Federal Reserve Banks

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Industry report:

This classification includes the Federal Reserve banks and their branches, which serve as regional reserve and rediscount institutions for their member banks.

Industry Snapshot

Although U.S. banks were experiencing greater autonomy as restrictions were relaxed in the late 1990s, the U.S. banking structure was still heavily regulated by the U.S. Federal Reserve System in the mid-2000s. The Fed, as it is popularly called, also greatly influences the U.S. financial markets and monetary supply, to which banks must continuously react. There are twelve Federal Reserve banks, representing twelve Federal Reserve districts. In 2007, about 3,000 of the roughly 8,000 commercial banks in the United States, or 38 percent, were members of the Federal Reserve. The total net income of the Federal Reserve banks was $34.2 billion in 2006. Most of this income was derived from the interest earned on federal government securities, which the Fed acquires on the open market. The twelve Federal Reserve banks spent $2.4 billion on operations in 2006. The Federal Reserve banks reported a net income of $36.1 billion in 2008, a reflection of the financial crisis and $48.4 billion in 2009.

Banking institutions can be regulated by as many as four major, independent federal agencies as well as state agencies. Historically, there have been two distinct types of financial institutions in the United States: commercial banks and savings banks. Commercial banks are depository institutions with investment and broad lending powers for short- or intermediate-term purposes. Savings banks include thrift institutions, which hold passive deposits and investments in long-term real estate mortgages, and credit unions, which are owned by the members and provide short-term personal loans. Either of these types of financial institutions may be state or federally chartered.

The Federal Reserve banks enforce Federal Reserve Board regulations, clear and collect checks for depository institutions, extend credit to depository institutions, and act as the fiscal agent of the United States. In addition to the Federal Reserve, the banking industry is regulated by several other agencies. The Federal Deposit Insurance Corporation (FDIC) insures deposits in commercial banks and thrifts and regulates these institutions. The Office of Thrift Supervision has a role in overseeing thrift institutions. The Office of the Comptroller of the Currency supervises national banks. Finally, each state has a banking office to regulate state-chartered banks.

Banks and savings institutions chartered under state law are subject to the laws and regulations of that state, as are nationally chartered institutions, where the state provisions are not preempted by federal laws. The resulting combination of federal and state regulation and charters has created an interrelated system under which most state banks are subject to some federal supervision, and state laws are often applicable to national banks.

The Federal Reserve is the primary federal supervisor and regulator of all U.S. banks and of state-chartered banks that are members of the Federal Reserve System. In its supervision of the general operations of these financial institutions, the Federal Reserve seeks to promote the soundness of these institutions and ensure their compliance with relevant laws and regulations. The Federal Reserve is also responsible for reviewing the participation of these institutions in electronic data processing, fiduciary activities, government and municipal securities dealing and brokering, and securities underwriting.

The Federal Reserve greatly influences the amount of money circulating through the country's financial system. By purchasing and selling Treasury bills, the Federal Reserve causes fluctuations of the rates charged to banks for short-term loans to other banks. These open-market transactions can also raise or lower interest rates throughout the economy, since higher rates force banks to set a higher bar for lending practices, thus leading them to favor more expensive funds. In addition, the Federal Reserve can alter the interest rates charged to member banks for loans involving government securities. These discount rates more or less monitor the pulse of the U.S. bond market. Conversely, the Federal Reserve can create printed money with which to purchase securities, increasing its reserve supply and lowering interest rates.

During the early 2000s, the Fed cut interest rates several times in an effort to bolster a faltering economy. This led to a boom in the mortgage and housing industries. Many home buyers were swayed by subprime and adjustable rate mortgages, which created financial difficulty for many as interest rates climbed through the mid-2000s. Consequently, mortgage defaults and foreclosures had a negative impact on the economy, forcing the Fed to address those issues toward the late-2000s.

Organization and Structure

The Federal Reserve banks are an integral part of the Federal Reserve System and were created under Section 4 of the Federal Reserve Act.

The Federal Reserve System is composed of four parts: a board of governors, known as the Federal Reserve Board, which is an independent government agency; the Federal Open Market Committee (FOMC); the Federal Advisory Committee (FAC); and twelve Federal Reserve banks, each with its own board of directors, which are independent instruments of the government.

