very much in your
debt.
This is an issue that does agitate us on this committee. We do
not want to do what has happened so often in the immediate past
three decades where you have these burgeoning issues coming up
and Congress apparently not aware or at least not confronting
them. So we do, of course, intend to have the Federal Reserve and
others testify on this particular section of this bill.
So thank you very much, gentlemen. You have been most pa­
tient. We have gone right through the lunch period.
And I am going to request, as is customary and as I have been
asked, unanimous consent that all members, including myself, be
provided the privilege of submitting written questions to you; ques­
tions that you should receive by the time you get a transcript of
the proceedings of today’s hearing.
There are so many things going on right now, including business
on the House floor. But, more importantly, the quite unexpected
visit of the President and his wife this morning and the consequent
change in the schedule of the House and its business today, which
accounts for so many members being out and a few of those that
did come in only having to leave.




52

But everyone has a copy of your testimony and some will be sub­
mitting questions in writing as well as I. But thank you very much,
gentlemen.
The committee will stand adjourned until further call of the
Chair, which will be tomorrow at 10 o’clock in this hearing room.
[Whereupon, at 1:15 p.m., the hearing was adjourned, to be re­
convened 10 a.m., October 28, 1993.]







53

APPENDIX

October 27, 1993

54
Opening Statement
C h a i r m a n H e n r y B. Gonzale z
C o m m i t t e e on Banking, F i n a n c e a nd U r b a n A f f a i r s
U.S. H o u s e of R e p r e s e n t a t i v e s
O c t o b e r 27, 1993
F o u r t h Day of H e a r i n g s
on the Iss u e s Inv o l v e d in
t h e " F e d e r a l R e s e r v e S y s t e m A c c o u n t a b i l i t y A c t of 1 9 9 3 ”
H R 28

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on

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welcome

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the

C o m p t r o l l e r G e n e r a l of the Ge n e r a l A c c o u n t i n g O f f i c e (GAO) a nd l o o k
forward

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l i m i t a t i o n s t h e G AO faces in e x a m i n i n g Federal R e s e r v e o p e r a t i o n s .
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during

these

hearings

on

October

Fede r a l R e s e r v e C h a i r m a n A l a n G r e e n s p a n told us,

"GAO,

13,

1993,

in t h e 1978

Act, c o u l d a u d i t all as p e c t s of the Federal R e s e r v e S y s t e m w i t h t h e
e x c l u s i o n of t h o s e whi c h ref e r t o the q u e s t i o n of t h e d e l i b e r a t i o n s
r e l a t e d to m o n e t a r y p o l i c y . "

W a s he t r y i n g to m i s l e a d us?

Let m e t e l l y ou some ar e a s of Federal R e s e r v e o p e r a t i o n s t h a t
t h e G A O c a n n o t i n vestigate. M o s t p e o p l e do not k n o w t h a t w h e n t h e
F e d e r a l R e s e r v e c h a n g e s the m o n e y supply,

it does so from its N e w

Yo r k

separate

Federal

Reserve

Bank

in

an

auction

f rom

t he

U.S.

T r e a s u r y a u c t i o n s u s e d to b o r r o w m o n e y for g o v e r n m e n t o p e r a t i o n s .
Ea c h m o r n i n g a r o u n d 10 a.m.,

the Fede r a l R e s e r v e B a n k of N e w Y o r k

h o l d s a 3 0 - m i n u t e a u c t i o n w i t h a p p r o v e d b a n k and n o n - b a n k d e a l e r s
in

order

to

change

t he

monetary

b u y i n g o r s e l l i n g securities,
agreements,
back

into

base

of

the

United

States.

By

usually very short-term repurchase

the Fed t a k e s m o n e y out of c i r c u l a t i o n or p u t s m o n e y
c i r c u l ation.

There

is

litt l e

information

on

this

auction. W e k n o w t h e r e is no m a r k e t c l e a r i n g pri c e as was r e c e n t l y




55
i n t r o d u c e d for Tr e a s u r y auctions- Thus, a c c e p t e d bids or o f f e r s are
t r a n s a c t e d at d i f f e r e n t prices.
run this market?

Is this t he m o s t e f f i c i e n t w a y to

W hy a re t he b i d s

and

offers

n ot p u b l i s h e d ?

Is

t h e r e a n y p o s s i b i l i t y of e x p l o i t i n g i nside infor m a t i o n , e s p e c i a l l y
since

participants

before

the

can m e e t

a u c t ions?

Can

at

the

t he G A O

Federal
send

Reserve

Bank

in a t e a m o f

shortly

experts

to

u n c o v e r t he a n swers?
The second example concerns the Federal Reserve's intervention
in f o r e i g n c u r r e n c y markets.
FOMC

meetings

intervention

t hat

the

wi t h o u t

We k n o w f ro m t h e m i n u t e s of t h e 1962

Fede r a l

Reserve

adequately

notifying

p u b l i c . T h a t fund is n ow $30.1 b i llion.
hand,

gave

t he

a

fu n d

Congress

T h e T r easury,

h a s a fund s imilar to th a t o f t h e FED,

S t a b i l i z a t i o n Fund,

itself

for

or

the

on t h e o t h e r

called the Exchange

but its b u d g e t is a p p r o v e d b y t h e C o ngress.

A c c o r d i n g to a d e s c r i p t i o n p u b l i s h e d

by t h e F e d e r a l

Reserve

B a n k o f N e w Y o r k in the 1970s, t h e F e d e r a l R e s e r v e u s e s c o m m e r c i a l
b a n k s t o i n i tiate some of the t r a n s a c t i o n s
an

intervention

by

the

F ederal

Reserve

i n c r e a s e the r e l a t i v e pri c e of U.S.

involved.

to

sell

dollars

F or example,

German

marks

to

i n c l u d e s t h e s a l e of

m a r k s t o c o m m e r c i a l banks, a r e q u e s t for a S W A P t r a n s a c t i o n to the
Bundesbank,

a nd a t w o - d a y s e t t l e m e n t period. C a n t h e G A O s e n d in a

t e a m o f e x p e r t s to d i s c e r n t he p r o p r i e t y of t h e s e p r o c e d u r e s ?
I b e l i e v e the a n s w e r to b o t h s i t u a t i o n s is "No." Is it o u t - o f ­
b o u n d s for t h e A m e r i c a n p u b l i c to l e a r n a b o u t t h e s e t r a n s a c t i o n s ?
Ag a i n ,

thi s

has

no t h i n g to do w i t h

FOMC deliberations

or m i c r o ­

m a n a g e m e n t of d a i l y Federal R e s e r v e ope r a t i o n s . T h e F e d j u s t w a n t s
to

keep

reviewing

the
how

curtains
we l l

—

closed
or

how

and

keep

bad—

any

its

outside

biggest

eyes

policies

fr o m
are

i m p l e m e n t e d . W h o knows w h e t h e r the Fed's e n g i n e n e e d s a t u n e - u p if
n o o n e w i l l let t he m e c h a n i c l ook u n d e r t h e h o o d ?




56
3
Now

let ' s

appropriate.
Federal

discuss

Earlier

Reserve

expensive

another grey
this

Bank

f r o m E.

Gerald

I

was

the

in f o r m e d

personnel

were
from

the

gi f t s

very

GAO would

that

accepting

and

restaurants

a u t h o r i t y to r e g u l a te.
reply

year,

area where

New

York

hospitality
banks

they

be

at

have

On M a y 18, 1993, I r e c e i v e d t h i s a s t o u n d i n g
Corrigan,

former p r e s i d e n t

of

the N e w

York

F e d e r a l R e s e r v e Bank:
"Our

review

indicates

that

in

the

limi t e d

number

of

i n s t a n c e s w h e r e B a n k o f f i c e r s have b een g u e s t s at m e a l s
hosted

by

regulated

insti t u t i o n s

at

what

would

be

c o n s i d e r e d an e x p e n s i v e restaurant, t hey have b e e n a c t i n g
within
into

Bank Guidelines
question

the

and their co n d u c t d o e s n o t call

e t hical

s t andards

of

the

Federal

R e s e r v e B a n k of N e w York."
T h a t s u r e l y s a y s s o m e t h i n g ab o u t the ethical s t a n d a r d s of t h e
N e w Y o r k F e d e r a l R e s e r v e Banks b e c a u s e such gi f t s w o u l d b e i l l e g a l
for

government

agencies

us i n g

appropriated

funds.

President

C o r r i g a n a l s o r a t i o n a l i z e d the a c c e p t a n c e of t i c k e t s for s p o r t i n g
e v e n t s f r o m r e g u l a t e d b a n k i n g i n s titutions w hen h e said:
"There

were

involving
which

a

literal

attendance

bank

acquaintances

hand f u l
at

officers
w ho

of

sp o r t i n g
were

w ork

instances
events

guests
at

in
of

regulated

institutions."
B u t w i t h no o u t s i d e review, we don't k n o w h o w m a n y c a s e s t h e r e
w e re.

Maybe this

is like the "rough notes"

of F O M C m e e t i n g s t h a t

t u r n e d o u t t o b e t a p e r e c o r d i n g s and transcripts.




57
4
T h e q u e s t i o n I ha v e for t he C o m p t r o l l e r Ge n e r a l is w h e t h e r t he
G A O c a n i n v e s t i g a t e t he r e c e i p t of h o s p i t a l i t y f rom r e g u l a t e d b anks
by

Federal

Reserve

employees

if

the

employees

say,

"We

we r e

d i s c u s s i n g m o n e t a r y p o l i c y d u r i n g o ur free m e a l s p r o v i d e d by the
X Y Z b a n k in an e x p e n s i v e r e s t a u r a n t " ? As I u n d e r s t a n d it,
case,

the

F e d eral

Reserve

must

give

its p e r m i s s i o n

for

in this
any

GAO

e x a m i n a t i o n . D o e s n /t t he p u b l i c h a v e the right to m o n i t o r p o s s i b l e
c o n f l i c t of i nt e r e s t s i t u a t i o n s ?
Fi n a l l y ,

t he rea s o n G AO h a s su c h lim i t a t i o n s

is b e c a u s e the

F e d c o n d u c t e d an e l a b o r a t e c a m p a i g n to p r o h i b i t any a u d i t b i l l from
passing

and

approved

by

succeeded
t he

for m a n y

Banking

years.

Committee

but

In

fact,

it w as

by

another

not

even

committee,

in

1978.
I

am

happy

to

ha v e

the

Comptroller

General

here

today

d i s c u s s t h e G AO l i m i t a t i o n s in e x a m i n i n g the F e deral Reserve.
B ows h e r ,

please

your testimony,




int r o d u c e y o u r a s s o c i a t e s w h o will
for the record,

a n d then proceed.

to
Mr.

a s s i s t y o u in

58
Statement for Second Panel
Chairman Henry B. Gonzalez
Committee on Banking, Finance and Urban Affairs
U.S. House of Representatives
Fourth Day of Hearings
October 27, 1993
on the Issues Involved in
the "Federal Reserve System Accountability Act of 1993"
HR 28

I w a n t to w e l c o m e W i l l i a m J. McDonough, Vice C h a i r m a n of t h e
Fede r a l O p e n M a r k e t Com m i t t e e
Reserve

Bank

of N e w

York,

Federal R e s e r v e Board.

(FOMC)

and

and P r esident of t he F e d eral

Governor

Wa y n e

D.

Angell

of

the

I w o u l d like to h ear your v i e w s on t h e G A O

a u d i t l i m i t a t i o n s and to k now if y o u think t hey a r e justified.
Before
address.

As

turning
you

to

I

in

know,

that,

bill,

my

the

re l e a s e

of

any

a

policy

very

the

HR 28,

Accountability Act of 1993,
require

ha v e

s e rious

Federal

there

are

change

matter

to

Reserve System
provisions

within

a

week

t hat
and

a

v i d e o t a p e of FOMC d i s c u s s i o n s w i t h i n 60 days. You b o t h k n o w t h a t I
in q u i r e d

of

all

the

Federal

Re s e r v e

g o v e r n o r s in m y l e tter of O c t o b e r 22,

Bank

presidents

a nd

the

1992 about m i n u t e s of FOMC

m e etings. C h a i r m a n G r e e n s p a n wro t e the following to m e on D e c e m b e r
24,

1992:
" . . . M e m b e rs felt that m a k i n g a tape or l i teral
transcript

public

would

have

an

especially

re s t r i c t i v e e f f e c t in d iscussions..."
For the h e a r i n g last w e e k on Octo b e r 19,
F ederal R e s e r v e official to include

1993,

I asked each

in his or h e r testimony,

any

k n o w l e d g e of n otes or re c o r d s ma d e by others at FOMC meetings. V i c e
Ch a i r m a n

McDonough,

t e s t i m o n y as follows:




although

you

did

not

appear,

you

submitted

59
"I

have

no

per s o n a l

knowledge

of

any

other

n o t es or records t hat o t h e r s m a y h a v e m a d e at
F O M C me e t i n g s
Ye s terday,

..."

I re c e i v e d a l etter from C h a i r m a n G r e e n s p a n s a y i n g

t h a t t h e r e h a v e b e e n t ape r e c o r d i n g s m a d e at F O M C m e e t i n g s s i n c e
1976, t h a t t h e FOMC has u n e d i t e d tra n s c r i p t s , a nd s t a f f not e s fr o m
t r a n s c r i p t s e xi s t b a c k to 1983.

In addition,

t he m e e t i n g ro o m for

t h e F O M C h a s a c ompete setup for t a p e r e c o r d i n g including:
"A g r e e n light on t op of t he m e e t i n g t a b l e n e a r its he a d
is l it w h e n the r e c o r d i n g s y s t e m is in use."
H o w cou l d anyone not know wh a t t h a t g r e e n lig h t m e a n t and fail
to

tell

the

Congress

or

report

th a t

there

were

no

l i teral

transcriptions?
I a l s o m u s t say I have some t r o u b l e w i t h C h a i r m a n G r e e n s p a n ' s
statements
office

t h at he

and

he

knew

also

about

knew

the

about

taping

unedited

when

he

first

tran s c r i p t s ,

assumed

but

just

forgot.
"Indeed,
last

until

a staff m e m b e r j o g g e d m y m e m o r y

few days,

I had been under the

in the

impression that

I

first lear n e d on l y abo u t a y e a r ago th a t t r a n s c r i p t s w e r e
b e i n g retained."
If I wer e s i tting in front of a g r e e n light lit up ev e r y t i m e
I talked,

I t h i n k I w o u l d have be e n a lit t l e b i t m o r e i n q u i s i t i v e

a b o u t w h a t w a s g o i n g on. It w o u l d j og m y memory.

I hope they didn't

t h i n k t h a t w h e n the g r e e n light w e n t on it m e a n t

"raise i n t e r e s t

rates."
Now

tha t

we

kn o w

that

Chairman

Greenspan

initiated

a

c o n f e r e n c e call and informed the g o v e r n o r s a nd p r e s i d e n t s abo u t t h e
t a p e r e c o rdings, why did they g i v e t h e t e s t i m o n y w e r e c e i v e d last
w e e k on O c t o b e r 19?




60
I

w a n t to t h a n k G o v e r n o r Angell

about the transcripts
case,

why did

you

several

join

years ago.

for t e s t i f y i n g t h a t h e knew
However,

in the m i s l e a d i n g

C h a i r m a n G r e e n s p a n on O c t o b e r 26,

reply

if th a t
sent

is the

to m e

from

1993?

T h i s is a t i m e in our nat i o n ' s hist o r y w hen the p u b l i c de m a n d s
accountability

f r om

citizens who are
truthful

its

government

officials.

There

l o s i n g th e i r trust in government.

response

to my

r e quests by the senior

are

many

T h e less than

officials

of the

F e d e r a l R e s e r v e a b o u t m i n u t e s and their t e s t i m o n y last w e e k raises
serious

questions.

Why

hearings

to

encourage

R eserve.

T he

all

outrageous

the

d i screpancie s?

greater

accou n t a b i l i t y

deception

of

the

last

We
of
few

he l d
the

these

Federal

days

shows

I can pa i n t no b e t t e r case

for a

p r e c i s e l y w h y g r e a t e r a c c o u n t a b i l i t y is needed.
Now,

as for t he GAO audit,

G A O a u d i t t h a n t he o u t c o m e of the inquiry I made on t he a c c e p t a n c e
of h o s p i t a l i t y a n d g i f t s by the Federal Re s e r v e of N e w Y o r k Bank
o f f i c i a l s f r o m t h e v e r y banks they regulate.
opening

statement

that

p r a c t i c e h a s n o t ended.
"paper

trail."

This

you

sent

us,

Evidently,

Pre s i d e n t

from the

McDonough,

this

You have yet to e s t a b l i s h w h a t y o u call a
is

not

an

a d equate

res p o n s e

when

such

h o s p i t a l i t y is i l l egal for oth e r govern m e n t employees. I e x p e c t you
to

stop

these

practices

and

to

e s t a blish

an

arms-length

r e l a t i o n s h i p w i t h t h o s e y ou r e gulate just as o ther r e g u l a t o r s have
a l w a y s done. N o t h i n g less will satisfy me or the A m e r i c a n public.




61
STATEM EN T O F CO N G R ESSM A N JAM ES A. LEACH
C O M M IT T E E O N BAN KIN G, FINANCE & URBAN AFFAIRS
O ctober 27, 1993

Mr. Chairman, as you know, I have previously stated my support for relatively
m odest reform s to rem ove certain indefensibly undem ocratic elements o f the Federal
Reserve System.

I am also sympathetic to a greater degree o f accountability for Fed

decision making which might include a somewhat m ore timely release o f F O M C
policy directives.

H owever, I have reservations about the potentially m ore draconian

action o f expanding G A O investigation, som e call it audit, authority to the monetary
policy functions o f the Federal Reserve.
In this regard, lest there be any misunderstanding, it should be noted that in
the government the term audit has two distinct meanings.

The G A O conducts

financial audits -- so-called dollars and cents audits o f balance sheets; and
perform ance audits -

or reviews o f programs and the implementation o f laws.

Perform ance audits are akin to audits o f the decision making process.
The issue o f G A O audit or review o f the Federal Reserve's conduct o f
monetary policy is not an issue o f first impression.

Indeed, beginning in the early

1950's the m ore general issue o f G A O audit o f the Federal Reserve, including the
monetary policy function, was widely debated on Capitol Hill.

The eventual outcom e

o f this 25-year debate was passage o f the Federal Banking Agency Audit Act in 1978.
That act, for the first time, authorized the G A O to conduct both financial and
perform ance audits o f the Federal Reserve, exclusive o f the monetary policy function.
T h e monetary policy function was excluded from the purview o f G A O review at that
tim e in recognition o f the special political vulnerability o f a central bank because o f
the opposition that may be generated, particularly when it imposes monetary restraint.
The Congress concluded in 1978 that Congress had a host o f very adequate
techniques at its disposal, including statutory requirements for semi-annual reports to
relevant com mittees by the Chairman o f the Federal Reserve Board, to assess Federal
R eserve monetary policy.

In this context, it was further concluded, I believe wisely,

that frequent congressionally directed perform ance audits would lead to a greater
politicization o f the Federal Reserve System and ill-serve the country's econom ic best
interests.
There was also, and I believe still is, an awareness o f the extreme sensitivity o f
the confidential nature o f the inform ation provided by foreign central banks and
governm ents - inform ation critically needed in the form ulation and implementation o f

73-435 0

-




94-3

62
monetary policy.

It is not unreasonable to assume that public knowledge that an arm

o f Congress, the G A O , had review powers and access to such information w ould have
a chilling effect on the F ed ’s relationships with foreign governments and central banks.
Indeed, two years ago when this C om m ittee subpoenaed all records held by the
Federal R eserve relating to the BC CI scandal, an action I supported, this issue was
raised, albeit in the context o f bank supervision.

In that case, the covered records

included confidential docum ents supplied to the Federal Reserve by the Bank o f
England.

T h e Bank o f England was prohibited by British law from releasing those

docum ents to its own Parliament and indicated that if the Fed were com pelled to
produce them pursuant to this Com m ittee's subpoena, it would decline to share such
inform ation with the Fed in the future.
The form ulation o f monetary policy is a decision making process that involves
confidential interchanges with a host o f foreign governments and central banks.

Just

as inform ation sources are not infrequently protected for reasons o f political security
in certain foreign policy agencies o f our government, an analogously com pelling
argument exists that in a world o f econ om ic com petition and friction certain financial
and econ om ic inform ation provided to the Federal Reserve should be protected for
reasons o f national e con om ic security.

It is conceivable that even the hint o f a

possibility o f the release o f such inform ation could jeopardize existing relationships
betw een foreign monetary authorities, the Federal Reserve and the United States
Treasury, thus aggravating our nation's international finance relationships.
Confidentiality may be the best protection for national econ om ic security, and the best
protection for taxpayers who w ould bear the brunt o f any losses resulting from the
com prom ise o f policies caused by untimely disclosure.
Indeed, in a financial world in which huge sums o f m oney are now, in effect,
being wagered everyday in currency markets, Congress w ould be opening itself up to
the potential o f eco n o m ic espionage against itself by Am erican as welt as foreign
nationals if an institution aligned to Congress had timely access to market sensitive
information.

T h e relevant question is need to know on a long-term policy basis, not

m icro-inform ation gathering o f a nature not immediately relevant to the legislative
process.

H ere, the analogy is to the Chairman o f the Joint Chiefs o f Staff.

she needs to know that an adequate second strike deterrent is at sea.

H e or

H e or she

doesn t need to know the precise location o f all our submarines at any point in time.
That know ledge is very narrowly delegated within the A rm ed Services.




