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S. HRG. 115–366 FEDERAL RESERVE’S SECOND MONETARY POLICY REPORT FOR 2018 HEARING BEFORE THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED FIFTEENTH CONGRESS SECOND SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978 JULY 17, 2018 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http: //www.fdsys.gov / U.S. GOVERNMENT PUBLISHING OFFICE WASHINGTON 32–517 PDF VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00001 Fmt 5011 : 2018 Sfmt 5011 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS MIKE CRAPO, Idaho, Chairman RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio BOB CORKER, Tennessee JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey DEAN HELLER, Nevada JON TESTER, Montana TIM SCOTT, South Carolina MARK R. WARNER, Virginia BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada JERRY MORAN, Kansas DOUG JONES, Alabama GREGG RICHARD, Staff Director MARK POWDEN, Democratic Staff Director JOE CARAPIET, Chief Counsel KRISTINE JOHNSON, Professional Staff Member ELISHA TUKU, Democratic Chief Counsel LAURA SWANSON, Democratic Deputy Staff Director PHIL RUDD, Democratic Legislative Assistan DAWN RATLIFF, Chief Clerk CAMERON RICKER, Deputy Clerk JAMES GUILIANO, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON C O N T E N T S TUESDAY, JULY 17, 2018 Page Opening statement of Chairman Crapo ................................................................. Prepared statement .......................................................................................... Opening statements, comments, or prepared statements of: Senator Brown .................................................................................................. Prepared statement .......................................................................................... 1 37 2 37 WITNESS Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System Prepared statement .......................................................................................... Responses to written questions of: Senator Brown ........................................................................................... Senator Corker .......................................................................................... Senator Cotton ........................................................................................... Senator Rounds ......................................................................................... Senator Scott ............................................................................................. Senator Tillis ............................................................................................. Senator Reed .............................................................................................. Senator Menendez ..................................................................................... Senator Warner ......................................................................................... Senator Cortez Masto ................................................................................ Senator Jones ............................................................................................ ADDITIONAL MATERIAL SUPPLIED FOR THE 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 41 58 59 62 64 66 69 70 122 125 141 RECORD Monetary Policy Report to the Congress dated July 13, 2018 ............................. Article submitted by Senator Brown ...................................................................... VerDate Nov 24 2008 4 39 146 212 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON FEDERAL RESERVE’S SECOND MONETARY POLICY REPORT FOR 2018 TUESDAY, JULY 17, 2018 U.S. SENATE, URBAN AFFAIRS, Washington, DC. The Committee met at 10:01 a.m., in room SH–216, Hart Senate Office Building, Hon. Mike Crapo, Chairman of the Committee, presiding. COMMITTEE ON BANKING, HOUSING, AND OPENING STATEMENT OF CHAIRMAN MIKE CRAPO Chairman CRAPO. This hearing will now come to order. Today we welcome Chairman Powell back to the Committee for the Federal Reserve’s Semiannual Monetary Policy Report to Congress. This hearing provides the Committee an opportunity to explore the current state of the U.S. economy and the Fed’s implementation of monetary policy and supervision and regulatory activities. Since our last Humphrey–Hawkins hearing in March, Congress passed, with significant bipartisan support, and the President signed into law S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. The primary purpose of this bill is to make targeted changes to simplify and improve the regulatory regime for community banks, credit unions, midsize banks, and regional banks to promote economic growth. A key provision of the bill provides immediate relief from enhanced prudential standards to banks with $100 billion in total assets or less. The bill also authorizes the Fed to provide immediate relief from unnecessary enhanced prudential standards to banks with between $100 billion and $250 billion in assets. It is my hope that the Fed promptly provides relief to those within these thresholds. By rightsizing regulation, the bill will improve access to capital for consumers and small businesses that help drive our economy. And the banking regulators are already considering this bill in some of their statements and rulemakings. Earlier this month, the Fed, FDIC, and OCC issued a joint statement outlining rules and reporting requirements immediately impacted by the bill, including a separate letter issued by the Fed that was particularly focused on those impacting smaller, less complex banks. But there is still much work to do on the bill’s implementation. (1) VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 2 As the Fed and other agencies revisit past rules and develop new rules in conjunction with the bill, it is my expectation that such rules will be developed consistent with the purpose of the bill and the intent of the Members of Congress who voted for the bill. With respect to monetary policy, the Fed continues to monitor and respond to market developments and economic conditions. In recent comments at a European Central Bank Forum on Central Banking, Chairman Powell described the state of the U.S. economy, saying, ‘‘Today most Americans who want jobs can find them. High demand for workers should support wage growth and labor force participation . . . Looking ahead, the job market is likely to strengthen further. Real gross domestic product in the United States is now reported to have risen 2.75 percent over the past four quarters, well above most estimates of its long-run trend . . . Many forecasters expect the unemployment rate to fall into the mid-3s and to remain there for an extended period.’’ According to the FOMC’s June meeting minutes, the FOMC meeting participants agreed that the labor market has continued to strengthen and economic activity has been rising at a solid rate. Additionally, job gains have been strong and inflation has moved closer to the 2-percent target. The Fed also noted that the recently passed tax reform legislation has contributed to these favorable economic factors. I am encouraged by these recent economic developments and look forward to seeing our bill’s meaningful contribution to the prosperity of consumers and households. As economic conditions improve, the Fed faces critical decisions with respect to the level and trajectory of short-term interest rates and the size of its balance sheet. I look forward to hearing more from Chairman Powell about the Fed’s monetary policy outlook and the ongoing effort to review, improve, and tailor regulations consistent with the Economic Growth, Regulatory Relief, and Consumer Protection Act. Senator Brown. OPENING STATEMENT OF SENATOR SHERROD BROWN Senator BROWN. Thank you, Mr. Chairman. Welcome, Mr. Chair. It is nice to see you again. This week the President of the United States went overseas and sided with President of Russia while denigrating critical American institutions, including the press, the intelligence community, and the rule of law. Our colleague Senator McCain expressed clearly what every patriotic American thought: ‘‘No prior President has ever abased himself more abjectly before a tyrant. Not only did President Trump fail to speak the truth about an adversary; but speaking for America to the world, our President failed to defend all that makes us who we are—a republic of free people dedicated to the cause of liberty at home and abroad. American Presidents must be the champions of that cause if it is to succeed.’’ The words of the 2008 Republican Presidential nominee. With our democratic institutions under threat, we cannot ignore what happened in Helsinki yesterday. But we must not lose sight of the other special interest policies of this Administration, includ- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 3 ing the rollback of the rules put in place to prevent the next economic crisis. Just last week, a Federal Reserve official said, ‘‘There are definitely downside risks, but the strength of the economy is really pretty important at the moment. The fundamentals for the U.S. economy are very strong.’’ That may be true for Wall Street, but for most of America workers have not seen a real raise in years, young Americans are drowning in student loan debt, families are trying to buy their first home. For most of America, the strength of the economy is an open question. Last month former Fed Chair Ben Bernanke was very clear about the long-term impact of the tax cut and the recent bump in Federal spending when he said, ‘‘in 2020 Wile E. Coyote is going to go off the cliff.’’ Last week the San Francisco Fed released a study finding that the rosy forecasts of the tax bill are likely ‘‘overly optimistic.’’ It found that the bill’s boost to growth is likely to be well below projections—or even as small as zero. It suggested that these policies could make it difficult to respond to future economic downturns and manage growing Federal debt. And it is not just the tax bill. The economic recovery has not been evenly felt across the country. Not even close. Mr. Chairman, I would like to enter into the record an article from the New York Times this weekend which talks about those families still struggling from the lack of meaningful raises and other job opportunities. Chairman CRAPO. Without objection. Senator BROWN. Thank you, Mr. Chairman. While hours have increased a bit over the past year for workers as a whole, real hourly earnings have not. For production and nonsupervisory workers, hours are flat; pay has actually dropped slightly, according to the Bureau of Labor Statistics. The number of jobs created in 2017 was smaller than in each of the previous 4 years. Not what we hear in the mainstream media, perhaps. Some of the very companies that announced billions in buybacks and dividends are now announcing layoffs, shutting down factories, and offshoring more jobs. Some of the biggest buybacks, as we know in this Committee, are in the banking industry, assisted in part by the Federal Reserve’s increasingly lax approach to financial oversight. Earlier this month, as part of the annual stress tests, the Fed allowed the seven largest banks to redirect $96 billion to dividends and buybacks. This money might have been used, as the President and members of the majority party liked to promise during the tax bill, this money might have been used to pay workers, to reduce fees for consumers, to protect taxpayers from bailouts, or be deployed to help American businesses. Three banks—Goldman, Morgan Stanley, and State Street—all had capital below the amount required to pass the stress tests, but the Fed gave them passing grades anyway. The Fed wants to make the tests easier next year. Vice Chair Quarles has suggested he wants to give bankers more leeway to VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 4 comment on the tests before they are administered. I guess it is OK in Washington to let students help write the exam. The Fed is considering dropping the qualitative portion of the stress tests altogether—even though banks like Deutsche Bank and Santander and Citigroup and HSBC and RBS have failed on qualitative grounds before. That does not even include the changes the Fed is working on after Congress passed S. 2155 to weaken Dodd–Frank, making company-run stress tests for the largest banks ‘‘periodic’’ instead of annual and exempting more banks from stress tests altogether. And, oh, yeah, Vice Chair Quarles has also made it clear that massive foreign banks can expect goodies, too. And on and on and on it goes. The regulators loosen rules around big bank capital, dismantle the CFPB, ignore the role of the FSOC, undermine the Volcker Rule, and weaken the Community Reinvestment Act. When banks make record profits, we should be preparing the financial system for the next crisis. We should buildup capital, we should invest in workers, we should combat asset bubbles. And we should be turning our attention to bigger issues that do not get enough attention, like how the value that we place on work has declined in this country, how our economy increasingly measures success only in quarterly earning reports. Much of that is up to Congress to address. Over the last 6 months, tragically, I have seen the Fed moving in the direction of making it easier for financial institutions to cut corners, and I have only become more worried about our preparedness for the next crisis. I look forward to the testimony, Mr. Chairman. And welcome, Mr. Chairman. Chairman CRAPO. Thank you, Senator Brown. And, again, Chairman Powell, welcome. We appreciate you testifying today, and we look forward to your opening statement. You may proceed. STATEMENT OF JEROME H. POWELL, CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. POWELL. Thank you and good morning. Good morning Chairman Crapo, Ranking Member Brown, and other Members of the Committee. I am happy to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress today. Let me start by saying that my colleagues and I strongly support the goals that Congress has set for monetary policy: maximum employment and price stability. We also support clear and open communication about the policies we undertake to achieve these goals. We owe you, and the public in general, clear explanations of what we are doing and why we are doing it. Monetary policy affects everyone and should be a mystery to no one. For the past 3 years, we have been gradually returning interest rates and the Fed’s securities holdings to more normal levels as the economy has strengthened. We believe that this is the best way we can help set conditions in which Americans who want a job can find one and in which inflation remains low and stable. I will review the current economic situation and outlook, and then I will turn to monetary policy. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 5 Since I last testified here in February, the job market has continued to strengthen and inflation has moved up. In the most recent data, inflation was a little above 2 percent, the level that the Federal Open Market Committee thinks will best achieve our price stability and employment objectives over the longer term. The latest figure was boosted by a significant increase in gasoline and other energy prices. An average of 215,000 net new jobs per month were created each month in the first half of this year. That number is somewhat higher than the monthly average of 2017. It is also a good deal higher than the average number of people who enter the workforce each month on net. The unemployment rate edged down 0.1 percent over the first half of the year to 4.0 percent in June, near the lowest level of the past two decades. In addition, the share of the population that either has a job or has looked for one in the past month—what we call the ‘‘labor force participation rate’’—has not changed much since late 2013, and this development is another sign of labor market strength. Part of what has kept the participation rate stable is that more working-age people have started looking for a job, which has helped make up for the large number of baby boomers who are retiring and leaving the labor force. Another piece of good news is that the robust conditions in the labor market are being felt by many different groups. For example, the unemployment rates for African Americans and Hispanics have fallen sharply over the past few years and are now near their lowest levels since the Bureau of Labor Statistics began reporting these data in 1972. Groups with higher unemployment rates have tended to benefit the most as the job market has strengthened. But jobless rates for these groups are still higher than those for whites. And while three-fourths of whites responded in a recent Fed survey that they were doing at least OK financially, only two-thirds of African Americans and Hispanics responded that way. Incoming data show that, alongside the strong job market, the U.S. economy has grown at a solid pace so far this year. The value of goods and services produced in the economy—or GDP—rose at a moderate annual rate of 2 percent in the first quarter after adjusting for inflation. However, the latest data suggest that economic growth in the second quarter has been considerably stronger than in the first. The solid pace of growth so far this year is based on several factors. Robust job gains, rising after-tax income, and optimism among households have lifted consumer spending in recent months. Investment by businesses has continued to grow at a healthy rate. Good economic performance in other countries has supported U.S. exports and manufacturing. And while housing construction has not increased this year, it is up noticeably from where it stood a few years ago. Turning to inflation, after several years in which inflation ran below our 2-percent objective, the recent data are more encouraging. The price index for personal consumption expenditures, or PCE inflation—an overall measure of prices paid by consumers— increased 2.3 percent over the 12 months ending in May. That number is up from 1.5 percent a year ago. Overall or headline inflation increased partly because of higher oil prices, which caused a sharp rise in gasoline and other energy prices paid by consumers. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 6 Because energy prices move up and down a great deal, we also look at core inflation. Core inflation excludes energy and food prices and generally is a better indicator of future overall inflation. Core inflation was 2.0 percent for the 12 months ending in May, compared to 1.5 percent a year ago. We will continue to keep a close eye on inflation with the goal of keeping it near 2 percent. Looking ahead, my colleagues on the FOMC and I expect that, with appropriate monetary policy, the job market will remain strong and inflation will stay near 2 percent over the next several years. This judgment reflects several factors. First, interest rates, and financial conditions more broadly, remain favorable to growth. Second, our financial system is much stronger than before the crisis and is in a good position to meet the credit needs of households and businesses. Third, Federal tax and spending policies likely will continue to support the expansion. And, fourth, the outlook for economic growth abroad remains solid despite greater uncertainties in several parts of the world. What I have just described is what we see as the most likely path for the economy. Of course, economic outcomes that we experience often turn out to be a good deal stronger or weaker than our best forecast. For example, it is difficult to predict the ultimate outcome of current discussions over trade policy as well as the size and timing of the economic effects of the recent changes in fiscal policy. Overall, we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate. Over the first half of 2018, the FOMC has continued to gradually reduce monetary policy accommodation. In other words, we have continued to dial back the extra boost that was needed to help the economy recover from the financial crisis and the Great Recession. Specifically, we raised the target range for the Federal funds rate by a quarter percentage point at both our March and June meetings, bringing the target to its current range of 13⁄4 to 2 percent. In addition, last October we started gradually reducing the Fed’s holdings of Treasury and mortgage-backed securities, and that process has been running smoothly. Our policies reflect the strong performance of the economy and are intended to help make sure that this trend continues. The payment of interest on balances held by banks in their accounts at the Federal Reserve has played a key role in carrying out these policies, as the current Monetary Policy Report explains. Payment of interest on these balances is our principal tool for keeping the Federal funds rate in the FOMC’s target range. This tool has made it possible for us to gradually return interest rates to a more normal level without disrupting financial markets and the economy. As I mentioned, after many years of running below our longerrun objective of 2 percent, inflation has recently moved close to that level. Our challenge will be to keep it there. Many factors affect inflation—some temporary and others longer lasting. So inflation will at times be above 2 percent and at times below. We say that the 2-percent objective is ‘‘symmetric’’ because the FOMC would be concerned if inflation were running persistently above or below our 2-percent objective. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 7 The unemployment rate is low and expected to fall further. Americans who want jobs have a good chance of finding them. Moreover, wages are growing a little faster than they did a few years ago. That said, they still are not rising as fast as in the years before the crisis. One explanation could be that productivity growth has been low in recent years. On a brighter note, moderate wage growth also tells us that the job market is not causing high inflation. With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that—for now—the best way forward is to keep gradually raising the Federal funds rate. We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary policy will be appropriate. As always, our actions will depend on the economic outlook, which may and will change as we receive new data. For guideposts on appropriate policy, the FOMC routinely looks at a range of monetary policy rules that recommend a level for the Federal funds rate based on the current rates of inflation and unemployment. The July Monetary Policy Report gives an update on monetary policy rules and their role in our policy discussions. I continue to find these rules helpful, although using them requires careful judgment. Thank you, and I will now be happy to take your questions. Chairman CRAPO. Thank you for your statement, Chairman Powell. The first question I have will relate to CCAR. As you know, the Fed recently released the results of the 2018 Comprehensive Capital Analysis and Review, the CCAR, stress test. This year the Fed issued conditional nonobjections to certain banks, which, as you are aware, some have criticized. What details can you share about the Fed’s decision to issue the conditional nonobjections while allowing those firms to maintain capital distributions at recent levels? Mr. POWELL. Thank you, Mr. Chairman. So the CCAR supervisory test is and will remain an important part of our supervisory framework, particularly for the largest and most systemically important firms. And I guess I would start by saying that this year’s test was by a good margin the most stringent test yet. Hypothetical losses for 2018 were $85 billion higher than during the 2017 stress test, and the hypothetical decline in the capital ratio was 110 basis points higher this year than last year; so a very significantly severe test, and it will result in a material increase in the effect of aggregate capital requirement of the firms subject to the test. So, you know, we carefully evaluated the results. We voted on them on June 20th, and the next day the firms received a call from our staff, which informed them of the results and their options. This is the standard operating procedure that we follow every year. There is no negotiation, there is no haggling. The decision has been made the day before by the Board, and they are just informed of their options, and they deal with them as they are. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 8 Almost all the firms finished above the required poststress minimums, which is a sign of how well capitalized the industry is. Two firms that did not were required to restrict their distributions to past years’ levels. That has always been the penalty for failing to meet the poststress minimums, and that will require the firms to build capital this year, these two firms. The third firm was required to take certain steps regarding the management and analysis of its counterparty exposures under stress. So the same exact penalty was paid. We labeled these as conditional nonobjects rather than objecting straight out to the plan, and we have done that over a period of years many times, and we thought that it was appropriate here. When we fail a firm, when we actually fail them and send—what we do is we send the plan back and say that your capital planning process is deficient, please take this plan back, please fix it and bring it back to us, and we will look at it again. So that sends a signal that we believe that the capital planning processes of the firms are deficient in some serious way. As I mentioned, in a number of cases we have gone with sort of an intermediate sanction, and we felt that that was appropriate here. One reason for that is the timing of the tax bill, as we mentioned, and firms plan, of course, well in advance so that they will have enough capital to pass the test. This particular bill passed, was signed into law on December 22nd. We used fourth quarter capital levels for the test, so the TCJA resulted in a significant decrease in the level of capital these firms have. But, of course, they do not benefit from what in the longer term will be a lower tax effect on their earnings. So I think whereas any analyst would look at that law and say that it is positive for banks and for their ability to earn money, it was strictly a negative in this test. So we looked at that, and among other factors we decided to use the conditional nonobject. I will stop there, Mr. Chairman. Chairman CRAPO. All right. I appreciate that explanation, and essentially what I am hearing you say is that the same—in fact, even a stricter test was applied, and the same standards of review were used in your analysis and in the consequences that were applied. Mr. POWELL. That is right, and I just would reiterate our commitment to this particular supervisory stress test. It is a very important thing for us, and we will make sure to keep it stringent. Chairman CRAPO. All right. Thank you. Chairman Powell, moving to regulation, the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act received significant bipartisan support, as you know. In addition to several provisions providing regulatory relief to community and midsize banks, a key provision of the bill raises the threshold for the application of the enhanced prudential standards from $50 billion to $250 billion. What is the Fed’s process for quickly implementing S. 2155, including its process for ensuring that the financial companies with total assets between $100 billion and $250 billion promptly receive similar relief to the relief provided for the financial institutions with less than $100 billion in total assets? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 9 Mr. POWELL. So our intention and our practice is going to be to implement the bill as quickly as we possibly can. As you probably know, I am sure you know, we released a statement the Friday of July 4th week laying out our plans to move ahead with some things. And, again, we will do them as quickly as possible, and we indicated that we will try to move that along very quickly. Chairman CRAPO. All right. Thank you. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. Mr. Chairman, I have a number of questions. I hope your answers can be brief. Thank you for our phone call the other day. I know you know this: In real terms wages have not budged recently. Last week BLS reported that hours for production and nonsupervisory workers are flat and pay has actually dropped over the past year. Of course, we should focus on real wages rather than nominal wages. By that measure, is the typical worker really better off this year than he or she was a year ago? Mr. POWELL. Yes. Yes, I would say that the labor market has strengthened. The labor report will show that wages went up 2.7 percent. That is significantly higher than trend inflation. There is a bit of a bump from gas prices going up and consumers do pay that, but I would say that overall workers are better off because—— Senator BROWN. I would partially contradict that and say that nonsupervisory workers, four out of five workers have seen nominal wages go up but real wages have not by those same BLS statistics. Let me move to another. You have called stress testing ‘‘the most successful regulatory innovation of the postcrisis era’’—you said that some time ago—but the actions the Fed has taken during your tenure undercut that effect when the Fed gave Goldman, Morgan, and State Street passing grades this year even though they failed to meet capital requirements in CCAR, the first time that has ever happened in CCAR history. The Fed proposes to weaken the leverage constraint, and CCAR reportedly may drop the qualitative portion of the test, wants to give bankers more leeway to influence the Fed’s models, and may soon adjust Dodd–Frank stress tests to make them less stressful and less frequent, hence the ‘‘periodic.’’ Stress test tests were adopted in 2009 to provide confidence to the public that the banks could weather economic shocks. How is the public supposed to trust the stress test when the Fed proposes all of those ways to weaken them? Mr. POWELL. So we are strongly committed to using stress tests. We really developed the supervisory stress test at the Fed, and as you know, we think it is a very important tool. It was one of the main ways that we used to raise capital, particularly among the largest firms, and we are committed to continuing stress testing as one of the three or four most important innovations, along with higher capital, higher liquidity, and resolution. It is one of the big four pillars for us. The program has to continue to evolve. We want to strengthen it. We want to make it more transparent. We want to improve it over time. And all of our actions are designed to do that, and I think if you look at the state of the banking system and the fact that this test will require higher capital, then I think you will see VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 10 that is consistent with—that our words are consistent with our actions. Senator BROWN. Well, I think the message coming out emanating from the business press—and those are not, you know, Democratic, liberal newspapers; they are the Wall Street Journal, the Financial Times, the New York Times business section—speaks to the fact that these stress tests are getting weaker. Let me ask another question. Vice Chair Quarles has given two speeches outlining how the Fed wants to recalibrate the rules for large foreign banks. You gave an answer, a carefully worded answer, I thought, to obscure the fact that large foreign banks may receive less oversight as a result of S. 2155. The public is getting mixed messages from the Fed. For the record, can foreign banks with more than $50 billion in U.S. assets—Deutsche, Santander, Credit Suisse, the others—can foreign banks with more than $50 billion in U.S. assets expect to get regulatory relief during your tenure? Mr. POWELL. You know, I think I can say that S. 2155, it is not clear to me how it provides regulatory relief to those firms. I mean, all of the banks that have $50 billion in U.S. assets have more than $250 billion in global assets. So I do not think there really will be much effect. I will not say that we will never do anything to provide regulatory relief to a group during my tenure, but—— Senator BROWN. So your position seems to be that if they are between—if they are over 50 in the U.S., under 250 as those are, but much, much, much bigger with all the—— Mr. POWELL. Globally. Senator BROWN. Globally, that you do not expect any regulatory relief for them? Mr. POWELL. Well, the main thing is the $50 billion threshold for internal holding companies will remain the same. We are not looking at that. And I think they will not see much difference. Senator BROWN. Physical commodities. The Fed proposed a physical commodities rule for 2016. You are moving presumably to finalize it. The Fed responded to questions for the record saying that the Board continues to consider this proposal. When can we expect action on it, Mr. Chairman? Mr. POWELL. I do not have a date for you on that. I know that we received extensive comments on it, and we are considering them. Senator BROWN. Do you feel some urgency on it? Mr. POWELL. I will have to go back and look and see where that is in the line. Senator BROWN. If you would please respond in writing to that. And a last question, Mr. Chairman. The Administration and some in Congress pushed through tax cuts and bank deregulation under the guise that it would trickle down to American families in the form of more loans. Loan growth has slowed in the last quarter. It was less than half the growth rate than during the last year of the Obama administration. The four largest banks, as you know, redirected record levels of profits into dividends and stock buybacks. The four big banks’ CEOs got an average raise of 26 percent. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 11 My question is simple: When, if ever, do you expect to be able to come before this Committee and demonstrate to us in this Committee, as Chair of the Fed, demonstrate to us how tax cuts and deregulation have actually benefited the real economy in the forms of more lending? Mr. POWELL. I guess I see my role as reporting about the overall economy rather than the effect of any particular law, although I will be happy to take questions on that. Senator BROWN. OK. Thank you, Mr. Chairman. Chairman CRAPO. Senator Scott. Senator SCOTT. Thank you, Mr. Chairman. And good morning, Chairman Powell. Thank you for being with us today. Mr. POWELL. Good morning, Senator. Senator SCOTT. It certainly is difficult to find negative news as it relates to our economic reality. The truth of the matter is that we are in the third largest economic expansion since 1854—not 1954—1854. An 18-year low in our unemployment rates. African American unemployment for the first time in recorded history below 6 percent at 5.9 percent. Hispanic unemployment at 4.6 percent, lowest recorded as well. Wage growth 2.7 percent, the highest level since 2009. And the Atlanta Federal Reserve suggests that we could have a 5-percent GDP growth in the second quarter. And the good news just keeps on coming. Small businesses said they have not been this optimistic in 45 years. That has got to be a record. Beyond a doubt, tax reform combined with responsible regulations have resulted in more Americans have more money in their pockets. And another great example of the economic reality that we face today is that the core primeage labor force participation rate has stabilized since 2013 and is starting to climb in the right direction. My question for you, Chair Powell, is: What has been the overall impact of the economic growth for the long-term unemployed? And can we read into the prime-age labor force participation rate’s increase really positive news for those long-term unemployed? Mr. POWELL. Yes, so prime-age labor force participation, Senator, as you pointed out, has been climbing here in the last couple of years. That is a very healthy sign because prime-age labor force participation is really—you know, it has been weak, and it has been weak in the United States compared to other countries. So it is very troubling, and the fact that that is coming back up is a very positive thing. We really hope it is sustained, and we hope that these gains in participation can be sustained. We have a long box in our Monetary Policy Report that talks about that. The other thing, you mentioned the long-term unemployed. Senator SCOTT. Yes. Mr. POWELL. So the number of long-term unemployed has come down dramatically since, I do not know, maybe 2010. I want to say the numbers were between 6 and 7 million, and unless I get this wrong, I think the current number of longer-term unemployed is around 1.5 million. So the people who are on the very edges of the labor force like those people, those are the ones who have benefited the most. Senator SCOTT. Thank you. With all that economic heat coming our way in a positive way, the prices seem to be going up, so the VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 12 CPI rose 2.9 percent, the fastest pace since 2012. Those rising prices could negate some of the wage growth that I just talked about if left unchecked. In the past we have discussed, you and I, the Fed role according to the congressional mandate seeking stable prices being one of those specific mandates. We have also talked about the downsides of low interest rates for extended periods of time. What do you see in the prices for energy, housing, health care, and transportation? And how is that going to impact your thinking moving forward? Mr. POWELL. Inflation has been below our 2-percent objective since I joined the Board of Governors in May of 2012 just until last month. For the first time, we have 12 months of core inflation being at 2 percent. So that is a very positive thing. We want to see overall inflation continue to come up so that it is sort of symmetrically around 2 percent. I would say we are just shy of achieving that. But we want inflation to remain right around 2 percent and be as likely to be a little above as a little below. I would say we are on the—and I think our monetary policy is really designed to help us continue to achieve that. So we are gradually moving up rates, and that we think is the policy that will help us get inflation to 2 percent sustainably. Senator SCOTT. Thank you. Just two more areas for you. South Carolina, my home State’s economy is built on trade. You name it, we make it. We grow it and we ship it. Cars, cotton, tires, jets, peaches, soybeans, turbines, solar panels, and the list goes on and on. What has generally happened in the past to economic growth when we have raised tariffs? Mr. POWELL. I have to start by saying that, you know, I am really firmly committed to staying in our lane and, you know, our lane is the economy. Trade is really the business of Congress, and Congress has delegated some of that to the executive branch. But, nonetheless, it has significant effects on the economy, and I think when there are long-run effects, we should talk about it and talk in principle. And I would say in general countries that have remained open to trade, that have not erected barriers, including tariffs, have grown faster. They have had higher incomes, high productivity. And countries that have, you know, gone in a more protectionist direction have done worse. I think that is the empirical result. Senator SCOTT. I only have about 5 seconds left, so let me use my time wisely. As you know, I have a background in the insurance industry, and I am seriously a fan of a State-based system of insurance regulations. I think it is the best in the world. As the Fed participates in developing the ICS with the IAIS, I strongly urge you to shape a final product that protects the U.S. system of insurance regulation, and I would appreciate you and I having a conversation in the near future. Mr. POWELL. Thank you, Senator. Senator SCOTT. Thank you. Thank you, Mr. Chairman. Chairman CRAPO. Senator Reed. Senator REED. Thank you very much, Mr. Chairman. Welcome, Chairman Powell. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 13 The issue of wages has been discussed by several of my colleagues and yourself. In 2000, the last time we were at this situation where we were touching 4 percent unemployment, the share of national income by corporations was about 8.3 percent, and the share of wages was 66 percent. Today we are once again reaching that point of about 4 percent unemployment, yet corporate profits account for about 13.2 percent of national income. They have gone up significantly. Wages as a share of national income have gone down from 66 percent to 62 percent. If those trends continue, we are in a situation where working men and women are not going to get their fair share of growth. What are you trying to do at the Fed to ensure that they get their fair share of growth? Mr. POWELL. The decline in labor share of profits—labor share of profits was generally, you know, oscillating fairly constant for a number of decades and right around the turn of the century began to drop precipitously and continued to do so for more than a decade. It is very troubling. We want an economy that works for everyone. And that happened, by the way, in essentially all advanced economies, and probably a range of factors are responsible for that. In the last 5 years or so, labor share of profits has been sideways. This is very much akin to the flattening out of median incomes over the last few decades. So it has got to do with a number of global factors. The thing that we can do is to take seriously your congressional order that we seek maximum employment, so in tight labor markets, workers are more likely going to be paid well and paid their share. I would say most of the factors that have driven down labor share of profits are really not under the control of the Fed. And so those are issues that we do not have control over. Senator REED. But would you say that the tax bill did not affect those downward trends in wages positively, that, in fact, it has done nothing to reverse what you have seen as a decade or more of decreases? Mr. POWELL. I think wages are set in the marketplace between workers and companies, and they are affected by a range of factors. I think it would be early to be looking for a bill that was signed into law less than a year ago to be able to visibly be affecting much of anything at this point, really. These things, big changes in fiscal policy, take quite a while to affect wages. Senator REED. So none of this good news we are talking about today is a result of this tax bill, it is too early? Mr. POWELL. It is very hard to isolate the—I mean, I would say wages have moved up meaningful over the last 5 years. It has been quite gradual. And, you know, we certainly think it would be fine for them to move up more. Senator REED. Do you think the European Union is a foe of the United States? Mr. POWELL. No, I do not. Senator REED. Thank you. As we look ahead to some of the potential obstacles—and having, both of us, lived through 2008 and 2009, it looked good and then it looked real bad. In retrospect, we saw some signs of the danger. What are the signs of danger that you are sort of focusing on? There are huge deficits, both Government deficits, private deficits VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 14 worldwide. You have got a trade battle brewing. And you have got things like Brexit that could complicate our life dramatically. So what are the two or three things that you think could throw us off this track? Mr. POWELL. There is a difference between the longer term and the short term. So in the near term, things look good. You know, we look very carefully at a range of financial conditions and financial stability vulnerabilities, we feel that those are at sort of normal, moderate levels right now, although there are some areas that are elevated, some assets prices are high, and there is an elevated level of debt in the nonfinancial corporate sector. More broadly, banks are well capitalized. Households are in much better shape. So financial stability I do not worry about too much at this point, although we keep our eye on that very carefully after our recent experience. You mentioned trade. It is hard to say what the outcome will be. Really, there is no precedent for this kind of broad trade discussions. In my adult life, I have not seen where essentially all of our major trading partners—hard to know how that comes out. If it results in lower tariffs for everyone, that would be a good thing for the economy. If it results in, you know, higher tariffs across a broad range of traded goods and services that remain that way for a longer period of time, that will be bad for our economy and for other economies, too. Senator REED. Thank you very much, Mr. Chairman. Chairman CRAPO. Thank you. Senator Rounds. Senator ROUNDS. Thank you, Mr. Chairman. Chairman Powell, first of all, I want to thank you for being here today. Before I get into the questions, I would just like to take note of the two rules that were announced this spring: the new stress capital buffer and the proposed changes to tailor the enhanced supplementary leverage ratio. I do appreciate the Federal Reserve’s efforts, and I hope we can continue an open dialogue on these changes as you move forward. I am just curious. You indicated with regard to Senator Reed’s question, based on the tax bill, clearly there is an improvement in GDP growth over the last couple of years. Was it anticipation of the tax bill being passed? I would like to flesh that out just a little bit, because most certainly I think a lot of truly believe that that tax bill is a key component in the development of an improvement in our GDP. Your thoughts? Mr. POWELL. I was really answering about whether you could see it in wages right now. That is hard to do. So growth averaged around 2 percent for 8 years, and then in 2017, I think the current estimate is 2.6 percent. And you saw significant improvements in household and business confidence levels. Overall confidence about the economy, you saw that coming on in 2017. Some of that was probably in anticipation of the passage of what finally passed. So probably that was already in the growth rate. I think it is hard to say, but I suspect that some anticipation of tax cuts and tax reform was already in the growth in 2017. Going forward—and we have said this—we expect—there are a range of estimates on this, but we would expect that the tax bill VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 15 and the spending bill would provide meaningful support to demand for at least the next 2 or 3 years, maybe 3 years, and also might have, you know, effects on the supply side as well. To the extent you are encouraging more investment, you are going to get higher productivity. So it is very—these estimates are subject to tremendous uncertainty both as to amount and as to timing. But I think we look at the range of estimates, and that is certainly where we broadly come out. Senator ROUNDS. I just want to be clear. That tax bill had a positive impact, even if it is the anticipation of the tax bill. It has a positive impact on our GDP growth, correct? Mr. POWELL. Yes, I think, so this year, maybe last year, too. Senator ROUNDS. OK. Let me ask you this: With regard to trade, you make notes specifically in your comments on trade and the fact that there are some things up in the air right now. There is perhaps some instability or some questions on the part of not only our businesses but businesses around the world. Are businesses looking for stability with regard to trade compacts? Or are they looking for opportunity and instability? Mr. POWELL. Well, they would clearly be looking for stability. Senator ROUNDS. OK. And then I would look to associate myself—and I support what Senator Scott indicated earlier with regard to the insurance issues and the fact that our State-based regulatory system for insurance I think is critical. I think it is a positive thing for consumers when it is as close to that State regulatory process as possible. When you came here before the Committee earlier this year, you discussed capital requirements in the options market and mentioned that the Federal Reserve was working on a rule to transition from the risk-insensitive Current Exposure Method, or CEM, to the internationally agreed upon Standardized Approach for Counterparty Credit Risk, SA–CCR. I am supportive of these efforts, but I remain concerned about the timeline for implementation. I noted with concern in a letter to Vice Chair Quarles last year, in response to my request that the Federal Reserve used its reservation of authority to grant interim relief, Vice Chair Quarles asserted that the Fed lacks such authority in this context. I originally raised this issue when Vice Chair Quarles was testifying at his confirmation hearing last July. Unfortunately, it has been a year since that time, and the Fed has yet to take meaningful action. I remain concerned about this because the longer we wait for American regulators to implement SA–CCR, the more market makers will exit the options market entirely, making our financial system more vulnerable to economic shocks and less competitive compared to our international peers. I noted in the Basel Committee’s last progress report from April of 2018 that 22 of the 27 Basel member countries have either implemented SA–CCR or made substantially more progress at implementation compared to the United States. I am a particularly strong supporter of risk-based capital standards, particularly in this context in options markets. Can you provide an update on when the rulemaking from CEM to SA–CCR will be released? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 16 Mr. POWELL. I know that we are working on it now. I know that we think it is good policy. And I cannot give you an exact date, but I know we are actively directing a rule. By not being able to provide interim relief, all we meant was we actually have to amend the rule. So we will be putting a rule out for proposal and get comments, and then it will go final. It is in train, but these things take time. We are working on it. Senator ROUNDS. OK. Thank you. Thank you, Mr. Chairman. Chairman CRAPO. Senator Menendez. Senator MENENDEZ. Thank you. Thank you, Chairman Powell, for being here. Lately we have heard a near constant refrain from the Administration, the President himself, corporate media outlets, and even from you that ‘‘the economy is doing very well’’ and ‘‘it has never been better.’’ Now, if we take a narrow view of the unemployment rate and corporate profits, then, sure, it is a real rosy picture. But take a wider lens to what working families are seeing, and the view is one of great contrast. Over the last year, despite falling unemployment, working families actually saw their real wages fall. By comparison, after-tax corporate profits increased by 8.7 percent just in the last quarter. There is something fundamentally wrong in our economy when workers are seeing their pay cut while corporations are benefiting from a $2 trillion tax giveaway. Working families not only cannot get ahead, but they are actually falling behind. I can tell you, families in New Jersey cannot keep up with the surge in costs, particularly for prescription drugs and health care. I just heard from a constituent in Glendora, New Jersey, who told me that even with his Medicare and secondary insurance, he cannot afford to pay for his insulin and diabetes equipment, and that is pretty unconscionable. So my question to you, Mr. Chairman, is: When will the benefits of this ‘‘booming economy’’ reach working families? Mr. POWELL. Thank you, Senator. I think we are aware and I am aware that while the aggregate numbers are good and unemployment is low and surveys overall of households are very positive about the job market, not everybody is experiencing the recovery. Not every demographic group, not every place are experiencing this. So we call that out in every FOMC meeting and in all of our public communications, as I did in my testimony this morning. And, you know, we understand that we have to take maximum employment seriously, and we do. We have been supporting a strong labor market for a long time. Despite many calls for us to raise interest rates much more quickly, I am glad that we stayed in longer than that, and I think gradually raising rates is the way for us to extend this expansion. Nothing hurts working families and people at the margin of the labor markets more than a recession. Senator MENENDEZ. Well, you are probably going to have a couple more interest rates. What specific steps then are you taking to foster broad-based wage growth so that the average worker, not just managers and executives, are reaping the benefits? I cannot accept that wages are growing when the Bureau of Labor Statistics VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 17 points out that production and nonsupervisory workers saw their wages fall two-tenths of a percent, and that is despite increasing their average work week to make up for it. So they are getting squeezed. Mr. POWELL. So the latest Government report was that wages went up 2.7 percent for production, nonsupervisory workers, and supervisory workers over the last 12 months. And that is higher. That is moving up. It also happens that inflation has moved up and that sort of a bump in energy prices is passing through the headline inflation number. So I think overall, though, you see inflation at about a 2-percent trend. You see wages at 2.7 percent. So I think those trends are healthy, and I think they are reflected in what are pretty positive surveys among workers generally. Senator MENENDEZ. Let me ask you this: These working families we are talking about are the first to feel the impact when banks, big banks, and corporations take risky bets with no accountability. When we passed Dodd–Frank, we included language to ban incentive-based compensation practices that reward senior executives for irresponsible risk taking. Regulators issued a proposal in 2016, but more than 2 years later, nothing has been finalized. In the meantime, Wall Street bonuses jumped 17 percent last year to an average of more than $184,000—the most since 2006, and that is bonuses alone. Now, you have made time to weaken Wall Street oversight by revisiting capital rules, revisiting leverage rules, proposing changes to the Volcker Rule, all of which were finalized after years of deliberation, public comments, and input from other regulators, and all of which protect our economy from another financial crisis. How is it, Mr. Chairman, that you have not made time to finish the incentive-based compensation rulemaking for the first time? And can you give me a commitment today as to a timeline for when this will be done? Mr. POWELL. We tried for many years—it is a multiagency rule, the incentive comp rule. We tried—we were not able to achieve consensus over a period of many years between the various regulatory agencies that need to sign off on that. But that did not stop us from acting, you should know. Particularly for the large institutions, we do expect that they will have in place compensation plans that do not provide incentives for excessive risk taking. And we expect that the Board of Directors will make sure that that is the case. And so it is not something that we have not done. We have, in fact, moved ahead through supervisory practice to make sure that these things are better than they were, and they are substantially better than they were. You see much better compensation practices here focusing mainly on the big firms where the problem really was. Senator MENENDEZ. Well, that does not have the power of a rule. I hope we can get to a rule-based purpose, because at the end of the day we seem to have revisited everything that was already completed, but yet we cannot get this one going. Thank you, Mr. Chairman. Chairman CRAPO. Senator Corker. Senator CORKER. Thank you, Mr. Chairman. And, Mr. Chairman, thank you for being here. I was remarking to our staff yesterday, as we talked a little bit about this meeting, that because of the way VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 18 that you are handling yourself, which I think is in a very positive way, following the Fed is getting really boring these days. But hopefully that will continue. I know that is your goal. We appreciate some of the transparency efforts that you have put forth. I think I heard you earlier talk about inflation, and obviously we are, you know, at full employment. Hopefully there will be additional people participating in the workforce that have not in the past, and I am glad to see those numbers are rising. But if I understand correctly what you are saying, the predictive stat for people who are watching the Fed today will be core inflation. In other words, that will be the determinative factor as it relates to rate increases in the future. Mr. POWELL. So we, of course, look at headline inflation, too, and that is our legal mandate. We look at core inflation when we are thinking about the path of future inflation, though, because it is just a better predictor. Many of the things that affect headline inflation do not actually send much of a signal about future inflation. Senator CORKER. But for people who are trying to see where things are going, now that the labor issue is where it is today, the predictive matter as it relates to future increases and the amount of those is really going to be inflation. Mr. POWELL. Inflation is going to be really important. You know, I think we are—for quite a while here, we have been in the range of achieving our maximum employment goal, and we are only just getting there with inflation. I would not declare victory on that yet, either. Senator CORKER. Yeah, it has really been difficult, I think, for many Western countries to get to a place that they are comfortable in inflation, which brings me to the wage issue. Look, like my colleagues, I am very concerned about wage stagnation, and I am not in any way trying to offload that issue to you. We all have responsibilities to put in place policies that will hopefully cause all Americans’ wages to increase. But what we are seeing here and what we are seeing actually, let us face it, in Western countries around the world is people are not—the anticipation that people had relative to where they were going to be in life is not being achieved, which is creating some extremes as it relates to the political environment—actually, in some ways beginning to destabilize, because people are, rightly so, concerned about the fact that they are not really increasing the ability to raise their families as they wish. Let us talk a little bit about that. What is it from your perspective that is causing us to be in this place where the economy is growing, but for the last 30 years, Americans really have not seen the wage gains that they would like to see? Could you just lay out—not in any way to take responsibility at the Fed solely yourself, but what is driving that? Mr. POWELL. You know, the stagnation of middle-class incomes, the relatively low mobility that we have, the disappointing level of wages over a long period of time, it is all of a piece, and it all does go to that. And I think the causes of these things are really deep. It is not something we can address really successfully over time with monetary policy, as you say. So, I mean, I think it is—— Senator CORKER. What are those deep causes? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 19 Mr. POWELL. So I think, you know, part of it is, in our case, in the case of the United States, stagnation of educational achievement, the leveling out of educational attainment. When U.S. educational attainment was rising, technology was coming in; it was asking for more skills on the part of people. They had those skills, and so you had productivity rising, you had incomes rising, you had inequality declining over a long period of time. U.S. educational attainment flattened out in the 1970s, and everywhere else in the world it has been going up. We really had a lead. We were the first country to have gender-blind, you know, secondary education universally. So that is a big thing. Really the only way for incomes to go up over a long period of time is through higher productivity. Real incomes go up over a long period of time because of higher productivity. Higher productivity is a function of, in part, the educational and skills and aptitude of the workforce. It is also, you know, partly the evolution of technology and investment. I think right now in particular we had a number of years of very weak investment after the crisis because there was no need to invest. That weak investment period is casting a shadow over productivity right now, which is one of the main factors that is holding down wages. These are deep, hard problems, but education is really at the bottom of the pile. Senator CORKER. And I am glad you alluded to that, and my time is up, I know. But we have had—we actually have had productivity growth without wage growth. Mr. POWELL. Over long periods of time, the only way wages can go up sustainably is with productivity growth. They do not necessarily match all the time. I mean, since the crisis ended, productivity growth has been—output per hour has been very, very weak. Increases have been very, very weak. Senator CORKER. Thank you, Mr. Chairman. Chairman CRAPO. Senator Tester. Senator TESTER. Thank you, Chairman Crapo and Ranking Member Brown. And thank you for being here, Chairman Powell. I want to run over some stuff that has been run over already just real quick. You had answered in a previous question that the stress tests continue. Is that correct? Stress tests continue on the banks? Mr. POWELL. Absolutely. Every year. Senator TESTER. And you said you were going to try to improve them, make them more transparent, which, by the way, I applaud that. Would you also add to that list that you are trying to weaken the stress tests? Mr. POWELL. No, absolutely not. Senator TESTER. You are still making them do what they need to do to prove that their soundness is there? Mr. POWELL. The 2018 stress test was by a margin the most stringent stress test we have done yet. Senator TESTER. OK. Folks also continue to be concerned that S. 2155 allowed foreign megabanks like Deutsche Bank, UBS, Barclays to see their enhanced prudential standards weakened. You have agreed—and you have said it again today—that S. 2155 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 20 does not do that. Do you have any plans to weaken standards on the largest FBOs that I mentioned? Mr. POWELL. No. No, sir. Senator TESTER. OK. In your testimony you said, ‘‘Good economic performance in other countries has supported U.S. exports and manufacturing.’’ What other countries are you talking about? Would that include the EU? Would that include Canada and Mexico, the other countries, I am talking about, that have good economic performance? Would that include China? Those other countries—— Mr. POWELL. It would include all those countries, yes. Senator TESTER. All those countries? And I know you said that the tariff situation and the trade situation is something that Congress deals with that you do not deal with, but it would appear to me—and I just want to get your opinion on this because I value it. It would appear to me that all this stuff about getting out of NAFTA and putting tariffs on folks and not being at the table when TPP was finally signed is a net negative on our economy. Would you agree with that long term—short term and long term? Mr. POWELL. I am going to try to walk that line that I mentioned earlier and not comment on any particular policy, but in principle, open trading is good. We do not want countries to have barriers to trade or, you know, tariffs being a barrier to trade. Senator TESTER. Both directions. Mr. POWELL. In both directions. We want to have an international, you know, rules-based system in which countries can get together and any country that violates that can face the other countries, and that system has served us very well. Tariffs have come down steadily over the years. Until recently, they were at their all-time low level. But the thing is we do not know how this goes. This process we are in right now, the Administration says it is going for broadly lower tariffs. If that happens, that is good for the economy. That would be very good for the economy—our economy and others’ too, by the way. On the other hand, if we wind up with higher tariffs, then not so good. Senator TESTER. That is correct. And in the meantime, just as a sidebar, if it cuts off foreign markets for grains, for example, there is going to be a lot of people in family farm agriculture that are put out of business. And that is my concern. You do not need to comment on that. I realize that you do not play a central role in our housing finance system, but you do play a central role in our economy, and the Fed does have a sizable balance sheet with billions of dollars’ worth of mortgage-backed securities on the books. In March it was announced that Fannie Mae and Freddie—no, not Freddie, but Fannie Mae would need $4 billion from its line of credit at the Treasury Department. How concerning is this to you and the Fed given the size of mortgage-backed securities that are on your books? Mr. POWELL. The mortgage-backed securities that we have are guaranteed by the Federal Government. There is no credit risk there. I would say more generally, if this is responsive, I think that the housing finance system, the GSEs, remains one of the big unfinished pieces of business postfinancial crisis, and I think it would VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 21 be healthy for the economy and for the housing finance system to see that move forward. Senator TESTER. You answered my second question. So you think that Congress’ inability to address Fannie Mae and Freddie Mac in the end could harm our economy? Mr. POWELL. I think it is really important for the longer run that we get the housing finance system off the Federal Government’s balance sheet and using market forces and some of the things that are already in place and carry forward some kind of a reform. I think it is very important for the economy longer term. Senator TESTER. OK. Thank you, Chairman Powell, and I appreciate your being here. I have got a couple other questions for the record that I would love to have you answer. Thank you very much. Mr. POWELL. Thanks. Chairman CRAPO. Senator Toomey. Senator TOOMEY. Thanks, Mr. Chairman. Thank you, Chairman Powell, for joining us. I just had a quick follow-up on this wage discussion. I think the most recent numbers we had were the month of June. Comparison to the previous June, 2.7 percent I think was the nominal growth in the wage number, so obviously a positive number. I think we would all like to see a bigger real growth. I think there is no question we would like to see that. But I would suggest that there is something peculiar about just the arithmetic of this sometimes, and maybe you could just briefly comment on this. As our economic growth has coincided with a significant growth in entry-level jobs and people coming into the workforce at entrylevel wages, since those wages are at the low end of the wage spectrum, isn’t it the case that the nature of arithmetic is that the average wage will reflect to some degree the fact that new entrants naturally come in at the low end of the spectrum and it would mask the growth in wages of people who have been continuously employed? Mr. POWELL. Yes, that is right. There can be compositional effects, is what we call them, so younger people coming in, lower wages; older people, higher wages, retirement can be an effect. I am not sure it is right now, but I can check on that. Senator TOOMEY. I think that is likely to be the case as we have increasing workforce participation. I think that is a likely consequence. You made a very important point, I think, earlier that sustained wage growth absolutely requires sustained productivity growth. It is not possible to have the former without the latter. We all know that productivity growth is driven by several things, but one of the principal contributing factors is capital expenditure. It is new tools and equipment and technology in the hands of workers that make them more productive. The June FOMC minutes included a disturbing observation, and I will quote very briefly. It says, ‘‘Some districts indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy.’’ So the FOMC is saying that there is already adverse consequence in the form of scaled back investment as a result of uncertainty in trade policy. If there VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 22 is more uncertainty—and we have threats of additional tariffs hanging over the markets right now—doesn’t it follow that this is a threat to wage growth because the continuum includes a reduction in capital expenditure, lower productivity growth than we would otherwise have in a corresponding relative weakness in wage growth? So, in other words, isn’t all this trade uncertainty a threat to wage growth? Mr. POWELL. It may well be. We do not see it in the numbers yet, but we have heard a rising chorus of concern which now begins to speak of actual cap ex plans being put on ice for the time being. Senator TOOMEY. Yeah, which is really disturbing. The Senator from Tennessee’s question about what causes stagnant wages, well, it corresponded to an extended period of very low productivity growth, which itself corresponded to very low capital expenditure growth. We broke that with the incentives in the tax reform that caused a big surge in cap ex. And it would be a tremendous pity to jeopardize that because of the trade policy. Let me move on to a somewhat technical matter regarding the Fed’s balance sheet. As you know, historically the Fed has manipulated just overnight rates, the discount rate and Fed funds rate, and let the markets decided all other interest rates. That all changed with quantitative easing when the Fed became the biggest market participant in the purchase of Treasurys. And it changed in an explicit way when the Fed decided that it would intentionally manipulate the shape of the yield curve with Operation Twist, which was very consciously and willfully designed to change the shape of the curve. My understanding is now, to the extent that you make purchases of Treasurys, which you do when payments come back to the Fed in excess of what you want to run off, you do so basically as a set proportion of what the Treasury is issuing without regard to where on the curve they are issuing. So while this is happening, the yield curve is flattening and in a pretty dramatic way, right? Twos, tens were like a hundred basis points a year ago. Today they are, I do not know, 25 basis points. Some people are concerned that a flattening curve or an inverted curve correlates with economic slowdown and recession. Here is my question: Does a dramatic change in the shape of the yield curve in any way influence the trajectory that you guys are on with respect to normalizing interest rates and the balance sheet? Mr. POWELL. Sorry. In other words, are we going to change our balance sheet policies due to the—is that what you are asking—due to the changing shape of the curve? Senator TOOMEY. Yeah, does the changing shape of the curve weigh into your considerations at all? Mr. POWELL. You know, I think what really matters is what the neutral rate of interest is, and I think population look at the shape of the curve because they think that there is a message in longerrun rates, which reflects many things, but that longer-run rates also tell us something, along with other things, about what the longer-run neutral rate is. That is really, I think, why the slope of the yield curve matters. So I look directly at that rather than—in VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 23 other words, if you raise short-term rates higher than long-term rates, you know, then maybe your policy is tighter than you think, or it is tight, anyway. So I think the shape of the curve is something we have talked about quite a lot. Different people think about it different ways. Some people think about it more than others. I think about it as really the question being what is that message from the longer-run rate about neutral rates. Senator TOOMEY. Yeah, I think that makes a lot of sense. I see my time has expired. Thank you, Mr. Chairman. Chairman CRAPO. Let me check. Senator WARNER. I got in under—— Chairman CRAPO. Senator Warner. Senator WARNER. Thank you, Mr. Chairman. Chairman Powell, it is great to see you again. Part of the challenge coming this late in the hearing is a lot of my questions have been answered. I want to follow up a comment at least on what Senator Toomey was addressing. I was going to cite the minutes of the Fed June meeting as well in terms of you say you have not seen these effects in the economy yet, but there has been a slowing of cap ex because of concerns about what I think is the President’s kind of ill-thoughtthrough trade war. I strongly believe we ought to take into consideration and have a fair and balanced trading system. I think China is the worst offender, particularly in the theft of intellectual property and other items. I was actually applauding the President when he moved strongly at first for a day or two on ZTE and before he folded at the first pushback from President Xi. And I would argue that we would be in a stronger position vis-a-vis citizenship if we had been about to actually rally other nations around the world, nations that are our allies. Instead, he is engaged in trade practices with them. No need to comment on that. Senator Tester raised an issue I wanted to raise as well, indicating foreign banks that have relatively small U.S. subsidiaries but large overall international assets are still going to be subject to stress tests. As a matter of fact, wasn’t it correct that at least, since there are a variety of stress tests, the CCAR stress tests still applies to institutions that have assets at any level or relatively any level, and that there was recently a foreign bank with $900 billion of total assets but only $86 billion in U.S. assets that the CCAR stress test still applied to? Is that not correct? Mr. POWELL. I believe that is correct. Senator WARNER. OK. I think you have addressed that, and there are some tensions here between—the Chairman is a good friend of mine and all. I think there may be appropriate regulatory relief for some regional banks, but I want to make sure—and I think you have addressed this with Senator Tester—that for those banks in that 100 to 250 range, you can have a thorough process and rulemaking process that stress tests are going to continue on a regular basis, and that these banks that fall into this category are going to be strictly reviewed before they might receive some of this regulatory relief to make sure that they—you know, size alone may not be the only indicator of significance to the overall market, and there may be some institutions that fall in that category but still need the enhanced SIFI diagnosis. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 24 Mr. POWELL. Right, so the bill gives us all the authority we need, frankly, to reach below 250 down to 100 and apply any prudential standard we want, either on the grounds of financial stability or just the safety and soundness of banking companies. We will published—we are thinking about it carefully now. We are going to publish for public comment the range of factors that we can consider. And, again, the bill is very generous in letting us consider all the factors that we think are relevant. Senator WARNER. But one of the reasons that I was supportive of the legislation was testimony that you had given prior to the passage that this was not going to be some blanket dismissal of these institutions, that you were going to go through a thorough rulemaking process and make an evaluation before those regulations were relaxed. Is that still your position? Mr. POWELL. We will, absolutely. In fact, there is one institution now that is designated as a SIFI that is less than 250. So we are not shy about finding financial stability risk when we find it. Senator WARNER. We think, again, the lines are always arbitrary here, but it is up to you and the Fed to make sure that institutions, particularly based upon their business practices that may be overall economically significant, that they still will have that determination, as you indicated, even if they fall below 250. Mr. POWELL. Yes, a wide range of factors it will be. Senator WARNER. Let me move to a different topic. I recently sent you a letter with a number of my Democratic colleagues on the Community Reinvestment Act, and I think the renewal of that act is very important. And I am concerned that the OCC has proposed a policy that will ‘‘only consider lowering component performance test ratings of a bank if evidence of discrimination or illegal credit practices directly relates to the institution’s CRA lending activities.’’ The way I read that would mean that under the OCC’s proposal, which I think is inappropriate, you could end up with a bank still getting a good CRA rating, even though they had discriminatory practices, but simply those discriminatory practices fell outside of its CRA lending processes. So my hope would be for those banks that fall under the Fed’s review that we will not see a relaxing of those CRA standards. Mr. POWELL. You have correctly stated what our policy is, and I have every reason to think that it will continue to be that. We am not looking to change it. Senator WARNER. I would hope so, and I want to make sure we will follow up with additional letters and requests on that subject. Thank you, Mr. Chairman. Chairman CRAPO. Thank you. Senator Van Hollen. Senator VAN HOLLEN. Thank you, Mr. Chairman. Mr. Chairman, welcome. Good to have you here. A couple questions that relate to the tax bill, because much has been said about that. Senator Toomey mentioned that it has resulted in increased investment. What I have seen is a huge whopping increase in stock buybacks. In fact, as of today, the number is $600 billion in stock buybacks. Those are corporations that have decided not to invest the money back into their workers or their VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 25 plant or their equipment, but give it to stockholders, which included, I should say, one-third of the stock holdings in this country are foreign stockholders. So it is a great windfall for the accounts of foreign stockholders. Much has also been claimed about the economic impact. I am looking at the most recent projection that the Fed had for median long-term growth. As of your June 13th report, I see it is 1.8 percent, is that correct, for the current long-term growth median projection? Mr. POWELL. Yes, it is. Senator VAN HOLLEN. Are you aware of what the projection was a year ago before the tax bill was passed? Mr. POWELL. I am going to say 1.8 percent. Senator VAN HOLLEN. It was 1.8 percent. I mean, the reality is, despite all the hype around here, it is not really going to have an impact on our long-term growth. Surprisingly, a lot of us did think there was going to be a sugar high. When you dump $2 trillion into the economy, you would think there would be some sugar high, and maybe there will be some sugar high. But I was interested in an analysis that came out of the San Francisco Fed. I do not know if you saw it. Two economists there actually said that the 2017 tax law is likely to give maybe not even a sugar high. Have you had a chance to review that analysis? Mr. POWELL. I have, and I would just say that, you know, there is a wide range of estimates of the effects of the recent fiscal changes, and, you know, they are talking about the possibility—I think their point was late in the cycle when you are near full employment, the effects might be less. You know, they might or they might not be. I think there is a lot of uncertainty. One of the great things about the Fed is we get a range of views, which is a healthy thing. Senator VAN HOLLEN. But it does stand to reason, right, that you would have a smaller impact late in a cycle? I mean, that is why most fiscal policy in this country over the years has said that we want to provide stimulus during the really tough times when a lot of people are out of work, but you do not necessarily want to provide stimulus sugar high when the economy is clicking on all cylinders. And I think that is the point these economists made, is we are actually in the ninth year of growth. So when you are talking about some increase in real wages, not nearly what we want—I mean, that is over the 9-year period. Is that right? Mr. POWELL. I am sorry. Your question? Senator VAN HOLLEN. When you talk about some small uptick in real wages, that is over the period of recovery, right? Mr. POWELL. I was really talking about nominal wages, and what I was talking about was if you look at 2012, 2013, 2014, all of our main wage things sort of were around 2 percent, measures around 2 percent. Now they are close to 3 percent. So it was not an overnight thing, overnight sensation. It was a gradual increase. But you have seen a meaningful increase. Senator VAN HOLLEN. Right. And isn’t a fact that real wage increases were higher during the last term of the Obama administration than during the Trump administration? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 26 Mr. POWELL. I would really have to go back and look at that. Senator VAN HOLLEN. I have the advantage, Mr. Chairman, of having your detailed Fed analysis and the Bureau of Labor Statistics. And what it shows is that, in fact, real wage increases were higher during the last term of the Obama administration. The point here really is not play make-believe, as we sometimes hear around here, that this tax bill somehow miraculously helped a lot of people out. The reality is, as we heard, real wages are pretty flat. I understood your testimony about oil price increases. We do not know how long they will be with us. But we also know that real wage increases were higher during the 4 years of the Obama administration than so far in the Trump administration with the tax cut and everything else. So I hope that my colleagues will bring more of a discussion based—a reality-based discussion to this. The one thing we do know that tax bill did, the one thing we did know is it is going to add about $2 trillion to our national debt, a debt that will have to be paid off by everybody in this room and their kids and grandkids. And at the same time, the Fed projection shows no change in the long-term growth projections. So we just blew $2 trillion. A lot of it is already going to stock buybacks, and I just hope we will sort of end the happy talk about what this tax cut did. Thank you. Chairman CRAPO. Senator Heitkamp. Senator HEITKAMP. Thank you, Mr. Chairman. And thank you, Chairman Powell, for once again coming before the Committee and being willing to answer our questions. I want to just make a point about wages, and you do not need to comment on this. Almost 20 percent of the people in our country who are wage earners earn less than $12.50 an hour. I do not know how many of you think you can live on $12.50 an hour, but I think—given that you are working a 40-hour week. Thirty-two percent earn between $12.50 and $20 an hour. Twenty dollars an hour is just barely $40,000 a year. And the next 30 percent is $22 to $30, much of it heavily weighted on the light end. In fact, I have seen one survey that has told us that two-thirds of all wage earners in this country earn less than $20 an hour, hourly wage earners. If you do not think that that presents economic challenges if that does not change, we are wrong. I think that there is optimism. Optimism is leading to taking on more consumer debt. I think we are seeing that. The response, and I think appropriate, that you have on interest rates is going to drive increased costs. We have targeted or linked the student loan rate to what you do, thereby exacerbating those people who are attempting to take that next leap forward. So I just want to make the point that where your job is to look at macro, we visit with people every day in our States who are struggling, struggling to make ends meet. And I want to transition to the next place for me on North Dakota struggles, and that is trade. You know, I have been asking questions about trade for 2 years now. So if you look at the minutes of the Fed meeting, which I think Senator Toomey talked about, businesses across the country from steel and aluminum to farming have been telling Fed officials about plans to pull back VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 27 their investments in their business or offshore their business. We have now pork producers talking about moving their pork production offshore to basically avoid what has been happening in the pork industry. These industries I think have good reason to be concerned. Economists across the spectrum, including economists in the private sector, Morgan Stanley and Goldman Sachs, European Central Bank, the IMF, they are all raising alarms with trade tensions looming. So if the President’s trade policies continue to result in escalating tariffs by our trading partners, I think this is going to have serious damage to the economy and, in particular, to producers and consumers in my State. Now, just to give you a number, North Dakota is the ninth most dependent on imported steel. That surprises people, but you think about our base industry. What is one of the primary inputs in drilling and in moving oil? It is steel. What is one of the primary inputs in large equipment manufacturing? It is steel. And I have heard from my equipment manufacturers that what amount they got in tax savings has been gobbled up in the first 2 or 3 months of this fiscal year. Then we are not even talking about farmers with the double whammy of getting hit with steel tariffs—they are large steel users—and seeing their commodity prices being challenged. You offered a view last week that the President’s trade war results in other countries actually lowering their trade barriers. Then that would be a positive outcome. I do not disagree. However, the historic and economic evidence suggests the opposite is likely to occur. In fact, if you look at efforts such as Smoot–Hawley—we can go all the way back there—we know and I believe history will tell you that it contributed significantly to the depth of the Great Depression. I do not say it causes it, but it certainly did not assist in early recovery. So would you agree with former Chairman Ben Bernanke when he said in a 2007 speech on trade that restricting trade by imposing tariffs, quotas, or other barriers is exactly the wrong thing to do for the economy? Mr. POWELL. I would, assuming you are talking about them remaining in place over a sustained period of time. Absolutely. Senator HEITKAMP. Well, you know, I get a little frustrated by this short-term pain for long-term gain. I think that we are going to have long-term consequences in agriculture because I think we are going to have emerging markets in the competitive space that we have not before. We already see the Chinese are subsidizing their farmers to grow soybeans. We see that Brazil and Argentina are amping up their soybeans and, arguably, could be, in fact, buying American soybeans, marking them up and enjoying our market with the markup as we struggle. So in that same speech, then-Chair Bernanke cites studies which show that the effects of protectionist policies almost invariably lead to lower productivity in U.S. firms and lower living standards for U.S. consumers. Is there any reason to believe that these studies are no longer valid? Mr. POWELL. None that I know of. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 28 Senator HEITKAMP. OK. Chair Powell, I make the point on Bernanke’s comments and historic record because we cannot afford to put our head in the sand and ignore the facts about the impact of the Administration’s trade policies on our economy. I think it is clear—I have been probably one of the most outspoken critics of the President’s trade policy here, certainly on this side of the aisle. And if we want to improve trade, the right way to do it is to expand trade agreements, in my opinion, not impose reciprocal tariffs. And so I am deeply concerned—and I know that at this point you are taking a watchful eye. But I am deeply concerned about the long-term ramifications of this so-called short-term policy. And certainly if we see the next tranche, the $200 billion, and then beyond that we see tariffs on automobiles, we will, in fact, be in a full-on, escalated, damaging trade war. And I do not know where that ends. And if this is a game of who blinks first, the best thing to do would be to get to the negotiating table. Now—oh, I am over my time. Chairman CRAPO. Yes. Senator HEITKAMP. I am sorry. But I want to make the point that I am going to stay on this. I am going to stay on the macro effects of this trade policy, because this is not good for our economy, and we are going to look back at this time perhaps in a year and say that is the point at which we turned the corner and the economy started taking a downturn. Chairman CRAPO. Senator Warren. Senator WARREN. Thank you, Mr. Chairman. And good to see you again, Chairman Powell. Before the financial crisis, banks loaded up on risky loans while regulators just looked the other way. And when those loans went bad, taxpayers were left holding the bag because big banks did not have enough capital to stay afloat. Dodd–Frank included two major reforms to make sure that this never happens again: first, rules that make big banks meet higher capital standards so they are better equipped to handle losses; and, second, rules that make the banks take annual stress tests to ensure that they are not taking on too much risk. But since you have taken over, Chairman Powell, the Fed has rolled back on both of these reforms, and I just want to explore what that means for our economy. In April the Fed proposed an amendment that lowers the enhanced supplementary leverage ratio. That is the special capital requirement for the too-big-to-fail banks. The FDIC claims that this reform will allow the banks to maintain $121 billion less in capital, but the Fed disagrees with the FDIC’s assessment. Why is that? Mr. POWELL. We actually think that the effect of that proposed change which is under consideration—we are looking at the comments—would be pretty close to zero as it relates to the firm itself. And, also, we think—in other words, if you look at the entire entity, it would be less than $1 billion. I will not say zero, but I think our estimate was $400 million. Senator WARREN. So you just think the FDIC’s $121 billion estimate is made up? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 29 Mr. POWELL. They are talking about the bank; whereas, we are talking about the whole firm. Within the whole firm, at the firm level—— Senator WARREN. But the banks we have to worry about are the banks that get bailed out here. Mr. POWELL. Yeah, and the enhanced supplemental leverage ratio, the problem with this is that we do not want a leverage ratio to be the binding capital requirement because it actually calls upon—if you are bound by that, you are actually called upon to take more risk. So we would rather not have the bank bound by that. Senator WARREN. So let us take a look at this in terms of trying to strengthen the banks so that we do not have to be in a position to bail them out. The second thing you have done is you have put a lot of stock in stress tests, and last week you called the stress tests ‘‘the most successful postcrisis innovation for bank regulation.’’ But under your leadership, the Fed has weakened the stress test regime. Here is one example. Results of this year’s exercise recently became public and reportedly three banks—Goldman Sachs, State Street, and Morgan Stanley—had capital levels that were too low to pass the test. I wrote to you about these banks a few weeks ago, and I appreciate your response on this. But just to be clear, after they flunked, did you give those too-big-to-fail banks a failing grade? Mr. POWELL. We gave them what we call a ‘‘conditional nonobject,’’ which is something we have done—— Senator WARREN. OK, but that is not a failing grade, right? They did not flunk. Mr. POWELL. They suffered the same penalty, which was to have to limit their distributions to the prior years. Senator WARREN. Well, that is what I want to ask. If you did not flunk them, did you at least follow the Fed guidelines and make those banks submit new capital plans that would pass the test? Mr. POWELL. No. In fact, when we do the conditional nonobject, we do not require them to resubmit—— Senator WARREN. So you do not require them to actually meet the criteria. Mr. POWELL. In the many times we have used that tool over the years, we have not required that. Senator WARREN. In other words, the Fed looked the other way. You let these banks off with what you call a conditional nonobjection, letting them distribute capital to their shareholders instead of keeping it on their books. In fact, because of your action, Morgan Stanley and Goldman Sachs investors took home about $5 billion more than they otherwise would have. That is nice gift to the bank, Mr. Chairman. On top of that, the Fed also proposed a rule in April that would make the stress tests less severe, effectively reducing capital requirements at the eight largest banks by a total of about $54 billion, according to a Goldman Sachs analysis. So, Chairman Powell, by your own account, the economy is doing well. We all know that bank profits are gigantic. The banks just got huge tax breaks. Three Fed Presidents—President Rosengren, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 30 President Mester, and President Evans—have suggested it is an ideal time to raise capital requirements to strengthen the banks instead of siphoning off cash to shareholders. So why is the Fed under your leadership persistently seeking to reduce capital requirements and weaken stress tests? Mr. POWELL. With respect, Senator, we are not doing either of those things. In fact, the stress test in 2018 was materially more stressful—the amount of the loss and the amount of required capital to pass the test was the highest by far of any test. Senator WARREN. Look, I do not know what to say. The FDIC does not see it that way. Goldman Sachs does not see it that way. The data do not seem to back you up on this. The Fed’s capital requirements and the stress test are like a belt and suspenders. You can loosen the belt and rely on the suspenders, or you can take off the suspenders and rely on the belt. But if you do both, your pants will fall down. And, Chairman Powell, we learned in 2008 that when the big banks’ pants fall down, it is the American economy, American taxpayers, American workers who get stuck pulling them back up. So it looks like to me the Fed is headed in the wrong direction here. Thank you, Mr. Chairman. Chairman CRAPO. Senator Schatz. Senator SCHATZ. Thank you, Mr. Chairman. Chairman Powell, thank you for your service, and thank you for being willing to engage. I understand the need for you to stay in your lane, so I am going to ask a question, and I want to have as constructive of an exchange as possible, knowing that some of this ground has been covered, and I do not want to turn this into a partisan conversation. Banks are doing well. They had record-breaking profits in the years 2016 and 2017, and it looks like 2018 is going to be another gangbuster year. Across the board, banks increased their dividends by 17 percent in 2017, 12 percent in 2018. Community banks’ earnings are also up. Household credit is up. In April, after your speech to the Economic Club of Chicago, you said, and I quote, ‘‘As you look around the world, U.S. banks are competing very, very successfully. They are very profitable. They are earning good returns on capital. Their stock prices are doing well. So I am looking for the case for some kind of evidence that regulation is holding them back, and I am not really seeing that case as made at this point.’’ The data backs up your statement. Banks are the most profitable that they have ever been. So what is the motivation for weakening Dodd–Frank rules like the Volcker Rule? Mr. POWELL. I think we want regulation to be as efficient as well as effective as it can possibly be. Regulation is not free. Regulation, good regulation, has very positive benefits—avoiding financial crises, avoiding consumer harm, and things like that. But nobody benefits when regulation is inefficient. And so we have taken the job, particularly for the smaller institutions going back and looking at everything we have done over the last decade, to make sure that we are doing it in the most efficient way possible. That is what we are doing. We want the strongest, toughest regulation to apply to the biggest banks, particularly the eight SIFIs. And then we want VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 31 to make sure that we have tailored appropriately as we move down into regionals and subregionals and then large community banks and then smaller ones. Senator SCHATZ. OK. A fair answer. What would you say to someone back home who says, ‘‘Why would the Fed focus on this? Why would the Banking Committee focus on this? Why would the Federal legislative branch focus on making life easier for the banks given income inequality, given that these are literally the most profitable institutions in American history?’’ I get that it is always better to make things more efficient. It just seems like you have limited resources and we have limited political capital to spend on priorities for the Fed. What do I say to someone back home who says, ‘‘Why are you taking care of these guys who seem to be feeding at the trough pretty nicely?’’ Mr. POWELL. I think you have to distinguish between different kinds of institutions. You know, I do not think that the smaller community banks are maybe feeling quite as healthy as you are saying. I think they are healthy. But I think, you know, we want them to be devoting their efforts to making loans and investing in their communities, supporting economic activities in communities, not—— Senator SCHATZ. But lending is up, right? And profitability is at least somewhat of a proxy for the efficiency of the regulations. I will not belabor this. I take your answer in good faith. In a recent interview with Marketplace, you were asked what keeps you up at night. This is one of the things I enjoy about you, is you are frank in your responses while trying to stay in your lane. And you said, ‘‘We face some real longer-term challenges, again, associate with how fast the economy can grow and also how much the benefits of that growth can be spread through the population. I look at things like mobility. If you judge the United States against other similar well-off countries, we have relatively low mobility. So if you are born in the lower end of the income spectrum, your chances of making it to the top or even to the middle are actually lower than they are in other countries.’’ Understanding that the Fed cannot address these issue squarely, can you talk a little bit about income inequality and what ought to be done? And then my final question around income inequality is whether, to the extent that you have expressed this view, a tax cut that provides about $33,000 for individuals in the top 1 percent of earners and about 40 bucks to the poorest of the poor, whether or not that helps or hurts in terms of income inequality. Mr. POWELL. There are a range of—the question I was answering in that interview and that you are really asking is really these are issues that the Fed does not have the tools or the mandate to fix, but they, nonetheless, involve significant longer-term economic challenges. So I just would—you know, I pointed out low mobility, which is the research of Raj Chetty, who is a professor back at Harvard now, and also just the stagnation of median incomes for a long time. And if you look at things like labor force participation among prime-age males, you have seen a decline over 60 years. These are unhealthy trends in the U.S. economy that we do not have the tools to fix. You do. These are things for the legislature to work on. And, you know, it comes down to things that are easy VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 32 to say and hard to do, like improve education, deal with the opioid crisis, things like that. And I also think, you know, balanced regulation plays a role in this and in enabling capital to be allocated freely and people to move from job to job. All those things go into it. But these are long-run important issues, particularly—another one is the potential growth rate of the country, which looks like it has slowed down because of aging, really, and demographics and things like that. So these are big issues. We cannot really affect them with monetary policy. Senator SCHATZ. Thank you. Chairman CRAPO. Senator Cortez Masto. Senator CORTEZ MASTO. Thank you. Chairman Powell, thank you for being here, and thank you for also answering our questions. I appreciated your comments earlier in the introduction, and noting what you admitted that the aggregate numbers do look good. But I also noted in your presentation that there is a quote that you say, and it is this: ‘‘And while three-fourths of whites responded in a recent Federal Reserve survey that they were doing at least OK financially’’ in 2017—‘‘at least OK, only two-thirds of African Americans and Hispanics responded that way’’ when it comes to financially whether they were doing OK. And I think that is what this comes down to. It comes down to those individuals who are living out there who are struggling, how much money is in their pocket, how much it can pay for. I notice you talked about the wages are up 0.27 percent, price index increased 2.3 percent. So in response to Senator Menendez’s question about the steps that you were taking for broad-based wage growth, you answered several things. But let me ask you this: Is it your opinion that it is the Fed’s responsibility or role to do something about wage growth, broad-based wage growth to play a role there? Mr. POWELL. I think, you know, what you have assigned us is literally maximum employment and stable prices, and also financial stability, we have an overall responsibility for that. Maximum employment, the sense of that is it is not just one measure. It is a broad range of measures, and I think we have really—you know, we have worked hard to provide support for the labor markets. Senator CORTEZ MASTO. And that would include wage growth then? Mr. POWELL. It would. Wage growth comes into really both of those things. It comes into maximum employment. It also comes into inflation. Senator CORTEZ MASTO. Good. I am glad you said that because here is the other thing that you said that concerned me, and you said one way to address and increase wage growth was incomes need to go up, and they only go up with higher productivity. And that is what you said needs to occur. But let me ask you this, because I have looked at some of the economists and studied some of the reports in the last 30 years or so, and I know that was true probably from 1950 to the 1970s, that they were both going up together. But we also have studies that show from 1973 to 2016 it was just the opposite. They are divergent, that productivity went up by 73.7 percent, but the hourly pay VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 33 went up 12.5 percent, only 12.5 percent. That is 5.9 times more, more productivity than pay. So knowing that, how can you say that we need to focus on higher productivity because that will also increase wages? Mr. POWELL. So what I said was that over a long period of time, wages cannot go up sustainably without productivity also increasing. It is a different thing to say that higher productivity guarantees higher wages. I did not say that, and I do not think that is true. I know very well the charts you are talking about. Senator CORTEZ MASTO. So then what tools—then what are you doing to address wage growth to ensure that we are increasing wages? Because here is what is happening—and you know this. If you are in your community—and I am hoping you are—and you are talking to people across America, you know that wages have been flat since 1973. That means that the people when I go home—and me and my family and Nevadans in general who are struggling, they do not have enough money to pay for housing costs, for health care, for education, for prescription drugs. And what do I tell them that you are doing to look out for their interests to help them and improve their lives with the tools that you have? Mr. POWELL. The tool that we have is monetary policy, and we can and we have—— Senator CORTEZ MASTO. No, I appreciate that. Let me ask you this: Can you just put it in terms if you are talking to a constituent in my State to explain to them what you are doing—now, remember, Nevada was a place where we had the foreclosure crisis. People lost their homes, and they lost their jobs. We had 15 percent unemployment at one point in time, underwater in their homes. What would you say to those individuals that you are doing to ensure, one, it does not happen again and, two, improve the wage growth for them? Mr. POWELL. We are doing everything we can with our tools to make sure that if you want a job, you can have one, and we are also—— Senator CORTEZ MASTO. But having a job and having a livable wage are two different things. Mr. POWELL. Over the long term, we do not have those tools. You have those tools. Congress has the tools to assure stronger wage growth over time. We really do not have that with—we can move interest rates around to support activities, support hiring. We do not have the tools to support higher productivity, for example, which tends to lead to higher wages without guaranteeing them. Senator CORTEZ MASTO. As an economist, you can work with us and tell us the tools or the things that can be done, like increasing the minimum wage, that might improve livable wages for individuals, correct? Mr. POWELL. I would say principally over long periods of time investing in education and in skills are the single—that is the single best thing we can do to have a productive workforce and share prosperity widely, which is what we all want. Senator CORTEZ MASTO. And I know my time is up, and I appreciate that. But I am concerned. Is that based on your own individual opinion, or is that research or data or information that you know that shows that? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 34 Mr. POWELL. It is a lot of research. Senator Cortez Masto. OK. Thank you. Chairman CRAPO. Senator Donnelly. Senator DONNELLY. Thank you, Mr. Chairman. And thank you, Mr. Chairman. Mr. Powell, I am worried about farmers in my State. I checked about an hour ago. Soybean prices are $8.40 a bushel, well below the cost of production right now. Corn is $3.48 a bushel, well below the cost of production. In the last couple of weeks, I have visited with a number of Hoosier farmers and groups like the Indiana Corn and Soybean Alliance and the Indiana Farm Bureau to hear their growing concerns with falling commodity prices and uncertain trade policies, which are already harming Hoosier farmers in rural communities. Let me tell you a conversation I had last Friday. It was with a businessman who is also a farmer, and he was telling me about he just bought 140 acres from another farmer. And he said, ‘‘Joe, I told the farmer, ‘I do not want to buy this from you right now because I know you are struggling. And I know you do not want to sell this. And I do not want to take advantage of you.’ ’’ And the farmer who was selling it said, ‘‘If I do not sell this, I could start losing everything else, and so you are actually helping me out.’’ This is where our rural economy is going right now. I have also heard from local businesses dealing with canceled orders because of the tariffs. The price of soybeans, as I mentioned, it is a 10-year low—a 10-year low—due largely to the Chinese tariffs on U.S. exports. This current policy, what I worry about is that it has already damaged foreign export markets that took decades and decades to build. And so what I am asking you is: What would be the long-term impact of falling commodity prices and reduced agriculture exports on rural communities, which are struggling in so many ways already? Mr. POWELL. Well, I think we know it would be very bad, and we have seen periods in American history where that has happened, and it can be extremely tough on farmers and rural communities. Senator DONNELLY. And if they lose the markets that they have developed—I was over in China talking to some of their defense leaders a few years ago about North Korea, and I was walking through the airport, and there was a group just by coincidence— it was a flight back home, the flight to Chicago and then go back home to Indiana. It was a group of Indiana soybean farmers who were traveling the country, developing the market. What happens to rural communities if China just looks up and says, you know, ‘‘we found more reliable suppliers’’? Mr. POWELL. As we discussed, it can be very tough. Senator DONNELLY. So as Fed Chairman, what would you say to all those farmers who are really nervous, really concerned about what their future will be? They look to us for smart policies, for reasonable policies. Is there anything you can say about this trade war that is going on right now? Mr. POWELL. I should again start by saying that it is really not the Fed’s role. We do not do trade policy. That is Congress and the Administration. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 35 But, you know, I think if the current process of negotiation back and forth results in lower tariffs, that would be a good thing for the economy. If it results in higher tariffs, then I think—you know, I hardly need to tell you what higher tariffs would do for agricultural producers. Agriculture is an area where we lead the world in productivity and we are great exporters, and, you know, you would be very hard hit by these tariffs. Senator DONNELLY. If this goes on for a couple more years, what would be the impact on our rural communities? Mr. POWELL. I think certainly it would be very tough on the rural communities and, you know, I think we would feel that at the national level, too. Senator DONNELLY. Let me also ask you about opioids, which you have mentioned, and workforce participation. My State has been deeply impacted by the opioid crisis. Last summer, during one of her final appearances before Congress, I spoke with former Chair Janet Yellen about the opioid epidemic and its connection to not just health outcomes but also economic and employment outcomes, the impact of opioids on the labor participation rate, which has declined from 66 to 63 percent over the last decade. She agreed there was a connection and noted surveys suggest that many prime-age individuals who are not actively participating in the labor market are involved in prescription drug use. You know, I look at these people we have lost, the next doctors, the next electricians, the next nurses. What do you see is the impact of the opioid epidemic on our workforce participation and, in general, the economy? Mr. POWELL. You know, it is a terrible human tragedy for many communities, certainly for the individuals and their families involved. I think from an economic standpoint, some high percentage of the prime-age people who are not in the labor force, particularly prime-age males who are not in the labor force, are taking painkillers of some kind. I think the number that Alan Krueger, who is a professor, came up with is 44 percent of them. So it is a big number. It is having a terrible human tool on our communities, and also it matters a lot for labor force participation and economic activity in our country. Senator DONNELLY. Thank you. Thank you, Mr. Chairman. Chairman CRAPO. Thank you, Senator Donnelly. That concludes the questioning, but Senator Brown wants—— Senator BROWN. Thirty seconds, Mr. Chairman. Thank you. A number of colleagues have talked about productivity and nonsupervisory pay, that pay has gone up 27 percent and—I am sorry, 2.7 percent, but it is important—from June to June, I think, was what one of my colleagues said. But it is important to recognize that CPI has gone up 3 percent in that period. So we should really never talk about nominal pay. We should talk about real dollar pay. Thank you, Mr. Chairman. Chairman CRAPO. Understood. All right. Thank you. And thank you, Mr. Chairman, again for being here. We appreciate your work and also your taking the time to come here and respond to our questions. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 36 For Senators wishing to submit questions for the record, those questions are due in 1 week, on Tuesday, July 24th, and, Chairman Powell, we ask that you respond as promptly as you can to the questions that may come in. Again, we thank you for being here. This is very good timing. We have got a vote underway right now, so we appreciate you helping to steer this hearing to a good conclusion. With that, the hearing is adjourned. Mr. POWELL. Thank you. [Whereupon, at 11:53 a.m., the hearing was adjourned.] [Prepared statements, responses to written questions, and additional material supplied for the record follow:] VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 37 PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO Today, we welcome Chairman Powell back to the Committee for the Federal Reserve’s Semiannual Monetary Policy Report to Congress. This hearing provides the Committee an opportunity to explore the current state of the U.S. economy, and the Fed’s implementation of monetary policy and supervision and regulation activities. Since our last Humphrey–Hawkins hearing in March, Congress passed, with significant bipartisan support, and the President signed into law, S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. The primary purpose of the bill is to make targeted changes to simplify and improve the regulatory regime for community banks, credit unions, midsize banks, and regional banks to promote economic growth. A key provision of the bill provides immediate relief from enhanced prudential standards to banks with $100 billion in total assets or less. The bill also authorizes the Fed to provide immediate relief from enhanced prudential standards to banks with between $100 billion and $250 billion in assets. It is my hope that the Fed promptly provides relief to those within those thresholds. By right-sizing regulation, the bill will improve access to capital for consumers and small businesses that help drive our economy. And, the banking regulators are already considering this bill in some of their statements and rulemakings. Earlier this month, the Fed, FDIC and OCC issued a joint statement outlining rules and reporting requirements immediately impacted by the bill, including a separate letter issued by the Fed that was particularly focused on those impacting smaller, less complex banks. But, there is still much work to do on the bill’s implementation. As the Fed and other agencies revisit past rules and develop new rules in conjunction with the bill, it is my expectation that such rules be developed consistent with the purpose of the bill and intent of the members of Congress who voted for the bill. With respect to monetary policy, the Fed continues to monitor and respond to market developments and economic conditions. In recent comments at a European Central Bank Forum on Central Banking, Chairman Powell described the state of the U.S. economy, saying, ‘‘Today, most Americans who want jobs can find them. High demand for workers should support wage growth and labor force participation . . . Looking ahead, the job market is likely to strengthen further. Real gross domestic product in the United States is now reported to have risen 2.75 percent over the past four quarters, well above most estimates of its long-run trend . . . Many forecasters expect the unemployment rate to fall into the mid-3s and to remain there for an extended period.’’ According to the FOMC’s June meeting minutes, the FOMC meeting participants agreed that the labor market has continued to strengthen and economic activity has been rising at a solid rate. Additionally, job gains have been strong and inflation has moved closer to the 2 percent target. The Fed also noted that the recently passed tax reform legislation has contributed to these favorable economic factors. I am encouraged by these recent economic developments, and look forward to seeing our bill’s meaningful contribution to the prosperity of consumers and households. As economic conditions continue to improve, the Fed faces critical decisions with respect to the level and trajectory of short-term interest rates and the size of its balance sheet. I look forward to hearing more from Chairman Powell about the Fed’s monetary policy outlook and the ongoing effort to review, improve and tailor regulations consistent with the Economic Growth, Regulatory Relief and Consumer Protection Act. PREPARED STATEMENT OF SENATOR SHERROD BROWN Thank you, Mr. Chairman. This week, the President went overseas, and sided with President Putin while denigrating critical American institutions, including the press, the intelligence community, and the rule of law. Our colleague Senator John McCain expressed clearly what every patriotic American thought, ‘‘No prior president has ever abased himself more abjectly before a tyrant. Not only did President Trump fail to speak the truth about an adversary; but speaking for America to the world, our president failed to defend all that makes us VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00041 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 38 who we are—a republic of free people dedicated to the cause of liberty at home and abroad. American presidents must be the champions of that cause if it is to succeed.’’ With our democratic institutions under threat, we cannot ignore what happened in Helsinki yesterday. But we must not lose sight of the other policies of this Administration—including the rollback of the rules put in place to prevent the next economic crisis. Mr. Powell, thank you for appearing before the Committee to discuss these policies. Just last week, a Federal Reserve official said, ‘‘There are definitely downside risks, but the strength of the economy is really pretty important at the moment. The fundamentals for the U.S. economy are very strong.’’ That may be true for Wall Street, but for most of America workers haven’t seen a real raise in years, young Americans drowning in student loan debt, families trying to buy their first home—the strength of the economy is an open question at best. Last month, former Fed Chair Ben Bernanke was very clear about the long-term impact of the tax cut and the recent bump in Federal spending when he said, ‘‘in 2020 Wile E. Coyote is going to go off the cliff.’’ Last week, the San Francisco Fed released a study finding that the rosy forecasts of the tax bill are likely ‘‘overly optimistic.’’ It found that the bill’s boost to growth is likely to be well below projections—or as small as zero. It also suggested that these policies could make it difficult to respond to future economic downturns and manage growing Federal debt. And it’s not just the tax bill—the economic recovery hasn’t been evenly felt across the country, either. Mr. Chair, I’d like to enter into the record an article from the New York Times this weekend which talks about those families still struggling from the lack of meaningful raises and other job opportunities. While hours have increased a bit over the past year for workers as a whole, real hourly earnings have not. 1 And for production and nonsupervisory workers, hours are flat and pay has actually dropped slightly, according to the Bureau of Labor Statistics. The number of jobs created in 2017 was smaller than in each of the previous 4 years. Some of the very companies that announced billions in buybacks and dividends are now announcing layoffs, shutting down factories, and offshoring more jobs. Some of the biggest buybacks are in the banking industry, assisted in part by the Federal Reserve’s increasingly lax approach to financial oversight. Earlier this month, as part of the annual stress tests, the Fed allowed the seven largest banks to redirect $96 billion to dividends and buybacks. This money might have been used to pay workers, reduce fees for consumers, protect taxpayers from bailouts, or be deployed to help American businesses. Three banks—Goldman Sachs, Morgan Stanley, and State Street—all had capital below the amount required to pass the stress tests, but the Fed gave them passing grades anyway. The Fed wants to make the tests easier next year. And Vice Chair Quarles has suggested he wants to give bankers more leeway to comment on the tests before they’re administered—that’s like letting the students help write the exam. The Fed is considering dropping the qualitative portion of the stress tests all together—even though banks like Deutsche Bank, Santander, Citigroup, HSBC, and RBS have failed on qualitative grounds before. That doesn’t even include the changes the Fed is working on after Congress passed S. 2155 to weaken Dodd–Frank, making company-run stress tests for the largest banks ‘‘periodic’’ instead of annual, and exempting more banks from stress tests altogether. Vice Chair Quarles has also made it clear that massive foreign banks can expect goodies, too. And on and on and on it goes. The regulators are loosening rules around big bank capital, dismantling the CFPB, ignoring the role of the FSOC, undermining the Volcker Rule, and weakening the Community Reinvestment Act. When banks are making record profits, we should be preparing the financial system for the next crisis, building up capital, investing in workers, and combating asset bubbles. And we should be turning our attention to bigger issues that don’t get enough attention, like how the value placed on work has declined in this country, and how our economy increasingly measures success only in quarterly earnings reports. 1 https://www.bls.gov/news.release/realer.nr0.htm VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00042 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 39 Much of that is up to Congress to address, but over the last 6 months, I have only seen the Fed moving in the direction of making it easier for financial institutions to cut corners, and I have only become more worried about our preparedness for the next crisis. I look forward to your testimony. Thank you. PREPARED STATEMENT OF JEROME H. POWELL CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM JULY 17, 2018 Good morning. Chairman Crapo, Ranking Member Brown, and other Members of the Committee, I am happy to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. Let me start by saying that my colleagues and I strongly support the goals the Congress has set for monetary policy—maximum employment and price stability. We also support clear and open communication about the policies we undertake to achieve these goals. We owe you, and the public in general, clear explanations of what we are doing and why we are doing it. Monetary policy affects everyone and should be a mystery to no one. For the past 3 years, we have been gradually returning interest rates and the Fed’s securities holdings to more normal levels as the economy strengthens. We believe this is the best way we can help set conditions in which Americans who want a job can find one, and that inflation remains low and stable. I will review the current economic situation and outlook and then turn to monetary policy. Current Economic Situation and Outlook Since I last testified here in February, the job market has continued to strengthen and inflation has moved up. In the most recent data, inflation was a little above 2 percent, the level that the Federal Open Market Committee, or FOMC, thinks will best achieve our price stability and employment objectives over the longer run. The latest figure was boosted by a significant increase in gasoline and other energy prices. An average of 215,000 net new jobs were created each month in the first half of this year. That number is somewhat higher than the monthly average for 2017. It is also a good deal higher than the average number of people who enter the work force each month on net. The unemployment rate edged down 0.1 percentage point over the first half of the year to 4.0 percent in June, near the lowest level of the past two decades. In addition, the share of the population that either has a job or has looked for one in the past month—the labor force participation rate—has not changed much since late 2013. This development is another sign of labor market strength. Part of what has kept the participation rate stable is that more workingage people have started looking for a job, which has helped make up for the large number of baby boomers who are retiring and leaving the labor force. Another piece of good news is that the robust conditions in the labor market are being felt by many different groups. For example, the unemployment rates for African Americans and Hispanics have fallen sharply over the past few years and are now near their lowest levels since the Bureau of Labor Statistics began reporting data for these groups in 1972. Groups with higher unemployment rates have tended to benefit the most as the job market has strengthened. But jobless rates for these groups are still higher than those for whites. And while three-fourths of whites responded in a recent Federal Reserve survey that they were doing at least okay financially in 2017, only two-thirds of African Americans and Hispanics responded that way. Incoming data show that, alongside the strong job market, the U.S. economy has grown at a solid pace so far this year. The value of goods and services produced in the economy—or gross domestic product—rose at a moderate annual rate of 2 percent in the first quarter after adjusting for inflation. However, the latest data suggest that economic growth in the second quarter was considerably stronger than in the first. The solid pace of growth so far this year is based on several factors. Robust job gains, rising after-tax incomes, and optimism among households have lifted consumer spending in recent months. Investment by businesses has continued to grow at a healthy rate. Good economic performance in other countries has supported U.S. exports and manufacturing. And while housing construction has not increased this year, it is up noticeably from where it stood a few years ago. I will turn now to inflation. After several years in which inflation ran below our 2 percent objective, the recent data are encouraging. The price index for personal consumption expenditures, which is an overall measure of prices paid by consumers, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00043 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 40 increased 2.3 percent over the 12 months ending in May. That number is up from 1.5 percent a year ago. Overall inflation increased partly because of higher oil prices, which caused a sharp rise in gasoline and other energy prices paid by consumers. Because energy prices move up and down a great deal, we also look at core inflation. Core inflation excludes energy and food prices and generally is a better indicator of future overall inflation. Core inflation was 2.0 percent for the 12 months ending in May, compared with 1.5 percent a year ago. We will continue to keep a close eye on inflation with the goal of keeping it near 2 percent. Looking ahead, my colleagues on the FOMC and I expect that, with appropriate monetary policy, the job market will remain strong and inflation will stay near 2 percent over the next several years. This judgment reflects several factors. First, interest rates, and financial conditions more broadly, remain favorable to growth. Second, our financial system is much stronger than before the crisis and is in a good position to meet the credit needs of households and businesses. Third, Federal tax and spending policies likely will continue to support the expansion. And, fourth, the outlook for economic growth abroad remains solid despite greater uncertainties in several parts of the world. What I have just described is what we see as the most likely path for the economy. Of course, the economic outcomes we experience often turn out to be a good deal stronger or weaker than our best forecast. For example, it is difficult to predict the ultimate outcome of current discussions over trade policy as well as the size and timing of the economic effects of the recent changes in fiscal policy. Overall, we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate. Monetary Policy Over the first half of 2018 the FOMC has continued to gradually reduce monetary policy accommodation. In other words, we have continued to dial back the extra boost that was needed to help the economy recover from the financial crisis and recession. Specifically, we raised the target range for the Federal funds rate by 1⁄4 percentage point at both our March and June meetings, bringing the target to its current range of 13⁄4 to 2 percent. In addition, last October we started gradually reducing the Federal Reserve’s holdings of Treasury and mortgage-backed securities. That process has been running smoothly. Our policies reflect the strong performance of the economy and are intended to help make sure that this trend continues. The payment of interest on balances held by banks in their accounts at the Federal Reserve has played a key role in carrying out these policies, as the current Monetary Policy Report explains. Payment of interest on these balances is our principal tool for keeping the Federal funds rate in the FOMC’s target range. This tool has made it possible for us to gradually return interest rates to a more normal level without disrupting financial markets and the economy. As I mentioned, after many years of running below our longer-run objective of 2 percent, inflation has recently moved close to that level. Our challenge will be to keep it there. Many factors affect inflation—some temporary and others longer lasting. Inflation will at times be above 2 percent and at other times below. We say that the 2 percent objective is ‘‘symmetric’’ because the FOMC would be concerned if inflation were running persistently above or below our objective. The unemployment rate is low and expected to fall further. Americans who want jobs have a good chance of finding them. Moreover, wages are growing a little faster than they did a few years ago. That said, they still are not rising as fast as in the years before the crisis. One explanation could be that productivity growth has been low in recent years. On a brighter note, moderate wage growth also tells us that the job market is not causing high inflation. With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that—for now—the best way forward is to keep gradually raising the Federal funds rate. We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary policy will be appropriate. As always, our actions will depend on the economic outlook, which may change as we receive new data. For guideposts on appropriate policy, the FOMC routinely looks at monetary policy rules that recommend a level for the Federal funds rate based on the current rates of inflation and unemployment. The July Monetary Policy Report gives an update on monetary policy rules and their role in our policy discussions. I continue to find these rules helpful, although using them requires careful judgment. Thank you. I will now be happy to take your questions. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00044 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 41 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM JEROME H. POWELL Q.1. In response to questions at your confirmation hearing on Federal Reserve efforts to increase diversity in the System, you said, ‘‘I assure you that diversity will remain a high priority objective for the Federal Reserve. Reserve banks, working closely with the Board, have also been looking at ways to further develop a diverse pool of talent in a thoughtful, strategic fashion, readying them for leadership roles through the Federal Reserve System.’’ Since you have become chair, what specific steps have you taken to encourage more diversity in the Federal Reserve System? A.1. The Federal Reserve System (System) needs people with a variety of personal and professional backgrounds to be fully effective in discharging its responsibilities, and we have observed that better decisions are made when there are many different perspectives represented around the table. Since 2016, my colleagues and I on the Federal Reserve Board (Board) have implemented a framework to better understand and discuss a range of Board and System efforts that address diversity and inclusion as well as research on economic inclusion and economic disparities in the economy. Since becoming the Chairman in February, I have worked with Board staff to refresh the framework and prioritize our focus on diversity and economic inclusion initiatives both at the Board and elsewhere in the System and have ongoing discussions with staff, including the Board’s Office of Minority and Women Inclusion (OMWI) Director, on ways to support various efforts. I continue to stress to Federal Reserve leaders and staff the importance of having a diverse workforce and providing an inclusive work environment to our people. System leaders have fostered a range of diversity and inclusion initiatives, including the development of leadership pipelines and ongoing engagements with our own staff and with the financial services, economic, and academic communities more broadly. Of the various efforts, I would like to highlight the following: • The System launched a leadership development initiative to provide a structured way to share information about our talent pool and to find opportunities throughout the System to more rapidly grow our talent and prepare them to take on expanded roles. • Through the Financial Services Pipeline Initiative, 1 the Federal Reserve Bank of Chicago is working to increase the representation of people of color in the financial services industry in the Chicago region. Over the last several months, the Reserve Bank of Chicago has hosted events designed to develop leadership skills for high-performing people of color. • Researchers throughout the System continue to produce cutting-edge research on how and why disparities exist for different demographic groups in their experiences in employment, education, and health, and in the housing and credit markets. In addition, seminars and panels about diversity and inclusion 1 For more information about the Financial Services Pipeline initiative, go to: https:// www.fspchicago.org/. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 42 • • • • topics are being fostered by local leadership and employee resource networks and are shared across the System. Through the Opportunity & Inclusive Growth Institute, 2 the Reserve Bank of Minneapolis is conducting research on structural barriers that limit full participation in economic opportunity and advancement in the country. The Institute looks beyond aggregate economic indicators in order to examine how national policies impact diverse communities of people within the U.S. economy. The Board cosponsored a Gender and Career Progression 3 conference with the European Central Bank and the Bank of England in May of this year. There were about 140 people in attendance, including participants from central banks, academia, think tanks, private industry, as well as a number of local students. The topics and papers from the conference focused on gender diversity in economics, finance, and central banking, including gender-based discrimination, the benefits of increased diversity, the role of culture, and the approaches that could be used to improve gender diversity. We continue to explore ways to leverage the knowledge gained from this event for the Board, the System, and the broader economic community. The Board subsequently held a panel discussion for its employees sharing key insights from the conference. Throughout the System, we continue to increase our outreach to local universities, with a particular focus on outreach to under-represented groups. The Board will soon be hosting Exploring Careers in Economics, 4 an event for high school and college students, in October. Organized to broaden awareness of careers in economics and to further develop a diverse pool of talent interested in the field, Exploring Careers in Economics will offer students a chance to learn about and discuss opportunities in economics generally, and learn about mentoring opportunities, resources, and career opportunities within the System. The agenda includes a discussion of why inclusion and diversity matter for economics. In addition to welcoming students to the Board in Washington, students from around the country will participate in this event via webcast. The Board’s OMWI Office, in collaboration with the OMWI Directors from the Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), and Consumer Financial Protection Bureau (CFPB) (collectively, the Agencies), hosted a Diversity and Inclusion Summit (Summit) on September 13 at the Federal Reserve Bank of New York for the institutions regulated by each regulatory agency. The primary purpose of the Summit was for the Agencies’ OMW is to provide feedback on submissions received from regulated entities responding to the questionnaire developed through the Policy 2 For more information about the Opportunity & Inclusive Growth Institute, go to: https:// www.minneapolisfed.org/institute. 3 The conference program and discussion materials are available on the Bank of England’s website at: https://www.bankofengland.co.uk/events/2018/may/gender-and-career-progression. 4 For more information about the Exploring Careers in Economics event, go to https:// www.federalreserve.gov/newsevents/pressreleases/other20180823a.htm. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 43 Standards for Assessing Diversity Policies and Practices pursuant to section 342 of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act). Additionally, an important aspect of the Summit was the dialogue and insights between representatives from the regulated entities and the OMWI Directors on leading diversity practices. Q.2. In your role as the head of the Reserve Bank Affairs Committee and now as Chair of the Board of Governors of the Federal Reserve System, did you ever ask the search committees in Atlanta, Richmond, or New York for a lists of candidates under consideration? At any point did you urge the search committees at any of the Banks to broaden their searches to include more women or minority candidates? A.2. As the Chair of the Reserve Bank Affairs Committee, I had worked closely with the search committees to ensure a strong and transparent process that identifies a broad and diverse slate of qualified candidates for president searches. Now as Chairman of the Board, I continue to work closely with my colleague Lael Brainard, Chair of the Reserve Bank Affairs Committee, to exercise the Board’s oversight responsibility and stress the importance of conducting a broad search throughout the search process. We also recognize that the appointment of a president is, as a legal matter, a responsibility of the Class Band Class C directors. During the recent Reserve Bank president searches, the search committees proactively sought out candidates from a variety of sources. The search committees have also carried out extensive outreach programs intended to solicit input and candidate recommendations from a range of constituencies across the districts. These engagement efforts were done with the goal of having as broad and diverse of candidate pools as possible for the searches. Throughout the search process, the chair of the search committee typically provides status updates, including information about the candidate pools, and discusses potential candidates with the Chair of the Reserve Bank Affairs Committee. Q.3. What is your role, directly and indirectly, in the San Francisco Federal Reserve Bank’s search to select its next President? A.3. The San Francisco Fed announced the appointment of Mary Daly as its new president on September 14. As Chairman of the Board, I stayed abreast of the search through the Chair of the Reserve Bank Affairs Committee. When the search committee settled on the finalist, my colleagues and I at the Board interviewed Ms. Daly. Upon final approval by all Class B and Class C directors of the Federal Reserve Bank of San Francisco, my colleagues and I at the Board voted on the Bank board’s request for approval of the appointment of Ms. Daly as the new president for the Reserve Bank. Q.4. Recently proposed legislation would override the Securities and Exchange Commission’s (SEC) 2014 reforms to money market funds. Specifically, that legislation would permit sponsors of money market funds that satisfy certain conditions to utilize a stable net asset value, or NAV. In addition, the proposal would exempt those funds from the liquidity fee requirements in the SEC’s rules. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 44 As you know, the SEC’s 2014 reforms require institutional money market funds investing in corporate or municipal debt securities to use a floating NAV and provide nongovernment money market fund boards with new tools—liquidity fees and redemption gates— to prevent runs. Those mechanisms are intended to prevent runs on money market funds and the freezing of the short-term liquidity market that occurred during the financial crisis. Nellie Liang, who served for 11 years in senior roles at the Federal Reserve in the Division of Financial Stability and the Division of Research and Statistics, recently wrote an article titled, ‘‘Why Congress shouldn’t roll back the SEC’s money market rules’’ (attached). Ms. Liang’s article explains the market dislocation that occurred during the crisis that led to the SEC’s implementation of the 2014 reforms. Ms. Liang highlights several important improvements to the structure of money funds, explaining that during the crisis ‘‘there was no doubt that the structure of prime MMF’s amplified losses and spread problems to many companies when their investors ran.’’ She concludes that the ‘‘post crisis rules aim not only to prevent a repeat of the last crisis but to reduce the probability and costs of the next one,’’ and that, ‘‘reverting to precrisis rules would risk a return to high levels of private short-term liabilities and another destabilizing run on money market funds, and threaten stability in the financial system and the economy as a whole’’. Do you agree with Ms. Liang’s concerns that reverting to precrisis rules could create vulnerabilities in the stability of the financial system? A.4. Susceptibility of money market funds (MMFs) to runs was a significant vulnerability and flashpoint in the U.S. financial system during the financial crisis and afterwards. The run on MMFs in September 2008 destabilized wholesale funding markets used by banks, dealers, nonfinancial firms, and municipalities for shortterm financing. The Securities and Exchange Commission’s (SEC) reforms were designed to mitigate these risks. In part due to these regulatory changes, funding markets have undergone significant shifts; while markets have largely adjusted to these shifts, considering additional changes at this moment would likely be unhelpful to the funding markets. Q.5. In your testimony, you noted that the banking industry is well-capitalized. Recent research from the Fed system suggests that large banks may hold less capital than is optimal in terms of balancing the cost of another financial crisis with any incremental increase in bank lending rates. 5 5 Former Fed Chair Yellen cited research noting that ‘‘research points to benefits from capital requirements in excess of those adopted.’’ See remarks by Chair Janet L. Yellen. ‘‘Financial Stability a Decade After the Onset of the Crisis’’. Speech at the ‘‘Fostering a Dynamic Global Recovery’’ Symposium Sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 25, 2017. Available at: https://www.federalreserve.gov/newsevents/speech/ yellen20170825a.htm; Firestone, Simon, Amy Lorenc, and Ben Ranish, ‘‘An Empirical Economic Assessment of the Costs and Benefits of Bank Capital in the U.S.’’, Board of Governors of the Federal Reserve System, 2017. Available at: https://www.federalreserve.gov/econres/feds/files/ 2017034pap.pdf; Federal Reserve Bank of Minneapolis, ‘‘The Minneapolis Plan To End Too Big To Fail’’, December 2017. Available at: https://www.minneapolisfed.org/-/media/files/publications/studies/endingtbtf/the-minneapolis-plan/the-minneapolis-plan-to-end-too-big-to-failfinal.pdf?la=en. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 45 What do you think of this research? Do G–SIBs need to hold additional capital? A.5. Maintaining the safety and soundness of the largest U.S. banks is critical to maintaining the stability of the U.S. financial system and the broader economy. These firms must be well-capitalized in order to be considered safe and sound. Accordingly, the U.S. banking agencies have substantially strengthened regulatory capital requirements for large banking firms, thereby improving the quality and increasing the amount of capital in the banking system. From before the crisis to today, large U.S. banking firms have roughly doubled their capital positions, making them significantly more resilient, as well as able to support lending and financial intermediation in times of financial stress. Firestone et al., the staff working paper that you cite, analyzes aggregate capital levels across the U.S. banking sector and does not address targeted capital requirements that apply to specific banks. A firm identified as a global systematically important bank (G– SIB) is currently subject to more stringent capital requirements than those required of other, less systemic firms. Under the Federal Reserve’s final G–SIB surcharge rule, a G– SIB is required to hold an additional amount of risk-based capital that is calibrated to its overall systemic risk as well as an additional supplementary leverage ratio buffer of 2 percent above the 3 percent minimum in order to avoid restrictions on distributions and certain discretionary bonus payments. G–SIBs, together with certain other large banks, also are subject to annual examination of capital planning practices through the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) and to a supervisory stress test. Finally, G–SIBs are required to maintain minimum levels of unsecured, long-term debt and total loss-absorbing capacity (TLAC), which is made up of both capital and long-term debt, in order to further help reduce the systemic impact of the failure of a G–SIB. The purpose of these more stringent requirements is to increase a G–SIB’s resiliency in light of the greater threat it poses to U.S. financial stability. This capital regulatory framework is designed to ensure that G–SIBs, as well as the banking industry as a whole, maintain strong capital positions. Q.6. When asked at the July 17 hearing about your plans to implement S. 2155, you said it is your intention ‘‘implement the bill as quickly as we possibly can.’’ Does that mean you are going to move to the rulemakings and implementation of S. 2155 before you finish the remaining unfinished rulemakings required by the Wall Street Reform and Consumer Protection Act enacted 8 years ago? A.6. Many of Economic Growth, Regulatory Relief, and Consumer Protection Act’s (EGRRCPA) changes require amendments to existing rules. The Board is working expeditiously on these rulemakings and plans to solicit public comment on the proposed rule changes. EGRRCPA includes a number of statutory deadlines for implementing certain sections of the law. It is our intention to prioritize rulemakings with statutory deadlines in order to ensure that the Board’s rules are compliant with the law in the timeframe mandated by Congress. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00049 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 46 The Board has implemented the majority of its assigned provisions from the Dodd–Frank Act. Sections of EGRRCPA, along with the remaining unimplemented sections of the Dodd–Frank Act, which do not have statutory deadlines, may take longer to complete. Q.7. Does the Fed view any provisions in S. 2155 as providing a statutory requirement to revisit or recalibrate the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets? A.7. One of the fundamental lessons from the financial crisis was that the largest, most interconnected financial firms needed to maintain substantially more capital, take substantially less liquidity risk, and face an effective orderly resolution regime if they fail. Firms with assets of $250 billion or more can present a range of safety and soundness and financial stability concerns. Therefore, the Board has tailored, and will continue to tailor, as appropriate, our regulations to the risk profiles of the firms subject to those regulations. In light of EGRRCPA’s amendments, and consistent with the Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets are appropriate. In doing so, the Board will consider individual firms’ capital structure, riskiness, complexity, financial activities (including the financial activities of their subsidiaries), size, and any other riskrelated factors that the Board deems appropriate, as provided in EGRRCPA. Q.8. Either pursuant to S. 2155 or pursuant to other authority conferred to the Fed, does the Board intend to alter the threshold at which foreign banking organizations must establish a U.S. Intermediate Holding Company? Does the Fed intend to provide any regulatory relief to foreign banking organizations that have more than $50 billion in domestic assets? If so, what regulatory relief is the Fed planning to propose? A.8. Pursuant to the Board’s regulations, foreign bank organizations (FBOs) with global assets of at least $100 billion and U.S. nonbranch assets of at least $50 billion are required to establish or designate a U.S. intermediate holding company (IHC). In our supervisory experience, the requirement to establish an IHC has worked effectively, providing for appropriate application of capital, liquidity, and other prudential requirements across the U.S. nonbranch operations of the FBO, as well as a single nexus for risk management of those U.S. nonbranch operations. The Board presently sees no reason to modify this threshold. We continue to review our regulatory framework to improve the manner in which we deal with the particular risks of FBOs in light of the distinct characteristics of such institutions. Q.9. Does the Fed have any economic evidence suggesting that the recently enacted tax bill, S. 2155, or any deregulation finalized by regulators since 2017 has benefited the overall economy through increased lending? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00050 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 47 A.9. Economic conditions remain strong. Gross domestic product growth thus far this year is estimated to have averaged a little above 3 percent at an annual rate. Households and businesses have been able to obtain the financing needed to support this growth. Financial institutions are well-positioned to meet the needs of borrowers. However, it is too early to determine the economic effects of the tax bill or recently implemented changes in regulation. Generally speaking, it is difficult to isolate the effects of such changes given the myriad factors influencing the economy. Q.10. Does the Fed intend to revisit the calculation of the G–SIB surcharge? If so, when and in what ways? A.10. The Board’s capital rules have been designed to reduce significantly the likelihood and severity of future financial crises by reducing both the probability of failure of a large banking organization and the consequences of such a failure, were it to occur. Capital rules and other prudential requirements for large banking organizations should be set at a level that protects financial stability and maximizes long-term, through-the-cycle, credit availability and economic growth. Consistent with these principles, the Board originally calibrated the G–SIB surcharge so that—given the circumstances of the financial system—each G–SIB would hold enough capital to lower its probability of failure so that the expected impact of its failure on the financial system would be approximately equal to that of a large non- G–SIB. The bulk of the postcrisis regulation is largely complete, with the exception of the U.S. implementation of the recently concluded Basel Committee agreement on bank capital standards. It is therefore a natural and appropriate time to step back and assess those efforts. The Board is conducting a comprehensive review of the regulations in the core areas of postcrisis reform, including capital, stress testing, liquidity, and resolution. The objective of this review is to consider the effect of those regulatory frameworks on the resiliency of the financial system, including improvements in the resolvability of banking organizations, and on credit availability and economic growth. In general, I believe overall capital for our largest banking organizations is at about the right level. Critical elements of our capital structure for these organizations include stress testing, the stress capital buffer, and the enhanced supplementary leverage ratio. Work is underway to finalize the calibration of these fundamental building blocks, all of which form part of the system in which the G–SIB surcharge has an effect. In this regard, I would note that the G–SIB surcharge rule does not take full effect until January 2019. Q.11. When does the Fed intend to finalize a 2016 proposed rulemaking related to bank holding companies’ allowable activities in physical commodities markets? A.11. The Board undertook a review of the physical commodities activities of financial holding companies after a substantial increase in these activities during the financial crisis. In January 2014, the Board invited public comment on a range of issues related to these activities through an advance notice of proposed rule- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00051 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 48 making. In response, the Board received a large number of comments from a variety of perspectives. The Board considered those comments in developing the proposed rulemaking that was issued in September 2016. The proposed rulemaking would address the potential catastrophic, legal, and reputational risks of financial holding companies’ (FHC) physical commodities activities by applying additional risk-based capital requirements to some of these activities; tightening some of the existing limitations on physical commodities trading by FHCs; and establishing new reporting requirements for physical commodities holdings and activities of FHCs. Under the proposal, FHCs would be permitted to continue to engage in a number of physical commodities trading activities with end users subject to new limits on physical commodities trading activities. After providing an extended comment period (150 days) to allow comm enters time to understand and address the important and complex issues raised by the proposal, the Board again received a large number of comments from a variety of perspectives, including Members of Congress, academics, users and producers of physical commodities, and banking organizations. The Board continues to consider the proposal in light of the many comments received. Q.12. At the July 17 hearing, when asked when the Fed will finalize the rulemaking required under Dodd–Frank related to incentive-based compensation at large bank holding companies, you stated that the interagency regulators have been unable to reach consensus and that the Fed has accomplished some of the goals of the rulemaking through the supervisory process. Please provide specific examples. A.12. Section 956 of the Dodd–Frank Act 5 prohibits incentivebased compensation arrangements that encourage inappropriate risks. Federal Reserve staff have worked with firms in the implementation of the 2010 Federal Banking Agency Guidance on Sound Incentive Compensation Policies, 6 a core principle of which is that incentive compensation should appropriately balance risk and reward. In so doing, Federal Reserve staff have observed improvement in incentive compensation practices in the following areas: • Risk adjustment: Firms have increasingly begun adjusting compensation to more appropriately take into account the risk an employee’s activities may pose to the organization, including through use of deferral and forfeiture features in compensation arrangements. Firms also have increasingly focused on nonfinancial risk (e.g., compliance failures, misconduct, and operational challenges) in risk adjustment decisions. • Involvement of risk management and control personnel: Risk management and control personnel generally play a greater role in the design and operation of incentive compensation programs than before the financial crisis. • Director oversight: Boards of directors are now increasingly focused on the relationship between incentive compensation and risk. For example, at the board level, finance and audit com5 Public 6 75 VerDate Nov 24 2008 14:11 Dec 18, 2018 Law 111-203, 124 Stat. 1376 (2010). Federal Register 36395. Jkt 046629 PO 00000 Frm 00052 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 49 mittees generally work together with compensation committees with the goal of promoting prudent risk-taking. • Policies and procedures: Firms have increasingly developed written policies and procedures to guide managers in making appropriate risk adjustments. Q.13. What is the your view on the Fed’s role as the consolidated Federal regulator for insurance companies that have a savings and loan holding company? A.13. The Federal Reserve is charged with consolidated supervision of savings and loan holding companies to promote the safety and soundness of the subsidiary insured depository institution (IDI) and the holding company. Our principal supervisory objectives for consolidated supervision of insurance savings and loan holding companies (ISLHCs) are to ensure that they operate in a safe-andsound manner so that the subsidiary insured depository institution is protected from risks related to nonbanking activities, including insurance, as well as intercompany transactions between the parent and IDI, and to ensure that the IDI is not adversely affected. To avoid duplication, we rely on the State insurance departments to the greatest extent possible, including their supervision of the business of insurance. In applying our consolidated supervision, we work to ensure that regulations, supervisory guidance, and expectations are appropriately tailored to account for the unique complexities and characteristics of ISLHCs. We remain committed to tailoring our supervision of ISLHCs to the firms and their insurance operations, as well as conducting our consolidated supervision of these firms in coordination with State insurance regulators. Moreover, the Board continues to welcome feedback from ISLHCs and other interested parties on the potential impact of our supervision and proposed rulemakings in the context of ISLHCs’ business and practices. Q.14. Vice Chair Quarles recently gave a speech suggesting that the Fed should ‘‘consider scaling back or removing entirely resolution planning requirements for most of the firms’’ in the $100 billion to $250 billion total consolidated asset range. Please describe further the Fed’s plans in this regard, along with any cost-benefit analysis suggesting that the economy would benefit from such a change. How does the Fed view the directive in S. 2155 that companyrun and certain supervisory stress tests be made ‘‘periodic’’ rather than semi-annual or annual? Does the Fed anticipate changing the frequency of stress tests for banks with more than $250 billion in total consolidated assets? A.14. Consistent with the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), the Board is considering the application of enhanced prudential standards, including resolution planning requirements, to firms in the $100 billion to $250 billion total consolidated assets range. Resolution planning is especially critical to ensure that the largest, most complex, and most interconnected banking firms structure their operations in ways that make it more possible for them to be resolved upon failure without causing systemic risks for the broader economy. The Board therefore anticipates focusing resolution planning requirements on these VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00053 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 50 firms. Firms with total assets between $100 billion and $250 billion, especially those that are less complex and less interconnected, do not pose a high degree of resolvability risk. Therefore, we should consider no longer imposing the resolution planning requirement on at least a subset of the firms with total assets between $100 billion $250 billion. The Board will solicit feedback, including feedback on costs and benefits, on any proposed changes to the applicability of resolution planning requirements through the public notice and comment process. The provisions of EGRRCPA are generally consistent with the Board’s view that supervision and regulation should be appropriately tailored to the risks posed by firms to the financial system. The Board also recognizes that the complexity of banks can vary significantly from bank to bank, even for institutions within the $100 billion to $250 billion group. Those banks, which provide a significant amount of credit to the economy, range from large regional banks to an institution that has been designated a systemically important financial institution given its size and complexity. That suggests we may need to consider factors beyond size when we consider whether it is appropriate to reduce the frequency of the stress test. Pursuant to the provisions of EGRRCPA, the Board will assess the necessary and appropriate frequency of supervisory and company-run stress tests to effectively ensure the safety, soundness, and resiliency of the financial system while concurrently minimizing regulatory burden. In general, firms that pose limited risk to financial stability would be expected to be subject to less frequent supervisory and company-run stress tests than those with a large systemic footprint. Of course, we would invite public comment on any proposal to change the frequency of the stress test. Q.15. Does the Fed intend to exempt any firms from the requirement to calculate risk-weighted assets according to Advanced Approaches? A.15. The Board is currently focused on ways to simplify the existing capital rules and to reduce any unwarranted complexity of the applicable capital requirements overall, rather than on considering exemptions for particular firms. The Board believes there is room to simplify the capital framework, while preserving the stringency of the overall capital requirements. The Board is also actively reviewing the requirements applicable to firms with more than $250 billion in total assets to make sure they are appropriately tailored to the firms to which they are applied. Q.16. How does the Fed’s planned rulemaking regarding ‘‘reach back’’ application of enhanced prudential standards anticipate expeditiously capturing quickly growing firms whose risk to the economy may rapidly escalate? For example, Countrywide grew from $26 billion in total consolidated assets in 2000 to $211 billion in 2007, and posed systemic threat to the economy. A.16. EGRRCPA tailors supervisory requirements to the size and complexity of banking organizations. As is reflected in EGRRCPA, regulations should be the most stringent for the largest and most complex institutions. Rulemakings proposed by the Board to tailor existing requirements would be designed to maintain a safe, sound, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00054 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 51 and stable banking system that supports economic growth without imposing unnecessary costs. Under this principle, if a bank grows in size and complexity, the Board’s regulatory framework would apply increasingly stringent requirements to that banking organization commensurate with the organization’s size and complexity. Q.17. In what ways, if any, does the Fed intend to revamp the Community Reinvestment Act (CRA)? A.17. The Federal Reserve supports modernizing the Community Reinvestment Act (CRA) regulations so that they better reflect structural and technological changes in the banking industry and strengthen the rules to help address the credit needs of low- and moderate-income communities. We think an Advance Notice of Proposed Rulemaking (ANPR) is a good starting point to gather input on the impact of the significant advancements in technology and other changes in the financial services marketplace since the regulations were last revised. We value input from all stakeholders on the impact of the significant advancements in technology and other changes in the financial services marketplace since the regulations were last revised. We look forward to reviewing suggestions that result from the OCC’s ANPR on possible refinements to CRA regulations. While there are many positive aspects of the current regulations, we believe that there are opportunities to improve clarity and consistency through modernization efforts, which would benefit both banks and the communities they serve. The Board also believes that revised regulations should recognize that banks vary widely in size and business strategy and serve communities with different credit needs. An interagency modernization process is also an opportunity to define ways to evaluate a bank’s CRA performance in light of its size, business strategy, capacity, and constraints, as well as its community’s demographics, economic conditions, and credit needs and opportunities. To this end, more metrics could provide clarity. It is important that the use of metrics is sufficiently responsive to local credit needs and account for differences in performance expectations based on a bank’s size, business model, and strategy. The Board values the interagency process, and we look forward to working with the OCC and the FDIC on any regulatory revisions that would promote consistency in the implementation of CRA across the industry, as well as offer the greatest impact to benefit reinvestment in local communities, consistent with the spirit and intent of the law. Q.18. Assessment Areas under CRA are geographical areas where bank performance is evaluated on CRA exams. Currently, these areas include bank branches and deposit-taking ATMs. Many banks are making loans outside of branch networks, using alternative delivery channels including the Internet. Has the Federal Reserve given thought to changing the definition of Assessment Areas to reflect the changing landscape of banking? A.18. Yes. The central focus of the law is on a bank’s affirmative obligation to meet the credit needs of the communities it serves, including low- and moderate-income communities, consistent with safe-and-sound lending. The Board believes it is time to modernize VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00055 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 52 the regulations, including making changes to the definition of a bank’s ‘‘assessment area,’’ in which its CRA performance is evaluated. The banking environment has changed significantly since CRA’s enactment and since the current CRA regulation was adopted. The regulation focuses on assessing performance where banks have branches, but many banks may now serve consumers in areas far from their physical branches. Therefore, the Board agrees that it is sensible for the agencies to consider expanding the assessment area definition to reflect the various ways a bank can serve local communities, while retaining the core focus on place. Q.19. Comptroller Otting, during Committee testimony in June, suggested reducing CRA performance measurement to a simple formula system comparing the sum of CRA activities to bank assets. Making this ratio the totality of a CRA exam would abandon current examination weights which judge certain activities as more important than others, based on local needs. Do you support this single ratio approach? A.19. We support updating the CRA regulations to make them more effective in making credit available in low- and moderate-income areas. In enforcing CRA, we have identified principles to guide our work. For example, the Board believes that revised regulations should be tailored recognizing that banks vary widely in size and business strategy and serve communities with widely varying needs. We believe this can be done while retaining the flexibility to evaluate a bank’s CRA performance in light of its size, business strategy, capacity, and constraints as well as its community’s demographics, economic conditions, and credit needs and opportunities. We recognize the importance of considering the ways in which a bank’s business strategy, no matter its size, influences the types of activities it undertakes to meet its CRA obligations. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00056 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 53 Why Congress shouldn'1 roll back !he SEC's money marl<<I rules hlq>s:/lwww.brooking;.<dulbloglup-fionii2018/0I/121why-<Oilgress-shou... BROOKINGS Why Congress shouldn't roll back the SEC's money market rules Nellie Liang Friday, January 12, 2018 A t the height of the financial crisis in 2008, the Primary Reserve Fund ran into triggering a run on money market mutual funds. Investors pulled nearly $450 out of prime money market funds (MMFs) in just a few weeks, causing the fun stop lending to big banks and industrial giants General Electric and Ford and endangering their ability to promptly meet payrolls and other bills. The government responded, quickly and creatively, with both a guarantee for existing MMF investors to stop the run, as well as an emergency liquidity facility, the Commercial Paper Funding Facility, to provide financing to companies that lost their access to short-term funds amid the turmoil. In2014, the Securities and Exchange Commission changed the rules for moneymarket funds so this would never happen again. Those rules are working well. But some in the industry want Congress to undo them. That would be a mistake. Before the crisis, prime MMFs (those permitted to invest in short-term IOUs issued by borrowers other than governments) were allowed to promise investors $1 for their shares even when the value of their portfolios fell below $1 ashare. If values fell to less than $0.995 a share, the fund could no longer round up to $1, and a board couldclose a fund. Unlike banks, the money market funds weren't required to hold capital or insurance to back up their $1 promise-even though they were investing in securities that fluctuated in value. This structure created a classic investor run problem similar to the runs that banks faced before the creation of deposit insurance in the 1930s. Investors who believe the value of the investments will fall to less than $1have an incentive to pull out their funds before others. The first investors to withdraw money will receive $1 per share. Those who wait will get only the Oower) market value-often with a delay. As investors run for the exits, funds sell assets to meet these redemptions. The sales cascade through the economy, pushing down the price VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718101.eps 7124nOI8, 1:19PM I ofS 54 Why Congrw shouldn'l roll back lhe SEC'.s money !llirk<l rulos hnps'ilwww.broo'r.ings.edulbloglup-frool/2018/0I/12iwlly.<on8f,...•hou ... of these assets and forcing big companies who borrow from money market funds to scramble for funding, making the problem worse. In 2010, the SEC tightened the rules to reduce the credit and liquidity risk of the assets that prime money market mutual funds could hold. The SEC also required greater disclosure of the assets, but the rules cannot eliminate the risk of price fluctuations and thus the incentive for investors to be the first out the door. So in 2014, the SEC changed the rules, which ultimately took effect in October 2016. Today, the value of both prime money market shares and shares of municipal tax-exempt securities sold to institutional investors float with the value of the securities in their portfolios. (The rules didn't apply to money market funds sold to retail investors.) Funds that invest in U.S. Treasury and other sovereign securities were permitted to maintain the fixed $1/share value. Since the rules went into effect, short-term markets have been functioning smoothly-and in a much less risky environment. Anticipating the change, some money market investors moved money from institutional prime funds and tax-exempt funds to funds that invested in less risky Treasury and government securities. The total amount of money invested in money market funds-nearly$:> trillion-did not change. It just shifted from riskier prime investments to more stable government funds that can maintain the $1/sharevalue. 2ofS 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00058 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718102.eps VerDate Nov 24 2008 712412018, I:S9 PM 55 Why Coogrcss sllouldn'1roll bock the SEC'; moo<y""11<<1 rules hllp11/\\ww.brool<ing<«<ulblogl•p-fnl<llfl018101112/llily<OIIgrcss·sllou..• Money Market Mutual Fund Assets by Type of Fund 12113/IS IQI31Ml Source: Securities and Evchange Commission Moreover, the shift has not led to any notabledisruptions in short-term funding markets. The commercial paper market, an important source of short-term funding for large corporations, remains at roughly$1 trillion outstanding, after havingshrunk dramaticallyin the financial crisis. Nonfinancial companies have been increasing their commercial paper outstanding, despite the drop in prime MMF assets, and are issuing at spreads that have remained quite low. JofS 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00059 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718103.eps VerDate Nov 24 2008 712412018. 1:59 PM 56 Wloy Congress shouldn·, roll back lh< SEC's ""'~Y nwi<« rul<s hllp;:IA"'w.brookins><dufblogluf>fronlf201S/Olll:!lwhy«>ngress·shou... Commercial Paper Outstanding Source: Federal ReseiVe Board 4cfS 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00060 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718104.eps VerDate Nov 24 2008 71'...11201S.I:59PM 57 Why Congr<ss <l10111dn ·,roll bac~ the SEC's money m•r!:et rules hupsJ/Miw.brookings.<dulblog/up-frontllOIS'OI/l:!lwhr<OIIgrCSS·<Iiou... Overnight CP Spreads, Nonfinancial lO day moving average 0.7 0.6 0.5 0.4 0.3 .0.2 .0.3 0!112107 03113111 06/13114 01109118 Source: Federal Reserve Board Most big money managers adjusted to the new rules, but a few- apparently unhappy that the changes have cut into their revenues-are pushing Congress to undo them.These managers want to allow institutional prime and tax-exempt funds to once again be able to promise to redeem shares at $!/share, even when they hold risky assets. Their argument is that these funds didn't cause the financial crisis and reforms have gone too far. But there is no doubt that the structure of prime MMFs amplified losses and spread the problems to many companies when their investors ran. Prime MMFs that promise a fixed $1 are a source of systemic risk. Post-crisis rules aimnot onlyto prevent a repeat of the last crisis, but to reduce the probability and costs of the next one. Reverting to pre-crisis rules would risk a return to high levels of private short-tem11iabilities and another destabilizing run on money market funds, and threaten stability in the financial system and the economy as a whole. Sofl 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00061 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718105.eps VerDate Nov 24 2008 7/2li201S.I:59 PM 58 RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER FROM JEROME H. POWELL Q.1. The Federal Housing Finance Agency (FHFA) has proposed a new regulatory capital framework for the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (each, an ‘‘enterprise’’). See Proposed Rule, Enterprise Capital Requirements (83 Federal Register 33,312) (Jul. 17, 2018). FHFA’s proposed rule contemplates that the credit risk transfers (CRT) of the enterprises would provide capital relief. Id. at 33,356. According to FHFA, with respect to capital relief for CRT, ’’the proposed approach is analogous to the Simplified Supervisory Formula Approach (SSFA) under the banking regulators’ capital rules applicable to banks, savings associations, and their holding companies.’’ Id. at 33,358. But FHFA also acknowledges that ‘‘the proposed approach deviates from the SSFA in that it: (i) [p]rovides for a more refined view of risk differentiation across transactions by accounting for differences in maturities between the CRT and its underlying whole loans and guarantees, and (ii) docs not discourage CRT transactions by elevating aggregate post-transaction risk-based capital requirements above risk-based capital requirements on the underlying whole loans and guarantees.’’ Id. What are the material differences between (i) the rules governing the capital relief afforded a CRT of an enterprise under FHFA’s proposed rule and (ii) the rules governing the asset credit, liability reduction or other capital relief afforded a similar transaction of a banking organization under the rules of the Board of Governors of the Federal Reserve System (the Board)? A.1. The Federal Housing Finance Agency’s (FHFA) proposal on ‘‘Enterprise Capital Requirements’’ recognizes the risk mitigation effects of credit risk transfers (CRTs). CRTs are transfers of credit risk from Fannie Mae and Freddie Mac on a portion of their loan portfolio to private sector investors. If CRTs meet certain qualifying criteria, Fannie Mae and Freddie Mac are able to reduce the amount of capital held against those portfolios. The treatment for CRTs proposed by the FHFA is tailored for two types of products: single-family home loans and multifamily loans. These products have standardized characteristics that are incorporated in the FHFA’s proposed approach for risk weighting these exposures. The regulatory capital rule, adopted by the Federal Reserve Board of Governors, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (collectively, ‘‘banking agencies’’), similarly recognizes credit risk mitigation effects of credit risk transfers and allows a banking organization to assign a lower risk weight to an exposure. However, relative to the approach proposed by the FHFA, the banking agencies’ capital rule recognizes credit risk mitigation for a much broader variety of exposures. The banking agencies’ approach for recognizing credit risk transfer through a securitization needs to be flexible enough to accommodate a wide variety of securitized asset classes without standardized characteristics. The approach may require more capital on a transaction-wide basis than would be required if the underlying assets had not been securitized, in order to account for the com- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00062 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 59 plexity introduced by the securitization structure. Furthermore, the banking agencies’ capital rule requires banking organizations to meet certain operational requirements. An inability by a banking organization to meet these operational requirements may lead to higher risk weighting, relative to the FHFA’s proposed approach. Q.2. Does the Board expect to consider FHFA’s approach to capital relief for CRT, and also the experience of the enterprises with CRT, when the Board next reviews its own rules governing the capital relief afforded to banking organizations for CRT and similar transactions? A.2. The FHFA’s proposal is specifically designed for Fannie Mae and Freddie Mac and their specialized lending purposes. The FHFA has calibrated its proposed capital requirements and tailored its credit risk mitigation rules to two specific categories of exposures: single-family home loan and multifamily loan portfolios. Banks have a wider variety of exposures than Fannie Mae and Freddie Mac. Thus, banks require a different calibration of capital requirements and a more general set of rules governing the recognition of credit risk mitigation. RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON FROM JEROME H. POWELL Q.1. International Organizations. Background: The Federal Reserve has membership in several international standard-setting bodies. Among them are the Bank for International Settlements (BIS) and the Financial Stability Board (FSB). These standard-setting bodies provide opportunities to push U.S. interests and greater regulatory harmonization globally. The level of participation by the Federal Reserve going forward is unclear. The question is intended to give Chairman Powell an opportunity to describe his vision for the Federal Reserve’s participation in these international organizations. Chairman Powell, the Federal Reserve has traditionally played an important and active role in international standard-setting bodies such as the Bank for International Settlements (BIS) and the Financial Stability Board (FSB). This has been important for both representing the interests of the United States and promoting policies that benefit the global financial system. In the Treasury Department’s first report to the President on financial regulatory reform, it advocated for robust U.S. engagement in international financial regulatory standard-setting bodies as a way to ‘‘promote financial stability, level the playing field for U.S. financial institutions, prevent unnecessary regulatory standard-setting that could stifle financial innovation, and assure the competitiveness of U.S. companies and markets . . . .’’ The Treasury Department recommended in its report that U.S. regulators advocate for international regulatory standards that are aligned with U.S. interests. As Chairman, what will be your top priorities when representing the United States in international standard-setting bodies such as BIS and FSB? A.1. One of our top priorities in international standard setting bodies is to consolidate the financial reform gains we have achieved globally. These include a responsible increase in bank capital VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00063 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 60 standards, introduction of liquidity standards, recovery and resolution planning for the most globally active and systematically important banks, and mandates to increase incentives for financial firms to centrally clear derivatives. As we get further from the financial crisis, it will become easier to forget the reasons for which we took actions to strengthen significantly the prudential framework for banks and global financial stability. Therefore, it is important that the United States, with its large number of globally active financial firms, continue to play a central role in reenforcing this message at the international level. At the same time, we believe now is an appropriate time to evaluate the reforms to ensure that they are working as efficiently and effectively as they can and do not give rise to adverse incentives. The evaluation work, already underway, may lead us to adjust various standards to achieve these objectives while maintaining the strength and resiliency of the system. Q.2. Can you describe the work you hope to accomplish or new initiatives you hope to pursue in BIS, FSB and other relevant international standard-setting bodies? A.2. One priority is to finalize the bank capital framework for trading activities. Strong standards are necessary for these activities as trading activities facilitated many of the riskier bank practices that led to the crisis. At the same time, it is important to ensure that these standards are well-crafted in order to avoid adverse effects on market liquidity. The international standard-setters are also working to build up financial firms’ resiliency to operational risks, including those emanating from cyber-risks. These risks are some of the most important risks that financial firms face today. These international efforts are aimed at ensuring that we have common terminology to discuss these risks and have a common set of expectations for firms’ resiliency in the face of operational risk incidents. Q.3. EU. Background: Legislative bodies in Europe are considering draft revisions to the European Market Infrastructure Regulation (EMIR) that would bring U.S.-based and other third-country central counterparties (CCPs) under the regulation and supervision of the EU for the first time. The proposed changes would expand the European Securities and Markets Authority’s (ESMA) and the European System of Central Banks’ supervisory authority over thirdcountry CCPs, including U.S. CCPs, that are recognized to do business in Europe. EMIR’s stated purpose for making these changes is to address the potential risks that third-country CCPs could pose to the EU’s financial system. These changes could also reopen a 2016 equivalence agreement for derivatives clearinghouse supervision between the CFTC and the EU authorities. CFTC Chairman Giancarlo has expressed significant concerns regarding the potential impact this proposed legislation could have on U.S. CCPs. In recent testimony before the U.S. Senate Agriculture Committee, Chairman Giancarlo stated that ‘‘regulatory and supervisory deference needs to remain the key principle underpinning cross border supervision of CCPs. Deference continues to be the right approach to ensure that oversight over these global markets is effective and robust without fragmenting markets and trading activity.’’ The question is intended to determine how Chairman Powell’s intends VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00064 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 61 to address this issue and whether his views align with that of other U.S. regulators. The European Union is considering legislation that, for the first time, would permit EU regulators, including the European Central Banks, to directly supervise systemically important U.S.-based and other third-country CCPs, including U.S. CCPs in the securities and derivatives markets. This approach itself could pose risks and potentially interfere with the Federal Reserve’s ability to ensure its policies are being effectuated without interference by EU supervisors. The U.S. Congress and regulators have chosen to not take this approach and instead adhere to the long-standing principal of regulatory deference. How do you plan to address this situation as Chair? The proposed legislation (EMIR 2.2) would subject U.S. CCPs to overlapping EU regulation and supervision without deferring to U.S. regulators that oversee these entities; namely, the Federal Reserve, SEC, and CFTC. Do you share CFTC Chairman Giancarlo’s concerns about this proposal? If so, are you coordinated in your position and messaging to the EU? A.3. The U.S. central counterparties (CCPs) that may potentially fall within the scope of the proposed European Union (EU) legislation to amend the European Market Infrastructure Regulation include those designated as systemically important financial market utilities (DFMUs) by the Financial Stability Oversight Council under Title VIII of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act). The Commodity Futures Trading Commission and the Securities and Exchange Commission are the supervisory agencies with primary responsibility for supervising and regulating these firms. The Federal Reserve Board (Board) plays a secondary role in the oversight of these CCPs under Title VIII of the Dodd–Frank Act. The proposed EU legislation has more direct implications for the primary supervisors of these firms, and those agencies are actively involved in a dialogue with EU authorities. To date, Board staff has worked to educate EU authorities on the legal framework created by Title VIII, explained the nature of the Board’s role in the oversight of DFMUs, pointed out differences considered in the proposed EU legislation, and expressed support for cooperation among authorities. The Board has a long-standing policy objective to foster the safety and efficiency of payment, clearing, and settlement systems and to promote financial stability, more broadly. 1 In that policy, the Board has set out its views, and related standards, regarding the management of risks that financial market infrastructures, including CCPs, present to the financial system and the Federal Reserve Banks. It has also described how it will engage cooperatively with authorities with direct responsibility for particular CCPs located outside of the United States. As a central bank, the Federal Reserve has a particular interest in liquidity issues. As far as liquidity risks are concerned, it is immaterial whether a CCP is based in the United States or abroad so long as it clears U.S. dollar denominated assets and makes and 1 See, Federal Reserve Policy on Payment System Risk: https://www.federalreserve.gov/ paymentsystems/files/psrlpolicy.pdf. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00065 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 62 receives U.S. dollar payments. The current EU legislative proposal outlines that the European Commission, in consultation with the European Securities and Markets Authority and the relevant EU member central bank, may determine a third country CCP to be of such systemic importance to the EU that the only way to mitigate the risks posed would be for that CCP to establish its clearing business within the EU. This aspect of the proposed legislation presents a risk of splintering central clearing by currency area, which could fragment liquidity and reduce netting opportunities. Given the extensive cross-border nature of the firms potentially covered by the proposed EU legislation, we support the EU and U.S. authorities’ efforts to search for cooperative solutions to these issues that promote CCP resilience while upholding the aims of both U.S. and international authorities. RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS FROM JEROME H. POWELL Q.1. Supervising large, globally active banking organizations—such as those covered by the Federal Reserve’s Large Institution Supervision Coordinating Committee (LISCC)—are among your agency’s most important responsibilities. While LISCC supervision traditionally relates to areas such as lending, credit risk, and capital and liquidity risk, many of the strategic and operational risks that larger banks manage are in areas unrelated to traditional banking services and functions. My concern is that as these areas become a larger potential source of risk, supervisory teams may not have the technical expertise to properly oversee these complex financial institutions and may in fact be tempted to substitute their judgement rather than apply bright line regulations. In fact, if regulators without technical expertise begin to substitute their judgement for that of bank management in these areas, this could lead to increased systemic risk. How do you make certain that your field supervisory teams possess the requisite amount of technical experience in areas like cybersecurity, technology, incentive compensation planning, and human resources management to oversee banks in the LISSC portfolio? Do you agree that supervisory staff should not substitute their judgment on such matters of general corporate strategy, especially when they do not have the requisite technical expertise? A.1. As you note, supervising Large Institution Supervision Coordinating Committee (LISCC) firms is one of the most important responsibilities of the Federal Reserve. The purpose of this supervision is to ensure that these firms operate in a safe-and-sound manner, consistent with U.S. financial stability. The Federal Reserve conducts supervision of LISCC firms by assessing the adequacy of firms’ capital and liquidity positions, effectiveness of resolution and recovery planning, the strength of risk management, governance and controls, and compliance with laws and regulations, including those related to consumer protection. All areas of supervision—including quantitative assessments—require some amount of judgment. Supervisors undergo extensive training to en- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00066 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 63 sure that this judgment is exercised in a fair and consistent manner that furthers the safety and soundness of the supervised firms. While the Federal Reserve has significant experience in evaluating lending, credit risk, and capital and liquidity risk, it also has a depth of experience in evaluating strategic and operational risks. We assess these risks by considering the effectiveness of boards of directors, senior management oversight, reporting quality, independent risk management, and internal audits, among others. As needed, the Federal Reserve develops or hires personnel with the necessary expertise. In all technical areas, the Federal Reserve uses both quantitative and qualitative analysis to assess the strength of firms’ practices. 1 We also use cross-firm comparative analysis, commonly referred to as horizontal analysis, to ensure that our assessments reflect the range of practices that constitute safety and soundness standards; furthermore, this tool allows for a more consistent application of supervisory standards. To ensure the appropriateness of supervisory findings, material supervisory judgments and assessments of LISCC firms are subject to a rigorous internal governance process, which includes oversight by committees of individuals from different parts of the Federal Reserve System. This process is designed to bring the collective expertise and perspective of the Federal Reserve to bear on assessments of LISCC firms. A key objective of LISCC supervision, and in fact, supervision for all firms, is to ensure that a firm’s governance, risk management activities, and internal controls adequately support the firm’s current risk taking and strategic objectives. To this end, the Federal Reserve has well-defined and controlled processes that are appropriate for technical and specialized activities. Q.2. For several years, banking organizations that provide services such as safekeeping and custody to asset managers, have engaged with the Federal Reserve on the critical need to refine exposure measurement calculations for use in capital rules and credit exposure limits. These discussions have led to the inclusion of technical changes to these capital rules in the finalization of the Basel Committee’s postcrisis capital reforms agreed to by the Federal Reserve in December 2017. One of the most important portions of this agreement relates to securities lending which provides a critical source of revenue to pension funds, mutual funds, endowments, and other institutional investors. Given the importance of securities lending to these asset managers which include pension funds, such as the South Dakota Retirement System, enacting these technical changes to the capital rules for securities financing transactions is an urgent matter. I hope the Federal Reserve will consider separating these targeted, technical changes from the rest of the Basel IV package and begin domestic implementation. Is there an opportunity for the Federal Reserve to propose rules to implement these technical changes, and perhaps others, separately and ahead of its longer range plan to solicit public input on 1 Other technical areas include, for example, trading and counterparty credit risk management, stress testing, and credit underwriting, and risk management monitoring models. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00067 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 64 the broader and more substantive capital changes later this year through the Advanced Notice of Proposed Rulemaking (ANPR) process? A.2. The Federal Reserve Board (Board) understands the concerns with respect to the capital rules’ treatment of securities financing transactions, and Board staff participated with their international colleagues on the technical changes provided by the Basel Committee in December 2017. These changes would provide a more risk-sensitive treatment of such products, including to better account for diversification and correlation. Board staff, in coordination with the other Federal banking agencies, are evaluating this new standard as well as other standards adopted by the Basel Committee at the end of 2017 to determine whether and how best to incorporate them into the capital rules. In addition, the Board has been tailoring its regulations regarding the treatment of securities lending and, more generally, securities financing transactions. On June 14, 2018, the Board finalized the Single-Counterparty Credit Limits rule. The final rule applies to the largest banking firms, placing limits on a firm’s credit exposures to a single counterparty. These limits address the risks to the economy that are created when large firms are highly interconnected. During the public comment period, commenters argued that the measurement methodology for exposures resulting from securities financing transactions would not create proper incentives for risk reduction and would not accurately measure the actual exposures associated with securities lending activities. In order to address this concern, the final rule allows a firm to use any methodology that it is authorized to use under the Board’s risk-based capital rules to measure exposure resulting from securities financing transactions. This approach is consistent with other Board regulations, including the capital rules. RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCOTT FROM JEROME H. POWELL Q.1. I appreciate your timely response to my written questions from your March 1, 2018, appearance for this Committee. In your reply, you wrote that ‘‘the State-based system of insurance regulation provides an invaluable service in protecting policyholders.’’ I could not agree more—and believe that the U.S. system of insurance regulation is the best in the world. That is why I’m concerned that recent International Association of Insurance Supervisors (IAIS) negotiations on the International Capital Standard (ICS) in Kula Lumpur (KL) suggest an embrace of a European-centric approach to insurance capital standards. For example, in the KL agreement, it was decided that the reference ICS shall have European-like capital requirements (Prescribed Capital Requirement) and use a European accounting method (Market Adjusted Valuation). In the past, the Federal Reserve has stated that the IAIS does not have any authority to impose enforceable obligations on U.S. insurance firms and that there is no way that IAIS negotiations could result in the application of a capital standard on U.S. insur- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00068 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 65 ance firms that is inconsistent with U.S. laws and regulations. However, if U.S. negotiators agree to a standard at the IAIS that does not formally recognize the U.S. insurance regulatory system or, worse, requires that the U.S. change its regulatory system to match the agreed upon standard and we do not change our laws, then the EU or other jurisdictions could penalize U.S. firms operating in said jurisdictions. Please answer the following with specificity: What positions will you take during upcoming IAIS negotiations on the ICS to ensure the protection of the U.S. system of insurance regulation? A.1. I agree that, in order for an Insurance Capital Standard (ICS) being developed through the International Association of Insurance Supervisors (IAIS) to be implementable, it cannot be unsuited or inappropriate for the United States, which remains the world’s largest insurance market. As such, an overly European-centric ICS would face challenges to being readily implementable in the United States. As the Federal Reserve Board (Board) has suggested in relation to insurance firms supervised by the Board, such a framework may not adequately account for U.S. Generally Accepted Accounting Principles (GAAP), may introduce excessive volatility, and may involve excessive reliance on supervised firms’ internal models. 1 Indeed, the Board strongly supports the U.S. State-based insurance supervisory system, which has proven its strength and resilience for well over a century. Among other things, this motivates our advocacy of an aggregation alternative, and the use of the GAAP-plus valuation method, in the ICS. We continue to advocate, and contribute to developing, the GAAP-plus valuation method for inclusion in the ICS. In addition, we support the collection of information through the monitoring period on an aggregation-based approach. We also participate along with the other U.S. members, together with other jurisdictions including Canada, Hong Kong, and South Africa, in the development of such an approach through the IAIS. Furthermore, the Federal Reserve continues to develop the Building Block Approach, an aggregation-based approach that, together with the Group Capital Calculation of the National Association of Insurance Commissioners (NAIC), can be used to advocate the aggregation method. Through field testing and monitoring, we will advocate that an aggregation method provides comparable outcomes in supervisory actions and insurance company results relative to the standard calculation method for ICS that is emerging from the IAIS. As a member of the IAIS, the Federal Reserve, in partnership with the NAIC and Federal Insurance Office, remains committed to pursuing an engaged dialogue to achieve outcomes that are appropriate for the United States. As a general proposition, we believe in the utility of having effective global standards for regulation and supervision of internationally active financial firms. When implemented consistently across global jurisdictions, such standards help provide a level playing field for global financial institutions. Further, consistent global regulatory standards can help limit regu1 See Advance Notice of Proposed Rulemaking, Capital Requirements for Supervised Institutions Significantly Engaged in Insurance Activities, 81 Federal Register 38631, 38637 (June 14 2016). VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00069 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 66 latory arbitrage and jurisdiction shopping, as well as promote financial stability. While we would refrain from agreeing to any international standard that is inappropriate for the United States, it is important to recall that the IAIS has no ability to impose requirements on any national jurisdiction, and any standards developed through this forum are not self-executing or binding upon the United States unless adopted by the appropriate U.S. lawmakers or regulators in accordance with applicable domestic laws and rulemaking procedures. RESPONSES TO WRITTEN QUESTIONS OF SENATOR TILLIS FROM JEROME H. POWELL Q.1. Chairman Powell, I’d like to turn to S. 2155 implementation. Many of us are hoping that you and Vice Chairman Quarles will be taking a robust role in crafting the rules to implement the newly enacted law. What role are you currently playing in the implementation of S. 2155? A.1. The Federal Reserve Board (Board) is working in an expeditious manner to implement the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). The Board has a well-established governance process for implementing rulemakings and ensuring that such rulemakings are compliant with the law, including statutory deadlines set by Congress. Draft rulemakings are carefully reviewed and considered by the Board’s Committee on Supervision and Regulation, which is chaired by Vice Chairman Quarles. I meet with staff on a regular basis to discuss regulatory proposals and provide direction. The Committee’s proposals for amendments to the Board’s regulations are finalized only after a vote by the full Board of Governors. Q.2. Many of your staff are the same staff that helped write the implementing rules for the Dodd–Frank Act. In some sense, the new law mandates they revise their own prior work. From experience, I would say that such a mandate will take robust oversight on your part and on our part—do you agree? Can you give us some insight into how you and Vice Chair Quarles are managing these workstreams and orchestrating the workstreams? A.2. As I mentioned above, the Board is working in an expeditious manner to implement the recently enacted EGRRCPA. The highest priority of the Federal Reserve is to implement the laws that we have been entrusted to administer and to work to protect and enhance the safety and soundness of financial firms and the financial stability of the U.S. financial system. The Board has a well-established governance process for implementing rulemakings and ensuring that such rulemakings are compliant with the law. I meet with staff on a regular basis to discuss regulatory proposals and provide direction. Of course, Vice Chairman Quarles has a statutory obligation to develop policy recommendations for the Board regarding supervision and regulation of depository institution holding companies and other firms we supervise. He is actively involved in the development of proposals to implement EGRRCPA from the initial design through finalization. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00070 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 67 I would also note that, in general, Board staff regularly revisits, revises, and tailors previously approved rulemakings. Through the rule implementation process, the Board receives feedback from affected banking organizations and other interested parties. The Board also learns from the experience of the on-the-ground Reserve Bank examiners. Because of this continuous dialogue, the Board may conclude that aspects of a regulation require amendment or streamlining. Q.3. One area where I would hope that congressional intent is followed is with respect to the SIFI threshold in Section 401 of the bill. My view is that all banks under $250 billion in assets are out of the enhanced prudential standards and that those above $250B are able to take advantage of the mandated robust tailoring so that the larger regional banks are not treated like the money center banks and that we are taking business model and risk into account when applying enhanced regulations. Is this your view? A.3. Section 401 of the EGRRCPA raised the threshold for automatic application of enhanced prudential standards for bank holding companies from $50 billion to $250 billion in total consolidated assets. Under this section, the Board has the discretion to apply enhanced prudential standards to bank holding companies with total consolidated assets between $100 billion and $250 billion, based on consideration of various factors, such as capital structure, riskiness, complexity, financial activities, size, and any other riskrelated factors that the Board deems appropriate. The core reforms put in place after the financial crisis—stronger capital and liquidity requirements, stress testing, and resolution planning—have made our financial system more resilient. Firms with assets of $100 billion or more can present a range of safety and soundness and financial stability concerns, depending on their risks and systemic profile. These concerns typically increase for firms with assets of $250 billion or more. Therefore, the Board has tailored, and will work to continue to appropriately tailor, our regulations to the risk profiles of the films subject to those regulations. The Board is carefully considering the statutory criteria under the EGRRCPA for determining which enhanced prudential standards should continue to apply to firms with $100 billion to $250 billion in total consolidated assets. The Board is also evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets are appropriate. Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through the public notice and comment process in the coming months. Q.4. I also expect the agencies to take a look at all of the regulations where they used $50 billion as the asset threshold for application, including those outside of DFA Section 165, and raise the number accordingly. What are your thoughts? A.4. As part of its implementation of EGRRCPA, the Board is considering which of its regulations require changes given the amended applicability thresholds in the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act), including section 165, as well as section 11 of the Federal Reserve Act. In addition, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00071 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 68 in light of EGRRCPA’s amendments to section 165 and consistent with the Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any other changes to the prudential standards applicable to large banking organizations are appropriate. The Board’s capital plan rule utilizes a $50 billion asset threshold and was not affected by the changes made to section 165. Per the Board’s public statement on July 6, 2018, the Board will not take action to require bank holding companies with total consolidated assets greater than or equal to $50 billion but less than $100 billion to comply with the capital plan rule. Q.5. Chairman Powell, the Federal Reserve and the Office of Financial Research have studied systemic risk and have determined that banks under $250BB do not pose a systemic risk and Congress passed and the President signed S. 2155 to raise the threshold to $250BB for the application of enhanced prudential standards. I believe that the FED should expeditiously follow this directive and should follow the will of Congress, and not wait 18 months. Will you commit to me that you will direct Fed staff to effectuate this new threshold and then move on to tailoring above the $250BB threshold? A.5. As stated above, the core reforms put in place after the financial crisis—stronger capital and liquidity requirements, stress testing, and resolution planning—have made our financial system more resilient, and I would not want to see any material weakening of these reforms. The Board has the discretion under the EGRRCPA to apply enhanced prudential standards to firms with total consolidated assets between $100 billion and $250 billion. When doing so, the enacted legislation requires us to consider various factors, such as capital structure, riskiness, complexity, financial activities, size, and any other risk-related factors that the Board deems appropriate. The Board is carefully considering the statutory criteria under the EGRRCPA and is evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets are appropriate. Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through the public notice and comment process in the coming months. Q.6. The relief in S. 2155 is not immediate, and without prompt action, the relief will not come until Nov. 24, 2018, 18 months after enactment. Do you plan to take action immediately? A.6. There are a number of provisions in EGRRCPA that provided relief immediately upon enactment. The Board, along with the other Federal banking agencies, have taken action to address the EGRRCPA changes that took effect immediately. As described in the Board’s July 6, 2018, statements, the Board will not take action to enforce existing regulatory and reporting requirements in a manner inconsistent with EGRRCPA. For example, the Board will not take action to require bank holding companies with less than $100 billion in total consolidated assets to comply with certain existing regulatory requirements. These requirements include the en- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00072 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 69 hanced prudential standards in the Board’s Regulation YY, the liquidity coverage ratio requirements in the Board’s Regulation WW, and the capital planning requirements in the Board’s Regulation Y. The Board’s statement and interagency statements also discuss other changes that took effect upon enactment and the interim positions that will be taken until the relevant regulations are amended to conform with EGRRCPA, including the treatment of high volatility commercial real estate exposures and certain municipal securities in the context of liquidity regulations. EGRRCPA also raised the threshold for automatic application of enhanced prudential standards for bank holding companies from $50 billion to $250 billion in total consolidated assets. Under this section, the Board has the discretion within 18 months of enactment to apply enhanced prudential standards to bank holding companies with total consolidated assets between $100 billion and $250 billion based on consideration of various factors. The Board is carefully considering the statutory criteria under the EGRRCPA for determining which enhanced prudential standards should continue to apply to firms with $100 billion to $250 billion in total consolidated assets. In addition, in light of EGRRCPA’s amendments, and consistent with the Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets are appropriate. Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through the public notice and comment process in the coming months. RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED FROM JEROME H. POWELL Q.1. If changes are made to the Community Reinvestment Act that lead to financial institutions, including those that have an online presence, to take deposits from communities but actually make less of an effort to reinvest in these same communities, would you consider that to be a good or bad outcome? A.1. I would view revisions to the regulation that cause financial institutions to make less of an effort to reinvestment in these communities as an undesirable outcome. In addition, a successful update to the Community Reinvestment Act (CRA) regulations should encourage banks to spread their community investment activities across the areas they serve and encourage them to seek opportunities in areas that are underserved. Currently, a bank’s performance in its major markets is evaluated most closely and weighs most heavily in its CRA rating. This emphasis has resulted in what banks and community organizations refer to as credit ‘‘hot spots’’ where there is a high density of banks relative to investment opportunities. Meanwhile, other areas have a difficult time attracting capital because they are not in a bank’s major market, if they are served by a bank at all. We believe that any new set of regulations should eliminate such market distortions and avoid creating new ones. No matter how we VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00073 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 70 define a bank’s assessment area in the future, new regulations need to be designed and implemented in a way that encourages performance throughout the areas banks serve. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JEROME H. POWELL Q.1. In response to my question about the joint agency rulemaking required by Section 956 of Dodd–Frank, you said, ‘‘We tried—we were not able to achieve consensus over a period of many years between the various regulatory agencies that need to sign off on that. But that didn’t stop us from acting, you should know. We—particularly, for the largest institutions, we do expect that they will have in place compensation plans that—that do not provide incentives for excessive risk-taking. And we expect that the board of directors will make sure that that’s the case. And so, it’s not something that we haven’t done. We’ve, in fact, moved ahead through supervisory practice to—to make sure that these things are better than they were and they’re substantially better than they were. You see much better compensation practices here, focusing mainly on the big firms where the problem really was.’’ 1 Your response suggests that the relevant agencies have ceased work on this rulemaking. Is that correct? A.1. After the Federal Reserve Board (Board), Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities Exchange Committee, National Credit Union Association, and the Federal Housing Finance Agency (the agencies), jointly published and requested comment on the revised proposed rule in June 2016, the agencies received over one hundred comments. These comments raised many important and complicated questions. The agencies continue to consider the comments. The Federal Reserve believes that supervision of incentive compensation programs at financial institutions can play an important role in helping safeguard financial institutions against practices that threaten safety and soundness, provide for excessive compensation, or could lead to material financial loss. In particular, supervision can help address incentive compensation practices that encourage inappropriate risk-taking, which may have effects on not only the institution in question, but also on other institutions or the broader economy. Additionally, The Federal Reserve continues to work with firms to improve incentive compensation practices and promote prudent risk-taking at supervised entities. Q.2. Please provide a detailed explanation of how the Federal Reserve is either limiting or prohibiting incentive-based compensation practices that encourage excessive risk-taking through supervision. A.2. The Federal Reserve, along with the other Federal banking agencies, issued Guidance on Sound Incentive Compensation Policies (Guidance) in June 2010. The interagency guidance is anchored by three principles: 1 https://plus.cq.com/doc/congressionaltranscripts-5358712?4 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00074 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71 • Balance between risks and results: Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks; • Processes and controls that reinforce balance: A banking organization’s risk-management processes and internal controls should reinforce and support the development and maintenance of balanced incentive compensation arrangements; and • Effective corporate governance: Banking organizations should have strong and effective corporate governance to help ensure sound incentive compensation practices, including active and effective oversight by the board of directors. The Guidance explains how banking organizations should develop incentive compensation policies that take into account the full range of current and potential risks, and are consistent with safe-and-sound practices. Relevant risks would vary based on the organization, but could include credit, market, operational, liquidity, interest rate, legal, conduct, and related risks. The Guidance also discusses the importance of considering compliance risks (including consumer compliance) when evaluating whether incentive compensation arrangements balance risk and rewards. Currently, supervisory oversight focuses most intensively on large and complex banking organizations, which warrant the most intensive supervisory attention because they are significant users of incentive compensation arrangements and because flawed approaches at these organizations are more likely to have adverse effects on the broader financial system. Q.3. Please provide any guidance issued to regulated institutions or materials provided to bank examiners on incentive-based compensation practices. A.3. Attached to this response are: • Guidance on Sound Incentive Compensation Policies, issued by the Federal banking agencies in June 2010; 2 and • A Report on the Horizontal Review of Practices at Large Banking Organizations, issued by the Board in October 2011. 3 Q.4. What metrics, thresholds, and standards is the Federal Reserve using to evaluate incentive-based compensation practices? A.4. The Federal Reserve’s approach is principles-based, and recognizes that organizations have unique incentive compensation practices that vary depending on the firm’s organizational model and operating structure. The supervisory process focuses on assessing how firms have integrated their approaches to incentive compensation arrangements with their risk-management and internal control frameworks to better monitor and control the risks these arrangements may create for the organization. Supervision also considers whether appropriate personnel, including risk-management personnel, have input into the organization’s processes for design2 https://www.federalreserve.gov/newsevents/pressreleases/bcreg201000621a.htm 3 https://www.federalreserve.gov/publications/other-reports/incentive-compensation-report201110.htm VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00075 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 72 ing incentive compensation arrangements and assessing their effectiveness in restraining imprudent risk-taking. Q.5. Which institutions are subject to the Federal Reserve’s supervision of incentive-based compensation practices? A.5. The Guidance, issued by the Federal banking agencies in June 2010, applies to global consolidated operations of all U.S.headquartered banking organizations and to the U.S. operations of foreign banking organizations with a branch, agency, or commercial lending company in the United States that use incentive compensation. Because of the size and complexity of their operations, Federal Reserve supervision focuses on large banking organizations, those with the most significant use of incentive compensation, and those with the most complex operations. Q.6. Were those institutions selected for supervision by asset size or some other factor? A.6. The principles-based Guidance issued by the Federal banking agencies in June 2010, applies regardless of size; however, the Federal Reserve focuses supervisory oversight on the largest banking organizations, those with the most significant use of incentive compensation, and those with the most complex operations. The banking organizations involved in the horizontal reviews 4 were selected based on asset size and complexity of operations. Q.7. If there is no rule clearly delineating prohibited practices, how are you ensuring consistency across regulated institutions? A.7. Supervision of incentive compensation by the Federal Reserve is governed by the Guidance, which is integrated into the Bank Holding Company Supervision Manual. Federal Reserve understanding of incentive compensation practices was developed through the information collected during the horizontal reviews. With that understanding, the Federal Reserve has integrated incentive compensation in ongoing supervisory reviews, whether targeted (such as sales incentives or compliance reviews) or within individual lines of business (such as mortgage lending operations, or trading). A team at the Board monitors these reviews to encourage constituency. To foster implementation of improved incentive compensation practices, the Federal Reserve initiated multidisciplinary, horizontal reviews of incentive compensation practices at larger banking organizations. The primary goal was to consistently guide firms in implementing the interagency guidance. 4 For additional information on the Federal Reserve’s horizontal reviews of compensation practices, see: ‘‘Incentive Compensation Practices: A Report on the Horizontal Review of Practices at Large Banking Organizations’’, October 2011, available at: https:// www.federalreserve.gov/publications/other-reports/incentive-compensation-report-201110.htm. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00076 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 73 fedoral Register /Vol. 75, No. 122/Friday, june 25, 2010/Noticas an exemption under lhB ftoodom or lnfonnation Act (5 U.S.C. 5521bX4Iand (b)ISI). The confidentiality status ~f the infonnation submitted will be judged on a =·br..:ase bas~. Abstract: The infonnatioo oollocted assis~ tho Pedernl Re5a<Ve,the0fficeof the Comptroller of the Currency. lhe Federal Dep~it Insurance Corporation, and the Offico of Thrifi Supervision in fulfilling their s~tutory rosponsibililios as supervison. Each of these fOilll$ is used to collect inronnation in wish to utiliU!the exe-mption in that sectton to provide a notite to irs broker· dealer panner regarding nam,. and other ide11tifying information about bank emplor..s. Section 723 roquires a bank that chooses to rely on the exemption in that section to exclude certain trust or fiduciary accounts in determining its: compli,anoo with the r.hicfly componsaled tcsl in section 72.1 to maintain certain records relating tn the excluded atwunts. Secl.ifln 7-41 requires a bank relying on the COliRI!ItliOll ~~1th applicaliOI\Sand c.~emption pro\'ided b)• ~1at section to notices filed prior to proposed ch:!llges provide customers ~>ith a prospedus for in lhe ownership or rnaaagement of the money market 1\md securities, not banld:1g organizalions. The agencies use later than the time the cuSiomer the itlformalion t-o evalu.alc l.bc outhoril,.lhe bank lo effect the controlling owners, stnior om~. 30d transaction in such securities, if the directors of the in$\lred depository class of S<~ries of seoorilic:s are no! noinstitutions subiect to thetr oversight. load. 4. Repo~ title: Recordkeeping and lloord ofC9•m~oriM fo<lm!KIW!'~ Disclosure Requirements Associated Sytltm. )U:18 2'2, 20tG. "'ith Regulation It Jenn.ifer).Johnsl)n. Repo~e1>: Commertial banks and savin&s associations. ESfimared onm.rnl reporting hours: Section 701. disc:losures to customers12,500 hours; Se<tion 701, d~losllrnS to brokers--375 hours; Section 723, rocordbepillg---188 hours; Se<tion 741, disclosures to custome~l~OO hou.,, Bstimoted tJveropt houn per ~ponsc: SecHon 701. disclosures to customersS minutes; Section 701, disclosures to b:okers-15 minute.<~: Section 723:, recordk.,pir>r15 minutes; Se<tion 7<11. distiOSUfC;S to customcrs-5 minutes. Number oflllSpomknts: Section 701, disclosures to customers-1,500; Section 701, disclosures to broker:s1,500; Se<tion 123, reco<dkeepins---75; Section 741, disclosures to customl!fS750. C.neroJ description of reporl:This information collection is required to obtain a benefit pursuant to section 3(a)(!)(F) of the Securities Exchange Act (15 U.S.C. 7&:(a)(4)(F)) and may be gi\•en oonfidenti.'!l treatment tmderthe authority of the Freedom of luforrnation Act 15 U.S.C. 552(b)l4) and lbXal). Abslroct: Regulation Rimplements certain exceptions for banks from the definition ofbroket underSedion 3(a](41 of tho Securities El<change Act of 1934, as amended by the Cramm· Leach· Bliley Act. Sections 701, 113,and 141 ofRegulario11 R contain information collection requiremenls. Section 701 reqllire.s banks thai wish to utilize the e>:emption in th3t section to maku ceciain disdascres to lhe high nel worth customer or institution31 Cllstomer.ln addition, section 701 roquircs lllnks !hal VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 from lhc National tnrorm~tion Center web.~:;ito at 11'1.-.w.lfiec.govlnic/. Unless othcl'\vi.sc noted. commetlls regarding each olthese applications must be recei•ed at the Reserve Bank indicated o: the offices of the Board of Governors notlatetthan July 22,2010. A. fed<ral Resme Bank of AOanta (Clifford Sl>nlord, Vice President] 1000 Peachtree Strett, N.R, Atlanta, Coorgia 30309: r. USAmeriBollC<ltp, Inc.. Largo. Florida; to "'.JUire at least SO pertent of the votiogsbares of Aliantl'inancial ColJlornlion, and thereby indirectly acquire voting shares of Aliant Ban.k, both cf Alexander City, Alabama. B. Fedora! Rosme Bank of Minneapolis ljacquelineC. King. Communi\)' Affai" Officer) 90 Hennepin Avenue, Minnt:apolls, Minnesota 55480-0291: 1. Fim Holding D>mpcny of Pnrk Rirer, llfC., Park River, North Dakota; to establish a 1vbolly owned subsidiary. s..rtMryoftheS..rd. Sbeytnne Bancorp.loc., Park Rh·er, IFR Doe. 201o-1~!)2f'UII!Id 6-2Hit t.4~ol i\orth Dakota, and thereby acqu.ire 100 flllU't3CO()(UID-01...P pen;ent of the 1·oting shares of First - - - - - - - - - - - Sharon Holding Company, Inc.. Ane!a, North Dakota, and indirectly acquire fEOERAL RESERVE SYSTEM votingsharos of First State Ba1lk of Sharon, Sharon, Nonh Dakota. In Formations of, Acquisitions by, and connection with this application, Mergers ot Bank Holding Companies Sheyenne Bancorp, lnc., has also applied to become a bant holding Tho companies listed in this notice have applied to the Board for appmval, compan}'· pursuant to !be Bank Holding Company brd Gf Covetr.Of$ or the redmt RestiVe Systtlll, jt:ne2"2,'l0t0. Act ofm6 (12 u.s.c. !841 tt stq.) R.obett deV. Frit:tMn, (BHC Act), Regulalion YIll CFR Pan 225), and all other applicable statu:.. 0.}1fJtyS<m!aryoftheS..rd. and regulations Ill become a bank holding company and/or to acquire the assets Oi the ownenllip of, control of, or the power to vote shares ofa bank or bank holding company and all ofthe DEPARTMENT Of THE TREASURY banks and nonbanking companios Office of the Comptroller ot the 01vned by the bank holding company, includir:g thecompanios li~ed belo". Currency TI>e applications listed below, as well (Do<l<et IDO<:C-2010..0013) as olhor related filings roquirod by the FEDERAL RESERVE SYSTEM Beard, are a\·,ailable for immediate inspection at the Federal Reserve Bank IDo<!<oiNo.OP-1374) iDdicated. The applications also 11'itl he a.vailabls for inspection at the offices of FEDERAL DEPOSIT INSURANCE the Board ufCul'etnors. Interested CORPORATION persGns ma~· express their views in writingon the standards enummtcd in DEPARTMEtiT Of THE TREASURY tho BHC Act (12 U.S.C. 1842(c)).lfthe proposal also involves the acquisition or Ollice ol Thrill Supervision a nonbanking CQinpany, the rc\•icw also includes whether the OC<JU~ition of tho (Dooi<et 10 OTS-2010..0020] nonbanking company complies with the Guidance on Sound Incentive Slandards: in sedion 4 of the BHC Ad Compensation Policies (1?. U.S.C. 1843). Unlessothorwise noted, nonbanking activities will be AGENCY: Office ofthe Comptroller of the conducted throughout the United States. Clurency, 'TreasUl)' (OCC): Board of Additional information on e~ll bank Covemors or the Federal Reserve holding companies may be oblained Sy•lem, (Board or Pedernl Resarve~ Frm 00077 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718201.eps ~t8~~:, ~::~ ~:!i•• Freql1ency: Onocx:asicn. 36395 74 Federnl Register!Vol. 75, No. !22/Friday, )une 25, 2010/Nolicos foder.ll Deposit lnsurnnceCorporation (FDIC); Office ofThrifi Supervision. 'lmsury (OTS). ACTIOlt FinaJ guidance. SUW!AIIY: The OCC. Board, f'DIC and OTS (collecti"ely.tho Agencies) are adopting final guidance drsigned lo h(llp ensure tbal incellli~·e compensation policies 2l banking orgauiutions do not encourage imprudent risk-taking and areco1tsistent ~<ith the safety and soundness of the organi«~tion. OATES: Effective Dote:11m guida.llc:e is effecth•e on Jun~ 25, 2010. FOR RJRTHER INFORJIATlON CONTACT: OCC: Ka«!n M_KwHosz, Oim;:h>r, Operntiolllll Risk Policy.(202) 81~9~57, or Reggy Robinson, Policy Analyst, Operntiolllll Risk Policy, (202) 67l-i!36Board: William F. Treacy, Advi,.r. (202) 452-3859. Divi~on of Banking Supervision and Regulation; Marl: SCarey. Advi,.r, (202) 452-2781, Division o(fntematiorutl Finance; K1eran J. Fallon, Associa1e Gellernl Counsel. (202) 452-5270 or Mich.acl W. Waldron, _Cotl"'?l, (202) m -2798, Legal DJ\'tsto~. F?r users ~r Teleoommumcattons Oe\•tee for the Deaf MllD'J only, contact (2~2) 2ii:H869. FDIC: Mondy Wast, Ch•.•C Pohcy and Prosram Development, Dw•s1Gn of Supervision and Consumer Proteclion, (202) 898-722t,or Rc~rt W. Walsh, Revoew i!ltamm<:'·.P~hcy and Pr~m Development, Oo,soon of Supen-~oon and Consumer Protoctoon, (202)8986649. , . . OTS:Rit~ Gaffin, fman:oaJ Analyst, RIS~ Mod~hngand Analysos, (202) 0066181, or R1chard Brulnett. Semor Con!pli~ce Cou?sel, Regulations and Leg.slatton Dnli.sJon, (20219?6-7<a09; Donna Deale, Oorector,Holdmg_ Company and International Pohcy, (202) 906-7488. G_roYOtto G3rdineer, Managmg Dtrector, Corporata and ln!""'tionaiA<:Ii•ili", (202) 906-00611; Office o~Thnft SupcmSIOn,l70~0 C Street, NW.. Washmgton,OC 20>52. SUPPLEMEnURY l~RMAliO~: I. Background Compensation a.'T3ogcmc.nts arc critical tool~ in lhe.sucee.,~ful management of financial institutions. These amngemenL~ serve several important and worthy objecti•·,.. including attracting skilled staff, promoting better organiz.ation-wLde and employee performance, promoting employee retention, providing retiremer.t secttrily to employees, and allowi~1gan mganiz.alion's pC'I'S{)nnel oosiS to Vlry along with re'"nuss. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 It is clear, however, that compensation arnngemenls can provide executi•os and employees IYith ir.ccnli\'C:S lo lake impmdcnl risks tht are nol consistent with the long·tenn heahh of the organiution. for example, offering large payments to manager> or employees to produr,e ~iU!bfc inaeases in short-term revenue or profit-without regard for the potentially suOOI>ntial short or lttng-term risks associated wllh that nwenue nr profil~n encourage managers oremploy.,. to toke risks that are beyond the capability ofthe financial institution to Jnan3gc and control. flaw00 ince11tive compensatiOJl practices in tho financial industry wm one of many factors ct~ntributing lo the fin•ncial crisis that began in 2007. a.n~ing organiutions too often rewarded employees lor increasing tho o~ganiution's rsvenuc orsllort.tenn profit without adequate recognition of the ris!<.s tho employees' actiYitios posed to the organiution. H"ing wito\e.<sed the damaging consequences tbat can result from misaligned mamli\IBS, many financial institutions are now te..c:Q.rrnnmg the1r compcr.sation structures with the goal t~rbeuer aligning the intere.~ls or managers and other e1nployees with the long-term health ofthe institution. hlignillg tho inll>rests ofshareholders and employees however, is not always sufficient to p~tect th8 safely and soundness of a banking organi«~tion. Because banking organiutions benefit dinlctly or indirectly &om the prote<tions offered by the Redoral safety net (including the ability of insured depository institution.< to,..;,. inS\ored deposits and access tloe fedemI Reserve's discount window and payment servictS), shareholder$ of a banking organization in $0me cases may be willing to tolerate a degru of risk that is incons~tent with the orgonitation's safety and sou.ndness. Thus, a reYiew or incentive compensation amonge.:nents and related corporate govemance practicts: to ensure that they aro efre<ti" from the Sll!ndpcint ofshareholders is not sufficient to ensure they adequately protect the 53fety >nd .~<~undness of the organization. A. Proposed Gtridonce In Octobor 2009, tho Fedond Reserve issuod and requcslcd oommcnt on Proposed Cuida«:e on Sound lncenti" Compon.<ation Policies ("propo..d guidane<")lo help protect thesaroty and soundness of banking O<ganitations supervi"'d by the Federnl Reserve and to promote the prompt impro\'cmcnt of ittten~vew:n~n,<alion practices Frm 00078 Fmt 6602 Sfmt 6602 thro~out tho banking indusky.' The proposed guidance'"' based on lh,.. key principles. TI1ese principles provided that incentive compensation arrangements 31 <lt ba11~ing organiution should• Provide employm incentives (hat appropriately balance risk and reward; • Be compatible with p,ffectivc. controls and risk-n1anagement; and • Be .<upported by •trong r.orpornle governance, including actiV"e and effective ovmight by the organization's board of directors. Because incentive compensation arn11gements for exet:uth·e and nonexecuti•·e employees may pose safety and souodness cis!<.! if not properly SW<tured, the proposed guidance applied tos~::•,iotexeculives as well as other employees who. cithe.c iodi,idually or as part ofa group,~~" the ability 10 exp~ the relev~>t :~~~o1~~i~tion to matori.1l 0 With respect to the first prinoiple, the proposed guidanco, among other things. pro•ided that a banl:ing organiution should ensurs that its incentive comptnsalion arrangtlmf!nts do not encourage ~horl-le:rm profits at the expense of s.hort· and longM-term risks to the organi«~tion. Rather, the proposed guidance indicated that banl:ing 0'8'11iL1tions should adjust the incenti~·eoompe•,salion pro\lided so that eonployees bearsome ol the cisk associated with their activities. To be fully effecti,e, thesa adjustmentssbould takoacoountol the full range of risk< that the employee.-:' acth1ilies may pose for the organiution. Tho proposed guidance highlighted "'""'I methods that banking organizations could use to adjust incentive compensation awards or payments to take acoouot of risk. WiL~ respect to the saoond principle, the proposed guidance provided that banking organi1~tions should integrate their approaches to incentive compensation arrangements witli their risk~management and internal control frameworks to better monitOT and control the risks: these. 81't'8Jlgtments may create For lhe organization. Accordingly, the proposed guidance provided that banking orgoui«~tions shuuld ensure that ris~-management personnel have an a.ppropriate role in dtiSigniug incentive compensation arrnngements and as.~ing whether the amngcmcnts may encourage impntdent risk·taking.ln add ilion, the proposed guidance provided that banking organil.ations should track incentive oomptm~tion aw·ards and payments. risks lakcn.and actual risk outcomes to L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718202.eps 36396 75 Federal Register/Val. 75, No. 122/Friday. )uno 25, 2010/Notices adverse risk outcomes. With respect to the third principle, the proposod guidance providod that a ban~ing Olll'nization's OO.rd or directonshould pia)' an informed and active ro!e inensuring that the organiution's oor.tpoosation arrangements strike the proper balance bct~vccn risk and profit Mt only at the initiation ofa compensation progrnm. butoo 8JI ongoing basis. Thus. the prop~1ed guidance provided that boards of dired.or::;:should «wiew· and approve b:)• elements of their organizali01a1 ina~nH\•e C<lmpe.nsation systems aaoss the org,ani23tion, receive and review periodic evaluaUons of whether l11cir organizations' compensation systems for all major sogments or the 0'8'nil3tion are achieving their risl::-miligaliom objecliv<iS, and directly approve tbe incentive compensation arrangen•enls for senior executives. The Board's proposed guidanc:e applied 10 all banking organi-za1ions suptrvistd by tho Federal 1\esom. How·eve.r. the proposed guidance also included provisions intended to reflect the diversityamong banking org.miutions, both with n>Spec1to the scope and complexity of their activities. as ~><II a.s the preval~1ceand soopoor incentive compensation amngtmellts. Thl!.l, lor mmplc. the proposed guid8Jico provided that the revieiVS, policies, pra<edures, and S)"ttms implen10nted by a smaller banla~ orgat~iz.ation that uses incentive compensatkm anangements or• a limited basis would bo substantially less extensive, fonnaUzed, and detl!iled than those at a la.oge, complex hankins ocgonization 0-CBO)' that.,.. incenti\'e compensation arrangements extensively.Jn addition, because sound inoenti\'e compensatiGn practices are important to protect the safetyand soundness or all banking <>~&ani,.lions, the Federal Reserve announced lhal it wa.uld wlX'k with the a.ther Federal banking agencies to promote application of theguidance to all banking organizations. The Board invited comment 011 all aspects ol the proposed guidanco. The Board abo specifically requested comments on a number or issues. inch.tding whetbe:r. Jl:l~p."'ppS(d!\l~(lmledbrllleFednl ~~lbe ltrmLCIIOifiSUiedu 1his fs tbt l(ft utiHud by ll~e F'edmlftmml ~, d4r.nlligg SIJChoc.g,taiztlio.'K.lbefiul8'1Nill:.c:el:Se'.Sibt ... o..g.e.n~.. ~"'""'r..eo~"""" CI'I(((DI)J$St$ tmli~ 111111* b)' tM 00:. 11l1Cwlfti'S. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 • Thn thloc core princi,,les are appropriate ami suffiticnt to hclp ensure that inccntiYc compensation amngements do notthroater. the safoty and soundness of banking organizations; • There are any m3terialleg,tl, regulatocy, or other imptdinlents to th< prompt irnplemenration of inc.:enlh•e compensation arrangements and related processes that would be oonslsicnt wilh thDWprinciplcs; • Fonnutaic limits on incenli\'3 compensation ~~·ould likely promote lhe ..fely and soundness or banking O<ganiutions. "'heth<r applied gonerall)' or tospecific types of t.'l.lployees or banking organizations; • Markel forces or practices in tlle broader iina:1cial services industry, such .as the usc of•goJdcn pa.rachutc• or "golden hands~ake" am~ng..,cn~ to itlain or attract employees, present challenges for ban~lng ocganiutions in dc"Jclopingand maintaining balanced itl;ertHve compensation arrangements; • Ttte proposed guidance ,~·ould in1pose undue burdens on. ur have unintended consequences for, banking Of8aniz.ations, parti<:ularly srnallu) I~ complex 0'8anizations, and whether the:re are \l"ays such ~enti~J burdens or com•Equene&~ could be addressed in a manner r.onsistent with saftty and soundne.'l.S; and • There are types ofincentive contpen.salion pla:1s, such as organization-wide profit sharing plans that proYide for di~\ributions in a manner that is not materia.lly linked to the performance or specific cmpiGyces or gcoups of ernployoes, Ihat could and should be cxcmptod from, or lre.ltcd differently under,lhe guidanr.e t«ausc they are unlikely to affocttho risk·taking incentives ofall, or a significant numbP.r or employees. B. SupeNisory lniUalivts In conneclino wid' the issuance of the proposed guidance, tho Federal Rosorvo announced two supervisory ioitialives: • Aspeci>l horiaootal review of incentive compensation practices at lCBO's;and • ArcYicwoftnccnhvccompcnution practicos at other banking Ofganizations as part orthe regular. risk·focused examination process for these organizations. The horiurntal review was designed to asss..~: The potenlial for thase arrangements or practice$ toencourage improde.nt risk-taking: the actions an o:ganizatio11 has taken or proposes to take to correct dcficicndcs in its incenti\'O oompc:uation practices; and the adequacy of the organization's compensation·related ri.•k·management, Frm 00079 Fmt 6602 Sfmt 6602 control, and eorporate governance proce<SOS. U. 0\·erview ofComments The Board rer-.eived 3~ written comments on the proposed goi~ance. wbic:h """ shao:d and reviewed by all of the Agcnde:s. Comrncnters included banking organizaUnn.s,linancial serviC6S trade associations, setVi:.e pro\lide:rs to financial organizations, re~resentalives or institutional sh.archoldcn,la:bor org.aniZC'Itions, and individuals. Most commenters supported the goal of the proposed guidance-to ensure that incentiYe compensation amngements do not encourage imprudent or undue: risk·taking at banking ocganizations. Corumenters also generally suppo~ed the principlos·based approach of the proposed guidance. for example, many commenters specifically supported the avoidanct or formulaic or one~ill!-fiJs. all approaches to inc.enti\'t compensatiotl in the proposed guidance. These commenters noted financial org::anitations are \'ery di,·crso and should ho permitted to adopt incentive compensation measures that fit tbeir noeds, while also being consistet~t with sare and sound GJ)Ctations. Scvt!rnl comruenters also asserted that a rom10laic approach would inevitably lead to exa88eraled ri>k·taking inc:enti\•as in some situations 'l'hile disooureging emplo)'e<iS from taking reasonable and appropriate risks in olhezs. One comrneoter also argued that unintandcd con~uence.~ would be mere likely to rosult from a "riRid rulcmaklnf than from a flexible. principl~d approach. Many conunenters "''uested lbat the Board revi"' or clarify the proposed guidance in one or more respecl.~. For example, several commenters asserted that~" guidance should impose specific restticlio1\S on incenti\le compensation at bankingorganiloatiGns or mandate certain corporate govunance or risk~managen1eot practices. One commentor recommended a requiremcnl that most compensation ror senior executivas be provided in the fonn or variable, pcrlormance·l'cstcd equity aiVardslhat ac• dalerred lor at least five yoars, and lhat stock option compensation be prohibited. Anotheroommentet advocated a ban on "gold~• parachute" paymenls. and on bonuses based on metrics related to one year or less or perfonna:nce. Othe:r contmenters sugsested tbatthe guidance should require banking orgaotzations-to have an independent ehairman of the board of diroctnrs, reqt~ire arrnua\ majority \'Oting for all directors, or pro\1idc far shareholders 10 haoc ovote (so c~llcd L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718203.eps determine whether incentive compensation pa,ments to employoos are reducod oc adju.stod to retlect 36397 76 Federal Register/Val. 75, No. 122/Friday, june 25. 2010/Noliccs retain qltalified .staff and compete wilh other linancial services pn)\'tdcts. In light of these concerns, some commontors suggested that tlte guidance t1xpres:sly allo~\· bankingruganizations to enterinlosuch compensalic9 arrangements as the)' deem necessary forrecruitttlt:nt or retention purposes. A number ofcomnu~nters also encouraged the federal Re.~e.rve to ~\-ork \\·ilh other dom651ic and foreign supea·irors and authorities to promo1e ccmsiste.nt standards for incentive compensation pracllces at financial inslitulions and a ri~k. level competitive playing field far Sevaral commentm, however. .did not financial service providers. support the proposed guidance. Some of thest commenters felt that the proposed The comments rocein~d on the guidance was unneocssary and that the proposed guidance are further diSCil!sed bclOh". principles used ln the proposed guidance were nol needed. These IU. Final Guidance commentersarsued that the existing Alter carefully reviewing tile system ol flnanc~l regulalion and enforcement is sufficient toaddress tho oomntents on the proposed guidance, concerns raised in the proposed the Ageucios h01~ adapted final guidance. Several comnte:nters also guidance that retains the same l:.ey thought that the proposed guidanco was principle> em!>odied inthe proposed too vogue to be helpful, and that tho guidance. ·~th a number oladjustm~•ts ambiguity of tl10 proposed guidance and clarifications that addross mattcrs would make compliance more difficult. rajs.ec:J by lhe commenters. Those leading to increased cosband principles are: (lllnceotivo regulatory unceruinty. Som• compensation arrangements at a comoenlers alsn argued tbat the bonkingorgani>atian should provide guidance was not wamnted beca'USe employees incontives that appropriately there is insufficient evidence that balance risk and financial resuhs in a incentive compensation praclices manner that does not encourage contributed to sa(Cl)' and soundness or empiGyee..~ to expose their organitation.~ financial st3bility problenu, or to imprudent risk; (2)tltOS<: quostioned the authority of the Federal arrangements should be compatible R"""e or the ather Federal bonking with efiecti\'e r.onlrols and riskasencies to act in Ibis 8rP.a. manag<menl:and (3) those In addilion1 a nun1ber Gfcomme:mers arr-ange:nent.s should be supp<t<ted by expressed amcem that the proposed strong corpcr1tego\'emanoo. including g11ida.nc~ would impose undue burde.1 :tctive and effective oversight by the on bonking arg>nlMtions. particol>rly organization's board of directors. The smaller, less c:o:nplex orsanizations. 1\gellcies believe that it is important that These comment"' believed that incenth·e oompensalion arrangements at inoonti'ole r.ompensation practtces. at banking organizations do not JlrO\:ide !imaller hanking organizations were incenti\'es for employoosto take risks genorally nnt problematic from a safBty and soundness perspective.> Anumber that could jeapardile the safety and ~oundne:s.s oflhc organization. The final of oommcnters sugg.,.ted thatall or guidance seeks to address tile safety and most smaller banking organizations should be exempt from the guic!allc~ /1 soundness risks of illcentive compensation practices by focusing on nwnber of oommenters expressed the basic problem they can poae from a concoros that the proposed guid:lllce risl:.-managemrmt perspe«iva, that is:, would impose un:"Casonablc demands incentive compensaticm amngemenlson the boards of direc!ors of banking if improperly slructured-<an give organiutions and t$pecially srnallct empiGyccs incentives lo take imprudent orgaabation.~. risks. Several c:ommentel'$ also e~pre.ssod concern tltat the pmp.'>S<ld guidaRCO, il TheAsencies bel:evo the principles of implemented, could impede the abil:ty the final guidance should holp protoct ol banking "ll•nizations to attract or the safety ond S<>undnoss of banking organiutia:IS and the stability ol the lQulht olbr:t.ud,o::t<OCilfhe:lltt•oquesto:l financial system, and that adoplion of l~lhep!Of'J(ISI:dCG~~beCilfOICtJd the guidance is fully oomistent with the dii'f«etll)'t: lotJ'Sf!'l~lMIMtstlldylltmustof Agancies' statulol)' mandat1 to protec! UOrsil:l'. •say-on·pay" voting pro\•i.sions) on the ince1~tiva compensation amngemenls for certain employees ofbanking organizations. Otherwmment615 requosted that W1ain types of compensation plans. such as org>nlzation-wide profit shari113 plans or 401(kl plans or plans covered by tlte Employee Retire:nent lnCO!Ite S.CUrity Act (29 U.S.C. 1400 et seq.l. be exempted front the scope ol tho guidance bocau.sa they were unlikely to provide employees inccnli\'CS to expose their banking organiution to undue VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00080 Fmt 6602 Sfmt 6602 the safety and soundn~" of banking organi ?.atlons.~ Tho final g~tidance applies to alllho OOnking Olganizations su(M)rvistd by the Agencies. indudil18 national b3nks, State member banl:.s, Sl2te nonmember banks. savings associations, U.S. ban_ k holding companies, savings and loan holdingcompanies, the U.S. aperalian.< ol foreign bonks with a branch, agency or commercial lending company in tho United Slates, and Edgo and ogrooment oorpotations (collectively. t.t.lar1ldng organizations'). Anumber of ch.a.ngc:s have been made to the proposed guidanco iu response to comments. For example. tho final guidana inclt~des several provisions designed to reduce burden on smaller banl:.ing organizations and otller banki~-3 orgillii\lUo•l \bill•e nol significant tt~ of inoonti\•e compensation. The l!gendes also have mode a number of chongos to clarify the scope1 intonl, and terminology of th& fiuaf guidance. A. Scope ofGuidonco Compensation practices were oot lho sole cause of the financial crisis, bul thty certai;1ly ware a contributing <Ouse-a fact rocognized by 98 percent of the. responde.nls loa ~llfVey of ba:nking01:ganizations engaged in wholesale banking activities eondueled in 2009 by the Institute oflntemational finance and publicly by a number of individual fiuancial institulions.' Moreovcr,thc problems caused by improper compensation practices were not limited to U.S. financial institutions, but \vtre e~·ident at major financial insliluUons llo'orldwide, a fact recogntzed hy intamational bodies such ~~~;ts~~~:;!~"e~~ ttlhcrit)" i• Sl!'dion. s olllte f'oim.l Dtposil lu':lf'lllee{fl)O Ad. Ouid&auis tied eo i&Alify pruitc.that lbeAgtoc:fcsbtliettwoddc:or~i111te ICti~OI:UL.~p~[(~a.&'Ot lcfmlfyrisk.- W'~.t~)'}l.OO:U. ($1rob.. «otbarpn.c(m llntlhoA~l.ldicvt.,.UJidNiub:!Jll:iot ~~it,ltiMS f.1 e.'ISUiillg~\hey OpcaitiR I :Afll ~swlld-.&:~1Mr.S,fi'$SI~l*"r.\oll1d Uso rm to OTS"s •~;~loon tr.lpiO)'Illenl «<~!.lidS IZCfRS6J.39. l$ot.lt!Ai:lltoofb:oma:.iolulfl'~lnc. !201»~ C«nprrtJOfi«l in:I'JmtrifJlSsrlim.: ,,..,., l'ropu . , j l1w.._..,.../«CI>Of~ lW.W.ii$11:1W.MMcblmil&ll Mpi/ !a,IW.otil'tW•)W!OrvAt:I/CI'IflpdJ.firtPCfN.~~ ,.,._c.m,....... ·~-"'"'/ol$.pdf- s.. .... CBS.Sbul!lbo!d« Report OllliliS'I WriteOo;vU. April1a. 1!103. pp.41-12 (i&a:in-. inw.ti'l't ~!feW olt.rBS ((RJ*L'.llil)fl prKtiON as contr:b.lti:~g~ot:s.ltJIOissaA!f!ttedbJURSduo tot:.:pott:r=eiOtbt~me~tmaM.} ltalll!blt~ 1:-lr-pih!b'tt.Aibf.e«nni/Siw.r~li'GifJI im.~?~kJ1 J~IIICIIO&f>ll.. 5/mrAo.'&w/\tpC<!,4/. L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718204.eps 36398 77 Federal. Register/Val. 75, No. 122/Friday, june 25, 2010/Nolices and the Senior Supnrvi~ Croup.«~ Because ()Ompensation arrangemllnts for executive and non~ec.ulive '"'ployecs alike may Jl""' safety and S<lundnoss risks if not proporly structured, these principles and the final guidance apply to senior executives as well a.s other emplo.yees who. either indi\•iduaUy or as part of a group, bave the ability to CXJ""" the bankingocganiutionto material amounts of risk.' These enlployees are refened to a.~ •covered emplo}·ees." in the final guidanco.ln response to comments, tbe final guidance clarifies that on cmployoo or group of employees has thoobility to exp<><ea bank in$ orsani7.ation to material amounts of risk ifthe eruployee:s· activities are material to tho organiz.ttion (lr are matttial to a business line: or operating unit that is itself material to the organization. Some commenters sugge5ted that certain categories of employeos, .,ch as tellers, bookkeepm. administrative assistants, or cmployoos who proc::cs:s but do not originate traosactions, do not expose banking otgauizations to si&nificant levels of risk and therefore should 1M! exempted irom e<>verage under tho final guidance. The final guidance, like the proJ"""d guidance, indicates th31 the facts and circumstances will d&lerminc which jobs: or categories ofemployees h:n-c the ability to exp<>se the o~ganiutioo to n1aterial risk:s and whiclt jobs or cat~ries nf employees rna)' be- 0\tiS-ide tho soope of the guidance. The fi11al guidanu ~nizes, for exa111ple, that tellers, bookkoopm, couriers. and data processing per>OMel would lil:ety not expose wgani2ations 10sigoifia.l:'lt risks. of tho types ruunt to 1M! addressed by the guidance. On the other band, elllpiOJe<s or groups of employees who 'Sst.1'ilt.I.IKi.ltSt~litJFONJll(1(0)1 fSF P,ir~{tJr&er.d~poen$0fiMI'rrx:fia!Sll7 .U PDFJ(Ba.ei,Siri!ml.llld: FSJI'. April~a\·llbblt ll:ltrlpi/ht"il'l~.~aCJJJtjt#Jtd.ot$1 pcblicorio.'l$/r fl»4'b.pdf; .a1ld Sec.~s.perrisM 1$p f~l.ffisi·li!O'IV~lliiA'rOMjJ~I~ ~&:Vln:Oilnq~(B.N.el.Suit~b~: SSC.O:tobcr),i\1!Wlleii.A!tp'J/ tm1t,ftt'tt)~~~~DJ1/wti.•'Jit».'li.if',JI 1tJ()'JindJ'11011brr.J. 1bF'Ula.od.IISbbili1y t'o:u. W.IJ.:OGaU!fli!llefi~IS:fbllit)Bc»rd 111 .'1~1 2009. ~brespon.tetoa~ru~ofooo:~~cnosr<lq'di!Q& t.hrifiatio:: cqprdi~iiibcl(.cptoll.holetr~•..,~tw ~ti\'tf *S idtdiiii.!M$11!duloe. tbefi.-yt SUI6noe$1.1lti t.\al'"~~ ui:C.II:i,-o.indodts.*' JJIIfJii•DL"txta.~':iftoiEccts"wllhlnihe maniAgo!I.... S.d'$~\l.!,ionO[IlO'R 21$.2($)1\t) tc.d.fccpA:I:clytr.Wto~~~nW.S.. -.wiUdolllorn•wit\liot!Mr. -i_,oftbe Sec\ltUICJ.&f!d~(".o:~~ml!iN«<'.srdMoe ditclostw.o!exoarllw<xw:1pema<iooll?c:AA m.AOl(&){l)). S.l'ings.moci.Mtls sboulo:i also ttfertOOT'S'$rolc4."tloutsbys:evir.gs~Kw IO!Ktnocalift!oiTK:tts.dir«::.ac#,.andlari~l s.\¥~ows. 11~S6H3. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 coor<iinatinn in this area is important do not originate buslness or ipprG\'C tra11sactionsoould Siill expose a banking both to promGte competitive balance and to ensure that internationally acti\'e organi1..ation to material risk in some cil'C'Um.<;lance:s. Therefore, thAgem::ie.<; banking o~gan i>ations are subject to do not believe it would be appropriate consistent requirements. For this reason, to provide a blanket exemption from the the Age.ncies will continue to work t.,ith their domestic and international final guidanco fot any category of co1•ered omploj·cos that would apply to COU(llerpa!U to foster sound compensation practices across lhe all banking organiutions. Afte.rroyiewingthcoomments,lha financial services industry. hnpo.rtantly, Age-~1cies ha\'eretained lhe principles· tb(l final guidance is consistent with based framework ofthe proJ"""d both the Principles for Sound guidance. The Agencies believe this Compensation Pru<ticc.~ and the related approa~ i$lhC most effective way tn Implementation Standards adoptt<! by address incenliYe compensation thei'SB in 2009.• h number of practices, given the differences in the commentcrs expressed concern about size and tomplcxity of banking the levels ofcompensation paid to"'"'' "'l!aniutions oo1·ered by tho guidanoe employees or bankil'8 ocgani>ations. As and the complexity, diversity, and range noted above, severaloommentfttS of use of incentive eompen..10;Uion r"''ucsted thot tho Board eliminate or arrangements b.y those org3J'Ii7.3tions. limit certain types ofinoentive compensation for employees or banking For example. acth•ilies and risk.s may <arysignit.can~y across ban~ing orgGnizatioBS. Other eommenhtrs crgani?.ations 2nd o:~cross employees advocate<! that oenain forms or compensation 1M! required. For ex.unple, within a parttr.ular banking organization. For this reason. the some cornmentcrs ~d a ban on methods used to achieve appropriately incentive compensation payments made risk-sensitive compensation io stock options, while others suppo~t<! anan~ments iikely will differ ar.rGSS their mand2tOl)l use. Comments also and within organizations, and use or a were received with regard to tbe use of singlo, formulaic app...,ch li~ely will olher types of stock-based provide al !cast some emplO)'OOS \\.lith compensation, such as restricterl stock incentives to take imprudent risks. and stock appreciation rights. The Agencies, howt\'er, htwe not Consislent toJith it:s principles-based. modified the guidance.&< some approach, the final guid"tco dOC$ n01 commenters reques.led, to provide that a mandate or prohibit the usc of any bankingmganization may enter into spoci6c forms of paymcnl for inccnti\!C incentive compensation amngeruents compensation or establisb mandatoty that are incon~i.~tenl wHh lhe principles compensation lc\lels or caps. Rathcr,the of safetyand soundness whenever the rnrrns and le\'els of inrenlive orga:niution believes: that such action is compeosalion varmonl.! at banking needed to retain or attract cmpiO)'OOS. organizations are expet:ted to renect the The Agencies rec:<>gniu that while principles of the lin.! guidance in a incentive compensation serves a manner :ailored to the busjnes.s, risk number of important goals for banking profile, ond other 3\~ibutes of the organizations, including attracting and banking organization.lna~ntive retainingskillod s~ff. these goa~ do n01 tompensation stJUCtllres that offer override the requirement for bao~ing cmplayeas rewards for increasing sh()[(· organiutions to have incentive tem1 proGt or revenue, without taking compensation systctm~ that are into atctJunt risk. may encourage. consistent with safe and sound imprudent risk-taling e\leO if tlley meet operations and that do not encourage fannuJaic levels o: include or exdude imprudtnt risk·taking. Tite final certain forms of oorupensation. On ll1e guidan\.6 proYide.~ banking othe:r hand. in~ntivt~ compensation organizations \•;ith considerable arnrngcmcnts of various fortn.5 and flexibility inslructuring their incentive l"els may bo properly Slroctured so as compensation arrangements in ways not to enr.ourage impruderHrisk-taking. that both pro,Ole safety and soundness ln response to c,;omme.nls, the final and that help achie\1Cthe arrangemonts' guidance clarifies in a nun1ber of other obj"'-i1·es. l'C$pccl$l.be expectalton of the Agencies The Agencies: are mindful, howe\·er, ti10t tllc irnpact oftbo final guidanco on that banking organizations operate in both domestic and international 4$«, FhuOOd St~lizy f'orv..a. t'SF'P:ttdp&e:$ competitive environments that include lor~~,io:'1Pndioe4ID$01C:Ci:e~ financial services pro\liders that aro not ~Siabi.li:yBe.~{NIO'J].FSBPrinc:iplesb Sou.ad O:illlpcu.AIIoe Pnct~ lti!pkMMIIIiou subject to prudtntial oversight by tllc StAr..duds ISS !::IS roFi !!Sasei.Swltzelild: l-'S!I. Agenci" ond. tllus, not subject to the ~).Mileh!ettNrp:// finalgu.idanee. The Agencies al"' "'rl1)'.fi~s!oSIN)'boc~~ ,_CMJI!qi<l/. retOgnlu tbll inlcnutional Frm 00081 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718205.eps as the Financial Stability Board (FSBJ 36399 78 Federal Regist•r/Vol. 7S, No. 122/Frid.ay, June 25, 2010/Notices baUI.Qa ....,;..oo.s ,.,;u '"Y dcpcndi~ on lht .;,. iDd comp!tlCity of tho orpntulion and its le<et of usas• of incentive compensation a.rrangeJntnts.ll iJ oxpeded tbat the guidance will gene<111ly have Jess impact on smallflr banking organitalions. which typi<>~lly on: less complex ••d make less use ofincenli,-ecompensa1ion amngements tiwllargtr banking ClplliUti-. o..,..,.. of tbe sim..d oompltxity oflheiropontions, large boAki"' orpnizatioos (U!Os)• $hoald have and adhere to •)'Siemalic: and fonNiiud pohdes, procodures and proooM... Th"' are considoted important iu cruuring that icccntivo con1pensation antnge•nents for all coverod en1ployeos are identified aud !11vicwed by appropriate Jcvcls of m•uagoment (Including the board of directrut whl'ftlppropriala and cnntrol units), aod Wilby appropmtcly bobaoo NJ:s 111d -ards . n. r.w pid.cce~tllelyJl'Sof polities, procodum, and system !hal LBOs should ba'" ond ,..int>in, but allot are nor o:petlod olothtr banking organizations. II is oxpeWd that, porticul.lrly in tho c;o,. o/LBO's, adoption ofthis 11rinciplcs·based approach will require an iterative sup<rvisory proeess to ensure lhotthe embed dod noxlbility that allo·.•~ ior CU$10mieod amngments for each ba~orpniutionclocsnot uodennino ellocti•"C illlplcmentatioo of rhopi.W.... With rospoct to U.S. oper>lioos of fouigo bank$, incentive compensation Tho 6ul guidano>, lil:e tho PfOIIO<OCI auidmco, Ollllines b:r method. that are B. Bo/oncedtnoemil~OIIr.~ Arto~nLr Tho first principle of the fi11al SUid.anco is that i1~centh'e compei'Wition arta"i'monts should pmvide employoos incenlivos thai appropriately balanco rlsl:und n:wards in a manncrlbal does not encour1ge imprudent risk-taki~. The &mOUIIIS orincentive pa)l flO~\'lllg IO ccvtred a:r.ployea shculd lab •«ounl olaod adfliSl lor the rid:sand losseou wdlupi--=ialed ,.;tJ: ecplo)"" activilits. so that employoos do lUll baw inccr>li,.., to lab imprudent rille. Theformulztionofthis principia b •li&hdy difl..,nl hom that u.lod In tho propostd guidance, "hieh Slll!od lhat 01pni~ations sh<>uld provide omployoes lncontil'81 that do not enoou,.go imprudent risk-taking beyond the "l:'nitalion'• ability 10 efleclivoly identil)'end manl!Pirisk. This change ...., oudoiO cWify that risk· IBO:IIC-t proc:td..... udCOIIInll fl:lldioaslhal Ofdinarily licit risk· llb~ do not obmf& the need IO idaltify co•·•ad omployea and 10 develop inCCDtive cornpen.salioa amngcmenuthat properly bal"'co risk· taking incentiva. To be rully effedive, balandng~djustn'lents to inttnti~e compensation amngc.menls should take account of tho Ml range of rub thai employees' acti,·itics may pase for the oosaoitation, inclodin$aedi~ Mlr'<el. liquidily, Ojlfntional.iogol. corepli._ ..drtpulatic:lllrisks. A aur>ber oiiXIOl- expzessed tho view that lnaeosed coo:nlb c:oold milif>!&at.iolba!...,ia incentive comptnsalion amngement.s. Under this view, unh:!hlnetd inoantive oompensatlon anangoments couldbo addreMed oi!hor through the modifl<>~lion of the incentive compensatioo em1ng<monts or through the application of additional or more effec:th~ riU. oonlrols to the busin= Tho fioal gu!dwe recognizos that polides, includins management, review. and oppro"l "''uiromonts fora foreign ~>nk's U.S. OJl"ration! should be oeordiuattd wilh thoforeign ban~ing orsanlzalloo's group-wide policies developed In acoerdanco with the rules oftht fortiS~' banking OJi'lliution's homo coonllJ suporvi10r. These policies and pnQiccs should llo coosistmt "ith ~andcllec:tii'OriU.·~· the foro1p boo!:'• ••-.rail oorpora!& arul aed lnternaiCOIIIJOI fuctions"' ........,..t SINCiultaod its &omewort for rbk-managemODt aJid intmnal conlrot.. as weii&S with tho final guldor.co. aitk:altolhtsofdyand~of banking "'ll"'italions. HOI<ever,t!lt Agencies believe that poorly designed "' managed lnce11lh·e compensation armngcmonts can themsclve:s be a sowoc of risk to banli11g organitations at1d undennine tho controls in place. Ur.balanr.:ed inctntivecompen.\ation arranaement.c; can plaoa sub$tantial Mio on tho riU.·maoa;ec:ent and ictemal oon~ol functions of.,... ~·ell· rnsnaco:l OlpDIZIIi""" Furl.,.,_ poorly llo.bnc:od bcoctin compoas<tiao or...ge~~toiS caa enco•r-. employees to take affinr.aw;·e ad.iOILS to weaken the 01:g3nization'.s risi·managemenl or lnt!mal conllol r.mclions. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00082 Fmt 6602 Sfmt 6602 cuntntly in USI to make oompe~tion more scnsili\'o to risk. These are nsk odju.llm<nl ofawards; defeml ol paytnl!lll: longer perfonnance periods: and reduced se:nsili\'ity to shorHorm performance. F~ch method ha.s odvlniOSN and disadvantages. For oample. incentive compensation arransements b se.,iOftxeaJti\"CS at LBO.< arolibly to bo bett&r balooud if thq lm-oh'l cleflml of. sub<u.'llial pGIIioo ol tile ......U.-es' i...nliYO compensation over a molti·y<Ol period, with payment made in the fonn of stock or othw<quity-bast<l iOlltumenls and h'ith lhe number of ir.stnuuenl$ 11ilimlltcly rccch·cd dcpcndenl on tho petformauco nl the organization (or, idt.~lly, the perfom,.nce of the executh·o) during the deferral poriod. Dcfoml. ho11·ever, may ool be effecti,.. II> coostoining the i..,.,ti,·es o! employees wbo may lm-. the ability to lllo Cllplliutic:IIO loolttmt ~these ri>b ""Y not bo ,..li,..j durin& • ......,.ble defeml poriod. For this ruson, tho final guidanco recognizes that in SOint cases, two or mot11 mathod< may be needed in combination (•.g., risk adjustment of awards and defonal of payment) to acbiovc all inoontive tompt~Wtion am~~pmenl that properly balances risk ond reward. f\nll11nn010, the lew motholis ootod II> the fmal a•ndance.,. oOiexdusi•t. and olhot elfecti" Olelhods or variatioos NY cxi5t or be dt\-.lopocl. Mllhnd.< for achievina babncod cotuptnsollon ar.angemenu at one arg;tniutiou may nol be effed.h·e at another OJganizotion. Each orcanization is respo..lble for ensuring that its incentive compensation arrange1ttents arc consisten! with the safety and soundness of the organiulion. Tho guidaocaclarifies thatLBOsshould acthely 111011ltor Industry, acod""lc. and ....latory de>"eloplr:EIIIS !• i-'liYO OOIIpwatlon prxb<&< and theory ud bo pRpared 10 inoorpol>ll into tbetir incenth-e compensation sy>l•ms now or emaging methods that '" liktly 10 improve tho organization'< long·term financial \~·ell-being and 13fcty and soundness. In responso to a question asked in the propo!td guidance, several commentor$ "''UOSiod that certain t)"POS of compensation plans be lreltod as beyond tho scopo of tho final guiduco boca1111 ........,.... belie;-..1 theso pbns do oollhraleo the saf.ry aod ,..nd"noss ofbanbg 01pniuticns. Those !nclud4d orgaaluliorl-lvide profit •haring pions. 4~1(1:1 plans, defined benefit plam. and ERISA plant L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718206.eps 36400 79 Federal Rtgisttr/Vol. 75, No. 122/Friday, )W18 25, 2010/J'(otices """~JP~l«<t:t:lbtpt0t1dtror• on'lpkyos. (l)'f)laltJt•kirDtw.in!Lupo.'lclipartU111l"'O' u~iutblorathi:JStinmnt!aloltht «J"'IUihCWI,IOriiOrirt l.a:pa4d~-..PII)•e:'ll* ••"-.a&eu:od~)'l:'*lol~t~Y.*t.U --allol"'ood-,.,.,._. ll"ili!MI"Pt!IONk:•rW:~.we VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 neutnliu tilt effect of any bolancing fatu"" lncludod In tho ornngon•ent to help prevent lmpntdent risk·"-king. Orgoniutions should ooraider including balancing featur~ch as risk adjustn•ents ordefuml requlren~ents-in golden pa..chutos and similar arra ngc1n~nlS to mitigate tho potentlol for the omns•ments to encou. . lmprudent risk·tokir.g. Provisions ll)al requirt a departing employeo to !Oifeit defemd inoantive co:r.pensotlco p.1yments may also tho olfoc:ti- oil u.n.I mangmtatlf the departi"' oraployoe is .We to nq;otllll 1 'Joldoo with the wdshab" •ployoe's new "'S"'iution." Colden hiUtdshako pro<isioos p,...tt special ;,.u.. for banki.. ocsoniwions and s.pervisors, some ol •·hich are d;.cussed In tho flnolguldanc:o. bec::ouse it ts the oction of the employee's new employer-which may noI boa reguloted in.<titution-that Clln affoct the cunent ernploye(s abllit)• to properly align tho employee's interest with the ''ll'"i,.tion's long-term h..lth. The final suidanco •totes that LBO.,hould monitor whothor golden handsluke atTall$emcr11< are motoriolly "'tlkening the orpnizalioa'5 eft'CHU IOCIWI.raitl the risk-latina iroc:onth-.sol omplo~ 1be ~will contiaueto wen with bonkiJia 01pniza1ioos aad otheos to .b-dop approprbto rnrtllods for odduuioc "1 elloct tlut sucll ~ll! my h>'l on the.afoty and "'urtdness o!bonkie& oqania:arions. C. Ct>mporibiliryWllh E/f«<ive Ct>ntrol• end RisMiono,!tmenr The seoond prinelpleoflho final guidance statos tlult a banki•l8 organi7Atlon's rlsk-n"n~mont protlcwtS und internal controls should reiofo""' ond support doc development and maintenance ofbalanced incenlh•e "''"P"""tiOO ""'111""<111S. Banl:.ing organiutions s.hGuld integrate lncenth·• compensation .,..,..u ioto tbeir rlsk·r.....,ent and int...lcootrol fnroeworb 10IIIIUrt thai baiiD<e IS ochit\-od.la poniatt.r. bonking Olplllnllons should hm oppropri.lte controls 10.....,. thai poocessos for acltlevi"' balulco"' followed. ,.,ppropri"c pc®IUICI,lncludlos risk· """"'ment per$0nnol,should II>" input In the desisn and assosMleot of inc:entiw cot:'lpensaliGnamngements. r.ompensatlon for risk·m•nagoment and control pertMn•l should bo 1ullicient to "..wa. .,..,.....t ~'*l~o~kt.-.~llltr:b lbll .. a:~, ~.._b-.'fCif•~loflbe ii:IIIIM:.d,~wiUOof~Cin'lidilll*lt'r& ~~e~WtwuWM\'t'bo.lcdt!ltd"Upo~~ ~c:reii'Mit'ie ..J'I&o)Wsp.~ ...,l.p.rd. Frm 00083 Fmt 6602 Sfmt 6602 attract aod ret>in •rpropriotefy qualified P"'"nne and •uch compen5ati<m should not be bued subslanttally on lhe financial periormanco of tho b.,;n,.. unit that they review. Rather-, t1teir performance silo11td bt baser! prirnarily on the achievement oftho objectives of their functions (e.g"'adtLere.noe tD inte~nal controls). Banking O!Jiniutions •hould monitor inc;e..,th"etompensation awil'dsl risks token and aet\JOI risk outCOI!les to delenair.t whether ii'I(.Cti\.. <OIIlJl"l"tioo P'fi"'''IS toemplo)artmlucad to reflect od-risk outcnrnes.l_,rjn coaperu.ttioo .,..,.,..,...u that uo r..,nd not to appropr'..tely reflect risk .noutd bt modi6edasn....,.ry.c:Jr&tniutioos should not only p<ol'ido rewuds when ptrformanco stand>nls are mot<>< exceeded, they should ol.o roduco compensation when 11tandards are not mru.. Usenior cxocutives or other emplorees are paid substantially oil of their potential inctnti\1e comperuation ~vhen risk outcomes are matt:riall)' "'orse tban expected, ernployees may be enco~ed to take large risks In tho hope olsobstantillly increasing their personal compensation, kllowioc that their do~'ll5ide risu mlimitod. Simply put, ioceDtin cempe:uzlion mangemeou shoold 1101 "'"'"."lleods lwin,tlilsthe6rm Jooo."upor:sation. A .ificant number ol .,.pres>oe~ conc.rt~S about tilt scope of the applicability of tho propooocl pidanco to ..,.lltr ban'<lng O!Jinizations as well.,tho burd~1 the proposed guidance "'Uid irnp0$8 on these 0'113nizatinns. In rt~pon.lll to th.,. oomments. the final guidan<:o has made more explicit the Agencies' view that doe monitoring 10othods and proe...., used by a banking organl7~tinn should be cor.unensurate with the si~ and complexity of the organization. as well as its use of inoenlive COlnpensatloo. Thus, for example, a smaller otganization th!t u.ses ii\Cinthoe compeosallon ooly to a limited exlcllt moy End tbt it con appropriatoly "'""""'IS IDODitor its amnge:r:ents tluou8h ,._t ......t ... proco$>OS. Tbo fioal~abod.....,..specilic aspecu of policies ond procodures related to controls :md risk-managentent that aro•pplicable to LBOsand aro not C'.(pCCI.ed or other b3nktng Ol'S'ftilations. D. Strong Ct>rporote Gcwtflro~ The third principleoftho final g1.1idance is th~l inCC~nti~·o cnmpcnseUon progr.>m.< at bonking otganiwions should be supponed by strong corporate governance. including activo ond ef!!dioe o1•arsi!)tt by the otganl~ation'l L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718207.eps The fi..t &uid.lllU does 1101 exempt any broad categories of<:omperudion plan• bued on their tax structuro. corporate fonn. or &latus~ a retirement or other employ.. benefit plans, btcau,. any type of incentive compensation pla.11 may be implomantf!d in a wa)' that inaeases ri•k Inappropriately. In response to thas4 comments, how"'"· the fin at guldanco nlCCIJtDiw that the tcnm •incaath'O compensatkln• does DOl iaclude .,.llli""..IS that an: based *>~ely oo the emploj-'level of <:or.lpawatiooaid that do DOl W1r}' buodoo ...