The Federal Reserve Board.
The Federal Reserve Board is made up of seven members appointed for 14-year terms. The president names the chairperson and vice-chairperson to four-year terms. The Federal Reserve Board supervises and examines the Federal Reserve banks; state-chartered member banks, bank holding companies, and nationally chartered commercial banks; international operations of domestic banking organizations; and the U.S. operations of foreign banks. The Federal Reserve Board also has the authority to act on bank mergers involving member banks and to review changes in control over state-chartered banks and bank holding companies.

The Federal Reserve Board implements U.S. monetary policy. The board seeks to maintain low unemployment, price stability, and economic growth. The board exercises this authority through open market operations, the review and determination of discount rates, and the prescription of specific reserve requirements of financial institutions.

The supervisory role of the board includes prescribing rules and regulations governing advances and discounts by Federal Reserve banks to member banks; open market purchases by Federal Reserve banks; acceptance by member banks of drafts or bills of exchange; legal reserve requirements; purchase of warrants by Reserve banks; accounting and disclosure requirements of member banks; extension of securities credit by lenders other than banks, brokers, and dealers; eligibility requirements for membership in the Federal Reserve System; issuance and cancellation of stocks of Federal Reserve banks; collection of checks and other items by Federal Reserve banks; regulation of foreign banks operating in the United States; loans to executive officers of member banks; regulation of interlocking relationships under the Clayton Antitrust Act of 1914; prescription of minimum security devices and procedures for member banks; regulation of interest on time and savings deposits; relationships with securities dealers; extension of credit for margin purchases; bank service arrangements; loan guarantees for defense procurement; regulation of bank holding companies; and the regulation of a variety of consumer-related functions.

The above does not exhaust the range of supervisory powers assigned to the Federal Reserve Board. It is also active in the regulation of mergers, consolidations, or acquisitions of assets by state member banks, a responsibility it shares with the FDIC, the Comptroller of the Currency, and the attorney general. The board is empowered to fix for each Federal Reserve District the percentage of individual bank capital and surplus that may be represented by security loans. The board may take punitive action toward member banks and Reserve Bank employees for the violation of regulations or laws relating to the bank or engaging in unsound practices.

The board's supervisory powers also include the oversight of the implementation of the international credit guidelines under the Voluntary Credit Restraint Program, permitting Federal Reserve banks to rediscount paper for one another at rates approved by the board, allowing Federal Reserve banks to make four-month advances to adequately secured member banks and to make loans to groups of five or more banks that are inadequately secured, and requiring the writing off of worthless assets from the books of the Federal Reserve.

Finally, the board's powers include the operation of the Interdistrict Settlement Fund (a bookkeeping system used for Federal Reserve interdistrict transactions), the examination of Federal Reserve banks and member banks, the production of various reports on the Federal Reserve banks and member banks, suspension of reserve requirements for 15 days (renewable), imposition of penalties for deficiencies of reserves of member banks, supervision and regulation of the issuance and retirement of Federal Reserve notes, and the appointment of the three Class C directors of each Federal Reserve bank, as well as selection of the chairman and vice-chairman from these directors.

The Federal Open Market Committee.
The Federal Open Market Committee (FOMC) consists of seven Federal Reserve Board members and five Federal Reserve bank representatives. The FOMC sets monetary policy by selling government securities to influence the credit supply and interest rates. The FOMC has centralized direction and control of the open market operations of the Federal Reserve System.

The FOMC was organized under the Banking Act of 1935. Each Federal Reserve bank is required to participate in the FOMC's operations and may not engage in market operations on their own without the committee's approval. Policy directives of the FOMC are issued to the Federal Reserve Bank of New York for the execution of transactions on the open market. The individual Federal Reserve banks are authorized to engage in open market transactions in foreign exchange, subject to the direction and regulation of the FOMC.

The Federal Advisory Council.
The Federal Advisory Council (FAC) consists of one member from each Federal Reserve District. The FAC meets regularly with the Federal Reserve Board to discuss general business conditions and make recommendations regarding the Federal Reserve System. The FAC has a purely advisory and consultative function.

The Federal Reserve Banks.
The 12 Federal Reserve banks are located in the Federal Reserve Districts and include numerous branches and regional check processing centers. The 12 district banks are located in Boston, New York, Philadelphia, Richmond, Atlanta, Cleveland, Chicago, St. Louis, Dallas, Minneapolis, Kansas City, and San Francisco. Each of the 12 banks has its own distinct organization and serves its own district. The minimum capital for each district bank is $4 million in subscribed capital; most of the banks hold significantly more capital than this amount.