2

Likewise,

63
Congress needs to know policy direction; we don’t need to know alt market sensitive
inform ation.
In the end, the Congress has no choice but to say that the Fed must, and
indeed is, being audited in a balance sheet way, and that the Fed must be, and
indeed is, subject to perform ance reviews o f its implementation o f bank supervisory
policies.

But there is a com pelling argument for confidentiality in the conduct o f

m onetary policy.

That confidentiality is central to the continued integrity o f our

central bank and its capacity to exercise independent judgm ent free from external
pressures.

It is also central to helping ensure that government resources are not

needlessly at risk to insider speculation.
A s Arthur Burns said in his valedictory speech before the National Press Club
(January 30, 1978):

"...substantial independence in exercising pow er over money

creation is not som ething that Federal Reserve officials have arrogated unto
themselves, nor is it something that others have conferred because o f a belief that
central bankers have unique insight that sets them apart from other people.

Rather,

the ability o f the Federal Reserve to act with som e independence from the Executive
Branch, and also with immunity from transient Congressional pressures, was
deliberately established and has been deliberately maintained by the Congress in the
interest o f protecting the integrity o f our money."
In conclusion, I w ould like to re-em phasize that the fundamental question in
the issue o f G A O auditing o f the Federal Reserve's monetary policy function involves
an understanding or misunderstanding o f the word "audit."
"audit" carries connotations that are misleading.

Unfortunately, the word

The com m on usage o f the term in

everyday life is an accounting o f the incom e and out-flow o f dollars.
there is already a 100 percent audit o f the Federal Reserve.

In this sense,

But what we are talking

about here is fundamentally a review o f the information and decision-making process
which raises implications m ore o f data sources and timeliness than it does o f dollars
and cents.

A s this C om m ittee well understands, the Federal Reserve makes a profit

every year (ov er $16 billion in 1992) that goes to the Treasury.

T o the degree that

m arket sensitive inform ation is released in an untimely manner that profit is
jeopardized .

The greater protection provided the Federal Reserve System, the better

o f f the taxpayer.

Thank you.




3

64
United States General Accounting Office

GAO
Release oo Delivery
Expected at
10:00 a.m.EDT
W
ednesday
October 27,1993

Testimony
Before the Committee on Banking, Finance and Urban Affairs
House of Representatives

fed er al r e se r v e

SYSTEM AUDITS
Restrictions on GAO’s Access
Statement of Charles A. Bowsher
Comptroller General of the United States

GAO/T-GGD-94-44




65
Mr.

C h a i r m a n a n d M e m b e r s of the C o m m i t t e e :

W e a r e p l e a s e d to b e h e r e to d i s c u s s t h e l i m i t s of o u r a u d i t
a u t h o r i t y o v e r t h e F e d e r a l R e s e r v e Sy s t e m .

M y remarks

p r i n c i p a l l y w i l l c o n c e r n t he p r o v i s i o n s of s e c t i o n 3 of H.R.

28

w h i c h w o u l d r e m o v e all r e s t r i c t i o n s o n o u r a u t h o r i t y to e x a m i n e
Federal Reserve activities.

Currently,

we lack audit authority

over the Federal Reserve's monet a r y policy,
and Federal Open Market Committee

(FOMC)

In r e s p o n d i n g to t h e C o m m i t t e e ' s r e q u e s t ,

foreign transactions,

operations.

I will

first d e s c r i b e

o u r e x i s t i n g a u t h o r i t y a n d so m e of t h e w o r k w e h a v e d o n e u n d e r
this authority.

I w i l l t h e n e x a m i n e t he i m p l i c a t i o n s of r e m o v i n g

a ll r e s t r i c t i o n s o n o u r a u t h o r i t y , w i t h s p e c i f i c r e f e r e n c e to
s e v e r a l t o p i c s t h e C o m m i t t e e a s k e d u s to a d d r e s s .

Fin a l l y ,

I

w i l l d i s c u s s c e r t a i n s a f e g u a r d s t h a t w e feel w o u l d b e a p p r o p r i a t e
to a d o p t if r e s t r i c t i o n s o n o u r a u t h o r i t y a re t o be remov e d .

T h e q u e s t i o n of w h e t h e r to lift t h e s t a t u t o r y c o n s t r a i n t s o n o u r
a u t h o r i t y to a u d i t the F e d e r a l R e s e r v e S y s t e m u l t i m a t e l y d e p e n d s
o n w h a t C o n g r e s s w a n t s us to do.

O u r a c c e s s n e e d s to be

c o m m e n s u r a t e w i t h t h e t y p e s of a u d i t s C o n g r e s s e x p e c t s us to
perform.

1




66

GAP AUTHORITY UNDER THE BANKING AGENCY AUDIT ACT AND WORK AT THE
FEDERAL RESERVE

We derive our Federal Reserve audit authority from the Federal
Banking Agency Audit Act of 1978.

This act was passed after we

did a special congressionally mandated study of the supervisory
activities of all of the federal bank regulatory agencies.

Before the act, our work at the Federal Reserve was mainly
limited to audits of the fiscal agent functions performed by
Federal Reserve banks for the Department of the Treasury.

We did

this work under our authority to audit the Treasury.

Although the act significantly expanded our access to the Federal
Reserve System and the other bank regulatory agencies, it
precluded us from auditing activities related to monetary policy,
foreign transactions, and the FOMC.
limitation is set out in Appendix 1.

The exact wording of the
The act also prohibited us

from disclosing certain information identifying open financial
institutions and customers.

Appendix 2 describes these

prohibitions in greater detail.

The act does not require us to perform any particular type of
audit.

This means, as is true with most of our work, that our

audits are determined largely by specific congressional requests,
or by our discretion under our basic legislative authority.

2




As

67
appropriate, we coordinate our activities with the Federal
Reserve's Office of Inspector General.

Notwithstanding the limitations on our authority, in the 15 years
since the act was passed, we have audited many aspects of the
Federal Reserve System in areas in which our access has not been
restricted.

I would like to mention some of the studies we have

done in a few key areas:

—

Bank supervision and regulation.

Much of our work

in this area has included the Federal Reserve along with the
other federal bank regulators.

For example, our analysis of

bank failures and supervisory efforts to deal with problem
banks led to our recommendations that legislative efforts were
needed to require prompt corrective action and other
regulatory reforms.

More recently, our work on examinations

of banks and bank holding companies has underscored the need
for the Federal Reserve and other regulators to strengthen
their efforts to assess the quality of the management systems
banks use to monitor and control risk.

We have also studied

how risk-based capital standards have been implemented in
different countries around the world.

Work that is unique to

the Federal Reserve has included studies documenting the scope
of the activities of the securities subsidiaries of bank
holding companies that are supervised by the Federal Reserve
under section 20 of the Glass-Steagall act.
3




In a recent

68
study, we pointed out that the Federal Reserve had not yet
implemented the mandate in the Foreign Bank Supervision
Enforcement Act of 1991 to charge for its examinations of
foreign banks operating in the United States.

—

Payment system activities.

We have conducted several studies

of Federal Reserve pricing of payments services under the
Monetary Control Act of 1980.

Our recommendations have, I

believe, increased the Federal Reserve's awareness of how it
competes with private sector banks in providing these
services.

We have also evaluated the implementation of the

legislation on accelerated collection of checks and have made
recommendations on ways to improve security procedures in Fed
wire transactions.

-- Government securities activities.

Work we have done on the

government securities market has, I believe, contributed to
greater openness in the primary dealer system, particularly
concerning the disclosure of price information.

Our audits

have also contributed to pending legislation that would help
protect customers and maintain the integrity of this very
important market.

Our current work that involves the Federal Reserve, either
exclusively or as part of a study of all bank regulatory
agencies, includes (1) studies of regulatory burden,

4




(2)

69
implementation of major provisions of the Federal Deposit
Insurance Corporation Improvement Act of 1991,
the risks and benefits of interstate banking,
and supervision of derivative products,

(4) the regulation

(5) an analysis of the

banking industry's activities in mutual funds,
reserving by banks,

(3) analysis of

(6) loan loss

(7) review of efforts to ensure a safe and

sound international banking system through coordination among
national regulators, and (8) analyses of the expenses 'and
revenues of the Federal Reserve System as they affect the federal
budget.

IMPLICATIONS OF H.R. 28

As I have indicated, section 3 of H.R. 28 would remove all of the
restrictions on our authority to examine Federal Reserve
activities.

This would provide us with full access to FOMC

transactions; to transactions for or with foreign central banks,
governments, and international financing organizations; and to
deliberations, decisions, and actions on monetary policy matters,
including discount window operations, member bank reserves, and
open market operations.

In considering the implications of removing restrictions, it is
useful to look more closely at the types of work we do.

Our

audit work can be viewed as falling into two broad categories—
financial audits and performance audits.
5




A financial audit

70
basically sets out to verify the financial reports of an entity,
including its balance sheet, income statement, and cash flows.
Our financial audits also assess the systems of internal controls
established by the audited institution and the institution's
compliance with specific financial requirements.

Performance

audits are designed to assess whether an entity is achieving its
stated goals, and include questions of efficiency, effectiveness,
and compliance with related laws and regulations.

Appendix 3

describes these types of audits in more detail.

Turning first to financial audits, the nature and volume of
transactions associated with the day-to-day operations of the
Federal Reserve System make financial auditing extremely
important.

For example, in providing services to the banking

system in 1992, the Federal Reserve processed

—

20 billion checks with a value of $14 trillion;

-- 20 billion pieces of currency with a value of $278 billion;

—

68 million electronic fund transfers for $199 trillion; and

—

76 million issuances, redemptions, and exchanges of U.S.
government securities with a value of $143 trillion.

6




71
In 1992, the FOMC also purchased, sold, or exchanged
approximately $350 billion of securities, engaged in over $750
billion in repurchase agreements, and conducted almost $3
trillion in matched transactions.1

All told, about 90 percent

of the $368 billion in assets on the combined balance sheet of
the Federal Reserve banks consist of assets acquired as a result
of FOMC or foreign exchange operations.2

Passage of H.R. 28

would allow us access to the full range of Federal Reserve System
transactions.

The nature and extent of auditing that presently takes place
within the Federal Reserve System is a factor that Congress may
want to consider in deciding whether to expand our authority.
The Board of Governors examines the 12 reserve banks and the FOMC
annually.

Such examinations, which involve both financial

statement audits and compliance reviews that concentrate on
financial controls, are conducted by the Division of Federal
Reserve Bank Operations.

The Board's financial examination

Repurchase agreements essentially are transactions by which the
Federal Reserve buys or sells securities for specified periods of
time, typically overnight or short terms. The agreements are
used by the FOMC to adjust the level of reserves in the banking
system.
According to Federal Reserve officials, in matched
transactions the Federal Reserve essentially executes
transactions that have no net effects on bank reserves or the
balance sheet of the FOMC. Matched transactions are conducted
principally with foreign central banks.
2
The assets, with amounts as of December 31, 1992, in billions of
dollars shown in parentheses, are as follows:
U.S. Treasury
securities ($302), federal agency obligations ($6), and assets
denominated in foreign currencies ($22).
7




72
program involves a full-time staff of about 22 people at an
annual cost of approximately $2 million.

Each Federal Reserve

bank also has an internal audit department, which— in the case of
the New York Federal Reserve Bank— includes examination of the
activities of the FOMC.

The Board's financial examination program has been subject to
some outside scrutiny by public accounting firms.

Each year, the

Board contracts with an outside accounting firm to review the
examination program's operations.

In the last letter the Board

received, the outside accounting firm said that the financial
examination program was effectively meeting its objectives and
made some suggestions for improvement.3

The Federal Reserve's Office of Inspector General, which has an
annual budget of about $3 million, is authorized to conduct its
own financial and performance audits, although the Inspector
General has indicated to Congress that there are some limitations
on the office's ability to gain independent access to the reserve
banks.

The Inspector General has just completed a report on the

Board's financial examination program.

This report raises some

fundamental questions about the comparability of the financial
examination program to an outside audit that is geared toward

3
Letter to the Federal Reserve Board dated December 27, 1991,
from Coopers & Lybrand.

8




73
certification of financial statements.4

The report also

contains recommendations for improving the financial examination
program.

For some time, the financial statements of the Board of Governors
itself have been audited by an outside public accounting firm.
For 1993, the Board also contracted with independent accounting
firms for audits at the Kansas City and Cleveland Federal Reserve
Banks.

As a part of this latter experiment with engaging outside

auditors, the firms were asked to comment on those aspects of the
Board's financial examination program concerned with both audit
of financial statements and of compliance with board policies and
controls.

We understand that the reports from the outside

auditors for 1993 have just recently been presented to the Board.

According to Federal Reserve officials, in the Kansas City and
Cleveland Reserve Bank audits, some access issues were negotiated
with the accounting firms.

Although these audits did not involve

a full-scale audit of the System Open Market Account or foreign
accounts, we understand that the auditors required some testing
of the systems in these areas to determine if the allocations of
assets to the particular reserve banks were appropriate.

4
0ffice of the Inspector General, Board of Governors of the
Federal Reserve System, Report on the Audit of the Board's
Financial Examination Program. September 30, 1993.
9




74
Section 3 of H.R, 28 proposes that all Federal Reserve banks, as
well as the Board of Governors, be audited annually by an
independent public accounting firm.

I am inclined to believe

that this outside review would be beneficial for both the Federal
Reserve and the general public.

If the restrictions on our

access were removed, we would be better able to assess the
quality of financial controls and auditing in the Federal Reserve
System and make recommendations for improvements.

Concerning performance audits, I would like to discuss access
issues by referring to the three areas we were asked to address
in our testimony.

These issues are

-- the daily government securities auctions at the New York
Federal Reserve Bank, which the Federal Reserve uses to manage
the money supply;

-- the Federal Reserve's interventions in foreign currency
markets; and

—

safeguards in the auctions, and presumably foreign currency
transactions as well, against the Federal Reserve's releasing
inside information.

Our access restrictions would be a major limitation to studying
any of these issues in a way that required us to analyze data on
10




75
actual transactions.

Although it would be necessary for us to

consider the actual scope of a request before reaching a
judgement in any particular case, we must recognize that the
restrictions in the law are quite explicit.

Therefore, with

performance audits, as with financial audits, the major question
is really what Congress wants us to do.

SAFEGUARDS

If Congress decides to remove the existing restrictions on our
audit authority, we believe certain safeguards should be included
in the legislation.

These safeguards, which are similar to those

that already exist under our present authority, should

(1)

prohibit us from disclosing the identity of foreign central
banks or governments;

(2)

prohibit us from disclosing confidential documents and
require safekeeping of confidential information; and

(3)

specify delays in our access to certain types of
confidential information.

These safeguards are important because they make clear that
removing our audit restrictions will not necessarily jeopardize
the Federal Reserve's independence.
11




For example, with these

76
safeguards we could not use our expanded authority to undertake
contemporaneous reviews of the Federal Reserve's monetary policy
decisionmaking functions.

Also, immediate disclosure of

information about Federal Reserve decisions in a situation such
as the stock market break of October, 1987, might not be in the
public interest because it could disrupt the financial markets.
Our role should be to make after-the-fact assessments of the
Federal Reserve's performance, both in general and in problem
situations.

SUMMARY

In summary, we have been able to do significant audits of the
Federal Reserve, despite the existing limitations of our
authority.

Congress obviously must decide whether our audit

authority should be expanded.

However, if our authority is

expanded, we believe measures should be included to protect
against release of confidential documents and to prevent undue
interference with the Federal Reserve's ongoing policymaking
functions.

This concludes my prepared statement.
be pleased to answer questions.

12




My collegues and I would

APPENDIX 1

APPENDIX 1

Restrictions on GAO Audits Contained In the Federal Banking
Aaencv Audit Act8
Audits of the Federal Reserve Board and Federal Reserve banks may
not include
(1)

transactions for or with a foreign central bank,
government of a foreign country, or nonprivate
international financing organization;

(2)

deliberations, decisions, or actions on monetary policy
matters, including discount window operations, reserves
of member banks, securities credit, interest on
deposits, and open market operations;

(3)

transactions made under the direction of the Federal
Open Market Committee; or

(4)

a part of a discussion or communication among or
between members of the Board of Governors and officers
and employees of the Federal Reserve System related to
items (1), (2), or (3).

531 U.S.C, section 714(b). This section codifies a portion of
section 2 of Public Law 95-320, July 21, 1978, which amended
section 117 of the Accounting and Auditing Act of 1950.




78
APPENDIX 2

APPENDIX 2

Provisions in the Federal Banking Agency Audit Act Concerning
Disclosure of Information and Safekeeping of Records6
Except as provided in this subsection, an officer or employee of
the General Accounting Office may not disclose information
identifying an open bank, an open bank holding company, or a
customer of an open or closed bank or bank holding company.
The
Comptroller General may disclose information related to the
affairs of a closed bank or closed bank holding company
identifying a customer of the closed bank or closed bank holding
company only if the Comptroller General believes the customer had
a controlling influence in the management of the closed bank or
closed bank holding company or was related to or affiliated with
a person or group having a controlling influence.
Except for the temporary removal of work papers of the
Comptroller General that do not identify a customer of an open or
closed bank or bank holding company, an open bank, or an open
bank holding company, all work papers of the Comptroller General
and records and property of or used by an agency that the
Comptroller General possesses during an audit, shall remain in
the agency.
The Comptroller General shall prevent unauthorized
access to records or property.

6Excerpts from 31 U.S.C. section 714 (c), (d).
14




79
APPENDIX 3

APPENDIX 3
Types of GAO Audits7

financial aupiis
Financial statement audits determine (a) whether the financial
statements of an audited entity present fairly the financial
position, results of operations, and cash flow or changes in
financial position in accordance with generally accepted
accounting principles, (b) whether the entity has complied with
laws and regulations for those transactions and events that may
have a material effect on the financial statements, and (c)
whether the internal controls were effective and met standards.
Other financial audits include determining (a) whether financial
reports and related items, such as elements, accounts, or funds
are fairly presented, (b) whether financial information is
presented in accordance with established or stated criteria, and
(c) whether the entity has adhered to specific financial
compliance requirements.
Financial audits include an assessment of internal control risks
related to the scope of the audits.
In the internal control
phase, the auditor should obtain evidence about the effectiveness
of internal controls to (1) form an opinion on internal controls
as of the end of the audit period and (2) assess control risk and
the effectiveness of budget and compliance controls during the
audit period.
Control risk is a factor in determining the
nature, timing, and extent of substantive procedures for the
testing phase.
PERFORMANCE AUDITS
Economy and efficiency audits include determining (a) whether the
entity is acquiring, protecting, and using its resources (such as
personnel, property, and space) economically and efficiently, (b)
the causes of inefficiencies or uneconomical practices, and (c)
whether the entity has complied with laws and regulations
concerning matters of economy and efficiency.
Program audits include determining (a) the extent to which the
desired results or benefits established by the legislature or
other authorizing body are being achieved, (b) the effectiveness
7
These definitions are taken from Government Auditing Standards.
U.S. General Accounting Office, 1988 revision, and the GAO
Financial Audit Manual, June 1992.

15




80
of organizations, programs, activities, or functions, and (c)
whether the entity has complied with laws and regulations
applicable to the program.

16




81
For Release on Delivery
10:00 A.M. E.D.T.
October 27, 1993




Statement by
Wayne D. Angell
Governor, Board of Governors
of the Federal Reserve System
before the
Committee on Banking, Finance
and Urban Affairs
U.S. House of Representatives

October 27, 1993

82
I am pleased to have this opportunity to speak on the
General Accounting Office's authority to audit Federal Reserve
operations and the changes to that authority that would be made
by H.R. 28 "The Federal Reserve System Accountability Act of
1993 ."

President McDonough is addressing the scope of GAO audit

authority from the perspective of the Federal Reserve Bank of
New York.
At the outset, I would like to dispel the notion I have
frequently heard that the Federal Reserve is not subject to GAO
audit.

In 1978 the Federal Banking Agency Audit Act gave the GAO

broad authority to audit most of the operations of both the
Federal Reserve Board and the Federal Reserve Banks.

Since then,

the GAO has completed more than 100 reports on various aspects of
System operations, as well as numerous other reports that
involved us less directly.

At present, the GAO has roughly 25

audits of the Federal Reserve under way and maintains several of
its staff in residence at the Board and at selected Reserve
Banks.
The GAO has free rein to audit the System, subject to
explicit exemptions for: deliberations, decisions, or actions on
monetary policy matters including discount window credit
operations, reserves of member banks, securities credit, interest
on deposits, and open market operations; transactions made under
the direction of the FOMC; transactions with, or for, foreign
central banks and governmental entities; and discussions or
communications among or between members of the Board and officers




83
a n d e m p l o y e e s of the Federal R e s e r v e S y s t e m rela t e d to these
m a t t e r s and transactions.

