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Full text of "H.R. 28, the Federal Reserve Accountability Act of 1993 : hearing before the Committee on Banking, Finance, and Urban Affairs, House of Representatives, One Hundred Third Congress, first session, October 27, 1993"

!\ / H.R. 28; FEDERAL RESERVE 

V ACCOUNTABIL ITY ACT OF 1993 

Y 4. B 22/1: 103-86 

H.R. 28: Federal Reserve Account abi... XvliNLr 

JRE THE 

COMMITTEE ON BANKING, FINANCE AND 

URBAN AFFAIRS 
HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRD CONGRESS 

FIRST SESSION 



OCTOBER 27, 1993 



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

Serial No. 103-86 







U.S. GOVERNMENT PRINTING OFFICE 
7»-435CC WASHINGTON : 1994 

For sale by the U.S. Government Printing Office 
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402 
ISBN 0-16-044286-9 



H.R. 28; FEDERAL RESERVE 
W ACCOUNTABILITY ACT OF 1993 



y 4.B 22/1:103-86 

H.R. 28: Federal Reserve Accountabi. . . IvlINijr 



JRE THE 

COMMITTEE ON BANKING, FINANCE AND 

URBAN AFFAIRS 
HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRD CONGRESS 

FIRST SESSION 



OCTOBER 27, 1993 



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

Serial No. 103-86 







U.S. GOVER>fMENfT PRINTING OFFICE 
73-435 CC WASHINGTON : 1994 



For sale by the U.S. Government Printing Office 
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402 
ISBN 0-16-044286-9 



HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS 



HENRY B. GONZALEZ, Texas, Chairman 



STEPHEN L. NEAL, North Carolina 
JOHN J. LaFALCE, New York 
BRUCE F. VENTO, Minnesota 
CHARLES E. SCHUMER, New York 
BARNEY FRANK, Massachusette 
PAUL E. KANJORSKI, Pennsylvania 
JOSEPH P. KENNEDY II, Massachusette 
FLOYD H. FLAKE, New York 
KWEISI MFUME, Maryland 
MAXINE WATERS, California 
LARRY LaROCCO, Idaho 
BILL ORTON, Utah 
JIM BACCHUS, Florida 
HERBERT C. KLEIN, New Jersey 
CAROLYN B. MALONEY, New Yoric 
PETER DEUTSCH, Florida 
LUIS V. GUTIERREZ, Hlinois 
BOBBY L. RUSH, Illinois 
LUCILLE ROYBAL-ALLARD, California 
THOMAS M. BARRETT, Wisconsin 
ELIZABETH FURSE, Or^on 
NYDIA M. VELAZQUEZ, New York 
ALBERT R. WYNN, Maryland 
CLEO FIELDS, Louisiana 
MELVIN WATT, North Carolina 
MAURICE HINCHEY, New York 
CALVIN M. DOOLEY, CaHfomia 
RON KLINK, Pennsylvania 
ERIC FINGERHUT, Ohio 



JAMES A. LEACH, Iowa 

BILL McCOLLUM, Florida 

MARGE ROUKEMA, New Jereey 

DOUG BEREUTER, Nebraska 

THOMAS J. RIDGE, Pennsylvania 

TOBY ROTH, Wisconsin 

ALFRED A. (AL) McCANDLESS, California 

RICHARD H. BAKER, Louisiana 

JIM NUSSLE, Iowa 

CRAIG THOMAS, Wyoming 

SAM JOHNSON, Texas 

DEBORAH PRYCE, Ohio 

JOHN LINDER, Georgia 

JOE KNOLLENBERG, Michigan 

RICK LAZIO, New York 

ROD GRAMS, Minnesota 

SPENCER BACHUS, Alabama 

MIKE HUFFINGTON, California 

MICHAEL CASTLE, Delaware 

PETER KING, New York 

BERNARD SANDERS, Vermont 



(II) 



CONTENTS 



Page 

Hearing held on: 

October 27, 1993 1 

Appendix: 

October 27, 1993 53 

WITNESSES 

Wednesday, October 27, 1993 

Angell, Wayne D., Governor of the Federal Reserve Board 15 

Borden, John P., President, National Organization of Clearing Houses 31 

Bowsher, Charles, Comptroller General of the United States, General 

Accounting Onice 5 

Carreker, J.D., Chairman, J.D. Carreker & Associates, Inc 35 

Lauffer, James R., Chairman, President, and CEO, the First National Bank 

of Herminie; President, Independent Bankers of America 38 

McDonough, William J., President, Federal Reserve Bank of New Yoric 19 

Wentworth, Howard B., Senior Vice President, Philadelphia National Bank .... 41 

APPENDIX 

Prepared statements: 

Gonzalez, Hon. Henry B. (First panel) 54 

Gonzalez, Hon. Henry B. (Second panel) 58 

Leach, Hon. James A 61 

Angell, Wayne D 81 

Borden, John P 99 

Bowsher, Charles 64 

Carreker, J.D 108 

Lauffer, James R 123 

McDonough, William J 92 

Wentworth, Howard B 130 

Additional Material Submitted for the Record 

Chairman Gonzalez requests to have minutes from the Reserve Banks in 

what turned out to be the Bank Audit Act of 1978 132 

John Borden requests the Federal Reserve's documents of approval process 

for the payer group sort under the Freedom of Information Act 134 

Written statement of Tom C. Frost, San Antonio, TX 150 

Written statement of E. Gerald Corrigan 157 

(III) 



H.R 28; FEDERAL RESERVE ACCOUNTABILITY 

ACT OF 1993 



WEDNESDAY, OCTOBER 27, 1993 

House of Representatives, 
Committee on Banking, Finance and Urban Affairs, 

Washington, DC. 

The committee met, pursuant to notice, at 10 a.m., in room 2128, 
Raybum House Office Building, Hon. Henry B. Gonzalez [chairman 
of the committee] presiding. 

Present: Chairman Gonzalez, Representatives Neal, Waters, 
Klein, Hinchey, Leach, Roukema, McCandless, Nussle, Pryce, 
Knollenberg, Lazio, Grams, and Huffington. 

The Chairman. The committee will please come to order. 

The Banking Committee begins the 4th day of hearings on issues 
involved in H.R. 28, the Federal Reserve System Accountability Act 
of 1993. 

I welcome Charles Bowsher, the Comptroller Greneral of the Gen- 
eral Accounting Office, and look forward to his testimony. He will 
tell us about the legal limitations the GAO faces in examining Fed- 
eral Reserve operations. 

In testimony during these hearings on October 13, Federal Re- 
serve Chairman Alan Greenspan told us, and I quote, "GAO, in the 
1978 act, could audit all aspects of the Federal Reserve System 
with the exclusion of those which refer to the question of the delib- 
erations related to monetary policy," end of quote. 

Was he trying to mislead us? 

Let me tell you some areas of Federal Reserve operations that 
the GAO cannot investigate. Most people do not know that when 
the Federal Reserve changes the money supply, it does so from its 
New York Federal Reserve Bank in an auction separate from the 
U.S. Treasury auctions used to borrow money for government 
operations. 

Each morning, around 10 a.m., the Federal Reserve Bank of New 
York holds a 30-minute auction with approved bank and nonbank 
dealers in order to change the monetary base of the United States. 
By buying or selling securities, usually very short-term repurchase 
agreements, the Fed takes money out of circulation or puts money 
back into circulation. There is little information on this auction. We 
know there is no market clearing price as was recently introduced 
for Treasury auctions. Thus, accepted bids or offers are transacted 
at different prices. 

Is this the most efficient way to run this market? Why are the 
bids and offers not published? Is there any possibility of exploiting 
inside information, especially since participants can meet at the 

(1) 



Federal Reserve Bank shortly before the auctions? Can the GAO 
send in a team of experts to uncover the answers? 

The second example concerns the Federal Reserve's intervention 
in foreign currency markets. We know from the minutes of the 
1962 FOMC meetings that the Federal Reserve gave itself a fund 
for intervention without adequately notifying the Congress or the 
public. That fund is now $30.1 billion. The Treasury, on the other 
hand, has a fund similar to that of the Fed, called the Exchange 
Stabilization Fund, but its budget is approved by the Congress. 

According to a description published by the Federal Reserve 
Bank of New York in the 1970's, the Federal Reserve uses commer- 
cial banks to initiate some of the transactions involved. For exam- 
ple, an intervention by the Federal Reserve to sell German marks 
to increase the relative price of U.S. dollars includes the sale of 
marks to commercial banks, a request for a swap transaction to the 
Bundesbank, and a 2-day settlement period. 

Can the GAO send in a team of experts to discern the propriety 
of these procedures? 

I believe the answer to both situations is, of course, no. 

Is it out-of-bounds for the Congress, therefore, the American pub- 
lic, to learn about these transactions? 

Again, this has nothing to do with the FOMC deliberations or 
micromanagement of daily Federal Reserve operations. The Fed 
just wants to keep the curtains closed and keep any outside eyes 
from reviewing how well — or how bad — its biggest policies are im- 
plemented. Who knows whether the Fed's engine needs a tuneup 
if no one will let the mechanic look under the hood? 

Now, let's discuss another gray area where the GAO would be 
appropriate. Earlier this year, I was informed that New York Fed- 
eral Reserve Bank personnel were accepting hospitality at expen- 
sive restaurants and gifts from the very banks they have authority 
to regulate. On May 18, 1993, I received this astounding reply from 
E. Grerald Corrigan, the former president of the New York Federal 
Reserve Bank, and I quote: 

"Our review indicates that in the limited number of instances 
where bank officers have been guests at meals hosted by regulated 
institutions at what would be considered an expensive restaurant, 
they have been acting within bank guidelines, and their conduct 
does not call into question the ethical standards of the Federal Re- 
serve Bank of New York," end of quote. 

That certainly says something about the ethical standards of the 
New York Federal Reserve Bank because such gifts would be ille- 
gal for government agencies using appropriated funds. 

President Corrigan also rationalized the acceptance of tickets for 
sporting events from regulated banking institutions when he said, 
and I quote: 

'There were a literal handful of instances involving attendance 
at sporting events in which bank officers were guests of acquaint- 
ances who worked at regulated institutions," end of quote. 

But with no outside review, we don't know how many cases there 
were. Maybe this is like the rough notes of FOMC meetings that 
turned out to be quite extensive tape recordings and transcripts. 

The question I have for the Comptroller General is whether the 
GAO can investigate the receipts of hospitality from regulated 



banks by Federal Reserve employees if the employees say, "We 
were discussing monetary policy during our free meals provided by 
the XYZ Bank in an expensive restaurant"? 

As I understand it, in this case, the Federal Reserve must give 
its permission for any GAO examination. Doesn't the public have 
the right to monitor possible conflicts of interest? Are the Fed's em- 
ployees then invested wdth infallible comportment, merely because 
they are sacrosanct officials of the Federal Reserve? 

Finally, the reason GAO has such limitations is because the Fed 
conducted an elaborate campaign to prohibit any audit bill from 
passing and succeeded for many years. In fact, it was not even ap- 
proved by the Banking Committee, but by another committee, in 
1978. 

I am happy to have the Comptroller General here today to dis- 
cuss the GAO limitations in examining the Federal Reserve. 

Mr. Bowsher, please introduce your associates after I have given 
a chance for our minority leader, Mr. Leach, to say a few words or 
place his remarks in the record. 

Mr. Leach. 

Mr. Leach. Thank you, Mr. Chairman. I have a lengthy state- 
ment. I would like to read about half of it and place the rest in the 
record. 

The Chairman. Sure. 