Each of the Federal Reserve banks is overseen by nine directors divided into three lettered classes: A, B, and C. Class A and B directors are elected by the member banks of the district, while Class C directors are appointed by the Federal Reserve Board of Governors. The Class A directors are intended to represent the member commercial banks and are usually bankers by trade. The Class B and Class C directors are intended to represent the public. Directors may not be members of Congress, while Class B and C directors may not be employees of any banks, and Class C directors may not be stockholders of any bank. All directors are expected to exercise discretion and to avoid participation in partisan political activities. These directors are elected for three-year terms on a staggered basis. The Class A and B directors are elected by mail by the member banks of the district. The banks of the district are divided into three categories, based on capitalization, and each category may nominate three directors for each class.

One of the Class C directors, armed with significant banking experience, is appointed by the Board of Governors as the chairperson of the Federal Reserve Bank and as the Federal Reserve agent. A second Class C director is appointed vice-chairman, and the final Class C director presides at meetings of the bank's board of directors. The Federal Reserve agent may appoint experienced assistants, with the approval of the Board of Governors, to assist the agent in the performance of his duties and to act in his place during absence or disability.

Despite the fact that the member banks are the sole stockholders and elect two-thirds of the investors, policy control lies with the Board of Governors. The district banks are required to participate in the programs of the FOMC. Discount rates set by the district bank directors are subject to the review and acceptance of the Board of Governors, which makes the final determination as to reserve requirements and has broad control of operational matters through its regulations.

The responsibilities of the Federal Reserve banks include: enforcing Federal Reserve Board regulations, clearing and collecting checks for depository institutions, extending credit to depository institutions, and acting as the fiscal agent of the United States.

Federal Reserve banks are actively involved in the enforcement of Federal Reserve Board Regulations. The breadth of these regulations is comprehensive, spanning the full authority of the Federal Reserve System.

The district banks are responsible for providing an efficient system of collecting out-of-town cash items such as checks. Each district bank acts as a regional clearinghouse for the depository institutions in its district. The Board of Governors acts as the national manager for clearing debit and credit balances among the Federal Reserve banks through the Interdistrict Settlement Account.

Regional Check Processing Centers (RCPC), located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, and Minneapolis, are responsible for collecting checks overnight. These RCPCs are operated by the Federal Reserve banks to expedite check collection. The RCPCs sort, clear, and deliver checks deposited by commercial depository institutions.

The Federal Reserve banks offer credit to depository institutions by accepting eligible paper for rediscount or by offering secured loans to the institution with eligible paper or government securities as collateral. The depository institution may choose to receive the proceeds in Federal Reserve notes or other forms of currency to meet deposit withdrawals or as credit to its reserve account. These institutions may also return excess currency to the Federal Reserve Bank for credit to its reserve account. To maintain the stability of this arrangement, the Federal Reserve Bank must meet collateral requirements for Federal Reserve notes. These notes must be fully secured by gold certificates, special drawing rights, eligible paper, or U.S. government obligations, tendered to the Federal Reserve agent at the district Federal Reserve Bank.

The Federal Reserve banks act as the fiscal agent of the United States, supplying currency and coin to more than 9,700 institutions. Each of the 12 Federal Reserve banks carries an account for the U.S. Treasurer and undertakes transfers of treasury balances, handles issuance and redemption of U.S. government obligations, and performs other functions for the federal government. The banks are also responsible for the replenishment of currency to the member banks and the issuance of new currency to replace worn and mutilated bills and coins.

The Federal Reserve banks maintain 25 branches, 37 automated clearinghouses, 32 regional check processing centers, and 10 check clearing offices in the major commercial centers of the United States. The branch offices perform many of the functions of the district banks for their territories. Each branch is directly supervised by a board of either five or seven directors, the majority of whom are appointed by the district bank and the remainder by the Board of Governors. These directors are subject to the regulations of the Board of Governors and the general supervision of its district bank.

National banks are required to become members of the Federal Reserve System. State-chartered banks may become members if they wish. Each member bank is required to hold stock in its district's Federal Reserve bank in an amount equal to 3 percent of the bank's capital and surplus. Access to Federal Reserve credit facilities and to Federal Reserve services, including check clearing and transfer of funds, is open to both member and nonmember institutions.

Last, the Federal Reserve brings all of the nation's diverse financial activities into a tight statistical relationship with each other via the flow of funds (FoF) system. This system identifies, tracks, and monitors the influences on financial markets of nonfinancial activities. The FoF system divides the economy into basic sectors (households, governments, nonfinancial businesses, financial businesses, and all foreign activity) in order to make sure that all the sectors' transactions balance with each other. In so doing, the FoF system tracks the proliferation of financial claims and the size of capital stock throughout the economy.