By e x c l u d i n g t h e s e areas,

the Act

a t t e m p t s to b a l a n c e the n e e d for p u b l i c a c c o u n t a b i l i t y of the
F e d e r a l R e s e r v e th r o u g h G A O a u d i t s ag a i n s t the n e e d to i nsulate
th e c e n t r a l b a n k ' s m o n e t a r y p o l i c y f u n c t i o n s f r o m s h o r t - t e r m
p o l i t i c a l p r e s s u r e s a nd the n e e d to e n s u r e that f o r e i g n central
b a n k s a n d g o v e r n m e n t a l ent i t i e s c an t r a n s a c t b u s i n e s s in U.S.
f i n a n c i a l m a r k e t s thro u g h the F e d e r a l R e s e r v e on a c o n f i d e n t i a l
basis.
T h e p r e c i s e line d i f f e r e n t i a t i n g t hose F e d e r a l R e s e r v e
s p e c i f i c o p e rations a nd a c t i v i t i e s that a r e subj e c t to G A O audit
u n d e r t h e B a n k i n g A g e n c y A udit A ct a n d th o s e that a r e e xempt fr o m
a u d i t is difficult to d r a w in the a b stract.
t h e p a s s a g e of the Act,

O v e r t he y e a r s since

the Fe d e r a l R e s e r v e has w o r k e d w i t h the

G A O to d e fine those limited a reas that are not s u b j e c t to audit
on a c a s e b y case basis in the co n t e x t of i n d i v i d u a l audits.
t h o s e cases,

In

the Federal R e s e r v e h a s w o r k e d w i t h t he G A O to

f u r t h e r the GAO's audit o b j e c t i v e s w h i l e h o n o r i n g the s t a t u t o r y
ex e m p t i o n s d e s i g n e d to e n s u r e the i n d e p e n d e n t c o n d u c t of m o n e t a r y
p o l i c y and t he c o n f i d e n t i a l i t y of f o r e i g n t r a n s a c t i o n s .

In the

future, w e w ill co n t i n u e to w o r k w i t h the G A O to a d d r e s s its
c o n c e r n s c o n sistent w i t h the m a n d a t e of t h e Act.
E x p a n d i n g the G AO's a udit a u t h o r i t y o v e r the Fede r a l
R e s e r v e into the exempt ar e a s w o u l d b e c o n t r a r y to t h e p u b l i c
i n t e rest.

S uch a n e x p a n s i o n c o u l d a d v e r s e l y a f f e c t F e d e r a l

R e s e r v e e f f e ctiveness in the co n d u c t of m o n e t a r y poli c y .




As the

84
B a n k i n g A g e n c y A u d i t Act recognized,

such a c hange c o u l d r e d u c e

th e c e n t r a l b a n k ' s i n s u l a t i o n f rom da y - t o - d a y p o l i t i c a l
pressures.

E v e n w h a t a p p e a r s to be a v e r y l imited a u d i t of the

e f f i c i e n c y of m o n e t a r y p o l i c y operations could in fact tu r n into
p r e s s u r e for a c h a n g e in m o n e t a r y p o l i c y itself.

F o r example,

t h e q u e s t i o n s p o s e d to C o m p t r o l l e r B owsher in c o n n e c t i o n w i t h
t h e s e h e a r i n g s as to w h e t h e r the m a g n i t u d e of o u r o p e n m a r k e t
o p e r a t i o n s r e f l e c t s u n n e c e s s a r y b u y i n g and s elling of g o v e r n m e n t
s e c u r i t i e s ar e m o n e t a r y p o l i c y questions,
questions.

not e f f i c i e n c y

T h e n u m b e r of t r a n s actions that the O p e n M a r k e t De s k

c o m p l e t e s in c a r r y i n g out the FOMC's d i rective c o r r e l a t e s
d i r e c t l y w i t h t he s u b s t a n c e of the p o l i c y in place.

Indeed,

a

c o m p r e h e n s i v e a u d i t of t h e s e operations w o u l d l i k e l y r e q u i r e a
c o m p a r i s o n of t h e a c tual results of the operations w i t h i n t e n d e d
results.
G A O s c r u t i n y of p o l i c y deliberations,

d i s c u ssions,

a c t i o n s a l s o c o u l d i m p e d e the p r ocess of fo r m u l a t i n g policy.

and
A

f r e e d i s c u s s i o n of a l t e r n a t i v e p o licies a nd p o s s i b l e o u t c o m e s is
e s s e n t i a l to m i n i m i z e the c hance of p o licy errors.
of G A O r e v i e w of f o r m a t i v e discussions,

The prospect

b a c k g r o u n d docu m e n t s ,

and

p r e l i m i n a r y c o n c l u s i o n s c o u l d h a v e an adve r s e effe c t on t h e free
i n t e r c h a n g e a n d c o n s e n s u s - b u i l d i n g that leads to g o o d policy.
T r a n s a c t i o n s m a d e u n d e r the d i r e ction of t h e FO M C
i n c l u d e f o r e i g n e x c h a n g e operations.

The effic a c y of t h e s e

o p e r a t i o n s is c r u c i a l l y d e p e n d e n t on c o n f i d entiality.

Imp o r t a n t

d a i l y c o n t a c t s a n d e x c h a n g e s of infor m a t i o n w i t h f o r e i g n m o n e t a r y




85
a u t h o r i t i e s a r e an integral pa r t of t h e s e o p e r ations.
t a k e p l a c e in a candid a n d c o n s t r u c t i v e a t m o s p h e r e .

They now
T he

p o s s i b i l i t y of a G A O audit of o u r f o r e i g n e x c h a n g e o p e r a t i o n s
w o u l d r e d u c e the wil l i n g n e s s of f o r e i g n a u t h o r i t i e s to share
i n f o r m a t i o n w i t h us and w o u l d t h e r e b y r e d u c e the e f f e c t i v e n e s s
a n d e f f i c i e n c y of o u r oper a t i o n s w h i c h a r e f r e q u e n t l y c o o r d i n a t e d
w i t h f o r e i g n authorities.

This c a u t i o n a l s o ap p l i e s to the

e x e m p t i o n for t r a n s actions that the F e d e r a l R e s e r v e ca r r i e s out
as a g e n t

for f oreign entities; h o wever,

t h e r e t h e p r i n c i p a l iss u e

is o n e of s e n s i t i v e p r o p r i e t a r y i n f o r m a t i o n a bout f oreign
go v e r n m e n t s ,

f oreign central banks,

and international financial

organizations.
T h e benefits,

if any,

of b r o a d e n i n g the G A O ' s a u t h o r i t y

i n t o t h e areas of m o n e t a r y p o l i c y a n d t r a n s a c t i o n s w i t h fo r e i g n
o f f i c i a l en t ities w o u l d be small.
f i n a n c i a l audits,

W i t h r e g a r d to p u r e l y

the Federal R e s e r v e A c t a l r e a d y r e q u i r e s that

t h e B o a r d c o nduct an annual f i n a n c i a l e x a m i n a t i o n of e a c h R e s e r v e
Bank.

The F e d e r a l R eserve p l a c e s g reat i m p o r t a n c e o n b o t h the

R e s e r v e Banks'

internal audit r e s p o n s i b i l i t i e s a n d the B o a r d ' s

r e s p o n s i b i l i t i e s for e x a m i n a t i o n of F e d e r a l R e s e r v e Banks,

in

p a r t b e c a u s e it r e cognizes that its a b i l i t y to p o l i c e F e d e r a l
R e s e r v e B a n k o p e r a t i o n s is c r i t i c a l t o p u b l i c a n d c o n g r e s s i o n a l
c o n f i d e n c e in t he Federal R e s e r v e System.
T h e proc e s s of c o n d u c t i n g a n n u a l f i n a n c i a l a u d i t s is
r e v i e w e d by a p u b l i c a c c o u n t i n g f i r m to c o n f i r m that the m e t h o d s
a n d t e c h n i q u e s b e i n g emp l o y e d a r e e f f e c t i v e a n d that the p r o g r a m




86

f ollows g e n e r a l l y a c c e p t e d auditing standards a p p l i c a b l e to the
a udit of F e d e r a l R e s e r v e Banks.

These e x a m i n a t i o n s a re

c o m p l e m e n t e d b y e x t e n s i v e B o a r d oversight a nd s u p e r v i s i o n of
F e d e r a l R e s e r v e B a n k activities,

i n c l uding B o a r d o p e r a t i o n s

r e v i e w s of R e s e r v e B a n k effe c t i v e n e s s a n d efficiency,

as w e l l as

b y c o m p r e h e n s i v e a u d i t s c o n d u c t e d b y e ach R e s e r v e B a n k ' s
i n d e p e n d e n t i n t e r n a l a udit function.

Oversight a n d s u p e r v i s i o n

of F e d e r a l R e s e r v e B a n k activi t i e s include r e v i e w of F e d eral
R e s e r v e B a n k b u d g e t s a n d expenditures as w ell as p e r s o n n e l a n d
operating p o l i c i e s .
T h e B o a r d ' s a nnual financial exam i n a t i o n s of Fe d e r a l
R e s e r v e Banks,

o p e r a t i o n s reviews, a nd its o v e r sight a n d

s u p e r v i s i o n of F e d e r a l R e s e r v e Bank acti v i t i e s s p e c i f i c a l l y
include examinations,

o p e r a t i o n s reviews and o v e r s i g h t of op e n

m a r k e t a n d f o r e i g n t r ansactions.

The annual financial

e x a m i n a t i o n s i n c l u d e r e v i e w of all a c counts for accuracy,
c o m p l i a n c e w i t h i n t e r n a l controls,

and c o n f i r m a t i o n that b a l a n c e s

r e f l e c t e d on t h e b o o k s a g r e e w i t h the records of a c c o u n t holders.
Operations reviews

for effecti v e n e s s and e f f i c i e n c y of op e n

m a r k e t a n d f o r e i g n o p e r a t i o n s are c o n d u c t e d b y m u l t i - d i s c i p l i n a r y
teams,

i n c l u d i n g e c o n o m i s t s familiar w i t h F OMC opera t i o n s ,

s p e c i a l i s t s i n d a t a a n d p h y s i c a l security,
communication,
settlement.

accounting,

and

automation,

a n d secondary m a r k e t t r a d i n g a n d

T h e s e o p e r a t i o n s reviews also incl u d e t h e F ederal

R e s e r v e B a n k of N e w Y o r k ' s internal audit a t t e n t i o n s to the o p e n
market a c c o u n t .




87
Further,
b a l a n c e sheet,

a p r i v a t e a c c o u n t i n g f i r m a u d i t s the B o ard's

a n d the Board's I n s p e c t o r G e n e r a l a udits the

e f f e c t i v e n e s s a n d effici e n c y of B o a r d p r o g r a m s a n d o p e r a t i o n s
u n d e r t h e I n s p e c t o r G e neral Act of 1978 as a m ended.
Th e B o a r d has c o n t i n u a l l y r e v i e w e d its p r o c e d u r e s for
e x a m i n a t i o n s a n d over s i g h t of F e d e r a l R e s e r v e act i v i t i e s .
example,

For

r e c en t l y the B o a r d has c o n t r a c t e d for i n d e p e n d e n t

p r i v a t e au d i ts of two Federal R e s e r v e B a n k s
Cleveland)

(Kansas C i t y a n d

in o r d e r to p r o v i d e an i n d e p e n d e n t e v a l u a t i o n of the

R e s e r v e Banks'

control e n v i r o n m e n t s a n d t h e B o a r d ' s e x a m i n a t i o n

p r o c e d u r e s a n d to d e t e r m i n e the f e a s i b i l i t y of s u b s t ituting,

from

t i m e to time, o u t s i d e audits for fin a n c i a l e x a m i n a t i o n s b y the
B o a r d ' s examiners.

T hese audits h a v e i n d i c a t e d that p r e v i o u s

f i n a n c i a l e x a m i n a t i o n s of these R e s e r v e B a n k s w e r e at least as
t h o r o u g h as the o u t s i d e audits,
w e l l controlled,

that t h o s e R e s e r v e B a n k s w e r e

a n d that financial c o n t r o l s m a y b e r e g a r d e d as

s a t i s f a c t o r y f rom an audit pers p e c t i v e .

Indeed these audits have

i n d i c a t e d that m a n y p o l i c i e s a re u n i q u e l y a p p l i c a b l e to F e d e r a l
R e s e r v e B a n k s a n d that in these a reas t he B o a r d ' s e x a m i n e r s h a v e
a s i g n i f i c a n t a d v a n t a g e in a u d i t i n g f or R e s e r v e B a n k c o m pliance.
T h e B o a r d is s t r o n g l y c o m m i t t e d to e n s u r i n g that its
examinations,

b o t h internal a n d external,

s u p e r v i s i o n of the F e deral R e s e r v e Banks,

oversight and
as w e l l as its o w n

i n t e r n a l audit fu n c t i o n a n d e x t e r n a l audits,

a r e as e f f e c t i v e as

p o s s i b l e a n d will con t i n u e to r e v i e w t h e s e f u n c t i o n s w i t h a n eye
to e n s u r i n g t h e i r future effectiv e n e s s .




88

Finally, and more broadly, Congress has, in effect,
mandated its own review of monetary policy by requiring
semiannual reports to Congress on monetary policy under the Full
Employment and Balanced Growth Act of 1978 (also known as the
Humphrey-Hawkins Act) and by holding hearings on various monetary
policy issues as they arise.

In addition, there is a vast and

continuously updated body of literature and expert evaluation of
U.S. monetary policy.

In this environment, the contribution that

a GAO audit would make to the active public discussion of the
conduct of monetary policy is not likely to outweigh the
disadvantages of expanding GAO audit authority in this area.
In sum, we believe that the Board's supervision and
oversight of Federal Reserve Bank activities and the Board's own
audit functions have served the public interest well,
particularly in the area of confidentiality of monetary policy
information.

In this regard, Mr. Chairman, you have asked about

the security checks on personnel involved in the monetary policy
process and incidents of so-called insider trading by Federal
Reserve officials.

Attendees at FOMC meetings are now required

to have "secret" or higher clearances and, over the years, there
have been only three known incidents where monetary policy
information may have been used for private gain.

In the first

instance, in October 1979, there were errors in the deposit data
reported by a large New York commercial bank.

These errors were

technical or clerical and were not intentional on the part of the
bank.

The Federal Reserve's screening procedures flagged the




89
data as possible errors, but the bank stated that the numbers
were correct as reported.

The data therefore resulted in

overstatements of the estimates of the money supply published by
the Board.

Subsequent data submitted by the bank indicated that

the deposit data were indeed incorrect; as a result the bank
revised its deposit data and the money supply figures were
revised downward correspondingly.

At the request of the House

Committee on Banking, Finance and Urban Affairs, the Board
conducted an investigation to determine if any institution or
individual had improperly profited from the errors.
In order to ensure objectivity in the investigation,
the Board engaged the services of a private law firm to conduct a
complete inquiry and prepare a report.

That firm, with the

Board's concurrence, in turn engaged a private accounting firm to
review trading activity.

The report concluded that neither the

bank that had made the reporting error nor persons connected with
it, the Board, or the Federal Reserve Bank of New York had
improperly and knowingly profited from the erroneous estimates or
revision of the erroneous money supply estimates.

Nor did the

report find that any other institution or individual had
improperly and knowingly profited from that error.
Nevertheless the report did identify one transaction
that gave rise to an appearance of a conflict of interest in
which an officer of the Federal Reserve Bank of New York who had
knowledge of the impending revision of the money supply data had
purchased units of a municipal bond fund immediately after the




90
revised data had become publicly available.

That officer

resigned from the Reserve Bank shortly thereafter.
In the second incident, in 1982, an ex-employee of the
Board managed to gain telephonic access to confidential money
supply data stored in the Board's computer system shortly after
the employee had left the Board to work for a private firm.

This

access was identified quickly and the matter was referred to the
Federal Bureau of Investigation promptly.

The individual

ultimately pleaded guilty to one count of wire fraud and received
one year's probation.

Subsequently additional security measures

were implemented to prevent a recurrence of similar data security
violations.
In the third incident, in 1986, in connection with the
United States Attorney's investigation of allegations of
securities fraud and tax evasion by former principals of a failed
government securities dealer, the U.S. Attorney's office
contacted the Federal Reserve Bank of New York concerning a
former director of that Reserve Bank.

After further

investigation by both the Reserve Bank and the U.S. Attorney's
Office, the U.S. Attorney's Office brought a criminal proceeding
against the former director.

In 1989, the former director

pleaded guilty to charges of bank fraud based on the illegal
disclosure of sensitive, non-public information regarding changes
in the discount rate and was sentenced to a jail term, probation
and community service.

Again, Board and Reserve Bank procedures

were revised after this event to prevent a recurrence.




91
W e b e l i e v e that the p a u c i t y and n a t u r e of the i n cidents
that h a v e o c c u r r e d o v e r the e i g h t y - y e a r h i s t o r y of the Fede r a l
R e s e r v e S y s t e m is s t r o n g e v i d e n c e of the i n t e g r i t y of the Federal
R e s e r v e m o n e t a r y p o l i c y process.

F u r t h e r it is d o u b t f u l that any

of t h e s e i n c idents w o u l d ha v e b e e n p r e v e n t e d b y a b r o a d e n e d G A O
a u d i t a u thority.
For t hese reas o n s a n d the r e a s o n s s t a t e d p r eviously, w e
b e l i e v e that e n a c t m e n t of the p r o v i s i o n s of H.R.

28 that w o u l d

e x p a n d t h e G AO's a udit a u t h o r i t y b y r e m o v i n g t h e curr e n t
e x c e p t i o n for m o n e t a r y p o l i c y m a tters;

transactions made under

t h e d i r e c t i o n of the FOMC; a n d t r a n s a c t i o n s with,

or for,

o f f i c i a l en t ities w o u l d b e c o u n t e r to the p u b l i c interest.




fore i g n

92

TESTIMONY BY
WILLIAM J. MCDONOUGH, PRESIDENT
FEDERAL RESERVE BANK OF NEW YORK
BEFORE THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
OF THE
UNITED STATES HOUSE OF REPRESENTATIVES




OCTOBER 27, 1993

93
I w e l c o m e t h e o p p o r t u n i t y to app e a r bef o r e t h e
C o m m i t t e e t o d a y to p r o v i d e m y v i e w s on the p r o v i s i o n s of H.R.

28,

t h e F e d e r a l R e s e r v e S y s t e m A c c o u n t a b i l i t y A c t of 1993, w h i c h
r e l a t e t o t h e a udit of R e s e r v e B anks by t h e G o v e r n m e n t A c c o u n t i n g
Office.

H.R.

28 w o u l d e l i m i n a t e t h e e x e m p t i o n s in t he F e d e r a l

B a n k i n g A g e n c y A u d i t A c t for fore i g n cent r a l b a n k s and g o v e r n m e n t
t r a n s a c t i o n s , m o n e t a r y p o l i c y deliberations,
actions,

decisions,

and

a n d F e d e r a l O p e n M a r k e t C o m m i t t e e transactions.

G o v e r n o r A n g e l l will be a d d r e s s i n g t h e c o n c e r n s of the B o a r d of
G o v e r n o r s on t h i s l e g i s l a t i v e proposal.

J w i l l focus on t h e
.

i m p l i c a t i o n s of the p r o p o s a l for t h e ac t i o n s t a k e n by t h e Fede r a l
R e s e r v e B a n k of N e w Y o r k in i m p l e m e n t i n g F OMC d e c i s i o n s a n d
c a r r y i n g ou t a c t i v i t i e s for our fore i g n accounts.
I w a n t to c o m m e n t on t h e sc o p e of t h e c u r r e n t e x e m p t i o n
a n d t o m a k e c l e a r to t h e C o m m i t t e e m y a p p r e c i a t i o n and r e s p e c t
f o r t h e a u d i t process.

Also,

I w o u l d like t o t a k e this

o p p o r t u n i t y t o n o t e s teps t h a t c a n be t a k e n t o e n s u r e f u r t h e r t he
e f f e c t i v e n e s s of G AO a u d i t s of t h e Bank, w i t h i n t h e G A O ' s c u rrent
aut h o r i t y .

In m y opinion,

that authority provides sufficient

s c o p e to a d d r e s s m a n y of t h e c o n c e r n s y o u h a v e a s k e d m e to
d i s c u s s today.
I b e l i e v e t hat t h e e l i m i n a t i o n of t h e c u r r e n t e x e m p t i o n
w o u l d i n t e r f ere w i t h t h e F e d ' s a b i l i t y t o f o r m u l a t e a n d e x e c u t e
a n o p t i m a l m o n e t a r y policy.

It w o u l d i n t r o d u c e t h e u n m i s t a k a b l e

p o t e n t i a l for p o l i t i c a l influence; e v e r y m o v e m e n t a n d n u a n c e of
p o l i c y w o u l d t h e n h a v e t o b e e x a m i n e d in light of t h a t potential.
A t t h e cor e of m y c o n c e r n is t h e fact t h a t t h e p r o c e s s b y w h i c h

 73-435 0 - 9 5 - 4


94
we implement monetary policy is inextricably entwined with the
policy itself.

For example, questions regarding the volume of

open market operations on the surface may appear to be questions
of efficiency.

In fact, they relate to the policy intent to

avoid undue volatility in the markets.

The idea that the process

of executing open market operations may be audited without
imposing judgments about the policy itself is simply not
realistic.
Simply put, optimum monetary policy is achieved only
when the public and the markets perceive no short-term political
influence.
part.

This is not a new issue, nor a new conclusion on my

I have had plenty of opportunity to consider the import of

the exclusion of the GAO from auditing monetary policy in my
former role as manager of both the domestic and foreign open
market accounts.

I have no doubt that the potential for damage

to a credible and effective monetary policy would be very real if
the exclusion were to be lifted.

This potential for damage

clearly would outweigh any possible benefit to the public from
GAO audits of monetary policy operations.
I feel equally strongly about the impairment of our
policy implementation if the exclusion were to be lifted on the
foreign side.

Foreign.exchange intervention is conducted not

only in conjunction with the Treasury, through the Exchange
Stabilization Fund which is exempt from GAO audit, but also
frequently with or on behalf of foreign central banks and
monetary authorities.




95
We hold a very large amount —
present —

over $300 billion at

of marketable U.S. Government securitiesr-representing

dollar reserves of these official foreign entities.