«IIICII1petf.....,.. lllllrics (o,s.. a 401(1;) plul wuftr l<bich the Olplizalioo coolribul<s.... l""*'l>iO of an ea~ployee's salary~ fn addition, the ft..l guid.,.. notos that incentive compensation plans that provldo for '"a«<s basod ,.lely on nV<ttlll "'l!anization-wide performan<:A! ore ltnlikoly to provide o:nployoes. other lhiln senior executives and incUYi duals who hR\'C tl1o abilit)' to materially affect tho "'ll•nization's overall periomance. with unbalancod risk·tal:ing incenti<es. In m;Jny casu, there were commtnlli on both ~des of on issue, with,...., wanting less or no guidance and other$ ~'lllting toush, or ''Ct)' Jpecific prohibitions. Por wmple. a num !>er of com.-aJgUed thai the use of "pldon pmtbutes" and $1Jmlar mention and roauitrDOOt pro>i>ioas to ..Wn emp!oyoes $hould bo ~Oiled bocawo sucll provUions hm been lbu...t ill tbe post." A laJgu r.lt:llber of commenters, ho\\"t.ver, argued egaiDst a per st bon on •uch mangements, S.Uting that th~ provisim1s were in some cases ....,llioleloment< of effective recruiting a11d rtte:nlion pac&.lgos and arc cot noc:!Warily a threat to sofety and soundness. One: oommenter slatet:l that golden pamhute p&)'l>tnts triggered by ch•rl£el in cootrol of abanking Olpnh:.•uoo are too sreculati\·t to '"COW1i' imprudenl risk-tal:ing by employeos. '1111 final &uiduce. like the projlCI!«< guldanoo. p:o1ides that banl:ing OlpniDtions should cartfclly c:omiclu tbo po10nli<l for goldta pa!1Chu:.S and s!IOit.r.....,..,..utoal!octthorisk· !U.ing beha'riocolomployees.'lbe final picbnc:o.dds Lln&u'&< noting !bat amogemenu that pro1ide an employee 't~ith 'sum:nteed payoul upo.n deJMrtme hom .anorg<!nization rog.,dlw of perfonnan<:A! rnay 36401 80 Federal Rtgilter/Vol. 75, t<o. 122/Friday, juno 25, 20t0/N01ices idtotifi• specifiC aspoclsoldla oorponlo ,.......,... provisioas ol tho final cuidanco lhalaro applicable to LBO. or other Oli>llizalions that u.. incenli'I'C compen~tion to a11ignificant degr,., and arc not oxpe<ted of other banking organizations. In particular, boards of dircciOIS of UlO. and other arsaniutions that usc incentive "'"'pensatlon to a signiliant degree should acti,..ty ov,_ the de>..lop....,t aod oponlion of the Grf'nlulioa'$ in:;:mtive aaopensatioD policies. syskms and nl&led a>Otrol closipland~ollhe mpniutio.:a's inc:entiYI c:o:npc:!\Sition prootSS~S.If sudo aa .,...:,.tion does lm"l:t:mtnU are consistent uilh the a c:ompensatioo 1101 already cornminee. rnporting to ll:e fuU boord. org:aniz.ation's .safety and soundness. n.,. "'vlo~<s and roports should be with primary responsibility for appropriately ""P'd to reflect the sire ince.nti\Cc:ompenu(ion arrar.gemenls, the board should consider establishing and complexity of the banking one. UlOs, lu po~icular, .hould follow O'i'fllutlon's activities and lhe • systematic approach, outlined in tbo prevaleract and scope or its incentive final cuid&m, in de~·elopins annpenutioo trrall,l~lllts. Tht Mlc:lutt, romposition, and """"""'of co~<ptnsation <ys:.,.. balucod lncoati" OOIIlpe:>S>tiorl tho lloarcl o( diteciGra siloaM be oonsttuclod to penoit effecli;'tcv~ ol iacoalive cr>mpwatioo. The baanfof SmniCOIIIIIIODim~ dir«ton slloold, for example, have, or ooocom lh>i the propose<! guicb.""' "-'''""'*"to, alevel of expertist 111d 1ppe:artd to create a naw substantive qualificotion for boards of dioo<>« that cxporienco in risk·~m~gcme..-1t and compensation pracliccs in tht fin.aocia! requl,.,. tho boards of all banking serviCM !«lOr thai is appropriate for tho organizatiOJU to han~: members wlth expertise in compensation and risk· nature. •oopo,and oomplexity of the ma.,.gomeot Issues. Agmup of Olgl.ni:tll1ion'a ICiivities.u DOr.lmenten nolod thai s!M:h • Ci¥on thel:ey role of senior exocuthu in man~l8 the o\·er.dl risk· requlrem<~U could limit Ill already pool ol poople suilab!e to sen·e 011 tW~activiticsofan etpnizatioJI, the lloards oldiloclon of llorilio3 boa.-.! ol dirctors slloold din>111v orpoiutioas aod :llat....U... appnwo-pon.<a!IOO~U to. or U\\'olvtaa,..ior IJIICUii,.., and clcsely """'fzotions ""'Y oot tllo.-rtos tocompmsa~t,diractm monltror "'ch poymo.1ts and thfir requiremenl.!. additional th.,. meeting .sensitivity to risk outcomes. lf th.e tompensation amngamenu fot a senior Somo oommenlors at.. stated that terms executive include a deferral ofpayment .su<:~ as -r;IOHly monitor" and •actively O\'enoo" could be read to impose a or•clawb;)ck• provision, then tha higher s~nd.lrd on dire<tors for their review sl1ould lncludesufficicnt OYcnlgbt of locentive oo<:~pensation L~ if determine to infonnation woos. On the other hand. one pro11sloolw been Uiggered and COJ'!Imenler noted that execu~ as plWie<l. The boord olso requiros finaDdal expertise on the sbould IJ'Jil'CI"t and dotuiMIIllll)' boards ol dillldon ..d ...tit lllllorial oxcopCioos or adjustmtrns to commiaccs ol public CCillpor.ies ..d the ii'M::I:ftlive Q)(D.per.Rtion ~dlalspecial:zedrisl: am.,...ol.!eslablishedforSCiliC< tcompetoru:iosbe"''•inod ......... txeQitives and should ClrefuHy c:onsid. ar.d monitor the effecu ~f any on tho boards ofoll banking o1ganizalions. approved exctpHons or adjuslmenls to To address concemsraistd by th.,. the arrangllmenl~ In feSJ>OT\SU lo oomnumls expressing commcntors.thofinal guidance clarifies that ri.d:.·m.anJgemo.nl and comptns.ation conoorn nboutthe impa~ ofthe proposed suidanoo on smaller b..nkiug expertise and experience a1 the boord lo>tl may be present oolleelively among orp.nizadons,l.hc final guidance the memben of the boord, and 1111y .... _ _ , _ _ COlli from fomaltrailli,. or frn:n tnOolllo ll . .$1ecwfl-..~~ exptrieoce ID addmsio& risl:· a.'ld compor:>Woa isso<s, .....~ ........u.s. l)efiO'sowra!l lodudi,.; u a din:c'.«, or may be C*'pCfl.. ..,.,......... llnlda."C. 1dvi<:e r""il-.d frccn fror:t obtained •Srtiw....:~tllliaMMid*ll:5rloOTS'' outside COUD$01, oonsultan~. or other l'lllea~~d~:~~uc~ ..~·am uperu with expertist in incentive 56Ul. bomd ofdi11d<n." Thcboordof diteclors olen "'8"'tUiico is uhinwtly rosponsiblt for ensuting tb2t the organization's lnce:"Jtive mrnpensalion arrange"'enl.! for all CGVered employees-not,.lely ,.nior oxoculi\·~re nppropriau:ly bill anced and do n01j0<1perdizelhosafety and $0Ut\dncu of the organization. Boords of d1leclori should ncei1'0 cia:. and anel)£is fnml ~"""tor other """""dlatansuffiticnt toallo1• tho bomd to WOOS .....Iller the o1..nll ha•" ........,..... that""'' ,,.n bal-......, "'""''tlaw ......_c.:t:MII_. .....,.,.,t 1 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00084 Fmt 6602 Sfmt 6602 compmsallon and risl:-:naugcment Fluthcnnoro. !befiul guic!ance ""'i"luslhat S.'llaller O'i'flizations witllles$ complex ond ext""i''t incentive compensation arrangemenls may not find il necossary or appropriate to roqui111speciolly tailored board tJCpel1i.se or 10 retain and useoutsidt~ txperts in lhis area. Abanki113 organiz.ation's disclosure proc~iccs should supputsafund sound iactnbv.c:oo~tioa~ts. SpoclAcally,a banJcir\scrrprtiuliorl ....,ld supply an appropriate amount ol inronatllon oonc:saizas ils ir.antin oompmsation a:ransunenu and rtlatod Nk·nlanagemen!, control, tnd JOVemanoe processes IO shan:holders to allow thern to monitor a1ld, where appropriato, lake actions to reslr.lin the potential for sucharrangmnents to enoou,.go emplo)'OCS to ta!<o iloprudent ruts. While some <=mentors supporlod lncnwd public clisclosure of tho "-tiytcompensallonpoll<tioosof bantioa "'8"'izaliorls.a piS IIIIJ!It. OJ>rus.d conams that illy requind di.sclos.ui1S of ineonti\'e cornpensation. lnfonnation by ~anti"3 orgar>it1tions be llflored toprotecttheprimyof employees and take account of the Impact of such disclosures on the ability or Of.88nitatiOI1S IO a.tlract 2nd retain talent Several commenters sup~ed an allfJl-t ofroquirod disclosures ~ith exi•~ """""""onl.! for public that addilion&l canpeoies, roquirmtnl.! woul.i add to tlu ,...~a~ory borde:> on bmnns ugu"" C~~"ganiution.s. The propoood guidance did not impose specific disclosure "'!uirements on bantl1J8 organizations. The final guldanc:e m¥kes ou.significant changu &om the proposed guidance with rogard to di£tlosures. and st.ltcs that the soope and level of infonnation discl....S by t bankin& orpoization should 1le tailored to tho ••lure and complex:ty of the '"l!'niution""' i:S ioc:or.ti\'0 compensation a.~ 1\efioal pitlaaco notes thfl banking organlzalioos should comply with tho inctnt.i\'t compensltion disclosure requlremenu of lhe Fedenl secwilies lnw •nd other l011~. as npplicablo. Anumber of oommenters supported additional goyemancc rcquire1n.ents for ban~ h:g orgaJliz.ltions, such as .:say on poy" pro1·i>ions roquiringsharel10lder appro~·•l ofcompoesation p!w, >eparation of the boord cmirand cl>ief ..-tircolf~a<positions.INjority voti~ !or di-.&DDual clcctions !or all di...,!Dn, and iopm......,l.! to the audit function. Some of these comments ,.,.t cha"8"1n Federal law< beyond th jw1!dictinn nlthoAgcnci~; oth~ L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718208.eps 3640Z 81 Federal Regisler/Vol. 75, No. 122/Friday, fune 25. 2010/Nolices The Agencies intend to actiYoly """'itor thoa<lioru being laken by ballki"* orpaiulions wi:lo ....,...to iac:eotiTec:ompe.r.salioDana.,_..nu and willnview and updalolhiJ guidanct as appropriate IG inct~rponlte best pract[oes th~t emuse.ln addition, in order lo mnnitor and encourase imp.~,..,..,.._ Federal Re.orvoo~tff will pR:IIOI8. repon. ia OO!ISUitalioo with !he ollie< Fod.nl balll:inz accncics. after the conclusion of ZOHl nn lrends and de\'elopmants in compensation practices II banking OJB'lli,.tiOD$. tV. OtherM1tten lo ac:r:onbnco with lilt hpervcrt Redudion Act (PRAJ of 1995 (44 U.S.C. 3506; 5 CPR Pa~ 1320 Appendix A.I). the Agencies have determined that C<llain aspocu olthc final guidanco a cr>ll«<ion of iniMaatloo andmrpontts<>~.....,aceprooesse.s.lo constiluto !loud tWI this do!ami!W~ 1ht mal)"la bmi:!ed .. h.lvt LBOs additioa. under tho authority dt!egated to tho olshortcomings ar"pJl'" in uining Board by the Office of Managant~ltond prat1ices relallve to the principles contained in the propo5ed guidat\ct, as Bud~(OM8). An agency may oot ooodu<l or •-elias pb"' lor addressing identified sponsor, and ao OflUiUiion i.s not ~..........._Some ocpniulions oltcady ID respond ID. an ialomation reo;uited ba10 illlplco>oated dlooges ID m.tb allledion unl.., the inlarmatioo lheirincentivec:ompe:n.sation displays a cumlndy valid collection arrangements moro risk sensitive:. OMB control number. Aoy changes 10 lndet!d, many organi:ations aro resulatocy reporting forms mc.ognit:og lhat strnng risk-management thallgencias" thai may be made in the futureiD oollect and control S)~:ems are not sufficient to i,..,..tioD t.Uted ID inoeoliv. protett the orpDWiion m. Ulaoe cxuupensarioa • ..,.,..IllS would M &om Nb. ioduding riUs addnssed in a IOJIII'It Federol Ke,isttr unba!a.nctd incentive compen~tion arrangements. Othu orga.nizatioJU hav6 JlMice. The final guldanco lndudcs considorably more ,VOfi to do. rucllu prov'.sions that statel"it banking dt,·eto¢ng procosscs that can ILBOsl $hould (ij "".. ••iutlOD$ dfetti.-.ly0001pminc:entin policies illld praciedWO$ !hat identify .....,....tioopaymttiStorUI:sa..t rol<(sl of tho pmonntl tho desaibt and rUt outcomes. The Agancies inre:nd to and units authoriud to be involved in eontinue to regull!rly review ince:ntivo inctntivo comJHHlS3tion arrnngcrncnl$, compensation arrangements and related identify tho souroo of sl3nificant ris).. risk·:nanog<menl, oor.trol. and eo<porelt related inputs•..w.lish appropNit go>......,.,. prattiw of IJlOs a.•d to oonL-ols p-n~ thoso inP<Is ID http work willlt'-o orp.natioas lltrouaJI er=otboirin..,-;ty.illld id.JotlfYtho the supem...y pnx:es. 1n promptly individual[s)and unittsl whosa COITOCt any deficiencies that may be approval is necessary for tho inconsistent wlth .safety a11d establishment or modification of soundness.u incenli,·e C031.pt.isation amn;.em~lls.; (iii emit illld ruinllill sullicient ~r.scalfr..-.~tlo,...... 4ocurlmllatioo 10 pamitiD >udit of tbe a.ml . ... oastad ~tt:b«h.Wu.lelll borba organiutioo'j processes for ina:nti\'t ollh<<IMI _ _ ,....... _ compensation lmJl8011'ents: (iii) have I• to ldtrJifr tM (w~ot U.C.~it'O plai~S in p!M 4ny ruaterilll exceptions or adjuslmcnts th4cbx'..m:ia:. lbt(obt)1lllon'Cf\'d4Gid pttw'~~~Ool~l\~tablilkf to the incentive compe.ns:a:ion for senior _ _ ""'YNt ........... ..... .,......,enu asbhlishe<l .......bo _ _ ... __ e:«<Uti.... appmtdaacldocumoolell 6•1 bve and dire<lon; cf board its by ~tlttoN-.aMC!c:aapkdyoflJo,.. ifs board of direct~ rett:i\·o and oq&a~t.4t!oottAI:sl:o.cttJi\'t~ review, on an :.nnunl or moro frequent ltflltSO-'tlo.'lls.Fo.-d'MMuwllorbanlq D~p:~il.lliou.thu.•q*"-•!oaktlluthn~llbe basis. on ......,mcnt by manO&Oment of 'C')' l ..ield. if..,.Cqoct~ t'allir.i~k:. vor\:tt tho effectiveness olll>o desi3" ar.d wu.: -- - ........ ................... ---,u..u. __.. ..-..nr----.. ==::.:::.:= . _............. 11011i1ot!Msetrf~attopedcd :o,bt VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 ..........n.............jilll .....- . . Frm 00085 Fmt 6602 Sfmt 6602 ofinc~ntivecornpwuation amugemflnl!. Forexampfe. tho final guldance m1kes more explicit the ''iew !hat tho monitoring methods tod P'"""'"' asod by • balll:ins cwganization should be cnttun&mUT1t• with thosltt and oomplexity ol the O¥g.tnlza1ion, as \..-ell as its use: of incenlhtt c:ompensntion. In addition. tho 6nalguidznot highlights the typcs al policies,pracied...... S)'$1emS.ad specific aspects of oorpcnte JIO'"I'Nn<Z ll>at IJlOs should hm and maintain. but that an nO( expected ol other banking organizations. In rospo0$1lo c:omm"'~ and laking i"""""' tn~o aa::ount the COQSide:ttiou diswl:sod ..... tho Board 1$ the bunien estimate for implementir.g oc modifYing policies and procodurosto monitor incentive compensation. for this purpou, cor~ideration ofburdon is limited 1D it..., in the final £uidanco oonstitul~ Ill inl...,..tioo oolloelion within the IMOning ol the PRA. 1bt Board tstimato:sthatt,502largo respondenlt~ would take. 0 11 :.~·emge, 480 bows (lwo .nonths] to modify pollcl~< and procedure.s to monitor inccnlh"C """pwatioa. 1lleBoard estimates !hat 5.058 ,...nrospond"'ts ~-..ld tth. on ar~. an hours nwo busine!.< ......, L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718209.eps address issu~ucb as ..say on pay" 111quiron:eo.......,.tarecurrendy under co..,.idmtiGabythCoa&J= 1be6.,1 pda""' does nd preempt ar P'tdudo theoe proposal•. and indicates that the ~cies exp<d Oli'niutions to oomply with allopplicable >latutory di.!closuro, 'oli"3 and other nqaire.uots. E. Continuinr Supurisol)•lnitiolila The horizont~l review or incelllivo compensation 11racliccsat LBOs i3 well underway. While Ibis initiati\•6 is: being lod by the Fedalol R...,.._lhe other F....lbanl:i"' ......... par'Jcipati~ in tho work. SuporvUc>ry t,.m, bave oollec:ted substantial information from LBOs concemi11,11 e.xisUng incenti\ot compensation prlCiices and rewed risl:·~~W~ag~Sntnt 36403 opcr.~tion oflhoorg.~:nizalion's inoc11Uvc oomponsation •)"'en> in providinarisk· taking incontii"IS tbat are ooruUieclt ,.;th the "'»U'izatiort"s saflly tnd soundness. The occ. rn:c. and ars have obtained emclflncy approval under 5 CFR 1320.13 for ;,.uaru:e of tho guidanee and ~ill issue a Federal Resister IIOli<o shol11y lo:60 days cl comment as pa11 of tllc regular PRA deannce P""""· During tho regular PRA cle<~,ncc process thocslimaltd average re.sporw time rnay be roe..,lu<tcd. 111• Bo.-d bas approvtd lha mlledioo ol illfarmmoo under iiS d.leg>ted authllrily. J.s dis<ussod arlie< in this nO(Ice, on October 27. 2009. tho Board published In tl10 Federal Register a notice roqucsling comnu~nt on the proposed Cuidanc:o on Sound lac:onti"' Co:!tpwal!on l'lllides (7~ FR 55U7l The comment p<t...J for tbi$ DOUot expired November 27, 2009. The Board receh·ed threo: comments thai !pecifically addrosstd paperwork botden. Tho conunenun werted that the loocrly estimato olthe cost of CIOI:lpliance sllould be COII.\idenbly hiiher than tho Board projoc:tod. tho fi111l guidance clarifics In a number of re.peclllhe expectation thot ll>e elfoct oltht fiRalguidance on banli"8 ocpniutions ~ill vary dtpeodinc oo tbe size and -plf<ity of the crpniution and its Jevcl of use 82 Federal Re&i<ter/Vol. 75, to &llahlish or modify policies and procedures to monitor incentive compensation. The total one-time: burden iustill'~ted to be l.125,&l0 hours. In addition, the Board estimates that, on a co;tlnuing basis. respoodents 40 hou,. (one WO<tld take. on business week) each)'eM to maintain policies and procoduros to monitor iuocntive compEmSation arrange:~nenls and OS\Imatcs the aunualon-goillf: burd.. to ho 261.400 bows. The 10101 anooal PRA blud<o I« this iolorrnatiorl oollaclioll is wiued 1o be 1.388.000 '""&"· '-'- )lo. 122/Fricby. )uno 25, 2010/Nolices t463.1464,ond 14671~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 ort'~~:d':~~=~~u~::; 594~800 hours. res&;i,,~~~·~~f.l!'nnuol burden: OTS 1.388.000 hours. As mentioned abovc.thcOCC, FOIC, and 01'S have obtained em"B<ftcy approval onder 5 CI'R 1320.13. The OCC and 01'S •w:o<als ,..,.. obtained prie< to tho Boon! mlsina Its lrJrdm OSiimateshosodootbtCOIDIIIOIIts rectivee!. For this reuon, tlto OCC and OTS are pablillli,.la this IIOii::o tho oripul ho:d.n ostiaates. ts.uc a federal R<Ji!ler notice ~ortly for 60 d>ys orcom-las pa:t or tho rq;ul.!r PRA doonnco p.....,, Doring the resular PtV. clearance process the e.<ti:nated avenge response timc may be ,...valuated ba5ed on enmments rii(Oived. The FDIC is publisltiog in this notice tho rovlsod burden ostinutos dmloped by Ihe Board ba.sed on the comments receh·ed. The FDIC will issue a Federal Resister notice shol11y fa< 60 days orcomm~tiiS pan or lhc n:gul.lr PRA cl""'oce p.-s and, durir~ the recuJar PRA clear1nce process. the .uitUted •...,. ruponso time may be rH\'Iloated !wed on cornzne:>l.s C...ZGI Dtsaiplit»t oflltpo1l Thislnfonrlaliollcollet1ionis aulhoriiOd punWIIto: S.Ord-Soctioru 11(a), 11(i), 25, and 2SA oliho Fedenl R!serve Act (12 U.S.C. 2AS(a). 248(i), 602, and 611J, soction sol dlO Bank Holding Company Act (12 U.S.C. 1844), and se<tion 7(c) of th• lntti<~ationol B>ltking Act (It U.S.C. 3t05(c)). OCC-12 U.S.C. 161. and Scction39 or the fodcllll Deposit insurance .Act (12 U.S.C.t831p-t). FDif~'ioclion 39 of the Federal lloposit lnsunrtce Act (12 U.S.C. 1831p-1). OTS-.Sectlon 39oltlte Federal llopostii.,...._Ad (12 u.s.c. naived. 1831JH) and Secliom 4, S, and 10o! tllo Home O~<nert Loon Ad (12 U.S.C. The Agt<~<ies oxpod lo r..W.· tile policlos and proc:oclures for inCOIItive comptl"'t:oo ornng<~~~en!S as part ol lheirsupeiVisary processes. To the exlent lhe Agencies ooHect information durin.g an examination ora Mnkil'lg organization. confidential treatment may be afforded IG the reoorcls under OJ<omption 8ol the r'roedom or lnfonnolion Act (FOIA), 5 U.S.C. SS!(bXa). llr>crd 1'>11e oflnfr>rmalion U>lkdion: Reccrdkeepin& Provisions Associ>led wilh lb Ctziclaoco oo Sound lacenti>~ C..porualion Policies. Alftqfotm numllrr. FR 4027. ().\IJ oorJrolnolllli<r: 11011-loho wiplld. F'rrJj~tq: Anr.ually. Afftt:ttd Public: Busi...,., e< other for·profi:. Respondenls:U.S. honk holding componles. State member banks, edge and agroo1nent corporations, and! the U.S. opcraUoru of foreign honks "ith a branch, agency, or comntcrdal lending conopany subsidiary in the Unitod States. &limortd oreroge hours per response: lDiplementi'l or modi{yL'18 policics ar.d Estimo"d numbtr ofrtJpondtnls: Implementing e< modilyi•ta policlas and procedures: l..gc '"pondent>-10: small responde:nls-4,870: Mainte:nanct J)rOCOdu..,: large rospor!dents 486 hounamall rtSpolldtnls 80 hour$. Mainten.lnco of polt•ies and procedures: 40houn. E~imoled numi!fr ofrrspondonl$: Lt.rge respondents, t .SOt:Small Tille oflnfonnalion Colkdlon: Sound Incentive CompenAtion Guldanee. ~r,s~:; ~~~~ ~l~l29. Fltqlltn<y: Annually. A/fo<Ud l'llblic: lnr-prolit a..;,..,.. e< cdtor l!:<'po.C.ms:smncs..-u.as. They.,,, EsUmottd 40bows. .,..,.Jioarspu mpo.'ISO: Eslimoltd nurnbtr ofrtJponWtl$: 765. Estimated latol annual burden: 30.roo hours. The Agencies have a continuing interest in the public's opinions orour collections or information. At any tin1e, comments regatding the burde-n estimate or any otherospoel olthis <:ollcction o£inrormation, including suggestions for rodurlng the burd•n. may bt sent to: llr>crri Sombry. Board oreo........ortJ>o Fedml Rosorve Symra, 20'.h and C Slr1ets.~<1~.. wasl-~.DC2055t. oa; occ Tilloll/ln/cmtGtion CtJI/oaion: CosomWlicatioN Di•isioo. Ollice or tile Comptroller of the Omency. Guidance on Sound lnc:ontivo Compen.utio~ Polic:it-1. Mailstop 2-3. AIUDtion: IS57..024S, 250 ESlreel, sw.. Washinaton, DC 20219. 1n addition, comments may be F"'9utncy: Annually. sent by fax to (202) 874-5274 or by Affe<ttd Public; 6uslnesw or other electronic mail to lor-profit. regs.comnrentstocc.lttJOf.30V. You n111y Rc.pondcnls: Notion>I banks. personally inspoctand photocopy &rtmoled ••~mJ:• houn per respo~:se: comments at the OCC, 250 ES~eol, 40bours. SW., Washington, DC 20219. For Estimated numbtr of..,ponlknts: .socurity rr.asons, the~ requires that 1.650. Eslimottd toto/ onn110J burden: 66.000 visitors :r.ate .. >ppointrnentlo inspoel oommena. You maydoJOhycolllna hours. [202}874-4700. Upon arrival. •bitor< FDIC will be roquirod Ill pre<tnt valid gonmi!Wit·issuod pholo idonbfic:oUno Titlt of lnfom>olioR Co/loctioll: and IGRihroit to ""'rily saeeni• i4 Cuid.nce oo Sound lnaotive order to insped and phOIOCOpJ Co•pensation Policies. comments. ~~8~~;:, ~~:~t~~i~;~45. ~t:Y.:,:; :::t;.~t7S. l'ltquency: Aonuolly. Affe<ttd l'llblic: Bu•lnosses or other ror·profit. Rtspondcnls: ln!Urod SUtc nonmember bank.t. &limolcdu••croge hnun por response: lmplmnonlhl& or modifying policies and procedures: Ia~ respondents 460 hours; .<ruallmspondents 80 hours. Maintenance of policies and procedu..., lOhours. Frm 00086 Fmt 6602 Sfmt 6602 FDIC All comments should rtferto the name or the colloc:tlon, "Coldanco on Sound lncanlivo Contpoltl3tion Policies.· Commentsu,.y he •uhmitted by any orthe following methods: • hltp:l!llww.FDIC.govlroguliJiioMI lows/federollpropo<t.hlrnl. • t.moil: comrnenrs&fdic.$0v. • Moil: Cary Kuiper (202.8983877), Coullltl, Fedmlllepasit lrt.!Utlnct L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718210.eps 36404 83 Federal Regisler /Vol. 75, No. 122/Friday. )une 25, 2010/Nolices 36405 guidance is intended to a.ss~t b.ln)jng organizations indesigningand impleJnenting incentive compensation a110ngemcn~ and related polidcs and procedures that effectively consider pohmtial risks and risk outcomes.' Alignment or incentives provided to employees with the interesL~ of OTS shareholders of th(t organiu tion often Information CollccUcn Cc))ron~tlls, also bencfi ~ safety and soundn&<S. Chief Counsel's Office, Offi<:e of'l1lrifi However, aligning c:nptGyee incentives Suporvision, 1700 CStroct, NW., with the interests or shareholdcr.s is not Washington, DC 20552: send a facsimile always .sufficic.ul to address safety·and· transmission to (202) 906-6513;or ,.nd roundno.."-S concerns. B&eau.~ of the an e-mail to presenc. of the Fodera\ safety net, (including the ability o! insured ~~~:rfio~·::::~~=t~ depository institutions to mise in.sured indox on OTS lntemel Site a1 httpJI deposits and aeoess the Fodera! wWlv.ols.!roas.gov.ln addition, Reserve's discount \~indow and inlc!tSiod persono may inspect paymeJlt services), shareholders of a comments al the Public Re.lding Room, banking OJS3tli23tion in sornc cases may 1700 CStreet, ~'W.. Washington DC be willing to tolerateo d'SJ"eofrisk 20552 by appoinlment. To make an that is inconsistent with the appointment. call (202) 906-692Z, send o~aniza.tion's safety aud soundness. an e·mailto public.info&ts.tre;JS~ov. or Accordingl)',the Agencies expect send a facsimile transmission to ('2:02) banking ocganizalions to maintain 906-1155. incenlive compensation pr3ctictS tha1 are consisteot with sarely and OMB fo\lOIVS: soundness, e.ven when these practices Additionally, pl'"se send a copy of go beyond those neodod to align Guidance on Sound lnetnti.-e yo•~ comments by""" to: Office of shareholde< and enJployee inteoosts. Ccmpensotion Policies Managcn:enl and Budget, 725 11th To be con.slstent wilh sarety and Street. NIY., 110235. Papen,orl< l. lntroduclion soundness, incentive compensation Roduction Proje<t (insert Agency OMB Incentive oompe!'IS8lion practices in .arrangemenls• at a banking organi28tion control number), IVashinglnn. DC the financial industry were one of many should: • Provide empl()yees inoonli\1ts thai 20503. Comments can alsn bo sent by factors contributing to the financial fax to (202) 395-<\974. <risis that began in mid·2007. Banking approprial•ly holancc risk and reward; While the Regulatory Floxibility Act organizatioM too (lf\en rewa.rded • Be cornpatible wittl effec;tive (5 U.S.C. GOJ(b)) doos not opply to this emp!oy88.~ for inc:n:wing the controls and ris:k·managtnlent; and • Be supported by strong corporate guida1tce, becau.so it is nol being organization's Te\'811UB or short-term goyemance, includingactiYI! and adopted as a rule., the Asencies h<lve profit without adequate recognition or effectiveo,·ersight by the organiz.ation'.s considered the potential impac:l. of the the risks the employees' acti~·itie:s posed board ofdirectors. prop<l"'d guidanco or. small banking to the organizction.1 These practices Tbese pnnciplas,and tho typos of organi,.tions. For the reasons discussed wcetbated the risks and I= at a policies, procedures. and systems Ihal in the SUPPUUEHTARY mFOJWAOON ntunbcr ofbanki.ng c:Mganizations and banking organizations should have to above, the Agencies bolievc that resulted in the misalignment of the help eosurc compliance "ith them,'"' issuance of th.e Jlrt:lpascd guidance is interests of employees with the long· discussed later in this guidance. neodod to help ensure that incentive term \\'ell-being and safety and The Agf.ncies expect bonking compe.:'lsation anangemenls do not pose soundness of their organization$. This a thr'"t to the safety and$0undness of document provides guidance onsound organitations to regu,arJy revie\lo' their incentive compensation arrangemenls bankill8organi2ation.s, intluding sJnall lnocr.tive compensation pr.actioos to b.mking organizations. The Soard in l.h.c banking orgaoizations .supenised by the )"NSf!!l~tlldlht.Pfiuti:'JGJdltdaf proposed guidance $0Ughl comment OA Federal Reserve, the Offioo of the bnd'l .ncw.sWMI witlllt:.cPrir'ICJp!ufor~Jill wltether the guidance would impose ComptrollerofthcCUmucy, the Federnl l'loc/iccsu...lby ... fll>!r.ci>l undue burdens on, or ha~·e unintended Deposit Insurance Corporation. and the SI01ily bd IFSBl ill Aj\(112Ct». and with lbe f'Sfrslr.t,o.lft.Nt~S.~Idcld$!oll~ ctutsaquences for, small organizations Office or Tldrt Supervision poio<.plof.iso:<d!oSopl.....,...,. and whether there wm w·ays such (collectively, the • Agencies").' Tbis ~ ID lhisplcf•xe.tl\et.a'. "illttr.tiw potential burdens or wnsequences «ttl~·rerers1oll'.ttportMxlo1~ could be addressed in a manner 'F:ataplesoltisb~~pte:ICIU.alb:u:IO ~!))oyee'sCUII\'fltorpc.:Miillcacopansa:iOAlhal consistent with safely and soundn~JSS. d~~~·~~1bdS(IUr.dr..essltlclude isliedtG~O,¢c:ltC«'IIlt."O$pecific: l:lttria(~.&.•lo\'dof$tles.r~<finetJrnt). It i.~ estimated lhallbeguidanoe ,~·ill ac<~a. n...t.t. :~y.o,....iood,lqool, (Oit~e.l:xifl!lp'J':allionaltisb. lo«n:i i"'o-.perl$llio"d:~tSnotinclucle apply to8,763 small banking tAsusedi:slllisgo~ll:C(COI'I"bir.'t\il~ OOfi'II*U'iioCIWth.M.~'oa:ded~}' ~•and~ organi<alion.<. See 13 CPR 121.201. As (I!JlDiT.a~"' pt)'I'NllolwbidlbiOk.)lled I(I.(Odit.ued itdades !Wionalb&nU.Sll:~ notod in tho "Suppl•mentary e:~pkyn:tKI(to&.stl&ryl.ll\.crditio~tot~tt;rl'llcbM tO«l~bub.Sittt~r.Ot~berblnb.a.Y". Jnfonnation'" above. a number of ~ioai:. U.S.bld::t-.oldiflll<XIOpM!~U~ lld.icdviJcc:orJpo:uallico~IDISt~Mt ISKet~:tlllod~delyMt.\ett~ploree'slc.,..lol con1menters expressed ooncem that the l."ldlo.l!!bolditta.opan5es.£dge.t.-..:5~'1C:IIelilt compe::t<Sdi.ocla.."ffibt!;DCil nlJba.t.edCCIOIItO( rorporatioM. w.<i:l a. U.S. opmtioM of to.aign proposed guidance would in1pose ~tM~pakt!JNxe 111tt1k:$ (q..• 40J(t) pl•n ~le: Nnk.i1J3~l~~(tl0t~\(i:h•brl.~ undue burden ou SD13!1er organizatioBS. ~.Or~~tl(':ldlns;D'IIl'IIJ&."'Jin!Ac ""'lchl}-.eetg,'flit;~.~iollc:u:~le$a~l~ ot.. ....,~o,...·...t.ry). '!be Agencies have carefully considered lklted~ Corporation, P-1072, 550 11th St.re<t, NW., Washington, DC 20~29. • Ho1td Delirety:C.onunants rna)' be hand·delivcred to the guanl station at the rw of the 550 17d> Str"'t Bui Iding (loco!Od on f Stree:), on business days between 7 a.m. and 5 p.m. r. the comments ror.ei,·ed on this issue. In response to theseeomments,tho final guidance includes several pro\lisions designed to reduce burden on smaller banking nrg3nization.(. For ftxampla, the flnal guidance has made more explicil tile Agencies' view lhat the (nonitOiing methods and processes u$Cd by a banking organildtion should be commensurate with U1e si?.e and complexity ofthe organiU~tion. as well as its usc or inoontivc compcnsatLon. The final guidonco also highlights the types orpolicies, procedures, and systems that I.BOs should have and maintain, but that are not exper.ted of other banking organizations. Like the proposed gu.idance,lhe final guidance focustS on those emp!O)'W w\10 haYe the ability, either individually or as part of a group, to expose a banking organization to material amounts of risk and is laiiOJcd to actOunt lor t.he dil!erenc~< b<tw..n large and small banking organizations. V. Final Guidance Tbe text ofthe final guidance is,. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00087 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718211.eps c.m,..,.,.,. 84 Federal Register/Vol. 75, No. 122/Friday, june 25, 2010 /Noti~ ror all executive and non-executive employoos who, either individually or as part of a group, have the ahilit~ to e.x.pose the organization to material amounts or risk., as well as to regularly rt\'iewthe risk-management, control, and corporate governance processes related to those amng<men~. Banking or&ani7,.ations sltould immediately address any identified dellc:icnciw in these arrangements or processes tl1at act inconsistent with sarcty and soundness. Banking Grganiz,alions arc ~-ponsiblc lbr ensuring that their inCGntiYe oomp3n.Qtion amngmnents are consistent with lhe principles described in this guid.Jnoe and that they do not encourage employees to e.<poso the organitation 10 imprudent risks lhat may pose a thmt to the safety and soundness of the organization. The A&encies recogniu tltat incenth•e com~nsation artan,gemenls often seck to seTVe seven'll important and warthy objcctiv().S. For example, incentive compensation arrangements may be used to help attract skilled staff. induce better organization·wi.dc and employee pcrlormance, promote emp!oyoc retention, provide retirem~nt security lo employees. or allow com~~tion expen.~e.~ to vary with revenue on an organizalion·widebasis. Moreov"r, the anoiJ•is and methods for ensuring that inct~Uive eompoosalion arraogemeuts take appropriate aecount ofrisk sl10uld be tailored to thesize, complexity, business strategy, and risk tolemnoe or e:~ch otganizalion. The resources required will depend upon the complexity of ll1e firm aDd its use of incentive compensation amngtn,ents. For some, the task of dosigning and implementing compenstnion arrangements that properly offer incentives for c:xoculive and non~ c.xccuti1,·eemployecs to pur:ruc: the: organi2ation's long-tenn well·being and that do notenr.oumge imprudent risk· taking is a complex task that will require the eommitment of adeq.,.te resources. While issues related to dasjgning and implementing incentive compensation am~ngements are eomplex. the Agencies are committed to ensuring that banking organizaliOJJS. move fOlWard in incorporating the principles dCSC'ribed in this guidance inta their ineenti\·e compensation praclices.s ' loDeaab&20ML.itFtdt:r•IRcstm!, wutar.a aitnt.WOilM:~es.bo\.iti&h:claspdl~ ~I:Ot:fal14'\'lt'.A'ofbcot.lll'\'l~:i.Qn ~ClltJUldrd.t:edri$l~t.CIIX!trol. alldeotporatap'trlW)OIIpOOiu:sofaa.bMl.ixlf: ~(Uia.~Thi.sillililfi\'IWJ;Sd'~ t<ISpCifandi:IOilitortbtladu.<l)"s~mtow.vd.s ~~.cir~~pknlc:~lai~Mtl~reu.cJ ~I~"'· ~~Lo..~:lr~l&ntirr~Cfliasbo;t VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 As discussed further below, because of the .size and cornplexit)' or their Optr'i'!lion:s, LBQst~ should have and adhere to syste1natic and formaliud policies, procedures, and proct.ssi.S. These are considered important in cnsuril\g that inctntive compensation srransements for all r.ovored employees aro identified aud Te\1iewed by appmpri•te levels of management (indudins l.he board of dircclots where appropriatoand oonuol units), and that they appropriately balan<e rim and te\'lards. In se\•eral pla~.lllis guidance specifically hightl,lhiS the types of policies. procedu.,.·es, and systems that LBOs should have and maint~in, but that generally are 110t e.<pecled of smaller, less complex organizations. LBOs warrant the most inten.si\'8 supervisory attention because they are significant u.sers of in~ntive contpen.-.atiM arrangements and because flawed approachesot th.,. organiutlons are more likelj• to have a.dverseeffects on the brooder finaucial system. The Agencies will Wllli with LBOs as necessary through the supllrvisory prouss to ensure thatlhe.y promptly oorred. aay dclicicndcs thai may be ineonsi~ent with the sofely and soundness of the organization. The policies, proCedures, and SJ'I•ms ofsmaller banking Olg3ni,.tions that use incenti\16 compensation arrangements 7 are cxpoctcd Ia be less extensive, formalized, and detailed than those of LBO~ Supervisory reviews of incentive compensation macge:meJits at smaller, loss.eomplex banking organizations lVIII be eonducted by the Agencies as part of the evaluatlon of those orgaoizations· risk·nnuagemem, internal control~. and oorporate goveman<e during tho regular. risk· focused examination prooess. Thtst reYiews will be tailored tore0ect the seope and complexity of an crganization'saclivities, as well as the prevalence and scope of its incentive compensation arrangements. Uttlo, if ~•r.d~~llwtst.ltool~core ~IJblllcilldustty. •f01Sllp«Vls«'fpirpo$$$.tbt}.p::.0es~t =~=:.o~~ tbieec.$izo.(:Q'Ilple::Qty.t11dtl$kprolile.Fot parpGSCS(Iflllc~~I.OOsill(~ln:.bc ~,~'t_~~.'!~t~eyr~~~ ~oiu*u~fiedbfi.M:P'tldeuiR«tc\"1! bf.J:JVf:n'isoryflllrpostS:UillheOO::.Ibt~est 4r4\1lo«coap!e-< Micfltl~bas deli~ i:11he ~.o,.. ....~-l>oolldoC~. Qxll('lt[l)r.tr'sl~.bock;~i9tbcFOIC.~ C(llllp)«lilwuttddtposi!Clf)'i~i:utiol:i(lOki:•lld [il·)lhears.~~el~ar.d!JIOI$I.co:~q~!e:xsaft!IS' ti50ci~andwi~arxllol11bolding tompMOies. 'Thl$g.ui<b~dCieSI'Iot•Vfllytobanl:~ ~iDtiooslbar:d!:ir.::KUWiinu•J:ive C:)lflpttlQi!Qc. Frm 00088 Fmt 6602 Sfmt 6602 any, additional examination workis expected for smaller banking organizations that do not use, to a significant extent, incentive oompensatiol\ arrangemenas.• For all banking organizations1 supcn•isot)l findings related to incentive compensation will 00 communicated to the organizatioo and inc.luded in lhe ntlevtmt report of examin~tion or io.spcttion. In addition, these findings ~viii be incorporatod, as appropriate, into the organization's rating oomponent(s) and suocomponent(s) rotating to risk·management, internal controls, and corporate go·mmao<e under thB relevant supen•isory rating system. a.s well as the org-anization's overall supwisory rating. An organiUltion's appropriate Fedet!l supervisor may take enforcement a<:tion 18aillila QankingorganiUltion ilits incentive compensation ammge.ments or related risk-management, control. or goven1anu pfOC(l.$:$C$ pose a risk to the safety and soundness of the ruganization. particularly when the organization is not bking prompt and effective measures to correct the deficiencies. For example, the appropriate Federal supervisor may take an enfoi'Ql:rr.ent action Uw.aterial deficiencle;s are found to exist in the organization's intentiYe compensation amngentents or related risk· managtment, oontrol, or governance processes. or the organization fails to promptly develop, subntit, or adhet'e to on effective plan designed to ensure that its incentivtcompensation arrangements do not encourage imprudent rlsk·taking and ate consistent wilh principles of safety and soundness. As provided under sec.1ion 8 of the Fedml Deposit lnsuranco Act (12 U.S.C. 1818), an enfor<cmcnt action may. among other things. require an mganizalion to take affinnative action, such as developing a cormcti\'e action plan that is acceptable to tlte appropriate Fedeml supervisor to rectify safety·and·soundness deficiencits in its incentive compensation amngements or related processes. Where wammted, the appropriate F'edera.l supervisor may require the organization to take additionaJ affirrnatJ1,·eaction to correct or Nntedy deficiencies related to the ~T~f.ei~:.o•loso~.'.I·Me.a~e.• S1111!1etban~~--1dmle:wiue ~J:rrir.plll«llslodtklnll~wJidhorll .sinon:.li\·tacper.$U~~e:~ISto.a SlgRif~Ut:lexttc.tlult$bu$lr.0$$~[011$.A. ~!kt bahllo,a o:pn~UIIU will odbe c.oui&rtd •~lb!ttsaoll~~t.t~~ll.ive oorn(:nl.l!1iol "":1111aut'.ll. simplyb.nwelhe ocv~illlticn hu afim·ll'iikp:o11t~N~JJ.plt.,IN.Iis t.so.to:~IJ!ebortl:'s~.ablliiJ.e't'Cflif tbeplan COTetS.allcr!IOifolt~.l.dk.ct'sw'i"~Of'.'CJo L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718212.eps 36406 85 federal Regisler/Vol. 75, No. 122/Friday, june 2;, 2010/Notices e\·olve significantly in the comingycar.s, spurred by the efforts of banking organizations, supen1iso:s, and other stakeholders. The Agencies will ,.,;,w and update this guidance as appropriate to im:orpomte best pr.actices that emerga from these efforts. II. Scope of Application The incenti\1e compensation arrangements and related policios and procedures of banking organizations should be consistent with principles or saret)' and souudness.f'lnoenli\•e oompe.as3tion arrangements for executive officers as ""ell as for non· execulive personnel who ha\·e lhe ability to expose a banking organi-zation 10 matcrialan:ouuls of risk may, if not properly stmctured, P"'" a threat to the organizalion'ssarety and soundness. Accordingly. this guidance applios to inC(lnlh·c: c:ompensation arrnn.gcmen:s for: • ~oior executi\•es and others who are Tl?..~ponsihle r{)r oversight of Ihe organization's fimi·Wide activitie.s or material business lines: to • lndi,;dW!I employees, including non-executive employees, whos.c activities may expose the orgaoi7.alion to material amounts orrisk (e.g., t.rader$ with large position limits Ielative to the ocgt!Uizalio:a's overall risktolerance); and • Croups oi employees who are :subject to the same orsimitar incentive compensation arrangemenlS and who, in tbe aggrogate, may'"'~""" the organization to material amounts of risk, cveo if no individ~l employ~ is likely to expose the organization to material ris~ (e.g., loon officers who, as a group, originate loans that account for a material amount of the organization's cre<litrisl\l. ttalbtCMoftlteU.S.optnlioo.soHUOs.tl-..c: 019'iu:icn'1polidos. ir.dodl.•~ent. HYiiiW, IIMhppt~llrtqDII~for l~U..S. opcnl.!otts..~fdbo~~odwlth l.bofB0"1 groop-wida polidas: cl!ftlcpdin llCONla!.ct~ tri~ It• ru!d oiL\cflJO's hoclwc:o:ll'Ar)' supcMsor. 1be poiKiaoflhe ftiO's U.S.open.l!ons si10t.11d akobtt«<iistrnlwi~:).of'SO'sl>'o·or.ll~ U>~lll.tJIIVollt:llslrlld.ue,.aswelluibfrw.."'lewort: (orl'W;..rD..~11 1n6i~IUKlll~ls.lrt ~i:i011. Uepollckosfoc'tbeU.S.~al Fil()$d:o,1dbt~tt'll~l:lhl$pi!Wo. NScnicre:tta~lhwbcl~tll!li:nimt.u::., "txi!ICQ!IN<IffiC:rf~'!fJtlntba•Mili~oftbs Fodcnlltesuvo's. ~~i011 0 (•12 O'R !~~~:~~~~c:r~~. ~tDdEx~f.-~eissbt'smllrsoa d:.dosu."GGfmtvl.iYC~iOIII($r.l17Cf'lt 229..tOZf•Vll..Sa.vinpiSIOriltlor.c~dl•!sc mtr ii)OTS'sru1eo.Wmer"¥i~~~ion$ loth<'r~t'QI(iYeo(fiee.-s.dit(IC(on..•tldp:inci~l ...-r,ltn56l.ln VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 for ease ofreference, lhese executive and non-executiveemployees arc eclle<ljvely roferredlo hereafter as .,covaed employees" or .-employees." Depending on 11\e facts ond circumstances of the individual organization, the typeso( emplo)·ees or categories of employees that aro ou~ide 11\e scope of this guidanco betause tboy do nol have the: abtlily t{) expose 1he organiulion to material risks w·ould likely include, ror example, teller$, bookkotpc!S, couriClS. or data processing personnel. In determining whether an employee, or group of employeos. may OXJlO"' • bankingnrgaaization to material risk, theor&anization should consider the full range of inherent risks arising from, orgenerated by, the employee's adiviUas, evtn i( the organization uses ri.sk·manaac-ntcnt processes or controls to limil tht risks such activilies ultimate!)• may P"'" lo the organization. Moreover, risks should be considered lo be matetial fer plli'J)OSe$ or this guidance if they are material to the organiution, or are material to a business line or operntill& unit that is itself material to the organization.1l F'or plli'J)OSe$ of illurntion, assume that • banking organiution has a structured· fmancc unittbal i.s material to the O!g!OiZ>tiOll ..~group of employees within thllt unil whD originate s~ucturcd·financo transactions that may expose the unit to material risks should be ecnsideted "covered employ...,. for purposes of this guid;utce e~·rul if those transactions must be approved by an independent risk fu11ction prior to cor-.stJnlmi\tion, or the organization uses other processes or methods to limit the risk that such t.ransac:tions may present to the organi"taHon. Strong and effective risk·managemcnt and internal control functions are: critical telhe safety and soun~nesso( bankingorganizations. Howaver, irrespective of the quality or11\ese functions, poorly designed or managed incentive compensation amn.gements can themsclves be a source orrisk to a banking organization. For example. incentive curnpensation arrangement:s that provide employees strong incentives to increase the qanization's sbort·lenn revenues or protils, without rc&ard to tho short· or loog·tcnn risk associated with such business, can place substantial .strain on the risk· management 3nd int&rnal control functions of oven wcll·managed organizations. 11 Thtt2$..ril&:u~.:fbetn.l;:trilll lllan~llir•Con -.ir~J~qo~~e.ottarae~tot.'lw.l~lms. th>NimtbolOI•""!'cltiGO>SIJitd;,, Frm 00089 Fmt 6602 Sfmt 6602 Moreo~·cr, poorly balanced iAcentivc compensation ammg<~ments can encourage fH'lll)loyec.s to take affinnali\•e actions to weaken or circumvent the Giganization's risk·mana.gcment or internal cont.rol functions. such as by providing inaccurate or incomplete information to those functions. to boost the employee's personal compensation. Accordingly, sound ecmpensation j)I'3Ctices are an i1•tegral part o(strong risk-management and internal control functions. A key goal of illis guidance is to encourage banking organi1.ations to incorporate the risks related toincentive compensation into their broadc: riskmttnagcmcnt framework. Riskm.anasement proceduntS and risk r.onlrols that ordinarily limit risk·taking do not obviate tbe need far incentive compensation arrangemen~ to properly batance risk·tttk.ing incentives. Ill. Prinoiples ofa Sound Incentive Compensation System Principle \: Balanced Risk·Taking Jncentives lnce.ntivtl compensation amngements should balance risk and financial results in a manner that does not enoour4ge employees to expose theirorganizations to imprudent risks. lnr.enti\•e con1pensation arrangcml!nts typically attempt to "'courage actions that result in greater reve!'tueor profit for the organization. Hm'le't'ar, short-run revenue or profit can often diverge sharply from actW!llong·run profit b&causa risk outcomes may becnme dear only over time. Activities that cany higher risktypically yield higher short·teml re~·enue, and an employee who is given incentives to ioCCMSO short·tcnn re~erme or profit, wilhout regard to risk, u·illnaturally be attrncted to opportunities to expose lhe organization to n1ore risk. An incentive compensation 81rtng<~mcnt is balanced "hen the amounls paid toan employee appropriately tab into 3('b)unlthe risk< (including compliance risks). as well a.~ the financial benefits, from the employee's activities and the impaCI of those acti\•itias on the organiu tion's sarety and soundness. As an exa.mp!&, under .1 balanced incent.i10e compensation arrangement. t1"o employees who generate the same amount of short·term re\·e.nue CM" profil for an organiz.'ltion should not recet1·e the same amount of incenti\·e compansation if the risks t>kcn by ~~• cmpto)'OOS in generating tOOt revenue or profit differ materially. The employee whoso activities creato materially l.arscr risks for the ocsanil.ltion should !ettivo L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718213.eps organitation's incenti~·e: compens.atlon pradioes. Effective and balanced inconliw. compensation practices are likely to 36407 86 Federal Register/Vol. 75, t\o. 122/Friday, funo 25, 2010/Notic:os well as other risks to tbo riabo1ity « opmticn of the oqaniutioa. Soaoe of these risb moy bo re;olized in the sMrt term, while otltm may become opparentonly over the long term. For examlllc. futuul re\·e.nueslhat an~ inccntlv~ pmvidod employees and, thus, the potential for thoarrang< ment booked as current income may not to encoura&clmprudent risk-taking. For materialitc, and short-term profit-Md· loss measures 1na.y not appropriately Wlt'lple, ir •n employro's incenli\·e compon<ation payme.,llere closely tied renoct dur....oos in the risks """'ioted w:ith thrtrenu.ed•i\·ed from diff.-:~1 i<>sborHemoreveaue«profit of ICtiviti.. (e.&.lbt •i&hor endit« bouilltSS pented by tho Olllp!oyce. wilhoutanyad;IISIIIIOIIU for the rUb Clllllplia""' risk usociotod with ...Utod wilh tbaboasinm!>"llonted, SUI:prilllliow \'GSUS prime loo..~" In 1<> the potentiol for tbo oddition,....,. risks (or combinations of •llCOUnSt lmprudaot risk~ng may be r~ky SII>I'Ci" and positions) ""Y h>ve quite strong. Similarly,uaders who a low probobility of beil18 realiud, but work with positions that t iOSft at year· would have highly adve~St effects on end could have an Incentive to take theorsomiza:ion if they were lobo i•~ge rlsl:$tow•rd the end of a year if realitod ('tad toil risl:s"). While d>ercls no mocmnism for fadoriQS how shnre:holdcrs ntay ha~·c loss incenth·e to such posllioru perform over a loBger suard l&'in.ll b>d tail risb OOcallSt of pericdofUmc. '111eSID1eresultoould tbo infrec;uoncy of tboir realization and IIISUt ifthe perfonn1Doe measures the oxlsknce ofthe Fodenl safely MI. lhomto!WIIiack in!epiiJ or cu be tbote risks womnt spec:W allmtioo for IU!lipulotod iaapptOPriottly by the s.fely•nd·~-g;.-..lht mployoes lflCO!vlna icanti•.. thnat tboy pore to tbo 01p1izltioo's comperwti<ln. sol•·eru:y ar.d tbo Fodonl safety 11tt On the olhet lwld, if an employeo's Banking Oll'•izatioos should incentive comfMin.sation parments ans: consider lhe full11nge of current and dcicnmincd b..oo on perfonmanoe p<>tMtial risks '""'iated with the mOMurosthaure only distantly I inked acUviiJe:~ of r.ovcrod empiO)'&e.s, tothe employea'• activities{eg., for including thocostend amount of capital most t~:mployee5, organiz.ation·t.,i de and li~uldlty needed tosuppott those proliO,the potentiol for the armgement risks, in dO\-.Icping balanced inconth·e to """"""ethe cmplo)... to W:e Reliable compansotioo imprudlllt risks .. behalf oftbo qu,.titsti\'tiiOISU!OSofrislcandrisk orpaiutioo ..y bo ....t. f'or this ..-("CJIIIIItil>li,..........., ....._,,piau that pnmide for owords w!lere an.it.ble, ""Y bo porti<ubrly bosod ..t.ty on 0\1!rlll organizltiOI!· ustlul io dmtcpingbWoced wide perlofmanee are unlihly tG oompt,.,Uoo artang<meOts and in provide employom, olhcc than ,.nior ......rngthoOl<l<ntiO which oXJ~a~liYU and Individuals who have arrangements ue properly baiAAc.d. the obllity to materially affett the However, relrablequantitativt mwuru organlutlon's o•·orall risk profile. with r.tlly not be aveilablc for all types of n.k unbalanced risk·takillg inceotiv.,. or for all a<lh·itios, •nd their utility for lnccntivo compensation a.rran;ements use in compensalion anange.menls should not only be balanced in destan. \'1~ aaoss. businw lines and they obo <hould bo implemented ,.thot employaes. Thuhsonce of reliable or:tul paJIUI!IS YliJ bosod co ri$b or qu'"tiUiivell6lSUrOSforc:eruin types risk...-.lf,i:>rwmple. ol risb or OCIOOalOS doesiiOI.,.,.Ihot ""Piol•..paid >VhstmW.lly all of baokiQ&OfJ'Cizatioassbocld ipa<e lhtlr potential i....,u,.. compeosation sudl rbb or outco,., for purpose~ of e\'tl2 when Nkor rUk outcor:li:S are WISSing wbdheran incentive mot!rlolly '"""' than expecled. compensation ana.n,gement achieves en1plO)'el$ haveltl$$ incentive to avoid balance. f'ormmple, while reliabla a<:tivltios with subslantial risk. quentitativc measures may not exist for • Bonklngo~g~~Joizalionsshould many bad·ttll risks, it is important that considtrtha full raoge of r~l:$ such risks bo considered given their associated with an employee's activities, potential clled on safety and ,.cndness. which O\'er horizon time tbe as well as thoso risks Ill)' bo !Uiit.ed, .,....,.ut.J. IMtiiH:Mrizo:t.OM"no•rid. loss lba tbo olhor employee, all ehe boiogoq..l. The perhmanoe msa.surBS used in an incentivec:ompensation arrangement hove on lmponaJUeffctt on the .,..,,..,...t "'""fl&tlll""ll. in"""""" "hethct iac:tnli\'t COAlpe:uation ~ISertbolaoced. <nlllo 1 wide mao olrisks fur a ba.WQS organiullon. such as aodit, marbl,liquldity, operotional.l'llal, oompltance, and repulolional ri.s k!, a! 14:11 Dec 18, 2018 Jkt 046629 PO 00000 bonLq oqanizations should r1ly"" informod j\:dgment.s, •uppaned by mil•hle dato,IO estimate risks and risk ouloomcs in the ohoenco of reliable qutmtit•tive risk mca.swas. l,o'),,. banking orgoniwtions. In dMigningond modifying incenti"" oompcosation amngement.s, I.BOs should .,.... in ad1·ance ol implcmenution wbc'Jlc< such ....,._,ll.,.!iblytopro•ido lrolar:r:ad risk-IWI18 incoolivos. Simulation onalysis ofinr:enti\'0 <COlpen>otioc amngemenll is ooe woy of tloi~~&so· Such ar.alysis""' forward· looking projection> of iccentive eompemationa\vards and payments haotd on a11nge of perfornoance Ieveb. risk outoomes. and levels of risks taken. Tbl.ltype Clf analysis, o·r other analy~is tbat,..uiiSin.......,entsoflikely tffactivcness, r:an help "'LBO assess whether iDcecti\-e Q)mpcma:tiou '"'~ and pa,_,ls 10 en ompJoree arelilcly to .. roducod approprialely as tbo risb to the "'&'•izllooo from tbo e:nploy•'• adivltits incase. • An unbal.nced am.ngement can bo moved I<>\¥Ord bailnee by adding or modifyi113 fealures that cau,.the runounlsultimatcly roccived by omployoosto appropriately rclloct risk ond risk ootcomes. If en incan\ive oompensalioo a:nngemcnt may encourage tmp1o)'MS to export their bonkios orgar.ization 10 impNdeot risks,llot crgmization should modifythc~IS noecleclto-lhatitisc:oruislent nith safety ond ,.undn= four mtthod.!moftoowediOmaloo cnmptn..sation mora sensitive to risk. ThCS<l method> ""' u nlsk Adju$1mtnt ofA•~rds:'rhe amount of an inccnlivecompcn.s:~tion •ward for onemployee ~adjusted b..oo on mwuros that tab inlo account tl:.e M< tho employee'• activities may po10 tr>lheoqanization. Such.....,.... Ill)' ..qUODtiWiva,«thtsi,.ofarisk adjustmontlllly boJet ~tally. subjoct 1r> appropria:e ov!ISiglol ~ Dtftrmf of Poyment The actual payout olan award to an employoe ~ delaytd •ignific:antly beyond tho end of the pcrfom~ance period, and the amounts paid '"'adjusted lor actual ).,.es or other aspects of performance tbataro realized or becoona better kr.own only duril181he defeml period.'' Defoned payouts may ho .......,........... ~::,tN-. • ...,..,.....,..,. . . . . . ,cru.plt. '1110 octivitils olemployoes may VerDate Nov 24 2008 A$ in other risk·-!'""'· ... .... .....,..bJ•• ~._ ......-.--~PIP"· ~--.tyMIIOIItyo:paRSik~IO -o.yaoblolol, ...... _ , . CIJUI~IO ....Idi'J:I:W.tNIJUJbeiOIIili!'d "~'·'•'l""'lly. Frm 00090 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718214.eps 36408 87 36409 Federal Registcr /Vol. 75, No. 122/l'liday, June 25. 2010/Notices aJimdiiCCOII!iJl&IOrisl:OIII<Oa>eS either lonnulalally or judglneot.lly, subject to apJ)IopriotooversigltL To be m05I rf!ectivo.tht dclmal pmod should bo sufficlontly lo"8IO allow for the ...u,.uon of asubslanl~l portion of the riskJ from employee activities. and Ihe mmu"" ofloss should be clc.vly explainod to employees and cl...,ly tied to thcir ottil'ities <!uri,. tho rete..., penon..,.. ,.nod. , lDn:tt l'tt(OIIIIUIIC1t Periods: 1\a time pmod CO\'II'Od by the perf«manco measuras wed in dctenniniag an employoo's aw;ud is extend«! (for example, from ono yoar lo two or moro rem). l.ongor J*fonnance periods and deferral of pa)'mllllla.. rel•lod in that boih methods allow owards or payments 10 be Nde oll<r somo or all risl: D:llalat<s Itt reolized or hoUtr I:Do~>'ll. c RtducrdStJW!ivilyiOSho:!-Ttm l'elfonrt<Jnct:The bonkingocpniulion reduces the 1\lto at whlc.b awards increase as an employte achievc.s higher liRVtll.$ of the roJ0\10nl perfOnM!lC8 mcasure(s). Ratherthan offsouing risk· latins incenti\'M associlted wil.h the use olshorwm perf0111W1C0 m....,,.., lhismedlod reduces IM~o! suchi,...li...,_ 'f11ismolhochlsocon intlude lmfi'O'i~ the quolily and reliability of perfurmanct measures in ~>king into account both short-term and long.term ri.lks. for w mple irupro1ing lhe.,liabllity and act\Jtoey of estinllll& of rmnues and long·lenn profits upon whicll perform.~noo mc:uures deptnd." , _ tG<Ihods 6Jr odlit>i"8 balaeco .............l't,tndadclitioaal methods or variatiooo moy existcr be da-.lopcd. Moroovcr.cocll method has its o"n advan~ ond disadvantages. For CllOimplo, whero mliable risk measure.' exbl, ri!!k adju.~tment of awards may he moro eJTccti\'e tha.n dclernl of paymtnl in redu<i"8 iocooti'os 6Jr lr.lprodonl risl:·taking. 1\isis ......... risl: odjlulm<nl the full po:eoti.tlly c:aa IW range and bme ho:i""' of risks. rathO< thao just th010 risk OUicat.lOS that occur or become mort ovidenl during tbe defcml period. On Ihe other hand, defcml of payment mar be more effective than rbk •djusllllenl in miU&~tins ;,_,i..,to IW hard~<> .,....,.risks ($orcb ostho risks of r:cw activititsor pn>:!octs. CO'artoio risb such u repulatlon.IOJ oporational risl Ihat may be difficult to mwurtiVilh to p>rticular adiliUC!$), etpec:i•lly ifsuch risks are likely to be reallud duri"81he defectnl pmod. According!)'. in srur.e:casa h,·oor men meahods mty be ooeded In """bination Cot an iADtAliw: co:opu..gtion """"""""ttobebolon<r>d. The pul<t the poten!W IDCOCtives .. omng<mcnl cn:ales for an cmplo)''" to lncrouethe ri.lks asoociatod 1<ilh the emplo)'et's 2ctiviUM. the stronger the effect should be of U1e mtthods applied toocllievebalanf.S.TIIus, for example, riu adjUSIIDents uzed to counteract • matorial!y unb.alinctd COIIlpensatioa amngaoeo: .booJd itol't I simil&rty material itDp3Cl oa the incantive cornponsotion paid under the arrangem<nL furl,.., improvemenl.l ia ~" qunlitpnd reliability of porfonnance measuresthamsel..,, for ex~llple improving the reliability and accuncy ofestimates or re\·em.1es and profil.l upon wh.ich pedom>ar.ce ,......,.. depo:lcl ao sipilico>~y ""PK' ir.piO"Ittb d~ofbaiiiiCOinrisl· tW118*-'Ii'-es. ll'liin judgment pl•ys t •lgniRcant role in the design oropentlon ofan incor.tlVG compcos.1lion amngame:nl, strong policios and pmoodures,lnton>al CODIIOb. and ex post monitoring of lncolllin compeosolion pa)'lll<nts !<lativclooctualrisl:ou"'"""""' particubtly imporllrlt lo ..lp oc.sure that the~as implcmtnlod ...bol...:ed :md do not.....,. imprudent risl:-!okiog. FD.'•xamplo, if a booking Olg'nillllion relies to e significant degree on judgment of Rnanci.tlwell-bei.. md afdy ond SG!Uld-. • , ......... u.wbaabanliog organization seeks to tchievo bolanctd =~~:n:d:~j:~~~~~:ts differences between employeesincluding tha •ubstantial diffe....,ces bctww senior execuli\!es and other employ-. well IS bee,.... bankilll organWliGnS. Aclilitl&. and rbb ..y ''UJ $ignifocoatly both ocross bonlilq: organizations and across employees within aparticular banking Ol}1ani7.0ltion. For b.lantple.activities, risl:.s, and incentive compensation pnldicos may d iffcrm.~teriolly among banki111 orsani11tlons b>std on, among other thiQC<.lho scope or Q)lllplexity of ltlivitios condu<tod and tho bus;ness sl.'IIACies pwsuedby tlta orpniZiilions. '!'Mit diffmnces....ac th2t methods I« achieving bal:mctd cornporuation arra~znenLt; 11 on.o organization m~y not be effecth·e in restraining incenti~·es to engage in impntdcnt risk-takingat .another orsani1.41io:.. Each organiz.alion is ruponsiblo fotensuring U..t its inoeotii'O -ponsatioa amngements .... cnosisltnt v.ilh tho A!tly and ~f=.f:.·r~"'th lhc activities of one Jl'OUP or non· executive employ"" f•.g., loan originators) \oJlthin abanking organization may differ significantly from tltoso ofanothor group of non· exeooli•o anplor- (,_spot foreign ~traders) witlWt lite orplliution.ln addition. rdWlle q=tiutivo rntasura risk ..d risk oul<omos are unlikely to be availahlo lor a banking Ol1!anl,.lionas a whole, particularly alarge, complex one or ruOJe managtn to ensurethnt tho organization. Thfs r~ctorcan make it difficult for banking "'¥4-1iutions to incenti\·e compensation awards to ach.ie\·e b.JI~~:nced compe:nsatio:. employees are appropril:aly risk· adjwlecllho o:pllt>lion shocld hal·e am.-ts for sen!oruecutiv.s ,.iro ~u... responsibilil)' for m.ln>Ci"& risks policies and ~wosthal claaillo how managors"' expeclod to wrciso 011 an orpniutioe·wide lrosis solely lhnl~ use of the risk..djust.,..t..f· that judgrne:1t lo achin~ balonce and award method. that provide for the rnanager(slto Fu.otltermore. the payment of deferred re<:cl'o appropriate available inf€1rmation about the employee's risk· incentive compenS~Uon in equity (such as ,..!rlctod stock of the organization)or taki"8 activitietiO male informed equity-based ilUirumenl! (Sllch as Judgmmts. _ _ _ _._,Widl l.orp llonliog Ol)lOIDWiion~ Methods optior.s 10 ICOJUire thtorpoizatioo's 'l'fliooiO ~Adti2IDOI(UU.$.C.?UJ! and pradioes for makingc:oarplllll!ion stocl:) 1111)'be bdpful in ...u.inirlg tho rist-Giilq:IMOIItivaofsmior sonsitiwetorisl:.n:lildyto"""vo executiva and Otha' co>N anploy,.. .....p..tb-r;>o*c,tol"diJ.> ocY npidly during the aext few yoors. qqgii'DB. whose activities m.ay ha,·e amateri.tl d~"n In part by the efforts of •4tu!~LUJIIUD4JM'tt&ll'.&tria.!tlect stakcholdt<S. effect on lhc overall financial supervl.,. and oe~cwl~i•. Wuzsets•1ofiet pcrf'Olmancc of tho OIWJnl-xalioo. LBO. <hould actively monllor tM~'eOiil (tt.Mtf' ftw&rds .forilll(fSioaiiS of Howe"'· cquily·rolatod deferred dmlopments in the field andshould pdorruna~ thai w*'-'CI~ i.i¢.C or JUY proviJe ININ~~ck will bl&*iododyifa Urs« Incorporate into lheirincenlive compe:n~lion may not be as effecth·e in 'iSa~~•at.eldtLbl~tMfbepwlinllL-tt comper.s~tion systems new or emerging ~raining the ineenlh't.' of lo•~-er·le\·cl &OCivt."AdiOklt~~~--brwil a><ere<l e:rnplor• (ptrtio>latly •tlarge methods or p<Odices tltatnlil:aly to G~ptimi<w) to tW risb blall!l suc.'l irnJ)IOI~ lhtorg,r.liD!icn's IIJCitln of tho """""'of __ ,,.........,........ ~ __ _"" other ...... VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00091 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718215.eps ........,........ 88 Regisler/Vol. 75, No. 122/Friday, lune 25, 2010/Nolicos employees are unlikely to believe that their actions will materially •ffect the organization's stock prioo. llanking organiutiOilS should take account of these difforcnctS wbe11 eorutructing bal3nccd oompcnsalton arrangeoenls. For most banking Of&'lnitalions, the use or.a single, formulaic approach tomaking employ.. incentive compensation arrangements appropriately r~k-scnsili1•e is likely to resull in amng.ements thai are unbalanc.ed at least with respecl to some employees.•• lotge bonking otgoniztJiions. ln~ntive compensation arrangernent"i for stnior execuli\•e..~ at LEOs aro lt~ely to be better balanced if they involve defmal of a subotantial portioo o! the e.\:ecutives' inamlive compensati(Jn over a multi-year period in a way that red~~ the 1mo~nt ooi1·ed in the evenl of poor performance, s.ubstantial use of multi-year pc:rfonnancc periods. or both. Similarly, the conopensation arrangements for senior e.xetutin~s at LBOs are lil<ely to be better balanad if a significant portion of the ino::nti\•e eompetlsation of lheseexecuti\·es is paid in tho form of cquity·basod instruments that vest ovtr mulliplc years:. ~"ilh the number of inst.rumcnts ultimately received dependenl on the performance oflhanrganiution during the deferral period. The pOJtion of the in«ntivl.! compensation of Olhcroovcred cmployoes that is deferred or paid in tho fonn of equity·based instruments should appropnately t>ke intoar.count tho level, nature. and duration of the risks that the employet\S' activities create for the organization.and the extent to which those activities may materially affect the o\•erell performance of the: O!g8ni:zalion and its stock price. Deferral of a .substantial portion of an cmplorec's incentive compensation rna)· not 'be workable for employees at lower pay scales beotUSt of their more limited financial resources. This may Nqll.lire increased reliance on other measures in the incentive compensation :nrangtrnents for these cmployw to achteve balance. • Banling organiz.>tions should carefullyoon~der the potential for "golden paraclmtes• and the l"e.<tlng ;nmnger.1ents for deferrOO compensation " for ~lllp1t. ~pr~ift8Jllll}'<lllbolinoect.h._ c.on'l~io·l~wa.-dsov«•SWidt.-dtluoeo)~r pe:lodl'la)'n3!-w~1~yreflocubtc.itT~ fntbt twetodtilHboriz.ooolrifkasaoc:ia~edwi:h tbeldit51iesoldi1l't'ftlllpp.sol~od r.&)• DOlbewffici«.tb)•i:.dttobibi'ICethc (l)lr.peutlion.~etltseltt~ployCIII$ ..t~,..y C.'lpolll:tliM:o~iQ(toi:I.O~~W ~ODI ri!b. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 to affect the risk-takil!J! bch"ior or empl\)}'e&S while at the mgt~nizaUons. Arrangements that provide for .an employee (typi<>lly a senior executive), upon departure from the organization or a change incontrol oftheorg,aniu tion, to receive latgeadditio11al paymenls or the a<tOimted payment of deferred amounts without regard to risk or risk outcomes can pro..,ide the employee significant incxnti\'cs to expose the organi~tion to unduo Nk. P'orCX3mp!e, an ammgc.-nent that pro,•ides an employee witha guaranteed payout upan departure fmm an organizatio.n, rq:ardl._<S nf performance, may neutralize U1e effect of any balancing features included in th•amngemant to halp pre•·ont imprudent risk-taking. Banking organizations should carefully revie\11 any such existing or propascd amngcmcnts {somclimcs called 'golden parachutes") and the potential impact of such arrangements on the organization's safetyand soundnes.~. In appropriate circttmStances an organization should consider inclnding balonci~ featuressuch as r~k adjustment or dafeml requirements that extend pasl th.e eo1ployee's departur&-in the arrangements to mitigate the potential for the amngemoots toencourage imprudent rlsk-taking.ln all cases, a bankingorganiution should ensure that the structure and terms of any golden parachute arrangement entered into by 1he cxganization do not encourage imprudent r~k-takiog in li,qht ofthe other features of the employee's i'1cenlive compensalion arrangements. 14tge banl:ing orgqniwlions. Pro'risions that require a departing employee to rorfeil dcftJrred incentive compensation paymenU: n1ay weaken the effccti•·enoss of the deferral anangemcnt if the departing cmployoe is ablo to negotiate a 'golden hand~baktf arrangomenl with tho new employcr.•&This woak.cni11.g cfJod can be particular(y significant for senior executivO$ or other skilled employees at LBOs whose services are in high dcm3nd IYithin tho m3rkct. C.ldcn handshake arr•ngmnents present speci.'!l issues for LBOs and supervisors. F'orcxample. while a bank.ing organLzaiion could adjust its deferral arrongcmonts so that dcpaning tt:'lployees ,..,;ncontinue toreceive any aCC!'\11\d defeCTed wmpensalion after d•p.1rture (subject to any dawbock or ••Colda~•re,mr.ptr.Utbll «aptnsalun e.p~ tor$00M oull Gf11M ~iBt:ed. ~.tdval~of&!tmd!ll(tdi\'t l'J):I~ior\ll-Aio!'Otlt4bt\'\\t.'l!(ddcdt.:I)CII l.rpa:twe trl'IOlhMiplo)'M·spr~ 0).1~!.. Frm 00092 Fmt 6602 Sfmt 6602 malus"). those cha"ges could reduce the employee's incentt,·e to remain at the organization ilnd, thus, weaken an organization'sability to retainqualified talent, which is an important goal or compensation, aod create conOicts of interest Moroo..,cr, actinn.s of the hiring organizalian (which may or mlty not be a supervisod banki~ O!llanization) ultimately may def"t thes. or other risk·balancing aspocls ofa banking organiution's deferralarrangemant.s. UlO.s should monitor whether golden handshake a!Til.flgcntcnt.s are materially weakening the organitation·~ efforts to cotastrajn the risk·taking incentives of employee.s.l11e :\gencies will conlinue to work with bankjn.g o~g.anizatious and others to de~elop 8ppropriate methods for addressiog any eflec{ that such arraJ18ements may have on the safety and soundness or bankingo11aniozaUons. • Banking Ol!!ani~lionl ~~ould cfTccti\'ely cumnnUlica.te to employees the ways in which incentive compensation awards and payments ~iii be reduced as risks iocroaso. In ordcz for the ris.k·sensili\·e provisions or incentive oompensation aJTaltS<noen~ to affect tmplo)·ee risk· taking behavior, theo~anization's employees need to understand that the amount of incentive compensation lhat they may receive will vary based on the risk as.\Oeiated with their activities. Acterdingly. banking otganiutions should ensure that employm covered by an incentive compen.sa!lon arrangement are informed about the key ~v~ys in which risks aro taken into account in detennining the amount of inccnti,•e coropcnSJiicn p3id. Where feasible, an ~niu.tion's communications with employees should includeexarnplesofhow incentive: compensation payments may be adjuSied to reflect pro;octed or actual risk outcomes. An organi?.ation's coromunicalions should be tailored appropri>tcly to reflect the sophistication of the relevant audience(s). Pnnciple 2: Compatibility With Effi!<6ve Contro~ and Risk·management Abankingoos>Oiution's risk· man~gemenl pnx:esses and internal controls should reinfcm:e and support the development .nd n~•intenance of balanced incenU\•e compensation amngemeols. "A auii:SaorqarD~C)l pennilJI!'Al ar.p!o)'e: 1.0 ptt\"(11:1..-estlQSolall «t»:'loltheDMftiDiola i!ritcrtd !MuCOMiU:I au~fd.MI!I.:$ provisio.'lSltt [nYOb::i 1M rbi«JQ31:1e51.1t WO."'SSIl:.an txpec:~Morv•h~ tM~1tooupon 1KbK111.be a~.wdt>"Ubt-rum5outl61uii'Cbocr1 ino:md. Lmol.:~rwcalcd<Oe:.~dt.:ot4o li:e tlr.p!oyM ~';~~~-~1:~-:~~;~?feol L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718216.eps feder<~l 36410 89 36411 federol Regisler/Vol. 7S, No. 122/frichy, June 2S, 2010/Nolicos .. p~o,..·, OCI.ioAs ...y .....u. not oofy the bal.nao ollho «giiliza~'s lncenti" CIOQpensation lmliF'""Is. butalsolht risk-~. ioternal conlrOI!, and oU>er fundioR$ U..l .,. •opposed lo act IS a separate chtck on ri>k·taklng. for this mson.lr.ldil.ional risk·rMn3.gcrncmt conlrols alone do not oliminate che n,.d to idantify employM.S who may expose the ~nlution 1o material ri>l:, nor do tbcy obviate tbc need for lhe inamtivo CCII"IIpwation amnge:r:aots fa these ..p~oyoes lobo balooood. Rath.-•• bonklns....,i:nliao's risk-aoaD~emall proccssos and inl«noo Q>nllols sl»old reinforcuad support the ciemopmO!II ar.d malnleMnco of balaRA:od i""'nti•e CO.'l..tperuation arrangements. • Banking organization.~ should hne llpprnpli~tc oontrols to ensure !bat thtlir p~ for achieving balen<od compensatioa amtlgements are followed and to maintain tho integrity or thoir risk·manogo:m..t and o:her functions. To lotlp pm"OOI duoo:go 1rono OClCOifliiC. • ~~Wins oq;onmoioa •'d ha"'MlaS"'•Orolsgonming ""' ics,...... deslgnins. impl..,enting, (or and monitorin, inc::enti\'1!1 compms:llion amtJ18tmoncs. Bankingocgaruzations shlluld ctt'te and maintain sufficient documentation co pennltan audi 1o(lhe effectivene.s.s or the otganization's piOCOSIIS (or establishing. modifying. and tDOnitorina inamth·e compensaticm """F'IIIt~ Sm~ior bat.l:ic& orplli,.lioru should u.x.ponte miows of dotso (IIOCISSOS into tbeir 0\'mllhlroowwtloroompliu:oe moniloriro~ (!oclllding !nt<mal auditl l.orp 60nl:ing "'8"niwtions. LBOs sboold hav.,nd maintain policieuud proo:ldurM that [i) idru>tify 111d d!SC!ibe VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 lhe roloUI of tho ~.busi,... units, and CDOltGI unics authorioool 1o bo Involved In lhe dasign, iaopiA:uoentltion, and monilOriJtS or incentive compen.<3tlon am~ngomcnts; {iil identify the •ource ofs]$nificanl risk-related inputs iAio these p..,...... and establish appropri<tlc <onlrOis govoming the developmenland approvol of these InpuiS to help ensurtlheir inleglity; and (iii) identify the indi,idual]s)and <onln>l unit($) ,.hoso appro,.. is ._,forlheestablis!u:leloo oi- C0\'1nd omploj'OO!; 6il appnrri!os che ri>k mouiiJtS ued in rishdjus!Menc. ond perfcmwoce mtaSUn!S, as well as measures of risk outcomes used in defemd·paycutamngements; and {oiil onaly;ing risk·laking ._,d risk outcom" 1'\ll~livo to lnct:nlivecompensation Jl3{)';~:'f~ncUons withi.n an org.anitation, such as iiS control, huma.n ....,......., or fi..nce fomclions, also pia)' llllmpoll&nl role iD loelping ...,.... that i~lin (X):npusation IICG6\-.octmpas.lioo~IS« .,.,..._LS.,.bolanced. For mcdilicaoion of existi"3amngomllliS. wople, these fwlctions may <onlribotle Aa LBO also 1hould <onduct r<gular to the dosicn aoul review of performance maasu."tS used in comptnSation internal reviews 10 ensure that its proowe.s for achieving and .Nintaining arrangomonl< or may supply daca u...J as ptot of theso measuras. ~lanwt incentlve co1npensation • Compensation forcmpiGyees in arrangements: are consistently roliO\l.'ed. risk·mtnagemeut and tontrol functions Such re•·lcws should be <onducted b)' au<llt, coonpliance, or Olher personnel in should bo sulncienlto allract and relaln q"'lifi!d ~"!!nnel and should 1\~d a m•nrtOr..,.,.~t..tllilhth conftids of iniAin>sl. "'l!'Odutlon's 0\-..11 boolewmt (or Tlo&risl:-~a:odamln>l C010plilncero:onil1Jrin&. An LBO"s porsoond io\"Oh-ed in the desip. lnt.nal audit depwncol also ohould Uld opontion ol inmoti•~ ovenia)rt, Slplrltdy corullld """" aau!its olthe compo:wUon anangemencs ohould organitation's complimce with its ltavo •Pi'fOprule skills and experience esoablishod polities and controls nt!t!dcd to cffect£\·ely fulfillthoir roles. relating to inOMti\'e compensation Those skills and experien"" should be omtngemcnls. ThoiOSulls should be sulnclencto equip che personnel to rcpor1od to appropriace le•als of 1'\llnain o.ffocti\'C inlbe face Of 1nan.mcnt and, where appropriate. rhallcnges by c:overtd employcos tnt 0'8'Ritalion"s board o( d.iroc!Ori. • Appropriaoc personoel. iucludi•ll seeking to inacase their incenth·e compensation in ways tht are risk·manteemtnt personnel, Jhould lnconsistanl 10ilh sow:d risk· hnelnpo:l io:o lheo.~ioo's .....,....,c,.intemal""'crols. Tloo processes for~"' iooenti\"0 ClnpelllitiOni~':Sfor oompo=liooa..,.....LSa:od tmpioywinrisk~cand WU$i~ tbeir tfftcti\-eoess ia con110l fwoctioru lb., should he rlllniniq imprudeol risk·taki"tg. Developi'1 •ncenti\'S compensation sufficient co attr.tctand ®in qualified personnel with experience and expertise ornngemeots tlta: pro\ide balanced in th6SO fields that is appropriate in ri.sk·taki113 incentives and monitoring lighl or lhe si,., a(:livilies.and arnngemenls to ensure they achiove. balance over time requires an <omploxicr of lhe orsaoization. In odoiuon, oo help preserve the undcrsanding of tho"'" Oncluding iodcpcndtn<O of their perspcclivcs,lhc compllonc:e risks) and polenlial risk oult.Oine.s associated with lhc aaivities iact:nth·c oompensatioo n:cci\'td by of Ihe rtlevanl omplOJ-. Actordingly, n,<....,.....,...d OClltrol l:ankirtCcrpoltalicwsloouldb..-. DOl he Nsed substanti>lly su« polidol and procedures thao mwnlhat "" '"' finana.l perforrnaJQ or the busiaoso uoiLS lbacchoy miew. R>tlter, risk·.....-• pmonocl ~~a.... oppropNie role in lhe organizatio.•'s in tho tht por(ormanco ~for dl$igning incenth-e inctDtift compensation arrangements for based be and should lor these personnel "''"ponsetion arrangements W6S.Si.og their effecti\·eness in pr1marily on the achiew~ment ofthe resualnlng lmprudontrisk·laking." objocll•os or their functions (e.g.. Ways lhat ri>k managc:s might ossisl in adheren1>1 to htlemal c:onlrols). • Banking ocgaoi,.tions should trhieving l~lan<od a>mpen.<alion monitor lho perlonnan1>1 of their amnger:unts iacluds, but a.re r.ol iDtenlinan:tpenSIIion arrangements limiled to, (ilreview~c& thei)"Jl<S of ad should mtso thearnogarroncs" n.b IS.10CiaiJcl •rilh lht :K:Ii;ities of ....w if poymeoiS do DOl fOI)dac.ly rdled risk. ~\ina a~ni:z.ationssbould menitor inctntive(X)mpensation awards and poyments, n,;, tabn,and actual risk Frm 00093 """''d '*"""'" """'""'used ouloomos 10 delermine whelhar Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718217.eps !heir.-., laordwco inaase COCllpenlllion, omployoos "'AY aei to endolhe p10eases escablisl\ed by a b.Jnkins org.11iution to achieve b313rtc00 COll\pens:~lic!l arrangements. Simllorly,on e01ploy,. ''"""'by an lnocnti~·o compensation arraAgcrncnl m~y *k tn inOuenr.c. in ways designed to inc:rouelhe employe&"s pay,lhe risk measi.II'Q or other information or jwlglncncs lhalore ued Co make lhe '"'Diovto's pay ...Wti\"Oio risk. ~oai<lasmay sipiliancly ...U..llooofloctinr.essolon «pnlutlon's ia'*'ti"' <0o:1pen»tion arnnaeruenos in ralricting imprudcnl risk~o1kir-8. Thesa :K:Iions can baw a particularly dam'3ing effect on lhe sefety end ..undncss of lhc ocganizalion if ohcy rosuh In the weakening of risk rneasures, in!onnalion, or judgments that oho orpni!Oiion us.s for o;bor risk· "'~'"~ iolomal <oniml,or fiAulci.IJ pw...,..._ln sud! cosos.lhe 90 federal Regisler/Vol. 75, No. 122/Friday, JuM 25, 2010/Notices inc:tntive compensation paymeots to employees are reduced to reflect advmo risk OUt<OJnCS Or high levols ofrisk taken. R.,ull.sshould be reported to appropriate levels or management, including tho board of direotors where wamnted and consistent with Principle 3 belo". The monitoring mothods and P""""" used by a banking organiuliOtl should be commen$Urale with the siu and co"plexity oftl\e organiza1ion, as well as its usc of iaccntivc compensation. Thus. fo·r example, a small, noncomplex org.ani:tation that uses incentive r.nmpAnsaticm only to a limited extent may find that it can appropriately monitor its arrangements lh.rougb nomtal management processes. A bankingorgani1.ation should lako the results of such rn<lnitoring into acwunt in e.stabl•shingor modil'ying inoentiv; t.on•p;nsalion o<T'Ingem!ntl and in overseeing associated eont.mls. If, over time, incentive co&!lpensaticm paid by a bankingor:ganizalio11 does not appropriately reflect risk outcomes, the adjuslments on tho bala11oo of the arrangement, the risk-taking incentives of the senior executive. and the saret~ and .~undness ofthe organization. The board of directors of •• organit.ation also is ultimately respcnsible for ensuring lhat tho organization's inoontive oo:-npensation arrangerntnts for all CO\Iered employees are appropriately bolanced ond do n01 joopardizathe safety and soundn.., of the organization. The im·oh·c-menl of the board of dire<tors in ov.,ight or the organization's ovan1ll intentive compansation program should be scaled appropriately to the scope and preV211!nce of the OLg.tni:zation's incenth•e compensation arrangements. Wrge l:cnhllg orgonizot~ttS ond organizations thai ore significonl u.rets of inc<nlive compenrolion. The board oi directors of an LBO or other banking organization tho! uses incenti'e compensation lo a significant extent should actively o,·ersee the development and operation of the organization's i.ne<:ntivc compensation rxganizalion should review and revise polici8S, systems, •od n~lated control processes. The board of directors of its incenth·e compensation such an OJga11i~tion should review and arrangement$ and relat~ eontrols to approve the overall goa~ and purposes ensute U~atthe ammgtntents, as o{theorganitati('ln's incantive designed aJld implemented, are compensation SJ"'entln addition, the balance<~ and do not provide employees board should pro\lidt!eleardil'tldion to incenti\les to tako imprudent risk:s. management 10 ensure lhat the goals Principle 3: Strong Co•porato and polkJe.~ it establishes are carried Go\•emance out in a mo.Mct that ach ie~as halan('..e and is consistent with safety and llonking ~altizations should bave soundn..,. strong and effoctive corporate The board ofdirector> of such an govcmanco to help ensure sound organization clsoshould cnswo that compensation practices, indudin;g steps are taken so that the incentive ach~.-·e and effect.ive oversight by lh~ r.ompensation system-including board of directors. perfonnance measures and targets-is Given the kO)' role or stnior executives in managing the overall risk· dasigned and operated in a manner that will .achieve balance. taking acli\•ities oranorganization, the • The board of direciOIS should board of directors of• hanking monitor the performance, and regulart)' organiutionshould directly approve reviO\v the design and function, of the incentive compensation int.e.ntive OO:ttpensation arrangements. arrangements for senior executives.~& To allow for infonned revie\\'5, the T'ne board also should appro''' and board should receive data and analysis doctuntntany material exceptions or ftom management or othersoW"'8S that adjustments to the incentive compensatio:. arrangements established are sufficient to allow the board lo assoss wh<lher tho o,..,..n de>ign and for senicrcxeo.~tive.s and should pcrfonnancc of tho organization's careful!)' consider and monitor the incc.nlive corr.pen~Lion arrangements effects of any approved exceptio1-s or are consistent with the OJS3nization's safety and so.undn~. These reviews ~A$U$01Sblllisguidance. th41ct~CII"botrdol and repons should bo appropriately ditGd.cWt"isuscdeo tt!« klthtrn~mbc«cdl.be 1»ud ofdilecku ~·ho lti\'t! pritu.-y rupomibUity scoped to refloct the~" and !Of OTmeein&\he i~K~MCi\"$CD;pe.'ISollia:l;Sysklll. complexity ofthe banking Dtpcod:~oat?.n~:JM:!nwhk.\tbebcDidi£ org:;miulion·s acli~·ities and the «p:~iud,l}it~u:».'fr(4:J41tt(l'l:.irt~ld¢( prevalence and scope of it.s incentive dir$ClOIS. a eotnpea~at!en coma:uce ollllo.bowd. o:aootberCOClmliUMolth.boudtblt bt: piiiW)' compensation arrangements. rt.!po:asibiti;ybto.\·m.tticgtheiucftltive T~e board of dire<lors of a banking eo~r.~f)'Siti::"LI~ll:eetH~oi'~'tiOs.UM!ttrn organizationshould closely monitor lef<n1o~~t.mdol~~1!6:ilMilim's incentive compensation pa;1nents 10 U~'iap!foll.kim.c..onAs!Ml~lhe~liO''.tJ\'etiU rorpoA~cii0013ar.agt~ttdatNmtl'l\; oonior cxfJtulii'IIS and tho S8~iti1•ity of 1 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00094 Fmt 6602 Sfmt 6602 those payn:l!nls to risk outcomes. In addition, if the compensation amngement for a senior executh·e induda.~ a cla.wback provisio!l, then the review should includl! sufficient inronna1ion to determine if the provision has been triggered and excculod as planned. The board ordirectors of a bonking orgoni23tion should mk to stay ab,..st ofsignificant emergingcb;m~ in oornpcnsation plan mc:ch4ni.'ims and incentives in the marketplace as well as developments inacademic research and rtgulatory advico regarding incentive compensation policies. However, the board should recogniu that organizatioi\S, adivities, and practices within the lndustry are not identical. Jncenti..,e compensation ammgeme.1lls et one organization may not be suitable for usc at another organization because of differences in the risks, controls, structure, and management among organlzalions. Tho board of directors or each orsanization is responsible- for ensuring thai the incentivl! compensation arrangements for its organization do not enr.ouraga emplo)·ees lo take risks the! are beyond the organi7.ation's ability to manage effectively, regardloss of the practices emplo)·ed by other orgoniutions. /..orge bonking orgoniwlions and orgoniznlitms Ihal art .signifioonl users of inanlh·e rompensorion. 'rho board or au LBO or other o~ganiUttion that uses incenti..,e compensation to a sig.oiftcant c.xtcnt .should receive and review, on an aJmual or more frequent basis, an assessment by management, with appropriate input iroll\ risk· managemttll personnel, of the effe<tiven.., of the d.,ign and operation of the organization's incenth·e compensation system io pro\•iding risk· taking incentives !hat are consistent with theorgani7..ation'ssaJ4:ty and .soundnBSS. These reports .should include an evaluation of'Yhethcr or hOIV inccnth•B compcmsalion practices may intrea~e the potential for imprudent ri~k-taking. The board ofsuch an orgoni23tion also •hould rec:eiva periodic reports thai review incentive compe:n~tion awards alld pa)'ments relative to risk outcomes on • bach•ard·looking bas~ to delcnnino \\'hcthcr the organization·s incentive compensalion ammgements may be promoting imprudent risktaking. Boards of directors of th""' organizations also should consider periodically obtaining and reviewing simulation analysi.lof <X>mptnsation on a fon•ard·looking basis based on a of per!omtance !e~o·els, risk outcomes, and UlC amount of ri~kz taken. ""8< L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718218.eps 36412 91 36413 Federal Regisltr/Vol. 7$, No. 1:12/Friday, june 25, 2010/NOI.ices expose lhemganiuticn 10 NIOI1al iueentiY& c:nmpensation sy$lems.1'hs compenAtion connnitt• shCM:IId work. <l..,.ly •<ilh any boanl·lovol risk and audil commiUOC5 where thc3ubslanoo or their acllons ···etlap. t A banking orgllniz(ltion's disclosure pra<lico.,hould ' "PPM safo and sound incentive compensation arrangements. If a bankin, o~niution's inctn\i\'8 compensalion arnnc<mcnu provide employoes incentives 10 lake risks that "" be)·ond tho tol....,ce ollho organiutiorl'uhmbolders.tht!l risks ore lil:tly 10 also pNMtl rUk 10 lha ..r..ymd...,.._oflha Olpitllioor." To ho!p proDIOie sallly md ...,.dnto$. • burkins ocguizalion io<ludi~~&asadireclor,ot~~aybe liumed throt:gll advic:o ...,.;...t &om slrCMIId """''de1D opproprillo CMIUide counsel, Oll!l$ulwus, or olber of information c:onC*nin& its iactntive t):perts with txpertise in incentiV't compansatioa ""'"'""""" for exenlive and nOtHXte\IU\'1 employees comptnll~OO and risk·managemenl and n>latocl risl:·wnqemanl, oonlrol, The board of dinclors of an and gov<rnane. proctS!O!IO aod conrp!ex less CMS~Diution with shareholders lO tllow them to mnnitor extensive incentive compensation and, where appropriate, take actions to tur.~ngements ma)' not find it necessary or llppropdate to require 5pecial board restrain tho potenlial for such amlllgemcnls and protc.<S0$10 expertise or to ratain a.nd u.se outside on<:c>u11go employoeslo lake imprudcol exports in thts area. In .seloctinx and using outside parties, risks. Such disc:losucos &hould include information re.lt\'allt to t:nployee:s other duo giv• should direcWs tho board ol than senior txtculh'OI. Tho scopund lllcnlion 10 potential conflicts of level olthelo!OIINlion dlsc:losed by lhe ol inloresl ulsiag lmm other cholings uilored to lho lha patti• "il•th• "'&'Diutioa Of fur "'l'ftlution •hoold beollha narunand toc~~plarly ""'"' ........11le board abo shc>uld ocplutioao:rd IUilctllti1.. t:C~c:at:lioa IDI\"oid tf~icg 0111S!da parties 10 obuio ll!lduole•..ls of t.otr.~ioaamnaanents.n • Llcll bonlJaaCIIIplllutiooss!rould inAUIIICI. While lilt.-uon and use as)'SiltDitk app-'r 1o orouulde parties moy ba helpfd, the follow a compansallo:l J)stemlbat devtlopilla boa.-.! 111aina ullimote re>poosibility fo: hAs bal.ancocllncenth·e compensation eMUiing !hOI tho Cll&aniution's amn~ents. inctnth·t compensation arnnsements All>anklng mganiulions "ilh ~ "" consblenl ~<ith safety aod numbm or risk·IOklng employees soundnass. ensaged In di\rerse tctivilies, an ad hoc L.otgc bonking orgonizolions ot.ld Of'80tti1Ations lhot oro dgnifiCGnt users approach 10 developing balanced ~unlikely 10 be reliable. of iiiCI!niivetomp<nsoiion.if a soparolO li!Tilngomenl• Thus. an LBO should""" a syslemllic c:ompon~tion committee i.s not a1rsady by robusland upported ........... appr In ploooor required by olher formalized policlos, procedwos, and outhoritios.•tho board ol directors ol SJSiems-lo IIIS\IJ'IIIullhose 1ft LBO or other banking mganizalion '"'"""""'"' are appropriately that u.sa inctnli\'e compenSZition to a baluted lftd coas1Jtonl1vith safdy 111d ~ exl&otshould COIISidt< '"'""'"..._ Suc:b an approach slrould Oll>blb!ri~~&slldr a oommiueopro>iclo lor !be orpaiDtioa clb:ti..ly ...,..W.lo!be full boanl-lllal1m lo: p.'im»y respoasibilily lo< ....-lag ' blartilyarpiQ}OIIwbore lhurra;ni%1tioo's iacenli•.. e!tp'blalo recai•·olnconth~ AOotnp<ll$llion conapw;ation nd whoM ac:ttviti.e:s may comp1010tion commi:too should be """posod solely or predominantly of non-executive ~ ...:d... -.ted~y. ditiCIOrs. If lha board does notba<e CMI~'Iam.-w.slll.atmii11Mw..&s: .surh a compensation cornmillee, tha t!U..W.-cbol-.tla'-~.,UUiionM board should lab other $lops lo ensure 1101 rc....nt, coull.cH w'lll$.1fdly81'1d Ihal non..xoeutive directors of the boon! "Abtnt~Ot~lrMIGI&Itod!OdkScomply aructivoly in.ol.-td in lheoversighl of r.ri'111rthtlr.ar:lll'fCOIM~tltlrdl"JdoQif'CI • The o:pnization, compositio-n. and resou:n:es olthe boanl of directors should ptrmilefleclivo oversight of incenlive compensalion. Thoboanl of directors of a ban king organization should bave, or hava access to, a level or expertise and ex.perien<:e in ri!k·management and compen.saUon practices in the fin~mclal .servioos induscry that is appropriate for the nature, .scope, and comp!cxily of the erpnizotioo's octivitics. This IC\'CI of uportlse "">'be J'IO'"tlt Ollleetively ollha boanl, may 'Mill lhc """"!tom r.m.llrainioa"' froo> .......... Hdra<siag lMse issues. risks. ThSS~emplo)·eesohould iocludo (i)seniorexeatlivcsand others "'ho 1ro ""J))nsiblc for ovcrsi&hlcf lho organization•s firm-wide acllvllil$ or malcrial bu.slnesslinO!; (iii indl,ldual employeas. including non-oxccutivo employees, whose acliYilies mf.y cxposo lhe organiution to material amnunts of risl:; and (iii) groups ol employ,.. •liro ""subjoct 10 lhe samo or •lmilar inamti\'t compensatio.1 atTaft&eMtnLS ond «ho, iolho '88''11'10. "">' axposo lhc ocpintion to II'.>IINIIIIIOWIIS of ,...,bas nu: o ldcotily lhtlypes aile! tiroc horizoos cl ri!l:s lo lha arp:ritllion froi!lthe adi•ilies ol llroso employ• amc""'' 0 A.ssessllltpole:rliallo<l!ra pu!ormaaoe rueasURS included in lha incer.li~r·ecompcn.s;ltion amngeme.nts ro. lhese employ«s to tn<OUJaSO tho cmploy...,to llkt impnrdenl ri!kl; n Include balancing elenrents. such ., risk adjustments or d.rernl perio<ls. \\'ithin the incentivacomperuation amnpeniS forth..., employees Ihal ate twOnabl)• designed 10 """'"thai tho arnr.g""'cnt will be balanced in light of the sizo. lypo, ond limo horiUIII ol lhe inbennl ri!b ol lha cmployeos' acti\"ities; o CommuniC:Uelo lhCimp!cr)'ealha •'3)-si:l\'l'b:chtheirinc:entive -pensotioo ....w....P"l...."u..m bead;.:.r.diOrtflectlhtriJUollhoir odivities IO lhe orpoiutiorl; md ~ Monitor incentin compen.$3.tion award., pa)'ll'e:rls, risks raklt\, and riJ: oulc:oroes r.. lhesa tmploycos and modify lhe ret.vaatem""""eniS if payments made are nolappropriarely sensitive t<J risk. and risk. outcomes. m. Conclusion Banl;Jng organizatiOn$ art responsible fO!' ensuri113 that their incenlh•e c:ompe!IS3tioa arrangemenlJ do nol .ncoumge improdont ri$k·Uking behaYior and are consistent with the safety and soundness o! the mgaoiuliorl. The Agemies oxpecl bankir>3 "'l'ftiuliooslo lako p<o<r~pl odion Ill acldttss defrdeodes Ia their iDcer..ti\11 ampemttion rn:-"~diOacliwtl 'Y"'""· ... ltqllfrM~CtUoltbeFtdtul_.,..•kw•r.dDtk eo.,..,,.....,_ ...... lt.uu&pplltllb:a.S..,q.,l'foxyiX.tdowre •ut•IIIIU.~IIlloll. olllOIIrklltooollttl. •s.-.,t~ewYcrt~otktuhl:tseLl.s.\o:t ,")~OI4o( u,u,.~a.5GOS:dktn:~•"'*'-.~eCcdcstetkll VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Eft~AU.Sf'.C~~OS.lHOI8.34- 611?J.74 f'RIW4 (l)lc. U.IIOOiltlot.(I)Cbrotd Frm 00095 Fmt 6602 Sfmt 6602 mooitoc lhe odions lakan by ~ranLns O!&""izations in this area and will promole further advanc.,ln deslacing and implemeatlng balanced lncenllvo compensation aw«ngcmlllnt:i. Wllt>m appropriale, dro Agencies wllltako supervisory orenron:ement action 10 ensure that material dt ncleneies that pose a1hrea11o lhosafory and soundness of the organization aro promplly addressod. The Agancieul10 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718219.eps - arrucem-ts or nblad nu·-.nrent. CMIJal. md 92 Fedenl R!lister/Vol. 75. 1\'o. 122/Friday, June 25, 2010/Nolices lollowing Wtb site: hnp:ll will opd.tte this guid>nce zs appn>priale to incorporate boot pr.~cti"" as tb.ey dmlop over time. Thu concludes the toxt of the Culdanco on Sound lnconti" Comptnsation Policies. U.ted:fune 17,2010. Amcf<lroAdmlnOttGIQ{, O{{KeofTro..t, Ttonsponorlon.cttd M$tl MonoJtmtnl. tfl Occ.1Gl0..1SW FIW ...l4• 1l\t;.4S to] ja.lmC. Ou1on, O>mpirolll...{tlMOmoncy. Dy onlorolt~o Boardof(lm:mOtS oltho DEPARTMENT OF HEALTH AND HUMANSERVICES Fodoralil<lon~ $p.tn:1, J'"e 21.2010. lobtrld<v.rn..Oof"''TS«moryoftb.Scotd. DUd:f... 21.:1010. Valwlt~Bcst, ---,.Ft4nJ Dlltcl:Jv.nt!&.2.010. lkdyRhodtr, 811.lflGtoct:ct20-tW J~ft£.8oWIIIIft, A«I~~&OilfiC1or. I~Doe.aoi0..1So43$fiW6-*tO:~a.'ll.l .... in certain facilities (or in some ~ses, any portion of tho facility) in which reguwor routine cdu~Jlion,library, d>y care, healTh cam, Ot early childhood dcl-elopment wvices ut prorided lo children. This is oonsl>!eot with tho Amerieorllndionolnto Psychology; PHS nrissioa to protectood od•~ocolho NOiice ol CootpeOOw Grant ApjllicetionsiOt A110ricen lnolOIISinto pllysicel and .....UI heott~oflho poopl& Aroeriaa Psydlology PlllgrJ111 Indian Huhll Service Drpod-~ Oo:od: fw:.t tO, 2010. Byd>e00ioooft1a:il50porv'......_ '"'"-~eollh.pl/heohhypeople. The PHS M>ngly encoura,c:as ollllJllnt and contract recipients In provide 1 smoke-froc "orkplacoond promoto tho non·u,. of all tobacco products.tn addition. Public Law I03-227,tho Pto0\ildren tlct of 1994. prohibits smoking D. Award lnformatioo 1)pe ofAn~tds: Cntot. f.<timaled Funds A\'oilohJe:Thototol •mount identified lot Fiscal Year 20t0 AMOU:w:rmtnfl)J>r.~ew. Funding Opponunity Number. HHSIHS-2011)-INPSY-<1001. CFDA Numbtr. 93.970. l5Sm.l86. Thoa,.~rd is for 12 months in duration and the average award h Key Oates Appli<oti<tt IA:odliiiC:)uly 23,2010. ncview Date: July 29.2010. l:iorlksf Atllicipoted Sto~ Date: Sepltruber 1, 2010. GENERAL SERVICES I. Fundins Opportunity Oeocription ADUINISTRATION Tltelndian HOI!th Smoice OHS) is accepting compelitit·e graot applicetions 1-2011).