Background and Development

The history of banking in the United States is characterized by a tension between a reluctance to give the federal government control over monetary policy and the concept of Federalism. Alexander Hamilton secured the establishment of a strong central bank in order to give stability to the fledgling republic's currency. The First United States Bank was authorized to stabilize United States currency for a period of 20 years. However, a bill to renew its charter was defeated by one vote in both the House and Senate in 1811. The ensuing chaos led to the establishment of the Second Bank of the United States in 1816. In 1836 the charter of this second bank was not renewed, and financial chaos followed once again.

The National Banking Act of 1863, coupled with the National Banking Act of 1864, established the contemporary banking system through the authorization of national bank charters and the creation of the Office of the Comptroller of the Currency. This action was a major improvement to the ad hoc system that was in place between 1836 and 1863. However, this system was still inadequate for the growing country's economy.

The Federal Reserve Act of 1913 created the Federal Reserve System. This act created the Federal Reserve Board, an independent government agency, and 12 regional banks. On April 2, 1914, exactly 100 days after President Woodrow Wilson signed the Federal Reserve bill into law, the Organization Committee released its report naming the cities of Boston, New York, Philadelphia, Richmond, Atlanta, Cleveland, Chicago, St. Louis, Dallas, Minneapolis, Kansas City, and San Francisco as locations for the Federal Reserve banks. On November 16, 1914, the twelve Federal Reserve banks opened for business.

During World War I, the Federal Reserve banks extended loans to the member banks to help them buy U.S. securities. Although this move aided the treasury, it also aggravated price inflation. The Federal Reserve's tightening of credit to halt gold outflows in the aftermath of the war exacerbated the economic recession of 1920 and 1921. This experience helped formulate the Federal Reserve's later policy of raising the discount rate to curtail credit in periods of expansion and lowering it to stimulate economic growth.

The system was faced with even greater challenges during the depression era (from 1929 to approximately 1939). As panicking depositors withdrew currency from member banks in response to the number of bank failures, the volume of Federal Reserve discounts declined. The depletion of commercial bank reserves led to reductions in new lending, which further aggravated the depression. In response to this crisis, the Federal Reserve was later given greater regulatory powers, including the power to regulate margins in stock purchases and the power to vary reserve requirements of member banks.

During World War II, the Federal Reserve was also involved in helping the Treasury borrow at low interest rates. The Federal Reserve banks purchased around $20 billion dollars of U.S. securities and provided member banks with additional reserves, so that they could also buy Treasury securities. Despite rigorous price controls and aggressive sales of savings bonds, inflation increased sharply in the late 1940s. The Federal Reserve Board was criticized sharply for not using open market operations more aggressively to curb inflation.

To increase lending, the member banks sold treasury securities during the Korean War, forcing the Federal Reserve banks to buy these securities to keep the prices stable. The increased inflation, financed by credit, presented a new set of problems for the Federal Reserve. In response, the Federal Reserve Board asserted its independence and reached an accord with the Treasury in 1951, agreeing that Federal Reserve policy should not be subordinated to treasury financing.

After 1951, the policies of the Federal Reserve were more focused on domestic economic stabilization than funding the Treasury. In the early to mid-1960s, the Reserve's focus was on price stability and the restriction of monetary growth; in the late 1960s, the emphasis was on full employment and growth of output. The late 1960s also marked the beginning of the concern with international trade deficits and the outflow of gold, the latter culminating in the repeal of the gold-reserve requirements for the Federal Reserve by Congress in 1968 and the end of the Gold Standard under the Nixon administration on 15 August 1971.

The events of the 1970s were difficult for the Federal Reserve. The discount rate tripled, the federal debt more than doubled, gasoline prices increased ominously, and inflation was seemingly out of control. Congress began looking for ways to limit the independence of the Federal Reserve or, at minimum, force it to reveal its policies and goals in specific terms. The bank was also becoming bogged down in the sheer number of transactions that it had to complete, including check collection and shifting deposits. Pressure was mounting to make significant changes to the Federal Reserve as well as to the overall financial structure of the United States.