Mr. Leach. Mr. Chairman, as you know, I have previously stated 
my support for relatively modest reforms to remove certain inde- 
fensibly undemocratic elements of the Federal Reserve System. I 
am also sympathetic to a greater degree of accountability for Fed 
decisionmaking which might include a somewhat more timely re- 
lease of FOMC policy directives. 

However, I have reservations about the potentially more draco- 
nian action of expanding GAO investigation, some call it audit au- 
thority, to the monetary policy functions of the Fed. 

In this regard, lest there be any misunderstanding, it should be 
noted that in the government the term "audit" has two distinct 
meanings. The GAO conducts financial audits — so called dollars 
and cents audits of balance sheets; and performance audits — or re- 
views of programs and the implementation of laws. Performance 
audits are akin to audits of the decisionmaking process. 

The issue of GAO audit or review of the Fed's conduct of mone- 
tary policy is not an issue of first impression. Indeed, beginning in 
the early 1950's, the more general issue of GAO audit of the Fed- 
eral Reserve, including the monetary policy function, was widely 
debated on Capitol Hill. 

The eventual outcome of this 25-year debate was passage of the 
Federal Banking Agency Audit Act in 1978. That act, for the first 
time, authorized the GAO to conduct both financial and perform- 
ance audits of the Fed, exclusive of the monetary policy function. 

The monetary policy function was excluded from the purview of 
GAO review at that time in recognition of the special political vul- 
nerability of a central bank because of the opposition that may be 
generated, particularly when it imposes monetary restraint. 

There was also — and I believe still is — an awareness of the ex- 
treme sensitivity of the confidential nature of information provided 



by foreign central banks and governments — information critically 
needed in the formulation and implementation of monetary policy. 

It is not unreasonable to assume that public knowledge that an 
arm of Congress, the GAO, had review powers and access to such 
information would have a chilling effect on the Fed's relationships 
with foreign governments and central banks. 

Indeed, 2 years ago, when this committee subpoenaed all records 
held by the Federal Reserve relating to the BCCI scandal — an ac- 
tion I supported — ^this issue was raised, albeit in the context of 
bank supervision. 

In that case, the covered records included confidential documents 
supplied to the Fed by the Bank of England. The Bank of England 
was prohibited by British law from releasing these documents to its 
own Parliament and indicated that if the Fed were compelled to 
produce them pursuant to this committee's subpoena, it would de- 
cline to share such information with the Fed in the future. 

The formulation of monetary policy is a decisionmaking process 
that involves confidential interchanges with a host of foreign gov- 
ernments and central banks. Just as information sources are not 
infrequently protected for reasons of political security and certain 
foreign policy agencies of our government, an analogously compel- 
ling argument exists that in a world of economic competition and 
friction certain financial and economic information provided to the 
Fed should be protected for reasons of national economic security. 

It is conceivable that even the hint of a possibility of the release 
of such information could jeopardize existing relationships among 
foreign monetary authorities, the Fed, and the U.S. Treasury, thus, 
aggravating our Nation's international finance relationships. 

Confidentiality may be the best protection for financial economic 
security and the best protection for taxpayers who would bear the 
brunt of any losses resulting from the compromise of policies 
caused by the untimely disclosure. 

Let me just conclude by saying, I would like to reemphasize that 
the fundamental question in the issue of GAO auditing of the Fed's 
monetary policy function involves an understanding, or misunder- 
standing, of the word "audit." Unfortunately, the word "audit" car- 
ries connotations that are misleading. 

The common usage of the term, in eveiyday life, is an accounting 
of the income and outflow of dollars. In this sense, there is already 
100 percent audit of the Federal Reserve. 

But what we are talking about here is a fundamental review of 
the information and decisionmaking process which raises implica- 
tions more of data sources and timeliness than it does of dollars 
and cents. 

As this committee well understands, the Fed makes a profit 
every year, over $16 billion in 1992, that goes to the Treasury. To 
the degree that market sensitive information is released in an un- 
timely manner that profit is jeopardized. The greater protection 
provided the Federal Reserve System, the better off the taxpayer. 

I thank the Chairman. 

[The prepared statement of Mr. James Leach can be found in the 
appendix.] 

The Chairman. Thank you very much. 



I am going to ask unanimous consent that all members present 
and absent have an opportunity to place in the record any written 
preliminary statement they may wish to make at the outset of this 
hearing to appear in the transcript. 

We will proceed and recognize Greneral Bowsher. 

If you will, introduce your associates. 

STATEMENT OF CHARLES BOWSHER, COMPTROLLER GEN- 
ERAL OF UNITED STATES, GENERAL ACCOUNTING OFFICE 

Mr. Bowsher. Thank you very much, Mr. Chairman, members of 
the committee. 

I am accompanied today by Mr. Socolar, who is my Deputy; Mr. 
Bothwell, who is in charge of all our banking and financial institu- 
tions work; and Mr. Swaim, who has done most of our work at the 
Fed in recent years. 

We are pleased to be here today to discuss the limits of our audit 
authority over the Federal Reserve System. My remarks principally 
will concern the provisions of section 3 of H.R. 28 which would re- 
move all restrictions on our authority to examine Federal Reserve 
activities. 

Currently, we lack audit authority over the Federal Reserve's 
monetary policy, foreign transactions, and the Federal Open Mar- 
ket Committee operations. 

In responding to the committee's request, I will first describe our 
existing authority and some of the work we have done under this 
authority. I will then examine the implications of removing all re- 
strictions on our authority, with specific reference to several topics 
the committee asked us to address. Finally, I will discuss certain 
safeguards that we feel would be appropriate to adopt if restric- 
tions on our authority are to be removed. 

The question of whether to lift the statutory constraints on our 
authority to audit the Federal Reserve System ultimately depends 
on what Congress wants us to do. Our access needs to be commen- 
surate with the types of audits that the Congress expects us to 
perform. 

For just a little history here, we derive our Federal Reserve audit 
authority from the Federal Banking Agency Audit Act of 1978. This 
act was passed after we did a special congressionally mandated 
study of the supervisory activities of all of the Federal bank regu- 
latory agencies. 

Before the act, our work at the Federal Reserve was mainly lim- 
ited to audits of the fiscal agent functions performed by the Federal 
Reserve banks for the Department of the Treasury. We did this 
work under our authority to audit the Treasury. 

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

The act also prohibited us from disclosing certain information 
identifying open financial institutions and customers. Appendix 2 
describes these prohibitions in greater detail. 

The act does not require us to perform any particular type of 
audit. This means, as is true with most of our work, that our au- 



dits are determined largely by specific congressional requests or by 
our discretion under our basic legislative authority. As appropriate, 
of course, we coordinate all of our activities with the Federal Re- 
serve's Office of Inspector Greneral. 

Notwithstanding the limitations on our authority, in the last 15 
years since the act was passed, we have audited many aspects of 
the Federal Reserve System in areas in which our access has not 
been restricted. And we mention several of those studies here. They 
were basically in the area of bank supervision and regulation, in 
the payment system activities, and in the government securities ac- 
tivities. 

Our current work that involves the Federal Reserve, either exclu- 
sively or as part of a study of all bank regulatory agencies includes: 
One, studies of regulatory burden; two, implementation of major 
provisions of the Federal Deposit Insurance Corporation Improve- 
ment Act of 1991; three, analysis of the risk and benefits of inter- 
state banking; four, the regulation and supervision of derivative 
products; five, an analysis of the banking industry activities in mu- 
tual funds; six, loan loss reserving by banks; seven, review of ef- 
forts to ensure a safe and sound international banking system 
through coordination among national regulators; and, eight, analy- 
sis of the expenses and revenues of the Federal Reserve System as 
they affect the Federal budget. 

As I have indicated, section 3 of H.R. 28 would remove all of the 
restrictions on our authority to examine Federal Reserve activities. 
This would provide us with full access to FOMC transactions; to 
transactions for or with foreign central banks, governments, and 
international financing organizations; and to deliberation, deci- 
sions, and actions on monetary policy matters, including discount 
window operations, member bank reserves, and open market 
operations. 

In considering the implications of removing restrictions, it is use- 
ful to look more closely at the types of work we do. Our audit work 
can be viewed as falling into two broad categories: financial audits 
and performance audits. 

I will just briefly describe financial audits, Mr. Chairman. And 
I hope my full statement could be put in the record. 

Financial audits are basically where the auditor goes in and 
checks the flow of funds through the organization. You check the 
internal controls, the systems; and according to the government au- 
diting standards today, we are asking for more review of the con- 
trols and the systems to see whether they are adequate or not. And 
then the auditor gives a report at the end of that work. 

Starting on page 10, section 3 of H.R. 28 proposes that all Fed- 
eral Reserve banks, as well as the Board of Grovernors, be audited 
annually by an independent public firm, not the GAO. In other 
words, the way your legislation is set up, it would be an audit by 
an outside public accounting firm. 

I am inclined to believe tnat this outside review would be bene- 
ficial for both the Federal Reserve and the general public. If the 
restrictions on our access were removed, we would be better able 
to assess the quality of those financial controls in auditing the 
Federal Reserve's system and make recommendations for 
improvements. 



Concerning performance audits, I would like to discuss access is- 
sues by referring to the three areas we were asked to address in 
our testimony. These issues are: One, the daily government securi- 
ties auctions at the New York Federal Reserve Bank which the 
Federal Reserve uses to manage the money supply; the Federal Re- 
serve's interventions in foreign currency markets; and safeguards 
in the auctions, and presumably foreign currency transactions as 
well, against the Federal Reserve's releasing inside information. 

Our access restrictions would be a major limitation to studying 
any of these issues in a way that required us to analyze data on 
actual transactions. Although it would be necessary for us to con- 
sider the actual scope of a request before reaching a judgment in 
any particular case, we must recognize that the restrictions in the 
law are quite explicit. Therefore, with performance audits, as well 
as with financial audits, the major question is really what Congress 
wants us to do. 

Now, if Congress decides to remove the existing restrictions on 
our audit authority, we believe certain safeguards should be in- 
cluded in the legislation. These safeguards, which are similar to 
those that already exist under our present authority should: One, 
prohibit us from disclosing the identity of foreign central banks or 
governments; two, prohibit us from disclosing confidential docu- 
ments and require safe keeping of confidential information; and, 
three, specify delays in our access to certain types of confidential 
information. 

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

I would like to say to the committee that we, in no way, want 
to jeopardize the Federal Reserve's independence. 

For example, with these safeguards, we could not use our ex- 
panded audit authority to undertake contemporaneous reviews of 
the Federal Reserve's monetary policy decisionmaking functions. 

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

In summary, we have been able to do significant audits of the 
Federal Reserve, despite the existing limitations on our authority. 
Congress obviously must decide whether our audit authority should 
be expanded. 

However, if our audit authority is expanded, we believe measures 
should be included to protect against release of confidential docu- 
ments and to prevent undue interference with the Federal Re- 
serve's ongoing policymaking functions. 

This concludes my prepared statement, Mr. Chairman. We would 
be pleased to answer any questions. 

[The prepared statement of Mr. Bowsher can be found in the 
appendix.] 

The Chairman. Thank you very much. 



8 

Is a private accounting firm in the best position to do an annual 
financial audit of the Federal Reserve? Or is it more desirable for 
the GAO to conduct the annual audit? 

Should the Banking Committee consider allowing the GAO to re- 
view any audits of the Federal Reserve by private accounting 
firms? 

Mr. BowsHER. You could do it either of those ways, I think, and 
have a satisfactory result. 