@;~ 31 f« llle Americon lodions into Federal Trnel Regulttion (FTR); PS)'tilolCCY l'n>pa. This p<Cpl is Directions lor Reporting Other Than ••thorized ur.derthea.lborityo£"25 Cooc!H:Iass Aa:ornmcldotions lor c.s.c. 16llp(a-d)",lndl.ao Heohll Cue ~on OlfJCiol Travel l~t Ad, Public l.aw94-'37, by Publ:c Law tOz-573 &Dd as AGENCY: Office ofCo.....,..twtcle Polley, Ceooer.il Services Administr.ltion Public Lawl\t-148. -~COO( 411~W U tWU Utul-' &1»- •-clc<l (CSA~ PutpOSl ACTIOK: 1\otico of GSA Bulletin fiR ID- The purpose of tho Indians inlo PsycholOGY Propm is lo dovtlop and maintain Indian J»)'fhOIOS)' Ql~ O.S. Suw.tARY: ·n.e C.neral Services VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00096 Fmt 6602 Sfmt 6602 !H. Eligibilay Information 1. Eligible Applioonts ~:~~:1u:':~~~t;·~:.~~i~es ..clinical prognms accredited by the r&r.nJitmenl prngro~ •~ a met~n$ nf encouraging lndil:ms to enterths bohaviotll health field. Th~ program Is dosalbed II 93.970 in thoCatologof Federtl Domoxtie M!~tance. Cos:s wi!l be determined In 1000rdance ~-ith applicable Offico of Ma~~~&tmMtlnd 8ud$tl Circular$. The Public Health Seni<o (PHS) ls co:omllleclto achieving lho health [IIODiolion ond disout pm-eatloo tlljocliva ol Healtlly Peoplo 2010,1 f'KS.led adi•ity fer sollio& priorityareas.'!\isp<opm aMoouu:cmentls related to tbo priority ftdero/t,...~ln:gulation. artt ofEduati~l4nd Community· OATtS: The provisions in lhis Bnltatin based p!Oj;ram~ Potential applicants ore •lfocti•·• Juno 9. 2010. may obtain acopyofH,.Ithy People FOil f\!RTHU II~ORIIATIOIICOff!ACT: Mr. 2010, .umrnary mpo<l in print, Stock No. Ot1-()()HlOS4?-8, or via Cll-R0:-.4, P~trick O'Grady, om., of Covernmon111;de Policy (M), Omce ol SlnckNo. tO?-()Qt-()QS49-S, through tho Superintendent of Documents. Tr.ll'el. 1'11nsportatlon, and Assot Govenunent Printing Office~ P.O. Box .lfanagemont (MT), Genet31 Services Adntlni!lntion at (202) 208-1493 or vi.1 371954, Pittsburgh, PA IS2S0-7945, e.o10il at potrick~dJ~go<'- Pleose (202)5tt-11!00. Youmayai>Ooocess this fnfont~allon viltho Internet a!lho cite GSA Bull~tin PTIIID-«>. Adn1ininralion (GSA}, in r.onjunc:lion with the Government Accountability Office (CAO) report, Premium cr~ss TrvveJ: lnremol Control Weaknesses CovtrnmeMwide Led to lmprope-tond Abum~ Use ofhemium Oass Tlot'tl (CA~1-1268), has issued CSA Bullllin PTIIIG-40. This bullttiJI piOYides <lirecliocs to Fed!<al AS""cies 1\w rtpOIIiDa otJJ. thon ex>acll-dass ICCOIDmodatlooslar 001ployoos on ofliciollrl•-.1. CSA Bulletin PTII IIHI5 moybolounclat hltp1h.--.p~pl <Jpproximately S'252,462. Awnrd.s under this announcement ara subiect to the availability of funds. In the abs<ncc of funding, the agtncy is under no obligation to make 01v.ards hmded under this announcement. Anti<ipoted Number ofA11nnU: An estimaled tt<O av.·ards ..; ll be •""• under the p«lSRm.lf lundi.'13 ~ ll'lilable. additionola...,ds ,.., be made. Projea Ptriod: 4 Awtmi Amount:~n. po<,...... American Psychological A!SOCialion ll'ill bo eligible to apply foro grant under this anuounct~mont. ltowevcr, only one grant ,~lJ be ••·arded and funded to • college or unh·mity per fundingcyclt. z. Cost ShDringli.lolchinf This a:>r.O\Illcement d... not require IIII!Chi11g fuods or cosl shorifl&. 3. Ql.httRoqui.....,DIS R!quiredAffiliatio~111tpt applicant must submit ofticill documenlotioa indi~Jtina a Tribe's cooperation with and support oltbo program within the schools on its reservation and its willingne.~s to haVIO :a Tribal representa.ti\·e ~i"S on tl1e prognm advisory board. Documentation must be in d•e fonn plllSCribed by the Tr;be'sgovemingbody. i.e.. lenerof support or Tribal resolution. Documentation musl be submitted from •V<IJ' Tribe in.·olvcd in the program. llapplicaliOll budgcls ClCOCd IV'"' L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718220.eps 36414 93 ..... ..... VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00097 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718221.eps BOARD OF GOVERNORS OF THE FEDERAL RESERYE SYSTEM 94 ...... Incentive Compensation Practices: A Report on the Horizontal Review of Practices at Large Banking Organizations October 2011 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00098 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718222.eps BOARD OF GOVERNORS OF THE FEDERAL RESERYE SYSTEM 95 To order additional copies of this or other Fooeral Reser\'e Board public.tion& rontact: Publications Fulfillment Mail Stop N-127 llo:trd of Go\'ernors of the Federal Resmc S)~tcm Washington. DC lOiSI (ph) 202-452-3145 (f") 201-71S-SSS6 (e-mail) Publications-BOG@'rb.gol' This and other federal Reserve Board reports are also a"ailable onlint at VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00099 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718223.eps IIIIW.ftlicraltNn~go,iboarddocslrptcooyt>~defaull.h!m. 96 iii Executive Summary ................................................................................................................. 1 Steps Taken by Firms .................................................................................................................. I Scope and Status of Reform Effort ... ........................ ...................... ....................... ... 3 Introduction ............................................................................................................................... s Pre-Crisis Conditions and Response ............................................................................................ 5 Risk·Based Adjustments to Compensation ................................................................................ 5 Principles of the Interagency Guidance and Supervisory Expectations .............................................................................................................................. 9 Affected Bank Persomnel: Executive and Non-Executive Employees ............................................. 9 Four Methods for Linking Compensation and Risk ................................................... .................. 9 Avoiding "One.Size·F~s-AII" Lim~s 0< Formulas ............................................ .................. 10 Well-Designed Manageme11tandControl Functions .................................................................... 10 Timelines fO< Adoption .............................................................................................................. 10 Incentive Compensation Horizontal Review ..... _ ............................... 11 Scope of the Horizontal Review and feedback Provided ........ ............................ II Balancing Incentives at Large Banking Organizations .............................................. 13 Topic 1: Risk Adjustment and Pertormance Measures .................................... ........................ 13 Topic 2: Deferred Incentive CO<npensation .... ..................... ..... 15 Topic 3: Other Methods that Promote Balanced Risk-Taking Incentives .......... ........................ 17 Topic 4: Covered Employees ..................................................................................................... IS Risk Management, Controls. and Corporate Governance ......... ..... 21 Topic 5: Risk-Managemeflt and Control Personnel and the Design of lncenlive Arrangements .......... ....... .... .......... ... ... 21 Topic 6: lnce11tive Compensation Anangernents for Staff in Risk-Management and Control Roles ... .......... ........................... ..... 22 Topic 7: Practices Promoting Reliability ......... 23 Topic 8: Strong Corpcrate Governance ... 23 international Context ................................................ .... 25 ConfO<manCe with Interagency Guidance . ....................... ..... 25 European Union Ajlproach to Deferred Incentive Compensation ................................................ 25 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00100 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718224.eps Conclusion ................................................................................................................................ 21 97 To fost<r implementation of improved practi~ in late 2009 the Federal ReserYe initiated a multi· disciplinary. horizontal review of inctnti\'erompensation praeli«s at 2) large. rompi~' banking organi· lation~1 One goal of this hori!ontal revie-v "~s to help fill out our understanding of the range of iru.~n ti\'e compensation practires across !inns and catego· riesof employees within firm< The second. more imponant goal"~' to guide each fimo in implement· ingthe interagency guidan«. Giwn tilt varie~y of activiti~at these complex firml. and tilt number and range of employees "no are in a position to asswncsignificant risl<, our approach has been to require each firm I<> dC\·clop. under our superYision. itsown practices and gO\-emance mechanisms to ensure ris~-appro-priate inctnlht compensa- tion that aorords "ith the interagency guidancc throughout the organilation. Supenisors assess<'<l areas of weakness at the finns.. in response to "hkh the firms ha1~ de1~lopod c()mprehensi'~ plans out lin· ing ho11' those weaknesses "ill be addressed. These plans as modified bas..'<! on comments fromsupervi· 1 ~lifKll).ialillSlilu!i<msiD lOC lnm'lli\'e Compms;uioo Hori. tonta! R.c\i-..'3rt 1\lly Fi~nciallnc.: A~ri"ln E.'pn-ssCom1\'11\)~ Bank of Anm"3 Corpor.uior.: The Blnk of Nt'fo' York M..tlon Corpora1ion; Capiro.! Qn.: F"m;mciatCOfJX!ration; ali- grooplnc-.: Di.{('O'o'tffitUncial SM~TbcGoedm3nSlcbs; Group. 1,._-.:JPMorp.n Chast &: Co.: Mo.pnS1anl')~ NonJl. troTrw Corpor.nion: The PSC F"IJllllcial St-1'\i:\.~ Croop. lnc.:S.ale Suctt Corpor.nioo: S~mlnN Blnl:s. loc,: U.S. B.:ln· oorp; :md Wclls fa~'O& ComJ"'n)~ and lhc U.S.op:ralionsof &srdl)'$ pk. B~P Parib.t,(. Credit Sui~ Group A(i.!A'tl~~ ll3nk AG.IISOC Holdings pi<. RO)III Blot of CaiD<b. Th: RO)>ItbnkofSro<JandG""'pplc.S..'i.1C~3nd UBSAG. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00101 Fmt 6602 sors, will be the basis for funher progress and e''aluation. As explained in more detail in this repon. every finn in the re1iew has made pi'O"JCSS during the reviC\v in dc1tloping practi~ and procedures that will inter· naliu the principles in tht interagency $uidance into the management S)~tems in each finn. Many of these changes are already Cl;dent in the actual rompcnsa· tion arrangements of finns. For example. senior executires now hlll~ more than 60 pcn:cnt of their inccnthuompensation deferred on M·erage, higher than illustratirc intemational guid<lin01 agrt'Cd by the Financial Stability Board. and some of the most senior exocutil'es ha1·e more than SO pen:ent defenred 11ith additional stoc.k retention requirements after defem.-d stock 1-csts. Mo"-owr. fim>S are now atten· tire to risk-tal<ing inccnth-cs for large numbers of employoos below the cxecutil< le\'el-at many firms thousands or tens of thousands of employeeswhich "-as not the case before the beginning of the horizontal reriew. 111lcn most firms paid little ancn· tion to risk·taking incxntires. or were anc.nti\'C on~' for the top employees. Yet '"''Y firmalso needs to do more. As Ol'crsight of inctntil'erompensation mov01 into the regular super· l'isory process. the Froeral Reser~~ willcontinue to 11urk to ensure progress rontinu01 both in the implementation of the firms' plans and in the risk· appropriate charae1er of ae1nalcompensation praCiices. Steps Taken by Firms With the oversight of the Federal Reseman<l other banking a~><nci~ the firms in the horilontal rel'iew haw implemented new practictS to make employcts' inccnth·e compensation sensiti\'e 10 risk. The fol1ow· ing is a brief progr..s repon on four key areas of the reviC\1'. More details can be found in the report: Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718225.eps Risk-taking inccntir~ pro,idt-d by inccnti1~ rompen· sation arrangements in the- financial services industl)' "''"' a contributing factor to the financial cri~s that began in 2007. To addr..s such prae1i<es, the Federal Reser~~ first proposed guidance on incen1i1~ rom· pensation in 2009that "~'adopted by all of the fed· eral banking agenci~ in J..ne 2010. 98 lnctntire Com~n~tion PractittS - Risk atljusrmems make the amoun1 of an in«n· ti\'ecompensalion all"ard for anemployee lake in1o accoumthe risk the employee's acti\'itics may pose 10 I he organization. At the beginning of the horizolllal re\'iew. no firm had a "<II· de•·eloped s1r.negy to use risk adjus1mems and many had nocm:cti\'e risk adjustment~ E•<ry firm has made progress in de\'cloping appropri· ate risk adjuslments. but most h.r.e more work 10 do to ensure the full range of risks are appropriately balan<td. An e.ample of a leading·edge practice thai is now u;OO by a few fim>s is includ· ing in int('rnal profit measures used in in~nti\'e compensation a.••ards~ charge for liquidity risk that takes into account stressed condition• This reduces incentil·es to take imprudent liquidity risk. 1\n example of a challenge for many firms isda<lopmcnt of pol[cics and pro<tdures to guidejudgmental adju.stments of in«nti•~ com· pensation a•>rd< Such internal guidelines help promote consistency and cft'ectho-eness in inetnti\'t compensation decisionmaking. - Deforriugpayout of a portion of incenti\'t compensation ""~rds can help promote prudent ioo:nti\'es if done in a •~Y that takes into account risk taking. especially bad outcomes Deferring payouiS ·~• fairly common before the crisi& especially for senior e.,.eutil~ and highly paid employm Howe:.·er. pre-<risis deferral arrangements typically "~re not Slruttun.'\llo fully take account of risk or aciUal outcomes Almost all finnsnow01sewhicles for some emplo)~ Ihat adjust <lm•n•ard the amount of deferred ioo:mh·ecompensation that is paid if losses are large. Hou-e-~r. most firms still hOlt work to do to implement such arrnngemcms for a larger set of emplo)= and to more closely link such reductions to indi•·idualemployees' action~ particularly for cmplo}ees below the seniorexecuti\'t levd. • Prog..ss in ldcnlif)·ing K()' Employees. At most large banking organi<:ation& thousands or tens of thousands of employees ha>~ a hand in risk taking. Yet. before the cri~& tbe con•~ntional wisdomat most lim1s was that risk-based incenti\'es were VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00102 Fmt 6602 important only for a small number of senior or highly paid employees and no fim1S)'Sien>aticall)• identifl«< the rele•~nt employees who could. either indi\'idually orasa group. influence risk. All firms in I he horizontal re•iew h:ll'e made progress in identifying the emp!Oyet$ for vohom incentirc com· pensation arrangements may, if not properly strue· tured. pose a threat to the organization's safet)' and soundness. All firms in I he horizontal re\'iew now recognize the importanre of establishing sound incenti•~compensation programs that do not encourage imprudent risk taking forthose who can indi•idually afl'octthe risk profile of I he firm. In addition. slighlly more I han half of I he firms ha•·e idcntifl«< groups of similarl)•compensated employees whose combined actions may expose the orga· ni:zation 10 m:ut!ria\ amouniSor risk. HOW'C\'Cr. some finns are still working to identili' a complete set of mid-and km~r·IC\ el employees and to fully assess the risks associated 11ith lheiractil'ities • Changing Risk-~laoagement Processes and COiltrois- Because finns did not consider risk in the design of inrenth-e compensation arrangements before the erisi~ fim1s rarely in•·oh·ed risk· man;wment and control personnel when consider· ingandcanying out inttnti'-e compensation arrangemont~ All fim1s in the horizontal n.'liew ha1~ changed risk-managcm.,\1 processes and internal controls to reinforce and support the de~~l opment and maintenanre of balan<td ioo:ntire compensation arrnngemen1s. Risk-management and control personnel are engaged in the design and operation of inrenti,·e compensation arrangements or olhercmployces to ensure that risk is properlyconsidcn.'\1. Some firms ha•·e further work to do 10 prol'ide suflicicntly acti,·e and robust engagctnent by risk management and control statT. • Prog..ss in Altrring CorporJie Gorrrnaoce Fr•mrworks. At the outset of the horizontal rel'il:\v. the boards of dirtttors of most finns had begun to considtrthe relationship be:nretnincenti\'C C'Om· pcnsation and risk, though many ~~~refocused exclush-ely on I he inccnti\'e compensation or their ~nn·s most seniore.xetuti\" es. Since then. all firms in the horizontal re•iew hOI~ made proo.ress in altering their corporate gowroance frameworks to be auentil·e to risk·taking inccntiws cn."atoo by the inrenti•·ecompensation process foremployees throughout the firm. The role of boards of directors in ioo:nti•<compensation has ''panded. as has the amount of risk information prorided to boards "'Iatoo to ioo:ntil·e compensation. The Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718226.eps • Effe<lirelocenli•·e Compens:uioo Design. All firms in Ihe horizonlal wiell" ha•·e implcmemoo new prn<tires 10 balaoo: risk and financial resulls in a manner that does not enooumgeemployees lo expose their organizations to imprudem risk& The most widely used methods for doing so are risk adjustment of a.mrds aod defertal of paymen1~ 99 October 2011 l'"'" Scope and Status of Reform Effort Supel\isors in the horizonlal rc·view gathcrt-d wnfi. dential supel\·isory infomtation from all firms and lound important diiTereoces in practices a<ross bU>i· ness lines and banking organizations. Additionally. practices are changing rapidly in r<>ponse to the Fa!· era! ResenT's e!Tons and industry de,·elopments. Thmrore. a moment-in-time. romparatiw anal)>is of indi1idual firms from the horizontal revi<IA is not possibk and rould he misleadiog. That said. the Fed· m1 Rcsene is wonting to foster market dilcipfult in the area of inttntil~ rompensation. On this front. the VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00103 Fmt 6602 Federal RcseM intends to impkment the Basel Committee's recent "l~llar J di><:losurt rt'(Juirements for remuneration.'' iS>ued in July 201 1.1 which will provide mort romplctc infonnationabout riskrelated ekmcnts of ineentil~ rompen~1tion practices of indhidual institutions. In pan spurred by the horiiontal m i¢'1•. ineenti,·c rompensation practictS at b.10king organizations are rontinuing to Clohe and <klelop. We''pect this evolution torontinue. The F«..cral Rc,ci\C •·ill rontinue to"ork •ith these firms through the supel\iSOI) proct» to el\lurt imp101emcnt and progrt'SS are sU>tainoo. = S.<t•Pll:ttJcb.iowA:rtqGI~\tll~nr:T'hlll~"'J~ lbrbd('-t«."Wfw /--~t•n ~'pl~"'l-~ Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718227.eps appropriateness of the degJtt of engagement of the boarrls will bee\'aluated aOer a few of experience. 100 Pre-Crisis Conditions and Response As discussed in the intera~cy guidance, the aclivi· ties of employe.s may cmue a wide range of risks for a banking organization. such ascn..'dit. market. liquidit)'. operational. kgal, romplianct, and reputa· tiona! risk~ as as oth~r risks to the \'iability or operation of the organization. Some of these risks may be realized in the short term. while others may become apparent only owr the long term. For example. future n..·wnues that are booked as current income may not matcriali~ and shon-tcrmprofit· and-loss measures may not appropriately reflect dif· ferences in the risks associated "ith the m·enue derived from difl'erent acti,ities. In addition. some risks-¢r combinations of risky strategies and positions- may hare a low probability of being realized but would ha-'C highly ad,'Crsc efl'ects on the organi· zation if they were to be realized ("bad tail risks"). Whileshareholders may hare less inccntire to guard against bad 1ail risks beeaose of the infrequency of their realiza1ion and the existence of 1he federal safety net.lhese risks warrant special auention for safety-and-soundness reasons giwn the threat 1hey pose to the orgaoization·ssolrencyand thefederal safely net. ""U Before the crisis. large banking organizations did not pay adequalcaucmion 10 ri>k \\'hen designing and VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00104 Fmt 6602 operating their inccnli\"e compensation systems. and some employees"~"' pro>ided incenti\ts to take imprudent risks. For example, an emplo)~ who made a high-risk loan may have generated more rev'''"' in the short run than one 1rho made a low-risk loan. lnccnti,·erompensation arrangements bast-d sokly on the Je,~l of shon-term m-enue paid more to theemplO)\'t laking more risk.thtreby inctnti\iting emptoyees to take more. sometimes imprudent. risk. Led by supeovisors in the horizontal rel'iew, O\~r the past two years banking organizations ha\'c impro\'ed theirinccnti,·e compensation arrangements to take appropriate acrount of risk. Thet\\O most common "~)'S to do so-risk adjustments and deferral- make use of risk infom~ation that becomes a-~ilable at different points in time. Risk-Based Adjustments to Compensation Information about risks taken that is known before inctnlil'erompensation is 3\\~rded can be used to make risk adjustments to those 3\\~rds. For example. if an cmpiO)~'e in a lending unit makes many high· risk loans during a )~ar. the estimated profit fromthe loans can be adjusted when designing theemployre's inctnth-e compensation package. using either quanti· tath·e or qualitatire information. In all cases. risk adjuStments should consider likely losses under stressed conditions. and not merely bu~ness-as-usual, so that larger, butlower-probability.loss outcomes can be taken into account. Both quantitati\~ a11d qualitati\'e risk information can be used in makingsoch adjust men" They can be applied either lhrough use of a formula or through the exercise of judgment and may pia)' a role in set· ting amountS of inccnti\~ compensation pools (bonus pools). in allocating pools to indi\iduals' incenli,·e compensation. or both. The ell'ecti,~ness of the difl'ercnt types of adju~ments \~ries with the situation of the employee and the banking organization, as "ttl as the thoroughness of 1hcir implcmcn· Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718228.eps Risk-taking inccntir~ pro,idt-d by inccnti'~ rompen· sation arrangements in 1he- financial services industl)' "''"'a contributing factor to the financial cri~s that began in 2007. To addr..s such prae1i<es, the Federal Reser~~ first proposed guidance on incenti'~ rom· pensation in 2009that "~'adopted by all of the fed· eral banking agenci~ in J..ne 2010. In 2009. the Fed· eral Reserve announced a horizontal review of inccn· ti,·e compcnsalion practices at a group of larg~ complex banking organization..\ (See "Principles of the lntera.,otnC) Guidance and Supef\isory E>pectations"" on pagc9 and ··lnccntht Compcnsa· tion Horizontal Review" on page II.) 101 lnctntire Com~n~tion PractittS tation. Banking organizations in the horizontal review hal"e maddgnificant progress in improving their risk adjustment~ but most still ha~'e work to do. The first topic in "Balancing lncenti1e, at Large Banking Organizations" on page 13 descri~ the main types of risk adjustments and someareas in which funher work is needed.' Ddcm:d incentil"tCOmpcnsation can contribute10 pmdent ioomtil'eS becauso risk taking and risk out· comes often become dC'3rer O\'er time. If pa)'OUI of a ~nion of inoonti'-e compensation a'"'-ards is deferred for a period or time after the a11~rd date.late·arril"ing information about risk taking and outcomes of such risk takingcan be used to alter the payouts in "'l~ that will impnwe the balaru:e of risk·taking im"tn· th-es. Banking o~-ranizations in the horizontal re\'iew ha1·e made progress in improving deferral practices. but many still hal"e work to do on pcrformaoce con· ditions for \\'Sting. Deferral practices aredescribc<l in the second topic in ··Balancing lnccnti\\~ at La~~! Banking Organizations" on page 15. Risk adjustments and deferral are not the only 1111)~ of improYing the balance of risk-taking incentil"c& Some altematires. such as the use of longer pcrfor· manee periods whenemluating employees· pcrfor· mance and awards and reducing the S<nsitilityof a11~rds to measures of sho.rt·tcrm perfom1ance are brieOy dcscribc<l in the third topic in ··Balancing lnC~:nti1t> at U.rgc B.1nking Organil.1tions" on page 17. Atlhc beginning of 1he horizontal review. the con· \'CntionaJ \'isdom at most firms was that risk-taking incenth·es were important <mly for a small number of senior or highl)' paid emplo)= Though the deci· sions and incentires or seniorexceuti1·es are indeed 1·cry imponant. the combined risk taking by a group of similarly compensated employees can also be material to the fim1"s risk profile. Thu.~ identif)ing the set of employ«~. who may individually or collcc· tirely expose the firm lo material amounts of risk. is a key dement of practice. The interagency guidance notes that such ""coven.'<! employees"" should include not only those who can indi1•idually aft"ec1the risk profile of the firm. but also groups of ~milarlycom· pcnsated employees 111lose actions when taken together can affect the risk profile. Examples of such groups rna)' include many types of traders and loan originators. Most finns in the horizomal re1•iew have made progress in identifying coren.'<l emplo)\'CS but some still ha1~ 111>tk to do. The founh lopic in "Bal· ancing lncentiles at Large Banking Organi1.ations" on page IS discusses co1~red employees and progress in identifying them. As described in the interagency guidance. establish· ment of prudcm risk-laking incentives should be critically supported by risk-management and control personnel. In addition. practices to promo1e impro1~11lell!S in the reliability aud effectiveness of inrentiw: compensation S)'Stems 0\"'Cr time can usefully suppon dc,<lopment of prudent risk-taking incenth·cs on a sustained basis. These elements are described in ··Risk ~lanagement. Control>. and Cor· porat< GowmanC\l·· on pagc21. 111lieh notes prog· ress in most areas.. Some obserwrs ha1~ been panicularly interested in comparing progress of incenth~ compensation ptac. ticesof firms hcadquanen.'<i in dincrentjurisdictions. Approximately one-lhird of the large banking orga· ni1.ations included in the horizontal re~·iew are h<ad· quanered out~de the United States (foreign banking organization~ or FBOs). In general. progres> in con· forming to the interagency guidance is similar at the U.S. banking organi1.ations and at the FBOs in the horizontal review. and progn"SS in conforming to the Financial Stability Board"s (FSB) Prilrciplesfor Sound COmJ!f1151JiiOn Practim(Principles) and the related fmplemRnUtti{)lr Srmulords.4 which are somewhat less demanding than the interagency guidance. is also similar. asdescribc<l in "International Context" on page 25. As the horizontal revie-w of incenti\'t compensation practices draws to a close. further \\.'OTk on incenli\·e compensation will continue through the normal supcrviSO'J' process. Much supervisory work is already focuS<d on risk managt~ncnt and control S)'S· tems. Risk-laking ineentil'eSare a complementary focus for supervisors. Howe\'er, incenth-e compensa.· tion practices are likdy to CYolve rapidly 01~r the next sewral years. so both firms and supcrYisors must continue to adapt and improre. The Federal R~rw also intends to implement the Basel Commit· tee·s n.'eent '"Pillar 3 diS<Iosure requirement:. for remuneration." issued in July 2011. lncrcaS<d public diselosure about risk-related incentil~ compensation pmctim at major fim1s may improre market disci· • Th¢ F$8 i§Ued !he ftit:<ipks i11 Aprill009 3JKI the Imp/~ Emplo)'l.\".i: SOtJ')Clinxs: lak ri~ io pul)U:il or~ Olhtt lb311 ~11-tcrm finJorial rcrfonml'lX.Ia suchca._~ ri5k adj®· ments lllJ~ oJoo oontribtltc to blblll\'d rilt-IJl:ingioo.'llti\\'~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00105 Fmt 6602 Mi<m St.aWrJJinStp~crY~bff 2009. Tbtsr FSBdocutn.."'''bl rt' :r.<tibbk aa"'",...r~atH1it1boaAJ. •t.if~_ publ>;liiO«l>tdJl.\"lll<l.~ hun. Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718229.eps 1 102 Oc1ober 2QII VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00106 Fmt 6602 compcnsa1ion pracliCl'l. as mandmed by 1he Oodd· Frank Wall Sure! Reform and Consumer Pro1ec1ion Acl (Dodd-Frnnk Acl). Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718230.eps plinc of such prncti«i. Finally, Ihe Fedcrnl RcscrYC is working ~ilh Olhcr oonking and financial regulaiOI)' agencies to de\•elopan intc-raget'IC)' rule on incenti\'C 103 -·-- · Principles of the Interagency Guidance and Supervisory Expectations + 1 _L 'I The intcrageney guidan<-.: is anchored by thn.-.: princip~: I. Balance betlll't n risksand r.sults. lncenti1~ compensation arrangements should balance risk and financial results in a manner that does not encourage cmplo)"C\'S to expose their organizations to imprudent risks; 2. PrO<t'SSI'S and controls lhalrrinforcc balan<c. A bankingorganization's risk-management pro- cesses and internal con1rols should reinforce and suppon the dmlopmeill and maintenance or balanC\'d in<:tntil'ecompensation arrangements: and 3. Effecti,·ccorporatc go,~nance. Banking organiza- tions should ha1~ strong and cO"cctil~ corporate gown1ance to help ensure sound incenti\"e com· pensation practices. including acti1·e and effectire owrsight by the board of director.;_ The interagcney guidance iseonsistent 11ith both the FSB Principii'S and lmpltmentarian Sromlards adopted in 2009.1 Afi"ected Bank Personnel: Executive and Non-Executive Employees lncenti\'"C compensation arrmngemems fort.\:t'Cuth'l! and non-cxecutil'e<mployces able to control or influenre risk taking at a banking orsanization may pose safety-and-soundness risks if not properly struc' On April t4.))ll.asnuod3!«lbylh< Dodd·fi'WA«.Ih< Fol<r.ll R"'o~ ~ •ilh tii<Ofl"«olti>:Cornp<roli<rolll>< Cum.·ncy. the Fro.."''3l IXpoo;.il IBSUr.lOO: Corporation. the rormcr Ol'fK"C" of Thrift ~J:'""fu.lbl: Natiooal C~t Unioo Admini){nl!ioo.. tl\;: Slxuritks.and b.ilang.! Commi$$.ion.. 3nd 1~ Ftdcral HoWns Fin.tr~Ct A~'\'flC').l'Sucd for oocnmcn1 a proposOO Nkoo i~\-n1ilt rompa~~ioo rract~ The prop>5«1 ruk build~ otT lbc inL~'Q.SCflj,)' guidan«. Th~ rc~ l"«us:cson the: obsmatiorLS from1bcl\orizootal mkv.. \\ftirb tured. Aocordingly. the interagency guidance applies to senior cxecutill'S as ·~II as other employ«S who. either individually or as pan of a group of similarly compensated employees. hare the ability to e'pose the banking organization to material amounts of risk. In identifying employees ro1~red by the interagency guidance, banking orsanizations are directed to consider the full range of inherent risks associated with an employee's work acti~·ities.. rather thanjust the Jerel or t)1JC of risk that may remain after application of the organization"s internal eontrols for managing risk ('"residual risk'} Four Methods for Linking Compensation and Risk The interagency guidance discusses four methO<Is that banking organizations often use to make in<entil~ compensation more sensitire to risk: (I) risk· adjusting incenti\'Ccompensation awards basz.."d on measurements of risk: (2) deferring payment of a•~rds using mechanisms that allow for actual '"~rd payouts 10 be adjusted as risks arc realized or become better known: (3) using long.:r performance periods (for e.>ample. more than one year) when emluating employees' performance and granting a•~rds; and (4) reducing the sensitivity of a•~rds to measun-s of shon-tcrm pcrfom~a•>ce.• Each method has ad,~n tages and disadvantages. A key premise of the interagency guidance is that the methods used to achie~-eappropriately risk-sensiti1·c incenth·eeompensation arrangements likely will differ across and within firm~ Employees" activities and the risksassociated 11ith those actilities vary ~gnifi eantly across banking organizations and potentially across employees 11·ithin a panicular banking organization. DiOerenees across firms may be baS<.'<! on their principal chosen Jines of business and the char- 11.35('(K'll.h.l•.'t«l iB lhc(WI(t\L o( t)): inlcQgo.-ncy p.~id3..r!lx :.J"'.. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 • AsDMcdintl'le'inl~f'agl.'tX')'ttJidaOO:.Ibislislofm.eth~istiOl -otbcrmethods~r.Us.lorbc abkaL n'll~,(..by;.,,;~fR·2011-M-IJ~fr.OII·~31 intto<kdlobenha.US1h-e p.lf. d..c>!oped. PO 00000 Frm 00107 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718231.eps doo.."$tl()ldi$CUS$1htpt'()fl05tdlll~~~ru~isao.'3il· 104 10 lncenti,·c Compensation Practices actcristics of the m1rkets in •·hich they operat~ among othtr factors, l fll'Cting both the typcs of risk faced by the firmand the time horizon of thoseris.h E\t:nwithin fim1S.. employees' acthities and the attendant riskscan depend on mauydiR'erent vari· abies. including the specifiC sales targe1s or business strategies and the natu"' and deg"" of control or influence that diRe"''" employees may hal'e 01-.r risk taking. These diOerences naturnllycrcate diR'erent opportunities and diO'erent potential incentii'C.S. broadly speaking. for cmp!oyees to take or influence risk. Thu~ the use of any single. formulak approach to incentil~ compensation by banking organizations or superl'isors is unlikely to be elfectil'e at addressing all incentives to take imprudent rish existing control~ For example. unbalanced inctntil'e compensation arrangements can place substantial strain on the risk-management and inlernaJ control funaions of C\'en well-managed organizations. Therefore. risk-manng.:ment and internal control functions should be inl'oi,·oo in designing. imple· mc:n1ing. and evalua1ing irte"emivt compe-nsation arrJngemcnts to ensure that the arrang?~nents prop. erly take risk into account. Avoiding "One-Size-Fits-All" Limits The interagency guidance l'lw gnizes that large bank· ing organizations tend to be signir.rant users of incenti\'eoompensation arrangements,. and Ihat ft311W approaches to incen1i1t compensation at these institutions are more likely to haveadwrseeR'ects on the broader financial St~tem. Accordingly. the inter· agency guidance elaborates with gn.-ater sp."Cificity cenain supervisorye.t pectations for large banking or Formulas organizations.7 The interagency guidan<-e ltelps to al'oid the potential hazards or unintended conS<.'quences that would be associat«l with rigid, one-size-fits-all superl'isory limits or formula< Subject to supervisol)' 01~rsight. each organization is respon~ble for ensuring that its incenti\'C compensation arrangements arc consisaent 11ith its safety and soundness. Methods for 1chic-•ing Timelines for Adoption b.-'llanc.\~ inctrllirecompcnsation arrangementsat oneorganizationmay not be eiT'ec:th-e at another o~0anization. in part because of the importance of integraling incenti,·ecompensationarnmgcrnen1s wi1h1he firm's own risk-managementsystemsand business model. Similarly, the cfi'ccti•·cncss of mcth· ods is likei)' to diftcr across business lines and units 11ithin a large banking organization. In general. large banking organizations a"' likely to need multiple me1hods 1oensure that inocnli\'ecompensation arrangements do not encourage imprudent risk taking. In adopting the interagen~y guidance. lhe banking a.oencies recoguiz«lthat achie1ingconfonnance 11ith its terms and principles would likely require signifi. cant changes and enhancements 10 lirmpractices and that fully implcm<nting such changes would requi"' some tim<. For the large banking organizations in the horizontal re'iew. \\t communiCi'Ued ourexpcclalion that e<~ch firmshould demonstrate significant prog· ress loward consistency wilh Ihe interagency guid· ance in 2010. should achie1~ substantial conformanco 11ith the interagency guidance by the end of lOll (aR'ecting the award of incentirecompensation a•~rds for the 2011 performance ym). and should fully conformtbe.,afier. ' Fore.'tampk. t~in1cra~·p!idaoo·S13!estbat b~ b3nklng org.anil<Uion:s~ba\'(aS)'S!ttnalirc~Pf>CC3Chtoitlcttlti'c (OO)pt:ns:;lionsuPJ)Ort<db)• formalilcdaOOt~o'ci!-<lc\Tk>propoti· ~ pr\\.'\'durc\ and ~)')t<m$ to oo~rc 1M. i~'\'tlti\..:<omJ'(a.(;J· The intmgenoy guidance ruso places grrat emphasis on the role of risk-managem<nt and internal control functions in pr01iding for balanced risk-taking inctn· tii'CS. Poorly designed or implemented incentilt compensation arrangcmcn1scan thcmsel\'l'S be a source of risk to banking organirutions and undermine VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00108 Fmt 6602 lionarrani~-111C!liS.att'~tct)• lxllar..'\'daodC'OilSislrnt \\ilhsafct)'and SO\Irxi!XSi s~.~~.t insl~ution:s~uklalso b.:J'I.'C rot..bt (lrl).'l."dun."$ foe colk\.'ti~ infoti'!Ulion aboutlbc dTC\'U of t"'-iriM'fllh-ccomp.'ltSJtion programs.on«n(llo)~ri:!l; laking. 3$ \\\il 3:S *'Siems 3nd prlX'.'&.""'"S for u.;ing this inf001)3tiofl to adjust COI'Ilp.."0..'31ioo arr3ns~'TIX'lns tocfimiMtr or !\"duct unirl· tm.kdi/K\-nml$ ror risk taking. SimiL1~.d~e iat~1· JUidanct lll\,'\':1 b~~ banting OJl3n!atioM 10 3(11\~· monitOr indll$lr). ac:tdnnk. .and regul:norydndopmrnl5 in int..'\-ntht ('(lmp."ll5oltionpr.tcti~:J.nd t~· 3nd~prcpal\"dtoiocofJ»' r.ue into lhcir i~K"mti\'( ('()Q't(!Ms.tlioa S~')l.ans o..'\\' Of ~ng mcthods.tlut ~re lil:dy to impnl'l.~ !b:: Otpnilalioc'J'sloog-ttrm (lll3ncial-.'dl-00in,g.and ..::Jfety 1nd ~ndot$. Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718232.eps Well-Designed Management and Control Functions 105 II The Federal Resem has communicated to the firms our assessment of their practices and ourexpocta· tions forremediation in areas "'here impro\'cmtnts are needed. The fin11~ with the or~rsight and input of the Federal Resef\'C. have each dcr~lop<-d remediation plans. These remediation plaos. along with updates and discuS>ion around them, h:~r·e betn a key mt(hanismfor bringing clarity about needed changes. Scope of the Horizontal Review and Feedback Provided To carry out this majorsupervisory initiatir\\ the Federnl Reser\~ made a substantial commitment of stan· resources and seniormanagement attention. Mor< than 150 indiriduals from the Federal Resent and the other b.1nking age11cies h:~r·e betn inrolwd in the horizontal review. In addition to senior superrisory stan~ these included a multidisciplinary group of professional~ includingsupef\isor.< economists and la"~-ers. st~·eraJ spociallyoonstituted inecntir~ rom· p¢nsation on-site rt\'iew teams. and the permanent supe"iso!)•tcams aS>igneclto each of the invohoo banking organization& Federal Resef\·e stan· has coordinated with other banking r<gulators in con· VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00109 Fmt 6602 ducting the horizontal reriew and communicating with the firms. To perform the superrisory aS>CS>ments of conformance with the interag<ncy guidance, 1r~ gathered extensi"e information from the fim1son their incentil'e compensation arransements and associated pro· cesscs. policies. and proo.'dures We rer·iewed internal documents go,eming existing ino:-nth-e compensa· tion practices as wdl as sclf-assessmtms of incenth'C compensation prJctiCl'S relatir~ to the interagency guidance. We rondu<ted many face-to-face - tings rrith senior e,,C(utire ofiicers and members of bo.uds of din.'<:tors' rompen~11ion ronutti11ces. To supplement this information and 10 er~luate spocifically how inrenti\'e rompcns:uion programs were implemented at the line-of-business kvel. the Federal Reserve conducted focused examination~ of incenth-e compe'nsation practices in trading and mortgagtorigination business lines at a number of the organizations inroh\"<< in the horizontal rc\iew. The Federal Res<"~ has continued to pror;de individualized feedback to each of the firms as additional information and updates of remediation plans hm been rmhoo. All of the firms har~ made prog· ress toward achieving consistencywith the interagency guidanre. Titc natur< and extent of rrmaining work \'aries across organizations and sometimes rrithin organization~ Achie~•ing confomtancc with the interagenty guidance depends on the snce<:ssful build-out of >)'stems and prOC\'lSCS. achiewment or intermediate implementation milestonL"S. and success· ful completion of rrrnediation plan• Er·en then. in many cast$. it 1rill be important fort he fimlSto keep in mind that new systems and practires ha,·e not been fully tested by experience. so ongoing monitoring of these new S)~tcms and prae1ire; 11ill be important. With regard 10 FBOs with activities in the United States,~~~ h:~r~ acknowledgt-d the particular chal- lenges that ariseasthey seek to conform their US opcrotions 11·ith the details of their home-country Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718233.eps In late 2009. in conjunction 11ith its initial proposal of principles-baS<(! guidance on inC~:ntil~ compensation,the Federal R<S<rw launched a spocial simultaneous. horizonlalw·iew of incenth·ecompensation prncti<es and related risk management. internal con· trol~ and corporate gorcmance practices at a group of larst complex banking Of!"nizations. These firms rmcchosen b«ause n:~rwtl appro.1Ches 10 inC~:ntir~ compensation attht:SC instilutions are more likely 10 har~ adrerse etTerts on the broader financial S)~tem and b«ause of their C.\tensiw use of incentirtcom· pensation pmctict$. The si)-'Cial work associated with the horizontal review i,s now nearing completion, but supervisory work on inceMirecompensation rrill continue through the ong<>ing supef\·isory process. 106 lncenti,·c Compensation Practices. consolidated regulalor'sc.<p<(lalions and 1hoscof 1hc in1eragency guidanre As no1ed.1he imcragcncy guidance is consistent with intemational regulatory efforts on iocentirecompensation practices. including lhe FSB PriJ1riplrsand lmplem<"llation Stamkmls. We ha1~indieued our imen11o lollo11·1hecomplc- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00110 Fmt 6602 menial)' principles of cO'eclil~ consolidated supervi· sionand nalionalU\'almenl of banking organi1,;11ions opcraling in lhe Uniled S1a1es.s 1 forobstr•arion~ regardislgi~~nthTromprnslliorl prlll.'tim 31 FOOi. Sl.~ -lnltm..,LlO!IJIC'oo!"C-"( on pa~ 2). Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718234.eps 12 107 13 lncenth·e compensation arrangements achie\-e bal· an<e belwren risk and financial ""'~rd \\ilen the amount of money ultimately n.>ttiwd by an employee depends not only on the employee's performance. but also on the risks taken in achie\ing this performanre. Firms ofien dctennine the dollar amount of inrenti,·e compensation "''•rds for a pcrfonnance year immediately afier the end of the year. Pan of the a\\ard may be paid immediately and pan may be defem'<l. Risk adjustments (S<O Topic I below) are features of incenti\'e compensation arrangements that incorporate information about risks taken into decisions about the total amount of '"~rds. Deferred payouts can also be adjusted for risk using information that becomes a1ailable during the deferml period. as dcscrib-'<1 under Topic 2. Topic 3 focuses on other balancing method& and Topic 4 on identification of co1~red employees (those employ~ for whom prudent risk-taking ineenti1~ are panicularly imponam). Topic I: Risk Adjustment and Performance Measures At the beginning of the hc>rizontal review. no firm had a \\tll-<leveloped strutegy to use risk adjustments and many had noefl'cctive risk adjustment~ Currently. all finns in the horizontal review employ some son of risk adjustment for at least some subset of employees. but the role of risk adjustments in the 01~rall mix of balancing st mt~~es 1-aries across fim1s and across businesses within fon\\~ Some adjust· mcnts ~I)' on quantitati\'C mea.sui\'S of risk, while others are based on pcrce~tions of risks taken by employees or business units. Quantitatire measures of risk may be applied mechanically(although this is rdathtl)' unusual) or as anelemtnt in judgm~nt· VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00111 Fmt 6602 based de<:isions. Risk adjustments may play a role in setting amounts of bonus pool~ in allocating pools to indi,;duals' in<enti1-ecompensation, or both. In all cases. risk adjustments should consider likely losses under stressed conditions. and not merely bu~ness· as-u>ual. so that larger. but lower-probability loss outcomes can innuen~ inO!nti\'es 10 take risk. E1~1)' fim1 has made progress in dmloping and implementing appropriate risk adjustments. butthe progress is une~-en, not only across firms. but 11ithin finns. Substantial work remains: to be done to achieve consistency and eO'ccti1·eness of such adjust· ments in prol'iding balanced risk-taking ineentire& lkcausc most inctnti,·ecompensation de<:isions im·oh-e some judgment, a key element of that work is impro1w written policies and procedures and impro,·ed monitoring pmctices. Disciplined, Judgment-Based Decisionmaking Judgment is an ekment of decisionmaking at CI'CT)' firm and at nearly cwry step in the design and opera· tion of inrenti\'C: compensation arrangements.9 This poses tll<l challenges: (I) ensuring that deci~ons based on judgment are made consistently can be dif· ficult and (2) risk adjustments may be only one of many inputs into decisionmaking about inctnti'-e compr!>sation a11-ards. Without appropriate restmint. judgments about other aspects of an employe''' performance. soch as achiel'inga certain lel'el of market share. could be made in a ""Ythat ""uld undermine the desired inecntii'C efl'ccts of the risk adjustments. To promote consistency and eflil<th·eness of the impact of judgment on balan<~.'<l risk-taking i""'n· ti1~ the interagency guidan<e notes that firms are expected to hal'e robust policies and procedures to guide the consistent usc of judgment. and that deci· sionsshould be documented so that flrmsean re1i<w ~ An e;.;~i® is fonnlllak I;OOI~'TIS:.Utoo pbn~ such as rom!Jlis. ~<3l.",$~~1,1ihith$00)Z1~sp..'\i(~· lml)tJDISofir'k.\'fltr.~ coolp."tl53tion:k\wdiagtoa sp."\"ir~eformubS~:tllt thebe-gin· niogoftht'~\"Jr. Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718235.eps This section describe> met~ods firms u:;c to pro1ide employto.'S "ith prudent risk-taking in<enth-cs, as"'" as idcntifll'S the rele1ant set of employ"" It is mostly related to the forst of the three principles in the interagency guidance. 108 lnctnti\e Compensation l'raelict:. ~ htlhn poli<i<> and prottdurts ,,. bring folio\\«< and C3n ,,.,.,. the etfe<ti\<ntSS of th~ poli<i<> •nd pr'OC(dures O\~r time.10 liquidit) risk that takes onto account >tressed rondi· lions and 10 u.c th~ ad)U>t<d profit m<3SIIre in dettr· mining ineentiw compensation awards. At the bq;inning of the horizontal I'C\' kw. most firms lacked ~rittcn policies and prooxlur<S to guide m>n· agm in making risk adjustments. and policks and prottdur<S for inctntne compensation ckcisionmak· ins often did not deally identify the~~ to b< P'tn 10rbl;s tal:m duri"! the ptrfonnanct )tar. Sudl policies and prooxlum. a!on' -ith uaimng for man~er> and t.t fi'JSI ,..;.,. of d<ci,ion' arr impor· tan! to achie\ ing con~•ten 1 applk>tion of risk adjustllll'nts. Some firms h:n·e mack progress in dmloping " riucn policies and prooxlure,and rrlatcd p = but others,,. still in the process of completing this work. 11 Most firms in the horizont:Jl re' iew also used quanti· tati\'e risk measur<S as an input 10judgmtnt·based inttnti\tcompensation d«i~ionrnaking. For eumple. boanh of dirte~Or> usual~· take into aCODIIIII3\aibbl< ri,J: ~when mal:ingckci· ~about """"spool> for the firm or about..-.~nh for senior et«utno. Some ri<l measures ean bt dif. fteult to con-.n into quantitati\e risk cha~ but ne.~nhelesscon"l' n.cful information. HO\\t\'Cr. as noted p~<'·iously. achie>ing a consistent balancing impact throughjud~mental d<cisionmaking is a chal· !eng~ Firms with more •dl.<fC\~Iopcd policies and proc:cdur<S to guide dcci,ionmakers in judgment:lll)' usingqll3ntitathe risk information scnned mol< likely to achine a roosistmt babocing impatt. This is an arta in •llicll ntafl) firms a1< ~orting to Quantitative and Qualitative Risk Measures imprO\ceiT«th~ In 1.':1\<'S \\Mre ri>k adju;untntS are applied based on a formula. i!K'tnlirc compensation dt"('bions ;u'l! made u~ing measures of li11ancial perrormancc Ihat are net of a risk charge based on a quantitnth·e meas· ure of ri<k. Such adjustments balanct inc:cnthos to take ri,k 10 the extent that such charges oiTsct incttalC> in financial ptrformanct(or reductions in C'OSI!) that a~< associated \\ith inmased rill. l4kt11J. Tht US( of mcdoanical ri>t adjtbunmb i; J10»1b1c "'htn suitablt quantitatn~ rill. mta>U~<~ ,,. :1\>il· abk. ond the etfttth'tii<SS of this t)'J'C of ri>k adjust· mcnt depends on the qualityof the ri>k mc:bure. One leading edge practice. obserwd at .ome firm, is to a>SCSS a charge against internal profit mca;un:, for 1 • h.'ll' ('\lf!lrk,111 orp~~iwioo ,;book! hl\t l"'t.~ ud fiRX'O' d""tNI"""'bc""'-alt""'...Sto"" ""JUds· 8JC'Q110Jdp(o.'t bDlrix, iDdadiiiJ I cJNrifUOI., ti •1fQ.C'I;tc4, o ( t k _.. _........,._oht......,.,, ""'""""'-""'100:-iiU..,IIIonor.l~ llml\.Wpob.-..-,.Uld~I(\'\J ... •oh~af'C't\'t'!i:' wl)><>tobcfoiloo<dio«-~-., ""'""l"''· ftftl'\ ~141ould f'CO'idcmo&.lfa st.~1mKid llhtnlr.'tiOrlllul d<\WOMQnt-:ji.OOfiC'd:aOO~t~'\J ona<'k-u~con ..;,,<111 b3~h ;m.J lho.'I'Cb) aJJOVo (« t'C poM 11)0fUioritiJ. II ~firm~h;r."tid«llift.."dinlflrit,.olri.."\ilndrc"OI.'NU~'f'C" dr..·r~~IOI)~tclot~ liDrotbusiM\):tndnnplo)l'( rolc••orliJdtngl\'fcrt1).~poiAh.,lObc «WW....J,."fC'db)maM$<'· Mrnl v.tnnW.in~~ risl.lllj\N.Mtnt' ~firm~ """'!'"""""""""'.mid • ~""'" ""' """"""",.... IN odjo;tm<at< and Jila<d • ,..,,..... do.'W· d<"""""""" ....."""'.. _."';..o( .. _ tdo.-~ ........ -.s-:-.:.Oimt""""'-- """"'"IOb.,.,..~....-.ro~o-""* ""''~' ......"""............ ~"' Tbc)lolt ~ol""'""'"""""' to-oa.lm;lo)tnlbout holl. ri.J.:.Jj~W.m(al)~A"Oft.~AtlirntifN.ialto(ulim~1on n<t.uJ.,,.d<\'NQo<. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00112 Fmt 6602 Almost all firn1> in the horizontru rc\·iew use non· quantitati,·e pcn:cptions of ri>k taking as a basis for some risk adju>tmcnt~ Such adjustments hare the potential to addi\'>S harli·to-mcasure risks and limi· tationsof exbting data and risk·measurementmeth· nd< For =mplt. the mana£<r of a lending business might be..-.~,. !hot $0111( nnployl'tl of the business make riskitr I<»D> and othtrs saftt loa~.,.., thoo~ the qll3ntitatn~ n,lmruures ;n-ailobk to the manager do not >hO\\ it. Based on th~ information. the manager could risk adjU>t by giving lower ine<n· th~ compensation ""rd> per unit of ,..·enue to the employees making the ri>kier loan< As in other cases whtre inc.:nti\'e contpcnsationa~,~rds are based on judgment·bascd deci~onmaking. they are more likely to be consistmt~· eiTttti'< "here firms h:n~ clear policies and prottdur<S 10!"ide application. 0..<1· oping sadl policks and prooxlures i; particula~ challmgjns b«aw.e the information about risk is qualitati\t and the natul< of the information tend>to changeorertimc. Risk Adjustment and Bonus Pools lnc.:nthe compensation practkcs or firmsdiiTer in the proms of dt~trmining the total bonus pools and the allocation of incenthc compensation 10 indniduals. In a to...,.,... ~ smior mattag<m<~~und 111< board of di~<e~or> dttnmine the size of an 0\er· all amount of fundinJ for the firm a; a ~itote near the end of the pcrformanc.: )ear. and this bunus pool is then split into >ub-pooh for rnch business. Pools Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718236.eps I~ 109 <Xtober 2011 are allocated to indit idual otmployccs in a manntr related to their indi,idual pcrformaoce. In a bottom-up proces~ the finn assesses pcrfomtance of each employee and assigns him or her an inctnti\'e compensation a11~rd. with the total amount of inctn· tire compensation for the year for the fim1as a whole simply being the sumof il>di,idual incentit~ compenS.1tion awards. Most firms' processes are a mixture or top-do1rn and bottom-up. but the<rnphasiscandiffer markedly. 12 Risk adjustments balance inccntire compensation arrang<ments to the extent they affect the incenti1•.:s provided to indit•idual~ The impact on incentires may be limited in cases wh<re a finn mak<:s risk adjustments onl)•whcn deciding amounts of pools because the a11~rd to each~mployce under the pool ,;n rective the same adjustment. This is appropriate when the nature and extent of risk taking of all employc.:s under the pool is the same, such as cases where a pool applies to a business unit in 111tioh all risk dceisionsareinfluell<\.'<l in the same "~l' by all employees. Where inditidual employe.s in a single pool can hare 1~ricd let~ls of impact on the amount of risk, the difleren<>.>s 11ill not be fully address..'(! by risk adjustments to the pool alon~ In such cases. additional adjustments inoorporatcd into decisions about individual incentire compensationawards would be netdcd to make the risk adjuStment fully etT«ti\"e. 15 uesand to evaluate best practices in this area as they C\'OIW. Topic 2: Deferred Incentive Compensation Another method for balaocing inccnti,·eoompensation arrangements is to defer the actual pa)lllll of a portion of an 3\t~rd to an employee significantly beyond thcend of the perfomtanc. period. adjusting the payout for actual losses or other aspects of the employec·s performanec that are realized or become better known on~· during the deferral perind. Such deferral arrangements make it possible for the amouut ultimately paid to the employee to reflect infomtatio~ about riJks taken that arrit~\luring the deferral perind. The interagency guidance does not require that deferral be used for all employees: does not suggest any specific formula for deferral arrangements: and does not mandate the usc of anyspecific rchicle for payment, such as stock. Ho11~w.the intcrageocy guidance does ha\"e some speciticsuggestions relating to deferral arrangements for senior executives. A substantial fraction of incentireoompensation a11~rds should be deferred for seniorexecutives of the firm because other methods of balancing risk-taking incentil'f.S are less likely to be effecti1~ by themselt'f.S for such indi,idual& Next Steps Elements of Deferral Practices continue 10 have work to d.o, includingde\'dopment of appropriate policies and procedures to guidejudgmental adjustments of inrentitt compensation a11~rds. Most finns should continue to ct~luate the cffecti~tnessof the quantilatiw: and qualilati,·e ris.k adjustments theyare u~ng and whether risks are appropri31ely balaneed. Additionally. in lll12 fonns should evaluate ho11· eft~ire the risk adjustments used forthc 2011 3\t~rds were. and makeimpro,~ ments as nettSsary. The Fodera! Reserve will continue towork with Ihe fin11slo make sure progn""SS comin- •: E\m a~lirms \liltt a bouom·uptm~ b...Js--1 roRSttairm: pb~\' apn..'"'li.:a! limit on lhc iii~ of the 3~1\);iltt booliS for 1~ lirmas:a"'OOk, SO~Iop-d®'ftl'L.-mtnti),pttStrl.L$imibt!): topodo'l\n firms l:lh-som: :K\.'Ount of JICC'I.'ei\'C'd p:r!orma~oC l:ey indilidlllls in feltins poole. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00113 Fmt 6602 The proportion of incenth"C compensation a1,-ards to be defemd "~'substantial at the fimts in the horizontal reriew. For example. senior executi\'es now h31~ more than 60 perrent of their inccntil'ecompensation defem>d on 3\~rage. higher than illustrJti1·e intemational guidelines agreed by the FSB. and some of the most senior executit-es h31·e more than SO per· cent deferred 11ith additional stock retention require· mcnts after defemd Stock rest& Most firms assign deferral rates to employec-s using a ft<ed schedule or "cash/stock table" under ll'hich employ"" m:ei1ing higher incenti1~ compensation .,,~rds generally are subject to higher deferral rates. thoush deferral r.ues for the most seniore>ecutit·.:s are often set separate!)' and are higherthan those for other employees Deferral periods g<nerally range from three to fit·e yea!$. with three year> the most common. Most organizations in the horizontal Miew use the same deferr.tl period for all employees in agiltn inetntiltCOnt· Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718237.eps Most of the firms in the horizontal retiew h31·e made significant change-s to thci• risk adjustment practices for a11~rds for the 2011perfomtanc. year. Still. most 110 lncenti,·c Compensation Practices pensation plan and often for all empiO)'l'tS. So~ firms tmnsfcrowmrship of the entire deferred award to the emplo)\'0 at theend of the \'OSting period f'clilr l"esting"). while others adopted a schedule under which a portion of the award l"estS at giren intervals. The most common 1~hiclts for conl'eying deferred incenti,·c compensation to employees are shares of the firm's stock. stock optionund perfomtance units (an instrument wilh a payout \'alue that depends on a measure of perfomtance during the deferml period. often an accounting measure like earnings or retum.on.((!uit)'). Some firms usc dcfem.'<l cash or debt·likc instrumenl<. Performance-Based Deferral At the beginning of the horizontal review. few•firms adjusted payouts of deferr<'d awards for risk out· comes or other infom1ation about risks taken thai boca~ a1•ailable during th.c deferral period. Without such performance conditions. deferral arrangemen1s are unlikely to contribute to balancing risk·taking incentil'es (for ease of reference, deferral with perfor· man~ conditions is refcm.-d 10 as ·-perfonnanrebased deferral")." n Tiloc:ommon tssucs 'llith pcr!ori'CI3o<\"-b.lio.-d 6.-ferQJ bo.'""JITIC Mrduritlgt~ ~tal rt\'i.-..: 'flit fitS!. is: fl.-bled to~·· mcnt ol dcfcrtc\J ina.'flti\·c«~mp.-mation in sh3~·ro'Std inst.N· ITICnL.;.\\~-tt\\.'biclc$.an:$hl~·ba-<i.-d.~1hrlillX'~r\'Sare il\l<ltdcd. ris.k·takingactio~during t~ ~rfotmal).'"t )~t migl'll ha'l'<' cil~r ups)& Of 00<;\·llOOc<'ffMs oo 1~ ~tot.-t prilx in Lhc rururc.sot~nctcll"mooim.,ti\tsis001d..w.Mor«<\t-r. IJK'IS.I<'1TI~'l\'S:bcio'a' thc:scniort.\<\'\lti\~le\\'iarenotlil:d)• to tdico.'tlhatth..;r oYonml:-Wint:&xi.~"U.l!lb'ta~cri:d irn.pad on the: lirm'sMock pria. forCMm(.kifthc lc'adrl'of a businomunit kiiC*'S I~I3!Xll1it,:ulat strat~ rna)' k-Jd to~ tiUt ar.: 1.14,"'<' from the )taOOpoiot o( 1~ Ullil,thc k-ad« mat bdico.'t any s~il ~ wookl be 100~ t113.n oll's..'l by pro(Jts rrom Olhcr busi().""S t.1niL.t Thu-~ the ~'f would 001 (',,f\'\1 the ~ to31l"IX'Iti'K- ultimatt ,'3Jueotd.:fcmd M' rl.'t\'i\\.\1. and dcl'tml woold h.:J\'tlillie' ir:npa..1 on his or"'-" risk-W.i~~g ln..\'11· ti\t$. In onkr for3d,:fcrnl ;unu~T!K'ntto rncatJiflgfull)•C'OQIn'ba~ to bllaore. '~.'Sting Lri£So--rs sbouJd b.: tlasc:d on mcast~n:s o(p!rfOITnaO«thataretird:«<ltotb:crnpiQ)w·$risk-takiQ.J a...'1i\i~ t"Spp.'i.lay t00sc Iilia bcfol'l: the iM."'''Ii\'t.{'l()tJIJ).."T\S3· tlonav.·:mL Th- 9:1.-ond rornmon iNIC tll3t b«a.rrx- d:ar durin-g~ borilonlalfl...,ira' rda!N to 1hc r.u1-.'\lla.r p.~rondilions (trisgcrs)~'fl by firm;;. Some rums h.ro~ pcrfonnanc.'\.'-ba...:cd dcfcrr.d 3ff.lll!tm:tlb Ibat all\w. (Of :1 b.~ OfOlJI~'\1 p;I)'OUI "'b'n the \~l.'i.'Softri~·r$ rdl..'\1 ~th't po."'fi'OnnliiiX. tiO'A'· C\'tr,th<-scarf3~'tll)r'ltl)'CI'ICOUrlS:ClTIMl\.'1tOtak:l."moct risk durin~ tbr: dcfm;tl p:riod.. in oni:r to ma.\"imU.c tt.: \,.JI.IC of)tt..ilt~£\3ndthli$Tni!)nolbili111.-.:-ri$1-tak.ingii'K\"ffti\c;;, On.:: wmpk of 1 tRuer thlt may~ appropriate- is oo: that rtduo.utbc:amol.llltofdcf\'fl\'d(;om~'fl~iootltalis,~cdif VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 Firms in the horizontal "'''it'll' ha1-e made progress in impkmenting performance-bas..'\! deferral armnge· menls Ihat promote balanced ris}Haking inccnti\'es., E>ch firm's setup is some111tat different. but thm: broad styles of armngement were ob;erved- formu· laic.judgment·bascd. and a hybrid of the two. In a formulaic approach, the perrentage of theaword that rests is din.'<tly related to a measure of performance during the deferral period. In a jud~nt-based arrangement. the circumstances under 111tieh less than full 1-esting11ill octur are decided judgmentally ruther than being linked to fixed 1'alues of perfor· mance mctrics.. and the amount of inctnti\'e compensation paid out under those tircumstaneos is also decided through a jud~nt·based proces.<. In a hybrid setup. a specific trigger ~~lue of performance is set at the beginning of the deferral period. and if perfonnance falls below that trigger valu~ a judgment-based process determines how much of the defem.'d incenti,·eoompensation 11ill not rest." To the extent that judgment pia)~ a role in the \'<Sting decision. firms aree.xpeetcd to ha1'\l robust policies and proce<lures to guide the consistent usc of judg· ment, and decisions should be appropriately documented so that firmscan monitor ~ehether their poli· cies and procedures are being follo1red." Policios and procedun.-s noed to be clear to employ~ or they will not ha~~ a dear understand in~ when risk·taking deci· sions are made of which outc~mes will l""d to forfei· ture. in \\1lich case deferral arrangements are not likely to have a significant impact on risk-taking beh:ll·ior. Many fimrs still hlllt work to do on their policies and procedun.-s in this area. Most firms in the horizontal rt~iew haredawback arrangements for at least some employees that are triggered by malfeasance- violations of the firm's policies. and material restatement of financial result~" Such dawbaek pro,·isionsean contribute to l''"""""''·bcl.«<l d<f<ml""flt"'l"' >!so $11oo~ bo •'l">ri) c.~pJaincd to em~~ C'O\'m"d b)•thost armn~'t'I'ICDL-.. ~ 1 In al"Q!!llf1011\'3ri3nlof\JI(-~'bridp~on;.'\:tlw.:-tri,~r~ mct fora particulirt:f\XIp(e.g.. abusitlffiul'lit).tbe~iofl. :\1) pro(.~ Qct('mlin('S. DOl 00~ tbc p:rt\'1113~ iJ]('I.'Il(i\1: ('(lmp:n$3lioRthat \61-\ but Jllo\\ilidl tmplo)\~;).I'I:SLI~'1 IO Je-ss than (ulJ \'CSI[ng_ ~ualJ) ba9.'d 00 'Uotl..il c-mr.4o)"\'\":S 'A'CCC ot rCSJIOn.<lit* for b.~ or rOf imprudent rk,l: taking. u Col).~msabout tbt u:st or diSI.-rttion in ck(crr.ll arT3Jl~'fn('nts all:'simibttO('(IIX\VllS3boot the Wtof disa\1ion int,TWltt risk ldjl.blmc-nt. asdi9:usscd LU'Idcr ro~ I of this ttpOrt 1 • TI-t: \\orJ Mtb.lb3d:..i$ !oQr:r'lctimcs u.W ton:(~r tOaD'I·d.-fcrnlof'.pa)'rrl(ntmbod. The term '"~iTANc-k.. alsoma)'t~.frr sp.... tb:firm(or bu.)il'lt$$ til\:' or unit, dtp.."'''diBgon thtlC\~ of tbt tmplo).x)c-.\p.'limc6 ~Lh-e nct incom: in :.n) fiS~.-al )ttr ('ifiCJ.!~· toa.n:am.n~"tf"-.'nl ucd«-.,r,hXfl:tncmplo)«m~ fttl1M il'ktnli\'t<'QnlpM.-.11iotJ ~)'m('B\$ pll"'.'iou.~• fl'tl.'i1.\.\i b~ tho: crnf'll~cte il" certain ffl); outoom:so:\.'Ut. ~tion 304 of lhi: during till cJortrrnJ J>IOOO. l'b.l n.ol.,lllt tri_~~ f<lr afl)' SJrb.l~-O>k)· Al1 of 1001(1l U.S.C. mJ; •hictt•Jlllli..• 10 PO 00000 Frm 00114 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718238.eps 16 111 <X1ober lOll balan<~.'<i risk-laking inccntirtS bydiS<Ouraging spe· cific I)'JX'S of b<ha1•ior. While po1cn1ially cfl'ecli1~. 1hey do no! affect most risk-related decisions and are not triBgered b)' most risk ()utoomes- the narro" focus of these arrangements mean !hat tile)' are unlikely 10 <"Ontribute meaningfully 10 balance 17 for achiering balanced inccnth'CS for taking risk. The intemg<tlcy guidanre also idcn!ifies the use of longer perfonnance periods (for example, more !han one year) and reduced sensitivily of a•ords to short-term performanre as mel hods for achicl'ing balance Our· ing the horizontal review. we obserwd theuse of bo1h me~hods. I hough neither ·~s uni1~rsalty used. Progress on performanre-based deferrol for !he 2010 ingrisk-taking incentiws~ such as senior managers within business lines and other employees engaged in activities that in\'OI\'e ris~s orera long duration. Next Steps Most of !he firms in the horizon!al te\iew h:n-e made signiflcant changes lo !heir deferml arrangemen!s. Many firmsin the horizontal O:\iew have increased the fraction of ina?nth·t! compensation that is dcfcm.'<l for both seniorex«:utive$and other employees. All firms haw more work to do 10 impro1-e !heir performance-based deferr.tl arr.mgcmenl< firms may aiS<> flne·tune !he role of defcrrol rda1i1~ 10 risk adjus1mems as they gain c>pcricnce 11ith how the 1wo 11~rk 10gc1hor. As flnns dcwlop and fine-!Une deferrol armngemenl< firms should 0\'aluate how ~~~ll lhese deferral arrangemenls h:n~ 11t>rke<land make impro,·cmems as n=l)'. Tile Fedeml Resen·c will monitor and eocourage progress and work 10 ensure I hat pmctices are eflfctive. Topic 3: Other Methods that Promote Balanced Risk-Taking Incentives Risk adjustments and deferral wi1h performancesensilive rcalUres represent importanl mechanisms cll.icf t:<l\."\111\~ oiTk\'fS.and clli..i finanri.al offll."tfSo( rublic b.:tnki~ol);anization..\ ii an~pk ol lhls mort ((\"'\ifw: 1~-p.: of -d3-a'bacl.~ tcqLJif'l."l'D«<I. N'..-J.rly all U.S.·l»$cd firms int~ horizontal mW.·are pubiW.i )· tradN. and tl'lcP.ofortsubj.'\1 10 1bisprtl\~ . VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00115 Fmt 6602 Evaluating Performance: Emphasis on Long-Term over Short-Term Firms used longer performanre periods (thai i< a backllard-looking muhiycar assessmcn1 horizon). for example. for senior c~oc:utiw~ in some cases, and in others for non-oxecut i1~ employees. Measuring and Cl'alua!ing performance or a11~rds on a multiyear ~is illlo"~ for agJ(;lt~r portion of risks and ris~ outcomes to be obse"~'<i 11;thin the performance assessment horizon. thus gamering many of !he b<n· efils of a defcrml arrangement wilh performancesensitive fe:uures. One simple variation involves using risk ou1comes from prior-year ac1ions as a consideration in reducing current.yea.r incrnti,·crompcnsa· lion award doci~on~ To be e!Tccti1~ muhi)~at assessmems should be b.1sed on policies and procedures that gh·e appropria!e weight to poor ou!comcs due 10 pas! docisions. O!herwise. ad1wse ou1comcs may be cfl'ec1iwly ignored due 10 an emphasis on current~year perfom1ance. Damping the sen~!iril)' of incentii'CS 10 measures of short·!crm performanre ~~~sa d•oice made by some institutions to reinin inctmhts when. for example.. concerns arose abou1 !hesigniflcance of the incenti\'CS or risks ilwol\'td. Fore.xarnple. increasing bonus pools or indiriduAI 1111~rd amounls a1 a lo11~r rate when financial perfonnance is 11tll above targe1 iti'CIS canlimit inctnti\'~':S 10 lake large risks 10achie\'C exucmc lc\-els or performance. Acap on incenth·c compensa1ion a11~rds b<)ond a rertain le~~l of per· formance is another example. However. in the hori· zontal rericw. there were few instanres where such caps and reduced sen~1iri1y 11trcsunicien! by them· seh~ to balance risk-laking incemii'<S. Next Steps The interagency guidance urges large banking organizations to acli,~ely monitor industl)~ ar.adcmic, and regula!ory de1~lopmems in illOOltirecompensalion prae!ietSand !hcol)' 10 iden!ify new or emerging me!hods that arc likely 10 impro1e !he organization's long-tenn financial 11tll-being and safely and sound- Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718239.eps performance )~r ~~~s mos1common for senior exccuti\'CS. Many lirms arc now in the process of re1;sing armngements to be used for the lOll perfor· mancc year and are extending performance-ba.st'<l deferml C01~rage 10 more employees as a mechanism 10 provide prudent risk-taking inren1i1~ Some flrms ha~~ implememed, or are implememing. perfom>ance-based deferral for all emplo)""' receil'· ing deferred ill00lti1-ecomp<nsa1ion. while o!hers are doingS<> mainly forempiO)'ffi whose au1hori1ics and influence over risk laking 3re such !hat risk adjus!· ments might h3'eonly limi!ed efl'ecti1~ness in balan<· 112 IIX'<'nti\e Compensation l'raelict:. """' Th< F<d<ral Rtstn~ ,.;11 do the same and ~ill encoumge firms to ust methods that are ntO>I approprime for their circumstanres. Topic 4: Covered Employees ldennf)ing the full Stt of emplo)<es •ho rna) indi· ,iduaJ~ or a~U«ti\'d) «post tilt fttm to matcriol amountsof risk in crucial step to..rd mallaJii!J rill., associaud •ith incenl~~a>mpeosotion. 1\lth· out identif)ing the rek\~nt empiO)ees. a finn c;~nnot be >Ure it has proper~ designed its inc:l!ntire a>mpen· >ation arrangements to prmide appropriate ri>k· taking inetnti\"eS. Three Categories of Covered Employees Th< intmgm<J' ~idanct describe;. three catttories of ;ud! nnplo)ttS. •flicb t~htr are rd'tmd to a. 'CO\ffld nnplo)~-= • other indh idual employees able to take or influence material risks: and ' giOUJ)> Of similar~· compensated indi\ iduaJS 1\hO, in aggrepte. can take or influence material rill<~ lnctnt~e a>mpensation aml\gtlllC!ItSfor all eo~er<d tmplo)ces5hould b< appropriatd) lxdanced. ~~~~ k» of • lk"lher the ""~red <mplo)ce ;, a .mior c.e.:uti,e. an indh·iduaJ. or pan of a group of ~mi· Jar~· compensated indhidual~ Though the Fedml Rcsef\t has no taf!!cl number or quota of cowl\'<! emp!O)·c.:s for any firm, many of the lafj\<">t firms ha\e detennined they haw thousands or tens of thoU>ilndJ of CO\~r<d empiO)·ees. Standald Approaches to Covered Employee Identification Finns foliO\\ oneoftwogenmlapproaehe> toid<ntif) CO\Cr<d nnploy= O~te approach im oh e. dC\d· oping and follo•ing a s)>tematic p = that idcnti· fi1S types or risk that each employee (or group of empiO)«S) takes or influeno.'! and thataSASCS the materiality of the risk< Such a p = should 'cast a wide net' and should consider the fullmnge or t)pes andle\eritiesofrisk. ~finnsbtin\esledin enhanced information syst(I!IS to faatitlt< th11 proee». Man) firms in the horizontal It\i'" folio\\ thi> appfll3ch. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00116 Fmt 6602 Th< S«<lnd approach ck:,ignat<:> a'"tl) Ia~ set of nnpiO)<e> as CO\tl\'d, such as all rn>plO)'«S reOO\ing any in<ttlli,~romptn<ation. or all nnplo)~ subject to a subset of the firm's iiX'<'nti\'e compensation plan~ Although this reduces the ell'on requir<d to identify a>ver<d tmpiO)= firms still n.OO to iden· tify the rele-~nlt)-p:s and S<\erities of risks that are inctnti\iud through iiK'ellt~ea>mpensation amngcmmb to b< sure iottntnes to take such risk> arebolancN. Man) firms appropriately id<ntif) at least some groups of similarly a>mpensated employ«:< "no may coll«ti\'cly expose the firm to material risk. Examples include originators or mongagtS, commer· cia! lending officer>. or groups of tr.ders subject to similar incenti\~ a>mpcnsation amngement~ Establishing Robust Processes Going Forward SC\~ral firms h;n-e )<Ito establish robust proc= for identif)ing co,ef<d Clllp!O)a'l that are a>nsistent with the intmgenC)' guidanco. e.pe.:ially for identify. ing groups of covered employe--s. Some firms rely he3\·ily on me.:hani(ll) materiality thl\'lholds in their identift<ation prottJS. Formmple. on~· empiO)ces able to make deci.ions that a>mmitatltast Sl billion of tb< fim's<ronomic:capilal might be eligible for consid<mtion as CO\fflO ClllpiO)-..s. or~ cmpJO) · cesalxnea gnen 1<\tl of totala>mpensation. Such materialit)thrtSholds as opplied b)' mOSt firms to exclude nnpiO)e>:s from being a>nsi<lel\'d cowl\'<! empiO)'CCS ha\·e three common weaknesses: (I) they often fail to capture the full extent to "1lich an empiO)'e\! maye<po>e the finn torisk.(2) they tend to exclude potential 00\~1\'<l emplo)<es who may sig· nir~<antly influence risk taking but do not make final risk dtci>ion$. and (3) the) often ignore groups of similarly«>mpcn>3tednnpiO)ces In mie-&ingtll< firms ust of threshold\ "e ~und that Ullder some circumstancel. a suitablychOStn materiality thrtSh· old a>uld appropriate~ play aa>mplementary role in idcntif)ing CO\~r<d empJO)CCS if used to include employees as corer<d ClllpiO)'CI'l. FBOs \lith U.S. operations that "~re pan of the horizontal mit\\ face special challenges in dC\doping procedures for idtntif)ing CO\er<d cmpiO)«S for purposes of tht inttratmt) guidantt. Gtnerall). home-country supen i>OO np.'<tthcir staodards to be met by the a>n>Oii<lated organization. and so in its Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718240.eps 18 113 <Xtober 2011 U.S. o~rations. an FBO must mett both home· count!)• and U.S. regulatorye<pe<:tation~ Ma11yof these lirms ha\'e home-rountry supervisors whose regulations focus on a more limited set of employees than dC$Cribed in the in1eragency gutdaoce.17As a result. these fimts n«d to develop proc:esses to iden· tify both COI~rcd employees in their U.S. o~rntions lor ' Jlplication of the interngency guidanre and those employees subject to home-count!)' regulation. The number of eo1~rcd emplorees for purposes of the interagency guidanre in U.S. o~rntions of an FBO mar mred the number of employees subj«t to home-oounuy regulation. Next Steps 19 sation programs that do not t1tcour..ge imprudent risk taking for those cmployct<~ who can indi1idually aftect the risk profile of the firm. In addition, many finns have identified groups of similarl)'COm~n· sated emplo)~ whose combined actions may expose the organiu.tion to material amounts of risk. Some finns h3\'e put in place a robuSt r= for idcntif)'· i11g rele~~111 i11di,;duals and groups of employoes. uith the na,ibility to adapt to the changing business em·ironmento\·er time. Howerer. some finns are still working to idemify a complete set of mid· and lower· level entplO)'<'OS. and others arc working to ensure their pi'OC\'SS is sufficiently robust. The Federal Rese/'\~ will II'Orlt 11ith the firms to ensure that progress continues. All firms in the horizontaii'C\icw now 1\'<ognize the importaoce of establishing sound incentil'eeom~n1 ' Sup:t\i~rs in trUII)' otlx'rjuLi:5d.ictions r..-quire tt..."ir finm 10 identify on~· lhcif cqukal-nl o( indi'iidual 00\WC'd rolpky)\\~ ofiC'I'Ill$ing N~crilfitySI3:1'1d3rds Ihal r~0.1 ancntioa 103 rrla- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00117 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718241.eps li\o:f)'NinurnbcrofindhiduaJs. 114 21 Establi~hment of balaoccd risk-taking in«:ntives should be support«! by the engagement of risk· manag<mcnt and oontrol personnel in the design and implementation of incenti~-ecompensalion arrangement~ in«:nti1·eoompen~tion for such personnel that is independent of the financial performan«: of the businesses they ovci$Ce (in order 10limit oonfliets of intere;t). pr.tcticts to promote improvements in the reliability and eOOCtireness of incenti,-ecompcnsation systems o'-er time-. and impro"emenlS in corporate governan«:. These features are discussed in topics 5 through Sbelow. TopicS: Risk-Management and Control Personnel and the Design of Incentive Arrangements role tr.tditionally inl'oh~ liule or no focus on inecn· tii'<S to take risk or the risk associat<d 11ith the cmplorec's aetil'ities. Risk·management personnel traditionally had relati~tly little in1·oh~ment in incen· til'c compensation design. and their itll'olvement in decisionmaking 11~1 often limit«!. for ~'ample-to only suppiJing information abou1 breaches of inter· nal policy and proc<durc by indi1idual emplorees or units.. Howt\'er, a few finns did incorporate risk measures produc<d by risk-man(l$ment personnel into financial performance measures used in inctn· til'e oompensation dcdsionmaking b¢fore the crisis. Increased Involvement of Risk-Management Personnel in Design and Decisionmaking Risk·management perronne-1 are now im·oh'ed in At all firms in the horizon!all'l.~icw, eertain limelions. such as human and finance. tr.tditionally were ill\'OI\·ed in incenti\'erompensation decisions and in the desigru and implementation of incenti,·t compensation arrangtments. Howe\'er, this =•= VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00118 Fmt 6602 incenti\·ecompensation system design anddecision· making at virtually all firms in the horizontal n:1iew. How-cwr. the intensity and nature of im·oh·cmcnt \"Jries. Forexample. risk·managrmtnt functions 1\0\'' pro1ide significant risk-related input to the boardle~~l deci~onmaking process for indi1·idual senior executil'e ill('Cntil~oompensation at all firms and for bonus pool size decisions at firms at wbic.h pools play a role. Mostlirms consider some quantitati,·e risk mea)ures in making atleaSI. some incenth·e oompen~tion decision~ and these an: usually pro1ided by the riskand finance functions. Nonetheless. at some finn~ risk c.xpertS primarilr play a peripheral or informal role Comrol.linance. and risk-management stall members provide some input to indi1·idual employee per· formall('C ~ie11' at many firm< For example. they report breaches of policy and proc<durt or rate the ··risk awartncss')or adherence to the linn's risk appetite of indi1•idual emploreesor business unit& At !inns that usc committee structures in their incenti\'C compensationdeci~onmaking process. oontrol. r.nanec. or risk-management personnel usual!)' are among the members of commiuees. AI most firms in Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718242.eps Properly identifying risks attendant to emplorces· acti\'ities and setting suitab!t balancing mochanisms an: critic;!! elementsof pro1iding balanc<d risk· taking incentives. The inte,.gcncy guidance notes that risk·man(l$ment proo:sses and internal controls should reinforce and support the devtlopment and maintenance of balanced incenti\'erompensation arrangements. Risk-management and comrol personnel (including Internal Audit) should be involv<d in the design. operation. and monitoring of incenti1·e oompen~11ion arrangements because theirskills and expertise pro1ide essential jperspeetil~ and support. Risk-managementstan: in particular. should partici· pate in the firm's anal)~is and deci~onmaking regarding the identification of oorored employ~ the seleetion of any risk-sensiti1·c performan«: mclrie& the dCI·elopmcnt of risk-adjustment metltodologi~ and 1~1ing triggers, and the orcrall cO'ecti~tness of the finn's balancinge!Torts 115 lncenti,·c Compensation Practices. the horizontal n"iew. risk· management and control functions are also involved in identification of COV· ered employees. At firms where risk-management personnel are intensely involl·ed in basic-design decisions for the incenth'C compensation system. as well as in determining details of the risk·n~ated elements of the inctnti,·e compensation process o1~roll. progress on risk-taking inrentii'CS has tended to be faster. At fim1s where risk e.\perts play a peripheral, informal role. progre>S has tended to be slo11~r. primarily because other personnel to nd to have less e,,perienee and e<pertise in designing risk identification and mcasul\'mcnt fratun.'S. Sc\'cral firms remain in the Iauer category. Next Steps The main challenge going lb"mll ~to ensure that risk-management and control personnel are actively engaged ~ith incenti\'e compensation and that impi'O\·ement) in risk management and in recognition of risks the firm takes are incorpomted into ineentil~ compensation decisionmaking. The Federal Rese,-e will continue 10 work \\ilh firms to ensure that such personnel have an appropriate rok Topic 6: Incentive Compensation Arrangements for Stan· in Risk-Management and Control Roles Improper incemirccompcnsation arrangements can compromise the independence of stan· in risk· managoment and control roles. Fore.<ampl~ a conmot of interest is created if the performance meas· uresapplicd to them. or tl>e bonus pool from 111\ich their awards are drown. depend substantially on the financial n.'sultsof the lines of business or business activities that such stan· Ol..,r;ee, Such dependence can gh'e stan· an incenth·eto allow or foster risk laking that is inconsiS!cnt 11·ith the firm's riskmanagoment policies and control fromt~~ork or the safety and soundness of the firm. Thu~ risk· managomcnt and control personn<l should be compensated in a way that makes their incentives independent of the lines of business whose risk taking and ineentirecompensation they monitor and control. Soch staff includes not only employees a;,'igncd to finnwide risk-management or control fuoction'but also employees 111!0 perform similar roles while VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00119 Fmt 6602 embedded 11irhin indi1iduallincs of business within the firm. Maintaining the Independence of Risk-Management and Control Personnel The firms in the horizontal review ha~~ completed much of the necessary work in this area. Pcrformanc. measures applied to staff in risk-management and control roles are usually oriented to the performance of their Ol'trsight duties and not the perfor· mance of the line of business the)' owrsce. Their incenth·e compensation may be indirectly related to financial performance. if. for exampl~ the bonus pool is dro1111 from the firm11idc pool. which is related to finnwide performantt. In most cases. linkage to finnwide performanre is likely to be too 11<akly linked to control and risk-management decisions to pose a significan! connict of interest. Where more din.'<! or substantial potential conOicts of interest have arisen, some finns achi"'Cd indepen· dence by moving risk-management and control function personnel out of linc-<lf·business incentive com· pensation plans or line-<lf-business bonus pools. establishing separate plans or pools for them. Other fimlS established separate bonus pools for stan· in risk-management aod control roles. the sizes of which do not depend din.-ctlyon the financial perfor· mance of a particular line of business or business actility. At some firm.~ low<r·l"~l risk-management or con· trol stan· members who are embedded in business lines receire their incentive compensation awards from the bu~ness line bonus pool. Such practices can beaeeeptable if the rele1~nt stan· members perform funotions that are unrelated to risk-taking decisions and if the product of their work is unrelated to incenth·e compensation decisionmaking. Some finns includecomments from cross-function re\iews (such as 360 degree re\'iews) in inctnth·e compensation decisionmaking for all stan· memberi This m~ the possibility that business line revi011~ could influence incentil~ compensation deci~ons for riskmanag.emcm and comrol stair members e''Cn if no formal link to financial performance exi<IR In addition. some firms ha,'e incenti\·e compensation arrnngements for staff in risk-management and control functions that are subject to adjustments based on management judgn>ent. Clear guidance from policies and proo.'durcs. clear documentation of indi- Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718243.eps 21 116 <Xtober 2011 Next Steps As part of its nonnal supenision of the indcpen· dence of risk and control funCtion~ the Federal Rcscn:e will continue to be attenti\t: 101he risk· related incentii<S pnwided by the incentil~ compen· sation arrangements for their personnel. Topic 7: Practices Promoting Reliability Firms should regularly reviewwhetherthedesign and implementation of their inremhoe compensation S)~tcms deliver appropriate risk-taking incentil\-s and should corroct dcfooiencies and make impro1·cments that are suggested by the finding.~ The interagency guidanct mentions sereral practices that cancontribute to theeOocti\'eness of such aeti,•ity. including intemaln.'l'iell~ and audits of compliance with policies and proo.'du~ monitoring of results relati1~ to expectation& and simulation of the operation of inctnti\'t compensation arrangements before implementation. Importance of Internal Reviews and Audits Internal re\'iews and auditS of complian<X 11ith policic:s and pi'OC\."'<Iuresare imponant to ensure that the incenti\'Ccompensation system is implemented as intended by those employees iu,•oh'td in incenti\'e compen~1tion deci~onmaking. For example. if pro· Cl.'dures r>.'Juirc that spcciltcquantitat il~ measures of risk are to be included in financial performanre measures us..'d in decisionmaking. but they are not, the scnsiti1ity of decisions to risk taking probably would not be as intended. Though the internal audit function should play a key role in this aeti\'ity, other functions such as risk management. finance, and human resourctS also should be in\'OI\'ed, An incenti\'ecompcnsation S)~tcm may be implemented as intended. but it may still fail toachie1~ the desin.'<l relationship bet~~• risk and re~~rd be<ause features of its design and operation do not work out as expected. Oetcetingsucll problems requires that a fim1monitor relationships among measures of short· a!MIIong·runfinancial pcrt'ormano:.amounts or VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00120 Fmt 6602 incenti\'c compensation 3\l~rds. measnrt"S of risk and risk outcomes, amounts of ultimate payments of defemxl incenti\'C compensation. and other factors relerant lo incenth·e compensation decisions. Such monitoring bears some resemblance to the "backtest· ing" that is often done for risk-management models and S)~tcms To be eRocth-., such monitoring should include somequantitatil~ anal)~is. but because all incenti\'e compensation sys.tems in,·oh'C some exercise of human judgn1ent in decisiomnaking. efl'«:~i"e monitoring is not likely to be purt~yquantitati\'e or mechanical. Lmgo banking organizations are morc likely to require some usc of automated s)'>tems to adequately monitor the effecti,~ness of inrentive compemation arrangements in balancing risk-taking incentir<>. especially systems that suppon capturc of rclmnt data in databases that support monitoring and anal)'Sis. Next Steps All organizations in the horizontaJn..,iew ha~~con siderablc work remaining to fully implement prac· titts promoting balan<Xd risk incenti,·es in their iocenth·c compensation arrangements. Few organizations perfonned extcn~re rcl'iell~ and analyses related to risk-taking incenti1~ before the crisis In some cases internal audit TC\'iewed other aspctts of inctntirecom.pensation activities. such as inctnth't compensation a11~rd disbursement pmctittsor adherentt to \'<Sting policies related to time-of-ser.·ire. 0\'er tim~ as incentil~ compensation is 311~rded and paid out and risk outcomes become better knoll'n, finnsand their superYisors 11ill learn more about the reliability of methods for balancing risk-taking inrentil'es and the eRC<ti\'enessof different methods of assessing rcliability. In the mcantim~ the Federal Resen~ will ~·ork 11ith finns as they dC\'clop the nceessary systems and cap.,bilities and ~·ill promote experimentation and inno"ation. Topic 8: Strong Corporate Governance Actil~ and eO'ecti,·c owrsight of in<Xntil~ compensa· tion practices by the board of din.-ctors is a key clement of the interagency guidance. The board of din.'Ctors of a larte banking organilJition. or its delegated committee. should actil~ly orersee the dereiOJ>ment and operation of the organiJ.ation's incenti\'e com~nsation policies. S)Will~ and related control Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718244.eps "idual judgmcm-based adj ustmems (and deci~ons made under such policies and proo.'dures). and review by internal audil he~p to ensure the incenti\'e compensationawards are not swayed by business line results 23 117 2-1 lncenti,·c Compensation Practices. processes. The board of dimtors or the dekgatcd committees of such organi!lttions should also monitor the cffecti\'eness of incenti\'e compensation arrangements in balancing the risk-taking inctnti\'CS of co'·ered employees. Most of the firms in the horizontal,.,;"''' already had in place a board-l01·<1 <Qmpcnsation committee composed of independent dill.'ctors. While historically these committees hare been acth·ely engaged in decisions relating to the inctnti\·e compensation arrangements for rertain seniorc.:<ecutives,their ill\'ol\'tlllcnt in oYcrstcing Ihe incenti\'tcompensation prnctieesand arrangement.s relating to other covered employees (in<:luding non..,~ecutircs) has inrn:ased considerably during the horizontal reriew. All firms in the horizontal re1icw h3'1unhanc..'<l the role of the board in orcrseeing the incentirc compensation system for all covered employees and are now paying iucwased attention to risk-wlated aspects of iocentire compensation. Some r.mts hare established man· agement committees that inclnde wpresentatii'CS of risk.management and control functions 10 support their cllort& Not11ithstanding progress made to date, fimtS indicated that they ,,;n continue to implelll(nt enhanced corporate gowmance practices and that these practi('<'S will continue to e~·oh~. Progress in Facilitating Effective Internal Communications The board of directors or its delegated commiuce should revi011•and appro1~ policies and procedures that appropriately address corporate standards and processes go1·erniug the design. appro1'al. administra· tion. and monitoring of inctnti\'e compensation arrangelll(nts for covered employees. At some firms in the horizontal w;ew, the rel01ont body is not yet consistently re1•iewingand approl'ing these standard.< The board of dill.'<lors should n.'gularly revi01v the results of monitoring of inecnti\'c comprnsation arrJngcments described in the Pl't\'ious section and results of other actil1ties undertaken to promote reli· ability of the iocentil't compen~1tion S)~tem. For example. boards should recti'~ periodic wports that review incenti\'C.COmpcnsation a\\ards and payments relati1~ to risk outcolll(S on a backllord-looking basis to determine "'hether the organization·s incentil'ecompensation arrangements may be promoting imprudent risk taking. As noted pre,·iously, at most finns such wports are at a relatircly earl)'stage of dmlopment. While some boards undertake an annual re'iew of the cff~.'tti\-eness of incenti\'e com· pensation in al'oiding inappropriate inccnti1·cs to incur risk. many currently wly on periodic pn.-stnta· tions by the cllicf risk officer or other risk· management stall' to the board of diroctorsor its compensation committee. the contentof which \-aries considerably from firm tO fimt. Next Steps Most firms ha1~ establishoo mechani~ns to facilitate tee and the risk and audit ccmmittec& Many finns ha\'\~ members of the compensation committee that are also members of the risk and audit commiuees. Other fimtS wly on regular m..'ttings between the compensation and risk comntiu~ whik others ha~·e not yrtenhanc.."d their communications S)'Stcrns and rely on oommunicalions thatare more ad hoc in nature. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00121 Fmt 6602 Though firms ha~~ implemented impro1~ corporate gowntancc practice& the efl'cctil'tnCSS of such ptJctices 11il1 not be known until S0111( years of experi· enre hare been accumulated. Errectil~ness will depend on the allentil·eness of lll(ntbers of compensation commilln'StO risk-taking inrentil'cs. The Fed· era! Rescrl'e will continue to work to promote efl"cc. tive go,-crnanre of i!K'enti\'ccompen&1tion practices at banking organization• Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718245.eps communication lxtwetn the compensation oommit· 118 25 About one·lhird of 1he la'¥e banking Of¥l'ni7.alions included in 1hr horizonl:!l rericw are h<adquancred ouiSidelhe Uniled Slate$. Almosl all of 1he FBOs in the horizontal Te\'iew are lu:.adquartcred in Europe (including 1he Uniled Kingdom). We obscfl'ed prog· ress in implemenling I he inleragrncy guidance. which is consis1cn1 11i1h 1he FSB<locument!, a1 bo1h U.S. banking organiza1ionsand FBOs. Howe1~r. 1he inleragency guidance. whilcconsisl<m 11;1h Ihe FSB Prin· <iples and lmplemematimr Stant/artis. is more de/ailed and demanding in many respeel~ Thu' sa1isfying 1he expee1a1ions implied by 1he FSB documenls is nol n=trily enough 10 salisf)' 1he exp<e~alions in 1he interagency guidance. Conformance with Interagency Guidance In geneml. progress on conforming to the interagency guidance is ~milar at the U.S. banking organiza1ions and at the FBOs in the horizontal re';"'"· Firms that are more and less far along rnn be found in both sets of finn• Wilh resp<CI to P"rlicular aspeeiS of the guidance. the FBOs hill~ ~ad more diOioulty in iden· tifying cormd employees in their U.S. oper.uions (as noted pn.