In 1980, Congress passed the Financial Institutions Deregulation and Monetary Control Act. This act was to have a significant impact on the Federal Reserve. It required all depository institutions that maintain transaction accounts or nonpersonal time accounts to maintain reserves with the Federal Reserve to the extent necessary for the conduct of monetary policy. It opened the facilities of the Federal Reserve to all banks, including savings and loan associations and credit unions. Finally, it required the Federal Reserve to charge fees for its services to banks in order to cover the costs, including taxes and interest, incurred by the Reserve for providing these services. The implementation of this new legislation was difficult and costly. By 1984, however, the goal of breaking even on services had been achieved.

The Federal Reserve's role in bank regulation was changed by the Federal Deposit Insurance Corporation Act of 1991. This act came in the aftermath of the savings and loan crisis of the late 1980s, when the viability of the banking system was in question. This legislation significantly modified the Federal Reserve Act in response to these uncertainties.

The Federal Reserve also assumed greater responsibility for consumer protection in the 1990s. The Division of Consumer and Community Affairs addressed concerns about fair lending practices in urban areas, access to credit by minorities and low-income households, possible discrimination in mortgage lending, and the need to match its consumer regulations to industry developments. In 1995, the Board joined in issuing revised interagency regulations under the Community Reinvestment Act that included the publication of two proposals. The new rules emphasized performance in lending; they will help promote consistency in assessments and reduce compliance burdens for many banks. In fair lending, the Board adopted streamlined procedures for referring discrimination complaints to the Department of Justice. In 1995, the Board also completed its first full year of operating a specialized fair-lending school for Federal Reserve examiners. The two-week school covers an extensive range of conceptual topics and practical, hands-on class work. A total of 109 examiners attended the three sessions offered during the initial year.

By the early 1990s, the Truth in Lending Act, the Fair Credit Billing Act, and the Equal Credit Opportunities Act involved the Federal Reserve in the protection of individuals' rights in obtaining consumer credit. The Fair Credit Reporting Act, the Consumer Leasing Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act involved the Federal Reserve in requiring and monitoring the disclosure of crucial financial information to consumers involved in credit transactions. The Electronic Funds Transfer Act provided a basic framework regarding the rights, responsibilities, and liabilities of consumers who used electronic funds transfer as well as those of the institutions granting them. Finally, the Federal Trade Commission Improvement Act authorized the Board of Governors to identify and implement legislation to prohibit unfair or deceptive bank practices.

Perhaps the most profound event affecting the Federal Reserve during the late 1990s was the passage in 1999 of the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act and thus began to dismantle the distinction between commercial and investment banks. Lobbyists for the financial industry had campaigned for more than 20 years to bring down the depression-era law. Overall, the legislation lifted a broad range of restrictions on the spectrum of financial institutions' activities, allowing them to offer insurance products and to run travel agencies and a host of other previously prohibited business activities. Among other features, the Glass-Steagall Act prohibited commercial banks from dabbling in the stock market. The Gramm bill knocked down that law and allows banks to directly underwrite municipal revenue bonds.

While the United States enjoyed unprecedented economic growth during the late 1990s, the rising number of weak or potentially weak loans at some institutions alarmed the Fed, which issued a guidance to banks warning them against the relaxation of credit discipline, including the over-reliance on the borrower's promise to pay. The Fed attributed the development to overconfidence in clients' portfolios.

In foreign affairs, the early 1990s saw the Federal Reserve begin to implement the Foreign Bank Supervision Enhancement Act of 1991. In conjunction with this act, the Federal Reserve Bank began to strengthen its supervisory role with respect to the operation of foreign banks in the United States. By the end of the decade, the Fed was working on a series of information-exchange agreements with the financial supervisory authorities in countries around the world, with the purpose of opening information channels regarding the banking activities of the respective nations. With the continued international face of finance, such agreements were set to allow U.S. banks to make further inroads into foreign markets and vice versa.

By the end of 2001, more than 550 U.S. bank holding companies had taken advantage of the Gramm-Leach-Bliley Act and transformed themselves into financial holding companies (FHCs). A handful of U.S. securities firms and one leading insurance player had also converted to FHC status by then. The total assets of FHCs totaled $6.1 trillion, which accounted for roughly 80 percent of the assets of domestic bank holding companies. The larger FHCs typically used the Gramm-Leach-Bliley Act to diversify into securities and insurance underwriting as well as merchant banking. Many of the smaller FHCs created insurance brokerages.