I think the big accounting firms could do the audit. We could do 
it, although we are somewhat strapped for people now as we are 
coming down in size. Just yesterday, the President, in announcing 
his new National Performance Review, Summary of Government 
Reform and Savings Act of 1993, called for audited financial state- 
ments of 23 key Federal agencies. That is, the 23 largest agencies 
in the Federal Government, which would comprise about 90 per- 
cent of the Federal Grovernment. 

So there is going to be a big effort here in all of the Federal Gov- 
ernment, if the Congress votes for that legislation. This would be 
a big effort too. So I would think it might make sense to have the 
independent CPA firm do the financial audit and then possibly 
have us do some review of that as we do on many of the govern- 
ment corporations. 

The Chairman. Mr. Leach. 

Mr. Leach. No questions. 

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

Mr. BowsHER. Thank you. 

The Chairman. Mr. Neal. 

Mr. Neal. I think you have expressed these views before over the 
years. They are not new, and I respect your opinion. And, in fact, 
as you know, just yesterday in another hearing we were lauding 
your operations, praising you for the good work that you do. 

I don't want to take a long time on this. I am just curious, what 
is it that, especially in the open market operations, that would 
trouble you to make you think that we — I guess I put it in terms 
of sort of a cost benefit view of things. I mean as a clear benefit, 
you said you don't want to interfere with the independence of the 
Fed. There is a well imderstood benefit in keeping the Fed inde- 
pendent from political pressure, so it can try to take the long view 
of things, which means that it can help keep inflation down, keep 
interest rates down, and so on, that could be compromised, every- 
one recognizes, if we do too much political meddling. 

Now, the worry — the reason that an audit of the open market op- 
erations was specifically prohibited in earlier legislation was that 
we didn't think that the benefit of getting into that area would out- 
weigh the costs. 

What makes you come to a different conclusion? 

Mr. BowsHER. I don't come to a different conclusion, Mr. Neal, 
other than to say that sometimes having any process reviewed to 
see whether it is being done fairly, efficiently, and things like that, 
has some benefit. 

But I have no knowledge of how that operation really works. So 
I have no evidence to put forth to you that there is a big need here. 



But in any operation of any large organization, sometimes it is 
good to have a performance audit as to how well is it working. 

Mr. Neal. I mean as a general principle, I can't disagree with 
you. I think that makes some sense. Again, I think here — ^well, let 
me ask this question: How about our inspector general over there? 
Is it your impression that 

Mr. BowsHER. Well, you know, I read his last report, and he is 
raising one issue that you might want to consider, and that is that, 
according to the government auditing standards, independence is a 
big issue; and he believes that independence would be enhanced if 
the Financial Examination Program reported to the Board, where- 
as now it reports to a division within the Federal Reserve. 

And so I would think that the committee might want to look at 
the issue that he has raised in his most recent report. And it is just 
really the question of independence that they have in doing their 
work. 

Mr. Neal. You know, when I was chairman of the subcommittee 
that had the oversight responsibility for the Fed, we heard from 
the inspector general once a year; and we always made it very 
clear, publicly, privately, and in every way, that the discussion off 
the record was open and we wanted to hear from him, if he had 
the slightest suspicion of any problem of any kind. 

Mr. BowsHER. I think that is very good that you would do that. 
Now the question is: How open of a door does the Financial Exam- 
ination Program have to the 

Mr. Neal. To the Board itself? 

Mr. Bowsher. To the Board itself? And that is the issue that he 
is raising in his report. 

Mr. Neal. That is something that we ought to take a look at? 

Mr. Bowsher. Yes. 

Mr. Neal. I guess I am still just a little — my worry is, I have 
seen what can happen when the Fed does not do its job right. We 
went through this veiy costly period in our economy: Huge unem- 
ployment, disruption, just incredible suffering that that caused. 

Now we are moving in the right direction, got inflation down, in- 
terest rates down. I am just worried about doing something to get 
in there and foul it up. 

So really, to me, it is a cost/benefit question. I don't quite know 
how to get at it. Because, I mean, as a general principle, I couldn't 
agree with you more, that we should have openness and no one is 
perfect. You know, the idea of getting in there and taking a look 
at things sounds very healthy. It is this other worry. 

I guess the worry is about sort of going too far, especially if we 
were to legislate it. Say we started the legislative ball rolling 
around here and it just seems to me the temptation would be great 
to just keep it moving in a way that would end up being harmful 
to us. 

Do you have any thoughts on that? 

Mr. Bowsher. I don't really have a lot of thoughts on it, Mr. 
Neal. In other words, we would be willing to do the work as the 
Congress wants it done. But I think it is up to you gentlemen and 
ladies to make your policy decision on this issue. 

Mr. Neal. Thank you, sir, very much. 

The Chairman. Mr. Knollenberg. 



10 

Mr. Knollenberg. Thank you, Mr. Chairman. 

I am a strong behever in the maxim that, if it ain't broke, don't 
fix it. And I think I have made that clear at previous meetings of 
this committee. 

But could you outline any benefits there might be that may be 
derived from having the GAO audit the FOMC? And aren't there 
some potential political risks in this process? 

Maybe you have some thoughts that you might want to elaborate 
on in regard to that. 

Mr. BowsHER. The benefits, basically, would be just having an 
independent check on the procedures and the systems that are 
used and the policies that they have laid out being followed. That 
is basically the way we do these performance audits. 

So what you are doing is you are just checking to make sure that 
things are working the way they should be in a manner that every- 
body has agreed is what they want done. 

The political concerns, I don't have any feeling on that one way 
or the other. I would leave that up to your judgment. 

Mr. Knollenberg. I have no further questions. 

Thank you. 

The Chairman. Thank you. 

Ms. Waters. 

Ms. Waters. No questions. 

The Chairman. Mr. McCandless. 

Mr. McCandless. Thank you, Mr. Chairman. 

Mr. Bowsher, you and I have spent quite a bit of time together 
the last couple of days. 

I am going to go back to our discussions yesterday at the Grovem- 
ment Operations full committee as to the procedures that are fol- 
lowed by GAO relative to the construction, the review, and the ulti- 
mate release of a document, a report on subject X. 

It was an interesting discussion, because there were checks and 
balances through the process, as we discussed it, not only inter- 
nally between your management reviewing the product, but also in 
some cases, the product being reviewed by the office or the depart- 
ment, in some cases, prior to release for purposes of maybe refining 
it. 

In the subject here today, we are talking about videotaping the 
actual proceedings of an action. We are talking about immediate 
release of a transcript of everything that has taken place and all 
of the surrounding aspects of making everything public, except I 
guess when somebody excuses themselves to go to the sand box. 

This seems to be a contrary approach to the process of adminis- 
tration of a public office. I would appreciate your thoughts on what 
appears to me to be a total opposite in terms of how you function. 

Mr. Bowsher. Well, the way we function is we 

Mr. McCandless. The comparison is what I am interested in. 

Go ahead. I am sorry. I didn't mean to interrupt you. 

Mr. Bowsher. The wav we function, Mr. McCandless, of course, 
is two ways. When we do a review, about 50 percent of the time 
on our major reports, we give a copy of the report to the agency 
and ask for their official comments and we bind those comments 
into the back of the report. 



11 

The other 50 percent of the time, for various reasons, we don't 
get official comments, but we always have an exit interview, and 
we try to take into consideration any of the issues that the audit, 
you might say, raises in finalizing our report. 

Now, as we discussed yesterday, sometimes, unfortunately, some 
people will leak a report from the agency or sometimes if it gets 
over here on the Hill — and we run into trouble when sometimes 
that happens. If that was to happen in the Federal Reserve type 
situation, it would be, I think, most unfortunate, as it is generally 
in all of the other cases. 

So one of the things we might want to do, if you wanted us to 
do these kind of reviews, is to set up special processes to safeguard 
the release of the reports; this would be one thing I might want to 
consider with you. 

Mr. McCandless. Do you feel from your experience and the op- 
eration of GAO that it is a good idea to have an agency operating 
in a fishbowl while it is developing policy? 

Mr. BowsHER. We have always generally been, in doing our 
work, after the fact. 

In other words, we have not been auditing, you know, right then 
and there while a committee is making a decision or while the de- 
fense officials are making their decisions on weapons systems or 
forces. 

And generally our process is to go in after the fact and to look 
and see how it was done and to report on the process, you might 
say. 

Mr. McCandle3S. Well, what I made reference to here is you are 
also examining compliance with existing regulations and making 
comments in your report relative to these issues. 

So that is where I was focusing from a policy point of view: Is 
it good government business to have such an organization operat- 
ing in a fishbowl environment while in the process of making rath- 
er substantial decisions on the future of the country's business? 

Mr. BowsHER. Well, I think that is a major policy decision for 
the Congress to make here. In other words, in some cases Congress 
has generally come out on the side of openness and sunshine. 

Other times you have made the decision that you thought, like 
with National Security Council decisionmaking and things like 
that, it was not. So I think that that is a policy decision for you 
people to make. I think it is a very important one. 

Mr. McCandless. Good political answer. Thank you. 

My time is up. 

The Chairman. Thank you. 

Mr. Grams. 

Mr. Grams. I have no questions. 

The Chairman. Mr. Huffington. 

Mr. HuFFESfGTON. No questions. Thank you. 

The Chairman. OK 

Do you have any further questions? 

Mr. Neal. May I ask one? 

The Chairman. Yes. Certainly. 

Mr. Neal. I would just like to ask one more question if I can. 
I am just trying to get a little clearer fix on what is and what isn't 
done. 



12 

As I understand it, the Fed — all the regional banks are audited 
internally, and then the Governors have an auditing system in ad- 
dition to that. They audit the banks. Then the operations of the 
Federal Reserve System itself are audited. 

Other than the transactions between our Fed and foreign 
banks — and the reason for that is that if we were to make public 
those relations — the foreign banks simply wouldn't do business 
with us. I mean they are much more secretive than our banks. And 
our Fed thinks it is valuable to have that information. And so the 
practical matter is, if they thought that their relationships with us 
were made public, then they would simply shut down their 
operations. 

The discount window operations aren't audited because if you 
make public the transactions between the discount window trans- 
actions between the Fed and the bank, that would signal that that 
bank was in trouble and you might cause a run on the bank. 

So there is a pretty good reason for not making all that public. 

And then the open market operations aren't audited, and the ar- 
gument has always been there that you don't want to audit them 
because that would start to compromise the independence of the 
Fed and get into the conduct of monetary policy itself, because, as 
a matter of fact, what they do, they buy and sell; and the only real 
thing to look at is, I mean, to say, did you buy this on a certain 
day? Well, sure, you either did or you didn't. I mean there is noth- 
ing to hide there. They did or they didn't. So there is really not 
much to get into except questions of policy. 

Mr. BowsHER. Yes. 

Mr. Neal. So as I understand it, these are the three main areas 
where we don't have audits, and everything else is well audited, if 
I understand you correctly. And that is what I would like for you 
to comment on. 

So I don't think that we ought to leave — my point here, to me, 
is that it seems to me there are probably pretty good reasons that 
almost anyone would agree to that we shouldn't get into these 
three areas. And we don't want to leave this impression that some- 
how this massive operation, all these banks and the regulatory op- 
erations and so on, aren't audited, because they are. That is what 
I want you to comment on. 

Mr. BowsHER. They are audited, Mr. Neal. And you described it 
basically right. They just don't pull it all together like you would 
with an external financial audit. And that is the thing. 

The one thing I should also say — and my colleague made a note 
here for me — is that if you are going to have a financial audit, then 
the outside auditor would have to be able to look at the necessary 
transactions to give his opinion on the overall operations. But there 
is no question that today, the Federal Reserve has certain compo- 
nents of their operation, most of the large components, being au- 
dited by their internal procedures. 