I cannot

presume to gauge the response of all of these central bank
governors and finance ministers, but I can tell you with absolute
certainty that there is some number of them, and perhaps a large
number, who would question the appropriateness of their reserve
activity being scrutinized by the GAO and the Congress.

This

would almost certainly be damaging to the relationships that are
so central to international monetary cooperation and, perhaps, to
the role of the dollar.

Certainly, it would impair the ability

of the U.S. monetary authorities to conduct their foreign
exchange intervention policies on a coordinated basis with the
same effectiveness and efficiency we enjoy today.
Having said that, I want to reiterate that I do not
have some sort of reflexive distaste for auditors or the audit
process.

To the contrary, as someone who has had managerial

responsibility for large organizations in both the public and
private sectors, I have a keen appreciation for the role of
auditors and the improvements they bring to the table in the form
of operational quality and effectiveness.
I view auditors as an important asset for management.
There is a long tradition at the Fed of recognizing the value of
independent oversight.

Indeed, I believe we subject ourselves to

an extraordinarily rigorous series of performance and operational
appraisals.




Within each Reserve Bank there is an independent

96
audit function that reports directly to the board of directors
and performs comprehensive audits of all aspects of that Bank's
work.
At the New York Fed, we have had a constructive and
positive relationship with the GAO for almost 15 years.

We

supply the GAO permanent space in the Bank and have assigned
staff as liaison in order to assist them in the orderly
completion of their tasks.

In addition, we take seriously their

findings and are responsive to their suggestions for
improvements.

While I do not want to wax too poetic and imply

that we love the result of each and every audit, I do want to
make clear that we have a great appreciation for the role of
auditors.
The conduct of Bank personnel with responsibility for
monetary policy matters is subject to the Bank's rules of
conduct, stringent standards regarding outside financial
interests and potential conflicts stemming from family and other
personal relationships.

The GAO always has had full audit

authority over Reserve Banks' personnel policies and practices,
disclosure statements, and the like, and, thus, has been able to
assure itself and Congress of the ethical standards and practices
of all our employees.
We are not, however, resting on our laurels.

There are

always ways to enhance the effectiveness of operations, and
audits by GAO can contribute significantly to that process.
plan to call Comptroller General Bowsher from time to time to




I

97
offer suggestions as to how the GAO might be even more useful to
the Bank.
I now would like to respond to matters raised in
Chairman Gonzalez* October 21 letter to me regarding our policy
on meals and entertainment and our ethics officer.

As I have

noted, there is no limitation on the GAO that prevents its
looking at our meals and entertainment practices or policy.
Moreover, we do not impart information on monetary policy or our
foreign account relationships to any outsiders, at luncheons or
elsewhere.

To the contrary, we use meetings with knowledgeable

people to gain information about market conditions that is
helpful in our monetary policy deliberations.
The Chairman asked a question regarding the cost of
meals at expensive restaurants hosted by regulated institutions.
Because others paid for these approximately two dozen meals that
were identified as having occurred over a period of a year and a
half, we do not have that cost information.

We are however, very

sensitive to the appearances of such things, and our internal
rules specifically caution against accepting inappropriate
entertainment, lavish meals or frequent meals from a particular
institution.

Further, we concluded that we do not have an

adequate audit trail.

Therefore, we are about to issue a policy

requiring that all business meals paid by regulated institutions
or vendors be documented as to restaurant, purpose, and
attendees, to provide an audit trail for us, the Board of
Governors, and the GAO going forward.




98
Finally, as the Chairman noted, we recently named an
ethics officer.

That does not mean this role was not being

performed previously within the Bank.

That function was

fulfilled by the Bank's First Vice President, its General Counsel
and the Personnel officers.

We concluded that we would focus

those responsibilities in a single individual, a senior vice
president of the Bank.

Since his appointment as ethics officer,

he has responded to inquiries from members of the Bank's staff
regarding ethics and conflict of interest questions. He also has
participated in redrafting our rules of conduct, which should be
concluded by year end, and other documents which will be helpful
to the Bank's staff in their compliance with these rules.

We

regard his efforts as a continuation and refinement of the
policies we have already put in place.

As far as I am concerned,

GAO staff has access to those policies and procedures, and I look
forward to receiving GAO's input on them.
I appreciate this opportunity to participate in this
hearing and look forward to answering any further questions the
Committee members may have.




99

STATEMENT OF
JOHN P. BORDEN
PRESIDENT,
GREATER KANSAS CITY CLEARING HOUSE
ON BEHALF OF THE
NATIONAL ORGANIZATION OF CLEARING HOUSES
BEFORE THE
U.S. HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS




OCTOBER 27, 1993

100

My name is John P. Borden. I serve as President of the Greater Kansas City
Clearing House Association in Kansas City, Missouri; and as President and CEO of the MidAmerica Payments Exchange (MPX). The Greater Kansas City Clearing House provides
check clearing services to over 100 financial institutions in the greater Kansas City area.
MPX, which was founded in 1975, is the largest of the 29 regional automated clearing house
associations in the United States.
I am here today on behalf of the National Organization of Clearing Houses (NOCH),
which I serve as President. NOCH was founded in 1989 to promote and support the
important role of check clearing houses in the U.S. payments system. In addition to Kansas
City, NOCH’s member clearing houses serve the regional check clearing needs of financial
institutions in Arizona, California, Connecticut, Illinois, New York State, Oregon,
Pennsylvania, Puerto Rico, and Texas. Our members also include the two national private
check clearing organizations.1
With this testimony, NOCH will provide its perspective on the role of the Federal
Reserve System in providing check clearing services. Our sole purpose here today is to
promote the goal of a competitive payments system.
The Goal is Balanced Competition
NOCH does not believe that it is necessary to establish a congressional commission
charged with evaluating the fair market value of the Federal Reserve’s check collection
operations for the possible purpose of privatizing these operations. We do, however, believe
that the concerns NOCH has with the Federal Reserve’s competitive role may be reflected in
the intent of this provision in Section 8 of H.R. 28, the "Federal Reserve System
Accountability Act of 1993."
NOCH believes that Congress should focus its attention on the goal of the
Monetary Control Act of balanced competition, and do so with the understanding that
the Federal Reserve System’s complete withdrawal from check collection is not a
precondition to achieving this goal. NOCH also believes that to pursue this goal
properly, a combination of active Congressional oversight through existing means and
greater public involvement in the review of Federal Reserve System check collection and
other payments practices is appropriate and necessary. Unfortunately, many decisions are
made by the Federal Reserve that have significant impact on private sector check clearing
service providers without the benefit of public comment.
It is clear to NOCH that the current check collection environment does not reflect
the competitive environment envisioned by the Monetary Control Act. The Federal
Reserve System accounts for roughly 50 percent of all interbank check clearing volume,

1
(ECCHO).

The National Clearing House Association (NCHA) and the Electronic Check Clearing House Organization




101
whereas no single competitor of the Federal Reserve accounts for more than about 3
percent.2
Much of the Federal Reserve System’s dominant market share may be attributable to
its ability to take advantage of a nationwide network and the many resultant opportunities
for economies of scale. In the current environment, these same economies of scale are
unavailable to most private sector providers, which tend to be focused on serving local or
regional markets. Even large bank holding companies that might otherwise have access to
similar economies of scale are constrained because of interstate branching restrictions.
Complicating the private sector’s ability to effectively challenge the Federal Reserve
System’s market share is the Federal Reserve’s dual role as a dominant competitor and
regulator. Since the Federal Reserve regulates the payments system in general, its policies as
regulator often inadvertently affect the abilities of private sector service providers to
compete.
A final complicating factor in the competitive relationship between the Federal
Reserve and the private sector is that the very same service providers that choose to compete
against the Federal Reserve must rely upon settlement services provided by the Federal
Reserve in order to offer their own check collection services. In short, as a private sector
clearing organization, perhaps the most important benefit you can offer - settlement in
immediately available funds —is controlled by your largest competitor.
While the Federal Reserve currently dominates the check collection market, NOCH
believes the goal of a more balanced competitive environment is attainable. In this
environment, a large number of competitors would operate, with no one competitor —
including the Federal Reserve System - enjoying more than a modest share of the market.
NOCH believes that Congress, in passing the Monetary Control Act, recognized that the
market forces operating in such an environment would do a better job of holding down costs,
fostering technological enhancements, and contributing to even greater efficiencies than are
currently present.
The Competitiveness Issue Is as Old as the Federal Reserve Itself
Given the unique role and construction of the Federal Reserve System, it is no
surprise that friction exists with the private sector. This friction dates back all the way to the
establishment of the Federal Reserve System in 1913, but really began to take hold following
passage of the Monetary Control Act in 1980. With the passage of this Act, the Federal
Reserve’s role in check collection was fundamentally changed from one of serving member

2
NOCH’s market share figures are derived from Federal Reserve clearing volume and that of the California
Bankers Clearing House Association. "On us" checks (checks drawn on the bank at which they are deposited) are
factored out of total estimated check volume (1992: 57.7 billion items) to arrive at total estimated interbank volume.




2

102

banks exclusively (by law), to one of competing directly with the private sector and serving
all depository financial institutions seeking check clearing services.3 This change in the
competitive balance led Congress - largely through the General Accounting Office (GAO) to become actively involved in exploring whether the Monetary Control Act was resulting in
a level playing field as intended. The most recent work on this issue was the GAO’s May
1989 report to this Committee and its counterpart in the Senate entitled Check Collection:
Competitive Fairness is an Elusive Goal. The purpose of the report was to evaluate private
banks* ability to compete with the Federal Reserve Banks in the provision of check collection
services as directed by the Competitive Equality Banking Act of 1987.
The May 1989 report does not stand alone, however, with several other studies
having been conducted by the GAO and two different Committees of the House of
Representatives. The common theme among all these initiatives has been the establishment
of a true competitive balance between the Federal Reserve and the private sector as
envisioned by the Monetary Control Act. For example, a 1984 report by the House
Committee on Government Operations concluded that "the objective of public policy must
be, among other things, to strike a balance that provides a fair and full opportunity to
compete to both the Fed and the private sector suppliers."4
A report by the House Banking Committee's Subcommittee on Domestic Monetary
Policy reached similar conclusions:
The Monetary Control Act did not envisage, nor does the Subcommittee accept the creation of a
theoretically pure and perfect competitive setting if the result is to drive the Federal Reserve out of
the payments system and thus weaken the safety, security, and accessibility of the system.
However, the Subcommittee would also not accept, nor did the Monetary Control Act intend, a
situation in which the Federal Reserve through its actions drives the private clearing banks out of
check clearing.5

NOCH shares the views expressed by both reports that the Monetary Control Act
does not specifically require the Federal Reserve to leave check collection entirely to the
private sector as a measure of compliance with the Act’s intent of a balanced competitive
environment. On the other hand, we do believe that a single service provider owning fully
one-half of the entire check clearing market in the United States is completely
Inconsistent with any reasonable definition of what constitutes a "balanced competitive
environment." In short, we believe the payments system should not be structured so as to
promote the interests of the Federal Reserve System as a provider of services at the expense
*
The Monetary Control Act does not mandate that the Federal Reserve System provide check collection services,
but that, if it chooses to, it must make such services available to all depository financial institutions.
4

H.R. REP. NO. 98-676, 98th Cong., 2nd Sess. 30-31 (1984).

3
STAFF OF HOUSE SUBCOMM. ON DOMESTIC MONETARY POLICY, 98TH CONG., 2D SESS.,
REPORT ON THE ROLE AND ACTIVITIES OF THE FEDERAL RESERVE SYSTEM IN THE NATION'S CHECK
CLEARING AND PAYMENTS SYSTEM 34 (Comm. Print 1984),




3

103
of the private sector.
At the time it was conducted, the May 1989 GAO report built upon these conclusions
and many of the concerns that remained regarding the Federal Reserve’s unique competitive
advantages. The report concluded with specific recommendations aimed at the Federal
Reserve:
[T]o ensure that competitive fairness issues are appropriately considered, the Federal Reserve
needs to (1) better define what is meant by its policy commitment to competitive fairness as a
means of providing clear decision-making criteria and (2) establish better procedural controls to
further payments system changes that promote competitive fairness while providing strengthened
safeguards against potential conflicts of interest It should then apply these policies and procedures
to H development of a same-day payment regulation.6
ie

Since the release of the GAO’s May 1989 report, the Federal Reserve has taken steps
to address the specific recommendations of the GAO. Most importantly, the Federal Reserve
has amended Regulation CC mandating same-day settlement for checks without the
imposition of fees, subject to certain reasonable conditions. Until these amendments were
approved, only Federal Reserve Banks were exempt from paying presentment fees.
Also subsequent to the May 1989 report’s release, the Federal Reserve revised its
policy statement entitled "The Federal Reserve in the Payment System" to require, among
other things, that a competitive impact analysis be performed for "proposed changes that
would likely have a substantial effect on payments system participants. "7
Do Federal Reserve Policies and Practices Now Reflect Congressional Intent?
While the Federal Reserve has taken actions to address the GAO’s recommendations,
at least two questions remain:
1.

Have the Federal Reserve’s actions thoroughly addressed the issue of
competitive fairness, and have they or will they result in a more equitable
competitive balance?

2.

In addressing the recommendations contained in the GAO report directly, has
the Federal Reserve Board also permitted other practices by Reserve Banks
that compromise the intent of the GAO recommendations and the Federal
Reserve’s own responses to those recommendations?

*
U.S. General Accounting Office, "CHECK COLLECTION: Competitive Fairness is an Elusive Goal,"
GAO/GGD-89-61, 61 (1989).

7

FEDERAL RESERVE SYSTEM, Policy Statement —The Federal Reserve in the Payments System 3 (1990).




4

104
NOCH believes these important questions must be resolved before full industry
confidence in the Federal Reserve’s adherence to fair competitive principles can be restored.
Furthermore, the evidence to date strongly suggests that the answer to both questions is that
the Federal Reserve has neither thoroughly addressed the competitive fairness issue in its
payments system policies, nor has it adequately enforced existing competitiveness polices in
its approval of Reserve Bank check collection services and prices. If this posture is
permitted to continue, the balancing of competitive opportunities promised by actions such as
same-day settlement will be lost.
For example, the Federal Reserve recently implemented changes to its Payments
System Risk Reduction Program (PSRRP) which included a change in the schedule by which
check transactions are posted to a depository institution's reserve account. Because of this
change, credits for checks cleared through the Federal Reserve are now available to the
collecting institution much earlier in the day than is possible for checks collected privately
under same-day settlement. This is an important distinction since, as part of the PSRRP, the
Federal Reserve is preparing to price "daylight overdrafts" in a depository institution’s
reserve account. As such, the timing of proceeds from check and all other payment
transactions will be very important to depository institutions as they control their overdraft
levels.
The impact of the risk reduction policy changes on the competitive playing field
represents a perfect example of how the Federal Reserve’s dual role as regulator and
payment services provider can operate to the detriment of the private sector. In trying to
reduce the Federal Reserve’s risk in the payments system, the Federal Reserve has set in
motion forces that will specifically discourage migration of check volume under same-day
settlement to the private sector.*
In addition to the Federal Reserve’s compromise of the attractiveness of same-day
settlement due to the change in the check posting schedule, allow me to provide another
example of what NOCH views as a deviation from the principle of competitive fairness
intended by the Monetary Control Act. Recently, the Federal Reserve Board approved a
Federal Reserve Bank’s request to offer a new check collection service dependent upon a
unique pricing mechanism. Known as a "payor service group sort" (PSGS), this service is
now being offered by over eleven Federal Reserve offices around the country (more have
recently announced that they too will add such a service). The service was approved by the
Federal Reserve without the benefit of public review, despite the determination by the
Federal Reserve Bank applicant that its proposal should be treated as "non-routine" because
the pricing mechanism represented a departure from Federal Reserve pricing policies in place
at the time.
This new pricing mechanism relies on revenues received from paying banks to offset

*
Checks pose minimal risk to the Federal Reserve and, as such, NOCH has long believed that the check posting
change recentiy implemented by the Federal Reserve was unnecessary.




5

105
the prices charged by the Federal Reserve to collecting banks for check deposit services.
According to the Federal Reserve Board staffs document approving the new service, the
pricing mechanism would "assess a fee to both the depositing bank and the payor bank for
deposits of checks in a Payor Service Group Sort."9 In short, the paying bank is paying a
portion of the collection costs for checks presented to it through this service, allowing the
Federal Reserve to offer a corresponding discount to the collecting bank choosing to use the
service.
The power of this pricing incentive should not be understated. Typically, a bank’s
determination of check collection method depends on price more than any other single factor.
Therefore, as NOCH sees it, the PSGS service is purposely structured to subsidize collecting
banks as an incentive for them to collect checks through the Federal Reserve System, instead
of through private banks that do not have the capability to link paying and collecting bank
services and prices.
Moreover, until this new pricing mechanism was approved, the Federal Reserve’s
pricing policies for check collection services had always been to assess fees only on only
those banks directly benefitting from the provision of the service. In short, the price borne
by the collecting bank for a collection service fully reflected the Federal Reserve’s cost of
providing the collection service plus a private sector adjustment factor. With the PSGS
service, when revenues from paying banks are factored out of the cost recovery equation,
NOCH questions whether this pricing mechanism is even recovering the marginal cost of
collecting checks through this service.
Between the recently implemented check posting changes under the Payment System
Risk Reduction Program and the Payor Service Group Sort pricing mechanism, NOCH fears
that the same-day settlement amendments to Regulation CC might be rendered meaningless.
The Solution: More Congressional Oversight and Greater Public Involvement
No one relying on the U.S. payments system stands to realize any benefits if one
group of organizations (e.g., the Federal Reserve and its Reserve Banks) is perceived as
dominant in a strictly one-sided game. Sooner or later in this situation, the private sector
might simply decide to stay home. Therefore, the perception that competition in the
payments system is one sided cannot be permitted to continue. The perception - and indeed
the reality —must be that the competitive playing field is level; the officiating fair and just.
This, in NOCH’ s view, was the intent of the Monetary Control Act.
The Importance of Public Opinion: In evaluating the Federal Reserve System’s dual role as

9 COMPETITIVE IMPACT ANALYSIS, PRICING PROPOSAL #542; accompanying an approval letter from
Mr, William W . Wiles, Secretary of the Board of Governors of the Federal Reserve System, to Mr. W illiam H .
Hendricks, First Vice President of the Federal Reserve Bank of Cleveland, (July 11, 1990).




6

106
regulator and dominant national payments service provider, NOCH can only state that when
public opinion has been sought before the Federal Reserve enters into a new or different
service, or a new or different pricing methodology for such a service, the resulting outcome
has been to the benefit of the banking industry, its customers, and the national payments
system as a whole. When the Federal Reserve has not subjected price or service proposals
from Federal Reserve Banks to public review, questions and concision have all too often
been the result. This has particularly been the case when the approved price or service
change has ultimately been adopted by other Reserve Banks around the country.
Frequently, proposed changes to a price or service by an individual Reserve Bank
have received Federal Reserve approval without the benefit of public comment because the
change might only have a limited effect on other local service providers. Meanwhile,
subsequent similar changes by Reserve Banks serving other regions are generally subjected to
only the most basic review process by Federal Reserve Board staff because, presumably, the
Board of Governors and its relevant committees have already reviewed the competitive
impact of the original application. The problem that exists is that a particular price or"
service change in one region may indeed have only a limited impact on competition with
local private sector providers, whereas, on a national or multiregional basis, the competitive
position of many other private sector service providers might ultimately be undermined by
the subsequent adoption of the change in their Federal Reserve districts. Since local changes
frequently have national repercussions, NOCH believes that virtually all changes to
Federal Reserve priced services should be viewed by the Federal Reserve as potentially
having "significant longer run effects on the Nation’s payments system" - thus
triggering public review requirements under policies adopted by the Federal Reserve
pursuant to the Monetary Control Act and the Administrative Procedures Act.
NOCH would like to add that not only does the Federal Reserve approve many
controversial services without the benefit of advance public comment, but even when the
public seeks more information about a service and its approval process, the response from
the Federal Reserve can be less than forthcoming. As an example, I have attached for the
record several documents NOCH received from the Federal Reserve in response to a request
under the Freedom of Information Act for information regarding approval of the payor
service group sort. A quick review of these documents reveals that a substantial amount of
information contained within has been deleted as not for public consumption.
The message here should be clear. All proposed changes to Federal Reserve prices
and services should be issued for public comment. Providing the public the opportunity to
review changes to Federal Reserve prices and services not only elevates the Federal Reserve
Board above any reasonable suspicion of conferring competitive advantages upon the Federal
Reserve System, but also permits private sector providers of payment services to respond
with the potential effects such a service would have in the region or regions they serve.
Even if the proposal is generated by an application of a Reserve Bank that is not directly in
competition with a particular commenter, as part of the public record, these comments can
serve as a guide to the Federal Reserve and its staff when reviewing similar changes




7

107
proposed by other Federal Reserve Banks.
Finally, public comments by individuals or organizations actively involved in the issue
being subjected to comment frequently suggest beneficial changes to proposals when adopted
in the final form. Examples o f Federal Reserve proposals that have benefitted in their final
form from useful suggestions made during the public comment process include not just rule
changes (e.g., same-day settlement and Regulation F), but also check service pricing
proposals (e.g., capped fees for interdistrict transportation, and tiered pricing for Federal
Reserve check deposit services). It is unwise to think that a single Reserve Bank or Federal
Reserve Board staff will always thoroughly develop a proposed price or service change to its
full potential without comment from those institutions that would use or compete against the
service if offered in their District.