The unprecedented growth of the U.S. economy in the late 1990s had come to an abrupt halt by the end of 2000. Therefore, the terrorist attacks on September 11, 2001, undermined an already weak economy. According to U.S. Board of Governors of the Federal Reserve System 2001 Annual Report, "The most pressing concern of the Federal Reserve in the first few days following the attacks was to help shore up the infrastructure of financial markets and to provide massive quantities of liquidity to limit potential disruptions to the function of those markets." To this end, Federal Reserve banks extended the hours of their funds and securities transfer systems. The Federal Reserve Bank of New York even relaxed certain restrictions related to securities lending. As a result, securities lending reached unprecedented levels in the weeks following the attacks. To encourage consumer spending, the Fed cut interest rates several times throughout the remainder of the year. Along with reducing the federal funds rate and working to facilitate liquidity, the terrorist attacks also prompted the Fed to initiate security measures to ensure that Federal Reserve banks are able to maintain operation in the event of disaster.

Signs of economic recovery began to appear during 2003, and by 2004 consumer spending and industrial and commercial activity were increasing. As a result, by early 2005 the Fed was incrementally increasing the interest rate. In May 2005, the Fed raised the rate by one quarter of 1 percent to 3 percent. The increase slowed the economy's growth.

According to its 2004 Annual Report, the Federal Reserve collected 13.8 billion checks valued at $15.1 trillion, processed 7.4 billion automated clearinghouse (ACH) transactions valued at $15.5 trillion, and handled 125 million FedWire transfers valued at $470 trillion. The Fed earned about $758 million for processing commercial checks in 2004. It received $75.2 million for ACH operations. FedWire fund transfers brought in $57.9 million in 2004.

These numbers reflect a growing trend in the U.S. banking sector away from checks in favor of ACH payments. ACH processing services increased by more than 16 percent during 2004. Electronic payment volume exceeded check volume for the first time during 2003 when the number of paid checks totaled 36.7 billion and electronic payment transactions totaled 44.5 billion. The expanding use of debit cards, which increased by 23.5 percent between 2000 and 2003, was driving the electronic payment sector. By 2006, more than two-thirds of all noncash payments in the United States were made electronically.

The implications for this shift are significant to the Federal Reserve. First, the Fed has increased capital expenditures for technology infrastructure to handle the increasing volume of ACH services. Second, as the number of checks processed declined, the need for check processing centers also fell, leading the Fed to close thirteen sites in 2004 and another nine sites during 2005. Site closings in 2005 resulted in the loss of about 700 jobs. Finally, the transition to electronic banking has had an operational impact on the Fed. According to the NACHA (the Electronic Payment Association), the Fed's cost for ACH payments were 99 cents per item during 2004. The cost for processing commercial checks, on the other hand, was 5.1 cents per item.

The economic rebound of the mid-2000s enabled more Americans than ever to enter the housing market, but that was not necessarily a blessing by the late 2000s. A report by RealtyTrac in June 2007 indicated that foreclosures increased 19 percent from April to May 2007, and the foreclosure rate in May 2007 was 90 percent higher than in May 2006. Moreover, the rate of delinquencies rose to 15.75 percent among subprime borrowers. Delinquency was defined as borrowers at least 30 days behind on their payments.

The Fed took measures in late 2007 to attempt to alleviate the problem in hopes of avoiding or lessening a possible recession. In December, the Federal Reserve Board proposed changes to the Home Ownership and Equity Protection Act (HOEPA), which amended the Truth in Lending Act (TILA). Included among the proposals for protections for higher-priced mortgage loans, creditors would be prohibited from engaging in a practice of extending credit without considering borrowers' ability to repay the loan and would be required to verify the income and assets they rely upon in making a loan, and lenders would be prohibited from compensating mortgage brokers with payments known as "yield-spread premiums" unless the broker previously entered into a written agreement with the consumer disclosing his total compensation. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.

"Our goal is to promote responsible mortgage lending, for the benefit of individual consumers and the economy," Federal Reserve Chairman Ben S. Bernanke said. "We want consumers to make decisions about home mortgage options confidently, with assurance that unscrupulous home mortgage practices will not be tolerated."

In response to the effect the struggling U.S. housing market had on the global economy, America's Federal Bank joined with the Bank of England, the European Central Bank (ECB), the Bank of Canada and the Swiss National Bank to announce a "dramatic, joint plan to ease the liquidity squeeze in global money markets," according to The Economist. Foremost in the plan was the Fed introducing a term-auction facility through which all banks eligible to borrow from the discount window could bid for one-month money, with $20 billion to be sold at each of two auctions in December 2007 and another two auctions in January 2008. The Fed also announced temporary swap lines with the ECB and the Swiss National Bank, worth $24 billion, allowing those banks to lend dollars to banks pledging euros or other currencies. "The actions have the potential to end the crunch that has paralyzed credit markets for the past few months. ... I think the Fed is getting ahead of the curve," Jay Bryson, a global economist at Wachovia, told U.S. News & World Report.