Mr. Neal. Is there any reason to doubt the adequacy of those 
procedures? 

Mr. BowsHER. We have not done any work that would answer 
that. 



13 

Mr. Neal. Do you agree that the reasons I gave for not having 
auditing — especially auditing that would be made public — of these 
three areas makes some sense? 

Mr. BowsHER. They do. But I think also some people would want 
to have those processes checked out every once in a while. I think 
that is really the other part, to just see how well are they working. 
After the fact, mostly. 

In other words, as you say, when they are in a crisis stage with 
some big problem, you don't want to have the auditors there at 
that point in time. But at some point in time, periodically or some- 
thing like that, it might be good to be checking the processes. That 
is really your policy question, I think. 

Mr. Neal. Well, you mean maybe with a timeline, 5 years or 
something. Say you had a bank in trouble and it had to do discount 
window operations with the Fed and you would say that it would 
be — possibly could be important to go in and take a second look at 
that after the fact — not after time — so that you might exacerbate 
a bad financial situation, but with a time lag of, what? How long 
a period of time would you say? 

Mr. BowsHER. Some audits of discount window operations that 
are related to bank supervisory activities we can do now, even with 
the exclusions that are there. 

What we can't look at is the foreign operations and the monetary 
policy aspects. 

The Chairman. The time of the gentleman has again expired. We 
have some witnesses following. 

Thank you very much, Mr. General and associates. We deeply 
appreciate your helping. And we will be in sustained communica- 
tion as we continue to travel along the road of H.R. 28. 

Our next and second panel consists of Grovernor Wayne D. 
Angell, the Governor of the Federal Reserve Board; and President 
William J. McDonough, president of the Federal Reserve Bank of 
New York. 

I want to welcome Mr. William J. McDonough, Vice Chairman of 
the Federal Open Market Committee and the president of the Fed- 
eral Reserve Bank of New York and Governor Wayne D. Angell, 
Federal Reserve Board. 

I certainly want to hear your views on the GAO audit limitations 
and whether or not you think they are justified. 

Before turning to that, however, I have a very serious matter to 
address. As you know, in H.R. 28, there are provisions that require 
the release of any policy change within 1 week and a videotape of 
FOMC discussions within 60 days. 

You both know that I inquired of all of the Federal Reserve Bank 
presidents and the Governors in my letter of October 22, 1992, 
about minutes of FOMC meetings. Chairman Greenspan wrote the 
following to me on December 24, 1992, and I quote: 

"Members felt that making a tape or literal transcript public 
would have an especially restrictive effect in discussions," end of 
quote. 

For the hearing last week on October 19, 1993, I asked each Fed- 
eral Reserve official to include in his or her testimony any knowl- 
edge of notes or records made by others at FOMC meetings. 



14 

And even though you didn't appear, Vice Chairman McDonough, 
you submitted testimony as follows — and I am going to quote from 
it: 

"I have no personal knowledge of any other notes or records that 
others may have made at FOMC meetings," end of quote. 

Yesterday, I received a letter from Chairman Greenspan saying 
that there have been tape recordings made at FOMC meetings 
since 1976, that the FOMC has unedited transcript and staff notes 
from transcripts existing back to 1983. 

In addition, the meeting room for the FOMC has a complete 
setup for tape recording including, and I quote: 

"A green light on top of the meeting table near its head is lit 
when the recording system is in use," end of quote. 

How could anyone not know what that green light meant and fail 
to tell the Congress or report that there were no literal trans- 
lations? 

I also must say I have some trouble with Chairman Greenspan's 
statements, that he knew about the taping when he first assumed 
office and he forgot when he learned about unedited transcripts. 

I am going to quote: 

"Indeed, until a staff member jogged my memory in the last few 
days, I had been under the impression that I first learned only 
about a year ago that transcripts were being retained," end of 
quote. 

If I were sitting in front of a green light, as we do here, and it 
lit up every time I talked, I think I would have been a little bit 
more inquisitive about what was going on. It would jog my mem- 
ory. I hope they didn't think that when the green light went on it 
meant raise interest rates. 

Now that we know that Chairman Greenspan initiated a con- 
ference call and informed the Grovemors and presidents about the 
tape recordings, why did they give the testimony we received last 
week on October 19? 

I want to thank Governor Angell for testifying that he knew 
about the transcripts several years ago. However, if that is the 
case, why did you join in the misleading reply sent to me from 
Chairman Greenspan on October 26, 1993? 

This is a time in our Nation's history when the public demands 
accountability from its government officials. There are many citi- 
zens who are losing their trust in government. 

The less-than-truthful response to my requests by the senior offi- 
cials of the Federal Reserve about minutes and their testimony last 
week raises serious questions. Why all these discrepancies? 

We held these hearings to encourage greater accountability of the 
Federal Reserve. And sincerely believing that, in the end, it would 
be helpful even to preserving and maintaining the rightful entitle- 
ment to independence. The outrageous deception of the last few 
days shows precisely why greater accountability is needed. 

Now, as for the GAO audit, I can paint no better case for a GAO 
audit than the outcome of the inquiry I made on the acceptance of 
hospitality and gifts by the Federal Reserve of New York Bank offi- 
cials from the very banks that they regulate. 



15 

Evidently, from the opening statement that you sent us, Mr. 
McDonough, this practice has not ended. You have yet to estabhsh 
what you call a, quote, "paper trail," end of quote. 

I don't think this is an adequate response when such hospitality 
is illegal for other government employees. I would certainly expect 
these practices to be curtailed, to establish an arm's length rela- 
tionship with those you regulate, just as other regulators nave al- 
ways done. 

I don't think the American public, and particularly those that 
have elected us to represent them as their agents, would be satis- 
fied with less. 

If it has seemed, through the years, that maybe they weren't, the 
impression I had all of these 32 years, is that they just didn't see 
any choice, they just didn't see any hope that anything they could 
do would matter, if their agents didn't care enough either. 

So, respectfully, I must say that the intent, the purpose of having 
the agency the Congress has created for that purpose, to give us 
some accountability of this great institution, is done with that 
single-minded purpose of accountability. 

I think that every one of our brancnes, whether it has been the 
legislative — through our history, or the executive or the judiciary, 
where it has power in accountability — our history shows we have 
had rather difficult times for the public interests. 

None of us, whether it is in the Congress, is exempt from the dic- 
tum that if we have power, we must render accountability to the 
best of the frail human abilities that we can summon. I have never 
had any satisfaction in seeing anybody's discomfort or anjAthing, 
and that is not the purpose. And I think my record, whether as 
chairman of subcommittees that I have chaired all through, or as 
full committee chairman at any time, reveals that I have, at any 
time, been abusive or even discourteous to any witness who has 
been kind enough and respectful enough to answer a request to ap- 
pear as witnesses. 

So thank you very much for your patience at hearing these pre- 
liminary remarks. 

And if there is no objection, I will introduce you as we listed you 
and recognize Grovernor Angell first. 

STATEMENT OF WAYNE D. ANGELL, GOVERNOR OF THE 
FEDERAL RESERVE BOARD 

Mr. Angell. Mr. Chairman, thank you very much. Mr. 
McDonough and I, of course, will want to respond directly and ftillv 
to any questions you have on these matters that you have raised. 

With your permission, I will go through the testimony. I will 
leave out a few items in my statement so as to provide ample time 
at the end to respond fortnrightly and directly to your questions. 

The Chairman. Certainly, Governor. 

In fact, may I say that we want to thank you for submitting your 
prepared statements. And they will appear, if there is no objection, 
as you gave them to us in writing, following your oral presentation. 

And you may proceed as you deem best, sir. 

Mr. Angell. Thank you, Mr. Chairman. 

I am pleased to have this opportunity to speak on the General 
Accounting Office's authority to audit Federal Reserve operations 



16 

and the changes to that authority that would be made by H.R. 28. 
President McDonough is addressing the scope of GAO audit author- 
ity from the perspective of the Federal Reserve Bank of New York. 

At the outset, I would like to dispel the notion I have frequently 
heard that the Federal Reserve is not subject to GAO audit. In 
1978, the Federal Banking Agency Audit Act gave the GAO broad 
authority to audit most of the operations of both the Federal Re- 
serve Board and the Federal Reserve banks. 

Since then, the GAO has completed more than 100 reports on 
various aspects of System operations, as well as numerous other re- 
ports that involved us less directly. At present, the GAO has rough- 
ly 25 audits of the Federal Reserve under way and maintains sev- 
eral of its staff in residence at the Board and at selected Reserve 
banks. 

The GAO has free rein to audit the System, subject to explicit 
exemptions for: Deliberations, decisions, or actions on monetary 
policy matters including discount window credit operations, re- 
serves of member banks, securities credit, interest on deposits, and 
open market operations; transactions made under the direction of 
the FOMC; transactions with, or for, foreign central banks and gov- 
ernmental entities; and discussions or communications among or 
between members of the Board and of officers and employees of the 
Federal Reserve System related to these matters and transactions. 

By excluding these areas, the act attempts to balance the need 
for public accountability of the Federal Reserve through GAO au- 
dits against the need to insulate the central bank's monetary policy 
functions from short-term political pressures and the need to en- 
sure that foreign central banks and government entities can trans- 
act business in U.S. financial markets through the Federal Reserve 
on a confidential basis. 

The precise line differentiating those Federal Reserve specific op- 
erations and activities that are subject to GAO audit under the 
Banking Agency Audit Act, and those that are exempt from audit 
is difficult to draw in the abstract. 

Over the years, since the passage of the act, the Federal Reserve 
has worked with the GAO to define those limited areas that are not 
subject to audit on a case-by-case basis in the context of individual 
audits. In the future, we will continue to work with the GAO to ad- 
dress its concerns consistent with the mandate of the act. 

Expanding the GAO's audit authority over the Federal Reserve 
into the exempt areas would be contrary to the public interest. 
Such an expansion could adversely affect Federal Reserve effective- 
ness in the conduct of monetary policy. 

As the Banking Agency Audit Act recognized, such a change 
could reduce the central bank's insulation from day-to-day political 
pressures. Even what appears to be a very limited audit of the effi- 
ciency of monetary policy operations could, in fact, turn into pres- 
sure for a change in monetary policy itself. For example, the ques- 
tion posed to Comptroller Bowsher in connection with these hear- 
ings as to whether the magnitude of our open market operations 
reflects unnecessary buying and selling of government securities 
are monetary policy questions, not efficiency questions. 



17 

The number of transactions that the Open Market Desk com- 
pletes in carrying out the FOMC's directives correlates directly 
with the substance of the policy in place. 

GAO scrutiny of policy deliberations, discussions, and actions 
could impede the process of formulating policy. A free discussion of 
alternative policies and possible outcomes is essential to minimize 
the chance of policy errors. The prospect of GAO review of forma- 
tive discussions, background documents, and preliminary conclu- 
sions could have an adverse effect on the free interchange and 
consensus-building that leads to good policy. 

Transactions made under the direction of the FOMC include for- 
eign exchange operations. The efficacy of these operations is cru- 
cially dependent on confidentiality. Important daily contacts and 
exchanges of information with foreign monetary authorities are an 
integral part of these operations. They now take place in a candid 
and constructive atmosphere. 

The possibility of a GAO audit of our foreign exchange operations 
would reduce the willingness of foreign authorities to share infor- 
mation with us and would thereby reduce the effectiveness and effi- 
ciency of our operations which are frequently coordinated with for- 
eign authorities. 

This caution also applies to the exemption for transactions that 
the Federal Reserve carries out as agent for foreign entities; how- 
ever, there the principal issue is one of sensitive proprietary infor- 
mation about foreign governments, foreign central banks, and 
international financial organizations. 