Active Congressional Oversight: Issuing proposed Federal Reserve price and service changes
for public comment in advance would greatly enhance the ability of the banking industry and
the Federal Reserve Board to fully review the full competitive impact of these types of
proposals before they are approved and implemented. However, the numerous questions
that continue to surround the Federal Reserve System’s role and market dominance in
the payments system strongly suggest that this role must be further evaluated by a
knowledgeable, non-biased third party.
Given the GAO’s substantial involvement in evaluating the Federal Reserve’ s role in
the payments system, NOCH would recommend that the GAO be commissioned to re­
evaluate the current competitive role of the Federal Reserve System given changes in the
competitive environment since the research for the May 1989 report was compiled. Of
particular interest would be the degree to which same-day settlement and changes to Federal
Reserve policies have addressed the recommendations in the May 1989 report and the intent
of the Monetary Control Act. As it evaluates the effects of recent Federal Reserve actions,
the GAO should also review what, if any, changes have been made by the Federal Reserve in
either its regulation of, or in its role as provider of services to the payments system that have
worked to compromise same-day settlement’s levelling of the playing field.
To measure progress towards the ultimate goal of achieving balanced
competition, NOCH would like to close its remarks by recommending that the GAO
follow up the comprehensive report described above with annual progress reports until
such time as the Congress may conclude that the competitive environment has reached
the stage of maximum fairness as envisioned by the Monetary Control Act. Congress
may therefore assure the public that continuous progress is being made towards this goal. To
this end, NOCH offers whatever assistance is requested of us to support any such GAO
reporting initiative.




8

108

TESTIMONY BEFORE THE U. S. HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
on
"The Federal Reserve System Accountability Act", HR 28

delivered by
J. D. Carreker
Chairman, J. D. Carreker and Associates, Inc. and
Executive Director, Electronic Check Clearing House Organization




October 27, 1993

109
PREFACE
Introduction

Thank you, Mr, Chairman and Members of the Committee*
I am Denny Carreker, Chairman of J. D. Carreker and Associates. We
are a management consulting and technology company, serving the
banking industry in matters of the payment system, bank operations,
check processing, and electronic check presentment.
Our client base includes most o f the country’s top 100 banks, their
regional clearinghouses, and banking industry associations. It has also
included Federal Reserve banks and the staff of the Federal Reserve
Board of Governors.

ECCHO

It is in my capacity as Executive Director o f the Electronic Check
Clearing House Organization, or ECCHO, that I have been invited to
address the Committee. ECCHO is a non-profit national organization
dedicated to facilitating the private sector’s implementation o f electronic
check presentment, or ECP (Exhibit 1). As I will describe later, ECP is
changing the payment system and the relative roles of the private sector
and the Federal Reserve.
ECCHO now has 58 members, who account for more than 60% of the
total domestic deposits of the 100 largest banks in the U. S, ECCHO has
become a central focus for many of the important changes currently
taking place in the nation’s check payment system.

Purpose

The Committee has asked me to address two questions about the Federal
Reserve’s payment system role: One, is it feasible to privatize the
Federal Reserve’s check clearing functions? Two, what is the "fair
market value" of the Federal Reserve’s check clearing operation?




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110

FEASIBILITY

Introduction

First, regarding feasibility. Not only is gradual privatization of the
Federal Reserve’s check clearing functions feasible and desirable, it is
already occurring.
It is ECCH O ’s belief that the Federal Reserve should encourage the
prevailing privatization trend and the success of private sector initiatives.
Doing so would involve addressing a fundamental issue, and that is the
basic conflict of interest in the Federal Reserve’s dual role as both
regulator of and competitor in the check collection system. In this dual
role, the Federal Reserve can, unilaterally and without accountability,
undertake regulatory, service policy, and service pricing initiatives to
maintain market share and recover costs, in direct competition with the
private sector.
There was a time when, thanks to non-par banking, unit banking, and
uncertain transportation conditions, the Federal Reserve’s operating role
was necessary. It is not necessary today, as Congress indicated in the
Monetary Control Act of 1980, and the private sector is meeting the
needs of the check collection system.
To address this conflict of interest, Congress should consider the example
of other countries such as Canada, and establish an entity to ensure that
the Federal Reserve’s conflict of interest is eliminated and the check
collection system evolves as Congress intends.

The

Privatization
Trend

Three main changes are contributing to the privatization trend
(Exhibit 2).
One, the continued consolidation o f the banking industry.
Two, the emergence of electronic check presentment, or ECP
Three, the increasing extent to which the payment information
needs of banks’ customers are directing the payment system.
Collectively, these three changes amount to the formation o f an
"electronic umbrella" (Exhibit 3) covering all parties in payment
transactions. And collectively, they serve to diminish the importance of
the Federal Reserve’s check clearing role and to increase the importance
of the private sector’s efforts to invest in further improvements without
the current fear of unpredictable and disruptive regulatory or pricing
changes by the Federal Reserve.
I would like to elaborate on each of these three changes.




page 2

I ll
FEASIBILITY (continued)

1.
Consolidation

2.

Electronic
Check
Presentment
(ECP)

First, consolidation. As banks consolidate, the nature of check clearing
volumes changes. Intra-bank checks increase, while inter-bank, or
"transit" checks decrease. The Federal Reserve’s check clearing role is
in transit checks. As a result, consolidation continues to diminish Federal
Reserve check volumes, and correspondingly, the required role o f the
Federal Reserve in the check collection system.

The second change I referred to is ECP. The essence o f ECP is that it
captures checks' payment information for electronic transmission, thus
separating checks’ most time-critical information from the paper item
itself. For the first time, the speed of check processing is not limited to
the speed at which a piece of paper can be handled and transported
(Exhibit 4).
For banks and their customers, ECP represents a
tremendous opportunity to reduce check risk and losses.
It is important to note that the private sector formed ECCHO and
invested in ECP in order to reduce the risk exacerbated by Regulation
CC. Thanks to this private sector initiative, there is less risk and more
efficiency in today’s check collection system.
ECP has substantial implications for the Federal Reserve’s future role in
the payment system. For most of this century, the basic check clearing
system was a daunting physical sorting and transportation challenge.
Banks were unit banks, many in remote or rural locations, and
transportation was slow (Exhibit 5).
This situation constituted a clear need for a national entity to provide a
standard sorting and transportation service at a reasonable price. It was
logical for the Federal Reserve to assume this dual role Of regulator and
operator, which it performed conscientiously and well, helping to create
the world’s most efficient check clearing system.
But now that the private sector is implementing ECP, physical
transportation and sorting is less time-critical. The private sector has
already developed ECP software, written the rules and agreements,
designed the implementation requirements, developed national standards,
formats, and definitions, and borne the expense and risk connected with
all these efforts. The private sector is adapting ECP service and delivery
mechanisms to serve the thousands o f small banks that cannot support
their own check clearing operations, helping these small banks reduce
their check risk and that o f their customers.




(continued)

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112

FEASIBILITY (continued)

2.
Electronic
Check
Presentment
(continued)

On the other hand, the Federal Reserve, while explicitly endorsing the
ECP concept, is planning to invest in a different approach to ECP that
will compete with the private sector’s investment and has already
complicated and delayed the private sector’s development of ECP
standards.
There is no reason for the Federal Reserve to duplicate the private
sector’ s ECP efforts. Additional competitive ECP activity by the Federal
Reserve at this juncture will unnecessarily complicate the work o f the
private sector, potentially introducing new systemic risk, and delaying
ECP’s benefits for small banks and their customers to ECP’s benefits.

3.

Customer
Participation

The third change I referred to is the greater customer responsiveness
required of the payment system (Exhibit 6). During the decades that the
Federal Reserve was expanding its role in the check collection system, the
system was not especially customer-oriented. Check services were largely
commodities, and customers did not demand differentiation.
That situation has changed. Now customers desire extensive payment
information along with payment transactions, and now they expect to see
services designed with the particular needs of their companies or
industries in mind.
For example, studies by J. D. Carreker and Associates and our bank
clients have shown that ECP has tremendous potential for providing
corporations with better payment handling and information, and reduced
payment risk. As a result, corporations are now taking steps toward
developing corporate ECP applications.
There are many other such examples that involve both corporate and
consumer customers, including electronic data interchange, home
banking, telephone bill paying, and ATM services.
In none of these examples is the involvement of the Federal Reserve as
a service provider required. As corporations and consumers increasingly
demand more responsive payment services, the opportunity for effective
participation by the Federal Reserve diminishes. The Federal Reserve,
appropriately, does not have customer relationships with these parties,
nor does it have the market-driven experience of the private sector.




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113
FAIR MARKET VALUE
Factors

The second question I’ve been asked to address is the "fair market value"
of the Federal Reserve’s check operations. Clearly, if the Federal
Reserve were to relinquish its check clearing role, it would forsake a
large investment in payment system capacity.
The most important factor affecting the value of the Federal Reserve’s
check clearing business would be timing. The business is valuable today,
but the value will diminish. I have just recounted for you the continuing
transition from paper to electronics. The Federal Reserve’s check
collection system mechanism was designed to support a paper check
system, not an electronic one requiring a national data communications
network. It was designed before the large-scale nationwide consolidation
of the banking industry and before the large-scale responsiveness to
corporate and consumer customers.
Thus the value of the Federal Reserve’s investment diminishes daily as
these trends continue. Its "fair market value", then, is tied to how soon
it is extracted.
The value of the business would also be affected by the scope of the
functions involved and the scale of the business. The combination of
settlement and check collection functions is clearly more valuable than
check collection alone, and the national scale of the total Federal
Reserve business is more valuable than several regional businesses would
be.




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114
FUTURE FEDERAL RESERVE ROLE
Overview

Having asserted that the early rationale for the Federal Reserve’s dual
role no longer exists, that the private sector is pursuing effective check
collection improvements in the form of HCP, and that the Federal
Reserve’s dual role jeopardizes private sector initiatives, the question
remains how the check collection transition should be managed.
ECCHO believes that Congress should encourage the prevailing trend
toward privatization by:
A.
B.

Recommenda­
tion

Establishing an entity to ensure accountability for Federal Reserve
check collection initiatives, and
Taking steps to eliminate the Federal Reserve's conflict of
interest, as other countries such as Canada have done.

ECCHO recommends that Congress establish a Payment System Advisory
Board, comprised of payment system experts drawn from the private
sector, Federal Reserve staff, and other parties as appropriate.
The Payment System Advisory Board (Exhibit 7) would advise Congress
or its agents on the following:
New Federal Reserve pricing initiatives
Major Federal Reserve investments in check collection
Changes in the scope of Federal Reserve services
Federal Reserve compliance with Congressional mandates
The Payment System Advisory Board would hold an annual meeting and
provide Congress or its agents with an annual report on these issues.
ECCHO believes that the General Accounting Office could play a useful
role in this regard.
An additional role of the Payment System Advisory Board would be to
provide a forum for discussing issues related to the evolution of the U.S.
payment system.




page 6

115
SUMMARY
Summary




In summary, the Committee’s attention to this issue is particularly timely.
It comes at a time when the private sector check clearing banks are
particularly well positioned to provide even better check clearing services
than ever, more cost-effectively than ever, with greater corporate and
consumer value than ever, and with even better service for small banks.
In other words, Congress can, with little or no impact on the quality or
safety of the check collection system, encourage current private sector
initiatives, the prevailing trend toward privatization of the check clearing
business, and the gradual elimination of the Federal Reserve’s conflict of
interest
To ensure the continuity and security of the payment system during the
transition and beyond, Congress should form a Payment System Advisory
Board of Federal Reserve and private sector parties. ECCHO is pleased
to offer its services in any way in the establishment of this Board.
Thank you for the opportunity to testify on behalf of ECCHO. This
concludes my prepared remarks.

page 7

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123
TESTIMONY OF

JAMES R. LAUFFER
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
OF THE FIRST NATIONAL BANK OF HERMINIE
AND PRESIDENT

of the

THE INDEPENDENT BANKERS ASSOCIATION OF AMERICA

before the

UNITED STATES HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, FINANCE, AND URBAN AFFAIRS

on the

"FEDERAL RESERVE SYSTEM ACCOUNTABILITY ACT OF 1993"




OCTOBER 26, 1993

124
Mr. Chairman, my name is James R. Lauffer, and I am Chairman, President and
CEO of the First National Bank of Herminie in Irwin Pennsylvania. I am also President
of the Independent Bankers Association of America, which is the only national trade
association that exclusively represents the interests of community banks.
We appreciate this opportunity to testify on your bill, the Federal Reserve System
Accountability Act of 1993 (H.R. 28). You have asked us to comment on the provision
of that bill that authorizes the formation of a commission to study, among other subjects,
the fair market value of the Federal Reserve's check clearing system and the advisability
of further privatizing check clearing. While we have a strong interest in that provision,
we also have serious reservations about other aspects of H.R. 28. We believe that this
bill would undermine the independence of the Federal Reserve System and politicize its
conduct of monetary policy. This statement will outline our views on all of these
provisions.

Federal Reserve Accountability Commission
The Study Would Ignore Key Factors
The IBAA believes that section 8(b)(3), as written, calls for a study that would
ignore crucial factors that must go into any consideration of whether the Federal Reserve
should divest check clearing services. It only requires the commission to take "into
account the economic benefits to be derived from, and the efficiencies to be achieved
as a result of, the divestment.'' This would result in a biased study, since it does not
clearly require the commission to consider any of the disadvantages of reducing or
eliminating the Federal Reserve's check clearing role.
Therefore, section 8 should be expanded to require the commission to consider
the indirect cost to the public if reasonably priced check clearing is no longer available
to financial institutions serving small and rural communities; the adverse effects on those
communities if they lose access to prompt and efficient payment services; and the value
of having the services retained by the Federal Reserve.
The Vital Role of Federal Reserve Services
Individuals and small businesses throughout the nation expect reasonably priced
banking services - checking accounts, interest-bearing checking accounts and savings
accounts. The availability of Federal Reserve services gives community banks -collectively the largest private sector market for Federal Reserve settlement and clearing
services -- access to affordable correspondent services designed to meet the needs of
these customers.
For many community banks, particularly in rural areas, the Federal Reserve is the
only provider offering check clearing services. The Federal Reserve ensures that all
financial institutions, approximately 30,000, have universal access to its services.




125
Historical Background
Prior to 1916, the Federal Reserve was involved only in a voluntary check
collection arrangement in which member banks voluntarily paid checks at par and
received immediate credit for checks deposited at a Reserve Bank. This voluntary
approach was a failure since most banks gained more by operating outside this system,
paying checks on a non-par basis. At that time, paying banks regularly charged "an
exchange fee" to the bank presenting the check for payment. Checks often were routed
in ways that delayed payment.
The Federal Reserve promulgated its first rules on check collection in July 1916,
requiring member banks to send checks for collection directly to the bank on which they
were drawn. Member banks were also required to clear at par.
Over the years, the Federal Reserve has endeavored to improve the efficiency of
the check collection system, sometimes at the request of the Congress. Most recently,
in 1987 the Congress directed the Federal Reserve to implement the Expedited Funds
Availability Act to provide depositors with more prompt access to their funds. This new
law required the Federal Reserve to implement numerous changes to improve the
efficiency of the check collection system. The Federal Reserve had to ensure that checks
were collected and returned in a timely manner to help protect banks against the risk
that they would pay checks that were drawn against insufficient funds.
Recent Developments
In the last 3 to 4 years several private entities have formed or expanded to
provide national correspondent services, including check clearing. Although these
services are available on a national basis, they are not universally available to all
financial institutions.
In 1992, Huntington Bancshares and two non-bank partners formed the National
Clearinghouse Association (NCHA), a nationwide check clearing network. The
membership is comprised of large regional banks, including NationsBank. The NCHA
membership requirements effectively exclude smaller institutions by establishing a $200
million minimum capital level for all participants.
Similarly, the Visa Automated Clearing House has identified the top 100 ACH
originators as its niche. Community banks need not apply.
The Electronic Check Clearing House Organization (ECCHO) was formed in 1990
to provide private-sector national electronic check presentment. The ECCHO
membership includes many of the country's 50 largest banks. Late last year, ECCHO
added a new membership category - associate member - to attract members that might
not otherwise be able to afford regular membership. Unless it has recently changed, the

73-435 0 - 9 4 - 5



2

126
annual cost of associate membership is over $10,000. This effectively excludes smaller
banks.
The membership requirements or niche strategies of the national private-sector
service providers make clear that most smaller institutions will continue to depend on
the Federal Reserve. Thus, they will not be able to obtain private sector services that
could produce cost savings for their customers.
New technology has emerged that will enable some private-sector entities to offer
some services nationwide. One of these entities is represented here today. However,
no single entity will provide universal, reasonably priced services to all of the nation's
financial institutions.
The private sector has demonstrated neither the capacity to absorb the Federal
Reserve's check volume -- about 30 percent of the total volume nor the willingness to
provide the services to all segments of the industry. The two private sector initiatives
by Visa and Huntington both demonstrate the willingness of the private sector to serve
only high-volume users. Capacity and willingness must be key considerations when
valuing the Federal Reserve services.
If the Federal Reserve abandons these services and the private sector is the only
correspondent service provider, many community banks would likely experience
substantially increased operating costs. In today's cost-cutting environment, community
banks would be forced to pass related fee increases on to consumers in various forms increased or new service charges and/or activity fees and lower rates of interest for
interest-bearing accounts. Consumers, small businesses, farmers, and ranchers would
bear the brunt of these fee increases.
Under current law, community banks already pay competitive fees. The Monetary
Control Act of 1980 requires the Federal Reserve to price its check services as though
it was a private sector player. The Federal Reserve calculates its cost for each
individual product which also includes a Private Sector Adjustment Factor (PSAF). The
Monetary Control Act also mandated that the Federal Reserve System match its costs
and revenues in the long run, while giving due consideration to competitive factors and
the continuation of an adequate level of services on a nationwide basis.
To date, the Federal Reserve has played a critical role in ensuring that
community banks, and their customers, have access to adequate payment systems. The
Federal Reserve must remain active in this role, as no other institution appears to be
willing or able to replace it. The study commission created by H.R. 28 must take these
factors into account.




3

127
Improving the Payments System
In addition to ensuring that all financial institutions have universal access to
check clearing services, the Federal Reserve is the catalyst for improvements in the
payments system, including check clearing operations.
Unlike any private-sector provider, the Federal Reserve has responsibility for
regulation and improvement of the payments system. As I indicated earlier, the
Expedited Funds Availability Act (EFAA) of 1987 directed the Federal Reserve to
improve the payments system. According to section 609(c)(1):
. . . "The Federal Reserve System shall have the responsibility to regulate:
(A) any aspect of the payment system, including the receipt, payment, collection,
or clearing of checks; and
(B) any related function of the payment system with respect to checks."
Given this responsibility, the Federal Reserve has a nationwide, long-term
perspective -- not just a short-term, regional or niche perspective characteristic of
private-sector providers.
The Federal Reserve's current role enables it to offer services which will assist in
executing its regulatory responsibilities. The EFAA, among other things, directed the
Federal Reserve to prescribe regulations resulting in an automated system for the return
of unpaid or dishonored checks. If the Federal Reserve did not provide a nationally
available return item service, this mandate would not have been met. The Federal
Reserve's role has greatly improved the return-check process .-- a benefit to both
depository institutions and most importantly, their customers.
The IBAA understands that the Federal Reserve is strongly committed to
remaining in the check clearing business and improving the efficiency of the nation's
check clearing system. The Federal Reserve's seven year research and development
effort in check image technology and the development of an electronic check exchange
service are prime examples. The Federal Reserve's leadership role in both of these areas
prompted software and hardware vendors to develop systems much sooner than privatesector market forces would have. The Federal Reserve cannot continue to improve our
payments system if it can no longer offer services to facilitate these improvements.
Any study must factor in the benefits of the Federal Reserve's dual role as a
regulator and service provider committed to serve all financial institutions.
Role of Studies in Legislation
Some may contend that community bankers should not worry about this provision,
since, after all, it is "just a study." I strongly disagree. Studies, particularly biased




4

128
studies, can lead to dangerous legislative proposals. For example, section 1001 of the
1989 savings and loan legislation directed the Treasury to conduct a study of the
federal deposit insurance system. That provision focused on ways to cut back on deposit
insurance coverage or reduce the deposit insurance funds' losses. The section failed to
require the Treasury to study any benefits of deposit insurance.
The end result was a Treasury recommendation that deposit insurance coverage
be greatly curtailed. Mr. Chairman, I know you favored that recommendation, while we
strongly opposed it. But certainly we can agree that the battle over deposit insurance
coverage that grew out of the Treasury study was hard-fought and highly significant.
The fact that the 1989 law did not require the Treasury to consider any positive aspects
of deposit insurance put a tremendous burden on those of us who opposed deposit
insurance cutbacks. Because of that experience, we will continue to closely scrutinize
proposals to "just study" topics of concern to community banks and fight to eliminate
bias.