~·iousl)'. fc1r foreign super~;sors employ 1hc concept of groups of co1~red employees. instead focu~ng their attention on r<lati1~ly small numbers of senior and highly paid employees). l'rogress on confonning to 1he clements of the interagency guid· anee 1hat focus on corporate go,~mance and the role of risk-management and control personnel is ~milar a1 FBOs and U.S. banking organization~ Progress on achie1•ing bala net-d incentiw eompensa· tion arrangcmems is similitr on1he "holt across the two groups. buttIN: balancing methods employed and VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00122 Fmt 6602 the rate of innoration are diffcr<nt betii\'"Cn the groups. For risk adjustment~ some for<ign supet~i· sors ha~umphas~ed risk adjustments mainly at the le~·el of firm11ide or business line bonus pool& Thu~ some FBOs have made progress risk adjusting such pools but ha,·c made les. progn.'SS implementing risk adjustments down to the ield of the indiridual employoo. Some obscr~·ers ha~t betn panicularly interested in the details of deferral praeliecs. focusing on the share of inetntire compensation a11~rds that isdeftrred and the use of equity as a '•hide fordefertt-d incentil< compensation_ Numerical examples of deferr.!l fraclionsscl out in the FSB Princip!ts and lmpftmetr· lllfio11 S1mulmrls are some!imes used as a benchmark (60 percent or more for senior mcutil·<$. 40 percent or more for other individual "material risk takers," which are not the same as CO\'Ctt-d employees). Defer. r.!l fraelions are at or abo1•e these benchmarks at both the U.S. banking organizalions and the FBOs in the horizontal review. In somcea"' substantial defem!l fractions are achicred in dinerent 11ays. As noted pn.~·iously. most U.S. firms and some FBOs usc a cash-stock table that increases the deferral rate as the amount of incentii'C compensation increase. As a proclieal matter. this resuhs in substantial deferral rates for scnion<ecutives and for some employees. In contrast. as noted pre1•iously. some European Union (EU) supefl'isors prescribe some elenltnts of pay structure for some employres at EU banking organization~ This also resuhs in substantial deferral rates for 1hose employoes. European Union Approach to Deferred Jncentive Compensation In many eases the pay structure under the EU regula· tion issomrn·hat differ<nt th3n that seen at U.S. banking organizalions. Undersome national implemenlalions within the EU. the dcfcm'd ponion of an Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718246.eps Some obscrwrs hare betn in1eres1ed in comparing progress of fimrs h<adquar1ered in diffcr<nl jurisdictions in improving their illQ."llli\'eoompensation prac.· licts, for example- in progress relalire 10 lhe FSB Principles and lmplemmuuion Stmrdiml< 119 26 lncenti,·c Compensation Practices inctnti\'t compensalion aw3rd isrt"Quired to be grnmed half in an equity-linked instrurntnt and half in cash or a cash·like -.hick The upfront portion of the incenti\'e oompens:uion award is required to be paid half in cash and half in stock subj(ct to a reten· tion requirement of sc< months 10 one year. Though the owall fmctioll of the incentil~ compe11sation a"md granted in stock is substantial ill such implementation& the upfront stock subj<ct to a retention requirement is likely to han: a limited balancing impact on risk-laking inrcn1h·csdue10 1he- shon retention period. The impact of the defcrrnl ponion depends on perfonnance conditions: in the absence of performance condition& dcferrnl cash will ha~·e only a modest balanci11g impact ~nee the amonm ultimately n>cti1·ed by the employee is rnlueed only in thecwntof the fim•'s failure. the EU n:gulation than under the ~mpl<r structures oficn seen at U.S. firms. For exampl~ if 6() pcn.'tllt of an inctnti\'erompensation a\\-ard is deferred for three years. half in stock and half in cash that I'<Sts unless the firm fails. then only 30 pero:nt of the incentire compensation a11~rd is c'poS<'d to poor performance short of failure. In contrast. suppose all deferrnl """rds are in stock defem'd for thn.-e )'"'"'as is common in the United States. If the same 6() pen."nt of the incenti1~compensation award isdeferrnl. the whole 6() pcrttnt is exposed to the ~~nation in the ~~ue of the stock. If the stock is also subject to eff<Co til~ performance condition& the whole 6() pen:ent is exposed to the condition& The details of resting and other performance conditions arc particularly impor· rant to the o1·ernll balancing impact. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00123 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718247.eps 01·ernll. the net e.<posure of an employee to a finn's perfomtance OI'Cr time is not necessarily larger under 120 27 Rcinfom:d by the supervioory acti1itics undenaken through the horizon1al n.~ iew. the large banking organizations in the re\'ie\\' ha\'c made significant progress t011~rd enhancing their incentil·ecompensation arrangcmtnts in 1111)~ that pro1idc appropriate~· balanced incenti,-es to take risks(as outlined in the interagency ~uidance) and promote safety and soundness. As described in this report. ho•t~~r. most fimts still haresignific:mt •mrk to do to achie~t full conformance with the interagency guidance. men1ing in<tnthre compensationpractk:es thai are consistent with prudent risk management and safety and soundness. Continued supervisor)' attention 11ill be IOO.sed on funher refinement and implemtntation and on making appropriatechan!" as business conditions change and business strategies erolre. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00124 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718248.eps The Federal Re><"~ remains committed to helping lllOI'C the industf)' forn~rd in d"'tloping and implc- 121 m~w.federalresel\~gov VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00125 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718249.eps lOll 122 Q.8. Many economists, including President Trump’s Chair of the Council of Economic Advisers, have long advocated for less restrictive immigration policies to help grow the U.S. labor force, especially in light of an aging population and low birth rate. According to the Pew Research Center, without a steady stream of a total of 18 million immigrants between now and 2035, the share of the U.S. working-age population could decrease to 166 million. 5 What repercussions would restrictive immigration policies have on our workforce and economy? A.8. Immigration is an important contributor to the rise in the U.S. population, accounting for roughly one-half of population growth annually. And population growth, in turn, affects the growth rate of the labor force as well as the growth of the overall economy. Thus, from an economic growth standpoint, reduced immigration would result in lower population growth and thus, all else equal, slower trend economic growth. However, immigration policy is not the purview of the Federal Reserve but rather is the responsibility of the Congress and the Administration. RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER FROM JEROME H. POWELL Q.1. Alternative Reference Rate: Some underappreciated work that you have guided at the Federal Reserve is that of the Alternative Reference Rate Committee. Global regulators have acknowledged that at the end of 2021, banks will no longer be required to submit to the panel that determines LIBOR, meaning that the rate could stop publication at that time. LIBOR is currently critical to the smooth functioning of our financial system, as it underlies $200 trillion in notional value, or ten times U.S. GDP, including a significant amount of floating-rate mortgages. As the FSOC’s annual report highlighted, if LIBOR disappears without a liquid market in the replacement rate, the effects could be catastrophic. Yet a switch to an alternative rate, the secured overnight financing rate, requires tremendous collaboration by the private sector and the official sector and the creation of financial markets that would facilitate the arbitrage between LIBOR and the secured rate, and the creation of new products in the new secured rate. Do you believe end users will demand products in the new secured rate sufficient to build a deep and liquid market in the secured rate before the end of 2021, even though first movers in this space are likely to pay a premium for the product before the market is fully developed? Why? A.1. As you note, the Financial Stability Oversight Council (FSOC) has highlighted the potential risks to U.S. financial stability from the London Interbank Offered Rate (LIBOR) since 2014. These concerns led the Federal Reserve to convene the Alternative Reference Rates Committee (or ARRC) at that time. The ARRC is a diverse group of private sector firms and institutions that has widespread support from the U.S. official sector. In addition to the Federal Reserve Board, the Consumer Financial Protection Bureau, the Com5 http://www.pewresearch.org/fact-tank/2017/03/08/immigration-projected-to-drive-growthin-us-working-age-population-through-at-least-2035/ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00126 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 123 modity Futures Trading Commission (CFTC), the Federal Deposit Insurance Commission (FDIC), the Federal Housing Finance Authority, the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency (OCC), the Office of Financial Research, the Securities and Exchange Commission (SEC), and the U.S. Treasury Department (U.S. Treasury) all act as ex officio members of the ARRC. The ARRC’s work in identifying the secured overnight financing rate (SOFR) as a recommended alternative to U.S. dollar LIBOR and developing a plan to promote use of SOFR on a voluntary basis has unquestionably been necessary in helping to make sure that the financial stability risks identified by the FSOC do not materialize. I have been greatly encouraged by the response of the private sector since SOFR began publication in April of this year. Even in this short period of time, we have already seen evidence that SOFR can and will be used by a wide range of market participants. The Chicago Mercantile Exchange is offering futures contracts on SOFR, and trading activity has already risen to above 5,000 contracts (or about $15 billion) per day with a total open interest of $75 billion. SOFR futures already have far more daily transactions underlying them than LIBOR. In addition, the London Clearing House group has begun offering clearing of SOFR swaps. And importantly, we have already seen two recent issuances of debt tied to SOFR. Both of these issuances were met with high demand and were oversubscribed, indicating that there is a robust pmt of the market that recognizes that SOFR instruments have value to them. There are several reasons that I believe we will see liquidity in SOFR instruments continue to grow. First, as a fully transactionsbased, International Organization of Securities Commissions compliant benchmark based on the overnight U.S. Treasury repo market—the largest rates market in the world—SOFR really does represent a robust alternative to U.S. dollar LIBOR. Because so many firms are active in the Treasury repo market, they naturally have incentives to trade SOFR instruments. Second, many market participants have come to realize that the risks the FSOC has pointed to in LIBOR are quite likely to materialize, and I believe they see that it is in their own interest to move away from LIBOR and toward SOFR. The ARRC and the official sector will ’need to continue to educate market participants about the risks to LIBOR, and work to make sure that this transition is a smooth one. Q.2. Foreign banks and prudential rules: I noticed that in the single-counterparty credit limit (SCCL) final rule, the Fed applied limitations on domestic bank holding companies that have $250 billion or more in total assets and the intermediate holding companies of foreign banks with at least $50 billion in total assets. And in the recent CCAR results, the Fed exempted three U.S. banks with assets between $50 billion and $100 billion, but continued to apply CCAR to the intermediate holding company of one foreign bank that has nearly $900 billion in total assets but only $86 billion in the U.S. Can you describe the philosophy guiding the Fed’s decisions to keep foreign banks’ U.S. holding companies covered by these important prudential rules? VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00127 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 124 A.2. In 2014, recognizing that the U.S. operations of foreign banking organizations (FBOs) had become more complex, interconnected, and concentrated, the Board adopted a final rule that established enhanced prudential standards for large U.S. bank holding companies (BHCs) and FBOs to help increase the resiliency of their operations. These standards include liquidity, risk management and capital, and require a FBO with a significant U.S. presence to establish an intermediate holding company (IHC) over its U.S. subsidiaries to facilitate consistent supervision and regulation of the U.S. operations of the foreign bank. The standards applied to the U.S. operations of FBOs are broadly consistent with the standards applicable to U.S. bank holding companies. However, the standards can also take into account the combined footprint of FBOs’ U.S. operations, including their branches and agencies. Accordingly, the 2018 final rule to implement single-counterparty credit limits (SCCL) for large U.S. bank holding companies tailors the application of SCCL to U.S. IHCs such that U.S. IHCs of similar size to U.S. BHCs covered under the rule are subject to the same SCCL, but the final rule also takes into account the IHC’s role as one portion of a significantly larger banking organization. Similarly, the Board’s annual Comprehensive Capital Analysis and Review (CCAR) applies more stringent standards to an IHC based on whether it is large and complex, meaning it (1) has average total consolidated assets over $250 billion or (2) has average total nonbank assets of $75 billion or more, and (3) is not a U.S. global systemically important firm. The Board monitors the impact of its regulations after implementation to assess whether the regulations continue to function as intended. In implementing enhanced prudential standards for FBOs with a large U.S. presence, the Board sought to ensure that FBOs hold capital and liquidity in the United States and have a risk management infrastructure commensurate with the risks in their U.S. operations. In general, FBOs with $50 billion in U.S. subsidiary assets are among the largest and most interconnected foreign banks operating in the United States. As a result of the IHC requirement, these films have become less fragmented, hold capital and liquidity buffers in the United States that align with their U.S. footprint, and operate on more equal regulatory footing with their domestic counterparts. I believe our current IHC framework with the current threshold is working well. Q.3. Volcker Rule: The policy behind the Volcker Rule is to reduce risky activities in banks, in particular high risk proprietary trading. I’ve long been a supporter of the Volcker Rule, and I think this is a worthy goal, as we never want banks to go back to that type of risky trading. The rule aims to achieve this in part by prohibiting banks from investing in hedge funds and private equity funds. I’ve heard, however, that the current definition has captured investments that seem far removed from the statute’s original concern—such as an incubator for women-run businesses—and prohibits bank investments in funds where banks are permitted to make the investment directly. The proposed rulemaking seems focused on easing compliance burdens that have been associated with the subjective intent test under the current rule, but it provides little clarity on the agencies’ thinking on the covered fund side. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00128 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 125 Can you describe how the Federal Reserve is thinking about changes to the covered fund rules? A.3. The Board, along with the OCC, FDIC, CFTC, and SEC (the agencies) adopted regulations to implement section 13 of the BHC Act, the ‘‘Volcker Rule’’, in 2013. These regulations included a definition of ‘‘covered fund’’ that, in the agencies’ view, was consistent with the statutory purpose of the Volcker Rule to limit certain investment activities of banking entities. Subsequently, and based on experience with the Volcker Rule regulations, the agencies identified opportunities for improvement and proposed amendments to the Volcker Rule regulations in June 2018. The proposal requests comment on how to tailor the regulations governing a banking entity’s covered fund activities. For example, the proposal asks whether a different definition of ‘‘covered fund’’ would be appropriate. In addition, the proposal requests comment on potential exemptions for particular types of funds, or funds with particular characteristics. Since proposing the amendments in June, the agencies have held meetings with and received comments from interested patties regarding the treatment of covered funds. The agencies expect to meet with and receive comments from interested parties throughout the comment period, and will carefully consider each comment to determine whether any changes to the covered fund regulations would be appropriate. RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORTEZ MASTO FROM JEROME H. POWELL Q.1. Home Mortgage Disclosure Act. I remain concerned about discrimination in mortgage lending, especially as we no longer have publicly available data on loan quality for 85 percent of the banks and credit unions. This means we need to rely on the staff of regulators to ensure banks comply with the Equal Credit Opportunity Act and the Fair Housing Act. How will you make sure that your bank examiners are looking at credit scores, loan-to-value ratios, interest rates, and other indicators of loan quality to ensure African Americans, Latinos, and single women are not getting lower quality mortgage loans? A.1. The Federal Reserve’s fair lending supervisory program reflects our commitment to promoting financial inclusion and ensuring that the financial institutions under our jurisdiction fully comply with applicable Federal consumer protection laws and regulations. For all State member banks, we enforce the Fair Housing Act, which means we can review all Federal Reserve-regulated institutions for potential discrimination in mortgages, including potential redlining, pricing, and underwriting discrimination. For State member banks of $10 billion dollars or less in assets, we also enforce the Equal Credit Opportunity Act, which means we can review these State member banks for potential discrimination in any credit product. Together, these laws prohibit discrimination on the basis of race, color, national origin, sex, religion, marital status, familial status, age, handicap/disability, receipt of public assistance, and the good faith exercise of rights under the Consumer Credit Protection Act (collectively, the ‘‘prohibited basis’’). VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00129 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 126 We evaluate fair lending risk at every consumer compliance exam based on the risk factors set forth in the interagency fair lending examination procedures. Relevant to an evaluation of loan quality, those procedures include risk factors related to potential discrimination in pricing, underwriting, and steering. With respect to potential discrimination in the pricing or underwriting of mortgages, if warranted by risk factors, the Federal Reserve will request data beyond the public Home Mortgage Disclosure Act (HMDA) data, including any data related to relevant pricing or underwriting criteria, such as applicant interest rates and credit scores. This data can be requested from any Board-supervised institution, including the institutions that were exempted from reporting additional HMDA data by the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). 1 The analysis then incorporates the additional data to determine whether applicants with similar characteristics received different pricing or underwriting outcomes on a prohibited basis (for example, on the basis of race), or whether legitimate pricing or underwriting criteria can explain the differences. At every examination, the Federal Reserve evaluates whether a lender might be discriminatorily steering consumers towards certain loans. An institution that offers a variety of lending products or product features, either through one channel or through multiple channels, may benefit consumers by offering greater choices and meeting the diverse needs of applicants. Greater product offerings and multiple channels, however, may also create a fair lending risk that applicants will be illegally steered to certain choices based on prohibited characteristics. The distinction between guiding consumers toward a specific product or feature and illegal steering centers on whether the institution did so on a prohibited basis, rather than based on an applicant’s needs or other legitimate factors. If warranted by risk factors, the Federal Reserve will request additional data, such as consumers’ credit scores and loan-to-value ratios, to determine that consumers would not have qualified for conventional loans. Q.2. Is it your expectation that the Fed will have the time and resources to proactively monitor these banks, without the required reporting in place? A.2. Provisions in the recently enacted bill, EGRRCPA, related to HMDA data collection requirements for certain institutions will not impact the Federal Reserve’s ability to fully evaluate the risk of mortgage pricing or underwriting discrimination. Although not included in the public HMDA data, if warranted by risk factors, the Federal Reserve will request any data related to relevant pricing and underwriting criteria, such as the interest rate and credit score. The Federal Reserve’s practice of requesting data relevant to pricing and underwriting criteria where warranted by risk factors predates EGRRCPA’s enactment, and the practice will continue. 1 See ‘‘Economic Growth, Regulatory Relief, and Consumer Protection Act’’, Public Law 115174, S. 2155 §104(a) (May 24, 2018). VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00130 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 127 Q.3. How many additional staff will it take to proactively monitor the more than 5,000 banks now exempted from reporting requirements? A.3. With respect to HMDA, the Federal Reserve supervises approximately 800 State member banks. Recently enacted EGRRCPA exempts certain institutions from reporting the additional HMDA data fields required by the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act). However, institutions exempted by EGRRCPA that meet HMDA’s data reporting threshold 2 must continue to report the HMDA data fields that are not the additional fields required by the Dodd–Frank Act. As noted above in response subpart (b), the Federal Reserve’s practice of requesting data relevant to pricing and underwriting criteria, where warranted by risk factors, predates EGRRCPA’s enactment, and the practice will continue. The Federal Reserve continually evaluates its workload and staffing needs to ensure that we are fulfilling our supervisory responsibilities. Q.4. Volcker—Postpone the Deadline for Comment. Congress passed the Volcker Rule to prevent taxpayer backed banks from gambling with insured deposits, destabilizing the financial system and failing or requiring bailouts. Recently, the SEC, CFTC, Federal Reserve, the OCC, and the FDIC have issued a new Volcker Rule proposal. However, I am concerned that regulators have only allowed for a 60-day comment period to respond to a 689 page rule. That rule includes 342 enumerated questions, dozens of additional questions on the costs or benefits of aspects of the proposal, and invitations to comment on numerous technical concepts and provisions. A limited 2 month comment period may not allow for outside groups, academics and researchers the full time needed to analyze the proposal. Will you extend the comment period by an additional 90 days? A.4. In early June 2018, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission (together, the ‘‘agencies’’) proposed revisions to the rules implementing section 13 of the Bartle Holding Company Act (12 U.S.C. §1851), also known as the Volcker Rule. The proposal’s comment period was for 60 days after publication in the Federal Register on July 17, 2018. On September 4, 2018, in response to requests from commenters, the agencies announced an extension of the comment period for an additional 30 days, until October 17, 2018. The extension will allow interested persons additional time to analyze the proposal and prepare their comments. The agencies will carefully consider all comments in formulating the final rule. Q.5. Wage Stagnation. For the past 8 years, we have added jobs every quarter. However, wages are not going up. In fact, worker 2 In general, if a financial institution has assets exceeding $45 million and originated at least 25 closed-end mortgage loans in each of the two preceding calendar years, or originated at least 500 open-end lines of credit in each of the two preceding calendar years, it must meet the HMDA reporting requirements for its asset size. See ‘‘A Guide to HMDA Reporting: Getting it Right!’’, Federal Financial Institutions Examination Council (Eff. Jan. 1, 2018), https:// www.ffiec.gov/Hmda/pdf/2018guide.pdf. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00131 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 128 pay in the second quarter dropped nearly one percent below its first-quarter level, according to the PayScale Index, one measure of worker pay. When accounting for inflation, the drop is even steeper. Year-over-year, rising prices have eaten up still-modest pay gains for many workers, with the result that real wages fell 1.4 percent from the prior year, according to PayScale. The drop was broad, with 80 percent of industries and two-thirds of metro areas affected. Meanwhile, many corporate profits have never been stronger. Banks are making record profits. Companies spent more than $480 billion buying their own stocks. The increased profits are not going to workers’ salaries. Additionally, productivity has increased by 73.7 percent from 1973 to 2016. Please expand on your views about the connection between wages and productivity. A.5. Over long periods of time, I believe that the best way to get faster sustainable wage growth (adjusted for inflation) is to raise productivity growth. The linkage between real wages and productivity is well-grounded in economic theory and both tended to rise together in the several decades following World War II. However, wage growth and productivity growth do not necessarily track closely over shorter periods, and even over a longer period of time, higher productivity growth does not guarantee a faster rise in real wages, as there are other factors that influence wages as well. This was evident between 1990 and 2010, when real wage growth for the average worker lagged despite a pickup in productivity growth. 3 That said, in recent years, both productivity growth and wage growth have been disappointing, and my sense is that efforts to boost productivity growth will be needed to support a faster sustained pace of real wage gains. Q.6. At the hearing, you said that investment in education and skills were ‘‘the single best’’ way to increase wages for workers. But many have found that connection to be overstated. For example, Thomas Picketty, author of Capitalism in the 21st Century, wrote in a blogpost: 4 ‘‘there’s a lot of hypocrisy’ in the rhetoric of conservatives who condemn inequality while failing to support policies like an increased minimum wage and ramped-up infrastructure spending . . . You’re saying let’s tax the top and invest that money into education for all. [Jeb Bush] is a proponent of school choice, of giving schools vouchers so they can attend public school or private school, whatever they want. Is this a good solution in terms of dealing with what he calls the opportunity gap?’’ Ball asks Piketty. 3 This pattern is evident in many other industrialized countries as well. Economists have been actively researching this issue, but thus far have not come to a consensus about the cause. Plausible explanations include the rapid advances in information and computing technologies during that period, increased international trade and outsourcing, and increased product market concentration among firms. But this is clearly an issue that warrants further study. 4 Brinker, Luke. ‘‘Thomas Picketty Slams Jeb Bush on Education and Inequality: ‘I Think There’s a Lot of Hypocrisy.’ ’’ Salon. March 11, 2015. Available at: https://www.salon.com/ 2015/03/11/thomas-piketty-slams-jeb-bush-on-education-and-inequality-i-think-theres-a-lot-ofhypocrisy/. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00132 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 129 ‘‘From what I can see, he doesn’t want to invest more resources into education. He just wants more competition . . . there’s limited evidence that this is working. And I think most of all what we need is to put more public resources in the education system. Again, if you look at the kind of school, high school, community college that middle social groups in America have access to, this has nothing to do with the very top schools and universities that some other groups have access to,’’ Piketty replies. ‘‘[I]f we want to have more growth in the future and more equitable growth in the future, we need to put more resources in the education available to the bottom 50 percent or 80 percent of America. So it’s not enough just say it, as Jeb Bush seems to be saying, but you need to act on it, and for this you need to invest resources,’’ he says. Asked about claims by Bush and other conservatives that a so called ‘‘skills gap’’ is responsible for the growth in inequality, Piketty dings that narrative as simplistic. ‘‘The minimum wage today is lower than it was 50 years ago, unions are very weak, so you need to increase the minimum wage in this country today. The views that $7 and hour is the most you can pay low-skilled worker in America today . . . I think is just wrong—it was more 50 years ago and there was no more unemployment 50 years ago than there is today. So I think we could increase the minimum wage,’’ Piketty says, adding that the U.S. should also invest in ‘‘high-productivity jobs that produce more than the minimum wage.’’ Education is important, Piketty acknowledges, but education alone is not enough to ameliorate inequality. ‘‘You need wage policy and you need education policy,’’ he says. ‘‘And in order to have adequate education policy, you also need a proper tax policy so that you have the proper public resources to invest in these public services. Also you need infrastructure. Many of the public infrastructure in this country are not at the level of what the very developed should have. You cannot say, like many of the Republicans are saying, we can keep cutting tax on these top income groups who have already benefited a lot from growth and globalization over the past 30 years.’’ Data from the Survey of Consumer Finances indicates that, even when accounting for educational and racial disparities, black households headed by a college graduate are still less wealthy than less-educated white ones. 5 Please provide citations for your argument that education is the main driver for falling wages. How do you respond to analysis from other economists that say other reasons—tax policies, weakening unions, regulations that benefit the financial sector—are a stronger predictor for wage stagnation? 5 Reeves, Richard V., and Katherine Guyot. ‘‘Black Women Are Earning More College Degrees, but That Alone Won’t Close Race Gaps’’. Brookings. December 4, 2017. Available at: https://www.brookings.edu/blog/social-mobility-memos/2017/12/04/black-women-are-earningmore-college-degrees-but-that-alone-wont-close-race-gaps. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00133 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 130 Can you further elaborate on the wage inequities between racial and educational disparities? A.6. I would like to start by noting two good references detailing the important link between education and wages are: The Race Between Education and Technology by Claudia Goldin and Lawrence F. Katz; 6 and ‘‘The Polarization of Job Opportunities in the U.S. Labor Market: Implications for Employment and Earnings’’ by David Autor. 7 The book by Goldin and Katz traces the coevolution of educational attainment and the wage structure in the United States through the twentieth century. They argue, in particular, that the demand for educated workers outpaced the supply beginning in about 1980, and that this supply–demand imbalance resulted in a rise in the wage premium for college-educated workers. In addition, both resources note that increases in educational attainment have not kept pace with rising educational returns, suggesting that the slowing pace of educational attainment has contributed to the rising gap between college and high school earnings. And, although the college wage premium has leveled off in recent years, it remains large. 8 Of course, education is not the only factor that influences wage growth. For example, the paper by David Autor points out that the rise in the relative earnings of college graduates reflected both rising real earnings for college workers and falling real earnings for noncollege workers. He attributes these trends to the polarization of job growth, with job opportunities concentrated in relatively high-skill, high-wage jobs and low-skill, low-wage jobs, and cites the automation of routine work and the increased globalization of labor markets through trade and outsourcing as the primary influences on this trend. He acknowledges that changes in labor market institutions, in particular, weaker labor unions and a falling real minimum wage, may also play a role but argues that these factors are less important, in part because these wage trends are evident in many industrialized countries. With regard to racial disparities in wages, research by economists at the Federal Reserve Bank of San Francisco shows that African American men and women earn persistently lower wages compared with their white counterparts and that these gaps cannot be fully explained by differences in age, education, job type, or location. 9 I agree with their conclusion that these disparities are troubling and warrant greater attention by policymakers. Q.7. Regulation. Chair Powell, at your nomination hearing, you told me that you supported strong consumer protections. 6 Claudia Goldin and Lawrence F. Katz, ‘‘The Race Between Education and Technology’’, Belknap Press, 2010. 7 David Autor, ‘‘The Polarization of Job Opportunities in the U.S. Labor Market: Implications for Employment and Earnings’’ Brookings, April 2010, https://www.brookings.edu/wp-content/ uploads/2016/06/04jobslautor.pdf. 8 A recent paper by Robert Valletta estimates that the wage premium for a college-educated worker (relative to a high school graduate) rose from about 30 percent in 1980 to 57 percent in 2010 and has leveled off since then. See Robett Valetta, ‘‘Recent Flattening in the Higher Education Wage Premium: Polarization, Skill Downgrading, or Both?’’ Working Paper No. 201617, Federal Reserve Bank of San Francisco, August 2016. 9 Mary C. Daly, Bart Hobijn, and Joseph H. Pedtke, ‘‘Disappointing Facts About the Black– White Wage Gap’’, FRBSF Economic Letter No. 2017-26, Federal Reserve Bank of San Francisco. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00134 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 131 Please name at least five issues areas where the Federal Reserve will continue to lead in consumer protection. A.7. The Federal Reserve has a strong commitment to promoting a fair and transparent financial services marketplace. We conduct consumer-focused supervision and enforcement; conduct research and policy analysis; develop and maintain relationships with a broad and diverse set of stakeholders; and work to foster community development. Our consumer protection efforts include investigating consumer complaints, assuring consumers’ fair and equal access to credit and treatment in financial markets, assessing the trends shaping consumers’ financial situations, and offering consumer help via tools and resources developed by Reserve Banks and other agencies. Examples of the range of our consumer protection priorities and efforts are described below. As part of our supervisory outreach, our Reserve Banks have various consumer and community advisory councils. Additionally, the Board meets semiannually with its Community Advisory Council (CAC) as well as with a wide range of consumer and community groups throughout the year. The CAC is a diverse group of experts and representatives of consumer and community development organizations and interests. This important line of communication provides the Board with broad perspectives on the economic circumstances and financial services needs of consumers and communities, with a particular focus on the concerns of low- and moderate-income populations. With regard to our enforcement of fair lending laws and unfair or deceptive acts or practices (UDAP) laws, our supervisory program is rigorous and we are clear in our communications with firms about our expectations when we find weakness in their compliance management systems or violations of consumer laws. When we find consumer hmm, we make sure that consumers are provided any appropriate restitution, and when the situations warrant, we also impose civil money penalties. Fair lending violations may cause significant consumer harm as well as legal, financial, and reputational risk to the institution. The Federal fair lending laws—the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA)—prohibit discrimination in credit transactions, including transactions related to residential real estate. The ECOA, which is implemented by the Board’s Regulation B (12 CFR part 202), prohibits discrimination in any aspect of a credit transaction. It applies to any extension of credit, including residential real estate lending and extensions of credit to small businesses, corporations, partnerships, and trusts. Lending acts and practices that are specifically prohibited, permitted, or required are described in the regulation. Official staff interpretations of the regulation are contained in Supplement I to the regulation. The FHA, which is implemented by regulations promulgated by the U.S. Department of Housing and Urban Development, 10 prohibits discrimination in all aspects of residential real estate-related transactions. 10 See VerDate Nov 24 2008 14:11 Dec 18, 2018 24 CFR part 100. Jkt 046629 PO 00000 Frm 00135 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 132 The Board is committed to ensuring that every bank it supervises complies fully with Federal financial consumer protection laws, including the fair lending laws. A specialized Fair Lending Enforcement Section at the Board works closely with Reserve Bank staff to provide guidance on fair lending matters and to ensure that the fair lending laws are enforced consistently and rigorously throughout the Federal Reserve System (System). Fair lending risk is evaluated at every consumer compliance examination. Additionally, examiners may conduct fair lending reviews outside of the usual supervisory cycle, if warranted by elevated risk. Section 5 of the Federal Trade Commission Act (FTC Act) prohibits UDAP and applies to all persons engaged in commerce, including banks, and the law extends to bank arrangements with third parties. The Federal Reserve has the authority to take appropriate supervisory or enforcement action when unfair or deceptive acts or practices are discovered at institutions under the Federal Reserve’s jurisdiction, regardless of asset size. We apply longstanding standards when weighing the need to take supervisory and enforcement actions and when seeking to ensure that unfair or deceptive practices do not recur. Examples of practices the Federal Reserve has found to be unfair or deceptive include certain practices related to overdrafts and student financial products and services. With respect to these and other UDAP issues, the Federal Reserve’s enforcement actions have collectively benefited hundreds of thousands of consumers and provided millions of dollars in restitution. In addition to carrying out enforcement actions, we provide training, direction and support to Reserve Bank examiners in assessing institutions’ compliance with applicable laws and regulations. On the consumer level, the System also has a robust process for responding to consumer complaints about the banks we supervise. We investigate every complaint of an institution under our supervisory jurisdiction and refer them to the appropriate agency if it involves an institution that we do not supervise. Reserve Banks must respond in writing in a timely manner. For the financial institutions we regulate, we develop and offer guidance to help reduce risk to consumers that supports our desire to ensure equitable treatment of all consumers, including those in underserved and economically vulnerable populations. We collect and analyze risk data and trends in the financial services sector affecting consumers and the financial institutions that we supervise, and we identify emerging consumer protection issues and promote compliance by highlighting these areas in publications, webinars, and other outreach. Examples include our recently launched Consumer Compliance Supervision Bulletin, which provides to banks and others high-level summaries of pertinent supervisory observations related to consumer protections, as well as our Consumer Compliance Outlook, a System publication focused on consumer compliance issues, and its companion webinar series, Outlook Live, both of which are targeted to the industry to support banks’ compliance efforts. Another example is our annual Survey of Household Economic Decisions (SHED). The SHED is designed to enhance our under- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00136 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 133 standing of how adults in the United States are faring financially, and the results of the survey are posted on our public website. Other areas include research particularly focused on the housing market, small business access to credit, and rural economic development issues. Through a number of events and on a variety of matters, we provide outreach to consumer advocacy and community development organizations that outlines the risks in consumer financial product markets. Examples of such programs have focused on auto lending, FinTech/marketplace lending, and student lending. Q.8. Monetary Policy. If the Fed usually cuts the Federal funds rate by 5 percentage points to fight a recession and the neutral rate is around 2.5 percent, what steps can the Federal Reserve currently take to offset a recession? 11 Expand the balance sheet by buying treasuries? A.8. The possibility that the Federal funds rate could be constrained by the effective lower bound in future economic downturns appears larger than in the past because of an apparent decline in the neutral rate of interest in the United States and abroad. Several developments could have contributed to such a decline, including slower growth in the working-age populations of many countries, smaller productivity gains in the advanced economies, a decreased propensity to spend in the wake of the financial crises around the world since the late 1990s, and perhaps a paucity of attractive capital projects worldwide. In any case, the Federal Reserve has a number of tools that it can use in the event that the Federal funds rate is constrained by the effective lower bound. One such tool is explicit forward guidance about the path of future policy. By announcing that it intends to keep short-term interest rates lower for longer than might have otherwise been expected, the Federal Reserve can put significant downward pressure on longer-term borrowing rates for American families and businesses. Another tool is large-scale asset purchases, which can also put downward pressure on longer-term borrowing rates and ease financial conditions. These tools have been an important part of the Federal Reserve’s efforts to support economic recovery over the past decade. Studies have found that these tools eased financial conditions and helped spur growth in demand for goods and services, lower the unemployment rate, and prevent inflation from falling further below the Federal Open Market Committee’s (FOMC) 2 percent objective. The Federal Reserve is prepared to use its full range of tools if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the Federal funds rate. Q.9. Many Federal Reserve officials—including most recently outgoing New York Fed President Bill Dudley—have talked about the need for Congress to beef up fiscal stabilizers that can react automatically to a downturn. 11 Bosley, Catherine. ‘‘Summers Warns Next U.S. Recession Could Outlast Previous One’’, Bloomberg. February 28, 2018. Available at: https://www.bloomberg.com/news/articles/201802-28/summers-warns-next-u-s-recession-could-outlast-the-previous-one. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00137 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 134 Do you agree that Congress should be working on this? If so, which stabilizers do you think are most effective? 12 A.9. The current monetary policy tools available to the Federal Reserve can provide significant accommodation in the event of an economic downturn, although we recognize that there are limits stemming importantly from the effective lower bound on the nominal Federal funds rate. As a matter of prudent planning, we continue to evaluate potential monetary policy options in advance of an episode in which our primary policy tool is constrained by the effective lower bound. Since monetary policy is not a panacea, countercyclical fiscal policy actions are a potentially important tool in addressing a future economic downturn. In particular, automatic fiscal stabilizers have been and continue to be helpful in providing timely accommodation and thus tempering the extent of a downturn. A range of fiscal policy tools and approaches could enhance their effectiveness in helping to provide cyclical stability to the economy. However, it is appropriate that the details of fiscal policy changes be left to the Congress and the Administration. Q.10. At your most recent press conference you said—‘‘we can’t be too attached to these unobservable variables.’’ If that’s the case, do you think it is possible that the United States could sustain a long period of unemployment at 3 percent or even lower? Japan’s unemployment has fallen to 2.7 percent and Germany is at 3.4 percent. A.10. Monetary policy necessarily involves making judgments about aspects of the economy that cannot be measured directly but instead must be inferred. One of those aspects is the level of the unemployment rate that can be sustained in the longer term without generating either upward or downward pressure on inflation. That level is sometimes referred to as the natural rate of unemployment. Economic modelers have only a limited ability to estimate the natural rate of unemployment at any given moment; moreover, there is every reason to believe that the natural rate can and does change over time. For both of these reasons, policymakers must always be vigilant in looking for evidence that might cause them to revise their existing estimates of parameters such as the natural rate of unemployment. As of today, most estimates of the natural rate of unemployment in the United States range between 4 percent and 5 percent. Other countries will have different rates of unemployment that are sustainable in the longer run (sometimes markedly so), depending on the characteristics of the workforces in those countries (such as age and education), the geographic mobility of jobs and workers, and structural labor market policies, to name a few factors. Q.11. At the last hearing you described the risks to the economy as balanced, but it seems like the Fed has much more room to tighten policy—by raising rates and running down the balance sheet—than it does to loosen policy. Doesn’t that change the balance of risks? If you hike interest rates too fast, you have limited tools to address an economic slowdown. If you hike too slowly, you have ample tools to address the overheating. 12 ‘‘Officials on Record: Automatic Stabilizers’’, Dudley, William C. ‘‘Speech: Important Choices for the Federal Reserve in the Years Ahead’’, The Federal Reserve in the Years Ahead. April 18, 2018. Available at: https://www.newyorkfed.org/newsevents/speeches/2018/dud180418a. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00138 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 135 A.11. The FOMC recognizes that the effective lower bound (ELB) on the Federal funds rate can impose a significant constraint on the conduct of monetary policy. This is one of the reasons that the Committee has normalized the stance of monetary policy at a gradual pace during the current economic expansion. That said, the Federal Reserve has other tools at its disposal to provide economic stimulus when the Federal funds rate is constrained by the ELB, including explicit forward guidance about the path of Federal funds rate and large-scale asset purchases. Moreover, with strong labor market conditions, inflation close to 2 percent, and the level of the Federal funds rate at a bit below 2 percent, the risk of returning to the ELB has diminished substantially since earlier in the recovery. Overall, the FOMC currently sees the risks to its economic outlook as roughly balanced. History has shown that moving interest rates either too quickly or too slowly can lead to bad economic outcomes. If the FOMC raises interest rates too rapidly, the economy could weaken and inflation could run persistently below the FOMC’s objective. Conversely, there are risks associated with raising interest rates too slowly. Waiting too long to remove policy accommodation could cause inflation expectations to begin ratcheting up, driving actual inflation higher and making it harder to control. Moreover, the combination of persistently low interest rates and strong labor market conditions could lead to undesirable increases in leverage and other financial excesses. While the Federal Reserve has tools to address such developments, these circumstances could require the FOMC to raise interest rates rapidly, which could risk disrupting financial markets and push the economy into recession. Q.12. Fed Governance, Diversity, and the San Francisco Fed Vacancy. At your confirmation hearing, you expressed your support for more diversity among the Federal Reserve’s leadership, saying, ‘‘We make better decisions when we have diverse voices around the table, and that’s something we’re very committed to at the Federal Reserve.’’ 13 You also commented on the role that the Board of Governors plays in approving new Reserve Bank presidents, and assured the Senate Banking Committee that there is always a ‘‘diverse pool’’ in searching for candidates to fill those positions. However, the December selection of Thomas Barkin as the president of the Richmond Fed gives reason for doubt. 14 Press reports note that you were very involved in vetting candidates. 15 Then, in April, John Williams was announced as the new New York Fed president. A source close to the process said that the New York Fed search committee just could not find qualified candidates who were interested in this position, even though community 13 CNBC. ‘‘Jerome Powell: I’m a big supporter of diversity.’’ November 28, 2017. Available at: https://www.cnbc.com/video/2017/11/28/jerome-powell-im-a-big-supporter-of-diversity.html. 14 Sebastian, Shawn. ‘‘Fed Up Blasts Process, Outcome of Richmond Federal Reserve Presidential Appointment’’, The Center for Popular Democracy. Available at: https:// populardemocracy.org/news-and-publications/fed-blasts-process-outcome-richmond-federal-reserve-presidential-appointment. 15 Condon, Christopher. ‘‘Fed Documents Show Powell’s Hand in Richmond President Search’’, Bloomberg. July 16, 2018. Available at: https://www.bloomberg.com/news/articles/2018-07-16/ fed-documents-show-powell-s-hand-in-richmond-president-search. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00139 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 136 groups had given a list of qualified and diverse candidates to the New York Fed board in January. 16 Can you explain why these candidates were not considered? A.12. It is crucial for us to conduct search processes that are transparent and open to public input, and that encourage interest and applications from qualified candidates with as wide a variety of personal and professional backgrounds as possible. The Federal Reserve System needs such diversity to be fully effective in discharging its responsibilities, and we have observed that better decisions are made when there are many different perspectives represented around the table. I am firmly committed to conducting each president search in as open a manner as possible. However, I also recognize the importance of maintaining the privacy of candidates and the confidentiality of the composition of the candidate pool in order to encourage as many qualified individuals to apply as possible. Therefore, it is not appropriate for me to comment on the qualification of individual candidates. During the recent Reserve Bank president searches, the search committees proactively sought out candidates from a variety of sources. More specifically, in addition to engaging the search firm Spencer Stuart, the Federal Reserve Bank of New York (FRBNY) search committee engaged Bridge Partners, which has a specific expertise in the identification of diverse talent. The FRBNY search committee itself also undertook an extensive program of outreach intended to solicit input and views from a range of constituencies across the district: • The search committee sent approximately 400 letters soliciting feedback on the attributes that would enable success in the role of FRBNY president, as well as specific names for consideration. • Members of the search committee met with the FRBNY’s standing advisory committees, including the Advisory Council on Small Business and Agriculture, the Community Advisory Group (comprised of nonprofit organizations), the Economic Advisory Panel (comprised of academic economists), and the Upstate New York Regional Advisory Board. • The search committee also held two meetings at the FRBNY with ad hoc groups of invitees, one focused on labor and advocacy organizations and the other on business and industry. Out of these large candidate pools, the search committees identified candidates who not only had the desired experiences and key attributes but also confirmed their interests in the president positions. The FRBNY search committee, at the conclusion of its search process, published the process timeline and the characteristics of the candidate pool. 17 16 Guida, Victoria, and Aubree Eliza Weaver. ‘‘In Defense of the NY Fed Search Committee’’, Politico. March 30, 2018. Available at: https://www.politico.com/newsletters/morning-money/ 2018/03/30/in-defense-of-the-ny-fed-search-committee-154624. Guida, Victoria. ‘‘Warren Leads Crusade for Diversity at Fed’’, Politico. April 2, 2018. Available at: https://www.politico.com/ story/2018/04/02/federal-reserve-diversity-elizabeth-warren-452122. 17 For more information about the FRBNY’s president search timeline, see https:// www.newyorkfed.org/aboutthefed/presidential-search-timeline. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00140 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 137 Q.13. Former Honeywell CEO David Cote served as a banker-elected member of the New York Fed board and search committee, but abruptly stepped down in mid-March. We later learned he had resigned this position to take a job with Goldman Sachs. 18 According to the New York Fed, the search committee had already settled on John Williams by the time that Cote resigned from the board. The outgoing New York Fed president was formerly Goldman Sachs’ chief economist, and there have been many reported instances of an overly cozy relationship between the Fed and Goldman Sachs, including tapes that leaked in 2014 showing that the New York Fed was very lenient in supervising Goldman. 19 Do you think it is appropriate that one of the people responsible for choosing a top Wall Street regulating position was negotiating a job with Goldman Sachs at the very moment he was making the decision about who the next New York Fed president should be? Does this event raise concerns that the financial industry has too much influence on regional Reserve Banks boards? A.13. The process for selecting a Federal Reserve Bank president is set forth in the Federal Reserve Act. Subject to the approval of the Board of Governors, a Reserve Bank president is appointed by that Bank’s Class Band Class C directors. These are the directors who are not affiliated with banks or other entities supervised by the Federal Reserve. Class A directors, who are bankers, are not involved in the search process. Since 2014, Mr. Cote served on the board of the FRBNY and on the search committee as a Class B director, representing the public. Mr. Cote brought to the board his background in the manufacturing and represented the industry while serving as a director. Mr. Cote promptly resigned his position on the FRBNY board of directors, recognizing that pursuing new business opportunities in the banking sector would affect his eligibility to serve as a Class B director. 20 Q.14. A recent analysis by the Center for Popular Democracy found that although there has been an increase in the gender and racial diversity of the Federal Reserve Bank’s directors, the Fed is still falling short of true public representativeness. 21 Williams’ selection has opened up a vacancy at the San Francisco Federal Reserve Bank. The twelfth Federal Reserve district is the largest and most diverse in the country, including a significant Latino population. Latinos comprise 30 percent of the district. There has never in the Fed’s history been a Latino Federal Open Markets Committee participant, either as a governor or as a Reserve Bank president. 18 Campbell, Dakin. ‘‘Goldman Sacks Teaming up With Former Honeywell CEO Cote To Strike an Unusual Acquisition’’, Business Insider. Accessed July 16, 2018. Available at: http:// www.businessinsider.com/goldman-sachs-and-former-honeywell-ceo-cote-teaming-up-to-buy-an-industrial-company-filing-2018-5. 19 Haedtler, Jordan. ‘‘Why Do Former Golden Sachs Bankers Keep Landing Top Slots at the Federal Reserve?’’ The Nation. November 30, 2015. Available at: https://www.thenation.eom/ article/why-do-former-goldman-sachs-bankers-keep-landing-top-slots-at-the-federal-reserve/. Bernstein, Jake. ‘‘The Carmen Segarra Tapes’’, ProPublica. November 17, 2014. Available at: https://www.propublica.org/article/the-carmen-segarra-tapes. 20 For more information about our policies governing the directors, see https:// www.federalreserve.gov/aboutthefed/directors/policy-governing-directors.htm. 21 Fed Up. ‘‘New Report Analyzes Diversity at the Federal Reserve in 2018’’, The Center for Popular Democracy. February 14, 2018. Available at: https://populardemocracy.org/blog/newreport-analyzes-diversity-federal-reserve-2018. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00141 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 138 Do you think it would be valuable for you and your colleagues to hear the perspective of a Latino FOMC participant? A.14. As I have said, we make better decisions when we have diverse voices around the table, and that is something we are very committed to at the Federal Reserve. The Federal Reserve seeks diversity in personal and professional backgrounds to be more effective in discharging its responsibilities. We value a broad representation of perspectives, and are working hard towards greater diversity at all levels of the Federal Reserve. Recognizing that the appointment of a Reserve Bank president is, as a legal matter, the responsibility of the Class B and Class C directors who are by definition not affiliated with financial institutions in the district, we at the Board worked closely with the search committee to ensure a strong and transparent process that identified a broad and diverse slate of qualified candidates. As you know, the Federal Reserve Bank of San Francisco (FRBSF) recently selected Mary Daly as its next president. The processes of the FRBSF search committee were fair, transparent, and inclusive. 22 The FRBSF search committee included eligible directors from its board who brought diverse backgrounds and experiences to the process. Further, the search committee partnered with Diversified Search, the largest female-founded and owned firm that specializes in identifying candidates from diverse backgrounds. The search committee carried out an extensive outreach program, both in person and virtually, with a range of constituencies across the district, to gain their input on the search process, obtain their views on the most important attributes for the Bank president role, and solicit their recommendations of potential candidates. At the conclusion of its search process, the FRBSF published additional information about the outreach conducted, timeline, and characteristics of the candidate pool. The FRBSF noted that of 283 prospective candidates 33 percent were from a minority background and 33 percent were female. Q.15. Inflation Target. In a paper that was recently presented to Atlanta Fed President Raphael Bostic, economist Dean Baker argued that the Fed should consider removing the shelter component from its core inflation indexes. 23 The reason is that higher housing costs, particularly in a handful of metropolitan areas, are significantly outpacing other measures of inflation—and that these increases stem from a lack of supply. Baker further argues that continued interest rate increases from the Fed might have the perverse effect of sapping housing construction, thereby exacerbating the very problem (rising inflation) that the Fed is trying to address. What do you make of this analysis? A.15. We interpret the Federal Reserve’s price-stability mandate as applying to a broad measure of the price of goods and services purchased by consumers. Shelter makes up a large component of con22 For more information about the San Francisco search, go to: https://www.frbsf.org/our-district/press/news-releases/2018/mary-c-daly-named-federal-reserve-bank-of-san-francisco-president-and-chief-executive-officer/?utmlsource=frbsf-home-in-the-news&utmlmedium=frbsf& utmlcampaign=in-the-news. 23 Baker, Dean, ‘‘Measuring the Inflation Rate: Is Housing Different?’’ Center for Economic and Policy Research. June 2018. Available at: http://cepr.net/publications/reports/measuringthe-inflation-rate-is-housing-different. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00142 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 139 sumers’ expenditures, and a price index that excludes shelter would provide a highly incomplete measure of the cost of living. To be sure, because monetary policymakers need to be forward looking in setting policy, we also pay attention to less-comprehensive inflation measures to help gauge whether a particular inflation movement is likely to persist. For example, we examine price indexes excluding food and energy items, as food and energy prices often exhibit large transitory movements. But idiosyncratic price movements are by no means limited to food and energy, and they could well occur in shelter prices at times; we need to be attentive to whether such movements might be providing a misleading signal about inflation’s likely future course. My fellow policymakers and I will continue to factor such judgments into our analyses, even as we remember that overall consumer price inflation must be the ultimate focus of our policy. Q.16. Immigration. Neel Kashkari, the chief of the Minneapolis Fed, stated that immigration has a net benefit on economic growth. He said slowing down immigration may slow down job growth and the U.S. economy as a whole. Do you agree with President Kashkari? A.16. Immigration is an important contributor to the rise in the U.S. population, accounting for roughly one-half of population growth annually. And population growth, in turn, affects the growth rate of the labor force as well as the growth of the overall economy. Thus, from an economic growth standpoint, reduced immigration would result in lower population growth and thus, all else equal, slower trend economic growth. However, as you know, immigration policy is for Congress and the Administration to decide. Q.17. SIFI Designation. As a voting member of FSOC, you and your fellow members are tasked with the mission of identifying and responding to risks that threaten the financial stability of the United States, particularly in the shadowy nonbank ecosystem that required numerous massive bailouts following the 2008 financial crisis. Despite the large number of bail-outs conferred, only four nonbanks were designated as systematically significant by the FSOC. As you considering whether to reduce monitoring and oversight of one of those institutions? What about the financial state or inherent systemic risk of large nonbank institutions has changed since FSOC made the considerations that warrants removing any enhanced prudential oversight? A.17. The financial crisis showed that the distress of large and systemic nonbank financial companies could imperil the financial stability of the United States, ultimately putting the American economy at risk. The Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act) gave regulators new tools to address this problem, including authorizing the Financial Stability Oversight Council (FSOC) to determine that a nonbank financial company’s material financial distress would threaten the financial stability of the United States. If such a determination is made, such firms are then subject to supervision by the Federal Reserve Board (Board). The Dodd–Frank Act authorizes the Board, in con- VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00143 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 140 sultation with the FSOC, to establish enhanced prudential requirements and to supervise nonbank financial companies that have been designated as systemically important. Further, the Dodd– Frank Act requires the FSOC to reevaluate each determination of a nonbank financial institution as systemically important on at least an annual basis. The FSOC is also responsible for making the determination to retain or rescind the designation of a nonbank financial institution. Financial vulnerabilities, such as high leverage levels and maturity mismatches between assets and liabilities, are not at the elevated levels they were prior to the crisis. Regulators have developed a deeper understanding of the ways in which nonbank financial institutions differ from banks, particularly in terms of their vulnerability to runs and the potential systemic impact this may have on the U.S. financial system. Further, several nonbank financial institutions have made significant changes to the organizational structure of their firms as well as the markets that they participate in, which has further reduced their overall risk to the U.S. financial system. However, the regulatory community has learned from the experience of the financial crisis that it is important to focus on potential regulatory gaps and to deal with vulnerabilities that may build in nonbank financial institutions before the risks become material. In this context, it is important to continue to monitor large nonbank financial firms to ensure that, should they encounter distress, the functioning of the broader economy is not threatened. Finally, the possibility of de-designation provides an incentive for designated firms to significantly reduce their systemic footprint. Q.18. Stock Buybacks. The Fed’s 2018 CCAR cycle allowed the 22 largest banks to payout $170 billion in dividends and buybacks, around a quarter more than 2017. Banks subject to the CCAR process are likewise paying out close to 102 percent in buybacks and dividends as a percentage of forecasted earnings. 24 In the wake of the Federal Reserve’s annual stress testing, Wells Fargo announced plans to buy back up to $24.5 billion in stock, and boost its quarterly dividend. Twenty-eight other firms were also allowed to proceed with additional proposals to boost stock buybacks and dividends. 25 In your testimony before the Committee, you noted that investments in training and education were ‘‘the single best thing we can do to have a productive workforce.’’ What does research suggest about whether dividends and buybacks raise wages for American workers? Does the Fed have any researching suggesting the impact on economic growth if a larger percentage of bank earnings instead went to raise wages of nonmanagerial and/or frontline bank workers? A.18. Productivity growth is a key determinant of wage growth, and investments in new capital equipment or innovative tech24 Larkin, Michael. ‘‘All Banks Clear Stress Test—But This Big Name’s Payout Plan at Risk’’, Investor’s Business Daily. June 21, 2018. Available at: https://www.investors.com/news/stresstest-results-federal-reserve-bank-dividends-buybacks//. 25 Bloomberg. ‘‘Wells Fargo Plans $24.5 billion in Stock Buybacks After Passing Fed Stress Test’’. Los Angeles Times. June 28, 2018. Available at: http://www.latimes.com/business/la-fiwells-fargo-stock-buyback-20180628-story.html. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00144 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 141 nologies are important factors for improving productivity growth. Similarly, increased worker compensation can be a factor in encouraging individuals to join or remain in the labor force and to develop new skills, which can further increase productivity and wage growth. However, comparing the economic effects of these uses of a company’s earnings to the eventual economic effects of stock buybacks is difficult because we do not know where the gains from buybacks will ultimately turn up. In particular, when a company buys back its shares or pays higher dividends, the resources do not disappear. Rather, they are redistributed to other uses in the economy. For instance, shareholders may decide to invest the windfall in another company, which may in turn make productivity-enhancing investments. Or they may decide to spend the windfall on goods and services that are produced by other companies, who may in turn hire new workers. In these ways, stock repurchases would also be likely to boost economic growth. Ultimately, companies themselves are the best judges of what to do with their profits, whether it is to invest in their business or increase returns to shareholders through dividends or share buybacks. RESPONSES TO WRITTEN QUESTIONS OF SENATOR JONES FROM JEROME H. POWELL Q.1. In the Federal Reserve’s 2018 Report on the Economic WellBeing of U.S. Households, the report finds that 40 percent of Americans do not have the sources to cover an unexpected $400 expense. While the number of Americans responding in this manner has shrunk since 2013, as noted in the report, it is still an alarmingly high number. The report notes that the most common response among those who could not cover an expense is to place the purchase on a credit card. Are there broader economic implications of such a reliance on potentially high-priced consumer credit? A.1. According to the survey, conducted in the fourth quarter of 2017, 18 percent of U.S. adults report that they would pay a hypothetical $400 emergency expense with a credit card that they then pay off over time. 1 In the initial survey in 2013, this fraction was 17 percent. The fraction of adults who said they would not be able to meet a $400 expense by any means declined to 12 percent in 2017 from 19 percent in 2013. Broader implications of such responses are difficult to gauge. The costs of financing such an expense would add financial burden on these households, relative to paying in cash. However, for some households, such credit access may act as a relief valve of sorts, allowing them to meet the emergency or avoiding even costlier forms of credit such as payday loans. Q.2. Does the Federal Reserve have further context on this response—how does the number of Americans unable to cover a $400 expense compare to previous decades, or to other advanced economies? 1 For the survey and report, see the Federal Reserve Board’s Survey of Household Economics and Decision Making at www.federalreserve.gov/consumerscommunities/shed.htm. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00145 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 142 A.2. The Federal Reserve first asked how individuals would handle a $400 unexpected expense in 2013. While we do not have an exact comparison in prior decades or in other countries, the Federal Reserve Board’s triennial Survey of Consumer Finances (SCP) reports that the share of households with easily accessible savings remains low and has changed little in recent decades. 2 Liquid savings, such as cash, checking or saving accounts, are the least costly and easiest assets to use for unexpected expenses. The 2016 SCP reports that nearly half of all families did not have $3,000 in liquid savings, almost the same fraction since 1989 in inflation-adjusted terms. Q.3. Does this inability to cover expenses increase dramatically across certain groups for example, seniors, young people, or minorities? A.3. Yes, financial security and the ability to cover expenses, differs across demographic groups. As one example, in 2017, one-quarter of white adults without education beyond a high school degree did not expect to pay their current month’s bills in full. Among African Americans and Hispanics with the same education level, that fraction was 41 percent and 35 percent respectively. Financial security is more common with more education, but a gap by race and ethnicity remains. As a second example, only half of young adults (under the age of 30) would use cash or its equivalent to cover an unexpected $400 expense, versus 57 percent of middle-aged adults (ages 30 to 64) and 71 percent of seniors (age 65 and older). Even with such differences by age, race, and education, the economic recovery has improved the finances across many groups. Q.4. I am concerned that for Americans that live paycheck to paycheck, the United States’ payment system can, at times, fall short. In particular, I believe there is great need for faster payments, including quicker access to consumer funds after deposit. When consumers do not access to their own funds, they often resort to and rely on high-cost products that are outside of the traditional banking system. The Federal Reserve has acknowledged the need to help foster a faster payments system with its work and creation of the Faster Payments Task Force. What are the next steps and future priorities for the Task Force? A.4. In July 2017, the Faster Payments Task Force (FPTF) concluded its work upon release of its final report. The FPTF’s Final Report reflected the task force’s perspectives on challenges and opportunities with implementing faster payments in the United States, outlined its recommendations for next steps, and included the proposals and assessments for the 16 participants that opted to be included in the final report. 3 The FPTF recommendations identified the need for ongoing industry collaboration to address infrastructure gaps; to develop models for governance, rules, and 2 For more information, see reports and research on the Federal Reserve Board’s Survey of Consumer Finance at www.federalreserve.gov/econres/scfindex.htm. 3 Faster Payments Task Force, ‘‘Final Report Part One: The Faster Payments Task Force Approach’’, January 2017, and ‘‘Final Report Part Two: A Call To Action’’, July 2017. Available at https://fasterpaymentstaskforce.org/. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00146 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 143 standards; and to consider actions and investments that will contribute to a healthy and sustainable payments ecosystem. A number of recommendations called for Federal Reserve support to facilitate this ongoing collaboration. Following up on the work of the FPTF and other efforts to advance the Federal Reserve’s desired outcomes (focused on speed, security, efficiency, international payments, and collaboration) for the payment system, the Federal Reserve published, in September 2017, a paper presenting refreshed strategies and tactics that the Federal Reserve is employing in collaboration with payment system stakeholders. 4 The Federal Reserve kicked off these refreshed strategies and tactics in the summer of 2017, by facilitating the industry’s work to address the FPTF recommendations related to governance, directories, rules, standards, and regulations. In addition, consistent with the FPTF recommendations, the Federal Reserve has been assessing the needs and gaps to enabling 24x7x365 settlement in support of a future ubiquitous real-time retail payments environment. Further, the Federal Reserve has started to explore and assess the need, if any, for any other operational roles to support ubiquitous, real-time retail payments. These efforts are being pursued in alignment with Federal Reserve’s longstanding principles and criteria for the provision of payment services. Q.5. As you know, new accounting standards, based on a ‘‘current expected credit loss’’ (CECL) model, developed by the Financial Accounting Standards Board (FASB) will go into effect in 2020. While the new accounting standards underwent multiple years of study, the implementation of these standards will result in one of the larger changes to banking accounting in recent memory. The CECL standard is likely to affect bank capital in uncertain and potentially volatile ways, especially as banks begin the transition process to this new accounting standard. Did FASB consult with the Federal Reserve for how these changes might impact bank capital? A.5. The Federal Reserve Board (Board) along with the other U.S. Federal financial institution regulatory agencies have supported the Financial Accounting Standards Board’s (FASB) efforts to improve the accounting for credit losses and provide financial statement users with more decision-useful information about the expected credits losses on loans and certain other financial instruments. Throughout the development of the current expected credit loss (CECL), the FASB conducted extensive outreach with a diverse group of stakeholders, including the Federal Reserve System. Stakeholders provided input and feedback through the public comment letters and participation in public forums. The FASB did not 4 The desired outcomes are outlined in the Federal Reserve System’s ‘‘Strategies for Improving the U.S. Payment System’’, January 26, 2015. Available at https:// fedpaymentsimprovement.org/wp-content/uploads/strategies-improving-us-payment-system.pdf. The refreshed strategies and tactics are outlined in the Federal Reserve System’s ‘‘Strategies for Improving the U.S. Payment System: Federal Reserve Next Steps in the Payments Improvement Journey’’, September 6, 2017. Available at https://fedpaymentsimprovement.org/wp-content/uploads/next-step-payments-journey.pdf. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00147 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 144 specifically consult the Board regarding CECL’s impact to bank capital since their mandate is to establish and improve financial accounting and reporting standards to provide decision-useful information to investors and other users of financial reports. In response to CECL, the Board, with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) (together, ‘‘the agencies’’), recently issued a joint proposal that would address the forthcoming changes. In particular, the proposal would provide firms the option to phase in the day-one regulatory capital effects of CECL over a 3-year period. The agencies intend for this transition provision to address films’ challenges in capital planning for CECL implementation, particularly due to the uncertainty of economic conditions at the time a film adopts CECL. The agencies are currently reviewing comments to the proposal in preparation for finalizing it. In addition, the agencies will continue to monitor the effects of CECL implementation on regulatory capital and bank lending practices to help determine whether any further changes to the capital rules are warranted. Q.6. Is the Federal Reserve taking into these rule changes as it continues to implement capital rules created by the Dodd–Frank financial reform law? A.6. The Board is indeed taking into consideration the impact of CECL in connection with the Board’s ongoing regulatory and supervisory functions. For example, the agencies, earlier this year issued a joint proposal entitled Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rules and Conforming Amendments to Other Regulations. 5 In the joint proposal, the agencies proposed to amend the regulatory capital rules of the agencies to address changes to U.S. generally accepted accounting principles (GAAP) resulting from the FASB’s issuance of CECL. The proposal would provide firms subject to the capital rules with the option to phase in, over a 3-year period, the day-one adverse regulatory capital effects of CECL that may result from the adoption of the new accounting standard. This transition period is intended to address the potential challenges in planning for CECL implementation, including the uncertainty of economic conditions at the time that a firm adopts CECL. In addition, the proposal identifies certain credit loss allowances under the new accounting standard that would be eligible for inclusion in regulatory capital. The agencies are currently reviewing comments received from the public on the proposal. The Board will continue to monitor the effects of CECL implementation on firms supervised by the Board and on the U.S. financial system. Q.7. As the CECL requirements go into effect in 2020, the first tests of how they impact bank capital may come during annual CCAR process. Will the Federal Reserve be taking into account these rule changes as it undertakes the 2019 and 2020 CCAR process? 5 83 VerDate Nov 24 2008 14:11 Dec 18, 2018 Federal Register 22312 (May 14, 2018). Jkt 046629 PO 00000 Frm 00148 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 145 A.7. In May 2018, the Board published a joint notice of proposed rulemaking with the OCC and FDIC to address changes to U.S. GAAP associated with CECL, issued by FASB in June 2016. Under the proposal, the Board would not incorporate CECL into the supervisory stress tests, and would not require a firm to incorporate CECL into its stress tests, until the 2020 cycle. If a banking organization were to adopt CECL for the first time in 2021, it would not be required to include provisioning for credit losses under the new standard until the 2021 stress test cycle. This proposal avoids ‘‘pulling forward’’ the effect of CECL, by aligning the dates that firms are expected to include CECL in their comprehensive capital analysis and review projections with the actual date of implementation for those firms implementing in 2020 and 2021. In advance of CECL implementation, the Federal Reserve is considering feedback received during outreach discussions with industry representatives, developing approaches for incorporating provision for credit losses in its supervisory models, and preparing for parallel testing of those models. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00149 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 146 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00150 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718001.eps MONETARY POLICY REPORT TO THE CONGRESS DATED JULY 13, 2018 147 LETIER OF TRANSMITIAL BOARDOf GOVER~ORS Of TilE FEDERAL RESI:RVE Sl'STEM Washington, O.C, July 13,2018 THEPREStO£~• Of TilE SeN,m THE SPEAKER OF THE HollSE OF REPRESENTATIVES The Board of Governors is pleased to submit its Monet(lr)' Policy Repqtt pursuant to section 28 of the Federal Resen·e Act. Sincerely. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00151 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718002.eps Jerome H. P01vell, Chairman 148 STATEMENT ON LONGER-RUN GOALS AND M ONETARY Poucv STRATEGY Adopted ~ffectiv~ January 24, 2012; as amended effeclile /anuary 30, 2018 The Federnl Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate fromthe Congress of promoting maximum employment, stable prices, and moderate long-term interest rates The Committee seeks !Oexplain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, r<'duces economic and financialuncertaint)', incre~ses the elfectil'eness of monetary policy, and enhances transparency and accountability, which are essential in a democr.uic society. Inflation. employment, and long-term interest rnte$ fluctuate o1·er time in response to economic and financial disturbances Moreover, monetary policy actions tend to influence economic activity and prices with a Jag. Therefore. the Committee's policy decisions reflect its longer-run goals, its mediumtermoutlook, and its assessments of the balance of risks. including risks to the financial system that could impede the attainment of the Committee's goals The inflation rate 01·er the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committeereaftirms its judgment that infiation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures is most consistent o1·er the longer run 11~th the Federal Reserve's Statutory mandate. The Committee would be concerned if inflation were nmning persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflationexpectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances Tile maximum level of employment is largely determined by nonmonetary factors that aft'ectthc structure and dynamics of the labor market. These factors may change owr time and may not be dir<'Ctly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximumlevel of employment. recoguizing that such assessments are n«essarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessment~ Information about Committee participants' estimates of the longer-run normal rntes of output growth and unemployment is published four times per year in the FOMC's Summar)•of Economic Projections. For example, in the most recent projections. the median of FOMC participants' estimates of the longer-run normal rate of unemployment was 4.6 percent. In setting monetary policy. the Committee seeks to mitigate de1~ations of inflation from its longer-run goal and de1•iations of employment from the Committee's assessments of its maximum level. TI!ese objectil'es 3re generally complementar)'. Howel'er, under circumstances in which the Commiueejudges that the objeeti1oes are not complementary. it follows a balanced approach in promoting them. taking into account the magnitude of the deviations and the potentiallydift'erent time horizons 01•er which empiO}~nent and inflation are projected to return to levels judged consistent with its mandate. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00152 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718003.eps The Committee intends to reaftirm these principles and to make adjustments as appropriate at its annualorganizational meeting each January. 149 CONTENTS Summary .. •. •• . •... .. •. . .. . . .. .. . •.. •. .. . . .. .•... . .. . •. . •• 1 Economic and Financial Developments . . . . . . . .. . . . . . . .. ... . . . . .. . . . . . . .... . . . . . 1 Monetary Policy . . ..... .. ........ . Special Topics.. ... _.. . . .. .. ... .. .. ... . 2 Part 1: Recent Economic and Financial Developments .... . .. .. . . . .... 5 Domestic Developments. .. .. .. . .. .. . .. 5 . . .. .. .. . • . .. . . .. .. ... ... 23 Financial Developments.... .. International Developments .. . ..... .. .......... . ........ . . . .... . ... . .... . . . . 30 Part 2: Monetary Policy . .. .. .... ...• ..•.... .. ........ . ....... • 35 Part 3: Summary of Economic Projections......................... 47 The Outlook for Economic Activity.. . .. • . .. .. .. .. . • . .. . • .. . .. . . . . The Outlook for Inflation ... .. ....... ... . .... . . . .. .. .. ... ...... . .. Appropriate Monetary Policy . . . . . ... .... . ...... . ..... .. . . . . .... . .. . . .... . . . . Uncertainty and Risk~. . . .. .. ............ . ......... . ..... . .. ..... . . .. 48 50 51 51 Abbreviations ............. . .. . .. . .. . ..... . .... .. . .... .. .. . . 63 List of Boxes The labor Force Participation Rate for Prime-Age Individuals. .. .. .. . ..•. .. .•. . . 8 The Recent Rise in Oil Prices . . . . . . . . . . . . . . . . . . . . . . . . . . .... . ... . .... . . . . 16 Developments Related to financial Stability. . . . . . . . . . . . .. 26 Complexities of •\\onetary Policy Rules.. . . . 37 Interest on Reserves and Its Importance for Monetary Policy. . . . . . . . •. . . . • . . ..•. . . . . 44 forecast Uncertainty_. . . . . . . . . . . . . . 62 Non: This rtporl refle<ls information thai was publicly available as of noon EDT on july 12, 2018. Unlessotherwise~Ated, thetinleseriesin the figures extend through. ford.>ilr d.>t.l, /uly II, 2018; formonthlyd.>t.l. June 2018; and. for quarterly dat.l. 2018:QI. In bar charts. except as noted. the change for a gi1~n period is Aleasured to i~ final quartet from the final quarter oflhe pre<eding period. ~=orr!pl'SI6¥1dl4,n.:«'ch.Jil.he$.\P>OOII'dbandlflt0ow~s..nloln6.'-:t;«tpcoductsd S.Sf>OoN~~llC<~ndbf~ai~IA'SM!d fl>,•b<toli<<•sollc•.,.brd<llo.«i.Ccp,~ONII~IPI)o.lcn<>Wct!llC.•<l'lslcoci~IPC!cb.l....t'eti:s"';t-.AII~""""' ~~~nd'or~'ingiB~<.fv;lCtocinp.ll'tMtprohl>ilednittloul ~<.li:wl~dS&POow~~ltC.Forfi'IOo't ~on-nrofs.\POowkww:ilndicflllC'$inclktsplt.as.e \~ 'h'"W.spd;A:etn.SSM~~·€'Jcd~dSund.Nd & fbor'sr~ I<M«>UC.">dD>w-~••..,;;,o«tv-ciO..-T•-Hcl6ni>UC.""-'"'!.!P O...-I""'"UC.D>w_T_ ~UC.thtu.-ifii'ICI:tsi'IOI'thtifi!Wd~li«nsmrrw~Mf)'«P~ion a Y>:A~r.l'*-~« -.i«lasiO!ht~·d'.vrt.'