The benefits, if any, of broadening the GAO's audit authority into 
the areas of monetary policy and transactions with foreign official 
entities would be small. 

With regard to purely financial audits, the Federal Reserve Act 
already requires that the Board conduct an annual financial exam- 
ination of each Reserve bank. The Federal Reserve places great im- 
portance on both the Reserve banks internal audit responsibilities 
and the Board's responsibilities for examination of Federal Reserve 
Banks, in part because it recognizes that its ability to police Fed- 
eral Reserve Bank operations is critical to public and congressional 
confidence in the Federal Reserve System. 

The process of conducting annual financial audits is reviewed by 
a public accounting firm to confirm that the methods and tech- 
niques being employed are effective and that the program follows 
generally accepted auditing standards applicable to the audit of 
Federal Reserve Banks. These examinations are complemented bv 
extensive Board oversight and supervision of Federal Reserve Bank 
activities, including Board operations reviews of Reserve bank ef- 
fectiveness and efficiency, as well as by comprehensive audits con- 
ducted by each Reserve Bank's independent internal audit function. 
Oversight and supervision of Federal Reserve Bank activities in- 
clude review of Federal Reserve budgets and expenditures as well 
as personnel and operating policies. 

The Board's annual financial examinations of Federal Reserve 
Banks, operations reviews, and its oversight and supervision of 
Federal Reserve Bank activities specifically includes examinations, 
operations reviews, and oversight of open market and foreign 
transactions. 



18 

The annual financial examinations include review of all accounts 
for accuracy, compliance with internal controls, and confirmation 
that balances reflected on the books agree with the records of 
accountholders. 

Operations reviews for effectiveness and efficiency of open mar- 
ket and foreign operations are conducted by multidisciplinary 
teams, including economists familiar with FOMC operations and 
specialists in data and physical security, automation, communica- 
tion, accounting, and secondary market trading and settlement. 
These operations reviews also include the Federal Reserve Bank of 
New York's internal audit attentions to the open market account. 

Further, a private accounting firm audits the Board's balance 
sheet, and the Board's inspector general audits the effectiveness 
and efficiency of Board programs and operations under the Inspec- 
tor Greneral Act of 1978 as amended. 

The Board has continually reviewed its procedures for examina- 
tions and oversight of Federal Reserve Bank activities. For exam- 
ple, recently the Board has contracted for independent private au- 
dits of two Federal Reserve Banks, Kansas City and Cleveland, in 
order to provide an independent evaluation of the Reserve banks 
control environments and the Board's examination procedures and 
to determine the feasibility of substituting, from time to time, out- 
side audits for financial examinations by the Board's examiners. 

These audits have indicated that previous financial examinations 
of these Reserve banks were at least as thorough as the outside 
audits, that those Reserve banks were well controlled, and that 
financial controls may be regarded as satisfactory from an audit 
perspective. 

Indeed, these audits have indicated that many policies are 
uniquely applicable to Federal Reserve Banks and that, in these 
areas, the Board's examiners have a significant advantage in audit- 
ing for Federal Reserve Bank compliance. 

The Board is strongly committed to ensuring that its examina- 
tions, both internal and external, oversight and supervision of Fed- 
eral Reserve Banks, as well as its own internal audit function and 
external audits, are as effective as possible and will continue to 
review these ftinctions with an eye to ensuring their future 
effectiveness. 

Finally, and more broadly, Congress has, in effect, mandated its 
own review of monetary policy by requiring semiannual reports to 
Congress on monetary policy under the Full Employment and Bal- 
anced Growth Act of 1978 and by holding hearings on various mon- 
etary policy issues as they arise. 

In addition, there is a vast and continuously updated body of lit- 
erature and expert evaluation of U.S. monetary policy. In this envi- 
ronment, the contribution that a GAO audit would make to the ac- 
tive public discussion of the conduct of monetary policy is not likely 
to outweigh the disadvantages of expanding GAO audit authority 
in this area. 

In sum, we believe that the Board's supervision and oversight of 
Federal Reserve Bank activities and the Board's own audit func- 
tions have served the public interest well, particularly in the area 
of confidentiality of monetary policy information. 



19 

In this regard, Mr. Chairman, you have asked about the security 
checks on personnel involved in the monetary policy process and in- 
cidents of so-called insider trading by Federal Reserve officials. 

Attendees at FOMC meetings are now required to have "secret" 
or higher clearances. And, over the years, there have been only 
three known incidents where monetary policy information may 
have been used for private gain. 

I have fully explained these incidents in the written testimony, 
Mr. Chairman. And I will be happy to respond to questions on 
these incidents as well as on the entire subject matter of these 
hearings and the particular questions that you posed at the 
beginning. 

We believe that the paucity and nature of the three incidents de- 
scribed over the 80-year history of the Federal Reserve System is 
strong evidence of the integrity of the Federal Reserve monetary 
policy process. 

Further, it is doubtful that any of these incidents would have 
been prevented by a broadened GAO audit authority. 

For these reasons, and the reasons previously stated, we believe 
the enactment of the provisions of H.R. 28 that would expand the 
GAO's audit authority by removing the current exemption from 
monetary policy matters; transactions made under the direction of 
the FOMC; and transactions, with or for, foreign official entities 
would be counter to the public interest. 

Thank you, Mr. Chairman. 

The Chairman. Thank you, sir. 

[The prepared statement of Mr. Angell can be found in the 
appendix.] 

Mr. McDonough, 

STATEMENT OF WILLIAM J. McDONOUGH, PRESIDENT, 
FEDERAL RESERVE BANK OF NEW YORK 

Mr. McDonough. Thank you, Mr. Chairman. 

I believe that, as an American citizen, it is always an honor to 
appear before a congressional committee, and I welcome the oppor- 
tunity to appear before you today to provide my views on H.R. 28. 

I will focus on the implications of the proposal for the actions 
taken by the Federal Reserve Bank of New York in implementing 
FOMC decisions and carrying out activities for a foreign account. 

I would like to comment on the scope of the current exemption 
and to make clear to the committee my appreciation and respect 
for the audit process. 

Also, I would like to take this opportunity to note steps that can 
be taken to ensure further the effectiveness of GAO audits of the 
bank, within the GAO's current authority. 

In my opinion, that authority provides sufficient scope to address 
many of the concerns you have asked me to discuss today. 

I believe that the elimination of the current exemption would 
interfere with the Fed's ability to formulate and execute an optimal 
monetary policy. It would introduce the unmistakable potential for 
political influence; every movement and nuance of policy would 
then have to be examined in light of that potential. 

At the core of my concern is the fact that the process by which 
we implement monetary policy is inextricably entwined with the 



20 

policy itself. For example, questions regarding the volume of open 
market operations on the surface may appear to be questions of ef- 
ficiency. In fact, they relate to the policy intent to avoid undue vol- 
atility in the markets. The idea that the process of executing open 
market operations may be audited without imposing judgments 
about the policy itself is, I believe, simply not realistic. The poten- 
tial for damage clearly would outweigh any possible benefit to the 
public from GAO audits of monetary policy operations. 

I feel equally strongly, Mr. Chairman, about the impairment of 
our policy implementation if the exclusion were to be lifted on the 
foreign side. Foreign exchange intervention is conducted not only 
in conjunction with the Treasury, through the Exchange Stabiliza- 
tion Fund, which is exempt from GAO audit, but also frequently 
with or on behalf of foreign central banks and monetary authori- 
ties. 

We hold a very large amount, over $300 billion at present, of 
marketable U.S. Government securities representing dollar re- 
serves of these official foreign entities. I cannot presume to gauge 
the response of all of these central bank Governors and finance 
ministers; but I can tell you with absolute certainty that there is 
some number of them, and perhaps a large number, who would 
question the appropriateness of their reserve activity being scruti- 
nized by the GAO and the Congress. This would almost certainly 
be damaging to the relationships that are so central to inter- 
national monetary cooperation and, perhaps, to the role of the dol- 
lar. Certainly, it would impair the ability of the U.S. monetary au- 
thorities to conduct their foreign exchange intervention policies on 
a coordinated basis with the same effectiveness and efficiency we 
enjoy today. 

Having said that, I want to reiterate that I do not have some sort 
of reflexive distaste for auditors or the audit process. To the con- 
trary, as someone who has had managerial responsibility for large 
organizations in both the public and private sectors, I have a 
keen appreciation for the role of auditors and the improvements 
they bring to the table in the form of operational quality and 
effectiveness. 

A number of years ago, Mr. Chairman, the Board of Directors of 
the World Bank thought that they would like to create an expert 
panel to evaluate their use of outside auditors; and my interest in 
auditing and presumed expertise in the matter led them to select 
me as the chairman of the panel. 

I view auditors as an important asset for management. There is 
a long tradition at the Fed of recognizing the value of independent 
oversight. Indeed, I believe we subject ourselves to an extraor- 
dinarily rigorous series of performance and operational appraisals. 
Within eacn Reserve bank there is an independent audit function 
that reports directly to the board of directors and performs com- 
prehensive audits of all aspects of that bank's work. 

At the New York Fed, we have had a constructive and positive 
relationship with the GAO for almost 15 years. We supply the GAO 
permanent space in the bank and have assigned staff as liaison in 
order to assist them in the orderly completion of their tasks. In ad- 
dition, we take seriously their findings and are responsive to their 
suggestions for improvements. While I do not want to wax too po- 



21 

etic and imply that we love the result of each and every audit — 
they probably wouldn't be doing their job very well if we did — I do 
want to make clear that we have a great appreciation for the role 
of auditors. 

The conduct of bank personnel with responsibility for monetary 
policy matters is subject to the bank's rules of conduct, stringent 
standards regarding outside financial interests and potential con- 
flicts stemming from family and other personal relationships. 

The GAO always has had full audit authority over Reserve 
bank's personnel policies and practices, disclosure statements, and 
the like and, thus, has been able to assure itself and Congress of 
the ethical standards and practices of all of our employees. 

We are not, however, resting on our laurels. There are always 
ways to enhance the effectiveness of operations, and audits by GAO 
can contribute significantly to that process. I plan to call Comptrol- 
ler General Bowsher from time to time — we talked just the other 
day — to offer suggestions as to how the GAO might be even more 
useful to the Bank. 

I now would like to respond to matters raised in Chairman Gron- 
zalez' October 21 letter to me regarding our policy on meals and 
entertainment and our ethics officer. 

As I have noted, there is no limitation on the GAO that prevents 
its looking at our meals and entertainment practices or policy. 
Moreover, we do not impart information on monetary policy or our 
foreign account relationships to any outsiders, at luncheons or any 
other time. To the contrary, we use meetings with knowledgeable 
people to gain information about market conditions, and that is 
helpful in our monetary policy deliberations. 

The chairman asked a question regarding the cost of meals at ex- 
pensive restaurants hosted by regulated institutions, which was 
mentioned in a letter which you cited this morning, Mr. Chairman, 
by Mr. Corrigan to you. Because others paid for these approxi- 
mately two dozen meals that were identified as having occurred 
over a period of IV2 years, we do not have that cost information. 
We are, however, very sensitive to the appearances of such things, 
and our internal rules specifically caution against accepting inap- 
propriate entertainment, lavish meals, or frequent meals from a 
particular institution. 

Further, we concluded that we do not have an adequate audit 
trail. Therefore, we are about to issue a policy requiring that all 
business meals paid by regulated institutions or vendors be docu- 
mented as to restaurant, purpose, and attendees. The purpose of 
that is to provide an audit trail for us, the Board of Governors, and 
the GAO going forward. 