Other Provisions of H.R. 28
We strongly agree with Federal Reserve Chairman Greenspan's earlier testimony
before this committee on the other provisions of H.R. 28. Whatever their stated intent,
their effect would be to undermine the independence of the Federal Reserve.
Presidential Appointment of Reserve Bank Presidents
The bill's first major provision would require that Reserve Bank presidents be
appointed by the President of the United States and confirmed by the Senate. Chairman
Greenspan has effectively outlined a number of very strong arguments in favor of the
current system and against the change proposed by H.R. 28. We see no need to repeat
those points in this testimony, but do want to add several points.
The Chairman and Vice Chairman of the Board of Directors of the Federal
Reserve Banks are not bankers. Second, the banking industry is not monolithic and the
non-bank directors represent a diverse constituency. Third, the Board of Directors at any
Reserve Bank does not have a carte blanche selection mandate - in selecting Federal
Reserve Bank Presidents there is an interface with the Federal Reserve Chairman and
the Board of Governors. The Board holds an effective veto.
We would be remiss if we did not point out that the advise and consent process
is not working that well for banking agency appointees. Extending this process to the
Reserve Bank presidents could lead not only to the politicization of the selection process
but also to serious delays in their appointment. We have not had an FD1C chairman
since August, 1992. And, since Director C.C. Hope's death - which caused a vacancy
which has not been filled - the FDIC has effectively been run by the Comptroller of the




5

129
Currency. This has undermined the independence of a key agency.
financial posts also remain vacant.

Other high

GAO Audit oi the Monetary Policy of the Federal Reserve
The GAO is the investigatory arm of the U.S. Congress. Increasing its auditing
role at the Federal Reserve increases Congressional power over monetary policy. This
will weaken economic and financial confidence. The GAO has been routinely auditing
the regulatory and supervisory {unction of the bank regulatory agencies, including the
Federal Reserve, since the late 1970s. After 15 years of experience, there is no
evidence that the GAO understands the difference between an audit and a supervisory
examination.
The GAO has no expertise in monetary policy -- it does not attract first-rate
economists. This is important because monetary policy is an economic specialization,
not an accounting function. And even its accounting expertise is suspect. The GAO's
accounting projections of the prospective losses of the FDIC-BIF are now widely viewed
as having been wrong. Its projections of future losses did not materialize. Ross Perot's
projected $100 billion taxpayer hit was a figment of the imagination that started with
the GAO's faulty projections.
These faulty projections were used to secure
Congressional passage of the FDICIA legislation which many experts, including those
at the Federal Reserve, regard as a drag on bank lending and the general economy.
We respectfully invite any member of the Banking Committee to pay a visit on
one of the 4,000-plus banks under $50 million to ascertain whether FDICIA -- which
added to previously existing regulations - has imposed a regulatory burden that
threatens its survival. The cumulative regulatory burden is so onerous that government
examiners often outnumber these banks' professional staff.
Legislation giving the GAO second-guessing rights over monetary policy decisions
serves no useful purpose - it will only undermine confidence in American economic
decision making. Our country's fiscal-policy house has not been in order for at least 20
years and this has put extra-ordinary burden* on monetary policy. Generally, oux
central bank has acquitted itself well. It does not need the GAO or this committee fine
tuning monetary policy.
These issues are not new to the House Banking Committee leadership and its staff
nor to the IBAA and its staff. They were last seriously fought in the late 1970s. They
were rejected then - they should be rejected today.
Thank you.




6

130
H O W A R D B. W E N T W O R T H

Mr. Chairman and Committee members, my name is Howard Wentworth.
I am a Senior Vice President with CoreStates Financial Corp.
I
would like to thank the committee for the opportunity to comment on
the issue of the privatization of Federal Reserve Priced services.
As documented in the 1989 General Accounting Office report "Check
Collection Competitive Fairness Is an Elusive Goal", the Federal
Reserve is engaged in an almost $800 million a year business of
providing priced services (activities that the Federal Reserve
provides for a fee such as check collection, wire transfer, etc.),
in direct competition with banks and other service providers. At
the same time, the Federal Reserve also regulates its competitors.
The dual roles of regulator and service provider effectively stifle
private sector competition for priced services.
Competition is
curtailed in several ways.
The Federal Reserve enjoys legal
advantages that no private sector provider can match. Among these
are the ability to present to any paying bank as late as 2:00 p.m.,
the ability to compete on a national basis and the ability to
spread costs over a variety of products including some products
where the Federal Reserve enjoys virtually a monopoly position.
As the manager of the payments system, the Federal Reserve
exercises its tactical rule making abilities, granted under
Regulation "CC", in ways that frequently appear to have as the
primary motivation improvement of the Federal Reserve's competitive
position at the expense of the private sector providers. A recent
example would be the establishment by the Federal Reserve of a 6:30
p.m.
deadline
for
the settlement
of Same Day Settlement
presentments.
The late deadline, which applies only to private
sector presentments, compares to a deadline as early as 11:00 a.m.
for Federal Reserve presentments.
The early deadline reduces
Federal Reserve risk while the late deadline increases private
sector risk and costs. Although the time under which payment can
be delayed may appear to be unimportant, the distinction could
effectively negate the cost avoidance opportunities for some of the
very banks that Same Day Settlement was supposed to benefit.
Finally, it is important to appreciate that banks view the Federal
Reserve primarily as a regulator.
As a result, banks frequently*
are reluctant to challenge Federal Reserve actions related to
priced services because of their concerns related to the Fed's
regulatory role.
The net effect is that the dual powers that
Congress has granted to the Federal Reserve sets up a governmental
agency with unfair competitive advantages over the private sector.
Although it is now seen as a cliche it is nevertheless true that
the FAA doesn't fly airplanes since it would place them in the
conflicting roles of regulator and operator. This is a truth that
the current Federal Reserve structure does not reflect.




131
Privatization of the Federal Reserve's priced, services function is
the most effective way to resolve the actual and perceived
conflicts of interest which the government has created in allowing
the Federal Reserve to function in its dual roles.
Three approaches to privatization of the Federal Reserve's "Priced
Services" functions should be considered.
1. The Federal Reserve could sell their operating units, on
a regional basis, to the private sector providers.
2.
"Priced services*' activities could be spun off from the
Federal Reserve on a local basis. The new charter would be to
operate as a private company with profits to be paid to the
Treasury. This approach would result in approximately 46
separate companies being created.
Each new company would be
subject to the same regulations as the private sector
providers.
3. The Federal Reserve could return to its historic role as
a processor of last resort providing those services that the
private sector elects not to deliver.
Each of the three alternatives provides benefits and challenges.
Additional work would be required to install any one, or a
combination of the above solutions.
However each would appear to
successfully eliminate the conflict in the dual roles of the
Federal Reserve without jeopardizing the safety and soundness of
the payments system.
Thank you for your attention.
questions.




I would be pleased to answer any

132
Th e o f f i c i a l m i n u t e s fr o m a m e e t i n g o n F e b r u a r y 19, 1974, w i t h
P r e si d e n t F r a n k E. M o r r i s of the B o s t o n Fe d e r a l R e s e r v e B a n k
s u g g e s t i n g that the b o a r d of d i r e c t o r s cont a c t the M e m b e r s of
C o n gr e s s to p r o m o t e the F ederal R e s e r v e ' s p o s i t i o n on t he G A O audit
bill.
Th e o f f i c i a l m i n u t e s of this m e e t i n g state {p. 95 of Fede r a l
R e s e r v e B a n k of B o s t o n D i r e c t o r ' s m i n u t e s 1972, 1974, 1975, as
d e l i v e r e d to th e H o u s e B a n k i n g C o m m i t t e e ) :

"Mr. Morris also called attention to the fact that H.R. 10265,
which would provide for a 6.A.O. audit of the Federal Reserve
System had not died in the House Rules Committee but was expected
to reach the floor of the House of Representatives on or about
March 5. He indicated that the System's position was to support an
amendment, to be proposed by Rep. Ashley of Ohio, which would limit
the scope of the audit so as to exclude monetary policy actions,
but to continue to oppose the bill, even if amended, on the final
vote.
The directors were encouraged to let Members of the House
know their views on the bill.n
O n M a y 23, 1974, G o v e r n o r G e o r g e W. Mitchell, t h e n v i c e c h a i r m a n of
the F e d e r a l R e s e r v e B o a r d of Governors, a p p e a r e d at the d i r e c t o r s
m e e t i n g of the C h i c a g o Federal R e s e r v e Bank.
A d e s c r i p t i o n of his
re m ar k s is p r e s e n t e d in the m i n u t e s of that m e e t i n g as follows:
"Remarks b y G o v e r n o r Mitchell, (p. 157, Fede r a l R e s e r v e B a n k
of C h i c a g o M i n u t e s of the B o a r d of D i r e c t o r s for. 1974, as d e l i v e r e d
to the H o u s e B a n k i n g C o m m i t t e e ) :

Governor Mitchell also noted that the GAO audit bill should
come up for vote next week on the floor of the House. Reserve bank
directors have been helpful in contacting Congressmen and hopefully
the bill can be at least amended to restrict the type of audit if
chances for outright elimination lessen."
Mr. R o b e r t P. Mayo, Pres i d e n t of the C h i c a g o F ederal R e s e r v e
Bank, t h e n c a l l e d on the directors, w h o are p r i m a r i l y p r i v a t e
b a n k e r s a n d b u s i n e ssmen, to cond u c t a l o b b y i n g c a m p a i g n ag a i n s t the
G A O a u d i t bi l l ( i b i d ) .

"Mr. Mayo commented further on the GAO audit bill, noting that
it is House Bill number 10265 and should be up for consideration on
May 29.
He then requested each director to make whatever calls
seem natural to him in order to encourage support for the Federal
Reserve position.
Although basically the System would prefer to
see the entire bill defeated because of its monetary policy review
aspects, if that is not possible then the Ashley amendment,
restricting the GAO to a financial audit is favored."
Mr. M a y o f o l l o w e d t h r o u g h on his c a m p a i g n in the J une 27 m e e t i n g b y
t h a n k i n g the d i r e c t o r s w h o c o n t a c t e d M e m b e r s of Co n g r e s s to secure
suppo r t fo r t he F e deral R e s e r v e position.
T h e m i n u t e s of this
m e e t i n g r e v e a l the f o l l o w i n g (ibid, p. 169):




133
"The
GAO
audit
bill
recently
passed
the
House
of
Representatives, but was limited to a financial audit. There is no
prosect of Senate action this session, however. Hr. Hayo thanked
those directors who were able to contact Members of Congress to
secure support for the Federal Reserve position."
T h e p a t t e r n of org a n i z e d F e d l o b b y i n g is a l s o se e n in c o n n e c t i o n
w i t h a t t e m p t s to get the Fed t o t a l l y e x e m p t e d f r o m the " G o v e rnment
in t he S u n s h i n e ” bill.
O n D e c e m b e r 11, 1975, the C h i c a g o Fed ' s
Pr e s i d e n t M a y o rep o r t e d to his d i r e c t o r s o n this legislation.
A f t e r n o t i n g the a lleged c o n s e q u e n c e s of o p e n i n g d i r e c t o r s m e e t i n g s
to t he public, he then d e s c r i b e d the o r g a n i z a t i o n of the l o b b y i n g
effort, ind i cating that W a r d J. L a r s o n {Senior V i c e President,
G e n e r a l Counsel and S e c r e t a r y to the B o a r d of the C h i c a g o Fed)
w o u l d fol l o w up w i t h each d i r e c t o r o n his l o b b y i n g a c t i v i t i e s (pp.
318-319, Federal R e serve B a n k of Chicago, M i n u t e s of the B o a r d of
D i r e c t o r s for 1975, as d e l i v e r e d to the H o u s e B a n k i n g C o m m i t t e e ) :

"Mr. Mayo reported that a 'Government in Sunshine' bill has
already passed the Senate, requiring all federal agencies headed by
a body of two or more members appointed by the President to conduct
business at meetings open to the public.
Even in those instances
where a majority of the members vote to close the meeting a
verbatim transcript must be made and retained for at least two
years.
"While this bill does not appear to apply to the individual
reserve banks, it does apply to the Board of Governors and possibly
to the FOMC, (Federal Open Market Committee) and this application
concerns us directly as a System.
RA similar bill, H.R. 11007, will be voted upon soon by the
Government Operations Committee of the House. We would hope that
the Federal Reserve System could be totally excluded from the bill
-- or at least that it be exempt from the requirement that a
verbatim transcript be made of all closed meetings.
"Keeping a verbatim
transcript
would
clearly
inhibit
discussion and could cause members to speak only for the record.
While such a transcript would be subject to court subpoena, even
more critical to the system would be the scrutiny of the Congress.
As you can see this legislation is particularly sensitive with
regard to Board discussions on monetary policy and bank regulatory
matters, (emphasis added).
"Mr. Mayo then read a list of Committee members from this
district. He asked each director to think about possible contracts
to explain Federal Reserve concern and indicated that Mr. Larson
would be in touch with each director tomorrow as a follow-up.”
(emphasis added).




134
BOARD

OF G O V E R N O R S

OF THE
F E D E R A L R E S E R V E SYSTEM
W A S H IN G T O N , O. C. 2 0 S S I

August 19,

1993

Mr. Ian W. M a c o y
D i r e c t o r , C h e c k Se rvices
N a t i o n a l O r g a n i z a t i o n of Cle a r i n g Houses
S u i t e 200
6 07 H e r n d o n P a r k w ay
Hern d o n , V A 22070
D e a r Mr. Macoy:
Th i s is in respo n s e to y o u r letter d a t e d A u g u s t 3,
1993, r e c e i v e d b y the B o a r d o n A u gust 4, 1993, in w h i c h y o u
request, p u r s u a n t to the F r e e d o m of Information Act, 5 U.S.C.
§ 552, c o p i e s of the f o l l o w i n g documents:
"1.
T he FRB's principles, including thosS p u r s u a n t to
p r o v i s i o n s in the M o n e t a r y Control Act of 1980 a n d all
o t h e r a p p l i c a b l e FRB polices, for reviewing
a p p l i c a t i o n s for p r i c e d services offerings s u b m i t t e d b y
F ede r a l Re s e r v e banks, branches a n d offices as in
e f f e c t at the time w h e n the Fourth Federal R e s e r v e
(Cleveland Federal Rese r v e Bank) District's "Pricing
P r o p o s a l #542" w a s r eviewed by the FRB and approved.
2. A n y a d d i t i o n s or changes to the FRB's p r i n c i p l e s
for r e v i e w i n g a p p l i c a t i o n s for priced servi c e s
o f f e r i n g s s u b m i t t e d b y Federal Reserve banks, b r a n c h e s
a n d o f f i c e s as d e f i n e d in #1 that are c u r r e n t l y in
effect.
3. T h e FRB p o l i c y statement entitled "The F e d eral
R e s e r v e in Payments System" as issued in M a r c h 1990 a nd
a n y o t h e r FRB p o l i c i e s currently in effect r e l a t i n g to
the p e r f o r m a n c e of a "competitive impact analy s i s " for
p r o p o s a l s a f f e c t i n g the Federal Reserve S y s t e m ' s
o f f e r i n g of p r i c e d services and its Reserve B a n k
operations.
4.
A n y p o l i c y s t a t ement that permits a Fede r a l
R e s e r v e bank, b r a n c h or office to u se fees c o l l e c t e d
f r o m p a y o r i n s t itutions to offset costs i n c u r r e d in the
p r o v i s i o n of c h e c k deposit services to c o l l e c t o r
institutions.




135
5. The Cleveland Federal Reserve Bank's application
and all supporting documentation resulting in the FRB's
approval of Pricing Proposal #542 and the date this
application was first received by the FRB.

T h i s FRB
re sp o n se
a tta ch e d

---

6. The FRB's statement of approval of Pricing
Proposal #542 and the date it was approved, the
competitive impact analysis accompanying this approval
and the date it was completed, and all other FRB
documentation supporting this approval. This request
includes any legal opinions prepared by FRB counsel
relevant to this approval and any documentation as to
why public comment was not recommended or required
before FRB approval.
7. Signed agreements between the Federal Reserve
office and each of those depository financial
institutions represented as payor institutions for
inclusion in the group sort for checks deposited
through the type of service represented by Pricing
Proposal #542 ("payor service group sort") offered by
the following Federal Reserve offices: Charlotte,
Cincinnati, Cleveland, Columbus, Dallas, Helena,
Indianapolis, Memphis, Milwaukee, Minneapolis and
Philadelphia.
8. A list of Federal Reserve offices, if any,
approved to offer the payor group sort deposit service
not referenced in #6 and all documentation requested in
#6 pertaining to these offices.
9. Correspondence from any depository financial
institutions to the FRB and/or their local Federal
Reserve bank, branch or office seeking to be added to
or withdrawn from, or seeking more information about a
payor service group sort deposit option.
Correspondence from the FRB and/or any Federal Reserve
bank, branch or office in response to such requests."

In your letter when you request "a detailed statement
of the reasons for the withholding or an index or similar
statement of the nature of . . . [any] documents withheld," you
appear to ask that the Board prepare a "Vaughn index." The right
to an index, however, applies only when an agency's decision to
withhold documents is made subject to judicial review. Vaughn v.
Rosen. 484 F.2d 820 (D.C. Cir. 1973), cert, denied, 415 U.S. 977
(1974) . "There is no requirement that administrative responses
to FOIA requests contain the same documentation necessary in
litigation.” Crooker v. CIA. No. 83-1426, slip op. at 3 (D.D.C.
September 28, 1984). Based on these and other precedents, the
Board's policy is to decline to prepare Vaughn indexes in
connection with administrative denials in light of the heavy
burden a contrary policy would impose on Board resources.




136
The staff's search of Board records has revealed a
number of documents that are responsive to items (1) through (3},
(5) , (6) , (8) and (9) of your request. Some of those documents
will be provided to you in their entirety. We have determined,
however, that the remaining documents contain the following kinds
of exempt information: commercial or financial information
obtained from a person and privileged or confidential; and staff
opinions, recommendations, and analyses that would not be
available by law" to a party other than an agency in litigation
with the agency. Such information will be withheld from you
under authority of exemptions 4 and 5 of the Act, respectively,
5 U.S.C. §§ 552(b)(4) and (b)(5)- The documents containing the
exempt information have been reviewed in accordance with the last
sentence of subsection (b) of the Act, and all reasonably
segregable nonexempt information will be made available to you.
With respect to items (4) and (7) of your request, the staff has
searched appropriate Board records and made suitable inquiries,
but has found no responsive documents. Accordingly,, we cannot
provide you with any information with respect to those items.
Your request for information, therefore, is partially
granted and partially denied with respect to items (1) through
(3), (5), (6), (8) and (9) of your request for the reasons stated
above. All documents being made available pursuant to this
authorization will be sent to you under separate cover. With
respect to items (4) and (7) of your request, a determination
that no responsive records exist is considered to be an "adverse
determination" under the Act. You may appeal these
determinations in accordance with section 261.9(d) of the Board's
Rules Regarding Availability of Information, a copy of which is
enclosed for your information.

William W. Wiles
Secretary of the Board
Enclosure




137
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Excerpts from the B o a r d 1s Rules
Regarding Availability of Information
12 CFR Part 261
Section 261.9(d)

(d) Appeal of denial of request for records— (1)
Request for review; time limits.
Any person denied access
to Board records requested in accordance with this section
may file with the Board a written request for review of the
denial by the Board or Board member(s) designated to hear
such appeal.
The request shall be filed within ten working
days of the date on which the denial was issued, or, where a
request for documents has been partially approved but access
to tihe documents has not been given, within ten working days
from the date such documents are transmitted to the
requester.
The request shall prominently display the word
"appeal1 on the first page.
'
An initial request for records
may not be combined in the same letter with an appeal.
(2) Untimely appeals.
The Board may consider an
untimely appeal if:
(i) It is accompanied by a written request for leave to
file an untimely appeal; and
(ii) The Board or designated Board member(s)
determines, in its discretion and for good and substantial
cause shown, that the appeal should be considered.
(3) Decision on appeal; time limits- The Board or
designated Board member(s) shall make a determination with
respect to any appeal within 20 working days of actual
receipt of the appeal by the Secretary and shall immediately
notify the appealing party of the determination and the
right to seek judicial review if the determination upholds,
in w hole or in part, the denial of the request for records.
Such determination is not subject to review under Section
265.3 of this chapter which provides for review of actions
taken under delegated authority.
(4) Mootness of appeal, (i) The Board, a Board member,
or a-staff person designated by the Chairman may declare an
appeal wholly or partially moot and instruct the Secretary
of the Board to reconsider the previous denial or to release
the requested documents, where a determination is made that
intervening circumstances or additional facts not known at
the time of denial have or may have eliminated any need or
justification for withholding the requested documents.
(ii) The Secretary may reconsider a denial being
appealed if such intervening circumstances or additional
facts come to the attention of the Secretary while an appeal
is pending.




Effective July 11, 1988

138
B O A R D

O F

G O V E R N O R S

OF THE

FEDERAL R ESER VE SYSTEM
W A S H IN G T O N ,

O-

C.

20551
* O O K C (( O f f l C l M . C O K II« r O H O ( N C C

f I

Mr- William H- Hendricks
First Vice President
Federal Reserve Bank of Cleveland
1455 East Sixth Street
Cleveland, Ohio 44101
Dear Bill:
The Director of the Division of Federal Reserve
Bank Operations, acting under delegated authority, has
approved your Bank's proposal to implement a Payor Service
Group Sort. It is understood that the group sort will
incorporate -the recently approvecTfee structure whereby
federal Reserve costs are recovered rrom rees 'ass^aseii' to
both, the depositing and payor banks. The Payor Service
Group Sort may be implemented after the usual thirty-day
announcement period. Please send a copy of your Bank's
announcement letter to Ms. Ellen Johnson, Stop 188, at the
Board of Governors.
Sincerely yours,
(Signed) William W . Wiles

William W. Wiles
Secretary of the Board
cc:

Mr. Robert Eisenmenger
Mr. William Stone
Ms. Joanna Frodin




mn

139
Board

of
of

G o v e rn o rs
th e

Federal Reserve System

OFFICE CORRESPONDENCE

Date: July 6, 1990_________
To:

Clyde H. Farnsworth, Jr.