~kl XW:Uf~l(~lflt~~CC~S«tord\Mit~IIOrtptt'Sti'C..-ndnei:her~f>Oo<n ~ lndic~ llC.I)ro!.v~lr~~ llC.I.hl:ir~il:tsncw~thitd!Nit)'lic~~ll~~.!ny lihl~b.lny~~orif(~d¥Jy~orr:ht'd$itd;ldPc;lt/ll.'c~ falisJ.n'Ailllhtbc».'hrrolMRfsmt'SM'Idlt'S~tb .\~A:IIq-,•nottttwt~DTCCSol~llCI"'i)fiiJfoii:u~WII bl-~iOI'o~t~t·ft!OtSOt~iti¥1)'0TCC~I'Icludtdin~p.blic¥oiol\.~d~\"<IV!t~nd.in~f'.tte.W!IOTCCc:r~d VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00153 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718004.eps .,,.....,t>."""'"'''Y~""-.,.'""""""'~~--1<!>1""-«"""'"'""os""'"'""'""""cl>. ti'Dig~.u'ldopp:ttlric')'(0>6tin~v.1tttlhis~iaca 150 SuMMARY Economic and Financial Developments The labor market. The labor market has continued 10 s1rengthe11. Over the first six momhs of 2018, payrolls increased an average of 215,000 per month, which is somewhat above the a1-erage pace of 180.000 per month in 2017 and is considerably faster than whal is needed. on average. 10 provide jobs for new emranis imo Ihe labor force. The unempi0)1nenl ra[e edged down from 4.1 pe~ttnl in December 10 4.0 percem in June. which is about Y, percentage point below the median of FOMC parlicipanls' estimates of its longer-run normal Imi. Other measures of labor milization were consis1e111 with a tight labor market However. hourly labor compensation gro111h l1as been moderate. likely held down in pari by the weak pace of productivity growth in recent years. Inflation. Consumer price inflation, as measured by the 12-monlh pen:entagechange in the price index for personal consumption expenditures. n101'ed up from a linle below the FOMC's objective of 2 percent a11heend of last year to 2.3 percent in May. boosted by VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00154 Fmt 6621 a si1.able increase in consumer energy prices. The 12-monlh measure of in8a1ion thai excludes food and energy items (so-called core inflation). which historically has been a beuer indicator of where overall inflation will be in the fmure than the Iota! figure, was 2 percent in May. This reading was '/: percentage point above where il had been 12 momhs earlier. as the unusually low readings from last year were not repealed. Measures of longer-run inflation expectations hal'e been generally stable. Economic growth. Real gross domestic product (GOP) is reponed 10 ha1-e increased at an annual tale of 2 percent in the first quarter of 2018, and recent indicators suggest thai economic growth stepped up in the second quaner. Gains inconsumer spending slowed early in the year. btlllhey rebounded in the spring. supported by strong job gains, nxenl and pas! increases in household weahh, fal'orable consumersentiment and higher disposable income due in par110 the implementation of 1he Tax OtiSand Jobs Act Business im'eSimenl growth has remained robust, and indexes of business sentiment hai'C been strong. Foreign economic growth has remained solid, and nel expons had a roughly neutral elfecl on real U.S. GOP groWih in the first quaner. However, acti,;ly in the housing market has leveled otr this year. Financial conditions. Domestic financial conditions for businesses and households hal'e generally continued 10 support economic gro111h. After rising steadily through 2017, broad measures of equity prices are modeslly higher. on balance. from their levels allhe end of last year amid some bouts of heightened volatility in financial market~ While longterm Treasury )ields, mortgage rates, and yields on corporate bonds hal'e risen so far this year, longer-term interest rates remain low by historical standard~ and corporate bond issuance has cominued a1 a moderate pace. Moreover, mos11ypes of consumer loans Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718005.eps Economic activity increased a1 a solid pace over 1he firsI half of 20 IS. and 1he labor market has cominued 10 strengthen. In8a1ion has moved up, and in May, Ihe mosl recent period for which data are a1-ailable. inflation measured on a 12-monlh basis was a linle above the Federal Open Markel Commiuee's (FOMC) longer-mn object h-e of 2 pen:enl, boosted by a sizable increase in energy prices. In Ihis economic em;ronment the Commiuee judged thai currem and prospective economic conditions called for a further gradual removal of monetary policy accommodation. In line with that judgment, the FOMC raised the 1arge1 for the federal funds rale 111;ce in the first half of 2018, bringing i11o a range of 1% 10 2 pe~ttnt. 151 SUMI\1\RY remained 11idely al'<lilable for hoLLSeholds 11ith strong crcditwonhiness. and credit provided by commercial banks continued to expand. The foreign exchange value of the U.S. dollar has appredated somewhat a,o:~instthecurrencies of our trading partners this year, but it remains below its le1<el at the start of 2017. Foreign financial conditions remain generally supportiw of growth despite recent increases in financial stn.'SS in several emerging market economies Financial stabilit)'· The U.S. financial system remains substantially more resilient than during the decade before the financial crisis. Asset valuations continue to be elevmed despite declines since the end of2017 in the forward price-to-eamings ratio of equities and the prices of corporate bonds. In the pril'ate nonfinancial sector. borrowing among highly le1<ered and lower-rated businesses remains elevated, although the ratio of household debt to disposable income continues to be moderate. Vulnerabilities stemming from le1•erage in the financial sector remain low, reflecting in part strong capital positions at banks. whereas some measures of hedge fund leverage ha1<e increased. Vulnerabilities associated with maturity and liquidity transformation among banks, insurance companies money market mutual funds, and asset managers remain below levels that generally prevailed before 2008. Monetary Policy Interest rate policy. Over 1he first half of2018, the FOMC has continued to gradually increase the targ~t range for the fedml funds rat~. Specifically, the Committee decided to raise the target range for the federal funds rate at its meetings in March and June. bringing it to the current range of I ~ to 2percent. The decisions to increase the target range for the federal funds rate reflected the economy"s continued progress toward the Committee"s objectil<es of maximum employment and price s1ability. E1<en with these policy rate increases. the stance of monetary policy remains VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00155 Fmt 6621 accommodatil'e. thereby supporting mong labor market conditions and a sustained return to 2 percent inflation. The FOMCexpects lhat further gradual increases in the target range for the federal funds rate will be consistent 111th a sustained expansion of economic acti1•ity. strong labor market conditions. and inflation near the Committee·s S)1nmetric 2 percent objectil<e over the medium 1erm. Consistent with this outlook, in the most recent Summary of Economic Projections (SEP). which was compiled at the time of the June FOMC meeting, the median of participants" assessments for the appropriate Jerel for the federal funds rate rises gradt1ally over the period from 2018to 2020 and stands somewhat above lhe median projection for its longer-run level by the end of 2019 and through 2020. (The June SEP is presented in Part 3 of this report.) Howe1·er. as the Committee has continued to emphasize, the timing and size of fmure adjustments to the target range for the federal funds rate will depend on the Committee·s assessment of realized and expected economic conditions relative to its maximum-employment objectil'e and its symmetric 2 percent inflation objective. Balance sheet policy. The FOMC has continued to implement the balance sheet normalization proo,ram described in the Addendum to the Policy Normalization Principles and Plans that the Committee issued about a year ago. Specifically. the FOMC has been reducing its holdings ofTreasury and agency securities by decreasing. in a gradual and predictable manner, the reill\'eStment of principal payments it recei1<es from these securities Special Topics Prime-age labor forct participation. Labor force participation rates (LFPRs) for men and women beh,·een 25 and 54 years old- that is. the share of these indi1iduals either working or actively seeking work- trended lower Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718006.eps 2 152 MONETARY I'OIICY Rri'ORT: lUll ' 2013 Oil prices. Oil prices ha1•e climbed rapidly over the past year, reflecting both supply and demand factors. Although higher oil prices are likely to restrain household consumption in the United States, much of the negative eft"ect on GDP from lo\\~r consumer spending is likely to be offset by increased production and investment in the growing U.S. oil sector. Consequently, higher oil prices now imply much less of a net overall drag on the economy than they did in the past, although they will continue to have important distributional effects. The negative ciTect of upward moves in oil prices should get smaller still as U.S. oil production gro11~ and net oil imports decline further. (See the box ''The Recent Rise in Oil Prices" in Pan 1.) Monetary policy rules. Monetary policymakers consider a wide range of intbrmation on current economic conditions and the outlook VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00156 Fmt 6621 when deciding on a policy stance they deem most likely to foster the FOMCs statutory mandate of ma., imum employment and stable prices. They also routinely consult monetary policy rules that connect prescriptions for the policy interest rate with variables associated with the dual mandate. The use of such rules requires. among other considerations. careful judgments about the choice and measurement of the inputs into the rules such as estimates of the neutral interest rate, which are highly uncertain. (See the box "Complexities of Monetary Policy Rules" in Part 2.) Interest on resmes. The payment of interest on reserves- balances held by banks in their accounts at the Federal Reserve-is an essential tool for implementing monetary policy because it helps anchor the federal funds rate within the FOMC"s target range. This tool has permitted the FOMC to achiere a gradual increase in the federal funds rate in combination with a gradual reduction in the Fed's securities holdings and in the supply of reserve balances. The FOMC judged that remo1~ng monetary policy accommodation through first raising the federal funds rate and then beginning to shrink the balance sheet would best contribute to achie1•ing and maintaining maximum employment and price stability without causing dislocations in financial markets or institutions that could put the ~anomie expansion at risk. (See the box '·Interest on Reserves and Its Importance for Monetary Policy" in Part 2.) Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718007.eps between 2000 and 2013. Those trends likely reflect numerous factors, including a long-run decline in the demand for workers with lower levels of education and an increase in the share of the population with some form of disability. By contrast, the prime-age LFPR has increased notably since 2013, and the share of nonparticipants who report wanting a job remains above pre-recession levels. Thus. some continuation of the recent increase in the prime-age LFPR may be possible if labor demand remains strong. (See the box '"The Labor Force Panicipation Rate for Prime-Age Individuals'"in Part 1.) 3 153 PART 1 RECENT ECONOMIC AND FINANCIAL D EVELOPMENTS Domestic Developments The labor market strengthened further during the first half of the year .. . Labor market conditi<>ns have continued to strengthen so far in 2018. According to the Bureau of Labor Statistics (BLS). gains in total nonfarm payroll emplo)~nent averaged 215,000 per month over the first half of the year. That pace is up from the average monthly pace of job gains in 2017and is considerabl)• faster than what is needed to provide jobs for new entrants into the labor force (figure I).1 Indeed, the unemployment rate edged down from 4.1percent in Docember to 4.0 percent in June (figure 2). This rJtc is below all Federal Open Market Committee(FOMC) participants' estimates of its longer-run normal level and is about Y, percentage point below the median of those estimates.' The unemployment rate in June is close to the lows last reached in 2000. I. N~1 cb-.lngc inp3)TOIJ C'mp!oymml !fJIJ l:IIO2011 2012 lOll XII~ rots 2016 roUllliS The labor force participation rate (LFPR), which is the share of individuals aged 16 and older who are either working or actively looking tbr II'Ork, ~~~s 62.9 percent in June and has changed little, on net, since late 2013 (figure3). The aging of the population is an important contributor to a downward trend in the o1·erall participation rate. In particular, members of the baby-boom cohort are increasingly mO\fing into their retirement years. a time 1111en labor force participation is typically low. Indeed, the share of the civilian population aged 65 and over in the United States climbed from 16 percent in 2000 to 19 percent in 2017 and is projected to rise to 24 percent by 2026. Given this trend, the Hat trajectory of the t. Monohlyjobgain< inolte mngeof tJO.OOOoo 160.0Cl0 areconsis1e-m ~i1h.an un~-hanged ui:'K'mploymcnt ratt and an unchanged Iaboor forct panicipationr.ue. 1. Set Ihe Summary cr£.conomic Proje\"1ions in Pan J VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00157 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718008.eps of this repon. 154 6 PART 1: R£aNTECOKO.IliCA-'O flNAKCW.0Ml0f'MENTS 2. Me3Sun:s of labor undcruliliZ3tion _,, -II _,. -12 I• - 10 - I I ~•o :Gl6 I llllS Non.: ll~a.'llln:tm..~.klCIJ~\'\Ias:a~/.!(lhtbh.Jc(OI\Y_ lJ..4~10C.al~~~~~'\1"'\'d:«S.asa ~"fmm~tJflht bbt'f'l«~~~~~utt"r$.~~·~fta~of~·~~ud:t.'liv.~•f»a:eflollcuTtl'ltlylootiflsl'or•orl. l).~theybcliC\~ tiO~ilCI\'ii~bb,I.,\S~wl~\"d~~~~· w.-btdi(Jih,:bborfot«,tii~Oflh::bl:« !Ot«pllb~~~~·~"dool:b;~f«<.'t. M~-ty.:tl(t,(d•'(lltcru:eCIXIOtb.:'bbot~."'11'lt~¥en-aibbkb•cd!. aodfs)I('~(IJ for:ajobia~~ llmotll.h:s.U-4~N ·~~l'J~~~·~" ,_.'<f~m.p.\seCIW~W,on~~:Xf«~\'CQlll'ni(~asa r-~ofehrbborl««plui;all~X!kb.'\1-..~-n..lb:~l:w~.s•f'C'OO:'of'~R\~as&-fino."b)·lb:~~o4 '""""""""'"'"' ~J:tt &wll'a!ofb.\xSietlo;'HbKmTAIIIl)OO.. LFJ'R during the pasl few years is consistenl wilh s1reng1hening labor markel condilion~ Similarly, 1he LFPR for individuals belween 25 and 54 years old- which is much less sensilil'e to population aging- has been rising for I he past se1-eral )'ears.(The box ''The Labor Force Participation Rate for PrimeAge lndil'iduals" examines I he prospecls for further increases in participation for these individual&) The employment-to-population ratio for indi1;duals 16 and over- the share of I he total population who are workingwas 60.4 pem:nt in June and has been gradually increasing $ince 2011 , refletting the combination of I he declining unemployment rate and the ftal LFPR. 3. Labor ron.~ padicip.11ioll rates :llld emp!oymcnt·to-popu13.1ion r.:nio !IXl6 l009 ))ll lOIS JJ\8 Non:Tkdaa:tl!ll.'ldtly.Tk~b.Xc'fon.Y ~'On!t. Other indicators are also consistenl 1111h a slrong labor market. As reported in 1he Job Openings and Labor Turnover Sumy (JOLTS), Ihe r.ne of job openings has remained quite elevated' The r.11e of quits has KlptTI.~dtfltp:tflllbOOa~H 10St Tht bb.."f btt~ ~lh:ldcr..:t. SdHl; BomMidl*'T~ Iiafl.ll'l:J~tlo:$,. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00158 Fmt 6621 J. lndetd.ohtnumber of job openings nowabouo matches: the numberof unemployed indl\ iduals. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718009.eps ~-lhrftiiPio)1llml·~ra'tioa:t~'T\~cllkp.'9Q~ 155 MONeTARY POLICYRtl'ORT: lUll ' 2013 7 s1ayed high in the JOLTS, an indication that workers are able to suc-cessfully switch jobs when they wish to. In addition. the JOLTS layoft' rate has been low. and the number of people filing initial claims for unemployment insuranoe benefits has <remained near its lowest le1'el in decades Other sun·ey evidence indicates that households perceivejobs as plentiful and that businesses see vacancies as hard to fill. Another indicator, the share of workers who are worki'ng part time but would prefer to be employed full time-which is part of the U-6 measure of Iaber underutilization from the BLS-fell further in the forst six months of the year and now stands close to its pre-recession le1•el (as shown in figure 2). . . . and unemployment rates have fallen for all major demographic groups The continued decline in the unemployment rate has been reftected in the experiences of multiple racial and ethr1ic groups (figure 4). Tile unemplo)'nent rates for blacks or African Americans and Hispanics tend to rise considerably more than rates for whites and Asians during recessions but decline - 4. Uncnlploymct\1 r3te by race and cthnicity ..... 8bd:orA.fnc.AIIICidl - IS - 16 - I• - ll - 10 - s -. - lOIO 6 lOIS U~~t.'qlkiJ.l':(:fllra!t~IOCllm..~'tiJas2~oflk bl:uk«e.P.:tSOC!So.f»s.:'tlhrtirily isid<a6fr.:das HI¢orl.airloe'lly"kof tl!l}' tlo.~. lll<~bw~a p..'f'iod~fbusioo:s$r~as6..'6o."dbrlk ~'21:~8:art:IGof~Rc:st:.wb. Soc.m : 8ur~oll.abxStMtis:ia \-i)K1,l'rr\tla~tKs.. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00159 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718010.eps 1\.orP. 156 8 PART 1: R£aNTECOKO.\liCA-'OflNAKCW.0MlOf'MENTS The Labor Force Participation Rate for Prime-Age Individuals The "'"'all labor force pMicipalion rale ILFPRJ 11M increases in au!ornation. such as the use oi robotics. generallyb..n vending lower since 2000, and ~>bile and \ '3fious aspec~ oi globali,.tion hm spurred 1he aging ol1he babr-boom generalion iniO reliremenl 1he eliminalion of <Orne lypes of jobs-in particular, ages !)lovides an importanl reason for lh.ll decline, some manufocturing jobs !hal h"'~ histor~llr been it is not the only reason. Al'tOlher contJibuting !actor, held by \\OOte~ wilhoula college education-and as shown in •igure A. is 1ha1 lhe LFPRs of f)li~age eme<gingjobs mar require a diiferenl Itt of skills. These men and '"'men (lhose f>et;,ton 25 and 54 )~•~ developmeniS mar 10 become old) vended lowe< lhrough 2013 Mn though primediscour;god "'"" 1he lack of S\Ji1<1ble job OflPO!Iunities age LFPRs are largely unaffected by lhe aging oi and dropOUiollhe labor force.' The ri~ng share of lhe population: The prime-age male LFPR has heen college-<ducated ""'ke<s, whidl m.l)' partly reflecl declining fO< ~'decades, and lhe pri......,ge female indi,;duals r"'Jlonding 0\'0IIime to lhe declining LFPR has drilled lcMe< sinoe 2000 afle< a multidecolde demand for jobs lhai require less education, has likely in<reast. Ne.'(l(lheless, f)limNge LFPRs ha'-e n101-ed pr.--ented 0\-en ~eeper r~lines in lhe prime-age LFPR. up nolably and consi~en1ly since 2013, as imp<01·ing as bette<-educated worke<s h<l\e highe<LFPRs and labor mad:et condilions have drawn some incf..iduals may be more adaptable to unfO<..een disruptions in back inlo lhe labor force ancJ encouragod Olhe<s 00110 particularlobs or iodoSiries. 1,,.,...These rece<ll increa<es in lhe prime-age lFPR. Anolhef po1en1ial factor may be !hat an incr~ng in lhe conlexl oilhe i<lnger-run !rend decline, fdiselhe share of lhe prime-age population has some rfiff~ulty que<~ion of hcnv much addilionalscope !here is for \\Ming bec>vse of f)h)•ical or n1en1al diSJbililies. iurthef increases in prime-age labor force participalion. For el<.lmple, flgUfe Cshcn•• !hal about 5 pe<cenl ci To gauge whether furthet increa<es are P"'Sible, a bOih f)liroo-age men and women reportlhallhey are useful ~arting point is unde<>landing lhe faclors behind ou1 oi 1he labor force and do nol """'' job due10 the longer-run decline in the p<in1e-age LFPR, aslhese diSJbilily or illness; !hose shares h.l'e ~ended highet iactoo ma)' limit additional increasg ii they continue "'"' 1he past decades. Olhef research wgges1> to exet1 some downward pressure. Ore f.(lctor ~· 1h.a1 iocreased opioid use may be ;,mociated with 41 10\,er prime-age LFPR, although il is unclear hOiv be a seculardecline in lhe demand for """'"' "ilh ""''" levels of edocolion. Indeed, "shcnm in figure 6, much of lhe decline in lhe prime-agelFPR can be lhe long-run decline< in prime-age LFPR ;re much dire<!~· explained br Of>ioid ust or "ilether increases larger ;mong ;dul~ without a college degree than (conlinuedl among college-edocaied aduiK Research wgg.,lslhal ""'•led "'""'"""'"' "'""'I I. for Miera oo d;,plac"""" '""" tt<hnologK-.JI ct.....,_ S<e0>.id H."""'- 03\id Oorn, •nd Go<don H. A. Primt·3gc 13-bor fM"e p311icip31ion r.ncs Ha.,..llOtSI, -u,.n&lingTr>de.OOT<Ciu>ology:E,·idenc• irom Lcolt..abot M1ri:et5," (COI'ICWr)(' loorrul, \'OI. 12) ~\\.1)1. W· Gll-16; Acemoglu ond r.scu.1 RC'511epofl017~ •lloiJols and fol>so Evidence from U.S. Llbor Mo&tts; 'BER \\'odin& P..-per Stvies l328S {C.Jinl:wid~e, ~\m.: National o,..., lkue.au Oi E<ooomk Rese.arch. Ma«hl, 1\'wv..nber..c)f,&' plj)MI\vl32BS; and O"""Acemoglu and Pa<cual Reslrepo (10181, "AMK~Il~e1Hgence,A!Jtom41ior1. and\\'~' '11ER II'O&ingP4ptrSO<i<$l4196 (~.•'""-' -'~;on,l 8v"<u of f<ooom~ Res<•rch. ~Mryl. llllw,nbef.or&' p.J:per.Jwl-1196. Few E.'\<idence on glol»liution-in p.lrtictJI~ impott~itionsillCttht 2000$~0a-.-id H. A~Of, b)• tx ~~ Bwmcrl~ '"""" So.:ta: BI.I't3ad~~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00160 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718011.eps Sott: Thrl!bbare~· ~Tht~Ntsildio.w~ of~ r~'twDti dtfD:,! Oa"id Oorn, and Go<don H. H..,.. (lOll~ "Tht O.illa Synd.-: Loc.!llabor Ma&~ rif«<S of lmpon Com"'""'" in the Uniled Sl.a:es: Amttk.dn Ccooomi<: ~·iew. \d. 103 (OctoiJ«), pp.llll-68. Ad"""'ioo oft'-"< and othe< e>p~.,..,;..,. ~also P<"''ided iA Kam.nne G. Abr•ham and Meli<~a S. Ke.l""!'ilOIBI, "b:p~irung 1he O.:l;nein 1he U.S. E~<o-lllput.tiooRalio:A Rev<wollhe Evidence; NBfR WO<I<iog Papers..;., l4133 1C.mbrici;<, Mass.: N.llional8urt.lu oiEcooomic ReseMCh,. frorwrv). \\\\W.nbet. "'&P•P'"IwWll. 157 MONeTARY POLICY Rtl'ORT: lUll' 2013 9 B. Prime·a.gt laborron.."'e pallicipationrates byfducation Worrw:n -1'8 _, - !0 - 86 Non:: The data are scasooally adjast«<ll-mooth mo,tng atms-.-s and <~te-nd through May lOlS. TM:sbadcd bus indk:atc- p:-riod$ of busi~ ~t~."'I."SSi\Jn as defined b) the Natioll31Buccau ot Ecooomic R~:arcb. Socao.:: U.S. C~s Bttl'\"3ll Cbrm:u Popt~btion Stm't)'· inopioid u<e are an indirecl re<ull ol poor eMploymenl opportunities.1 Caregi,ing r"'iJJ'''ibjlities play an import.ml role in expi.Jining "lly LFPRs for prime-.Jge women are lower than for men, and the)· n\a)' play an increasing role in e>:pl.lining de<lining prime-.JgelFPRs for men as well. As shown in figure C, rooghly IS percent ol primeage women report be;ng out ollhe labor force for caregi•ing reasons-by far the largest ,..son for primeage "omen to report not wantinga job-but this share has been fairly 141 "'~ aime.lncor*•ll. while a much smaller fraction ol men ;ue out olthe labor force fO< u regi\•ing reasons. t.hat s!Mre tw:s trended upinrecent decades, likely reilecling some sh;ft in household l<>tlo fouDd inI.Jnet Currit>, lorusY, lin. i!nd Molly Schrwll QOI31, responsibilities as women participate in the woMorce in greater numbe<s. for ~ially those for whom childc.are costs are not amajor concern-no~ p.utkipating in !he labor force may rep,....! an unconst,.ined choice to care for olher membffl oi thei< families. for others, howe>~. 1his decisioo may reilec1 alack of affordable chiIdea,.. Addilionally,lhe share ollhe populationpanicular~· block men-will> a hilloryol incar«<ation "" increal<!d "'~ time. lndoiduals who""'"' pr..iously been incare<t<!ed oiten ""'"' uouble finding ""'t in pan because many emplo)-et~ choose 001 to hire people with su<h a bad<ground and likelyalso in pan because in<•rceration preven~ IJeOPie from accumulating"""' experience and de\oeloping skills '·aluable to emplo)"'"· Discrimination could also help explain !helack ol panicipation for some minority group>. as •hey ""ognile that such discrimination limiu !heir job opportunities. ln<ernaliorul comparison; may help clarify the importance oi some ol those f.1ctoo. Since 1990, !he (contirwed on nexl page! NBERII'O<kinsP.>per SEries W.W !Umb<idgt, ·' ""-' N.lt.iooa18urNu d Ecooomk Rese.Jtclt Macch~ \\\\\\,nber, Chri•ina P•rk.•nd C~ud~ Salrm\20131, •S~mr"lgl;g!\1"" orsfP3P"""l"40. Some "'i<lenceOfl•hdhe< illeq>io<l Our Ecooomic .Jnd Fin.1ncial Lio.·es; FEOS NOles, h~A'<v.\\, 2. £\idence lhilt opX>id use could be signifiiC.lnt for undffilanding the doclillioglfPR ;, pr<w<Jed 17! AlanB. K'"'&"'\ZOin, "111lttelia\tAIIoheWO<k"'CootiAn l"'!!lity into !he Decl<oe rl the U.S.l>lw f01<0 P.ulicipJtion R>:e; 8Joof;;ngs P•pe<l Ofl !c"""""'AriMty, F•l~ pp, 1-32, hlrpsi"'"".b<ookings.~'lX""'"'~l&llll klueg«taof•llbpeJ.pdi, \\-hi~ little re-.iorohip """'"" a1 """"Y op'<>i<! pr<s<rip6ons ""' .....,..,...,. the ·u.s. Emplo,..,.,.•nd Opioid>: IsThere • Cormea<>nr VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00161 Fmt 6621 iederdfresen.'!.got."J'«OM'!Inol:~nolesfshedding-light.on· our-ec«XXIfllic..and·flnancial·I~'\'S·2018051l.hlm. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718012.eps epidemic v.tri(>s with loc-.a.l «onomic ooncfitions is pt01>-ided by feff lanimore, Alex Duran.:t. Kimberlr Kreiss, Ellen 1\.t,etry, 158 The Labor Force Par~icipation Rate rcominwdJ C. Prirrte·3gt nonp3rticipa1ion b)' reason - 16 -" - 12 - 10 - ; Non: The d3la art ~sonaiJy adjLISIN ll·moolb mo,inga·l'trng.::s aod ntmllhrough Ma)' lOIS. 11M~"<< bars indk21t> ~"tiood$ of~)if~C'SS rcn~n 3S dctira<.:d b)· Ihe ~31ioool &rt:~u of Economk R~~':lrth. Soulre U.S. Cmsus Bllr~\J. Currtnl Popu.la1torl SLI.I'\'C)'. ptime-agc LFPR in the Unit..O State> has de<lined conside<ably for bolh men and \\(K1len rela~il-e 10other ad»n«<J counlries. Some factors, like automalion and glob.llization, ila>'< affected all atl.•nct<J economies ro some degree and foe some lime, )'<i dil'<rging long·ron rrend< in prime-ago lalxi< foo:e participation ha'e ~ill occurred. Re>earch ~thai part oi the reJati,-e de<line in the United Stat.. ~ e;p!ained by diffe<ential changes in work-famil)' pofic:ies across countries. Olher parts of the dil'<'gence rna)' be ""plained by other policies, indudingp<>licies designed t"'' "d keeping those affected by automation and glob.lliution aruched to the labo< force, or other fa<toe>-such as incarcefation or opioid use-4at differ ac<oss those self·rep<>rt as """ting a job (de;pite not hol\;ng actil-e~· searched for a job recently) has beendeclining since 20t0, !hot sh.lre foe men remains between II and 11 pe<cenragc point ab...-e i~ 2007 I<-eland eatlier ""pansion pealcs. furthermo<e. ptime-age men and ",.,.,.. "llo had prO\·iously rep<>rted being oot oi the labor force and not "•nting a job due to disability or illness ha"e been enre~ing the lalxi< force at increasing rales in recent rears. looking fomord, hO\'' can politymaketS suppo<t additionJI imptO\-emen:s in 1he prime·agc LFPR? fol\'OOblel•lxi< market condirions can likely help. and monelary policy can rhe<ciore play a role through suppo<ting Slrong cyclical conditions as part oi ill countries..1 maximum-employment objecli\'e. Howm-er, Sltudural J. for receot trends oo prime-<v"lFPRs in the United ~at('S (()f't~rtd with ~her de---eloped coun!rie'S, see ~"'ion.,. EcooomicCo-optr"ion and De\~ U013), OfCO Ccr>norr>icSun")>: Unir<r!~"" 1018(Paris: OfCO Pu~ishiogi. cb.~O.Ii371«o..w•-q>-usa·l013oo. For <1 dtscription d polityd"afffftOCes ac-ross cou~rifs VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00162 Fmt 6621 factors lin contra~ wirh cyclical Ofi<S}"e also important to addr(>SS; policies to address ~uch factoo are be)<>nd the scope oi monela~· policy. and how 1M may aff«t diiier<nc« in tfPR. seel~""'tion>l Moot<")' fund aOJ31, 'labor fcrceP,n<;palioo inM·anced !conom;,s: o.;.,, and PrOSj)C<~; c•2 in ll'"ld !c-Ou!look:C)dico!IUpl"~SUocMo!ICh.lnge ~Ya>hinston: tMf; Aprill, Ill' 71-128. for "'"""'•on how "¢.familypolki<lmayaiicapri~lfP!tsinll>tUoi:ed 5u:es relati\-e to dher Q(CO coorntil's,. see francine 0. B!au and J.a\\·rence ' l Kahrl 1201)). ·r.m..~t tAbor Supply: 111>y lslheUnired Stn<'S F.allit~g Btbindr A.tnttk.m~ -'·'"'·10li'la)' pp.2Sl-Si>. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718013.eps Although many of the factors behind the multide<ade de<line in the ptime·•E< LFPR may persist. 50me continu.uion of the incre.l$t$ in the LFPR 0\-er the pa~ few years II<''OIIhei<ss seems possible, especially if !abo< marlet conditions remain fol\1lf.lhle. Indeed, as shO\·m in figu<e C. although the share of nonpal1icipating ptime-age men and",.,.,.. \\M 159 MOMTARY POliCY REPORT: MY2018 more rapid~· during expansion~ lndffil. the declines in the unemplo)ment rates for blacks and Hispanic;; ha1·e been particularly striking. and the rates have recently been at or near their lowest readings since these series began in the early 1970s. Although diiTerenccs in unemplo)ment rates across ethnic and racial groups have narro"ed in I\'ICtllt )ea~ they remain substantial and similar to pre· rt'ctSSion kl-els. 'fb( rise in LFPRs for prime· age indi1 iduals over the past few )ean has also been e1 ident in each of th~ racial and ethnic groups, with inmases again particular!)• notable for African American~ Even so, the LFPR lor whites remains higher than that for the other groups (figureS).' lncrtases in labor compensalion ha1e been moderale . .. Despite the strong labor market. the a1ailable indicaton generally suggest that increases in hourly labor compensation have be.:n modernte. Compensati.on per hour in the business sector- a broad-baS<.--d measure of 113ges. salaries. and benefits that is quite 1olatile-rose 2%percent 01-er the four quanen ending in 2018:QI. slight!) more than the 01\mge annual increase 0\er the pn'tcding se-en or so )"tats (figure 6). The empiO)ment cost index- a less I'Oiatile measure of both wages and the cost to employcn of pro1 iding benefits like"isc was 2% percent higher in the first quarter of 2018 relative to its year· earlier le1·el: this increase was 'h percentage point faster than its gain a )CarCJrlier. Among meawres that do not account for benefits. 01\tragt hou~· earnings rose 2'<peroolt in June relati1e to 12 months earlier. a gain in line 11ith the a1·erage increase in the p~'COOing few years. According to the Federal Reserve Bank of Atlanta. the median 12-month 11agc 11 5. ,..,... ...... rom: ~...-byractaod - - <tl!ructty " -ij -~ _., _,. _,.. 10 ,. - n \ort:lhc-l'l'f'INCt.._~~ra.:is a ~oltbt ,.~~u-~ hnom•t~DK~~ ~· ~· i.Jmo)BI)kfl-r~ Tk-lft~+Wt,·h'tltutr .Di llt ~a)llllf*'<ftFt. rktbloWhr~ apmlll tl -.-,.'*-ia.e.tl~lbar<\. ~~ ... s.:...r-a.ca.tfl.IM~' -·_, LL......... MIO ~ ~1-' 1011 -· 1016 Ml~ \ml:~-~1:'1)11 1~ ~~ -. r«lk~_..tolle.k\.~~""(f *•! ~~11" llltltla--ela..ilqr.Mtr;f« n~a..t)~ct.wrtSU..I! ~adltl;flrlkA*-rot, v. .C.0.1111TD<.i.a'.o.t-._. ~-- 1\~···!...-po:rg.w; ...... _...,,.,,... ..... .. ., Six*'.: lwa.fl. . . ~,.. tt.r.;:r!bll)~fiCd.:r11~ kletAIIIIca,••c-.•ttdcr 4. The t"''" 1<\<1< of labor fore< panicipauoo for tlw>< olhtt pwpsdilfer illlponant~· by"'· For Africaa , ...,..... - lu>• . ..., p>rlicipnioo "'" " """ to • lo:t111m. • llilt Ill< partiripolioa nolt IOf African iiiDtnC>ll•"""" ~"' •i!ltaslhat or •ll•t< ._,_ B) contt.l5t.tli< loa<r lFPRs fllf HispaniCS ond AsioJb VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00163 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718014.eps rcflc:tt 10\\n pJnicip;uioa among ~a.omt'ft, 160 growth of individuals reponing to the Curren1 Population Surrey increased aboU13\\ percen1 in May, also similar to its readings from the paS1 few years.s .. . and likely have been restrained by slow growth of labor productivity l. Cilang<in bulintss-s«tor OUtP'Jt per boor _, -; -l SQn; ~if'ti!IC'-cdflU!IIC)aolihr)~~-Jy~ tb:~~Q:(I(Ikli!W ~"C'.. oltkpericd. Tht- fll'ldp.oftod is m:-&.U{dfrom1COO!Q-:~2018!QI. Sot.IWi! Those moderate rates of compensation gains likely reflect the offselling inHuences of a strong labor market and persistenlly weak productivity growth. Since 2008. 1abor producti,;ty has increased only a linlc more than I percem per year. on average. well below the average pace from 1996through 2007of 2.8 percent and also below the average gain in the 1974-95 period of 1.6 percelll (figure 7). The weakness in productivity growth may be panlyanribtnable to the sharp pullback in capital im·estmenl during the most recen1 rece;·sion and the relatively slow recovery that follo11~d. Howe1-er, considerable debate remains abomthe reasons tor the recem slowdown in productivity growth and whether it will persist• Price inflation has picked up from the low readings in 2017 Batlllafi.M....,SLI:Nics \"iafLI.\'tt~ticf.. In 2017. inflation remained below the FOMC's longer-run objectil•e of 2 percent. Partly because the softness in some price categories appeared idiosyncratic, Federal Reserve policymakers expected inflation to mo1-e higher in 2018.' This expectation appears to be 5. The Alb11ta Fl."dS mt'3sure difttr.s fromOthers in 1ha1 it measures ~~ wage grov.-1b on~· of work«S who \\"tn! e:mptoycd both in 1he C'urrtnt SufltymoruhaAd VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00164 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718015.eps 12momhsearlier. 6. The bo' "ProdUCii,·ity De\'clopm<nts in the i\d-.n«d Eoonornies in thelu~· 1Qll.I/IJIU!IQf)' Polity Rtp!m pto,id.s more information. S.. Boefl! of Gowmors of the l'e<krnl Resen·e S)>tem (Wil). MMftOT)' Polity Rtpon (Washington: Boord or GO\·<rnors. July). pp tl-1J. hnps:ll" "'".fooemtre•"'·e. gov/mone<arypolk)·/1Qll·Ol·mpr·p.tnl.htm. 1. ;\dditionaldetails. ranbe foundin the JurlC 2017 Summary of Economic Projectioos. an addendumto the minut,~oftoe June2011 FOMC mNting. S.. Boefl! of GO\tmors of the FC<fernl Resen< S)>lem (2011). ~~linu1es of the Federal Open Market Cornmittce. 161 MOMTARY POliCY REPORT: MY2018 on Irack so far. Coosumer prict infta1ion. as measurtd bylhe 12-monlh pem:nlagechange in Ihe price index for personal consumplion cxpendiiUres (PCE), mored up 10 2.3 pcn;enl in May (figure 8). Core PCE inflmion. which excludes consumer food and energy prices !hat are oflen qui1e rolalile and l)pically pro> ides a beuer indicalion 1han Ihe 1o1al measure of where 01erall inflation "ill be in 1be fulure. was 2 pcrctnl 01er 1he 12 monlhsending in Ma) 0.5 perrenlage poim higher !han it had been one year earlier. The 1o1al measure exceeded core infla1ion. b.--cause of a siable increase in consumer energy price~ In contrasl, food price infla1ion has corninued 10 be low by his1orical s1andards-da1a lhrough M3)' show the PCE prioe index for food and be\eragcs ha~ing increased II'>Sthan 'l: pcrctOI 0\Crlhe past year. - 13 10 - !t • lj It w- - L.t............ - 1011 2012 201) I ZOI~ - J 201S 11)l6 2017 201S ..... \\m:TbrcOW..f\lt.'OoStllous' \lly.))lf:~.-tfnwnont)IW Soc.wr. f«lllllftlt.-.faSnlltorc!\tWfllDalbrl;:b• ct;t. Blftalel&...:A..t)'t>..•'•"-crAIII}1trr."5. The higher readings in bolh lotal and core infla1ion relalive to a year earlier reflttl fasler price increases for a wide range of goods and serrices Ihis )'ear and the dropping oul of 1he I2-monlh calculalion of Ihe Sleep one-monlh decline in Ihe price index for wireii'>Sielephone stl\ices in March last year. The 12-monlh change in the Irimmed mean PCE price index-an allemaliH: indica1or of undtr~ing inflalion produced by the Federal Restl\( Bank of Dallas that may be II'>Ssensilile Ihan Ihe core index 10 idiosyncm1ic price movcmenls- slowed by less Ihan core infta1ion over 2017 and has also increased a bil less 1his year. This index rose 1.8 perctnl om Ihe 12 momhs ending in May. up a IOlKh from Ihe increase 0\-.r the same period last )tar.' lull< 13 14.2011," pmo ~icaS<. Jui)' l. https:// '.1.\\'\\ .rooc-rnlrcst!' '·SO\"Inro-st\nt"pr&~lca'iN monttal)101 iOiOSa.htm. 8. Th< trimmod mean in<kx<'«lud<> •hart~cr Jlf1'<S ""*nl rio< b'l'<'l iom355 or ck<m"' oaa """ ..,.Ill: b-cwnplt. rheslwpdniiat 11 pric<sb•11<1<» t&phooc !mi«s,. ~ta~illOI J •» <l<'fudN VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00165 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718016.eps fromthi,~ 162 9. Brrno spoo ond filrut<S priees Oil prices have surged amid supply concerns ... - IJO - 120 110 - oco !0 - co lO - co,. Son! Th: 4r..llll\' 'i!IC..i.tj. ~\~of dally dl:a IOJC'\l«ld ~ Mr11.1<llt Soun.: lCEBfttllftr-J:a:,u~ As noted, the faster pace of total inflation this year relatio·e to core inflation reflects a substalllial rise in consumer energy prices. Retail gasoline prices this year were drio~n higher by a rise in oil prices. The spot price of Brent crude oil rose from about 565 per barrel in December to around S75 per barrel in early July (figure 9). Allhough that increase took place against a backdrop of cominued strength in global demand, supply concerns have become more prevalen1 in reccn1 monlh& (For a discussion of the reasons behind the oil price increases along with a reo~ew of the eft'ects of oil prices on U.S. economic growth. see the box "The Recent Rise in Oil Prices" ) ... while prices of imports other than energy have also increased - 101 - 100 - 9S co ~ll ~Jl Nl4 Wl5 2:016 :017 lOIS SO'n; llxQ:... CxrR.'adia:lpx1~-~:tQXIibl) DiC'\k'DJ~ Mt.~· lli$.Tk~ for~I!Xtlba:~ •~· f\~of43if)• dl:a Dl<>IO>l""'-'b""'l9. l01S. Soli((: F« C«<fo.i ~ ~ ~ o( b.\Y ~ t'« ~ (IXUlt.. CSC'I l~ ~~~%«~\Ill litl\"1 AM~tiel.. s..u VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00166 Fmt 6621 Nonfuel import prices rose sharply in early 2018, partly reflecting the pass-through of earlier increases in commodity prices (fignre 10). In particular. metals prices posted sizable gains late last year due to strong global demand but hare ret reated somc1111at in n.'Cent week& Survey-based measures of inflation expectations have been stable . . . Expectations of inflation likely influence actual inflation by afleeting wage- and price-sening decision& Surwy-based measures of inHation expectations at medium· and longer-term horizons hao·e remained generally stable so far this year. In the Sumy of Professional Fon.usters conducted by the Federal Reserve Bank of Philadelphia. the median expectation for the annual rate of increase in the PCE price index orer the next I0 years has been around 2 percent for the past several years (figure II). In the Unirersity of Michigan Surveys of Consumers, the median value for inflation expectations over the next 5to I0 years has been about 2\', percent since the end of 2016.though this Jerel is about V. percentage point lower than had pre>-ailed through 2014. In contrast. in the Survey of Consumer Expectations conducted by the Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718017.eps no - 163 MOMTARY POliCY REPORT: MY2018 15 - Federal Resm-e Bank of 1'1~ York. Ihe median of respondenrs· expected in Hal ion ra1e 1hree years hence has been moving up rectnlly and is currendy a11he lop of the range it has occupied Ol'er the past couple of years. .•• 1\hile market-based measures of innation compensation ha1·e largely mo1 ed side\\'il)s this year lnHatioo c.'pcctations can also be gauged b) market-based measures of inflation eompcnsation. Howel'er. the inference is not straightforward. because market· based measures can be importanlly aft'ccted by changes in premiums thai pro1ide eompcnsation for bearing inflation and liquidit)' risks. Mrasures of longer-term infta1ion eompcnsation-deri1ed cilher from differmces btt"l!ell yields on nominal Treasul') securilies and those on eomparable-maturit) Treasury lnflation-Prolected Securi1ies (TIPS}or frominflalion 111~ps ha1·e mol'ed sideways for I he mosl part I his year atler having reiUrned 10 lel'els S<.'en in earl)' 2017 (figure 12}.'The TIPS-based measure of 5-lo-IO.)r.tr·forward inflation eompensalion and I he analogoll$ mea;ure of inftalion swaps are now about 2 pereenl and 21': pclt'tlll. respcctndy. "ilh bolh measures below 1he ranges Ihal pcr..istcd for mos1 of the 10 years before Ihe s1ar1 of the nolablc declines in mid-2014.10 9. lnlbtion compensation impli<d by 111< TIPS ~"' icll.ttioo ratt ~ boS<d on th<dolfmocut C\lllj>Or>bi<mluriti<>.bec•... )idd>OO""""... Trmol} «a~~~~i<sw)ldd,; oo TIPS. •hoc!lorr111&l<d totll<k!IMaJilSWII<fpric<~(CPIJ. lafbtooa""PS - I ~~ · Tb: M~~:bi. . III'IC)' 6at1 rtt mor4ty, Tb: Stf 4m for intl.at1011 op.~f«pmcoal~npaldrtl#C'f~~·Wco'W'Dd m~'O•......,lOtiQl Solwt: ltn~ti\IIL'fllp~~'SolC~Ftd:n!IN1\co Bdttl~$w\c,.i~fctttMIItf\t$f'f\. ,. - u ,. -IJ - ,. L......u......u .:'010 r. ,z .. , , , . , " :014 !01! 2016 1~1$ ~. Thrd»wt M\"4.~ J'l~ol~ 4aci..J~Uted llwOIIJh hl)~:xttS.nPSr;:t~•dlat~"W~ of '~ \'91\. ~). ro.1collttitf'lt SOI.m· rcdml RM-ot """"'"- w 1rrromoosin •hich oot pon) mili> Jl3lll1tll~ or ~rtaln fiM.'d nomin31 amou11ts in twhn~ ri.lt cash ftffi'l that "~ index.C'd 10 cumuiJii\<CPI inH:uion OH'r some horizM. ~Ocu)ing on inflattoncornpcMalion5to VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00167 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718018.eps 10 )<aru.h<ad is useful paoti<ul3rly for mo""Ull) policy. b«3u« such fol\l~«< mtasu"" <nrompas:. mark<t ~niripanu',ft-s about wflere inllation 'lAili )(ttlt in tbc loasttrm •fkrdc\tto...,..ts inftutncinsinlbtlOII in th< sbon term hi>< ruo t11rir roDJ>t. 10. Asth<oe.....,.,..aoel>os<dooCPIIIILuoo. 00< >llollld prob>bl) subtnct ahoot '. to •,; 1""""1>¥< point th< ;nm~ d[~=tial•ith PCE infbtioo '"'' the pa~ h\O <kcldts:- 10 in ftr inftation comp:n~twn on a PCEbo<i> 164 The Recent Rise in Oil Prices Oil p<ic., h>l~ increased more than 50 pe«:ent the spot p<ice of Brent crude Oil rising from a bit 0010\V $50 per barrel tO ai'OUOO SiS per barrtl (tlgure AJ. for much of the period, iunhet-dated futures prkes remain<O reloti1~ly sl<!ble, in the neighbofhood of SSS per barrel; h''"~""· since February, futur., p<ic., """ fll0\.0 up app<eciably, reaching 0\'ef $70 per barrel. Bolh >upply and demand factO<> M'e CO<ltriboted ro the oil price iocrease. In p3nicular, the broad-based imprOI'efnent in the ovuook iO< the global economy was a ~(!)' dri\"er oi the price increase in the second half of 2017.1n recent months, supply concerns ha1~ become more p<evalent affecting both spot and furtherdated futures prices. Despite sharp!)• rising U.S. oil p<oduction, marke~ ha~'e bten attune< to escalating connict i>e!l1'ten Saudi Arabia and Iran as well as the p<ecipitov><!ecline in Venuuelan oil p<oduction amid 0\'l!f the pa~ l""· with the count~/' economic and poiti<al cris~. Prices ako increased aner President Trump announced on Ma)' 8 that the United Slates was withdr;n.,.ingfrom the lrJn nuclear deal and that "nctions again~ Iranian oil exports would be reins~ted. The pattem of spot and futures p<ices iiiOicates that 1113rket pilnicipilnl> generally anticipate that oil pri<es 11ill decline slowly over the next few )'earS, in pan retlecting'" expect.lion that supply, including U.S. !-hale oil production, will gt0\1' to l1lE<I demaoo. In addition, the higher p<i<es pu1 p<es>ure on OPEC's NO\'ember 201 b agreement with cert.Jin non-OPEC countrieos 10 restrain production. A Slated aim oi the agreen1ent 11~s to reduce the glut in global in~..,tO<ies, and, in recenl months. inv~nlocy le\-efs ha\-e iallen ldpidly toward long-run awtages. In response to both l01ver im'entories and higher prices, OPEC leaderS ~ightl)• relaxed the production agreen1ent in June thi> (corr!inu«<J - 90 _,. _, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00168 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718019.eps - «> 165 MONEIARYI'OUCYREI'ORT: JULYI018 17 )~ar, reducing some oi 1he upward pressure on priCI'I. Thai !did, fulures prices h.r.~ 1101 re\Uin<d 10 !heir early 20181evels, imp~·ing 1ha1 mad:el panicipan~ expecl some oi 1he rectoI incr<>ase in prices to be long lasting. IVhal is 1heexpec~ed effec1 of 1he recefll rheinoil p<ices on 1he U.S. economy? To begin wilh, high« oil prices are li~ely 10 resYain household consum1~ion. In p.1rticular1 the incttase in oil prices since last year ~ es1ima1ed 10 h.J1~ 1ronsla1ed inlo a roughly S300 ii"'Crease inannual expendituces on g.noline fOI' the 3\'1'138' household, from ahoul S1.10010 S2,400. H"'"''"'· as U.S. oil produclion h" IV"''" rapidly "'"'lhe pa11 decade, 1he ra1iool ne1 U.S. oil impons lo U.S. gross domeslic p<oduc:t (GOP! has declined suhllanlially (figure 81. As a result higher oil prices n01v imply much less ol a redis1ribu1ion of pu<Ch.Jsing 8. Nctoilimponsharc pow« abmad lhan in1he past as much of !he nega1ive effect on GOP from l011-et household conwmprion is likely 10 be offsel by inaeased produclion and in~'eSl.melll in lhe IVO'\''ing U.S. oil se®r. On netlhe drag on GOP from higher oil p<ices is likely a small iraclion oi ~~~al il was a decade ago and should get smallet slill il U.S. oil produc:tion conlinues to gr01v "jli'Ojecl<'d-<.gure C-and 1he ne1 oil import <hare shrinks toward zero. Indeed, if U.S. oil uade 1110\.., fully into balance, lheoiisetting effeciSof a change in the relatil~ priceoi oil mighl be expected 10 ne1 oul within the domesti< e<:ononl)'· How'e'\oer, f\'tn if the United States is no longer a net oil importer, to 1he extenlthat highe< oil pt:ices cause credii<OlUirained consumers to cut spendingby morelhan oil producers exp.1nd !heir in,~nl. this redi~i~tion oi purchasing po-orer could !lill have negalil'e effeciS on 01-erall GOP. C. U.S. crud< oil prorlli<tioo _,, - 12 - 10 11 I I I I, I I, I I I I I -' I, I :»li!OOl~lfi/I2009NI12'01lZOUlOI?~l9 - 8 I''"'"'''"'"""''' " 'I 20lS ZOI6 :'011 2'01$ Zlllt VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00169 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718020.eps )ll~ 166 13. O..nse ;, r<al gross dom..'SO~ produco and gross domes!i<: income ....._,.. _, _, Ql - ) - 2 _, 14, Ch:tnse inn:al ptrsooal ronsump1ioo c~nditures: and disposable p.'1><lfl3! iocome _, _, _, - ) _, _, _, _, _, Real gross domestic product growth slowed in the first quarter, but spending by households appears to have picked up in recent months After having expanded at an annual rate of 3 percent in the second half of 2017, real gross domeslic product (GOP) is now reponed to ha1-e increased 2 percent in the firs1 quarter of this year (figure 13). The step-down in growth during the first quarter was largely a11ributable to a sharp slowing in the gro111h of consumer spending that appears transitory. and gains in GOP appear to hare rebounded in Ihe second quarter. Meanwhile. business investment has remained strong. and net exports had lillie etfect on output gro111h in the first quarter. On balance, over the firs1 half of I his year, 01·erall economic activity appears 10 have expanded at a solid pace. The economic expansion continues to be supported by fa1·orable consumer and business senliment. past increases in household wealth, solid economic gro111h abroad, and accommodative domestic financial conditions. including moderate borro111ng costs and easy access 10 credit for many households and businesses Gains in income and wealth continue to support consumer spending . . . ~Oll~ Tht\1;1ucsbb)I3:HI~Iflt~~ MI)Q4~"S. - IS. Pcrsorolsa\ing t3te -11 -10 - J I l !1).16 I I '2«18 1 I ~10 I 1 l012 I I Xl14 I I 2016 I 8 1 l'OJS: San: D~lu.r~lk• ~'~r20tS Solt<t: S&muo!Eooa.:.mk~'Si:;: liatb,"CJArW)ticr.. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00170 Fmt 6621 Following exceptionally stronggrowlh in 1he founh quarter of 2017. consumer spending in the first quarter of Ihis )'ear was lepid, rising a1 an annual ra1e of 0.9 percent The slowdown in gro111h was evident in ouilays for mo10r 1•ehicles and in retailsale$ more generally: moreover. unseasonably warm weather depressed spending on energy services. Howe1·er. consumer spending picked up in more recent months as retail sales firmed. and PCE in April and May rose at an annual rate of 2\'. percent relative to Ihe average orer 1he first quaner (figure 14). Real disposable personal income (OP!), a measure of after-lax income adjusled for inflation. has increased at a solid annual rate of about 3 percent so far this )'ear. Real OPt Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718021.eps SOU<f: Bl.mae(E~A~~~11 1b\uAflal:.1id 167 MOMTARY l'OI.ICY REPORT: MY2018 19 has bctn supported b) the reduction in income ta'es 01\ing to the implementation of the Ta, Cuts and Jobs Act (TCJA) as 11ell as the continued strength in the labor market. With consumer spending rising just a little less than the gains in disposable income so far this year. the personal S3\1ng rat~ has edged up after having fallen for the past t\10 yms (figure IS). Ongoing gains in household net 110rtb hktly h:l\e ai>O supported consumer spending. flouse pri= which are of parti(ular importance for the balance sheet positions of a large set of households, ha1•e been increasing at an a1·erage annual pace of abo11t6 pcrtent in recent )~ars(figure 16}.11 Although U.S.t'quity prices hart posted modest gains, on net. so far this )ear. this Hattening followed Stltral years of sizable gains Buoyed b) the cumulati1-e incrmes in home and ~uity ~~ate household net worth was 6.8times household income in the first quarter. down just slightly from its ratio in the fourth quarter the hight~t-ever reading for that ratio. which dates back to 19~7 (figure 17). - '"(r<'"; 'I« •h !n u - to - s - 0 - l _,. - u - ~ ~11: lb:d.luror~S.~Pf~lkrllldtlu:cod~ApnllOtS. 11<... f«lklol""aboodib<C~®M1<11d~ lll) !Oil Scun: f«~ llo.._ PncT ~Uno.~ SlPC~ l.S ~lb!atfn«l!ldn. TltW~lfllhi$•po&d fi~P IFor b c.--,.., .... ..~ • .,*•• b Jam. I~ UC t)_ \\t>Jdl.to....-- ~~ J.s ~ ~ ~ ------------------~bo - 1.0 _ ., _, ... and borrowing conditions for conwmers remain generally fil1orable ... Financing conditions for consumers are gell(rall) fa1orable and remain supporti1e of gro11th in household spending. Ho11e1~r. banks hare continued 10 tighten standards for credit cards and auto loans for borrowers 11ith low credit scores. possibly in n.-sponse to some upward mores in the delinquency rates of those borrowers. Mongage credit bas remained readily :1\-ailable for households 11itb solid credit pro~les. For boiTOII~~ 11ith !011 credit scores. mortga.,oe financing conditions ha1e eas..'d somewhat further but remain tight overall. In this en1 ironment, consumer credit continued to increase in the first few months of 2018. though the rate of increase modemed some from its robust pace in the pm·ious year (figure 18). - -u :!tOO ,,,, t.t.ttrt !1111 !® 1006 1'IXJit ZOU MIS 2018 :-:.m: Th:l(ft.')nlkrlt!O~blu!doidlltlt~orll)~~ """"' Souc1: f« M ~~oOI'Iil, tNo:ul Rntrw 8owd,. ~ R~ 11, '"f--.'UII~ <illkl~S!m'":for~. lllwa.ol£~ ~\-lb\ftAMI)11rrr.'\. t...:....___;_; II. Forlh<1113jorit)of~,h<>mt<qull) m:ol<> up th< lat;'<>l sl!are of tbtir •<3Ith. ~ l!IUt .:'tl! !el.l :116 l'CII~ \1m.~ arr t~ &. ~.ccd to }'Of-tO! nftP1101S ~·~-~6\lml017'()4Dllll~l Sol.ttt: FC\Jml Rn."'Tit lk"'«'d. SUmigl IMc:a~ 2.1, "F~t~W.al VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00171 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718022.eps M~ollkt..'ntlil:d~~ 168 ... while consumer confidence remains strong 110 :-'\ ··-~.~¥ - 1\: · - lfi'\ -:. ,. _ .. - • .. ~~· Tllt~M'!tii'I)Md,IJJt<:ll~l'J'W Wt il'l6t\~10 100 il l~ tlN:rrtJ~~-II!t ~ a.tbt ltt~ oiN'q ~~~--faaif} ~IOptp lk'«' . . ~ ...,••utrc:wor ra-of'b i<O »>~ •-.••IIm-D)I6•.. " "'V Sroll'l .....fN).,,tdlptStnquCr~ ---------------------~--lO Ql Consumers hare remained upbeat So far 1his year, I he Michigan survey index of consumer sentimem has been atcar its highest iel'el since 2000.1ikcly renecting rising income. job gain~ and low innation (figure 19). Indeed. households" e.~p«tations for real income changes 0\Cf abe next)ear or 1110 now stand above le\els prcteding ahe pmious recession. Business investment has continued to rebound ... Investment spending by businesses has continued to increase so far this )"e"Jr. 1vith notable gains for spending, both on equipment and intangible$ and on nonresidential strudures(figure 20). Within strudures. abe rise in oil prices propelltd another steep ramp-up in imestment in drilling and mining stn•ctures-albeit not )et back to the le1~ls recorded from 2012to 2014-while investment in nonresidential structures outside of the energy sector picked up after declining in 2017. Forward-looking indicators of business in1-estment spending remain favorable on balance. Business sentim~nt and the profit e.xp«tations of industf) anal)-sts ba1e been positiveO\·erall. 11hile ne~~ orders of capital goods have ad111nctd on net this year. . . . while corporate financing conditions have remained accommodative Aggregate ft011~ of credit to large nonfinancial firms remaintd strong in tbe first quarter. supported in JX!rt b) rdati1e~ lo-~· interest rates and accommodati1e financing conditions 21. S<k«<d """""'""of"" cl..., f""""~l for ooaf.-ial bu!ixs_"' (figurt 21). The gross issuanct of corporate .. lO A•1-'HA-JLJLILILII~LIIJ - t _,. It 1 ~WI I I ll))) ))10 2012 t 201C :&It -· ~- f(d:nl RntM &.d. SIDIIcll l tbc' J I, -rNK'ill bonds sta)td robust during the first half of 2018, while yields on both inrc~tment- and speculative-grade corporate bonds mored up notabl)' but remained low by historical standards (figure 22). Despite strong growth in business imesumnt. outstanding commercial and industrial (C&I) loans on banks' books rose only modestly in tbe first quarter. although their JX!ct of t'JXInsion in more rerent months has strengthentd on arerage. In VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00172 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718023.eps ~cl thtl..'liled ~- 169 21 MOMTARY POliCY REPORT: MY2018 -~,l~=~ _, ~ - - son: 'lk)"-ld& ...,..••~>"'WtOII. lO.)ukoh. Soi.11Cr.: I('( W ot Al'll(tlo;• \krnll L)'Otb ~ ..S •lib - - _,.. But activity in the housing sector has leveled off Residential im-estment. which rose a modest 2~ percent in 2017, appears 10 ha1t largely mored sidtll'a)~Orer the first fi1e months of the )ear. The sl011ing in residential in1ts1men1 like!) is pari~ a result of higher mortgage intemt rates. Although these rates an: still lo11 by historical standards, the)' ha1e mo1ed up and are near their highest levels in SCI'en years (figun: 23). In addition, higher lumber prices and tig)ll supplies of skilled labor and dmloped lots reponedly hal'e been restraining home construction. While stans of both sing)e·fami~· and multifamily housing units ro;e in the founh quaner. sing)e·famil) stans ha1e been liulechanged, on net. since IU _,., ;- -1-· »>t ~u I I !Ot• I I Z~lf I I I .2011 ,..., __...._ then. "hereas multifamily stans oonlinuoo ll. ThtSlOOS is;~~~il>bl< oo lltdloonlh<b><IO :ot VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00173 Fmt 6621 '" - !I 10 climb earlier this year befort Hanening out (figure 24). Meanwhile. OI'Cr the first fil'e months of this year, new home sales ha1·c held at around the rate of late last year. but sales of existing homes hal'e eased some11 hal (figure 25). Despite the continued inertases in house pricts. the pact of construction has http;1~'••.f<ll<ratr<S<rl'e.E'J\IdatofsJoo,.'~oos.htm. II II -- - u lJ....L..... X£6 ~ Sfmt 6621 :!'OtO .!OU ~U !AI6 'MIS L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718024.eps April. rtSpe>ndents 10 1he Senior loan Offictr Opinion Surrey on Bank lending Praclkts. or SLOOS. reponed that demand for C&l loans 11cakened in the lirsl quar1cr e1·en as lending standards and terms on such loans eased." Respondents auribUied this d~XIinc in demand in pan to firms dra11ing on imemall)' generated funds or using aherna1i1e soun:tS of financing. Mean11ftile. gnllllh in commercial rtal estate loans has moderated some but remains strong. In add ilion, financing conditions for small b~sincsscs appear 10 ha1·e remained generally accommodatil'c, 11i1h lending standards liule changed almost banks and with most firms reponing that they are able 10 obtain credit. Although small business credit gi'OIIlh bas been subdued, suney data suggest this sluggishness is largd) due 10 continued 11eak demand for credit b) small businesses. 170 ----- .. ..-.-" " - u 6l ll u ,. !I - .. H It- ,,u-J....LJ l\1)6 !(lOS ~10 !012 :cll6 !01$ 11)1.$ J ~n· OM. J:c ~· at:d<'IC'OJ1b• ~by ::OIS: ~·~befar:-A.., -ool)~ok "'""'"""'""'-·""·~· ~-~.WC\Xl' Wts. Sol••·forlle'ilo~~li.S. l'm!Wikn:IIK..,('l_,bl,ww: . .' - ' - ' \~ol~·\llf ii.Mf.Wl}illl.'l, 16 ---... Clluov il rQ) illpx!s ad «ppil> ol"""' --- ··-· ,_ -' - l _, - .............(,Of not kept up \\ith demand. As a resuh. the months' suppl) of in1entories of homes for sale has remained at a relati1ely low level, and 1he aggregale vacancy ra1e s1ands a11he lowes! level since 2003. Net exports had a neutral effect on GOP grow1h in the first quarter Afler being a small drag on U.S. real GOP glll'l1h last ym. net e1pons had a neutral effect on p1h in 1he fii'SI quaner. Real U.S. exporls increased abou1 3'h pertenlal an annual mlc, as expons of atllomobiles and consumer goods remained robust Real imporl gro111h slowed sharply following a surge !ale last )eaT (figure 26). Nominal 1mde da1a 1hrough Ma) sug,_l!eSIIhat e.xpon groMh picked up in !he second quaner. kd b)' agricuhural C\por15. 11hile impon gfOIIth was 1epid. Alllold. !he 3\1!ilable data sugges1 thatlhe nominal trade dcficillikely narrowed relative 10 GOP in 1he second quaner (figure 27). Fiscal policy became more expansionary this year ... federal fiscal polic) 11 ill like!) pfO\ide a moderate boos110 GOP p1h this year. The indi1idual and corporate tax cuts in the TOA should lead to increased priva1e consumption and inves1men1. 11 hile 1he Bipanisan Budge! Acl of 2018 (BBA)enables increased federal spending on goods and ser~ ices As !he eftocts of 1he BBA had yet 10 show lhrough. federal g01~mmen1 purthases pos1ed only a modes! gain in !he fi~l quarler (figure 28). Afler naTTOIIiog significantly for !el'eral )tan. the federal unified deficit 11idened from about l _, _, ' !\~'~.! VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 xoa 3106 ' , ' . I It X(C PO 00000 ))It ~l :otn Frm 00174 I I I JliK :tlS Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718025.eps - 2Yi pertenl of GOP in fiscal year2015to 3Yi percenl in fiscal201 7, and il is on pace 10 move up further in fiscal2018. Ail hough expenditures as a share of GOP in 2017 were rela!ively stable 3121 percenl, receipts mo,·ed l011er 10 rough!)' 17 pertent of GOP and ha1e remained 31 aboulthe same level so far this year (figure 29). The ratio of federal 171 23 MOMTARI' l'Ol.ICY REPORT: MY20t8 debt bdd by the public 10 nominal GOP "as 16'!) perrent at the end of tiscal2017and is quite elel<lled relatiw to historical norms (figure 30). 2$. C1aot<. raJ"" ......... ~ .. '"""""""'ondinl - .......... . . . and the fiscal position of most slate and local governments is stable The fiscal position of most Slate and local go. emmems remains Slable. although there is a range of e.\perienctsacross these go.cmmtniS and some states are still struggling. After se•eral )tars of slow gro"1h. re1enue gains of state gol'ernmems hai'C strengthened notably as saks and income tax collections hal'e picked up OI'Cr the past few quarters. tn addition. house price gains have continued to push up property tax revenues at the locallc•el. But e\penditures by Slate and local go•emmtntS h:M been restrained. EmpiO)mtnt gM~th in this S«tor has been moderate, "bile real outla)S for conmuction by these go•emments ha1e largely been mo1ing side11a)s at a relatil'cly tow Jerel. - : _, -· Financial Developments The e\pOOed path of the federal funds rate has mo1 ed up Market·based mtaSures of the path of the federal funds rate cominue to suggest that market participants expect further gradual increases in the federal funds rate. Relatil'c to the end of last year. the expected policy rate path has moved up. boosted in part by imcstors' perreption of a strengthening in the domestic economic outlook (figure 31). In particular, the policy path m01ed higher in response to incoming economic data so far this year. especially the empiO)ment n:ports. 11 hich 11~re seen as supporting expectations for a solid pace of growth in domestic etonomic activity. In addition. itwestors reportedly interpreted FOMC communications in the first half of 2018 as signaling an upbeat economic outlook and as n:inforeing expectations for funher gradual rtm01-al of moneta!) polic) accommodation. t 71 t j I I - " ' ... f...t''""n..p lOt' ........ ...~ ~prar&ntGDP).,Iiwfxto. t~-~~ ~~•Q}.. I«!GIJ. It\~llld~~ttf«llk U llllllllhs~• \ Lir,(i()Vtt.6tl'twqtof!Ol7:Q; W101SQ1 ltn"ripps~ni-'Cftditut(\lff•• .,.~ks&s.. Sot.fi1: Off"'~ofM~ Wid ~ '~HI\'C'fAul)~ - It _,. - lO - 40 .....'* "-= lk... ...,... "--* ,.., tal',~.~ Fo.inl lickkM.,..""' ..... Wi:l:ll4kt. k T~~ adl •kdlftl~«~tGrill~~~w..~· ctld«lbtqiDM' Soulc'l:: f« (iOP.~of l.«o.JmK Aml)')H.\D ib\ftA!at}til."),l.'lf ~ ~ fCidml l Nft< t1o1n1 SUiutd Rcl-N Z.l. "f~l VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00175 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718026.eps M~od'~ L'11ki.! $U:c.~ 172 Sul'\'( )··bastd measu~ of the e~peaed path ~ --------------------~~~ )g ~-~ " lOll \.Jn- lbi' fcdml l'tle41'11t p6is ._-db)' ~ oo0\ft$bi ladt\ .... a dtmJIM (O!Ilfl(t titd 110 tb.t tfrc.n11C' (akul W, '* llK II!IPIK'df*b IIJofJII)· 11.201l. iitUlf*cd,..O. ao ol~ N, :'fl1. 1\t,..~.- ·191Dr awrw~t.~·kftlrm- ol0'--""""'"""'-~ S.t•n ~ fal:nl~.tsmc: &w;-;14~ of the po!ic) rate 01er the next few years ha't also increased modeslly since the end of last year. According to the resuhs of the most rettnt Survey of l'rimary Dealers and Sumy of Market Participant~ both conducted by the Federal Resene Bank of New York just before the June FOMC meeting. the median of responderus' projeelions for the path of the federal funds rate shifted up about 25 basis points for 2018 and beyond. compared "ith the median of a=sments last December." Market-based measures of uncertainty about the policy rate approximately one to t\\'Oyears ahead increased slightly. on balance. from their lewis at the end of last year. The nominal Trtasury yield curve has shifted up The nominal Treasury )idd cum: has shifted .... _, _, - s _, ' ·m. n.tT~- msod~ fltllt»rar~IWWlt} tmn• fdllw)l l.~la::d ~ "*ocra•Jct:..,f. ~ o.,.-or6t T:~-. s. • up and flanened some,.hat further during the first half of 2018 after flanening considerably in the second half of 2017. 1n particular, the yields on 2- and 10-year nominal Treasury ~unties increased about 70 basis poirus and 45 basis pointS. respccthcly. from their ~~~Is auheend of 2017 (figure 32). The increase in Treasury yield> seem, to largely reflm im-estors' yeater optimism about the domestic growth outlook and firming expectations for further gradual remo\'alof monetary policy aceommod:uion. Expectations for increases in the supply of Treasury s..'Curitie.s foll01•1ng the federal budget agreement in early February also appear to ha\e contributed to the increase in Treasury yield~ "hile increased concerns about trade policy both domestically and abroad. politiall d~elopments in Europe. and 1he roreign economic ou1look weighed on longer~ated Treasuf) yield1 Yields on 30-year agency mongage·backl-d securities (MBS)-an important determinant of mortgage interest t3. Tht r<>utt> o( th< Sun"l or Prim:ol)' D<al<ri and do• Suney o( \11rte1 P>ruapws m :n-.ilalik ooth<FcdmiRtstn<B.tnl: od''\'" \'od:S.'CioiittOI ~up>J;Iln-:ortfcd.orpln:uL«>pnmll}d<:lkr_ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00176 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718027.eps !111\')_qu.stion, html>od hllps;/•" '"'·""'1ortf<d.O<JI 1113rk&'>Uf\t).1113rl<t..pan<ip:~nt>. "''l'<ti>'* 173 MOMTARY POliCY REPORT: MY2018 ra1es increased about 60 basis poin1s owr !he find half of 1he year. a bi1 more !han !he rise in 1he 10·).-ar nominal Treasury yield, bul remain low by hi110rical sland.ards (figure 33). Yields on corpora1c dcb1 secu.ri1ies-bo1h in"es1mcm grade and high )ield- rose more 1han Treasury yield~ leil\ing !he spreads on corpora1c bond l ields 01er comparable-maiUrily Treasury )'kids no1ably \\ider tban a11he ~nning of !he )ear. - -·"' - l- Broad equity index~s ros~ mod~tly amid some bouts of market volatility Aflcr surging as much as 20 percelll in 2017. broad s1ock marke1 indexes rose modcslly, on balance. so far I his year amid some bouls of hcighlencd volalilil)' in financial markels (figure 34). The boos11o equil) p~ from fir.d-quaner earnings repons 1ha1 generall) beal analysis· e.'pectalions was reponedly offse1 by increased uncenainly abou11mde policy. rising imeres1rates, and conctrns about polilical de1-elo1)ments abroad. While slock prices for companies in the !ethnology and consumer discretionary sectors rose no1ably. those of companies in Ihe industrial and financial sectors dedincd modes1ly. After spiking considerahl) in ear~ Februar), the implied 1ola1ility for !he S&P 500 inde' tht VIX~eclined and ended the period slighlly above 1he low levels 1ha1 prevailed in 2017. (For a discussion of financial s1abili1y issues. see 1he box '·De1·elopmems Relaled 10 Financial S1abili1y.") 25 - l - -..:m~lbcO.Ut«d&.il~ Y~ld ·~ . ihollt1. f'ot tbtfatlfti.:o ~"'-:~ nnt«~ilk~l'l&c••W~n~«<!i«WWtln ti0116dk pnMI• ptt.« '"'· ,. ,,. SprQI~'IIIiilttG.:»mttd'dlt 5- a:il..rc•.-..TmNII) )dk. nt.-a..m~Jif) II, Sou,, ~t(dltTICW).Ia'<~'- lOO m ,., -- ,." - - ~ :UD X01 ~ :006 ~ ~10 ,,,, Mil MU 1016 ll ~II Sol.m!~~~lb.lonN. I~ \'il ~ IFor l);)oll JeM II'ldl.:uh.~·rot!UIIftl,ta:Chtnte.tOD!k('«~~MJpltt.) Markets for Tr~asury stcuriti~, mortgage~d~ ~riti~, and municipal bonds ha1 e function~ well VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00177 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718028.eps On balance. indica1ors of Treasury markel funelioning remained broadly s1ablc over 1he firs! half of 2018. A l'llriely of liqt1idi1y mc1rics-induding bid·ask spread~ bid si1.es. and e:.1ima1es of 1ransae1ion COSIS hal'e displayed minimal signs of liquidily pres:.ures 0\CraiJ, "ilh lhee.,ctp!ion of a britf period of redUctd liquidi1y in earl) February amid eiCI'31cd financial market 1ola1ili1). Liquidil) condi1ions in I he agency MBS markcl were 174 Developments Related to Financial Stability The U.S. fioancial system remains subolantially mo<e A. forward price·t0oe3Jflings ra1ioofS&:P 500 finns re;ii~~IIM~ duri~g I~ ~l~ bel~ t~ fiMollial crisis.'Vdlr.tations continue to be e1ev.ated fOI' a range oi assets. rn the pti\tJte nonlin.anc.ial sector, the r<~tio of - JO tool d<btto gross domeslic prodU<:l !GOP! is aboot in line with an ~imate ol its trend, and vulnetdbilities ... -1S associated with ~ rem.1in moderJte on balance. While borrowing among hi~hly lel-ered and ~q,,~. - rated firms is ele\'.ated and a future weake-ning in L'O)fl()l1lic activit)' could ampli~1 wme wlner.1bilities in the corpor.te ~tor, the ratio ol housdlold del~ to dispos.lble income h.Js remained stable in recent ~~ars. Vulnffi'lbi1ities associ<tted wilh !e"erage in the financ:ial sector appear to.v, reflecting inpart strong capital po>itions ol banks. How.,.er, sorne measures ol hedge fund 1"'-erage hil\~ increa>ed. Vul"""bilities associ"ed with maturity and liquidity transfCM'mation continue to be low cornpared with lel.-ls that generally prMiled before 2008. Valuation pressure-s in \'arioos asset markets remain el.,.•ted b)• hillO<ic•l ~andards, although they have ~lined """"''hat since the ~art of the ~~ar, as corporal£ bond prices h.Js~ fallen and higher earnings ha\-e hetped ratiomlize equity prict>S. l\o\ad.:et ffiO\-tments were outsized in Februa.ry, around Ihe time of the prtl\•ious MOI>Iltary Policy RRport. Since then, \OOtili~· h.Js receded, although it has ended up ~ightly above the low le,~lsseen in 20t7. Even with higher e>peeted earnings due in port to changes in Ia< law, the fomord <Guity price-to-earnings ratio fe< the S&·P 500 remains in the upper end oi i~ hi~orical disuibution !figure A). Treasury term premiurm ha'~ increased modeslly from the beginning ofthe)~" but remain to.v relati\~ to histori<ally obse<ved '~lues. Corpotate bond )'ields and their spreads to yields on comparable· maturityTreasury~urilies f't{l\"e increased no1abty, but they continue lO be to.v b)• hi~orical standard~ In particular, spe<ulati,-e-gr.Mie rields and spreads lie in the bottom fifth and bottom fourth of their respecrive historical disrributions.tn le-~raged loan m.1rke'~. issuance has been robust. spreads hil\~ re.!Ched their ""'~ 10\~ls since the fonancial crisis, and the presence olloan r:m~nB has ~reased further. In real estate lO - ro - s ~lkO..Ocplct(t!.:~crot-."WPf".~~rUot WXOfir!M.Th:~D!'Ibllsbt:$fdtalht.afrQCIII'meolh..• pt6(ftl~Nrl~ptfll'Jsofr~as&fllllo.'\lbyWNJI:KCW ikmool£maom~R(k&il. DlllJ«b&'llti!OCII!~C'\f'o.'~ """"'"'"""" ~"l(l!SufT'~~coT~R~IB£$.. m.1rl<ers, cornme<ei.ll property \Oiuations continue to be Wetched. Capitali,.tion rates (computed as the ratio of net operating income relati,eto property values) rem.1in low, and, in recent quarters, their sp~~ds to yields on 1().J~r Treasury ~urities h3\-e ..,..o down consider~blr ~Rilll)~ -.lu.11ion pressures in resi~tial r"l eslate m.1r~e~ increased modesll)·· Aggregate priceto-rent ratios, adj~ed for an ~irna1e of their long-run ~end and the carrying~ of housin~ are approaching the cycle peaks olthe early 1980s and early 19901 but remain "~II beiO\v the 10\-els obse/\.0 on the.,... oi the ilnanciC~I crisis. 1\'tth households and busines>es token togerher,the ratiooltotal ~to GOP is about in line with estim.1tes of i~ uend, although podret> ol stress are l?'i~t. In the household sector, the ne1 expansion of housdlold debt has been in line wilh income gr~)'l\1h and is conceotr~ted among prime-ritted borrowe-rs. Ho\\'e\'ef, deli~uertey rates for sorne forms of consumer credit hal~ 010\'ed up, ~ing rising strains among riskier borrO\\-e/Se\~ with unemployment '"el\' IO\,•.IIanks are reportedly tightening standards on credit card and auto loans. In the nonfinancial business sector,ltl\~e of corporate busines>es remain; high, as indkated by a po>iti'~ ~toral crediHo-GOP gap. Net issuance o1 Ag<od.l; !pet<h rkl'««<atrheCoo:er for C!ob;l !cononl)• riSL)• debt has. riset~ in recent quarters, mainl)' dri\·en D)· .wd Bu5.iness, Stetn School of 8usinl"!os, N'ewYM: Univmil\', the growth in 10\.,.agOO loans (frgure B!. While current ~ewYork.A¢13, lmps.1Mww.fedetJ!resen-e,g(rdnf'l.~~ff.tv 1._ MO\«vitwcltheframeworkfor.,..,;ngfiooncol stAbil1ty 1n 11'1e United St.lt('S is pcovidro in l~ Br<Jitwd ~Ot81, "An Upru:eOClthe f«<«at ResEnt's finaocial S..bili~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00178 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718029.eps (con!irwedJ spet<h1lraiNrdl018040Ja.hrm. 175 MONEIARYI'OUCYREI'ORT: JULYI018 27 - 00 - (<!) _,. _., _., _,. .\00: '*' l:t"~ 1110\1118 fl~tAdt\\:1'16~ ))J$.-W, TOblo.1~ofrisl)&btiS41.:-~ofrb.!r.d~Of Sf"\'1lbli\{'-p.k101utemlboo.k2tldk;~-- Sc:u:n: ~~ rt,Ciilroblmaii.Sti.~Dallttir.S&I" u..~ """"""'rl"'"CotpOiate credit conditions are f.l\'Oiable O'l<'fall, with low int«esl e>penses and default>, the elel>ated le\'e1'age in this se<.101' coufd result in higher future default rates. In addition, weak p<otec:tion from loon CO'I'enant> could reduce early inten~ntioo by lenders and ""'"' recO'I<'f)' rates for im-e<too on default lnvestOIS may also be el.p()Sed to signifiCant rep~icing risks bec:au~e bond yields and credit risk p<«niums are bothiO'Iv. Vuln«abilitie< from financial-sector continue to be relativ-ely low. Coce flnantial intetmediilties, including large banks, insurance companies, and broket-doaler;. 3J'P"" well positioned to weather economic stress. Regulatocy Cetpilal •atios {Of the global l)'<lemically impo<tlnt banks h.n't remained \\~II abo\~ the lull)• phaled·in enh,10ced r<gulatory requiremen~ and are d01e to hi~orical high~ Capit>l 1",.'' at insufdnce companies and lnok«·deal«> also r«nain relati\-elr ~ by historical ltandardl. some indicators of hedge fund in the equity marke~ ""'h •• the provi1ion of lola! margin crediuo equi~· invesloe<. h,we risen to hi~orically eiO\•ated 10\-.ls, and in the pa~ iO\\•qua~«> deal«s ha,,. reportedly ea...!, on net, price terms to their hedge fund client>. The resulu of wper\<iSOI)' wess tes~ relealed in June b)• lhe Fede<al Resen-elloard confirm that the notion's Llrgest banks are wongly capi~lized ;nd would be able to lend to houstho!ds ,,nd businesses""" during '""''&• H"''"'"'· VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 '""'age Frm 00179 Fmt 6621 a 50\-ere global recession.' The h)')lolhetical '"'"'ely a<h-· !t~n.lnO-t~ li'oO!t wintMt !t~atio ret .led in lhe Board's wess tesll, \\ith the u.s. unemployment r.ne rising almost 6 pe«entage poin~ to I0 pe«eot-proj~ S578 billion in total losses fO< the 35 panicipating bani> during lhe nine qua~e<s tesled. Since 2009, thole Rrn~ h;n-e added about $800 billion in common equity capit.11. The Board also 0\•;luates the capital planning p<OCesses of the participating banks. including the firms' planned capit.ll actions, such as dividend parments and !hare bo)1>lcks.' The Board did not o!Jioo to lhe copital plano of 34 firn11. Although the recent U.S.t<IX legislation is expected to increa<e bank( post·t.J• earnings, and hence their abili~· to accrete capital, it did !<ad to one-time losses. deueasingbanks' capit.11 ratios atlhe end of20ti, the jumping-<>ff point of the wess tes1S.In part bec:a01e of these effect<, evident in te>rt figure 36. ~\1) firms were required to maintain theit caplt.1l disllibutions at the 10\-.ls they paid in recent yea~. Separately, one firn1 \\ill be re<1uired to address the management and anal)'is of its counterpart)• exposure under stress. The Board objected to the capital plano! one bank bec:au~e of qualitative coneems. l'uln«abilities associated \\ith liquidi~· and mawrit)• lr.ansfotmation---{hat is, the financing of illiquid assets or long·maturity assets \\ith shor1· m<~lutit)• debt-continue to be !0\\~ owing in part to liquidity r<gulations for banks and money market refor-m. large baoks ha-. wong liquidity positions, bec:a01e their ""'oicore deposits as a sourte of funding and their holding> of high-quality liquid assets temain neat historic.al highs~ \\'hile their use of short·tefm wholesale funding as a share of lidbilities is~~ historiCAl! lows. Since the rn<>ne)' market fund refor-ms implemented in Octobet 2016, as~elS under ma.,gemcnt ot ptime fundi, iflllitutions that ptO\W wln«Jble to runs in lhe past. ha\~ retnained far l>eiO'I'' pte-reform 10\-els. In addition, the 8'"''1h in al:ernati\'t short·tetm in\estnle01 \'ebides, which- may htwe some (cor>~nued oo nex1 page! l. S..SoardofG<>...,ofthei'<de<aiR"""~S"""' i20t8l. ·f<de<aiRe<trwl!o.!rd R!'lt""' R'"'l"of~i""Y ~rd: S!res.sTests,'" prtSS refe.ase, June 21, https1Mww. ieder<J~tien"t,gorlntwSE'\~ts.sreleasesl lxff8W18061ta.t.m. 3. S..Bo.!rdofG<>""""oflhei'<de<al Resen~Sy•em t20t8•, ·f<de<aiR.,.,~ R!'ltasesResuhsof~~ upila1Mllr%and Re\ie-viCG\RJ; P"s' release.lune19, httpsiAw..w.fedef.alreservt~·Jnew~atn!i')xess.rele.J:SeS/ bcregrol !0629a.lllm. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718030.eps 8. TOE3IIltlissu>DC<ofrisky<l.-bl 176 Financial Stability (ccori~>wd! VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00180 Fmt 6621 rno<e pronoonced vulnerabilities, rellecting some combination of the foiiO\ving: substantial corpo<ate l~'efage, fiscal concems.. Of E"xcessi\'e ,e-Jiance on foreign funding. GlobalI)•. po:ential dO\vnside ris~s to international fi..,nci•l ""lltets and financial stability include political uncertainty, an intemification oi ttdde tensions, and challenges posed by rising intere<t r.ues. The countercyclical capildl buffer (CCy81 isa m.lCroprudentialtool the l<de<al Reser\~ Board call use to increase the ~lieroceofthe financial sy>tern by railing capit.tl requirements on lhe largest banks. Acti-.ting the CCy8 is appropriate "ilen S)'Stemk \'Uinetobilities are meaningful!)' abo\'e normal.~ The Board is cl<ll<l)' monitoring the le,~land configuration of 'l"en'ic \'Uinerabilities descrihed ca~ier. 4. SeeBo.udof<A.<1nMoltllefede<•IRe«r\~Sy•om 12016!, ·Rogu\Jtory Upi~l Rules: The Fede<•tR-• S..,<fs for lmpiem«<:ing s.!<!l 111 C..nt«q<r~•t Upilal Bufle<; fifi.Jt policy """""'t{il<rlet No. R·l S29), r,.,....,, '""u.s. l«<<r•l~· ,.... 3tlSept"""" to). pp. 636$2-83. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718031.eps similar \'Uinerabillti~, continues 10 be limited, ~s in.O<lor> ""'~ shifted p<inwil)' from p<irne fuM< into g<l'<rnmtnt funds. Risks from abroad are moderate 0\'<fall. Ad\om foreign e<:ooornie< (llfEs), many of which ha\-e signifocanttlnanci.JI and ,..I linkages to the United S~:es, conbnue to have nolable or ele-.ted v•luations in some .asset markets and. in a few coonu-ies, high le\-els of household debt relahve to COP. These fdCloo ha\~ conviooted to some AFEs onnooAcing or implementing ,..croprurlential actions. including increases in counterr;ydkal capildl ooff.,, 0\'eflhe p.llt couple of)~~. More ;gene,.lly, AFE financial sectors contiAue their siO\v pace of dele\-er•ging th.lt staned aiter the global financial and euro-arca SO\oreign debt crises. In a<ldition, low corpo<ate debt spreads in the p.11t few)~'"""'~ )~tto vanslate into an)' m<~rked iocrease in te\-erage in most of these countries' nonfln.andal COff>OJate sectors. Some major emerging ,..Ike; e<:ooornies conbnue to h.l!bor 177 MONEIARYI'OUCYREI'ORT: JULYI018 29 also generally stable. Overall, the functioning ofTreasury and agency MBS markets has not been materially affected by the implememation of the Federal Resem·s balance sheet normalization program. including the accompanying reduclion in reini'CSimenl of principal pa)1nen1s from the Federal Reserve's securities holdings Credit conditions in municipal bond marke1s haw remained stable since the tum of the year. 01-er that period. yield spreads on 20-year general obliga1ion municipal bonds over comparable-maiUrity Treasury securities edged up a bit Money market rates have moved up in line with increases in the FOMC's target range Conditions in domestic short-term funding markets have also remained generally stable so far in 2018. Yields on a broad set of money market instruments moved higher in response to the FOMC's policy actions in March and June. Some money market rates rose during the first quarter more t.han what would normally oceur with monetary tightening. For example. the spreads of certificates of deposit and term London interbank oft'ered rates relative to overnight index swap (OlS) rates increased notably. reportedly reflecting increased issuance of Treasury bills and perhaps also the amicipated tax·induced repatriation of foreign earnings by U.S. corporation~ The up1vard pressure on shorttermfunding rates, beyond that driven by expected monetary pol icy. eased in reoent month~ leading loa n;~rrowing of spreads of some money market rates to OIS rates, Ho11-ever, the spreads remain wider than at the beginning of Ihe y~r. Bank credit continued to expand and bank profitability improved VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00181 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718032.eps Aggregate credit provided by commercial banks continued to increase lhrough the first quarter of 2018 at a pare similar to Ihe one seen in 201 7.11s pare was slower than that of nominal GOP, thus leaving the ratio of total commercial bank credit to current-dollar 178 35. R.acioofc01al romi"Jl(fCial ~nk rn.'dit to norninal gross domeslk prodoc1 - - i.S GOP slightly lower than in the pre1•ious year (figure 35). Available data for the second quarter suggest that gr0\\1h in banks' core loans continued to be moderate. Measures of bank profitability improred in the first quarter of 2018 after having experienced a temporary decline in the last quarter of 2017. Weaker fourth-quarter measures of bank profitability were partly driven by higher write-downs of deferred tax assets in response to the U.S. tax legislation (figure 36). -» 1 It I I I! I II I I l'OOO Z00!~2():)6,X(IS 1 I I 1! !0102:012 :0014 I I International Developments J l 2GI~ZGIS Sort«.: F<'lin3 R~'t BttW. ~ Rd:N HJ. ·As5ru »d ~oiC«rm."!NNIbnksintb:-U~~"':Ikt.:.of~ A»>));is, J.J H.NfAnai)1Jr."$.. Profl1abiti~· of bank holding too1panies 36. lJl - - JO ~~~~~ IJ - _,. u5 - 5 - - 10 _,. u IJ - - JO 1..0 !1 I It !IJ I!!!! 2IXKt !'001101)1 2006 b:OS 1GIO1'012 ZOI" 1'016 2018 ~n: lb:dlti~U~¥!4il'c ~!)~~(li Sol.n Fc&nl ~t Ran fcm FR \'-9C. C~ Flt\Wial SW<o=f«lllel.I"""'C_ , _ 37. Equi1y indexes for .,t,~lod fO«'ign «<OllOIIios - IJO - 110 - 100 _,,. I It.! !IllS I! 2'01, t I. t ZOI1 I I!! I .. I j ))JS SOT!: 1k dau :we .,.-ffit)' l\~ of daly &:.1 MtJ ('lj(f)j ~ Jui) IUOI&. SQ..-.u; F«cwo.-a W EaS.:.,...\-.; l~:i«"UIIIl<'IJ K~F'TS$ Political developments and signs of moderating growth weighed on advanced foreign economy asset prices Since February. political developments in Europe and moderation ineconomic growth outside of the United States weighed on some risky asset prices in advanced foreign economies(AFEs). Interest rates on sovereign bonds in SC1-eralcountries in the European periphery rose notably relative to core countrie~ and European bank shares came under pressure, as in•-estors focused on the formation of the Italian go,·ernment. Nonetheless, peripheral bond spreads remained well below their lerels at the height of the euro-area crisis, and the mol'es partly retraced as a gol'ernment was put in place. Broad stock price indexes "~re little changed on net (figure 37). In contrast to the United States. long-term sovereign yields and market· implied paths of policy rates in the core euro area as "~II as the United Kingdom declined somewhat, and rates were little changed in Japan (figure 38). Heightened investor focus on vulnerabilities in emerging market economies led asset prices to come under pressure tm•estor concerns about financial vulnerabilities in sewral emerging market economies (EM Es) intensified this spring against the backdrop of rising U.S. interest rates. Broad measures of EMEso1~reigu VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00182 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718033.eps 100 ~i: lo&:~: b nn.,P. IIJiri:ct~ MSCl Uo..,P. ~ lcaiCwt<O.-yll).\:\;~ \~~ 179 M().\EIAAYPOXV~EI'ORT: MYl0t8 bond sprtads Ol'ct U.S. TrtaSUT)' )ields 11idened notably, and benchmark EMEequity indexes declined, as investors scrutinized macroeconomic policy approaches in se1-eral commie& Turkey and Argentina. which faced persistently high inHation. expansionary fiscal policies. and large cur~nt account deficits. 1\(re among the worst performer). Trodc polk)· de-dopmcntsbetwcen the United States and its troding panners also 11righed on E~t Ea&~et prires. especially on stock prices in China and some emerging Asian countries. EME mutual funds saw net outfl0111 in May and June after generally solid inflo\\S earlier in the year (figure 39). While mo1cmcnts in asset prices and capital flo11~ "~re notable for a number of economies. broad indicators of financial stress in EMEs remained 1011 relati1e to le\ds seen during other periods of stress in rcctnt )"ears. The dollar appreciated After depreciatingduring 2017, the broad exchange l'alue of the U.S. dollar has appn.'Ciatcd moderotely in recent months (figure 40). Factors contributing to the appreciation of the dollar likd) include modmting gr0111h in some foreign economies combined "ith continued output strtngth and ongoing policy tightening in the United States. do11 nside risks stemming from political dc1<elopments in Europe and sercrJI EMEs, and the recent de\'clopmcnts in trade policy. Sereral currencies appeared particularly scnsiti1c to trade policy del'elopments, induding the Canadian dollar and the ~k<ican peso. related to the Nonh American Free Trode Agreement negotiations. as well 31 lt ._....,. tO.)<ar pCftll<!llbood!i<ldsiD l<k<W ""''IIC<d C<ODOOii<s 10 lJ !. -u -- - ,. - J .... ........., ~1: lllt- ~ and~'-61\ow daa.a ~tt qunctt)'5111Mof•MI)· dU timll.nut) 1.201~. '0 M.W\il )l,201 &. illdmoolbly . . . ol•MI)· d3bf~ A;al 1. 201~ 1011rlt)O, ~I B ThtfBJ!bl:s41Un.ct.k(IDh ~ -a... Tbr JP \S.,"q.W~f. . . . MJdttsBoodlD&_, ~ (l\lEIJo. . . lrC' ..ml)' :t.\ (1"1~dlbd) 4lu -~"tid ltmiP Jut)' ~. ,,~ Sot.IU; ,.,..,*.., ,_,.,..),unc.wcliwl\181·. 1' -~""""-""'""'•8loooloi as the Chinese renminbi. which fell nolably against the dollar in J~ne. The pace of economic activity moderated in theAFEs VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00183 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718034.eps In the first quaner. real GOP growth dereleroted in all major AFEs and turned neg:uile in Japan. d011 n from robust rotesof actirit) in 2017 (figure 41). Pan of this siO\\ing is a n.-suh of temporory factors. though, 180 40. U.S. dollarexchange r.Jt~ indexes I~ - including unusually cold weather in Japan and the United Kingdom, labor strikes in the euro area. and disruptions in oil production in Canada. In most AFEs, economic indicators for the second quarter, including purchasing manager surreys and expons, are generally consistent with solid economic growth. Despite tight labor markets, inflation pressures remain subdued in mostAFEs ... Non: fh:4#1.•hidlaxa~CVT~X~.."Yu=sp:t6cltbJ.~ •~'~tr ~"""'old>Oy"'"ID!"'-""""'''>"I)' II.lOitM<O<..-.!b)d. ~. ~inlhtcW~US.cl-a.IJ'S('~m:ldc\-rt&-S """"' V.S."""""""""" Sot.«t: Ftd..'nl R('SCr\'t Jbrd. S~ Rc\cw' H.IO. "f~ '""""'"'"'" 4t. Rc;llgrossdom<s<~pr<J<flJclp1bin sck<l<d --- ld\"ilnoo.. roreign ec-onomies .,.., •""'"'• -s _, EuroJ;:t~ • c..o. -1 -I - lO" 2016 lOll I lOIS Sollt(t; F« tklini'.N K~Olrt« kc ~5:1tist)..,. f« ~ CJlO.'IO!l"~«.Go\o.'!1m.'CIIIothpD:tcw-tbtCua:~w:;.t~r...... c-*. ~c_..n ,il t b\~ ~~ Sustained increases in oil prices provided upward pressure on consumer price infiation across all AFEs in the first half of the year (figure 42). However. core inflation has generally remained muted in most AFEs, despite funher improvement in labor market condition~ In Canada, in contrast, core inflation picked up amid solid wage gro11~h, pushing the total inflation rJte above the central bank target. ... prompting central banks to maintain highly accommodative monetary policies With underlying inflation still subdued, the Bank of Japan and the European Central Bank (ECB) kept their policy rates at historicall)' low levels, although the ECB indicated it would again reduce the pace of its asset purchases starting in October. The Bank of England and the Bank of Canada, which both began raising interest rates last year, signaled that further rate increases will be gmdual, given a moderation in the pace of economic activity. In emerging Asia, growth remained solid ... VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00184 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718035.eps Economic growth in China remained solid in the first quarter of2018. as a rebound in steel production and strong external demand bolstered a recovery in industrial activity and overall growth (figure 43). Indicators of investment and retail sales have slowed in recent month~ howe·m. suggesting that theauthorities' effort to rein in credit may have softened domestic demand. Most other 181 MONEIARYI'OUCYREI'ORT: JULYI0t8 emerging Asian economies registered strong gro11'1h in 1he firs! quaner of 2018, panly reflecling solid ex1ernal demand. 42. Consumer prire inRa[ion inscl«tcd 31.1'-aoc«t foreign C\."00011l.ics. -· ·-·- . . . while growth in some Latin American economies was mixed In Mexico, real GDP surged in 1he firs! quaner as economic acli,;ly rebounded from 1wo major carlhquakes and a hurricane las! year. Following a brief reco\'ery in I he firs! half of 2017, Brazil's economy Sialled in 1he fourlh quaner and grew lepidly in 1he firs! qua ncr. and a lntckers' mike paralyzed economic aclivil)' in !ale May. 33 - J - l _, - 1 I I I I I 20lS I I I I 2(116 I. I Wl1 I I I 1 ~IS ;.;on: 'fb:&-.J:(Ot~C\IIO~~~ftWINZirtu~(«J~ Mt~n.«u"'c.,.,_.,..,~.,..~,-~ Mi~ !OIS. &;.,,:10: F«tbtl.~ K~Offi,.~IOt~S&a:istits:f<w~ \lmis.tr)ofi~AffM.~C~..UOOS:kc'ckCW\la:t&, ~<~I OO"~Ctt!itkEwopt.-C~fortw.i.l.Sbti.il).'5 C.-h:;all\illb\ttrAIQI)ta."s. 4). Real gross dom<stic product gMAl h inS<i«led ~'fi'ICrg.ing ll'l.11Xct ttOnomies I Clio> • K(m . Mrt.ieo I &.ol :0014 201S - 12 - J - J Ql 20'16 11)17 :'018 \Ott~ Th:dlltaf«OiRallc~·a6juib!~· bdd'Jhcd)Q I«K«t<~, \]tt;a.,JOJbl *'t~· adjw..'l!~lbrit~'tft~ J(I\\TM'ICI:I.~ Sol.' ltt f«(li:la.ChiniN~Bimiool~ies::IOr KOI'Q.Sri: of KON:(b~1ruro.I.D$tiMo~dt&tklb1it.l)~ll:f« VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00185 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718036.eps Brdlt~SU~It.JO&Iiiklro&~ut8&auslk&;al\lalb\('t'Aml)ti."s. 182 35 PART 2 MoNETARY Poucv of the labor market and the aocumulating evidence that, after manyyears of running below the Committee's 2 percent longerrun objectil'e. inflation had mol'ed close to 2 percent. The Federal Open Market Committee continued to gradually increase the federal funds target range in the first half of the year . . . Since December 2015, the Federal Open Market Commiuee (FOMC) has been gradually increasing its target range for the federal funds rate as the economy has continued to make progress toward the Commiuee's congressionally mandated objectil-es of maximum employment and price stability. In the first half of this year. the Commiuee continued this gradual process of scJiing back monetary policy accommodation, increasing its target range for the federal funds rate V. percentage point at its meetings in both March and June. With these increases, the federal funds rate is currently in the range of I¥. to 2 percent (figure 44)." The Commiuee's decisions reflected the continued strengthening ... but monetary policy continues to support economic growth Even after the gradual increases in the federal funds rate Ol'cr the first half of the year, the Commilleejudges that the stance of monetary policy remains accommodatii'C, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation. In particular, the federal funds rme remains somewhat below most FOMC participants' estimates of its longer-run value. The Commi11ee expects that a gradual approach to increasing the target range for the federal funds rate will be consistent with a sustained expansion of economic activity, strong labor market condition~ and inflation near the Commillce's symmetric 2 percent objective Ol'tr the medium term. Consistent with this outlook. in the most recent Summary of Economic Projections (SEP). which was compiled at the time of the June FOMC meeting, the median of participants' t4. S.. Board ofGo,<morsof the Fodera! Re;cmSyst<m(20t8). "fedtrnl Rosc~·dssucs FO~IC Stat<m<nt.'' press release. Man:h 21. htt(IO:i/ www.f«kral~rvc.go,/ne,:rSc!wnts/pressrekascY mon<tary201S0)2ta.htm: and Board of Gowmo,.of til< Fedcrnl Re;cn< (lOtS). "Fnlcrnl R""~< ls;ucs FOMC Statement." pres$ ~'lease. Jun<: IJ. hu(IO:i/ www.fOOer.tl~n·e..go\·/net\~\'entsfpressreleaSc.W montlary201S061.h.hun. Sl""" - l - ) -· _, _, It I I 2Im I I I I 2009 I I I I! 2(110 I I I lG\1 I I I I I I I Z'Oll I I 1'0U I I I I I 20!4 I I :'GIS I! I I I :'016 I I l0l1 I I 0 I 2018 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00186 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718037.eps !