Mr. Chairman, I would wish to assure you and the committee 
that in my days of private life, I don't know of any institution that 
had such an audit trail. We, in the course of evaluating it, said, 
how do we know who has been having a meal with whom? So we 
are creating a form that will require that information. 

Finally, as the Chairman noted, we recently named an ethics of- 
ficer. That does not mean this role was not being performed pre- 
viously within the bank. That function was fulfilled by the bank's 
first vice president, its general counsel and the personnel officers. 



22 

We concluded that we would focus these responsibilities in a sin- 
gle individual, a senior vice president of the bank. Since his ap- 
pointment as ethics officer, he has responded to inquiries from 
members of the bank's staff regarding ethics and conflict of interest 
questions. He also has participated in redrafting our rules of con- 
duct, which should be concluded by year end, and other documents 
which will be helpful to the bank s staff in their compliance with 
these rules. We regard his efforts as a continuation and refinement 
of the policies we have already put in place. 

As far as I am concerned, GAO staff has access to those policies 
and procedures. And lest I confuse anybody by what I mean by pro- 
cedures, in other words, what actually happens, not just looking at 
the policy. And I look forward to receiving GAO's input on them. 

I appreciate this opportunity to participate in this hearing, and 
I look forward to answering any further questions, Mr. Chairman, 
you or the committee members may have. 

Thank you. 

[The prepared statement of Mr. McDonough can be found in the 
appendix.] 

The CHAreMAN. Thank you very much. I appreciate your state- 
ment about sensitivity to appearances. That is very true. 

Many years ago, in another world, when I grew up and knew 
such things as melon patches and the like, I learned a lesson from 
a neighbor, a friend of my grandfather, who came from Kentucky. 
And tnere was an incident that somebody had snitched some mel- 
ons. And I will never forget Mr. Heddy saying, well, if you want 
to avoid suspicion, don't stoop in the middle of the melon patch to 
tie your shoestrings. It is so apt. It is true. 

And as you referred to, there is a vast difference between the pri- 
vate and the public sector. You have been involved in each one of 
those sectors. And there is quite a difference. And learning to ap- 
preciate a difference sometimes is the biggest challenge an elected 
or appointed public official learns. It is not as easy as it sounds. 
The standards of success in the private sector are not quite as ac- 
ceptable in the public area. So I appreciate that remark. 

Now, I gather from that statement that GAO has no restrictions 
on reviewing such things as the meals. 

Mr. McDonough. No. None whatsoever. 

The Chairman. OK. But then you also say something that kind 
of troubles me and may give rise to the fact that maybe you are 
trying to tie a shoestring there, and that is you say to gather infor- 
mation about market conditions, meals with bank personnel. 

Now, is it ever necessary to have meals involving that character 
of discussion paid for by regulated institutions? 

I mean, you may have some reason, but I am asking. 

Mr. McDonough. Well, one of the things that we try to do, Mr. 
Chairman, is, as oflen as we possibly can — and at some expense to 
our bottom line — recognizing that, since the days of the campfire, 
man, as a social animal, tends to perhaps talk more fully when din- 
ing or lunching or breakfasting we have them in as frequently as 
we can to the Federal Reserve Bank itself so the occasion is taking 
place on our premises. 

I do think that, on occasion, if a regulated institution, in a res- 
taurant of appropriate, reasonably modest price level, asks our peo- 



23 

pie to perhaps even reciprocate for a meal that they have had at 
the Federal Reserve Bank of New York, that they may accept that 
invitation. 

It is very important for us to know what is going on in the mar- 
ket so that we can implement monetary policy with the greatest 
amount of knowledge. I think it is fair to say that we are close to 
notorious for being very good at listening and very chary in saying 
anything. I think the ideal sort of person to have a conversation 
with us is somebody who likes to talk a lot and not to listen much, 
because we have to be so careful about not inadvertently sharing 
anything that would be inappropriate in the area of policy, and we 
tend to be very, very quiet and not forthcoming, deliberately. 

So I do think that a reasonable amount of accepting meals is ac- 
ceptable, we tell the people, you should certainly not do it fre- 
quently with the same institution. You should be very careful. 

New York City is an area where, as you know, the cost of living 
is quite high. And so we are very much pointing the people away 
from restaurants that would appear not to be the kind of place that 
Federal Reserve officials ought to be appearing, especially as the 
guests of regulated institutions. 

The Chairman. Well, time is catching up on us. I am a little 
troubled, though, if you say that you do invite private sector to the 
Fed for meals, then how is it accounted for? But I am not going 
to split hairs on that. 

I just want to say before I close out. Governor, the 1978 Bank 
Auditing Act did not come from this committee. This committee 
was thwarted. As a matter of fact, it wasn't until we had the catas- 
trophe that we have been dealing with since 1988, 1989, that it be- 
came obvious that the Congress had done everything to please the 
unseasoned demands of not only bankers, but S&Ls and everybody 
else. It did everything they ever asked for, and look where it got. 

On the other hand, it was obstruction when 1978 came because 
Chairman Ben Rosenthal of the Subcommittee on Monetary Affairs 
over in the Government Operations Committee, was the one that 
also brought to bear — Nelson Bunker Hunt and his brother, in 
their failed attempt to comer the silver market, which incidentally 
used over $25 billion worth of bank resources and credit. And it 
took him to do it from a subcommittee of the Government Oper- 
ations Committee, not the House Banking Committee. 

Because every effort was made — I know, because I have been on 
it for 32 years, and I can go back to the initial attempts in the 
1960's, and the Fed came and lobbied. And, in fact, I will place in 
the record the minutes from one of the Reserve banks in which 
they were trying to figure out how to obstruct Rosenthal in what 
turned out to be the Bank Audit Act of 1978. 

I just wanted to make that clear, that it didn't come with any 
help or any encouragement from the Federal Reserve Board. 

Mr. Leach. 

Mr. Leach. Well, I thank the Chairman. And I must say that 
there are several anecdotal instances raised by the Chair and then 
some larger public policy issues. I think we are all concerned about 
basic ethics and appearances. 



24 

On the food policy of the Fed, though, I think it has to be under- 
stood as a very small potatoes issue. We are talking about the mon- 
etary policy of the Fed here. 

In terms of the instance that the chairman raised on the silver 
issue, though, my own sense is it is one of the greatest mistakes 
in terms of individual decisionmaking of the Fed, and the chairman 
implied coverup or lack of cooperation with an investigation. 

I think the basic decisionmaking of a private sector speculator 
that was, in effect, protected through the banking system with the 
backup of the Fed was deeply wrong headed. 

And having said that, there is no reason that this Congress 
should not have the right to assess or reassess that kind of policy. 
But, again, that is a circumstance that I share on both issues with 
the chairman. 

But that means that some portion of the Fed's monetary should 
be open to pervasive performance audits which, after all, truly 
leads in the direction of politicizing of the Fed. 

And here, I think there are some analogies. Governor Angell 
mentioned the sensitivity of certain information-gathering from for- 
eign governments, which I think is valid. In this issue of defini- 
tions, the word "audit" has a very positive kind of implication. But 
we are really talking about performance review of policy. And here 
Congress has a number of techniques at our disposal, including the 
semiannual requirements that the Chairman appear before Con- 
gress and other techniques, many of which are public. 

In terms of information-gathering I think there are analogies to 
the national security front where Congress has always agreed that 
there are certain kinds of information, for national security rea- 
sons, that ought to be confidential, at least for a period of time. 

While the Chairman of the Joint Chiefs of Staff needs to know 
that we have a second strike capacity at sea, he or she doesn't need 
to know the precise location of any submarine at any point in time. 
Congress also needs to know the direction of policy but doesn't nec- 
essarily need to know all market sensitive information. 

Increasingly, market sensitive information is of an insider vari- 
ety and affects markets for market participants. We will be opening 
ourselves up to a lot of efforts literally of economic espionage with- 
in the Congress if this information is transferred to an arm of the 
Congress. 

By economic espionage, I mean foreign as well as American par- 
ticipants, that could be of a difficult nature. 

So I, for one, am not overly inclined toward intrusive perform- 
ance audits. I think that the review of your policy is what we need 
to know. With regard to the review of all of the market decision- 
making of the Fed, I think the country is better protected by a lit- 
tle bit of confidentiality. 

In order for that confidentiality to be respected, the Fed does 
have to recognize that there are times now and again that people 
will differ with decisions that are made and that the Fed has got 
to realize that there will be some accountability that will be 
expected. 

But I personally think that Congress ought to approach this 
issue with a great deal of chariness. 



25 

Anyway, I might just briefly ask if that seems relevant to you as 
an observation or irrelevant? 

Governor Angell. 

Mr, Angell. Mr. Leach, I must say that there are times that I 
think presidents and other oflficers and directors of Reserve banks 
think that the Federal Reserve Board examination process is in- 
deed intrusive. But we have a responsibility to do that, and Re- 
serve banks understand that. 

I have no other comments to make on your references. 

Mr. Leach. Mr. McDonough. 

Mr. McDonough. They seem to make a great deal of sense to 
me, Mr. Leach. 

I have no other comment. 

Mr. Leach. All right. Thank you. 

Thank you, Mr. Chairman. 

The Chairman. Mr. Neal. 

Mr. Neal. Well, again, I must say I wonder why — I think about 
some of the points I was trying to make earlier; you made them 
much better and much more thoroughly. 

Most anything of any significance that we are dealing with here 
is being audited, it looks to me like. And the things that are not 
being audited are not being audited because there are good reasons 
in terms of the impact on policy to not audit. 

I don't know why we — I mean so far in these hearings we have 
steered away from why we have a Federal Reserve and what the 
most sensible policy is. I mean, the American public today, the 
working people of iWerica, are able to buy houses at 7, 7.5 percent 
interest. They are able to buy cars — I noticed the other day the in- 
terest on cars is 6 to 7 percent. The banking system has been saved 
from a huge catastrophe a couple of years ago. Most people were 
saying we thought we were going to have to bail out the banking 
system. 

The Federal Government is able to borrow to — at much lower 
rates than it was a few years ago, but all because the Fed has done 
the job that we have asked it to do fairly well in recent years. That 
is, it has brought down the rate of inflation. 

Now, that is where the focus ought to be. Is the Fed doing the 
job that we want it to do, which is to control inflation and, thereby, 
create the conditions that will most enhance economic growth, jobs 
for our people, low interest rates, savings, investment, productivity 
growth, competitiveness in international trade. These are the key 
questions. 

And all this other stuff about whether someone had a meal 
there — I mean, I don't want you to do anything, frankly, that looks 
the least bit unseemly, because I think it detracts — ^it gives — it 
opens up the opportunity to detract from this primary goal. 

So, of course, I wince when I hear the least thing. But, frankly, 
I have to say I think the Fed has operated in a pristine sort of en- 
vironment. I am not aware of any hint of any scandal. In fact, I 
think you have conducted your affairs very appropriately and, on 
the most important question, have devoted your focus to bringing 
down inflation; and that has benefited the American people 
enormously. 



26 

Now, I have to point out that that inflation was caused by the 
Fed, also, a few years ago; and we ought to understand that and 
not repeat it. We wouldn't have had to go through the pain that 
grinding inflation out of the system has imposed on the American 
people if the Fed hadn't created that inflation in the first place. 

But the Fed has realized it and has brought it under control, and 
that has enormously benefited the American people. So that is the 
main issue. 

And this other — of course, to do that and to be able to maintain 
the independence that is necessarj' to do that, the Fed must con- 
duct its other business in an exemplary fashion. I think you have 
done that. 