Subj ects Proposed Pavor Service
Group Sort.

From: Thomas Luck

Action Requested
a proposal
by the Federal Reserve Bank of Cleveland to implement a group sort
composed solely of 'banks subscribing to payor services that require
the opening of fine sort packages.

The unique feature of this

proposal is a new pricing structure, which was recently approved,
under delegated authority, after endorsement by the Pricing Policy
Committee.

Under the proposed pricing structure, a fee would be

assessed to both the depositor and the payor bank for each check
deposited in the group sort.
DiscussionThe Federal Reserve Bank of Cleveland proposes to
implement a Payor Service Group Sort product to improve its check
operations, which have been affected by the growth in payor
services and package sort deposits'.

The proposed new product is

designed to eliminate a major bottleneck in Fourth District
operations caused by processing fine sort deposits in order to
capture the MICR data for payor services.

The group sort would

include only banks that subscribe to the payor services package
sort option and agree to be included in the program.




140

The Fourth District proposes to assess a fee to both the
depositing bank and the payor bank for checks deposited in the
group sort.

This pricing scheme represents a new structure for the

pricing of Federal Reserve check collection services-

No other

check product assesses a fee to both the depositor and payor bank
for the same process.




141
Under the proposal, depositors
would be charged $0,010 per item (except for Columbus City checks
which would be priced at $0,007 per item) and the payor service
customer would be charged $0,004 per item-

The attached competitive impact analysis concludes that
the proposed product meets the System criteria for new products.

Recommendation

 73-435 0 - 9 4 - 6


142
COMPETITTVE IMPACT AHALYSI8
PRTCTNG PROPOSAL #542

The Fourth District has requ e s t e d approval by the Director
of the Division of Federal R e s e r v e Operations, tinder
delegated authority, to implement a pricing structure that
w ould assess a fee t o both t h e depositing bank and the payor
bank for deposits of checks in a Payor Service Group Sort.
Payor banks that receive p a y o r ban k services could elect to
be included in th e group sor t a n d would pay the proposed fee
for all checks d rawn on t hemselves and deposited via the
group sort option.

1. Does the proposed service h a v e a direct and material
adverse effect on th e ability of other service providers to
compete effectively w i t h t h e Federal Reserve in providing
similar services?

The proposed Payor Service Group Sort does not
adversely effect the ability of other service providers to
compete effectively with the Federal Reserve in providing
similar services.

Both the underlying payor bank services

and the group sort concept are common Federal Reserve check
collection services,

and conceptually there is no .change in

the relationship of services b eing offered by the Federal
Reserve and its competitors.




T h e proposed fee structure,

143
w h i c h is new, could be imitated by competitors wishing to
enter the business of providing payor bank services.
The proposal will result in lower Federal Reserve
f ees for deposit of certain items tha t could prove to be
beneficial to a number of depositors,

including some

depositors not currently using the fine sort deposit option.
It is expected that the m ajor correspondent banks local to
th e Federal Reserve office will be the primary users of the
P ayor Bank Group Sort service.




144
F

e d h i ^a l

o r

R
C

e s e r v e

B ^

jntec

l e v e l a k d

C U C V tlA K O .O H IO -+4IOI
A « t * COOt

W IL L IA M H. h C N O R IC K S
viCC x i t l iO C N t

Fe b ru ary 1 4 ,1 9 9 0

Mr. Clyde Farnsworth, Jr.
Director, Division of Federal
Reserve Bank Operations
Board of Governors of the
Federal Reserve System
Washington, D.C. 20551
Dear Clyde:
The Fourth-District requests approval under delegated authority to
implement a. new check deposit service. The proposed Payor Service Group
Sort product is designed to reduce the processing pressures in our check
operations caused by the high growth rates of our payor services and package
sort deposits. The proposal uses a new pricing approach for recovering check
"floor" costs. Due to this change in pricing methodology, the proposal should be
classified as "non-routine".
Within the current Fourth District operations, approximately
package sort items each day are reopened and reprocessed for inclusion in ~
Fourth District payor services. Due to the nature of the package deposits, this
processing is occurring during our peak operating windows. The proposed
Payor Service Group Sort balances the Fourth District operational needs with
tliat of the package sort depositor and payor service customer. B combining
^r
revenues from the depositor and payor, the Fourth District "floor costs are
fully recovered.
This proposed Payor Service Group Sort has been supported by both a
sample of payor institutions and our largest package sort depositors. Other
Federal Reserve Districts with payor service capacity problems have also
shown interest in the proposed program.
Please direct any questions that you or your staff may have regarding
this proposal to Terrence J. Roth, Assistant Vice President, at (216) 579-2873.
Sincerely,

William H. Hendricks
Enclosure
cc:

Mr. Jack Guynn. Executive Director for Priced Services
Mr. W illiam S(one. Svslem Product Director







145

PAYOR SERVICE GROUP SORT

FEDERAL RESERVE BANK OF CLEVELAND

February 14, 1990

146
PAYOR SERVICE GROUP SORT

Action Requested
Each office within the Fourth District requests approval under
delegated authority to implement a new group sort deposit option
directed at lowering fees and processing costs for the package sort
depositor and payor customer.

The endpoints included in the group

sort will be only those customers which subscribe to the Fourth
District’s Payor Services Package Sort Option service (Fine Sort
Inclusion).

The new program is designed to eliminate a major

bottleneck in Fourth District operations in reprocessing Package Sort
Deposits.

Furthermore, the service is designed to pass financial and

operational benefits to current package sort depositors and payor
service customers.

Due to a new approach to pricing the Payor

Service Group Sort, the proposal is classified as "non-routine".
Executive Summary
Within the Fourth District, Payor Services (including the Package
Sort Option) and Package Sort deposit services continue to experience
tremendous success and growth.

The exponential growth rates are

beginning to impact dispatch times at the Cleveland, Cincinnati and
Columbus offices.




Payor S e r v i c e Group S o r t

-

Page

1

147
The Payor Service Group Sort product- is designed to create
incentives for package sort customer to deposit the current Package
Sort items that are reprocessed for Payor Service capture in a group
sort cash letter.




148
Background
The driving force behind the Payor Service Group Sort is the
exponential growth of our Payor Service, Package Sort Option and the
Package Sort Deposit services.

The following table summarizes the

annual 1989 performance compared to annual 1988:

1988

1989

MICR/Truncation Volume
Package Sort Option (Payor)
Package Sort Deposits
Local Processed Deposits




P a y o r S e r v i c e G r o u o Sort. - P ac e

% Growth

28.3X
53.6%
19.5%
V 0.8%)

3

149
increased to

per day.

This represents 23 percent of our

package deposits with a growth rate exceeding 50 percent for 1989.
Based on current trends, a very high growth rate will continue
through 1990.

Piscussio n
Current Environment
The Federal Reserve System guidelines governing deadlines and the
relationship between premium processed, package deposit and dispatch
times were developed to insure that all service providers had equal
and timely access to local FRS transportation services.

The System

guidelines stated that the Package Sort deposit program have a cutoff
time no earlier than three hours before courier dispatch.

During

this three hour period, the Fourth District physically sorts package
deposits, enters accounting information, and creates/distributes the
check supplemental accounting statements.




Pay or S e r v i c e

Group S o r t

-

Page 4

150
S t atement
T o t h e C o m m i t t e e on Banking,

Fina n c e and U r b a n A f f a i r s

U.S. H o u s e of R e p r e s e n t a t i v e s
By: T o m C. Frost
San Antonio, Texas
N o v e m b e r 15,

1993

As a c a r e e r b a n k e r w h o s e d e s i r e is t hat m y w o r k c o n t r i b u t e to the
growth

and

development

of

t he

community

that my

bank

serves,

I

a pp r e c i a t e t h e o p p o r t u n i t y t o pr e s e n t to t he C o m m i t t e e v i e w s on the
i n d e p e n d e n c e of our cent r a l b a n k w i t h i n g o v e r n m e n t and on the role
of t h e p r e s i d e n t s of t he 12 regio n a l banks in t h e a d m i n i s t r a t i o n of
m o n e t a r y policy.

Lest m y v a n t a g e p o i n t be m i s c o n s t r u e d as p u r e l y
i n t e r e s t of
with the

a commercial

Federal

tradition

the

grandfather

Federal

signed

the

San

Council.
will

explain my relationship

B orn

came

articles

of

into

into

my

a

125-year

life

incorporation

early
of

bank i n g
on.

the

My

Dallas

M y g r e a t u n c l e lobb i e d for t he e s t a b l i s h m e n t
branch

a nd

s erved

on

the

F e d eral

Advisory

M y f a t h e r w a s a d i r e c t o r of t he San A n t o n i o branch.

have

Antonio

Antonio

let m e

System.

Reserve

t he

F ederal R e s e r v e Bank.
of

banker,

Reserve

from t he ves t e d

15 y e a r s

branch

of

board,

A d v i s o r y Council.

s e r v i c e to
and

3

the

y ears

as

F ed
a

-

6 years

member

of

on the
the

I
San

Federal

N e x t m o n t h c o m p letes m y s i x t h y e a r on t h e bo a r d

of t h e D a l l a s bank.

I a sk t h a t m y v iews be a c c e p t e d as f rom one

w i t h a p r a c t i c a l u n d e r s t a n d i n g of the w o r k i n g s of our C e n t r a l Bank.
M y f o rmal educ a t ion,




t h e m e n t o r i n g of m y s u p e r i o r s a nd m y dire c t

151
e x p e r i e n c e h a v e b e e n focused on the F ederal R e s e r v e ' s significant
r o l e in a f f e c t i n g the well being of e ach and e v e r y individual who
p a r t i c i p a t e s in e c o n o m i c p rocess in this country.

It is f r o m t h i s c o n v i c t i o n that the c e n t r a l b ank be an instrument
of g o o d f or al l a n d not by serving a ny sin g l e s ector that I address
m y r e m a r k s t o y o u as you c o nsider c h a nges in t h e laws g o v e r n i n g the
F e d e r a l R e s e r v e System.

I have

been

taught

a nd

can

t estify

through

experience

t hat

the

i n d e p e n d e n c e of o u r c e ntral bank w i t h i n g o v e r n m e n t is the critical
element

which

allows

the

e f fective

administration

p o l i c y for b e n e f i t and g ood of the entire nation.
satisfaction

and great

a p p r e c i a t i o n t hat

the

of

mon e t a r y

It is w i t h m u c h

acknowledgement

of

this i n d e p e n d e n c e is not bas i c a l l y q u e s t i o n e d by t h o s e w h o p ropose
t o c h a n g e e i t h e r the m e t h o d by whi c h t h e p r e s i d e n t s of the regional
banks

are

elected

Commit t e e .
is

p r ocess,

t heir

participation

in

the

Open

M arket

It is a fact t hat the level of inf l a t i o n in a c o untry

directly

function.

or

related
The

to

closer

t he
a

i n d e p endence

central

b ank

is

of

the

t ied

t h e g r e a t e r t he inflation tendencies.

ce n t r a l
to

the

b a nking

p olitical

Conversely,

mo r e

i n d e p e n d e n c e is a s s o c i a t e d w i t h less i n f l a t i o n as s h o w n in Exhibit
A a ttached.

It is m y o p i n i o n
vision

of

that a lessening of t he

monetary

policy

will

have

s t a n d a r d of l i v i n g in this country.




i n d e p e n d e n c e of s u p e r ­

negative

influ e n c e

on

the

152
The g r a c e

of

our

system

lies

in t h e unique,

but most

eff e c t i v e

input of m a n y p e o p l e d i r e c t l y a c t i v e and i n v o l v e d in t h e m a r k e t ­
place.

The

participation

Committee

coming

political

p r o cess,

wo r l d "

and

direct

from

o nly

who

have

of

a

five
the

participation

minority
who

are

daily
in

the

of

not

the

Open

named

experience
economic

Market

through
in

the

the

"real

process,

is

a

fac t o r w h i c h m a k e s o ur s y s t e m r e s p o n s i v e to t h e a c t u a l a n d curr e n t
n e eds of t h e people.

The

contribution

of

the

12

regio n a l

bank

boards

through

th e i r

p r e s i d e n t s is invaluable. If t hose w h o r e f l e c t t h a t e l e m e n t do n ot
h a v e a v o t e t h e n the i r input w ill not b e effective.

Without

this

market-place,

direct

personified

monetary

policy

input

might

of

well

experience
be

f rom

deliberated

the •
by

a

c o m m i t t e e w h o s e m e m b e r s are isolated i nside t h e b e l t w a y en v i r o n m e n t
r e v i e w i n g c o m p u t e r p r i n t o u t s of e c o n o m i c trends.

The p r i n c i p l e t h a t such a p u b l i c e n t e r p r i s e as a c e n t r a l ba n k be
c o n t r o l l e d b y t h o s e subject to t h e d e m o c r a t i c p r o c e s s a p p o i n t e d by
elected officials

is not v i o l a t e d s ince a c l e a r m a j o r i t y of t he

O p e n M a r k e t C o m m i t t e e is app o i n t e d b y t h e P r e s i d e n t of t he U n i t e d
States a n d c o n f i r m e d by the Senate.

The

Board

of

Governors'

influence

is

far m o r e

pervasive

in t he

o p e r a t i o n of t h e cent r a l b ank th a n just s e r v i n g as a m a j o r i t y of




153
the O p e n M a r k e t Committee.

T h o s e a p p o i n t e d by an e l e c t e d official,

t h e P r e s i d e n t of t h e U n i t e d States, form 100% of t h e go v e r n i n g body
in al l o t h e r matters.

So t h a t t he r o l e of t he B o a r d of G o v e r n o r s in t he n a m i n g of the 12
b a n k p r e s i d e n t s not b e overlooked, I w o u l d like t o rel a t e m y p a r t i ­
c i p a t i o n in t he e l e c t i o n of the p r e s i d e n t of t he D allas bank.

The

s e l e c t i o n c o m m i t t e e of t h e b ank b o a r d was n a m e d b y the chairman of
the b a n k w h o w a s a p p o i n t e d by the B o a r d of Governors.

The Bank

B o a r d C o m m i t t e e c o n s i s t e d of o nly one b a n k e r or p e r s o n elected by
the s h a r e h o l d e r s

(commercial b a n k s ) .

It w a s u n d e r s t o o d and agreed

t h a t w h i l e t h e b o a r d of the regional b ank w o u l d in i t i a t e and manage
the s e l e c t i o n p r o c e s s th a t no c a ndidate w o u l d be p r e s e n t e d to the
b o a r d of t h e b a n k u n l e s s that can d i d a t e w a s a p p r o v e d by the Board
of G o v e r n o r s of the e n t i r e system.

T his g i v e s p r a c t i c a l evidence

t h a t t h e o f f i c e of t h e p r e s i d e n t of a r e g i o n a l b a n k is not outside
the d e m o c r a t i c process.

S i nce

its

inception,

c h a n g e a n d a daptation.

the

F ederal

Reserve

The o pen m a r k e t

System

function

has

a p p r e c i a t e d or u n d e r s t o o d at the b e g i n n i n g s in 1914,
e f f e c t i v e e x i s t e n c e later.

undergone

itself was not
coming into

On its own v o l i t i o n m o r e input from the

m a r k e t p l a c e h as b e e n soug h t by the Board of Governors.

The Federal

Advisory

c o nsist

Council,

set

o ut

in

the

original

a ct

to

of

b ankers, h a s b e e n join e d by similar g r o u p s c o n s i s t i n g of consumers




154
a n d s mall b u s i n e s s r e p resentatives.

The

diversity

branches

has

of

t he

been

12

banks'

expanded

boards

and

significantly

the

boards

through

of

the i r

e f f orts

and

i n i t i a t i v e s of t h e B o a r d of Governors, t he r e g i o n a l b a n k d i r e c t o r s
an d t he c o m m e r c i a l ba n k s w h o are s t o c k h o l d e r s of t h e Fed.

It has

b e e n m y p r i v i l e g e t o s erve w i t h women, m e m b e r s of m i n o r i t y groups,
a n d r e p r e s e n t a t i v e s of n o n - m a n a g e m e n t s u c h as labor leaders.

All

h a v e b e e n e f f e c t i v e c o n t r i b u t o r s t o t h e w o r k of t h e c e n t r a l ba n k
a n d a d d d i m e n s i o n t o t h e input f r o m t h e market p l a c e .

The observa­

t i o n t h a t t h i s d i v e r s i t y h as n ot r e a c h e d t he p r e s i d e n c i e s of the
r e g i o n a l b a n k s r e f l e c t s t h e h i s t o r i c a l s o u r c e of t a l e n t p o o l s and
no t t h e d e s i r e of all w h o m a n a g e a nd p a r t i c i p a t e
R e s e r v e proc e s s .

in the F e deral

T o r e c o g n i z e a nd be s e n s i t i v e to t he a p p r o p r i a t e

e l e m e n t s of v a r i o u s d i v e r s e eleme n t s is a m a j o r g oal of all w h o are
p a r t of t h e c e n t r a l bank.

T o close,

I a s k y o u not to chan g e t he p r e s e n t p r o c e s s of s e l e c t i n g

t h e 12 r e g i o n a l b a n k p r e s i d e n t s or a l t e r t h e i r r o l e
M a r k e t C o mmittee.

in t h e Open

To do so w o u l d be a m i s t a k e for a m o r e p o l i t i ­

c i z e d c e n t r a l b a n k leads to addi t i o n a l i n f l a t i o n a r y te n d e n c i e s w i t h
a negative

im p a c t on all.

O t h e r n a t i o n s a re m o v i n g t o w a r d m o r e

i n d e p e n d e n c e as a r e s u l t of our example.
An

independent

central

b ank

still

(See E x h i b i t B a t t a c h e d ) .

managed

and

operated

within

g o v e r n m e n t w i l l b e t t e r serve t he e n t i r e p o p u l a t i o n of t his g reat
country.




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157
R u s s ia n -A m e r ic a n E n t e r p r is e F u n d
33 Liberty Street
Ro o m 1101

New York. N Y 10045-0001
..
AREA CODE 212-720-7586

E. G erald C orrigan
C hairman

October 29, 1993

The Honorable Henry B. Gonzalez
Chairman, Committee on Banking, Finance
and Urban Affairs
U.S. House of Representatives
2129 Rayburn House Office Building
Washington, D.C. 20515-6050
Dear Mr. Chairman:
In accordance with the arrangements

worked

out with your

staff, I am forwarding to you my statement on H.R. 28, "The Federal
Reserve System Accountability Act of 1993."

As I understand it,

the

with

statement will

be part of the

record

regard

to the

Committee's deliberations on this subject.
I appreciate very much the opportunity to share my thoughts on
this

important

matter

with

you

and

your

colleagues

Committee.
Sincere!

Attachment




on

the

158

STATEMENT BY
E. GERALD CORRIGAN
FOR THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES




OCTOBER 29, 1993

159
Mr. Chairman, m e m b e r s of the Committee,

I a m p l e a s e d to

h a v e t h i s o p p o rtunity to share w i t h y o u m y t h o u g h t s on H.R.
"The F e d e r a l R e s e r v e S ystem A c c o u n t a b i l i t y A c t of 1993".
m e m b e r s of t h i s C o m m ittee k n o w v e r y well,

28

As the

t he b a s i c legal

f r a m e w o r k w i t h i n whi c h the cent r a l b a n k of a n y n a t i o n o p e r a t e s is
a m a t t e r of g r eat importance.

F or t h a t reason,

any material

c h a n g e in that framework m ust be e v a l u a t e d w i t h g r e a t c a r e a n d
w i t h a p a r t i c u l a r s e nsitivity to its c o n s e q u e n c e s —
p o t e n t i a l cons equences —

and

over t he l ong term.

From my perspective,

a u s e f u l p o i n t of d e p a r t u r e in

d e l i b e r a t i o n s t h a t wou l d a lter t h e legal f r a m e w o r k of t h e F ed is
t o r e f l e c t b r i e f l y on t he t r a c k r e c o r d of t h e F ed w i t h r e g a r d to
its b a s i c r e s p onsibilities.

Those basic responsibilities —

r e f l e c t e d in t he pream b l e of t he F e d e r a l R e s e r v e A c t —
t h e F e d ' s role in the conduct of m o n e t a r y policy,

as

r e l a t e to

its e f f o r t s to

h e l p e n s u r e t he s t a b ility of the b a n k i n g a n d f i n a n c i a l s y s t e m and
its e f f o r t s to h elp e nsure the efficiency,

s a f e t y a nd i n t e g r i t y

of t h e p a y m e n t s system.

B e c a u s e t h e s e ba s i c r e s p o n s i b i l i t i e s are

s o c l o s e l y interrelated,

I h ave a l w a y s v i e w e d t h e m as s o m e t h i n g

of a c e n t r a l b a n k i n g tril o g y in t h a t e a c h e l e m e n t of t he t r i l o g y
i n t e r a c t s w i t h the other in p u r s u i t of the c o m m o n t h e m e of
financial stability —
p o w e r of the dollar.




i n cluding s t a b i l i t y in t he p u r c h a s i n g

160
In l o o k i n g at t h e s e basic responsibilities,

I believe

m o s t o b s e r v e r s w o u l d a g r e e t hat the Fed has a s olid r e c o r d of
h i g h q u a l i t y p e r f o r m a n c e in the nation*s interest.
e xample,

no better,

T h e r e is, for

no m o r e efficient and no m ore t r u s t e d

n a t i o n a l p a y m e n t s s y s t e m in the w o r l d t han is found in t he U.S.
a n d that m a y u n d e r s t a t e the case.