Current Conditions

In January 2008, the Federal Reserve cut interest rates from 4.25 percent to 3.5 percent as both the economy and the financial sector worsened, which was the largest cut since October 1984, according to CNNMoney.com. The latest findings revealed the auctions set in place earlier for the most part were working. In the meantime, President Bush and Congress were expected to release a stimulus package that may ease some of the economic pressures for consumers and businesses. However, some felt the FED stepped in too late to deter a recession.

According to its 2009 Annual Report, the Federal Reserve collected 8.6 billion checks, down 10.1 percent compared to 9.5 percent in 2008. The Reserve Banks went from 13 paper check processing offices at the end of 2008 to two offices by the end of 2009 as electronic check processing continued to gain momentum. Additionally, there were 9.6 billion ACH transactions processed with a value of $92.9 million. The FED handled 127 million FedWire transfers, a decrease of 5.1 percent for the previous year valued at $64.4 million.

During the third quarter of 2009, total foreclosure filings grew 23 percent compared to the same time in 2008. According to RealtyTrac, "One in every 136 U.S. housing units received a foreclosure filing during the quarter--the highest quarterly foreclosure rate since RealtyTrac began issuing its report in the first quarter of 2005." At year-end 2009, there were a reported 900,000 homes repossessed.

The Federal Reserve helped to implement two important pieces of legislation through a period of financial chaos directed at protecting consumers. In May 2009, President Obama signed into law the Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (the "Credit Card Act"), and the Helping Families Save Their Homes Act of 2009. The Credit Card Act was the most comprehensive reform of the credit card industry to date. The Act ensures consumers are treated fairly, especially as it relates to transparency in the terms and conditions of credit card accounts. In short, the law bans unfair rate increases and protects consumers from deceptive lending practices and more. The Helping Families Save Their Homes Act is a key component in an attempt to keep families in their homes, thus reducing foreclosures.

The foreclosure rate escalated with a projected one million foreclosures expected in 2010. During the first six months alone, about 528,000 homes were already in the hands of their lenders. Another 1.7 million Americans received a foreclosure warning, or one in 78 Americans. According to Lender Processing Services, more than 7.3 million home loans were in delinquency in June 2010. Although the foreclosures were being felt on a national level, Nevada reported the largest number of foreclosures during the first six months of 2010, followed by Arizona, Florida, California, and Utah.

Meanwhile, in early 2011 controversy surrounded the Federal Reserve's proposed new regulations as part of an update to TILA. The new rule would require the homeowner to first pay the amount demanded by the lender, before the lender removes its mortgage lien on an illegal loan. In essence, the proposal "would tilt the balance in favor of creditors who have failed to comply with TILA's disclosure requirements," a group of six senators from the Senate Banking Committee argued in a letter to the Federal Reserve. More importantly, this comes at a time when lenders need to be boosting consumer moral versus stifling economic growth.

Lastly, the Federal Reserve Board and federal government called on the SEC and FINRA to adopt new rules and regulations following the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010. Under Section 619 of the Dodd-Frank Act, referred to as the "Volcker Rule," the board issued another Section 13 to the BHC Act restricting banking institutions from participation in "proprietary trading and from investing in, sponsoring, or having certain relationships with, private equity funds or hedge funds." The complex legislation was expected to touch every corner of financial services and multiple other industries over the next two to five years as regulations are set in place.

America and the World

During the mid-2000s, there was heavy interaction between Federal Reserve policies and international economic developments. The Fed engages in foreign-exchange transactions, which involves the purchase of foreign currencies and maintaining them in reserve. The exchange value of the dollar relative to foreign currencies is a primary instrument by which the Federal Reserve engineers U.S. monetary policy. By raising interest rates in the United States, the dollar rises in value relative to foreign currencies, thereby raising the cost of U.S. goods on the world market and decreasing exports. The reverse, of course, is true when the Fed lowers interest rates. Furthermore, after the Asian financial crisis and Russian bond default in 1998 sent shockwaves through financial markets, the Federal Reserve focused its international efforts on tallying the extent of U.S. banks' exposure to volatile economies.