I asked the Comptroller Greneral, a little while ago, if he had any 
reason to believe that there was anything inappropriate going on 
over at the Fed. He said he didn't. And we have an inspector gen- 
eral — ^he may not have been in the room when I said I used to 
Chair the subcommittee that deals with the Fed. We used to tell 
the inspector general, we wanted to know anything, just the least 
thing — and I am still sure that that is the policy. We want to know 
the least thing that is wrong, everything, anything that possibly is 
inappropriate going on over there, we want to know about it and 
we want to stop it. 

So I am not aware of there being any such thing. And I commend 
you for it. And I hope the focus — I hope we are able to put the 
focus on the key question and not some of this other stuff. 

I thank you. 

The Chairman. Mr. Knollenberg. 

Mr. Knollenberg. Thank you, Mr. Chairman. 

I concur with my colleague who just commented on your effec- 
tiveness over those 80 years, with just the three examples, I think, 
that were given as to problems perhaps that were created for you. 

You both have been very clear about your opposition to eliminat- 
ing the exemption. In fact, of the two, I think, President 
McDonough, you are maybe a little more pronounced in saying that 
if we made the elimination, it would introduce the unmistakable 
potential for political influence — I am just reading your comments 
from the page — and every movement and nuance of the policy 
would then have to be examined. And, of course, you mentionea. 
Governor, that it would be contrary to the public interest. 

My question, first for the Governor, would be: Could you provide 
a couple of specific examples of how a GAO audit would — of the 
FOMC — would negatively impact monetary policy, something that 
you seem to have had a pretty good handle on? 

Just give me a couple of examples, if you would. And you can 
share those, if you will. 

Mr. Angell. Yes. Mr. Congressman, the audit process cannot 
work well at all if you say, well, you can do this aspect of the open 
market operations and you can do this aspect of foreign exchange, 
and yet you can't do that aspect. 

We understand that to do a full balance sheet audit requires ad- 
ditional information. The information that would be required would 
be information dealing with the process of policy formation and the 
carrying out of the policy and making certain that those that are 
doing the operations do it precisely as it was developed. 



27 

Our monetary policy process is really a strategy that we are de- 
veloping. Macroeconomics and finance is always a changing study. 
We never get to the place where we have final answers in regard 
to how people in the financial marketplace will behave because ex- 
pectations are involved. 

Mr. Knollenberg. It is a dynamic kind of thing. 

Mr. Angell. It is a dynamic kind of thing. 

So the policy process is one in which we are looking at strategies 
and the Federal Open Market Committee has developed these 
strategies. To have someone come in and audit that £ind say, well, 
are you accountable for that, and knowing precisely what your ob- 
jective was and how it came out would, we believe, have a quieting, 
an inhibiting impact upon the policy process. 

The Federal Open Market Committee is a very unique kind of 
engagement. It is one in which all participants understand that 
ideas are raised. Someone is willing to say at the table: Well, 
maybe this might happen, and raising such questions about what 
might happen may have — may not be the most probable event, but 
the reason we have 12 people involved as voting members is we 
want to make certain that every perspective is being heard. 

The audit process from the GAO reporting directly to you rather 
than our reporting through the Humphrey-Hawkins hearings to 
you, in a sense, removes us from the full accountability and can 
have attention directed elsewhere. What is this going to look like 
in regard to some auditing procedure? We believe that the impor- 
tance of policy considerations for this country and, indeed, for the 
entire world, goes so far that we need to be sure that the process 
continues to work as best it can. 

Mr. Knollenberg. Would you concur in that? Or do you have 
another idea? 

Mr. McDoNOUGH. I do concur in it. And I think that the imple- 
mentation of policy by the Open Market Desk, which perhaps, as 
you know, I used to run before I became president of the New York 
Fed, is so completely intertwined with the policy formulation that 
I don't think it is possible to divide the two. 

What the desk manager is doing in consultation with others 
when he — now she — decides to enter the market on a certain day 
and do a certain thing fully reflects all the nuances and the discus- 
sions of the last FOMC meeting. The two are just as closely tied 
as you can imagine. 

Mr. Knollenberg. Gentlemen, thank you very kindly. I see my 
time has expired. 

Thank you, Mr. Chairman. 

The CHAffiMAN. Mr. Hinchey. 

Mr. Hinchey. Thank you, Mr. Chairman. 

Gentlemen, I think everyone would agree that there is great 
value in maintaining the independence of the Federal System. But, 
nevertheless, within that, within the context of that independence, 
there must also be accountability. I think that our chairman is at- 
tempting to establish a new balance between that independence 
and accountability through the introduction of the Federal Reserve 
System Accountability Act of 1993. And that is the focus of these 
hearings, to a large extent. 



28 

Now, in the context of that focus and of these hearings particu- 
larly, there has been some question about the availability of infor- 
mation and, indeed, the actual accumulation of information that oc- 
curs during the meetings of the FOMC. 

And I think that some of the members of the committee have 
been concerned because there seems to be some discrepancies in 
the messages that we have been getting from various members 
over the course of the last — over the course of these hearings. 

For example, Mr. McDonough, in your written statement that 
was submitted to the committee, you said as follows: I have no per- 
sonal knowledge of any other notes or records that others may have 
made at FOMC meetings. 

Now, we have learned that, of course, there are these recordings 
that are made. Each meeting is tape-recorded and there are also 
rough notes that are taken. 

Now, when you said, I have no personal knowledge of any other 
notes or records that others may have made at FOMC meetings, 
what was the relationship between that statement and the fact 
that actual tape recordings are made? 

Mr. McDonough. Thank you. Congressman Hinchey. I am de- 
lighted that you asked that question because it gives me an oppor- 
tunity to answer what was asked by the Chair earlier. 

I did not attend, as you perhaps remember, the hearings on Octo- 
ber 19 because I was asked by Chairman Greenspan to represent 
the Federal Reserve at a meeting in Moscow. My going permitted 
Governor LaWare to be here on the 19th. 

When I submitted my written testimony, which I had written 
and actually finished on the morning of the 15th and dispatched 
it by fax to the committee, I was not aware at the time that the 
recordings were ever made or that these rough transcripts existed. 
Consequently, when I wrote the statement and sent it, it was a 
completely accurate statement. 

In the course of the afternoon of October 15, I learned from 
Chairman Greenspan that the tapes and the rough transcripts ex- 
isted. Since he said on that occasion that he was going to acquaint 
the committee at the meeting on the 19th with the existence of the 
tape and the rough transcripts, I decided that it was not necessary, 
as I was literally heading home in order to pack my bags to go to 
Moscow, to change the testimony — change the submission, because 
I knew that the record would be established in an accurate manner 
the following Tuesday. 

Mr. Henchey. Well, I don't want to be too sharp about this, but 
I think it is an important question. And I think we ought to try 
to put it to rest for all time if we can. 

Let me ask you this, Mr. McDonough: How long have you been 
in your present position with the Fed? 

Mr. McDonough. Three months. 

Mr. Hinchey, Three months. How many meetings have you 
attended? 

Mr. McDonough. As a member of the Federal Open Market 
Committee, I have attended two. 

Mr. Hinchey. Just two. Were you aware of that green light that 
apparently flashes on when the recording system is in operation? 



29 

Mr. McDoNOUGH. I was aware of the green light. And part of my 
youth was spent as a naval officer, and I was the chief engineer 
of a ship. So I ought to ask the question of what is the light about, 
and I tnought that the purpose of the light was to say that the 
sound system was working. I had no idea that it had any other 
significance. 

Mr. HiNCHEY. The sound system meaning the microphones at the 
various 

Mr. McDoNOUGH. Yes. It is a big room, rather as you have here. 
Governor Angell and I, with our Midwestern and plains States ten- 
ors, are easily heard. Some others are not, so we have a system so 
that people can be heard around the table. That is what I thought 
it was. 

Mr. HiNCHEY. These kinds of questions arise for a number of rea- 
sons, not the least of which is the fact that Mr. Greenspan has in- 
dicated that, although at one point apparently he knew about the 
recordings when he made a statement that said that he wasn't 
aware of the recordings, he had forgotten of their existence; and we 
are trying to rationalize those two statements in the context of par- 
ticularly of this ocular proof, if you will, that the system is actually 
working. And that has given rise to some concern about the infor- 
mation that we are receiving in the course of these hearings. 

Now, under the Freedom of Information Act, is it your view that 
those transcripts are available? 

Mr. McDoNOUGH. Congressman Hinchey, I really don't know. I 
am not an attorney, and I don't claim sufficient expertise on the 
Freedom of Information Act. I really can't give a sensible, meaning- 
ful answer to your question. 

Mr. HiNCHEY. Who could answer that question for the FOMC? I 
think this is a question that you ought to be asking someone who 
could provide you with that kind of information. 

Mr. McDoNOUGH. I would assume the general counsel would be. 
He, being the senior attorney of the Federal Reserve System and 
of the Board of Governors, would be the appropriate person for the 
FOMC to ask. 

Mr. HiNCHEY. Would you be kind enough to instruct the attorney 
to provide us with the official view with regard to the Freedom of 
Information Act as it relates to the availability of these transcripts 
and rough notes? 

Mr. McDoNOUGH. May I pass that to Governor Angell? 

Mr. Angell. Yes. The general counsel will be giving the advice. 
And I see no reason for the general counsel's advice not to be made 
available. So we will provide you with that information. 

[Governor Angell subsequently supplied the following informa- 
tion:] 

I am advised by counsel that the deliberative portions of the transcripts, which 
we believe represent most of each document, would be exempt from public disclosure 
under exemption 5 of the Freedom of Information Act. That exemption permits, but 
does not require, an agency to withhold from public disclosure material that reflects 
the process by which an agency arrives at its decisions or policies. The exemption 
is based on the belief that disclosure of these deliberative processes would inhibit 
frank and open discussion to the detriment of the quality of decisionmaking within 
the government. In this regard, in 1976, the U.S. District Court for the District of 
Columbia addressed the availability to the public under FOIA of the FOMC's Memo- 
randa of Discussion, which were very detailed records of the discussion at FOMC 
meetings. In its March 9 opinion, the court ruled that the FOMC was only required 



73-435 0-94-2 



30 

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

Mr. Angell. May I, however, refer back to what Alan Greenspan 
said when he said he forgot? He said he forgot about the tran- 
scripts. He never forgot about the recording. I mean the Chairman 
knew from the beginning about the recording, the tape recording 
going on. And then those are recorded over after the minutes have 
been completed. 

He never forgot — ^he didn't say he forgot about those recordings, 
with that green light right in front of him. He just forgot about the 
fact that there was a rough transcript made up and from which the 
minutes were prepared. And that is what you see he was referring 
to. 

Mr. HiNCHEY. So he didn't forget about the fact that the record- 
ing was made, he just forgot about the purpose for which the re- 
cording was being made, forgot that the recording was being made 
in order to bring about transcripts? 

Mr. Angell. You know. Congressman Hinchey, we at the Fed- 
eral Reserve, do have sort of a single-minded purposefulness, as 
Congressman Neal suggested. We — the weight of being the world's 
reserve currency and doing it exactly right does dominate our 
thinking 

Mr. Hinchey. I am sure. 

Mr. Angell. And you get used to a green light. You get used to — 
I mean that is there. But certainly, I want you to know that I have 
never known anyone who is so scrupulous, in regard to what comes 
out of his mouth and its accuracy — and there are many of those 
around at Federal Reserve that feel that way. 

And I want you to know that in my view. Chairman Greenspan 
is one of those world's most accurate people; and he would never, 
ever want someone to believe what wasn't the case. 