\olt: Tbe 2-)'t*'~ l~'t'#Tt~111!e~o~ tht ~.f!'lllll.liJY)idds~cotbtt:IOSiani\'ttyuadai~ SoliO': ~ofrbe-Tr~~ Froctal ~c8QW. 183 36 PART2: ,\ION!TAAY1'0\«:Y assessmems for the appropriate le1•el of the target range for the federnl funds rate at year-end rises gradually over the period from 2018to 2020 and stands somewhat above the median projection for its longer-nm level by the end o( 20i9and through 2()i().1S Future changes in the federal funds rate will depend on the economic outlook as informed by incoming data Tlte FOMC has continuod to emphasize that. in determining the timing and size of future adjustments to the target range for the federal funds rate, it will assess realized and expected economic C<lnditions relative to its maximum-emplo)ment objective and its S)OJlmetric 2 percent iaftation objective. This assessment 11~11 take into aocount a wide range of information. including measures of labor market condition~ indicators of inflation pressures and inflation e.,pectation~ and readings on financial and international development& In evaluating the stance of monetary policy, policymakers routinely consult prescriptions from a varietyof policy rul~ which can serve 15. See oil< Jun< SEP. 11hkh appeared asan addeodum 10 rile minure<of rhe Jun< 12- 13. 2018. metringof rhe FOMC and ~ p= nre<J in ~an 3of rhis report ~~- as useful benchmarks. However. the use and interpretation of such prescriptions require, amongother consideration~ careful judgments about the choice and measurement of the inputs to these rules such as estimates of the neutral interest rate. which arc highly uncertain (see the box ·'Comple., ities of Monetary Policy Rules''). The FOMC has continued to implement its program to gradually reduce the Federal Reserve's balance sheet The Comminee has continued to implement the balance sheet normalization program described in the June2017 Addendum to the Policy Normalization Principles and Plan~" This program is gradually and predictably reducing the Federal Reserre'ssecurities holdings by decreasing the reinrestment of the principal pa)1nents it receives from s..cocurities held in the SystemOpen Market Account. Since the initiation of the balance sheet normalization program in October of last year, such payments hare been reinvested to the extent that theyexceedod gradually rising caps (figure 45). 16. The addendum,adople<l on June 13.1011, is 3\•ilablear hups:l/ll"w.f<dt'!'alrese~<.g<>~1moneta~poti()·/ flles'FO~ICYoli:yNom)a]izlt1ion.lllllU613.pdf. Principal po)'lll(niSon SOMA """rili<s As.:ncy d<bl and mong•~b.lck«< s<rurilics - so - ro - I R~ l kC'Itl\~ - - ~1oathl}~ 60 - - ~ _,. _, - 10 10 - ro 60 - ~ ~~1 1 1 1Whl11nuulnm~, ~ 1017 1018 ZOI9 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00187 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718038.eps Nore: Rtin\'(;)tmrtll3nd r\'(.!cmpbonamoUIItSof3~'fK1' mOf1pgr-lxtd:cd$00urit~art proj«1toosSUtnins inJW'IC 201$.. Thcd;,ti' o1cOO l~roustJ IAX\"'lllxr 2019. Sot'U"E': F<d.T.IIResc~t Bank.ofN~· Yor~: Fede-ral Rescot Soard staiT~l"'btiruls. 184 M().\EIAAYPOXV~EI'ORT: MYl0t8 37 Complexities of Monetary Policy Rules Overview \ \011&1)' polic\' rul<s are mathem.lliCallormuLH !Nt INto a pol~ in:.r.s~ r.!lt', such .os tilt r.do<.t foods r.>:e, 10 a,.,.n numbe< d och« t<onomic ,.,ial>loHipic.all) induclu>& tilt dt.'"'"'" d ioil•t""' from o:s wgt1 ·~lue•b>&"'"' on <SbmllOoi ,.....ICt ~ack in tilt ((0110111)'. Policy rules can Jl'O' ide helpful guidance for policyn13ke~S. lndetcl, since 200l, prescriptions from policy rules hm IX'«1 included InwfiUen ma~erials that are routinely sent to the fcde<.tl Open Market Committ.. IF0.\10. HO'>\t\'tl', lnte<preti~tion of the p<escriptions of policy rules «<~"'"' c>ttlul j~Jd&moat about the me-t of the inputs 10 the rules dOd the impl~aliORS d tilt""'"' coo<idotatiOIIS N tilt....., do no1 ul.t into acccunL Pel)() rule< c.n moo.pora:e I.e) proac•plts d good I1II>MII) poli<\. One by pnnciplt is that ntOIIOiat) polo<) silould respond in a preclicublt ""~ to ch.!nses in «ooomic concl~ions- A seconclley principle is that monet.try policy should be accornmod.lu•~ when inO<tion is below the desirro le-~1 and employment is ~ow its: m.tximum suSUiinab!c 1('\'tl; (00\'tfStly, mooetory policy silould be ftllricti•t "lten the opposito holds. A third key principle is""'' 10Sl.lbilize inR.!toon. the policy ra:e should bt acijustocl b)• more thon ..,..(or..... in «SppOiS< 10 ptr'i>ltnl inctt.JStS or c!Krt-ininlb:ion. Ecooom>S1S ila<-e onol) zed Nil\'-~ policy rulK, •n<lucling the "-ell-knol\11 Ta)lor tl9931 rule. Otlw< rulei include the •IJalancro "f'P'''Ch. rule, the •adjll!led Taylor (1993( rule, the •prict le..•l• rule, and the 'fil11 diffetence· rule If'S"'' 1\l-' These policy rules t. f<l1 di!<.,.iorlll'g.lrdi ng prin(lpifs for lilt CooclKI cl poli<yond-~ poliq Nios.I<'OIIoo<dol ec....... clthtr.deraiR«M•S)-~018 . , _ . ll>li<yi'Mciplfsondf'l_._.lloo<dciC..'""""haplc• ··"~'-f"'"""""'pol"'--poli<\ ...... ~ l. 1111'1A1ol'l19iliiUit""'~""""l."'lor <199!\ ·o-,...,..l'oloc\ xu~t> ..,.......-~ itoc'-'~S.O.Sooll.oblr.....,.,.,.JI.l9 mlKt 1M lltret ~ p<incipl~ of good mo~t~UI)' pGiily noled e"lier. Each rule t.J~es into .JC<O.Jnt estin13tes of how fat the economy~ from achit<ing the Ft<ler•l Resen~s clual-m.ndato pi; d ma.'li....., emplom-..nt onclprnsubolotl fcJul d the fn-e ruiK IIICiude the cfiifmn ~,... the rottd unempl0)100ftt that is SIJSUinablt in the Ionge< run and therurrtnt ~ment rate \the unempiO)ment "'" gipl; the first-diff"""t rule includes the change 10 the unempiO)ment gap "ther than its le-~1.' lit old<lition, four of the fi"e rules include the difference bC!\\ctn '"'"I inflation and the FO.\IC's longet-run oblecti,-ell pe«ent<11 measured by the annual change '" the price incle-< f<lr per!Mll <~ t>ptndturt<. ()I PC£1. while the prnle\-.1 rule in<bles thew btlween the le\"01 d pnces lOeb.· one! the le\-.1 d pn<K that would btob<tn~ ii inllalion hod IX'«1 consuot at 2 pe«ent from a spocif«<staning)-e••II'IJ~).'Theprn-les-.t rult there!>)· uk.s accoun1 of the dt\·iotion d inflation frorn lcoounu«i on nex~ p.~ge! Pclicr. -''""'"' ~"'~""'""'"""""""byther.de<ol R<l<nt S.nl< ol ~Cil\,lield in iKksonHole. \1\o. AiJ&u<ll·l ~CIII:f<d!r•IRtwn•B.InkciKarw m-s9. hap\JI••• U....:i!\1td.oo;~ a-,""' ,.._l9Mt&l.prlf"""'.""""................ iolrocb:tdbl""""'-~·lOOl\-.1 \-lllfic,ANI>·•*""""btulo.'Jovm ;l ....,-..,.,,_...... so~,pp.98l-tOli.A ~·""""clpoli<yNitsoonJohn&T"lor ondJohnC. 1\JI-•ZOin ~"'!!le•r<IRobuSIRulr-lfor MMtt.v)' PolK'\,.. 1n ~mli!IM. fr~n ilnd Mic:h.ltl Woodiool,<ds.. fl.lrx/bool.cl.lf()llf!~•lconomia.mi.JB (,\mll<<d.lllt NoroMfoiiJr<!l, AI· 8~S9. The,..,.,,(uMI' oltli<HlJ>dbooldM«-.wylcCI>I)tlli(s•lsol•""''' -hesooht<tb.anpolic\-rule>fordefflingpclin«l< pcescripclon5. J. The 11\lor <1991• rvlo..,..,......t!bd: in"""""' ..oliu:ioo""""' .....""'~--"""...... -lt.tlciiOIIp>!'-~(;I)I'·Md •b.at CiOP•ouldbtilf .. «OfOI'I'I \Jo.K~~~ tqib-. The NII-I <I f..... A..,.......,. !bd; i n - . L<iloubOII~IIIf-..."""'&'P""''ad,b<austN ~'~'beae<""'""'""ro'IC'•"""""l·sooiiOprornoot 0«....0..' PI'· t9>-1t<. -n.. b.l~n<«htpp!O>dl M<... trWitnumem¢q,tnM. ~\O'.emtnli in t~af:etN:ti\'t ln.>lyr<d 10 John & T>)lor(l9991, 'A Hi!IQII(,IMII)>Ool me.tWresol ft'§OU!Ct ut1l11~tion .1re higl~· corrfia:ed. fol 1\Jiicy Rules; in john 8. TO)lor, <do MOtWWr Policy mace inform.uion. K't lhe note bebv f~gUre A. Ruh!Chk"": Uni>«silyoiONugoPIC'SSi,pp. Jt~l. The 4. C.lcul.>ling lhe p«!Criptions ol lilt prict-lt\tl rule ol<ftv<~I T>ylor!l99llniltw"wcll<d10ll".JR~I;clwidor r~i•es setro.ng;) ~111ng )~.U fOt the price lt\-el from whkh '"' folln C. \\Ill;..~ 120001. 'lh<,.l,.,.., for Mor..Ury tocumul>:•the l p««111 ""'"I ioll.ltion. f'S'JreB u«s t998 IIIIi<-, on ,l.,......., 11.._• /<JuiiW/cl lloMy. Ctt61 ond asthe.,rting\fM.Arour<ltt.oliMf.tht...,....ingll<nd oliotWbonond ........... iliJI.tioo~!Uboltml """""''"· lll""<ftlbe1'. pp.9-Apn<....,.lrult .... """-'ioRdle<tltlol•t9$l\ .,_..,~ ". ~t<.t ,..,.,_ ~"' m.c.o. ......""" POns:.s..l' io -Siobbo ondft.IM. 1Jifl""l """"''Y VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00188 Fmt 6621 Sfmt 6621 "'"'dost.. L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718039.eps ra ""'' 185 38 PART2: ,\ION!TAAY1'0\«:Y Monetary Policy Rules (continu<d! A. Moneta!)' policy rules Taylor (1993) rulo Balaoo:d·approoch rule Taylor (1993) rule. adjl;ted FirsHiiffr:renct rule Non;: R.~. Rl-'. Rl'~. R/>t, and ~~·~ rtprcseot tlx: '"J.liJC'S. ofttM: oominal ffdml funds nne Pf(S('ribcd by the Taylor tl993), b313111.'\-d-3J1PCOOC'b. adjust~-d Ta) lor (1993). pri«·lc\\'1, and fifil-diffm'flfX ruks.ttSpX~i~cly. R.,cknot~thc- actual nominal f«l"tal fu.ndsra1t:forq1.13n:cr r.tt is four~uarttrprict infhtiott forqU3rttr r. u,i$ tht unemploymtnt rateinqoon~ r. and ,,u istJ\colt\'tlofthe ntult.ll real fNI.."nl funds r.ucin t~ longer run thlt on 3\'ttagt. iJ c-x~··ud to bcoonsistrnt \\itb :su~1aining ma.\imumnnpk)rmrnt and intbtion at the t!OMC's 2pcn.<totloogcr-runobj«ti\'t, t•. tnadditioo.u}•is ti:K- r:neofunemplo)mtflt in tik lor~~rrun. Z,isthccumulatirc sumofp.Jit dc\i31ioosofth:f~-&:r.tl f\ll'lds rate from~~ pl'\'$(Ti~nsofthcT3}1or(l9?3) 1'\11.! \\'hen that n.dc prescrilxsstnin,gtl'K- fcdr..'131 r~,~.nd$ ra.tc-~tow ttto. Plgilp,iStht J)el\'tntd.."\iationofthe3C:I.U3l k\<tl o(pricts rrom.a prire lt\·\'ltb.lt rists2 petctnt pt.."'l }'W fromitsltwlina S(JM!i<d Sl3ning period. TheTaylor (1993) rukand'()Li-.'f poli1• I'\IJ..:s are gco..'r.aU) v.'Ti!trn in tmn~ ofthe dt\iatioo of ml ootpul from its full <;'~~city lc\cl. In ~ t<juatic>ns.. the output gap has bctn rtplao.'d ~~oitb L~taP b:twctn tbt rateoft~MIJlpiG)mtnl in tt.t loi)$rrun3nd i1$3ttuallc'wi(LI$itlg3 f\"lalioal$}1ip kttO\Io'J\bOl:tln's law) in order to ttprtStt~ttbt ruk$ in rcrmsoflbc FO~IC's st3tUt01)·pk Historictlly. nxwcmcnts in the ®tput and un.:mploymcrll gars ha'l' bml high~·oombtcd. Bo..~ note 2 pro\».."S rd'crrnm: for •he poli..)' nJb. •bol• inflation~. The ~justed layiO< 11993) rule recogni<es that the federal funds rate cannot be reduced materiaII)· below zero, and that following the prescriptions ol the stond.udlayiO< (1993) rule after a reces~on during which interest r.tles ha\•e iallen to their lower bouoo may. for a time, 001 provide enough poli<y accornnlOdation. To make up iOf Ihe cumulati\-e shortiall ina<commodatiO<l I.Z), tilt ~ju~ed rule prescribes only a gradu•t return ol the policy rote to tilt lpositil'e) lewis prescribed I~· the st.lndard Taylor 11993) rule after the economy begins to recO\~r. The panicul•r p<ice-le-d rule spe<:iiied in figure A VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00189 Fmt 6621 also recognizes that the federal funds rate cannot be redoced matt<ially below zero. If inflation runs bei0\1' the l percent objecti1~ during periods 11i>en the rule prescribes sefling the federal funds Idle 11~11 bei0\1' 1..ero, Ihe price.lif\-el rule '~ ill, O'l't'f lime, ptO\•ide accOillmod,llion to ma~e up iO< the past inilation shorti•ll. The U.S. economy is con1plex, and the mooetary policy rules shown in figure A do 001 capture many dements that are relev•ntto the cooduct of monet.lry poli<y. MO<<OI'er, as shown in figure B, different monetory policy rules often offer quite differer~t p<esaiptions ior the federal funds rate.' In practice, thefe is no unique criterion for fawxing one rule 0\'ff ano!her. Inrecent l~•o;. alnlOSiall oi the policy rules (conUnu<d) S. These prescriptions"' alcul.!!ed uling !II poblisOOJ <bla ior inilation and the unem~-met~t rate and (21 SI.H\'t)..based estimates oi tht loogtt·,un \iii!Je oftht nt\ltril rul inle«ii. r.-tc and the !oog«-run \'alue of the u~mentralc. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718040.eps the long·run objl!(til~ in earlier periods as 11~1las the currer~t period. Thus, if inll.ltion had beerl running peru~erld)• 2 percer~t, the p<ice-lel'd rule would prescribe a high« It'-d for the federal fuoos rate than rules that u<e the curr"'t inflation gap. li~ewise, if inflation had beerl running pe<>ist..,tly below l p<tCer~l, the p<ice-iel-.1 rule would prescribe sefling the poli<y rate lower than roles that use the currer~t 186 MONEIARYI'OUCYREI'ORT: JULYI0t8 39 ... , -I _, _, -l _, -a "t' 2014 l0t6 ))IS ~:t: Th:rulo!:s~~'~¢1whr$on.~f<6.'0:1M6$~21'141h:~ltlmll'lC{,~iJt:o.'«<l::t{\j~lb:~p.'tt.~~ia lbt~iral."tlkc~~t'\j.\.~(fa)~fi»!XId~.~,~P'oj..'\1:it»SofiMtaa\~lkclbrW:ni~fll(ad llx-.~D."'Il!Wxt~-Ntboup~t(tumu:X~'1i.1csfNaaB~""'f.«a..lcaKID&~llx~\-biGilD:ots.bl'(ll ~~ pcttm. Thc-bl$(lukol6.:fM" lr\"i i&lb:n·.:"'~~p:hdcllh:~iD&'i f\'lrPCE('\~~~a'XI"R ia 199S~ •lr:'I'('I,'UP,'f )'Qt. Sct.JJCI:f~~~e.dolfflt~Wo."..;nK);v.-.,.,Bb:Cbp~~fo$cBJR.N't'l'f:Bo.1nJ.!tlfrat~ Uncertainty about Ihe neutral interest rate in the longer run The Taylor (1993), balance<l-app<oach, adju<ted Taylor (1993), and po-ice-level rules p<ovide p<escriptions for the ~f!l oi the i«letal funds rate; all require an <Siimateolthenewal real inlef<SI me in the longet run ~.''l-that is, the level oi the real f«letal funds role lhal is ""peeled 10 be consiSien( in the longet run, with maximum em~loyment and Sl>ble inllarion.'The neutral re~l interest r.are in the longer run is deietmine<l b)· wuclural features of the economy and is not ob<erloble. In addition, its _.lue may '"'Y Ol'et time becaUle ol flOC1uations in trend productivity 6. The flrst·cfriietence 1U~ st.cr...n in l"igure Adoes~ require .1n e!Aimatt d.1N! netJtril1re-.al in:ec~ r~e in the ion&e'rtW. HOWt\'tf, this ru1eh.Js itsQfl.\ll sbottcoolint>- for ~mple. restar<h sugses;s IN11hi:s sort U rufe will result in ye.r.e. ,OOtilit)· in tnlp1oo,'J'netlt ,dnd inii.Jtion rtbti\-e to \\hal •ould be obl.Jii'Ofd uncle< Iii<T<yb (199l)and b.l~· a~ rules unles the e!fimatesoitheti!Mt;d •tal ~.-1 funds r.J:ein the !onset run .lndtAer.J:eof uM"mplo•imt'nl in !he ~ nm ~t a1e illtluded in those rule$ are wfficiena~· i~ from thei1 ltue ~·alues. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00190 Fmt 6621 gt01~h. changing demogtaphk>, and 01he< shins in the ~ruclure ol the economj•. As a resul( estimales oi the ""'lr.l real interest rdle in the longet run made ioda)• may differ sub<!.lnliallj•lrorn estimates m.de late<. Academic lludies have <Siimated the Ienger· run \'t~lueoi the neut.tJI real inte~est rate using Slahllic.!ltechniques 10 capture the '"nations among inflation, inlet<SI taleS, real gross donl<Siic produc( unem~loymen' and other data series. The tang. oi estimates~ ll'ide but suggests that the newal real rate has decline<! since the turn oi the """lury tfq;ure 0.' Thefe is substantial ~~~stical uncertainty sum)mding each es~imale oi the longet-nm \•alue oilhe netJtral real rate, as evidence<! by the ll'i()th oi the 95 percent (conrinue<l on ,.,XI page! 1. The"nse""""''""OOilljJW<I"'""puiJI;s~-«~ va~ or \alues comjXf.ed using the met~· irom lhe foil&,, ing stud~ Marco Ott Negro, Domenico Ci.lnnone, •'"" P. Gu-i. and .Wm Tambok>lli llOtll. •SJle<y, liqu~<y• ..0 Ole NaMal Ra:e ciln:«"'-' B•ocki'8' PapeN on Ccooonlic A<m·il)•, Spring. pp. m-94, "''~""' \\uw..bccd:ings.edu.lwp-<ort;enl.<'~l7i081 dtl"'%'«"1!j)t7bp<aj)di; li.ltlwyn Hoi•Ot>. Thoma<Uubac~ .and John C. \\~lli.Jms t201 n, •Me.asuring tile NatiJfal Rate oi Interest: lr.::trnatklNITrends atd lX>cermfnJA·s.: /0<#"11 oilnt""'....,CcOI>OIIIi<s. SUW· I, ,'(li. t08 IMayt, pp. SS<)-75: S..~min K.iolw"""" Jtld nmar •"'"""(~16!. 'The E>p«W R.,lln;<-"' R.>te in the long Rul'l: T~ Set~ [vidt.>oce with lht Eff«til'f: loo.,·E'f Soond.' fl'DS No<es ~\'W>ing:oo; Boofd ol ""'"""" Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718041.eps shown have c.~lied for riling'"'""" oi the f«letal funds role, btr1 the pa<eoi ughtening lhatihe rules prescribe has ''aried widel>'· 187 40 PART2: ,\ION!TAAY1'0\«:Y Monetary Policy Rules lcontinwdJ unc<rt.lin~· bands lor !he estimated \Oiues in the tlr~ C. R:.nge ofsri~XItd ~tima!es fot' the- t~n~lral ml rrderal funds 11te in tk lon,g~r run quarte< of 10181figure0). The longer-run fl()(mallewl oi the iedefal funds rate under appropriate monet.lry poliC)'4'J'IIto the sum of the neutrolreal inte<est rate in the longer - s run and the FOMC's 1peroent inflation objectn..,._is one benchmark ior e\'JIUJting l.he current ~ance oi n)()fle(ary poli<y. Un<ertainty about the Ionge<· -) run value oi the neutral real interest rate leads to -! unc<rt.linty about how far the current federal funds -I rate is from i~ longer-run 110<maiiMI. For the Taylor n993), balan<ed-app«>ad>., adj~ed Taylor 11993). and price-1"'-el rules, different "'imates oi the neutralr<'al -I interest rate in the longer run tr<~nslate one·for·one to -! diffe<enctS in the prescribed settingoi the federal funds Idle. As a result !he subst.lntial s~ti~icll un<ertainty accompanying ~imates of the neutral rate in the 1\on: llK'sblall:llirs~pmo.h()(~~uikfiMib) longer run implies substantial uncertainty sunounding e.c~~bmc4~~cb. the r•escriptions of each poli<y rule. rollowing the $ol;l(1: r~1 Rrtc't\( ~wfl'takll.~alo:oo;•illlrddtl).~ lt!ltdilbo.\!Xkl p:escriplioM oi a policy rure with an incorrect value oi !he neutral rate coold lead to poor economic ootcomes. If !he Ionge<-run 10lue oi !he llefJtral real interest rate then moneta~· policy is more likely to be constrained is cunently at !he low end oi !he range oi estimates, bj·lhe lower bound on nomin.1l inte<est fdtes in the future. Hi~ork<llly, the FOMC has cut •he federal oi the Ft'dftal1testl\~ S)irtm, ffbc'wlty 9J, https:/An\W. funds rate by 5 pe<cent.lge poin~. on a-,.-age, dur;ng ftde<olr""'~¢ec""'eld.>"''"""~<ds"""'<'<l0tr,l doll'nturn< in !he e<Ofl()(ll)'· Cutting the federal funds the-txpect«J_,~.~I-i~eres~-r<~t~tD-(he-long-AA'Hime--sertes r.11e by !his much in nesponse 10 a lulure ecooomic f'\idence-with-the-ff!ectr.-e-b"·t!f·bou00.20160109.htmt MkhJ~T. KHeyQOtSI, "IW>.liC.nlheO.~T~IVsobovl downtum may no1 be feasible if !he ""'ual federal the Equilibrium R:t.al In~ R.\ltt?~ finance .and fCOtiOMics fun<~ rate is as low as most oi !he estimates suggest Discussion Series 2015·77 l\Vaslli~on: So.!rd ol Gol."tmM lconunwdJ of the rm•l Resen~ s1- . Sq><tmbetl, hlrptid<.dot O<Sf10.17016/FEili201l.071: Thom.lsuw.ch and lolln Co--..nors oflhe fm•l Resen• Sr•<m, June>, ht:ps11 C. \\~Ui.lms fl015~. ~Me.awrirll; the Niluf11 Rate of ln1«tsl. doi.OWI0.170WF(I)S.1011.059; Thom.lsA.Lubil< and R~· Hot<hlns C<niE<II'orl:;ngP'l"f IHII'>sh;"&'oet Cllti~ian M~tth6 (201>•. "Qkub1tng the NJ:1ur.al Rateoi 8rookiflgslnslr.U1ion.,N'<Yi'ftllbtf),~I'WW.b«dings.. _, natu~al-inll!feSI.·r.ltt·«'du~.pdi; Kurt r. Lev.is and ffal')(iSOO of tUcl>mond, Oci<>l>o<), haps;IA'""'·rkhrnondit<!.~-lm<dial tnter~: Al:emali\-e Speciflcjli()ns.,"' fiMnce and EconomiC$ DiS<ussionSetiE's. 2017.059{\V.ashi~oo: Bo.udoi pdi'eb_IS·IO.pdi. 4 VerDate Nov 24 2008 14:11 Dec 18, 2018 IA:t'l't'Sl: A Comp.J~ oiT\\'OAI~etnari\-t Appc~.... !<ooomic Bri<l 11·\0iRid>mond. Va.: fult<al ~.Ban\ Vazqutz·Crandet20171. o\1ea..suringthe N.ll\ltal Ra:eol Jkt 046629 PO 00000 Frm 00191 Fmt 6621 ri<Nnondiroof&~;oo,i"""'rd.:«oooo>~-bliA>V!Oill Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718042.eps eduA''fXOI<<OO'~t~1liiii'PIS.ullb>ch·I~IH"""' 188 MONEIARYI'OUCYREI'ORT: JULYI018 41 D. Poin1es1imaoosand uno:nain1y bonds for neuoral real rJtc in the long<r run as of lOIS:Ql Dcl N<gro and othm (2011) Holston ond others (20 17) Johannsen and Menens (1016) Kil<y(201)) 1.3 (.i.2.1) .6 .7 (·l.U.l) (·l.l.2.5) .4 (·.6. 1.6) l.auboch and Williams(2015) .I (·5.4. ).6) l.ewisan<l \'azquez.(;mndc(2017) 1.8 (5.3.1) lubi~ an<! Mauh<s(lO I)) 1.0 (·2J.4.5) 8. for fuMet d&ussion oi these issues, see Mi<Nt.>l T. Kilty and 1oM 'l Roben> l20171, ' Moneca'l' ll>l<r in aL~. In:fff'!.t R.lte\\'otid.' Brooking> Plf>M on CcMOml(' AcrliiJy. Sp<i~ pp. ltl-n ilttpsllh"'w.il<oolings.edu"'JKOOt"" uploj<W20t7100lcii<)~"1J1>tlilj>ta.pdf. 9. !cooomist< ""'~ fouoo oh.!t a' mokcup' policy"" bE'thebestr~inthoor)·v.henthepolicyinlerest rcl:eisconstr<linedat;:eto.~BMS.Sffnal'lk.et2017J. '""100ttat)' Policyin.JNev.· Er.t•papet~esenled<!t 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00192 Fmt 6621 In the)..~ foiJo<,·ing the llnancial crisis, with the iederal iunds ra:eclost to ttro, the FOMC recosnized lhal il woufd ha\'e limited scope to res.pond to an une>pected weakening in the e<O<>om)' b)•lo<"!ting short·term inle<est rates. This risk has, in recent)~'"· prcwided a sound ratiOMie f01 iollowing a more gradwl path oi rate increases than that prescribed b)• some policy rules. In lhese circumstooces, increasing lhe polity rate quick~· in O<der to ha1·e room to cut roltes during an economic downturn could be counterprodudive bec.1use it might m.1ke a do\\ ntorn more likely to happen. ·Rethinking t.licroeconomic Policy; .1 conft'ffOCe he$d at the """""'tn$!hute io< lo:..,.tioolt !cooomicl, ll'>lhingl<Cl. Oool>t< 12- 13, http</.'J>~.com.~r•e<Miles'documefliSI be<n.lnke2017tOll!"'"'.pdf: aoo Mkh3<1 ll'oodfO<d(t99!1), 'C..Ill>en~a')' ~·Should "''""ryl\>licy B< Coo<loct<d in.ln fla cl Ptice Slabilil)·~· in Nev.•ChJISMgt?s lot MOOfW)' Po/ky. p<Oeeedings cia S)mposium spoosclft'd bj•tl>e r.de"l R.,.f\0 Bank City (Ka""' City, Mo.: federal R""'e Bank oiKansos City)pp.177-lt6. ilttpsl!h~,w. of"'""' kan$.1SCityf~ica1i~'n'SearcM'5Cp.$.~UillY t!Cp-t999. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718043.eps As a result it may not be ie.~<ible to prcwide the iel-els ola<comrnodation !"<SCribed by many polity F\Jles, potentially leading to ele\o:ed unemployment and infl.1tion il\oeraging below the Comminee's l percen1 objecti1~.• Rules that t1y to oliset the cumulati1~ short/all oi a<comrnoda!ion posed by the lower boond on nominal interest rates, such as the adjusted Taylor (199}1rule, 0< make up the cumulalivt short/all in the lewl oi p<ices. such as the pric..Je..~l rule, ace inten<led to mitigate the eliec~ of the lower boond on the econom)' by P'OI' iding 1110<e acconmlOdation than P""ribed by rules that do not hill"e these n~keup ieatures.' VerDate Nov 24 2008 95 pm.~t ui'!Cfftaint)' band Point CSiim:ue Stud)' 189 42 PART2: ,\ION!TAAY1'0\«:Y In the first quarter, the Open Market Desk at the Federal Reserve Bank of New York, as directed by the Committee, reinvested principal pa)~nents from ;he Federal Reserve's holdings of Treasury securities maturing during each calendar month in excess of $12 billion. The Desk also reinvested in agency mortgage-backed securities (M BS) the amount of principal payments from the Federal Resen·e's holdings of agency debt and agency MBS received during each calendar month in excess of SS billion. Over the second quarter. payments of principal from maturing Treasury securities and from the Federal Reserve's holdings of agency debt and agency MBS 1vere reinvested tO the extent that they exceeded SIS billion and Sl2 billion. respectirely. At its meeting in June. the FOMC increased the cap for Treasury securities to S24 billion and the cap for agency debt and agency MBS toSI6 billion, both elfecti,•e in July. The Conunittee has indicated that the caps for Treasury securities and for agencysecurities will increase to $30 billion and S20 billion per month, respectively. in October. These terminal caps will remain in place ·until the Committee judges that the Federal Reset~oe is holding no more securities than necessary to implement monetary policy efficiently and elfecti1·ely. The implementation of the program has proceeded smoothly without causing disruptire price movements in Treasury and MBS market& As the caps ha1•e increased gradually and predictably, the Federal Resene's total assets have started to decrease. from about $4.4 trillion last October to about S4.3trillion at present, with holdings ofTreasur)' securities at appro,,imately S2.4 trillion and holdings of agency and agency MBS at approximately Sl.7trillion (figure 46). The Federal Reserve's implementation of monetary policy has continued smoothly To implement the FOMC's decisions to raise the target range for the federal funds rate in March and June of 2018, the Federal Reserve increased the rate of interest on e.1cess resen·es (IOER) along with the interest rate offered on overnight rererse repurchase agreements (ON RRPs). Specifically. the Federal Resen-c increaS<.>d the IOER rate to 1¥. percent and theON RRP oft'ering rate to Iy, percent in March. In June, the Federal Resen·e increased the IOER rate to 1.95 percent- S basis points below the top of the target range-and the ON RRP offering rate to IY. percent. In addition. the Board of Go1·ernors approved 46. F«l<r.ll Re<m'03SS<lS311d liabilili« m1 l!11l lOIO lOll ZOI2 2013 101~ ZOIS 2016 2017 2'01S NQw.*('f\'\Jil:aad~T)·f-.~M~(If~.9.\~, a/)lj~((~il;«'f"''Q*J(1jon~C\"'tta)ltW;!iquidir)$'o\-.,:iq,:«<(ct Milll.'fl ~. 8c.arSt.,"'"JJ!'M,.andAIG:ar4«btfet\"Jii f.xil~ incltJdinslh:Primar)• D:UrCrtdit f.lcibl). tb: Mio.1·Bad:cdCOC'WI'ICf~ Papo.'t ~l(6.1 M~ ~IUiual r~ ~~ f~!i~;y. 0: c~ hp:r f\tlding faciliTy. -.1 UJc T;:nn Mct·lbdo.~ ~"l.liziesl,(qn Facitay. ~ asscu~ i!>:bht;CWOtti:tcdpr<tfli1,1:1'11Satld~boo~ONI!cldour.rtp..~Widodlcttiabi1iti.::i-eo.:W:s~~~a~'ITII."f'R.'41tU.S. Trta.olur)·~,.,.,UAc.."o))..ll,anda.:US. Tl't'~~-mr:1lllf)'Fu*"-...,AC'«!!CL tkdaUit\k"'OihrougbJifly-1..2018, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 fcdcft]Rc$cn.:Bo.v.i~lisi~Rd..'t5t i i-4J.·f.1d011A~R<$m'tlb~- PO 00000 Frm 00193 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718044.eps Sol.-.«: 190 MONETARY POLICY REPORT: JULY2018 The elfec.tire federal funds rate mo1'ed up toward the IOER rate in the months before the June FOMC meeting and, therefore, VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00194 Fmt 6621 was trading near the top of the target range. At its June meeting, the Commiuee made a small technical adjustment in its approach to implementing monetary policy by selling the IOER rate modestly below the top of the target range for the federal funds rate. This adjustment resulted in the elfectire federal funds rate running closer to the middle of the target range since mid-June. In an environment of large reserve balances, the IOER rate has been an essential policy tool for keeping the federal funds rate 11ithin the target range set by the FOMC(see the box '"Interest on Reserves and Its Importance for Monetary Policy'"). Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718045.eps a V. percentage point increase in the discount rate (the primary credit rate) in both March and June. Yields on a broad set of money market instruments moved higher, roughly in line with the federal funds rate. in response to the FOMCs policy decisions in March and June. Usage of the ON RRP facility has declined. on net. since the IUm of the year, reflecting relatil>ely auractire yields on ahernati1·e investments. 43 191 44 PART2: ,\ION!TAAY1'0\«:Y Interest on Reserves and Its Importance for Monetary Policy The fin.Jncial crisis that began in 2007 uiggered the deepest rece«ioo in the United Sl<!tes since d10 Creal ~ession. In re>j)(Nlst, the ~ I Optn Markel Commillee lfOMO cut iu targe~ ior the fede<al funck rate to nea~)' zero by bte Z008. Oth« short-term interest rotes declined rooghl)' in line wilh the fede<al iunds rate. Addilional monetary ~imulus w"s neces_(,jjry to a<!dre« the signifrc.1nt economic downturn and lhe .associated downward pressme on inllation. The FOMC undertook other nlOOelary policy adions to put dol' mvard plesS<Jte on looge<·term int""' ldt.,, including la~S(.lle purchases oi longe<·term Treasu~· securiti" and agency-guaranteed mongage-baded securities. These polk)' ae1ioos ma.de financial conditions more acoommodati1-e and helped spuran f(onomic recm-ery that has become a long·lming economic ex,.nsion. The unempfor"""t rate has decline<l from 10 percent tole« than 4 pere<nt "'"' the course of the rf((JI-ety and expansion, and inflation has been !ow and iairly Sl.lble. The FOMC's a<:tions """'critical to fostering progre« toward m.u<imum ,.mp!ormentand stable pric~he Sl<llutOI)' soals ior the conduct of rl10f'oelary polic)' est.lbli>hed b)• the Congress. The FOO..al Reserve'> latge-scale a«el purchases had the side efff(t of generating a ~,.ble increase in the supply oi """~ balaoces, ~~~ich are the balances that banks main!41in in their accounts at the Fedet'al ResM-e.' From lhe onse1 of the financial ctisis in August 1007 until October 1014, ~~~ the FOMC ended the last oi i~ OS>elfJCJr<hase progroms,the supply of rest<\'t h.!Llnces rose from about SIS billion to about S2V: trillion.' R.,..~~ balances rose ~~~11 abol-e the l01-el necessary to meet resen~ requiren10nu, th<SS ~~·elling the quantity ol oxcess rest<\~ held b)' the banking I)'Siem. 1. All depo>itorr irnti!urioo> (((Witrnef<i411wlks,$3\ings As the economic oxp.1nsioo continued and unemployment declined-.Jnd with labor markei coodilions projected 10 continue impt0\1ing-the FO.I\C de<i<Jed !hat it would scale bad policy support by increa>ing the l01·el oi short-term int"est rates and b)• reducing the federal Re5el\·e·s securoies holdings. To th.lt end, the Comminee began gr.1dually r(lising its urget r~nge for the fedefJl funds •ate in December 101S.late<, in October 1017, il began gradual!)' reducing holdingsoiTreasury and agencl' securities; this gradual teduction rt»SU!ts in adecline in lhe supply oi rest<\oe balallCf>. The FQ.I1C judged that removing monetary policy >timulus throogh this mix of fir>t rai>ing the federal funds rate and then beginning to shrink the baJcmce sheet would best conttibute 10 achi~·ing and maintaining maximum emplo)•ment and price stabilit)• without causing di~loc:~tioos in financial matke~s or inslitutions that could put the economic expansion <~I risk. Interest on resen'eS_.he payment of interesl on balances held by banks in their accoun~atthe FOO..al Rese~~ l,..n an e«enlial policy tool that has permiHed the FQ,\IC to achiM a glddual increase in the fede<al fund> rate in combination ~~th a&lddual reduclion inthe fed's securities ho!ding.s and inthe suppl)'of resen't balances.• ln!er~ on resenoes is a tn011e1ary policy tool used br all oi the 11orld's ""'jor central banks. lnlerest on reserves is the principal tool the FOMC uses to anchor the fede<al funds rate in the target range. The fede<al funds rate, in turn, e>tabli>hes an important benchmark for the horrm1ingand lending deci;ions in the bankingsector (figureA). When the federal Rese~~ increaststhe large~ range for the fede<al funds rate and the in:erest rate it 1"1' on rosen• balAnces, banks bid up the rates in shon-t"m funding ""'rl:ets 10 le.,.els consi~ent with those increases; ra1es in Olher short-te<m funding markel>-00 as oommercial paper rates, Treosury bill rates, and rates on repurchose fconUnuedl banks, tlwih i~iMioM, crtdil uRioM, aOO most U.S. OOochts ar.d...,.il'sottore<snoonks) that""i""'inr""'•"''.li>CtS 2. for adtttiledcfisc:ussioo olOO.vthe<hantr-infeder,d R"'"" l«Urilie> hofd;~ •fi<ct tJ>t f<der•l Re~et~t's babocesheetand«<ttr;oltlwU.S. """""l);""~n< I!Kig, l.aw""'eMize, and Grett.l<nC. Wrinb.Kht!Otn, •Hf>vlloestl>e FOOAdi"" 11$ Sr!<OOtil's Hol<li~ ar.dl11>ols Aff«ted?" finaoce .1100 f<Onomics DOCussioo SeriE-s 2017· 099~V..,irrgton: llo.Jrd oiC..'"""'olllle f<deral R"'"' S)'Sttm, Sep!Mlbeft. httpS.:JAw.w.iedet<~f«>sMt.p.·reconrtY f....Mit.YIOIIO<J'lt»p.pdf. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00195 Fmt 6621 ).lheFinanc~ISe<v~esRosuto:oryReli«Aclof2(1()(, .t!Ahotil!ed d~ feckfal Resent &lrtl:s l<l M' iM~es~ on ba\Jnces 1-.1<1 by or oo bellaN oldepoOt~· ;ll!liMioos ~ federal R""'t Bani$. wbj«t 10 regu\Jtioos olthe llo.lrdol Gol""""'.effe<t,~Ocrober 1.1011. Theffi«ti\•da:eolthis '"hori~· sch.ulged to October 1,1006, by tile E""'S"l'Y Economic l{ollil;,.tioo Act oll008.lhe Congress •'-""riled 1~ p.lyment cJ inttft>SI oo rt'Stf\~ to he:p minitnite the i"'enli-1-es for c:ostty restn-e 1\oidar-.ce schemes and 1<1 PfO'ide .. tl>t f«k<al Rtsm• with • pol<y tool rhat could be usdul io< """""'Y polK)•i~,.,,~;oo more broodly. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718046.eps .Jre el~ 10 wn interest (ll'ltnose ba~nces. \\'e reiet-10 theseinstitutioosAS•banli,: 192 45 MONEIARYI'OUCYREI'ORT: JULYI018 ~~~---------------------=~~~~ ~~~---------------------~~~ ~· - l011 · 1~~ !SI) - . 201$ ~·: nw~ ~((lht-brf-~~ ii: tht Wt'll <o rt$«\c:;;.Dit dJtD: U. illltaflao • b.X'bilu SMisp.'tGl$hipr. Th: kd:nl flllds ~E'«\\oobrrxtsrloJc-l)'cnctoatwc!x'l.o\ttlb(~W.11.0Cfis G.....niCollt.ml f'~JUDX. Sou:o: F«TfC1;S;t)GCftcp>.DT((~I.l.C'. o~lb<oflb: ~10t)' TN$1~(.lurina:C~f«fcltt.tlfu:t.h.Fcdml~t L'O lOIO lOll . lOIS Sm: 'Tht~l\).:l)dof6:"'-...-ot ~ i:li~~«<~'($n:l.: rdll~l3.101talltn,!lidoit~Sbl11:1poilltl:bipKf. Scutt: f« US. TrM:I)' toil. ~ {'{ Chc Ttta9.1). kc AA (moriala.D.'fNIA"o'f.IDfnt)t on ~n..-.i ~ ~· fNml R=•Bori Sri:of~YM.-: bfx.c'1.'4Jib.Bb.la:lh1~ f«ilmn4«1~'tSao! ~~~.r~R~'C'BcG.'\1. banks c~o earn on alternative safe assets, including most U.S. g&.'ffnmem Of agency securities, municipal securities, and loans to b~inesses .and COO'SumetS.~ Indeed, the b.tnk prime ratHhe base rate that banks use lor loans to man)'of their cus.t()lllefS-is current!)' around 300 bas~ poin~ abol" the le--el of interest on resen'eS. Banks continue to find lending attt<~cti\'e$ and bank lending 11.1s been expanding at a solid pace since 2012. Households hal'e begun to see interest rates on relail deposics rising as well. MOI'OO'I.W,Ihe configuration oi interest rates im1>lits that the return the f«letal Resen.., earns on its holdings ol securities ~. The (oogr<ss'> autlloriz~ioo alk'"' tlte fed«aI R~e IOPJ)' intE«'SSondrposits rNintaiN!d by~Clr)' insliMions at a rate not 10 cxct>OO Ihe ...gtnerAIIe\tl oi ~·tfflll interesl r.Jtts..•lhe reclfnl Resm-e Boofd's VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00196 Fmt 6621 is highe< than the interest il pays on rese~.., balances. Each )'eor,the FOOetal Rosen-e remil> i1> earning>that is, i~ income net of expenses-to the Treaw~· Department in 2017, remiii.Jil(e51()1.tied more than SBO billion. Had the fede<•l Resen" not been ;ble to pa)' interest on resen'e balances Cll the same time that excess resM-es in lhe banking system wete large, it 11oold n01 ""'"been able to gradually raise the fede<al iunck rate ando;hef short-term int~eu rates while """'" balall(es were abundant the F0.\1C 1100ld "'"" had to take a different 3J>proach 10 scaling back monel-try polic)' acconmtO<idtion. This approach likely 11oold ha1-e inl<>l~td a rapid and sizable redue1ion in the r.deral Resen-e's securities holding< in order 10 put sufficient upwt~rd preswre on intetest rates. (continued on neKI page! ll<$ulatioo0d«1noss!Joo1{...,,int('r<$1r•tesfo<ihe(lllrposes oi th~ authotify M '""rdtts on oblig,llions. \\ilhm.uurities ci no mote than one }'E'.11, soch ~ lhe pim.Jry ctt'dil tillle.1nd ra:esonte<mf«tE<aliU!Idl.t«<nrepu<Chale•~. COOVI~i.ll pdpf't letm Eurodolbr deposas. And other simil.a.~ instrumeats. . The r~te oi intef('St on resm't'S has betnv.-ell 1\~hin .1 ra~oi $1'1oc't-leftn itltetesl M!es.<'sdtt'it!edin BoJ«f 1egutatioos. for cutfffit wes oo i number otshoo~enn mont)' JNrltt i~ruments.. see BNrd oi C.O..'tri'IOfS of lhe Ft"der~l Resm• S)"""· St.lt;,i<.tl Rolt..,.H.IS, 'Sel«t<d In""" btes,"' \\\m~ft>def.llrestn."t.goo.·!rele.JSeSih1 ~1ctmt'fl{. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718047.eps agt.......,IS-all tend to 100\" higher as well lfigure 8). This ill(rease in lhe gtne<OIIe-~1 of sho<t·term Idles. togelhe< with the expea.ed future l"th ol sholt·tetm Idles, !hen intluen<es the 1.\-el of olhet tinall(~l asset p•kes and 0\'etallfinancial conditions in the economy. Thu;, changing the inte<oest rate on resents has prOI'etl to be an eifec1ivetool fO< ~ansmil1ing changes in the FOMC's t.lrg.'l ldnge fO< the fede<al fund< rate to 01her inter~ rJtes in the economy. The rate ol interest the Fede<al Resen• pays on banks' resen•e balall(es is iar I0\1'et than the rate that 193 46 PART2: ,\ION!TAAY1'0\«:Y lntere.st on Reserves (c(Jftlinuedi ~ing the pace of as>e~!al" just right for a<hieving the fe<teral Rt!lef\~·, objeaives would have been e.u.....ty challenging. Such an apptoach to rerno,;ng accommodation would ha'-e run the risk of disrupling financial markds, with '"'""" eliec~ on the eoooomy. Indeed, as obsen'ed during the early summer of 2013, markd reactions to<hanges in the outlool: for the fe<teral R...,..~·s holdings of long·tMn securities <an h,..,. oul>ized elfoos in bond marke~. At that time, F0~1C communications lhat pointed to !he e\'entual cessalion oi asset purchases seemed to alarm in~tstors and 1<p011edly contributed to a rise in longef-le<m rates of ISO basi> points ove< just a fe.v months. Thar rise in rates quickly pu>hed up the cost of rnoc1gage cre<fit and rates oo other forms of borrowing tor households and yetknOI\0, thatlt~fl is likely to be much 101,-er than il i> today, though ;ppreci;bly high« than it was before the crisi>' In addition, the amount of U.S. currencyfe<teral Rt!lef\-e notes--dl.11 people in the United Sl<ltes and else\\here want to hold ha> incteosed substantial~· sin<:e the crisis.li ban~ wJnt to hold more resen-e balances and the public"""~ to hold more U.S. currency than before lhecri<is, the fe<teral Rt!lef\e will ne«i to >upplyIhe rese<Ves and currency, so lhe fe<teral Resen'e's securities holdings also will ha\-eto be larger than before the financial crisis.' Interest on reset\'es will remain an important f>Oiicy tool for keeping the i«<eral iunds ,.te within the l<l<gtl rang< set ill' the FOMC and thus managing thel.-.-el of short-renn interest rare-s, e\'M as the ongoing reduc1ion OO.ines>e>. in the Fe<leral Rt!lef\-e'>securitie> holdings g<neratesa Thus, Fede<al Rt!lef\~ policymake<s judged tha< gr;dual decline in the amount of resel\-e ba~nces on thebe>! >Ualeg)' tor arf)usting the >lanceoi mondary which the fe<ter•l Resen•e MS inlenest. In June 2018, policy "oold be grad11<1l inmases in the l<lrget range the fe<teral Resene m.1de asmalltechni<al adjustment tor the iede<al funds rate, supplement«! late< on ill• to de-link the Idle of in:ere>t oo ,.,.,..., irom the top gradual r«iuctions in the federal Resene's >e<Urities of the Committee's l<lrgel range for the iede<al full(~ holding$. The ongoing. gradual r«<uction in the fe<teral ldtf. At the June 1018 FOMC meeting. the Committee Rt!lef\'O's securities holdings that the fOMC set in increased the fede<al funds l<lrg<l range by 15 b<si• motion in 2017 will bring the level of Jeser\'0 balances points wflile the rate of intef~ on resM-e OOiances down subst.lntiall)' OI'Ofthe next fe\V)'Oars. The ~ze was increosed by 10 basis poin~. Thi• change is of rt!lef\-es that banks 0\-entu.llly want to hold will inlended to enwre th.ltthe federal iunds rate continues ret1ect balances held to me<?l resen'O requiremen~ and to trade well within the Comminte's t11rget range. The pa)'n>en~ ~as "~II as balances held to address spread beM.,.n the effecti,•e fede<al funds rate and the regul•tory and swctural c~anges in the banking system rate oi in1erest on reserves could continue to narrQ\Y since lhe fin<~.ndal aisi5.> A[though the le\'CI of r(.>$ef\1!' OI'Oftime as the Federal Resen-e's securitie> holding> balances that banks will e.-entually want to hold is not and the supply of resen'e balances graduall)•decline. 1 spe«h delio.'tfed •I"(urrtrKits, C~o~t .md<:tnlr.JI B.ank Conference:-"''"'""""" S..nford Un•.,,;~l SW>fo<d, C.M, M•y 4,1\ttpsi.lmwl<dcral..-e. 8a~"'"' Al\)l;cy goo,Jnewse\~'s.peech.'quarft520 180SOb.hlm. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00197 Fmt 6621 6. Unc..UOl(yal>outthe"'""'"''"-flolr""'tbo~nces i< """"" r"~tlh.it the fO.\lC II.!<boer> rt'dvcmg the r<dor,IR«<n•>holrl~olseo.~i<s.andtheoupplyol """'' ..,~.,. gr"""ltr 7. Currencygrowsrooghfyin ltoewithoominal gross ~ic prodocl, In Oectmber 1003. currtney in <ircukltion was around S3i0 billioo. COfi"'P<''~ wiU't S1.6 ttillion At lhe rodol)me2018. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718048.eps S. fO< ad"'"''"" ol the chang<> in tl>e bon~ns >)stem sillre IDe iinanci.'!l crisis .and !heir poc~lillf eii«ts oo the o.m.nd lor r""'• ba~nc.,, ,.. Ra~l K. ~,., 120181, ·tiquidil)· Rogulatioo •11<1 Ill< Si;e olthe !<d's 8abnce~~>e«: 194 47 PART 3 SUMMARY OF ECONOMIC PROJEOIONS The following materia{ appeared as an addendum to the minutes of the June 12-13, 2018, meeting of the Federal Open Market Committee. All participants who submiued longer-run projections expected that, in 2018. real GOP would expand at a pace exceeding their individual estimates of the longer-run gro111h rate of real GOP. Participants generally saw real GOP growth moderating somewhat in each of the following two years but remaining above their estimates of the longer-run rate. 17. 1lm.-e-meml>ersofthc BoardofGO'\nnors"wt in offi« at the tim< of the Juno 201$ meeting. t8. On< panicipant <lid llOt .ubmit tonser-run proje<1io"' for real GOPgroll'th. theu"""piO)~><nt rate. or the ftdml full<ls r.u~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00198 Fmt 6621 All participanls who submitted longer-run projections expected thai. throughoullhe projection period, the unemployment rate would run below their estimales of i1s longerrun level. All participants projected that inflation. as measured by the four-quarter percentage change in the price index for personal consumption expenditures (PCE), would run at or slightly above the Committee's 2 percem objecti\'e by the end of 2018 and remain roughly ftat through 2020. Compared with the Summary of Economic Projections (SEP) from March, most participants slightly marked up their projections of real GOP growth in 2018 and somewhat lowered their projections for the unemployment rate from 2018through 2020: participants indicaled that these revisions reflected. in large part, strength in incoming data. Alarge majority of participants made slight upward adjustments to their projections of inflation in 2018. Table I and figure I provide summary statistics for the projections. As shown in figure 2. participants generally continued to expect that the evolution of the economy relati\'e to their objecti"es of maximum employment and 2 percent inflation would likely warrant further gradual increases in the federal funds rate. The central tendencies of participants' projections of the federal funds rate for both 2018 and 2019 were roughly unchanged. but the medians for both years were 2S basis points higher relative to March_ Nearly all participants who submitted longer-run projections expected that, during part of the projection period, e\·olving economic conditions would make it appropriate for the federal funds rate to mo\'e somewhat above their eslimates of its longerrun le,-el. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718049.eps In conjunction 11ith the Federal Open Market Commiuee (FOMq meeting held on June 12-13,2018. meeting participants submiued their projections of the most likely outcomes for real gross domestic product (GDP) growth.the unemployment rate, and inflation for each year from 2018to 2020 and O\'er the longer nm." Each participant's projections were based on information available at the time of the meeting. together with his or her assessment of appropriate monetary policy- including a path lor the federal funds rate and its longer-run \'lliueand assumptions about other factors likely to affect economic outcomes. The longerrun projections represent each participam's assessmem of the value to which each variable would be expected to con\'erge. over time. under appropriate monetary policy and in the absence of further shocks to the economy." "Appropriate monetary policy" is defined as the future path of policy that each participant deems most likely to foster outcomes for economic acti\'ity and inftation that best satisfy his or her individual interpretation of the statutory mandate to promote ma.ximum employment and price stability. 195 48 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S Table I. Eoonomk proj«tions of Feder.!l R"""' Board m<mborsa!ld Federal ~"' llan~ presid<n" u!lderthcir indhidu~ assessments of proj«lro appropriate moneta!)' policy. June lOIS ""'"" \'.uiabk illIS ~in rdi GOP .... . u ;\bl\'b~j:t."4ioo... . ll l:o..~mcol~ ---·· :\11n,:b~"''tioo ...... u ).$ )~ J.(d.1 .UlS lH! J..4J.7 >.H! ll 3..8 J.6.-t0 -~.l l PC£-......... u ll 2.0 2.0! 1 1.0 !J ll ll 1.910 lOU Z.O!J U•li 1.8!.1 1_92.) Ull !0 ll U.l.O lOU U !.l Mat~:b~,ioo..... . 1 CmPCEinllMioo .••• Ma~iiiE"o>}:\1.~ ....•. \lt!JI0:~'\.1.1.-d 1.9 2.0 " lS 1.820 !OU 1.92.3 ·~t i'"'.1 (U!ll ~~~(~~ ....... MatiOhE"0,.'\"410e.... l oi 3.1 u !.9 2.1 ! l~ M 11 3~ ll 2.9 ,l,.l !.9 Z.l !.- .U ).~ U 1/J ~ !.S....).O !.S ).0 U !.6 1.9 3.6 1.~!.6 1.6 .l.9 1.9-4.1 lJ l.S I!J ~9 !.) J.$ Sqh:~-..-.fl~• raiPJ~~(GDf'lae.l~""~~PI~m~~rl\W~"-t!!quMottllri'""'._)GI""> tllrb:t!kqu~«<ltM)GII'.tneatfC£~-'""'K'l..._a.::l:k~rlk!.dcbttil.~:tiul).lh£roor~'~~~C\.~~ lfCa:MtJUor:-~~""'l'((~ko.'IJ,;aJ<O:I'f).Pr.~~lk~*CirMa.-(""lbc~CI'.._~_.r~ •lkkw111i'\"Wf~~)l'*l ~~r.,..,..,..·~~l>'i:~OIIb#otbrf~((~~P*).l.OIIfll'«a~~adlip...~·~~t:(~nk L>....iiUr."ii i~ ........~~'\CISLq~CII5tr~~p:o;s.'!ao,i•'l)r~o((~~-\)IQrJx~~~ ""'i,hcf.odcfa!f I'JW~Jlltl*('itk~cfC)(!"-,o;W~Uip:lflfll(~ik~fOOribfa6:C'I(k~~WJ'CCIMi""'6tWmafdf.nk• **cftilt ~~P"«cwrlk• ra Th: ,\l~~1)(0-.c"clli&a~1io.-...i:JI6c-a.cft~tcr~~:\bM:c-.iiiiii'IIC' ~Im~I.:O!ItC);:I( ~41da..'4~.......,."..,_,"tM.W:t....tX~•mi(;Df'.thc:~'IWII'*.«IX~alf..,.r*•~•Otb:!Wdi:O,!I. :xlll~d *~~11«*-il.:olt.irlf'('<l),,,.. . .~..iloekho:'lt l~iml~ lforadl~lko."dulla~IW4k~•kt0t~a.:'~f:«a~IO~'Abcltlk~«~~&f\o\'IIL!k0o.\lo»8e.tao~ol lkcwoDW!c~1Jo.lW. lTh:""*'*ll~~lbi:lk.:t....... M4~a..-..~'Ut.'ttibfdi~•'*")CW J.lb:rlllfl'l"'ll~il a~)nf~·SW'I~-"'·"tio:e.6.... ~1011is.\N,b'~NI•·w~:W•tl!Dt)GI' I«!Pf.,.."""'1icG!;I«norcl'([.a.o.:.*K.ocn&.~.N. In general, participanlscontinued 10 view the uncenainty attached 10 their economic projections as broadlysimilar 10 1he average of I he past 20 years. As in March. most participantsjudged the risks around their projections for real GDP growlh. the unemployment me. and infla1ion 10 be broadly balanced. VerDate Nov 24 2008 14:11 Dec 18, 2018 The Outlook for EcQnomic Activity memioned accommodati,·e mone1ary policy and financial conditions, strenglh in the global outlook, cominued momentum in 1he labor market. or positive readings on business and consumersentiment as imponanl factors shaping lhe economic oullook. Compared "i1h the March SEP, I he median of participanls· projeclions for I he rale of real GOP gr0111h was 0.1 percenlage poinl higher for 1his year and unchanged for the next 1wo years. The median of participants· projec.tions for thegrowlh rate of real GOP, conditional on 1heir individual assessmemts of appropriate monelary policy. was 2.8 percent for I his year and 2.4 percent for next )'ear. The median was 2.0 percenl for 2020, a touch above the median projec1ion of longer·run gro"1h. Mosl participanls continued 10 cite fiscal policyas a driver of strong economic aclivity over I he nexl couple of years. Many panicipants also Almosl all parlicipams expeeled the unemployment rate to decline somewhat further Ol'er the projection period. The median of parlicipants' projec1ions for the unemployment rate was 3.6 percent for 1he final quaner of this yearand 35 percenl for 1he finalquarters of 2019 and 2020. The median of participants' eslimates of lhe longer-run unemployment rate was unchanged at 4.5 percent Jkt 046629 PO 00000 Frm 00199 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718050.eps 4 196 MONEIARYI'OUCYREI'ORT: JULYI018 49 figure I. Medians. «ntral tendencks. and ranges of «<nomic pro~ions. 201S-20 and mn the longerrun """' Cll3ngcinf<a!GOP - Maiwt(l(~o,.,~ B CCt~tnlsc.J...,.,")(!(p'*'-'ti."CCS - ! ~«'".;.- ~ ~ w -) ~ ~ c:c -l -1 W13 lOI~ lOIS 1016 lOll lOIS 1019 lOlO Lon!'• run """" Unrnl~tl'k."n11'3tc - ~ !013 1014 lOIS lOI! 7 -6 -l lOll """" ~ lOIS 1019 ~ lOlO ~ -' -) lon!l'~ ""' """' PCEi:nlhtion -) == ~ 2013 1014 lOIS l016 lOll llliS ~ 1019 §§ llllO - l - 1 Lon!'• run """' C~PCEi:nftation -) == ~ iiiii 9§ -l - l'OI3 l\)14 lOIS l016 1017 lOIS l019 llllO I Lons-,-r ""' 1\'on~ D.:finitioi1Sof \'lrill.llbandotllcr ~phn.tlioos:a.re in the notcslola.bk l.Tkdltaforlbcartual,'Jll).."$o( VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00200 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718051.eps tl'.:- \'3~:llt 3Mwl. 197 50 PARTJ: SUM\~RYOf ECONO~IIC PROitCTIO:<S Figure 2. FOMC partkip.1nts' assessments of appropriate m0Jl(l31)' polky: Midpoint of target range or ta~t lew! forohef«kralfundsrate - - - - - - - - - - - - - - - - - - - - . , . . - - - - - - - - l.O .............................................................................. ~.............................. ,,,_ ~,j · · · - - - - - - - - - i ' ' ' ' ' ' ' ' ' ' ' ' ' ' ' ' '' ' ' ' ' ' ' ' ' ' ' ' ' ' ' - . ... - - - - - - - - - - - - - - - - . . . . : •....;•_ ___.._ _ _ _ _ _ _ <.0 . .•••••••••••••.••••••••.••••••••••••••••••••••••••••••••.•••.••••••••••••••.• , .•••.•••••••••• , ••.••••.•••••••• ••••••••.•••,.,_ J..S • •• ......................... • ••• ........................................ ... _ .........................., .. __________...;•....:.•...;•_·~-----·~-----~--+-----~ ' ................. .._ • -~---·········-J.. • , 2.5 ••••••• ••••• -----..---------------~.------- 1.0 ........................................ ········• ···· ···········- ....................................................1..............................- -···········......................................................................................................................,,,_ l.l _,,,,, ..............................................................................................1"'''''''"''"'''"''''''''"'''- - - - - - - - - - - - - - - - - - - - - - - T - - - - - - - - •.• ········ - O.l - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 0.0 1018 l..otl£1-'ftun 10t9 Noll: E3dl shado..-d rin:k iodM:.l!cs. tbl \;tli.X (rovDCkJ tot~ rK'3rcs.!IIS IX'n.'tnl~ point) o( a.n indi\id~ ['Jf1i.ip;1n1$ jud$fl'ltR1 of I~ mKipoinl ofttbt appropriatr 13~1 r3Jl~ forI~ ftdtt31 i'und$1'tllt'Ot tb.:- 3J'IIKOPri31e tatg-.'t il,'!l\'1 for Ilk' fedtra/ fund~ t.ttr: a1 tbr tnd of ttK- S"().'-iiW c-JIMdar ynr or O'o'tf I be long« run. On<: pilrticipantdid not submit k>tl~'l.."f·nll'l proj(\1k>ns for ol<fol:Ql fvndsral< VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00201 Fmt 6621 The Outlook for Inflation The medians of participants' projections for total and core PCE price inflation in 2018 were 2.1percent and 2.0 percem, respectil'ely, and the median for each measure was 2.1 percent in 2019 and 2020. Compared with the March SEP. the medians of participants' projections for total PCE price inflation for this year and next were revised up slightly. Some participants pointed to incoming data on energy prices as a reason for their upward l"e\1sions. The median of participants· forecaSts for core PCE price in6ation was up a touch for this year and unchanged for subsequent years. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718052.eps Figure'S J.A and 3.8 show the distributions of participants" projections lor real GDP growth and the unemployment rate from 2018to 2020 and over the longer run. The distribution of indil'idual projections for real GOP growth this year shifted up noticeably from that in the March SEP. Bycomrast, the distributions of projected real GDP growlh in 2019 and 2020 and over the longer run were linlechanged. The distributions of individual projections for the unemployment rate in 2018to 2020 shifted down relative to t~e distributions in March, while the downward shift in the distribution of longer-run projections was wry modest. 198 MONEIARYI'OLICYREI'ORT: tULYIOIS 51 Appropriate Mo11etary Policy Figure 3.E provides the distribution of participants' judgments regarding the appropriate target- or midpoint of the target range-for the federal funds rate at the end of each year from 2018 to 2020 and om the longer run. The distributions of projected policy rates through 2020 shifted modestly higher, consistent with the re1•isions to participants' projections of real GOP gro111h. the unemployment rate, and inflation. As in their Ma~th projections, a large majority of participants anticipated that evolving economic conditions wotlld likely warrant the equivalent of a total of either three or four increases of 25 basis points in the target range for the federal funds rate orer 2018. There was a slight reduction in the dispersion of participants'views, "ith no participant regarding the appropriate target at the end of the year to be below 1.:88 pe~tent. For each subsequent year, the dispersion of participants' year-end projections was somewhat smaller than that in the March. SEP. The medians of participants' projections of the federal funds rate rose gradually to 2.4 pe~tent at the end of this year. 3.1percent at the end of 2019, and 3.4 pe~tent at the end of 2020. The median of participants' longerrun estimates, at 2.9 pe~tent. was unchanged relatil~ to the March SEP. In discussing their projection~ many participants continued to express the view that the appropriate trajectory of the federal VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00202 Fmt 6621 funds rate over the next few years would likely im•olve gradual increases. This view was predicated on several fa"ors. induding a judgment that a gradual p.1th of policy firming likely would appropriately l>alance the risks associated with, among other consideration~ the possibilities that U.S. fiscal policy could have larger or more persistent positi1-e elfocts on real acti1•ity and that shifts in trade policy or de1-elopments abroad could weigh on the e.~pansioo. As always. the appropriate path of the federal funds rate would depend on el'olving economic conditions and their implications for participants' economic outlooks and assessments of rish Uncertai11ty and Risks In assessing the path for the federal funds rate that, in their view, is likely to be appropriate. FOMC participants take actOunt of the range of possible economic outcomes, the likelihood of those outcomes, and the potential benefits and costs should theyoo:ur. As a reference, table 2 provides measures of forecast uncertainty. based on the forecast errors of l'arious pril'atc and gol'ernment forecasts over the past 20 years. for real GDP growth. the unempiO)~nent rate, and total PCE price inflation. Those measures are represented Table: 1. A\trage hi:>torical proj«tionerrorranges ~"1'1~~ :IllS ))19 i))ll) a...,;.~"" Gt>r .... H) !lO ~1.1 UQo.~l'lle'QC!lt:' ... .o.• !1.2 !I.S iOIIIIOO(NIITXfrft,"tS1 •• 1~1 !1.0 .ti.O ~·tHCilllitl'ltft':ilral.CS~. .0.1 !1.0 ;u \'Wbk ~r.~R=#'..'~M't~b,.,.ft-~I\"'OICO;II!<F"~ Gf«{J(~,1io;e,~lm;~;ot1tllll-tllbdilotl..:--~\)f' -~1k....,~--.rtii"'U>I.""A•ibcfik.dit.O.:M·f,~~ t'"'-.:t• u.e~·.,.,.etn.r.~tktta~~~~~Wtl~ ~.b~GDf'.~'O.'M.....--,'1~.ao41ixWtt.11'-'* ~ilh:-ll~~~*""'•jq(«~motiMk••lltJ'. ru-~~«INo-.jJPd~USPMJ.r.,(~i)."''nPP: l.brL'~cfOoc~Od.'dl.... ll~t;."nt..,:.q~~ r~~osn~··~'l.-r~.-ldf~~ S..~lil1«\l {'llo~h;J(i(..olcrr~tJndiX ftdmiRNMS)..uc.l'mwy\,""' ./o.krak~~1Mf.l)li'(~l~~ I ~cf~·u:til*l*f.IIIDOC<:LO~I. !~"tttkti"C!1i~,n."Y..... i.bttm~~~~ .U•U:t)-'•~IIIXIII~fri.~~~ ~~~ ~-~<eabriqaanalo)bft.IIQW~CJt-.. ~- r«rw.~~.)t.lfhw6J..~"'e.WmlfliDI1.•.. ,~"( <dirr:t~~&•IIGi:C~G~J.a.J.U'J'~t.iktt...,.....ucamM.ut ~""'~.),:<.~-~-~)(~~ Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718053.eps Figures 3.C and 3.D provide information on the distributions of participants' vie11~ about the outlook for inHati()n. The distributions of both total and core PCE price inflation for 2018 shilied to the right relative to the distributions in Ma~th. The distributions of projected inflation in 2.019, 2020. and over the longer run were roughly unchanged. Participants generally expected each measure to be at or slightly abo1•c 2 pe~tent in 2019 and 2020. 199 52 PARTJ: SUM\~RYOf ECONO~IIC PROitCTIO:<S Figure J.A. Dislribu1ionorpanicipants proj<ction.for 111< chan~ in rtal GOP. 201S-20aoo om <he longer run ~IS -IS ~.~~ _, -11 - ll -10 .. .... u u 1.1 ~---,n =! ~ - - -'...---,~~n~ =: 2» 2.1 u ! c===J L____j -~' I z., !J l.J Ptrmlt rang.:- ,,'·' "~· J.O ll -IS _, -16 -12 -tO -s - _,6 ... ...,., u ... 1.9 2.0 !I u !~ U .!.S .." ~· ll P'M.\'fltr.ltl~ 11 -IS _, -16 -= I = 1..& -~ "=='In ----· rr=:J..!!....__!_ c=JI IJ l.t• IJ 2.lt 1.7 I' ll U U PtR.\'fltran~ - ll -10 - I -6 _, -l I "'"' ~ ~.1 a !9 J.O ll '\~<{~~ ~'fru.n -IS _, -16 - I~ -tO - 8 1.6 1-' 11 IJ !b U ,, U U P\'f\'\>fltrang.: VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00203 Fmt 6621 ~· Sfmt 6621 ,...,, ,," ...l l I L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718054.eps U· IJ _, _, _, 200 MONEIARYI'OUCYREI'ORT: JULYI018 53 Figure 3.8. Distribution of panidpants" projections for 1hc ua.entplo)1ntnt r.ue. l01S-203nd O\W the long_ec run lUIS _,, -II ~- ~~r,i~~ -I• -I~ A - 10 -I I-- ---: ~ H r:-1_ u ~ l.J 15 t = 'L ~ ~ 1.1 }9 _, -,l -6 - - u I ._._ u U AI " P\'fl.'\-ntran~ •• " .. u •• <I '~clpwb.'1(*1t• lUI9 - II - 16 -i' -ll -10 - I -6 ..... ... ~., .. " ... -·-,2 ,_, N~d~ lUlU - IS - 16 -i' - I! - 10 -I - 6 Br--~--~ n l7'91c::::::J I I ~ ll " ~· .... '"' .... ~1 .." .." .. .., . r: u •J P~m'lltl1ln~ - I u ,_, ,. -· -ll H ~~cl~ loagernm - IS -16 -1• -12 -10 -s ,. )I Jj. " ,._ ,. '"' 11 u " =flnh~-.. ... •• ~ ,. •• u " PM\.'fltran~ " ... " u -· - 6 _, I. " VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00204 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718055.eps Nou.:: Ddinilions of":;sri3bb 3nd Olbcr txp1an31ions 3rt in Ihe notes 1013bk I. 201 54 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S Figure J.C. DiSiribulion ofp3nicip3n1s projections for PCE inll.alion. lOIS-20 and owr the lollE'r run ltliS -IS ~. ~:::~~~ _,. - 16 ~ - - ----- ~. l =r- -- ----l l I ,, I IJ u L -·~IQ I ----- , - -s _, -;2 -6 ,, lJ. !I '~tlpm'lf'Cb ltll9 - IS -16 -I' -n -w -s -· _, I 1.1 " IJ u I I lJ. u 10 - -2 H S.-Mtl~'lPflb lt)}l) - IS -16 - r1--- --- -~ : _ .... F .I . j l 1.1- I~ IJ " ll 1..2 I' ll -w -s -· - 6 ----- 3 , -~ !J.!J -IS -16 '- - -c-;- -.!l .IJ_~;- -LI --7."""----~----'~1 u IJ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00205 L ! Fmt 6621 u ~ Sfmt 6621 lJ. :.~ L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718056.eps ~ IJ 202 MONEIARYI'OUCYREI'ORT: JULYIOIS 55 Figure3.0. Oistribtltion of participanl$. projections roroore PCE inftation. 2018-20 lOIS - IS -16 -I· -u r -10 I - s I - 6 _, - ,-------- J - I -! ,, .. ,." lJ "" '-' lOI? -18 -16 _,, - 11 -10 - s --------·1-f--- -- j~I -6 -· :I ,.·~ " OJ I ~ -/ '-' "u l• PM"Ctllr.l~ ;\~~(lllb.~ lOlO -18 -16 -I' -11 -10 - s j-1 ~I oJ ,.... I P<m1li1'3Jlgc VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00206 Fmt 6621 6 _, "" Sfmt 6621 11 I I ~ ~! lJ '-' L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718057.eps ,, - 203 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S 56 Figure 1 E. Distribution of panieipants' judgmmts of tile midpoint of the appropriate t<n:gtt mnge for the fedcrol furuJs r.lle or the appropriate l3~ttlevd for the ftdtral funds ratr~ 2018-20and Oh.'f tile longe-r run 1018 =--- I In-nlI r - tCJt I IU- u; 1..5$ :1: r=n !!).. !.~ u~ !.6! ~.ft.\- :r ~ J..l: .ti.J.- Ul .Ui ~ M'$U! UJ.- tJ$- .fJl '~ 1\-f\'tl'ltl'llllgt 1019 - IS -ll -I~ -I! -10 -s ~ - r - , C=Jit=., W BS:· W- IJjl !I~ Ul !~ !.6: tn JDElrl:c==tr-, W W Zl$ )I~ _, -l ) U.J.- IJ' l..'S W M.l »S- al)... J$1 ~I! A)i .&.U U! Pcf\'tfltr.lllgc .... w'" Ul - IS - ll -t.: -ll -10 -s r - ' r--1 IAl I.SS U7 tu w :J1 !~ 1A\- l# 2.6: !Jj )12 riDs. JU J.J1 US l6.! ;.6..t U'l c- -·_,_, 1 I. ,., "' )A 4,1! P~I\W~tmg.: _,, -IS -IJ - IZ -10 -s -l L-~~~K"==T~Dr=J~~r=I ~~r=l~~~~Uc=J~lli~~~~~~~~~__J~~ m m w w w u w m w u w u m IM l.fi lB '~ 1..6.J. US. ~.U :us l.M },&. ~ ~B 43$ !M uS VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00207 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718058.eps P~r«ntran~ 204 M().\EIAAYPOlO~EPORT: MYl018 the top panels of figures4.A. 4.8. and 4.C. The fan chans display the median SEP projections for the three l'ariables surrounded by symmetric confidence intcrmls deri1'Cd from the forecast error:s reported in table 2. If the degree of uncertainty attending these projcttions is similar to the typical magnitude of past forecast errors and the risks around the projeclions are broadly balanctd. then future outcomes of these 1'3riables 11ould ha1e about a 70 percent probability of being within these confidence intervals. For all three variables, this measure of uncertainty is substantial and generally increases as the forecast horizon lengthens. Panicipants' assessmmtsof the leld of unttrtainty surrounding their indnidual economic projeclions are sh011 n in the bottom-left panels of figures 4.A, 4.8. and 4.C. Nearly all panicipants 1ie11td the degree of uncenaint)' attached to their economic projections for real GDPgrowth, the unempi0)1nent rate. and inflation as broadly similar to the 31-erage of the past 20 )ears. a 1ie11 that was essentiall) unchanged from March'' Because the fan chans are constructed to be symmetric around the median projection~ they do not reflect any asymmetries in the balance of risks that participants may see in their economic projections. Panicipants' assessments of the balance of risks to their economic projcttions are shown in the bottom-right panels of figures 4.A. 4.8. and 4.C. Most participants judged the risks to their projcttions of real GOP gr0111h,the unemployment rate, total inflation. and core inflation as broadly balanced- in other words, as broadly consistent "ith a symmetric fan chan. Compared with March. e1·en more 19. Atlh:rndoftllisSUilllllat).thcbo\"Fo"''all ~IK'<NlDI)·discusses lh< sourm and IDtcrpmtioa oruocnuiot> ..,..,.,..jiQ: lh< .....,_;., btcoSt> and npbJo;th: opproodl us.d 10*""" th: ""'""""'>:ud n>l:uurndll& lh< panicipaAI>' projcruonl. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00208 Fmt 6621 participants 5311 the risks to Iheir projct1ions as broadly balanced. Specifical~·. for GDP growth. only one participant 1iewed the risks as tilted to the downside, and the number of participants who viewed lhe risks as tilled to the upside dropped from four to 1wo. For the unemplo)menl rate. the number of panicipanls 11ho sa11 the risks as lihed toward loo readings dropped from fourto 1wo. For intla1ion. all but one panicipant judged the risks 10 either lola! or core PCE price inftation as broadly balanced. In discussing the uncertainty and risks surrounding their projections, se1·eral panicipants continued to point to fiscal dewlopmenls as asource of upside risk. many participants cited de.dopments related to trade polic) as posing downside risks to !heir gr011th forecasts, and a fell' participanls also pointed to political di!\-elopments in Europe or the global otulook more generally as downside-risk factors. Afew participanls noted that the appn.'Ciation of the dollar posed downside risks 10 the inflation ou1look. Afi:\1' participants also noted the risk of inftation m01ing higher than anticipated as I he unemployment rate fall~ Participanls' asses>ments of 1he appropriate future path of the federal funds rate were also subject to considerable uncertainty. Because the Committee adjus1s the federal funds rate in response to actual and prospective de1-elopmen1s 01er time in real GOP gr011 lh. 1he unen1plO)ment rate. and inftation. uncenainl) sum>unding I he projected path for the federal funds ra1e importanlly rell«ts 1he uncertainties about the paths for 1hose key economic l'ariables. Figure 5 pro1·ides a graphical representation of this uncertainty. plotting the median SEP projection for the federal funds rate surrounded by confidence intervalsderi1'Cd from 1he resuhs presented in table 2. As with 1he macroeconomic 111riables, forecast unttrtainty sum>unding I he appropriate palh of the federal funds ra1e is substantial and increases for longer horizon~ Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718059.eps graphical~· in the -ran cbans-shown in 57 205 58 PARTJ: SUM\~RYOf ECONO~IIC PROitCTJO:<S Figure4.A. Ull(<nainl)' aoo risl<sin projo:tiOliSofGDPgrowJh Med~n projection and ronfiMnre inttl'\'31 based on - historical for«a~t trrorS Chan~c in rt31 GOP - M~i#lcl~ll~'ticwts ~~;,.,ol _, -) -I -· l(IIS 2(l]J 2(116 2(111 2(118 2(11? FO~iC panicipants' assessmenlS of unccrtainl)' and risks around 1beircwnomic projections ~ . . . 1/(f\1(\>.~' n· ._n UBt.~nainl~'3'o¢ut GDP ~·1h 0 lr:o:lM\'i;\'1..-os Risl:<toGDP.gt0\11ll 0 J\ltiC'~j<\'1ioM -IS ~· M3!1."b~P,'tiod~ •• -1~ I I - 10 - I - ~ - ' ~r:==-=:' 1]2 B:N~dl} -10 -tJ -·l -ll I I I I I -IS ~btrllproj.'\~ H1gh<r $mibr --- 1 - 10 =: _ I I - I L.. - - - - 1- ~ [ = ~r===l · l \\<ig!ncll!o doo._ Broodll· b.mn<\~ \\<is)lt«l!o up<i« NQJf:The bl~.t: :mJ n:d liocs in the lop p;md shCM :x!u:\1 \':lltxS 3r.d m.:"ian ~1N ''Jlucs..I'\'Sf>.'\."'ti\tfy. o( lk p:Tl..\'111 cfttnp: in n.".ll ~domeslic prodLtrt.'1 (GOP) rn'Kill~ fourth Qlllrtn t:i I~Jlft\ious >t3r 1o 1~fQtlnb qlllttcr of the )'C3:r iOOiclt\"d.'J'h:o l-onf'lli"aCtinttr\'a!3rooOO 1bt l'Do."diatl ~'ltd \'af\Ksis~~lotltsymR'l('tricaOO 6NSI..'doo tool ~nsquarcdttTOtSof \"Jriou:s pm'iUt and p.l'tlUTICilt fom:asts 1034: 0\Yr the f!C\"!olo~ ~ )'C3J'\: mort information 3boulll'...~dat3 i:$3\-:u"bbk in 13.tk l . lko~C1lrrtntro00iliMSmay difftr [n,xn ~ th3l p«''likd.on :r.tragc.O\\'t'ID:pm·ic)us21))'t31'S.I~\\idlb!od~ Oftbt coo~irttm'3leslimau·doa thc~oflhc hlil<lrir.ll fo~ error& flU)' 001 reB.'-.'1 FOMC p;li'1Xir4.nts'cut'mll ib.~"!'nmts olthcui)..'WUinty3ndri..J:s:tl'\)l)r.dthrirproj.'\.1iol'l5;the$c('lJrn.TJt8SSI.'S....m..."ttU3.reSummaM-dintho.:-lo'.lwpaD."k~· sp:akin-g. ~rtiti~nts\\floPfgllx' ui'IC('fUjnt)'aboutll!tir ~'tionsas"~.sinUiar~lo the:-&\~ k\'dsoil~~ lO)(OlfSV.Wld\icv. Lhc wi.Jthof tbc<'OOfkim.~ iDI«\"JI~l' in l.bc- hislorical (~l'ld'lar13S la~~· ronsiskclt wilh thcira~'if!X'rt1$ of lhc tlnctftail'll)'aboutthcit(M'oj.'-.'lions.li1'('4ist_('1ni..;t-atlt$111'1\ojudSf the ~SIO lb..'ir pro_ic\'lioi'Ji>U~btood~· babflctdR V.'OWd'icu.' t,hc('()O;f~" intm31arooadlhrir ~'tions:asapproximatd) S)mmctric. Ford.:tiRltioosof ~ntyand risk.sia VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00209 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718060.eps «vnomic projc<1ioo< S« Jhc bl11 ·fon'!'3!1 Uno:ruioJy.· 206 MONEIARYI'OUCYREI'ORT: JULYI018 59 Figure 4.8. Uncertaint)' and risks in projel.~ions of tbe unempfoyment rate MM~n projt'clion and oon~cnct inte"'31 baSr."d on hi!lotOrieal fon.'ClSI errors UI'IC'tnploym,•tn r:uc - - - 10 ~kdt.Ulof('(llj_'\'ti'Ci 8 10Cia.~iotm:;tl - ! -8 - I -· -5 _, -) - l -1 201) lOll 2014 Wll 2016 WIS l019 WlO FOMCpanicipams·a~nts of unctruinty and risks around their coonomk pro;.'ttions :...~ot~ D' _,. n-; -. U~inl) about the Utl(11)plo)mrnt rate 0 hzn.:proja.1iorb : •• ~ludlrn.i-"-"tioos I - IS -10 1 I I I I I I -11 -10 _,. -u -12 -10 - ' -r - - - - 1 1 ' r l r - - - - - - , _ 1 = Jl - 10 - I =r====:' RL4:s to the uncm(\lo)TOO!t me 0 Jun.:~"tiocb : - - ~bn:bJiroP,'tions -J ' l I - I -s I - \\'cigt'I!OOto u..,;d< Non:: Th:'bhxandn:dlil'IC'$inthctop(Xlndslw.Y,.,. :.«ull,'ai~XSandtl'IC'dianrroj«1cJ ,~I\."SJ).'\"tiw{)~oftl!cll\~ ci,ifu n unemplormcnt r.uc iD the- fourtbqua.rh:fof tbc )"tar ir)(Ht'3ted. TbcoCOJI&kw.: inur.-aJ arl.)\ltld 1~ m.'di:ln pro~"-"ted \'J.h.h."S is 3..~ to b-.:' ~ymmctrii: and is Nscd on root m..~ squal\"d etl'l)N.Of \3rioUS pri\':l!e and gO\'tml't'l('tll fol'(\"'3.S1Sf~Ud..:' 0\<tr tho: Pf'.'\ious ZO )'(3~ more inroonation aboot tbcstdal:1 is <rL-;aibbk in table 2. 8."CJ.Usti.'UtMltoond1tions nuydiiTcr from those- that PJI."~ik\1. on 3\'t.'r.lg\'. 0\Tr t~ pmi®s 20 )"ta.~ Ibe v.idtb and 4\ap: or tbc ronfld...-oo.· int('r.'J) c-;:!im3t«< 011 t~ oo...t~ ofthcllistorid(oi\'\"'3$1.CrrorsmayDOII'dl«tfm.ICp3RK-ip;tniS'C111'rtn.t1_~1Softhtlllk'tnairnyandrisksarou.OO dx1r proj:~tions I~CUm'ftt :aSSI.'S:!mcnts ar.:SI.LJJlm:IM:d in the lov.yr raocl'\ Gmc1al~· ~r-:-~in~ JQniri~nts v.-l'lojOO~ 1~ VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00210 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718061.eps Un..'\'ft3int) J.boutthtirpl'Oj..'\1io13$3S ybrc.'d~·$imi1ar''tothca..~ k\tl$00thcptSt 20 }\'31'$ would ,'i(y, thc,'idthoftht oonf~ inlm"J:I sbov.·o in lbc hi51oriraJ (an chan :LS br&'Cl}'~"'nsistrnl 'Aith their :15<ii."SSmefllS of the U!k'CI13.iiUy aboottbc:ir proj..~ion.." LikC'II·i:st. ~rliriJl3nlS\\1'tojudg(' the ~k'i 10 their pt!)j<\1iori(3'S ""br«ld~· lxlh!X\.'d-v.I)!Jkl \~the@~ iml"\'llarouDd thtir p."Oj.."dions asapproMmatrly S.)mmctril.'. For d~finitioMor LLnctnaint)' and risk~ in crot~omio:-pro~tlons. ~-.:the bo.\ •foM."l)t UIK'>.'>fUinl)~- 207 60 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S Figur( 4.C. U11cwta.inty ;md risks in proje\:l.ions of PCE inflation PCEinllalion - Molilncfpcj.\"li.., • ro'..o ~intcnll -l -l -I -o lll4 2!116 lOIS 2!117 2019 lOIS l)ll) FOMC partkipams· a~nlS of unttnainty arK! risks around their ~!\~nomic proj«tions ~~~~ Unocrtainl)";about PCEinfla.~ioo 0 -IS _, -16 ~n----: I I : [ D Junt~'tioM - 10 I I - I - 6 I I -' := J' -IS ~h:J\'hfllll1-\'tiotb _, -16 I -_ 10 I - 6 "8 L.-- - - .--~ ,]2 0 Junc~~"t)om •• Mal\tpr~'tiorb ~n ---- : -s : :c===:? j; _, 1 -10 I I - 11 -16 ~ , -ll [ ~' Risks to tore rcE il'lllation Ull(Xnainl)'aboutC'Cirt PCE inftation 0 Jll!IC'~"'"iom I I -16 \\tiglnoloo •r;i<k Simibi ... -II •• ~larrllpro;x~ - 1! I 8roodh· n _, n _,. Rl4s to PCE infl3.1ioo JIJntrro.J(\'tiQM ·· Mal\'h~ - 6 I I =: I I - 6 I L.----.-~ c===? ', .. Hi!M VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00211 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718062.eps Kou:Tf'x' btuc:md mlliibt$ in l.bc toppanri ~ 3<1ual'lo~3-nd rM.Iian proj.\"t~'\1 \altJ<S. t'\"Sf'.\1i,\iy.olt~~l\'\"ffl<'lta.n~ in tb: rri:c indc-\ for (I('I'SO!Ukoasump~)oa C'.\P.,'Oditi!KS(PC'E) from the fotlnb ctW11et of till: pmiollS )W 10 liM' founh \l~n.Cf ol'thc )~rind~t~. Tbt\vnfl&n.x intm';l]:uound I~ medial! r~\'t«< \"J;!ucsis3S:Sl.lm.'!J tobe ~mJ'l\.1rioalld is ~Ofl r004 mc3n squa.i\'1:1 mors of \-arious pri\'3tt' and $('\'C't'IUilCQ\ foi'(\"3S!Smadc 0\\'1' Ihe pmiou..:20 }\'a~ mort informationabout th<'sc dau isa'\'J.ilaJ:kint3bk l.lk'\"3118«Jmtltc:ooditlons~' dilfc-rrromthosc tlu\ (lm~il.:d. OIU\~ 0\'tf tl\t:pmioi.IS 20 )'tJI). t~ •'XIth and sb.l~of t~ C'OO:fl'lk"IIIX iottn-al ¢SLima.tOO Ofllhc b.l$iiQ( the historil:all'om."'.l)l crron l'll3fi'IOI rtfk.."1 FO~IC rarticirarltS' ~rm:JI3~'71K1llso( tlx' Wli."(rl3int)' :~00 risks aro\Jod their projroioos.: these- ~mnt a:sscssmrnts arc SllmmarUOO in 1~ ltM'tr pane-b. Gcctr.a!l)• ~3kirt,g. J"lrticlp.Jnts v.hojud~ the IIIK\'f13illt) 3bo'Uithcir proj•,"1ioas 3$ -broad~· simibr~to t~a\'tf"lg(' lt\'t'l~<lftlkop3S120 ~\"!N v.\)uld \·~· tht 1o1iodth oftMoonli~irum::alsbmm in tlt.:: lti)lorit.tl f:ao clu11 a.s I;~~A>ci)'C'OnAA(tlt •itb thdr a..~'lltmts oft~ UI'IC('rtaint)' 31xxlttlk-ir proj.,'tion!<.l.imi.;c. p:~l1iripotr:t1$ who jud~ ~~ ri~s to thtir rrojt\.'1ions a~ -brood~· NlltK·t~rwoold \'icv. t~oo-1lf.xi..."''Kt inttn"ll3routld tt.:ir proj«tioM.a:s :tppro~m:ncl) S)mm.mic. Ford:titlitioo$ of UIK\'f13itlty and ri.J:s in trofiOmil: pro~'tiol\-;.. sc.: the bo~ ~Fortcasl UDC.\'ft3int).~ 208 MONEIARYI'OUCYREI'ORT: JULYI018 61 Figure 5. Uncertainty in projections or the federal funds rate Median proje<oion and .;onfidenc. in<er\'al based on histori<al forecast errors r.."Ckralfuodsr.llc - )l~t<i>loiWJ<tl1!ll< - - -M~\I~ol~'1- • N'-•~iri1C'f'-af• 6 - s _, -J -l - I -o :!014 21116 lOll lOIS 2019 Non;:Thc-bi\X'nd 1\-d li!b..'$3rc b.l...-doo :K1U3I ,:lf'ues:and IJ'IC'diln prot-'1.1«1 l'3!Uo.'S. n.-.:p.."Cli\~·,of the Commiu«-'SI;tfld for the fcdcralfur.ds rateat tile:end of the )'Cal iDd.icaltd. Theac1ua! ''J.tucs:utth<' midpoint of tbela~'t ran~-: tllc ITIC'diao proj.'l.'tcd ,3J~"Sar( N..~'domcit"'ftllc midpoint of th-:13.1\'(1 rnn~orthcta~~ k\\'l.Th:('OJ!r».-nreiPim'JI;uound thcfl'll."d1<<r:~ pr()~'fOO ''3ll.li:S~b.1..\l'donr001 n'K'3.nsqu.li\'CI.~"frot'Sof,lrious pri'..ucandg<n'l.'f(ll,'l'l('ll:t fo~m:tdcoo.ttlhc p!\'\io\1$ :'0)'1.~ l'l:h: l-onfldm.'C intm'al is 001 :.tMtyro:Nstrnt OJ.ith the rro;:cioos for tb: fcdml fu.nds r.ne. primari~· lx'\"3~ t~ pro~ions ut OO{(orc\"'3stsofthc5kcl~(H,It('QR)("i((wthcf«k~fundsratc.b.Jt~t..:Jpro;.'\-tionsofp.,~t.ip;ult,'indi,iduaJa..~.;m:nts.of 3Pf1C0priatc mooct31')' pol).."): Still, hi:storic3.1 fon'\"J)I crrorspn)\idc i btt»d SIC'n..;o: of~ ur.."'!dainl)' :around L1lc future path o( the f~ fWlds:ratc ~'fl("r.tb:d b) tbruiX\-rtaintyabout the macroo."'OOO!lk,"Jfilbksa.s OJ.~Ias.~Jdition:lladjlbtn._>fltslomOOI:tar)' pol~'}· that ma)·bc :~ppropri.llc 1oo1T~ thcdTC\:t,~or ~..:~tolho:ct\XIOill): "fll.: ronftdc~Kt in1~r.<tl is ;nslJmed to be S)'ll'lmctric ti'<CXJI'I Men it is tru1K'31cd at wo-thc bottom of the~~ t3~t rany for the ftdcratfur'll.kr.11~tba1 has b«nadoptlid in tho.-Jm~ b)' tMCommincc This tnJIIC3tion '>'ould not ~intrndcd to indk.OlC' the likdi!\ood Of tbc U$C O(IICgJtii'CiniCJ'C)I talC$ tO prO\ide additional ll'!Otll.13~' J»!icy 3C('(Immod31iOn if dOing $0 \\'3$jlldsc<f 3pJ)ropriatc. In s:Lll.il situatiion5.1bc Committ~ rouldalsoc:mplo)•ottk.'f toot' induding fOt\\-atd gtOOanct and brgc«aac: ~ ~1\ilas<'\ to pfO\idc addi1io~ 3t\'Ommodltion. lk\;JuS~: '""rftflt N!Dditioa~ ~· dilfcr (rom t~ th31 pl\"l'likd. on 3\mgc. <»<tr t~ pre\ious 20 )~3rt\ the 'Aidth :1~ ltl~ of th¢ tontidctle'C intena! estimatt'd oo the- b;lsis ortht historical fur('('l:~-t crnm rrAy-not 1'1.'11«1 fOMC JKir1~;p;~nu:'amtn1 015'S(').""'l\(f(1Sof tM U!Ktrtainl)' a~ risks :m~u~ thcir projections.. 'Th:~'Onf'xf..-nreintcn~ is&.-.m\"dfromfofl.\4stsofthc-r.mg<~dof~·t«min[('ri."St~atcs inthtfounh~~olthcrear iOOi.:lttd! roorc il'lfomwion :ab<nn thc!.r clau is 61'3ibblr in ublt 2. Tht shaded 1~ cnootnp.usd ~than 1 7IJ pM't'l'lt tooflddh."t VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00212 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718063.eps irum-aliftbt-oo~in1tn~haslx'\'nlnJIX"Jlcd:atw\\ 209 62 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S Forecast Uncertainty uncertJlm)' surrounding theirprojections are sumrnarh;ed VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00213 Fmt 6621 in the bottom-left J"nels of those rlgur~ Pa~icipants also ptO\ide judgment> as to whether the risks to their projections are weighted to the upside, are 1\eighted to the down~de. or are bro.dl)•balanced. That i~ while the symmetric historical fan ch.l~s """' n in the top panels of figures 4.A through 4.( imply that the risl<s to pa~icipants' projections are oolanced, participants mar judge that there is a greater rislt that a gi'-en variable will be abO\-e rather than below their projections. These judgment> are sun1marized in tt'.t lrnveNight pallets oi tigures 4.A through 4.(. As with realacti\'ity and intlatioo, the outlool; for the future path of the federal funds rale is subj«t to considerable uncert.linty. This uncert.lin~· arises primarily b«ause each participant's assessment of the appropriate stonce of mone~ry policy depends importJntly on the e.-olution of realactivi~· and iniLltion 0\-er time. II econornic conditions e'\'01\'e in an unexpected mannec, then aSSll<ments of the appropriate se<ting of the federal funds rate would ch.lnge from that point forward. The final line in lab!e 2 shows the error ranges kw ioreca~ oi short·term interest rates. They suggest that the histO<ical confodence intervals associated with projections of the federal funds rate are quite wide. It should be noted, howe\'Cr, that these confidence intefvals are not strictly consilient 1rith the projections for the federal funds rate, as these projections are not forecasts ol the most likely qua~erly outcomes but rather are projections of pa~icipan~· ind'l\'idualassessmen~ of appropriate mooetary policy and are on an en<f.of·]'Oar oosi~ H0\1'0"er, the forecast errors should prOI'ide a sense of the unc~inty around the future path of the federal funds rate generated by the uncettainty about the macroeconomic variables as "•II as additional adjustments to moneta')' policy that would be appropriate to offselthe effects ol shocks to the economy. If at some point in the future the confidence interval around the federal funds rate 1\•re to extE<ld below zero, it would be truncated at zero fO< purposes of the fan chart """'" in frgure 5; zero~ the bottom of the 10\,·est target ra.nge for the federal funds rate th.lt has been adopted by the Committee in the past. This approach to the construction of the federal funds rate fJn cha~ "oold be tneftlr a C::M\'elllioni it \\ould not ha\'e an)' implications for pofiible fvt\Jie polity deci~QOI regarding~~ u~ ol negati\-e intertslta:es to ptovide .!dditional mone1ary policy accom~tion if doing so""'" appropriate. In such situations, the Committee could also en1ploy Olher tools, including forward guidance and asset pmch.1ses, to prOI'ide additional acconm10dation. While frgures 4.Atluough 4.C prOI'ide infomnation on the uncert.lint)' around the economic projections, figtJre 1 prOI'ides infornl.ltion on the range of vie"' across FO.\\C participants. Acon1parison of figure I with figures 4.A through 4.C """'' that the dilpersion of the p<oj«tions across participants is much smaller than lhe Cl\-er.age forecast errors"'"' the !"It 20 rea~. Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718064.eps The «onomic proj«tions provided by the mernboo of the Boord of Go"ernors and the presiden~of the r.deral Res«ve 8an~s infO<m discussions of monet.l')' policy among policyma~e<s and can oid public unde<standing of the basis f01 policy actioo~ Considerdble uncettainty attends these projection<, howe.1'<.lhe «onomic and statistical models and re~tion>hips used to help I~OOU<e «onomi< iO<~IIS are n«ess.lrily imperi«t descriptions of the real world, and the future path of the e<onom)' can be affected b)•myriad unfo!eseen developmen~ and e.-ents. Thus. in setting the stan(e of monet.l')' policy, participan~ coosic:lef not on~~ what appeMs to be the most likely«onomicoutcome as embodied in their projections. bulalso the range of altemato-e possibilities, the likelihood of their occuiTing. and the potE<ltial cOilS to the «onomy should they occur. Table 1 sumnl.lrizes the "''"&e hiiiOricalaccuracy of a "nge of fo<ecasts, including those r<iJ011ed in pall Monelary Policy (lppottsand those prepared by the r.deral Restn'O Boord's staff in advance of meetings of the Federal Open ,\Iarke~ Committee (FOMQ. The proj«tion error ranges shown in the table illustrate the conside,.ble uncertainty associated with eoonomic focec.cnts. For mmple, suppose a l"~icipanl projects that real groo don1<1<tic product (GOP! and wt.JI consumer prices will rise steadily at annual rates of, resp«ti\'ely, 3 percent and 1 percent. lithe uncert.lin~· attending those projection~ is similar to ihat experienced in the past and the risM around the projections are broodly balanced, the numboo r<iJ011ed in table 2would impl)' a probability of about 70 percenithat actual COP 1\0Uid expand within a range of 1.7to 4.3 percent in the current )'Oar, 1.0 to 5.0 percent in the second 1-ear, and 0.9 10 5.1 percent inthe third )'Oar. The corresponding 70 percent confodence inte<v.ols fO< 0\'0!all iniLltion would be 1.3 to 1.7 per<E<lt in the current 1-ear and 1.0 to 3.0 percent in the second and third )~ars. ~gures 4.A through 4.C illustrate these cooodence bounds in •f.n cha~!" that >re symmetric and centered on the me<lians of fOMC pa~iciP"nts' projec1ions for GOP groMh, the unemplo) ment r.ne. and inilation. Howe,~. in some instances, the risl:s around the projedions. may not be srmrneuic. In l"~icular. the unemployment rate cannot be negath~; fu~hermore, the risM around a pa~icular p<Oj«tion might be tilted to either the upside or t~ w,,·ns~, in 1\lti~h em the ~orresj)Qil(ling ian cha~ 1\oold be asymmetrical!)' positiooed around the median projectioo. Because curreot conditions ma)' differ from those th.lt prevailed, on "-erage, 0\'01 history, participants prOI'ide judgments as to whether the uoc~inty auached to their projections of each «onomic variable is sreater th.ln, smaller than, or bro.dly >imilar to typic.lle.~ls of forecast uncertainty seen in the I"~ 20 )'Oa~, as presE<lted in ~ble 2 and reflected in the widths of the conodence inten~ls shown in the top panels of figures 4.A through 4.C. Participants' currE<lt assessments of the 210 63 VerDate Nov 24 2008 14:11 Dec 18, 2018 AFE ad\'anced foreign economy BBA Bip.1nisan Budget Act of2018 BLS Bureau of Labor Statistics C&l commercial and industrial Desk Open Market Desk at the Federal Resen·e Bank of New York DPI disposable personal income ECB European Central Bank EME emerging market economy FOMC Federal Open Market Committee; also. the Committee GDP gross domestic product IOER interest on e.1cess reserws JOLTS Job Openings and Labor Turnover Survey LFPR labor force part icip.1tion rate MBS mortgage-backed securities Michigan survey University of Michigan Sun·eys of Consumers OIS O\'ernight index swap ONRRP overnight reverse repurchase agreement PCE personal consumption expenditures SEP Summary of Economic Projections SLOOS Senior Loan Officer Opinion Sun'C)' on Bank Lending Practices S&P Standard & Poor's TCJA Tax Cuts and Jobs Act TIPS Tn.>asury lnflation-l'rotected Securities VIX implied volatility for the S&P 500 index Jkt 046629 PO 00000 Frm 00214 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718065.eps ABBREVIATIONS VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00215 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718066.eps 211 212 ARTICLE SUBMITTED BY SENATOR BROWN Paychecks Lag as ProfitsSoar, and Prices Erode Wage Gains Julyl3,2018 Corporateprofits have rarelyswept up a bigger share of the nation's wealth, and . workers have rarely shared a smaller one. The lopsided split is especially pronounced given how low the official unemployment rate has sunk. Throughout the recession and much of its aftermath, when many Americans were grateful to receive a paycheck instead of a pink slip, jobs and raises were in short supply. Now, complaints of labor shortages are·as common as tweets. For the first time in a long while, workers have some leverage to push for more. Yet many are far from making up all the lost ground. Hourly earnings have moved forward at a crawl, with higher prices giving workers less buying power than they had last summer. Last-minute scheduling, no-poaching and noncompete clauses, and the use of independent contractors are popular tactics that put workers at a disadvantage. Threats to move operations overseas, where labor is cheaper, continue to loom. And in the background, the nation's central bankers stand poised to raise interest rates and deliberately rein in growth if wages climb too rapidly. Workers, understandably, are asking whether they are getting a raw deal. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00216 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718067.eps "Sure, you can get ajob slinging hamburgers somewhere or working in a warehouse," said Christina Jones, 53, of Mobile, Ala Ms. Jones spent eight months searching for a job with living wages and benefits, after being laid off from a paper company where she had worked for nearly 13 years: Dozens of interviews later, she land~d work last month at a concrete crushing company as an accounts payable clerk for 514 an hour- two-thirds her previous salary. 213 "You hear, 'Oh, the unemployment rate is as low as it's ever been,'" Ms. Jones said, but "it was discouraging." Businesses have been more successfulat regaining losses from the downturn. Since the recession ended in 20G9, corporate profits have grown at an annualized rate of 6.5 percent. Several sectorshave done much better. On Friday, for example, banks like JPMorgan Chase and Citigroup reported outsize double-digit earnings in the second quarter. Yearly wage growth has yet to ltit 3 percent And when it does, the Federal Reserve which has a mandate to keep inflation under control even as it is supposed to maximize employment- can be expected to tap the brakes. Labor's Declining Share Workers' paychecks account for much less of the nation's total income since the last recession, and the profits ofbusinesses account for more. Employee pay as ashare of national income 68% 67 66 65 64 63 62 61 1970 ·so 60 '90 2000 '10 '18 Corporate profits as a share of nalionaf income 15% 14 13 12 11 10 9 8 VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 ·so Frm 00217 '90 Fmt 6621 2000 Sfmt 6621 '10 '18 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718068.eps 1970 214 SOurce: Bureau o!Eoonomic Statistics I By The New York Times As Fed policymakers have explained, allowing the economy to run too hot "could lead eventually to a significant economic downturn." And persistent wage increases, unlike growing profit margins, are considered a signal that the heat is on. The bank's primary method of cooling the economy is to dampen spending and investing by raising interest rates and making it more expensive to borrow money - an antidote that could hurt profits in some sectors as well as trim payrolls. The thinking goes like this: Better to inflict some pain now, in the form of higher joblessness and sluggish wage growth, than to allow more pain later. After keeping benchmark interest rates at near-zero levels during the recession, the Fed has been gradually nudging them up. So far this year, it has raised rates twice. With tariffs piling up and potentially pushing prices higher, odds are that the Fed will push through two more increases before 2018 ends. The Labor Department reported this week that one inflation measure, the Consumer Price Index, had increased 2.9 percent in 12 months - the highest level in six years. Discomfort with a tight labor market and growing worker bargaining power is to some degree baked into the Fed's makeup. Pressure to raise wages during expansions will inevitably be seen as precursors to insidious inflationary pressure. The conventional wisdom that higher wages inevitably lead to higher prices, however, is flimsy, some economists argue. "It theoretically makes sense," Michael R. Strain, an economist at the conservative American Enterprise Institute, said of the link between wage increases and inflation, "but empirically, it's increasingly difficult to find a real strong link." VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00218 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718069.eps Astudy by the Federal Reserve Bank of Cleveland, for example, concluded that "the connections among wages, prices, and economic activity are more akin to a tangled web than a straight line," and that "the ability of wages to help predict future inflation is limited." 215 Atight labor market shoulod give workers someleverage to pushfor higher wages, but hourlyearnings have moved forward at a crawl. Olristie Hemm Klol< ror'l11e New YorS< Tunes Regardless, there is plenty of evidence that workers have yet to receive their fair share of this most recent expansion-or even the previous one. Since the century's start, labor's share of the nation's income has sunk to the lowest levels in decades. In 2000, when the jobless rate last fell below 4percent, corporations pulled in 8.3percent of the nation's total income in the form of profits; wages and salaries across the entire work force accounted for roughly 66 percent VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00219 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718070.eps Now, the jobless rate is again fluttering below 4percent. But corporate profits account for 13.2 percent of the nation's income. Workers' compensation has fallen to 62 percent. 216 If workers' share had not shrunk, they would have had an additional $532 billion, or about $3,400 each, said Jared Bernstein, an economic adviser to former Vice President Joseph R Biden Jr. And at this point in the recovery, shifting some of those corporate profits to workers would have no effect on inflation, he noted. In the tug of war between workers and irtvestors, Americans livirtg on a paycheck have seldom been left with a shorter end of the rope. Fredy Amador has spent years working for various temporary help agencies, packing boxes of baby clothes, quality-checking packages of popcorn and doing other work at warehouses across the Chicago area Despite what he says are frequent promises of permanent work, he has never been able to escape temp status. Recently, his situation got worse. He used to receive holidays and paid vacations, he said, but the agency that offered them lost its contract to another firm that did not "They want to avoid all the benefits,• said Mr. Amador. Mr. Amador, 34, said he earns $12 an hour, far less than the $20 an hour or more earned by permanent employees doing similar work. For extra money, he drives for the ridehailing service Lyft on the weekends. "Even if you have really good skills, you have to start as a temp,• said Mr. Amador, who moved to the United States from Honduras 12 years ago. "They never give you an opportunity to move on.• Economists have offered various explanations for why workers are not doing better: the steady weakening of labor unions, the ability of American companies to find cheaper labor abroad or automate further, piddling productivity growth and the rise of superstar companies that are extremely efficient with a relatively small labor force. VerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00220 Fmt 6621 Sfmt 6621 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON 71718071.eps The recent tax overhaul has further pumped up corporate earnings. Promises that lower tax bills for businesses would translate into higher wages have yet to materialize. Higher gas and medical care costs have eaten away at whatever gains most workers have made. 217 Nor are those extra profits going into business expansion. Since the first of the year, American companies including Apple, Wells Fargo and McDonald's have announced nearly S680 billion in buybacks of their own stock, according to the research firm TrimTabs. In essence, they are directing a majority of the windfall to investors and chief executives, who tend to have large stock-based compensation packages. Profits are also financing foreign mergers and acquisitions."Alot of U.S. businesses are looking abroad to see what they can buy," said Jason Gerlis, managing director ofTMF Group U.S.A., a global consulting firm, "because it's easier to finance or capitalize offshore." The reason is a change in the tax law that limited interest deductibility on domestic investments, but not on those abroad. International deals in the first half of 2018 nearly doubled compared with the same period last year. The United States may be leading other big industrialized countries in economic growth, but its labor force does not fare well in comparison. American workers' share of their country's total output fell much sharper and faster than the average reported by the Organization for Economic Cooperation and Development The United States also had a larger proportion of low-wage workers than nearly every other member. When the economy was struggling, employers became accustomed to inboxes flooded with resumes and snaking lines of eager applicants. Many may have forgotten, or never learned how, to compete for workers. When it comes to complaints of a labor shortage, as Nee! Kashkari, president of the Minneapolis Fed, has said: "If you're not raising wages, then it just sounds like whining." Follow Patricia Cohen on Twitter: @_i>cJtcohenN'(T. Ben Casselman contributed reporting. 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