Since the early 1970s, the Federal Reserve and other central banks have developed a reciprocal, or swap, network by which central banks may access each other's currencies. In this way, central banks can intervene to prop their local currencies. The New York Federal Reserve Bank handles swap transactions, transferring dollars to a foreign central bank in exchange for that country's currency, at the same time agreeing to reverse the transaction a few months later.

The concept of central banking was developed in response to the recurrent British financial crises of the nineteenth century. Modern market economies are subject to frequent economic fluctuations. The causes of these fluctuations are diverse; however, there is general agreement that the ability of banks to create money may exacerbate them. This situation raises the need for an independent monetary authority able to view economic and financial developments objectively and to exert control over the activities of the banks.

Central banks have four major functions: the maintenance of a sound commercial bank structure; the management of international trade and financial relationships; ensuring the adequacy of banking capacity and services for the community; and, finally, acting as financial advisor to and taking responsibility for the financial affairs of the government.

To maintain a sound commercial banking structure, central banks are often called upon to offer support to financial institutions in times of crisis and to avoid such crises. The Federal Reserve System examines the books of commercial banks and sponsors various educational programs. In some developing countries such as India and Pakistan, the central banks continually scrutinize commercial bank operations. The Bank of England plays a crucial role in the United Kingdom's banking system, ensuring that banks have a steady supply of cash, even during periods of credit restrictions.

Central banks also manage the international financial relationships of their country as well as the foreign exchange activities of that country. This role often requires coordination and cooperation with other central banks and international financial institutions, such as the International Monetary Fund (IMF) and certain regional, yet supernational organizations.

Another responsibility of a central bank is the assurance of the availability of banking services. In rural areas of India and Norway, the central banks have been active in ensuring that the banking needs of these areas are met. In France, this concern has led to the expansion of the central bank's activities to France's territories. Central banks are also active in assuring that the quality of banking services is adequate. In India and Pakistan, as in the United States, the central banks inspect and audit bank operations. In other countries, such as France and South Africa, this function is delegated to a separate authority.

Finally, central banks are often called on to act as the government's financial agent and advisor. The Bank of England developed into a central bank from its original role as the banker to the government. The Federal Reserve, as well as the Bank of France and the German Bundesbank, has historically been involved in granting credit to the government on a direct or indirect basis. However, many banks are severely restricted in engaging in these activities.

In 2003, many of the world's central banks were nationalized. These banks had taken a role as public institutions that exist to serve the community as a whole. Most of these banks, however, do garner significant profits. The European Central Bank, the Bank of Korea, the Bank of England, and others were raising key interest rates at that time. However, in areas where the spectacular financial performance the United States has enjoyed was lacking, such as continental Europe, such moves were widely viewed as an attempt to prop local currencies and make assets more attractive.

Research and Technology

The Federal Reserve Bank has been aggressive in implementing new technology. In 1999, the Fed revised Regulation CC to allow broader validity for check images as substitutes for physical checks. The ruling opens greater opportunities in electronic checking, a technology that was somewhat restricted by Regulation CC's vague passages regarding the handling of returned items. The revised ruling clarifies that images are in fact an acceptable replacement for paper, wherever the two parties, or a consortium of parties, agree to it.

In 1991, the Philadelphia Federal Reserve adopted the DISC Global Payment System for transferring and receiving Federal Reserve payment instructions. This system provided customer initiation, service delivery, and payment processing in a single product, operating a comprehensive electronic wholesale banking system on the same platform.

In 2001, the Fedline personal computer software was upgraded to offer greater flexibility in electronic transaction services. The upgraded software offered improvements that allow banks to make electronic bids for treasury securities, treasury security transfers, and automated clearinghouse and wire transfer transactions and currency orders.

In addition to decreased processing time and improved service, the Federal Reserve also cut costs through the implementation of new technologies. One of the most important of these cost-saving methods was the consolidation of twelve general purpose data processing centers into three regional operations: Dallas, Richmond, and the New York Bank's East Rutherford, New Jersey, facility.

Finally, the Federal Reserve has implemented measures to shore up the Banks' security systems, particularly in the growing area of electronic funds transfer. To ensure the $1.5 trillion in funds transferred daily through the Federal Reserves's bank network, the Fed has implemented the Triple DES (data encryption standard) method. Ready for application in June 2002 as an official government standard was the Advanced Encryption Standard (AES), which uses 256-bit key lengths to encode electronic data, compared with DES's 56-bit key lengths. During the mid-2000s, concerns over terrorism and cyber attacks continued to garner considerable attention, leading the Fed to continue to invest heavily in technological and security upgrades.

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