—

Wh i l e the m a r v e l of t he U.S.

p a y m e n t s s y s t e m is b y no m e a n s the exclusive prod u c t of the Fed,
t h e r e c a n be n o q u e s t i o n that the F e d fs o p e r ations a nd its
p o l i c i e s h a v e p l a y e d a m a j o r role in the e v o l ution and
d e v e l o p m e n t of t h e U.S. p a y m e n t s system.

Even the u n g l a m o r o u s

n u t s and b o l t s a r e i m p o r t a n t in this regard.

For example,

the

f a c t t h a t m i l l i o n s of h o u s e h o l d s and small b u s i n e s s e s —
e s p e c i a l l y t h o s e in m o r e remo t e areas of the coun t r y —

c a n have

t h e i r c h e c k s a n d o t h e r p a y m e n t s proce s s e d w i t h the speed,
c o s t and t h e t r u s t t h a t w e w i t n e s s can be traced,
way,

the low

in no small

t o t h e F e d ' s efforts.
T h e s e c o n d leg of the central b ank t r i l o g y rela t e s to

th e F e d 1s r o l e in h e l p i n g to ensure the stability a nd safe t y of
t h e b a n k i n g a n d f i n a n c i a l system.
note that many central banks —

Here,

it is inter e s t i n g to

including the Federal R e s e r v e —

w e r e e s t a b l i s h e d m o r e w i t h a v i e w toward this o b j e c t i v e than they
w e r e w i t h a v i e w t o w a r d w h a t we w ould reg a r d as c o n t e m p o r a r y
m o n e t a r y policy.

T h a t h i s t o r i c a l footnote aside,

t his too,

is an

a r e a in w h i c h I b e l i e v e m o s t observers would a gree t h a t t h e Fed
h a s p l a y e d a h i g h l y c o n s t r u c t i v e role —

es p e c i a l l y in c o n t a i n i n g

t h e m a n y f i n a n c i a l d i s r u p t i o n s of the past decade.




Indeed,

in

161
many circles —

perhaps espe c i a l l y a b r o a d —

t he Fed is s een as

h a v i n g a p a r t i c u l a r l y broad and h i g h l y p r a g m a t i c b ase of
p r o f e s s i o n a l i s m and e x p e rtise in t h i s a r e a —

a judgm e n t t hat is

c o n d i t i o n e d in p art from the Fed's w o r k i n g k n o w l e d g e of fina n c i a l
i nstitutions,

financial mark e t s a nd t he " p lumbing" of t he

f i n a n c i a l system.
The third —

and central e l e m e n t —

of course, m o n e t a r y policy.

of the t r i l o g y is,

R e c o g n i z i n g t h a t p r i c e s t a b i l i t y is

m u c h m o r e a state of m i n d t han a statistic,

I b e l i e v e t h a t the

b e d r o c k of a ny central bank's r e s p o n s i b i l i t i e s m u s t be t h e
p r e s e r v a t i o n of the p u r c h a s i n g p o w e r of t he c u r r e n c y of the
nation.

That,

in turn,

is the k e y t o s u s t a i n e d e c o n o m i c g r o w t h

a n d r i s i n g s t a n dards of living.

It is w i d e l y r e c o g n i z e d t h a t to

a c h i e v e t hose object i v e s r e q u i r e s —

ind e e d d e m a n d s —

an

i n t e r m e d i a t e - a n d longer-term p o l i c y p e r s p e c t i v e t h a t is
i n s u l a t e d from s h o r t-term p o l i t i c a l pressures.

T h a t is why,

from

t h e v e r y b e g i n n i n g of the h i s t o r y of c e n t r a l b a n k i n g in the
U n i t e d States, care was e x e r c i s e d in p r o v i d i n g t he cent r a l ba n k
w i t h a s i g n i ficant d egree of " i n d e p e n d e n c e w i t h i n g o v ernment".
T h a t is also w hy we h ave seen —

a nd a re s e e i n g —

so m a n y

c o u n t r i e s m o v i n g to g rant natio n a l c e n t r a l b a n k s a g r e a t e r d e g r e e
of a u t o n o m y and political independence.
all p a r t s of the wor l d —

Indeed,

g o v e r n m e n t s in

in d e v e l o p e d a n d d e v e l o p i n g n a t i o n s and

e v e n in n e w l y emerg i n g m a r k e t e c o n o m i e s —

s e e m to i n c r e a s i n g l y

e m b r a c e the concept of an a u t o n o m o u s a n d i n d e p e n d e n t ce n t r a l
bank.

And,




in so doing,

t hey o f t e n p o i n t to a n d d r a w on the

162
e x p e r i e n c e of t h e Fed in the U nited States.

It w o u l d be an

i r onic t w i s t if t h e U n i t e d States were seen as m o v i n g in the
d i r e c t i o n of g r e a t e r p o l i t i c a l influence over the c e n t r a l b ank at
just the p o i n t in h i s t o r y w h e n so m a n y other c o u n t r i e s are m o v i n g
in t h e o p p o s i t e d i rection.
In s u g g e s t i n g t h a t the Fed has a credi b l e t r a c k r ecord
w i t h r e g a r d to t h e m a n n e r in w hich it has fulfilled its ba s i c
r e s p o n s i b i l i t i e s I am n ot s u ggesting that the Fed is flawless.
H u m a n n a t u r e a n d h u m a n frailties b eing w hat t hey are,
i n s t i t u t i o n c a n e v e n b e g i n to m ake such a claim.

no

Nor am I

s u g g e s t i n g t h a t as an a b s t r a c t p r inciple it w ould be im p o s s i b l e —
w o r k i n g f r o m a c l e a n s late —

to conceive some a l t e r n a t e

s t r u c t u r a l c h a r a c t e r i s t i c s t hat m ight work as well as t h o s e we
have.

But, w e a r e w h e r e w e are, and w h e r e we are is the res u l t

of a l m o s t t w o c e n t u r i e s of debate and delib e r a t i o n abo u t the
s t r u c t u r e a n d f u n c t i o n i n g of the central bank in a h i g h l y
p l u r a l i s t i c society.
A l l of t his is n ot to suggest that we, a s a nation,
s h o u l d not p a u s e f r o m t ime to time in order to s a t i s f y ourse l v e s
t hat the b a s i c s t r u c t u r e of important institutions such as the
F ed r e m a i n s in k e e p i n g w i t h our national interest and our
national heritage.

By t he same token,

as we seek to sa t i s f y

o u r s e l v e s in t h a t regard, we m ust recognize that the d e l i c a t e
b a l a n c e t h a t h a s b e e n s t r u c k over the years in the s t r u c t u r e of
our c e n t r a l b a n k i n g system,
g o v e r n m e n t as a whole,




and its relati o n s h i p t o t he

is just that —

delicate.

W h a t m a y seem

163
to b e m o d e s t o r e ven i n c onsequential c h a n g e m a y b r i n g w i t h it the
a p p e a r a n c e or t h e re a l i t y of m a j o r c h a n g e o v e r time.
I c a n u n d e r s t a n d the sentiments t h a t lie b e h i n d H.R.
r e l a t e d proposals,
tinkering.

Indeed,

Thus, w h i l e
28 and

I do not c o n s i d e r t h e s e p r o p o s a l s to be m o d e s t
I be l i e v e that t h e e n a c t m e n t of H.R.

28

a n d / o r r e l a t e d p r o p o s a l s almost s u r e l y w i l l b e i n t e r p r e t e d b o t h
h e r e a n d a b r o a d as leading to g r e a t e r p o l i t i c a l i n f l u e n c e ov e r
t h e Fed.

In t hat connection,

I would caution against minimizing

t h e i n t e r n a t ional d i m e n s i o n of this concern,

k e e p i n g in m i n d th a t

d u e to our f isc a l imbalances w e h a v e b e e n a n d still a re imp o r t i n g
m a s s i v e am o u nts of s avings from the r e s t of t he world.
A g a i n s t t h a t g eneral b a c k g r o u n d a l l o w m e t o b r i e f l y
s u m m a r i z e th e b asis of m y concerns.

At t h e m o s t g e n e r a l level,

and g r a n t i n g t he v e r y best in t erms of intentions,

I am extremely

h a r d p r e s s e d to see how the changes c o n t e m p l a t e d c o u l d be
i n t e r p r e t e d any other w a y t han to p o i n t in t h e d i r e c t i o n of
g r e a t e r p o l i tical influence over t he Fed a n d / o r m a k i n g it m o r e
d i f f i c u l t to f o r m ulate and exec u t e m o n e t a r y policy.
Take,

for example, the w h o l e q u e s t i o n of t h e d i s c l o s u r e

p r o c e d u r e s r e g a r d i n g the d e l i b e r a t i o n s a n d d e c i s i o n s of the FOMC.
Here,

I w o u l d r e s p e c t f u l l y submit t h a t t h e m a i n issue is not one

of o p e n n e s s a nd di s c l o s u r e but one of p r a c t i c a l i t i e s .
as a v e r y p r a c t i c a l matter,

T h a t is,

open m e e t i n g s or v e r b a t i m m i n u t e s of

FOM C m e e t i n g s w o u l d surely s tifle d e b a t e a n d d i s c u s s i o n but such
a r r a n g e m e n t s a lso w o u l d m e a n that e s s e n t i a l i n f o r m a t i o n r e c e i v e d
from o f f i c i a l s a b road c ould not be i n t r o d u c e d into t he




164
deliberations.
record,

Indeed,

if such information w e r e p a r t of a p u b l i c

t h o s e f o r e i g n o f f i c i a l s w ould s i m p l y stop t a l k i n g to Fed

of f i c i a l s a b o u t m a t t e r s t h a t are often h i g h l y g e r m a n e t o m o n e t a r y
policy deliberations.
A t a n o t h e r level,

immediate rele a s e of t h e d e c i s i o n s of

t h e C o m m i t t e e r e g a r d i n g d a y - t o - d a y tactics of open m a r k e t
o p e r a t i o n s would,

as a n e n t i r e l y p ractical matter,

e i t h e r res u l t

in m o r e m a r k e t v o l a t i l i t y and unc e r t a i n t y or a less e f f e c t i v e
p o l i c y m a k i n g pr o c e s s,

or both.

P e r m i t m e t o e l a b o r a t e briefly.

T h e n a t u r e of open

m a r k e t o p e r a t i o n s a re such t hat m o r e o ften t h a n not the
d i r e c t i v e s of t h e C o m m i t t e e to the t r ading d e s k in N e w Y o r k have
a c o n t i n g e n t el e m e n t.

Indeed,

if they did not, the f l e x i b i l i t y

t h a t is so e s s e n t i a l a n d so central to this t oo l of m o n e t a r y
p o l i c y w i l l be c o m p r o m i s e d or lost.

I w o u l d go one s tep further

a n d say t h a t b a s e d on m y 13 years of e x p e r i e n c e as a m e m b e r of
t h e FOMC, t h e c o n t i n g e n t n a t u r e of the C o m mittee's d e c i s i o n s a nd
i n s t r u c t i o n s to t h e t r a d i n g d esk are an absol u t e l y indi s p e n s a b l e
p a r t of t h e p o l i c y p r o c e s s as it pertains to open m a r k e t
o p e r ations.

T h e r e i n lies the h eart of the dilemma.

T h a t is,

if t he d i r e c t i v e mu s t o ften be conditional,

its i m m e d i a t e r e l e a s e w i l l sur e l y spur m ore u n c e r t a i n t y a nd m o r e
market volatility,
release,

n o t less.

Moreover,

in t he face of i mmediate

it w i l l be m u c h m o r e dif f i c u l t for the p o l i c y m a k e r s to

r e a c h an o r d e r l y a n d f l e x i b l e consensus on policy.
words,

In oth e r

i m m e d i a t e d i s c l o s u r e w ill yield no s i g n i f i c a n t n et p u b l i c




165
b e n e f i t s that I can foresee but it w i l l i n c r e a s e u n c e r t a i n t y and
f i n a n c i a l m a r k e t vola t i l i t y and it w i l l w o r k to the d e t r i m e n t of
t h e p o l i c y m a k i n g proc e s s as a whole.
H a v i n g s aid that I s h o u l d h a s t e n t o a d d t h a t I can see
lit t l e or no d o w n s i d e risks to a revi v a l of t h e p r a c t i c e w h e r e b y
the FOMC —

w i t h an a p p r o p r i a t e t ime lag —

would make public

s o m e t h i n g a l ong t he lines of t he " M e m o r a n d u m of D i s c u s s i o n " that
w a s u s e d in t he past.

If t hat p r a c t i c e w e r e r e s u m e d t h e r e would,

of course, h a v e to be an u n d e r s t a n d i n g t o t h e e f f e c t t h a t c e r t a i n
i tems —

such as r e ferences to i n f o r m a t i o n r e l a t i n g to

d i s c u s s i o n s w i t h foreign o f f i c i a l s and i n f o r m a t i o n r e l a t i n g to
indi v i d u a l i nstit u t i o n s —

w o u l d h a v e t o be omitted.

S u b j e c t to

t h o s e s t i p u l a t i o n s and r e c o g n i z i n g t h a t s u c h an a r r a n g e m e n t cou l d
be w o r k e d o ut w i t h o u t legislation,

I c an see m e r i t to a n e ffort

on the part of t he Fed and the C o n g r e s s to p u t in p l a c e such an
arrangement.

A s s u m i n g that w as done,

it w o u l d r e p r e s e n t a

c o n s t r u c t i v e m o v e in the d i r e c t i o n of g r e a t e r d i s c l o s u r e a n d
g r e a t e r accountability.
T he o ther m ajor p r o v i s i o n of H.R.

28 t hat I w i s h to

a d d r e s s d i r e c t l y relates to its p r o v i s i o n s p e r t a i n i n g t o the
a p p o i n t m e n t and r e s p o n s i b i l i t i e s of F e d e r a l R e s e r v e Ba n k
presidents.

At one level, t he issue t h a t a r i s e s in th i s

c o n n e c t i o n is r a t h e r s traightforward; namely,

s h o u l d "private"

i n d i v i d u a l s be a dir e c t p a r t y to t he m o n e t a r y p o l i c y d e c i s i o n
m a k i n g pr o c e ss?

I am not a lawyer, m u c h less a c o n s t i t u t i o n a l

la w y e r but I am s e n s itive to history.




And, w h e n I look at the

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h i s t o r y of c e n t r a l b a n k i n g in the United States, w h a t I see is
t h a t the f o u n d i n g f a t hers of our nation, w h o p o s s e s s e d a d i r e c t
k n o w l e d g e of t h e intent of the Constitution, were q u i t e p r e p a r e d
t o v e s t in "p r i v a t e"

indiv i d u a l s a maj o r role in the g o v e r n a n c e

of t h e F i r s t B a n k of the U n i t e d States.
oversimplification,

Perhaps it's an

but I ' m inclined to the v i e w t h a t if it w a s

g o o d e n o u g h f or them,

it's good e nough for me.

E v e n if t hat h i s t o r i c a l argum e n t was legally
compelling,

it d o e s not,

of course,

imply that C o n g r e s s in its

w i s d o m m i g h t n o t opt for some other arrangement,
l e a s t t h r e e a r e n o w on t h e table.

of w h i c h at

One w o u l d have the R e s e r v e

B a n k p r e s i d e n t s a p p o i n t e d by the P r e s i d e n t and c o n f i r m e d by t he
Senate; a n o t h e r w o u l d r e m o v e the p r e s i d e n t s from t h e F O M C l eaving
t h e m w i t h o n l y a d v i s o r y r esponsibilities;

the third w o u l d h a v e

t h e p r e s i d e n t s a p p o i n t e d b y the B oard of G o v e r n o r s of the F e deral
R e s e r v e System.
T h e f i r s t of t h e s e clearly carr i e s with it t he r i s k of
b e i n g s e e n as e n t a i l i n g t h e t hreat or, over time,
g r e a t e r p o l i t i c a l c o n trol o ver the Fed.
p r a c t i c a l m atter,
of th e Fed.

the r e a l i t y of

The second would,

as a

s u b s t a n t i a l l y u n d e r c u t the regional c h a r a c t e r

O v e r time,

I feel certain t h a t the a d v i s o r y r ole of

t h e R e s e r v e B a n k p r e s i d e n t s w o u l d d rift into little m o r e t han a
ceremonial process.

B e y o n d that,

it w o u l d f u n d a m e n t a l l y and

i r r e v e r s i b l y a l t e r the w o r k i n g relat i o n s h i p s betw e e n the
i n s t i t u t i o n a l c o m p o n e n t s of the Fed t h e r e b y u n d e r c u t t i n g the




167
h i g h l y c o n s t ructive interplay b e t w e e n the R e s e r v e Banks and
Washin g t o n .
S p eaking as the only p e r s o n who h as serv e d as the
p r e s i d e n t of two R e s e r v e Banks a n d h a s w o r k e d at the Fed in
W a s hington, t here is no doubt in my m i n d t h a t o ver time such
a r r a n g e m e n t s could e asily d e p r i v e t he Fed of i m p o r t a n t ele m e n t s
of its v i t a l i t y and d i v e rsity t h a t g r o w out of its re g i o n a l
character.

Such a result,

in m y judgm e n t s i m p l y w o u l d n o t be in

t h e p u b l i c interest.
T he t hird proposal —

h a v i n g the R e s e r v e Bank

p r e s i d e n t s a p p o inted by the B o a r d of G o v e r n o r s —

h o l d s no

g r e a t e r at t r action for me than t h e o t h e r t w o approaches.
t h a t for two prim a r y reasons:

First,

I say

as a w h o l l y p r a c t i c a l

m a t t e r the B oard of G o v e rnors n o w has c o m p l e t e v e t o a u t h o r i t y
o v e r t h e a p p ointment of any R e s e r v e B ank president.

Second,

and

g i v e n t h a t absolute veto authority, w h a t the p r o p o s a l in q u e s t i o n
w o u l d a c h ieve w o u l d be to remo v e f rom t he p r o c e s s of s e l e c t i n g
R e s e r v e Bank p r e s i d e n t s the f ormal input of t h e b o a r d s of
d i r e c t o r s of the Re s e r v e Banks.

A s I see it, t h e n e t r e s u l t of

this a l s o w o u l d be t o f u n d a m e n t a l l y a lter the r e g i o n a l c h a r a c t e r
of t h e Fed and the delic a t e b a l a n c e of r e s p o n s i b i l i t i e s and
i n t e r a c t i o n w i t h i n t h e Federal Reserve.

It w o u l d a l s o m a k e it

t h a t m u c h h a rder to attr a c t the h i g h q u a l i t y m e n and w o m e n that
h a v e ser v e d the n a t i o n w ith d i s t i n c t i o n as R e s e r v e Ba n k
d i rectors.




168
It is n e ver e a s y to be in a posit i o n of r e j e c t i n g t h r e e
p r o p o s a l s w h i c h ar e p u t fo r w a r d in a s e rious and t h o u g h t f u l
manner.

But,

as a m a t t e r of u tter conv i c t i o n I c a n n o t see h o w

a ny of t h e s e p r o p o s a l s w i l l w o r k t o improve the p e r f o r m a n c e of
t h e F e d e r a l R e s e r v e r e l a t i v e to its b asic r e s p o n s i b i l i t i e s b ut I
c a n see c l e a r d a n g e r s t h a t a ny or all of these p r o p o s a l s could,
in s u b t l e but c e r t a i n ways,

alter the c h a r acter and f u n c t i o n i n g

of t h e F e d e r a l R e s e r v e in w ays t hat w o u l d not be in the nat i o n a l
interest.
In closing,

Mr.

Chairman,

let me return to t h e c o n c e p t

of the Fe d ' s " i n d e p e n d e n c e w i t h i n government",

a phrase that I

b e l i e v e w a s o r i g i n a t e d by W i l l i a m M c C h e s n e y Mart i n w h e n he was
c h a i r m a n of t h e B o a r d of Governors.

For me, that s e e m i n g l y

s i m p l e p h r a s e h a s always h a d a powerful meaning.

In its

s i m p l i c i t y it r e c o g n i z e s t h a t the Fed cannot be i n s e n s i t i v e to,
m u c h less i n d i f f e r e n t toward, the judgments of elec t e d o f f i c i a l s
in e i t h e r the e x e c u t i v e or legislative branches.

A t the same

t i m e t h e p h r a s e a l so r e c o g n i z e s that the Fed must be in a
p o s i t i o n w h e r e it can m a k e the h ard d e c i s i o n s requi r e d of any
c r e d i b l e c e n t r a l b a n k free from the vag a r i e s of s h o r t - t e r m
p o l i t i c a l pres s u r e s .

R a i s i n g interest rates,

for example,

is

n e v e r g o i n g t o be a p o p u l a r decis i o n but there are t i m e s it m u s t
b e done.

W h e n t h o s e i n h e r e n t l y u n p o p u l a r decisions are made,

i n t e r p l a y b e t w e e n t he F ed a nd the e x e c utive branch,

the

coupled with

t h e C o n g r e s s i o n a l o v e r s i g h t process, pr o v i d e ample o p p o r t u n i t i e s
a n d i n s t r u m e n t a l i t i e s t h r o u g h w h i c h acc o u n t a b i l i t y can be, a n d is




169
being, m a i n t a i n e d in a m a n n e r that is in k e e p i n g w i t h the
t r a d i t i o n of central b a n k "ind e p e n d e n c e w i t h i n g o v e r n m e n t " in
t h a t h i g h l y p l u r alistic society of w h i c h I s poke earlier.
T h a n k you.




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ISBN 0-16-044286-9

9 780160 442865