Mr. Hinchey. I have no difficulty in believing that whatsoever. 
In fact, that was my belief prior to this most recent experience. It 
is just that, in the existence of that belief, we have some evidence 
which seemed to be to the contrary. And what we are trying to do 
is to clear it up. 

Mr. Angell. I understand. 

The Chairman. Thank you, gentlemen, very much, for your time 
and your cooperation. 

We have our third panel 

Mr. Angell. Mr. Chairman. 

The Chairman. Yes, Governor. 

Mr. Angell. I would like to also affirm something that you said. 
Mr. Chairman, we at the Federal Reserve have opportunities to ap- 
pear on many occasions. And I agree, and I think everyone at the 
Federal Reserve that appears before you agrees, that this is a com- 
mittee in which courteousness does prevail. And I want you to 
know how much we appreciate the atmosphere that you develop 
which enables us to be as forthright and forthcoming so that every- 
one in this Nation has confidence in all we do. 

I wanted to give you a particular thanks from one person to an- 
other in regard to the courtesy that you provide to us. 

The Chairman. Thank you. 



31 

Mr. McDONOUGH. Mr. Chairman, may we make that two persons 
to another. 

The Chairman. Thank you. 

Mr. Neal. I had also written Chairman Greenspan on this tran- 
script matter, and I got a response back from him which I would 
like to make a part of the record, if I may. 

The Chairman. Without objection. 

Mr. Neal. Thank you. 

The Chairman. Thank you very much, gentlemen. And thank 
you for your generous words. 

Our third and final panel invited to discuss that part of H.R. 28 
that authorizes a reform commission to study a number of topics. 

The panel will focus on one of those topics, which is the desirabil- 
ity of further privatizing check clearing now handled by the Fed- 
eral Reserve. 

We have first, Mr. John P. Borden, president of the National Or- 
ganization of Clearing Houses; Mr. J.D. Carreker, chairman of J.D. 
Carreker and Associates, Inc.; Mr. Howard P. Wentworth, senior 
vice president, Philadelphia National Bank; and Mr. James R. 
Lauflfer, chairman, president, and CEO of the First National Bank 
of Herminie, Pennsylvania, and president of the Independent 
Bankers Association of America. 

Gentlemen, thank you very much for your answering our invita- 
tion and taking the time to be with us. Unless there is some time 
constraint on some of the other panelists, is there any objection to 
my recognizing you in the order that I introduced you? 

If not, Mr. Borden. 

STATEMENT OF JOHN P. BORDEN, PRESIDENT, NATIONAL 
ORGANIZATION OF CLEARING HOUSES 

Mr. Borden. Good morning, Mr. Chairman and members of the 
committee. 

I am John Borden. I am president of the Greater Kansas City 
Clearing House Association in Kansas City, Missouri, and presi- 
dent and CEO of the Mid-America Payments Exchange. The Great- 
er Kansas City Clearing House Association provides check-clearing 
services for approximately 100 financial institutions in the Kansas 
City area. The Mid-America Payments Exchange is the largest of 
the 29 automated clearing houses in the United States. 

I am here today on behalf of the National Organization of Clear- 
ing Houses, which is called NOCH; and I serve as president of that 
organization. 

NOCH was founded in 1989 to promote and support the impor- 
tant role of clearing houses in the U.S. payments system. In addi- 
tion to serving financial institutions in Kansas City, NOCH's mem- 
ber clearing houses serve the regional check-clearing needs for fi- 
nancial institutions in Arizona, California, Connecticut, Illinois, 
New York State, Oregon, Pennsylvania, Puerto Rico, and Texas. 

Our members also include the two national private check-clear- 
ing organizations. With this testimony, NOCH will provide its per- 
spective on the role of the Federal Reserve System in providing 
check-clearing services. Our sole purpose here today is to promote 
the goal of a competitive check-clearing system. 



32 

I respectfully request, Mr. Chairman, that my written testimony 
be included in the record. 

The Chairman. Certainly. Without objection. 

And likewise, with each one of the witnesses that gave us written 
testimony. 

Mr. Borden. Thank you, sir. 

NOCH does not believe that it is necessary to establish a con- 
gressional commission charged with evaluating the fair market 
value of the Federal Reserve's check collection operations. 

Instead, NOCH believes that Congress should focus its attention 
on achieving the goal of balanced competition as envisioned by the 
Monetaiy Control Act. 

NOCH also believes that to pursue this goal properly, a combina- 
tion of active congressional oversight, through existing means, and 
greater public involvement in the review of Federal Reserve pay- 
ments system practices is both appropriate and necessary. 

It is clear to NOCH that the current check collection environ- 
ment does not reflect the intent of Congress as expressed in the 
Monetary Control Act. The Federal Reserve System accounts for 
roughly 50 percent of all check-clearing volume, whereas no single 
competitor of the Federal Reserve accounts for more than about 3 
percent. 

Complicating the private sector's ability to compete with the Fed, 
is its dual role as not only competitor but also as regulator. None- 
theless, NOCH believes tnat the goal of a competitively balanced 
market in check collection services is obtainable. 

Given the unique role of the Federal Reserve System, it is no 
surprise that there is friction between the private sector and the 
Federal Reserve. This friction goes back to the establishment of the 
Fed in 1913 but really blossomed following the passage of the Mon- 
etary Control Act in 1980. 

With the passage of this act, the Federal Reserve's check collec- 
tion role changed fundamentally from serving member banks exclu- 
sively to that of serving the entire population of financial institu- 
tions seeking check services, and it involved competing directly 
with the private sector. 

This change in competitive balance led Congress, largely through 
the Greneral Accounting Office, to become actively involved in deter- 
mining whether the act was resulting in the intended level playing 
field. I refer you to the GAO's May 1989 report to this committee 
and its counterpart in the Senate, which is titled: "Check Collec- 
tion: Competitive Fairness is an Elusive Groal." 

Since the release of that report, the Federal Reserve has taken 
some positive steps to address specific recommendations made by 
GAO. Specifically, the Federal Reserve has amended regulation CC 
mandating same-day settlement for checks without the imposition 
of fees. 

Until these amendments, only the Federal Reserve could present 
checks to any depository institution in the United States and de- 
mand immediate payment without the payment of presentment 
fees. 

While the Federal Reserve has taken specific steps to address the 
GAO's recommendations, the current environment strongly sug- 
gests that the Federal Reserve has neither thoroughly addressed 



33 

the competitive fairness issue, nor has it adequately enforced exist- 
ing competitiveness poHcies in its approval of check collection serv- 
ices and prices. 

If this posture is allowed to continue, the balancing of competi- 
tive opportunities that is promised by such actions as same-day 
settlement will be lost. 

An example: The Federal Reserve recently implemented changes 
to its Payments System Risk Reduction Program, which included 
a change in the schedule by which check transactions are posted 
to a financial institution's reserve account. Because of this change, 
credits for checks cleared through the Federal Reserve are avail- 
able to the collecting institution much earlier than was possible — 
or than is possible with checks collected privately. This is an im- 
portant distinction since the Federal Reserve is preparing to price 
for "daylight overdrafts." Since the timing of proceeds of checks and 
all other payment transactions will be very important, it is impera- 
tive that we look at this particular matter. 

The impact of this change represents a perfect example as to the 
Fed's dual role as regulator and payment services provider operat- 
ing to the detriment of the private sector. 

In this case we see that the Federal Reserve is seeing risks in 
the check collection process which we do not see is there for them; 
and in their attempt to reduce this risk, they have established a 
competitive advantage. 

No one relying on the U.S. payment system stands to realize any 
benefit if one group, particularly the Federal Reserve, is perceived 
as dominant in a strictly one-sided game. Sooner or later in this 
situation, the private sector simply might decide to stay home. 

Therefore, the perception that competition in the payment sys- 
tems is one sided cannot be permitted to continue. The perception 
and indeed the reality must be that the competitive playing field 
is level and that the officiating is fair and just. In NOCH's view, 
that was the intent of the Monetary Control Act. 

Public comment is already required by the Federal Reserve's own 
policies governing the approval of changes in fees and services that 
would have significant longer run effects on the Nation's payment 
system. 

Frequently, however, changes to a price or a service by an indi- 
vidual Federal Reserve Bank have received Federal Reserve Board 
approval without the benefit of public comment. That is that the 
Federal Reserve's interpretation is that a particular change would 
have a very limited effect on local providers only. It is true that a 
particular price or service might, in one region, only have a limited 
impact on competition in that region with those local service 
providers. 

However, subsequent adoption of that change in other Federal 
Reserve districts, on a national or multiregional basis, may under- 
mine the competitive position of other service providers. Thus, we 
believe that all changes to Federal Reserve price services have the 
potential that might result in significant longer run effects on the 
Nation's payment system and, therefore, should be issued for public 
comment. 

A good example of this is the controversial service, that was ap- 
proved without the benefit of public comment, a relatively new 



34 

service known as "payer service group sort." This service is now in 
effect in over 11 Federal Reserve oflfices and relies on a completely 
different pricing mechanism than any other Federal Reserve check 
collection service. 

I would like to add that not only does the Federal Reserve ap- 
prove many controversial services without the benefit of advanced 
public comment but even when the comment seeks more informa- 
tion about the service and its approval process, the response from 
the Federal Reserve can be less than forthcoming. 

For example, when NOCH filed a request for more information 
about the approval process for the payer group sort under the Free- 
dom of Information Act, the information received was less than 
satisfactory. 

Mr. Chairman, with your permission, I would like to submit for 
the record a copy of the Federal Reserve's document of approval for 
this service which was received in response to our request. 

The Chairman. Without objection, it is so ordered, sir. 

[The information referred to can be found in the appendix.] 

Mr. Borden. Thank you. A quick review of this document would 
reveal that there is a substantial amount of information that has 
been deleted as "not for public consumption." I find it extremely 
difficult to understand how a simple and basic information request 
can result in a response where the Federal Reserve feels compelled 
to delete so much information. 

The message here should be clear: All proposed changes to Fed- 
eral Reserve prices and services should be issued for public com- 
ment. Providing the public with opportunity to review changes to 
Federal Reserve prices and services not only elevates the Federal 
Reserve Board above any reasonable suspicion of conferring com- 
petitive advantage upon the Federal Reserve System but also per- 
mits the private sector providers the opportunity to respond with 
potential effects that might be felt in the region or regions which 
they serve. 

Public comment would greatly enhance the ability of the public 
and the Federal Reserve to fully review the competitive impact of 
those proposals. 

However, numerous questions still continue to surround the Fed 
in its role, and market dominance in the post-Monetaiy Control Act 
environment strongly suggests that this role must be further evalu- 
ated by a knowledgeable, nonbiased third party. 

Given the GAO's substantial involvement with this issue, NOCH 
would recommend to this committee that the GAO conduct a thor- 
ough reevaluation of the Federal Reserve's role in the payment sys- 
tem. Given changes in the competitive environment that have 
occurred since the May 1989 report, this would be particularly 
appropriate. 

NOCH also believes that Congress should establish an ongoing 
process to measure progress toward the ultimate goal of achieving 
full competitive balance in check collection services. 

We recommend that GAO follow up this comprehensive report I 
have just described with an annual progress report until such time 
as the Congress may conclude that the competitive environment 
has reached the stage envisioned by the Monetary Control Act. 



35 

Congress may, therefore, assure the pubHc that continuous 
progress is being made toward this goal. To this end, NOCH offers 
whatever assistance is requested of it to support GAO's reporting 
initiative. 

Mr. Chairman, on behalf of the National Organization of Clear- 
ing Houses, I appreciate this opportunity to share our views and 
would be happy to answer questions at the appropriate time. 

[The prepared statement of Mr. Borden can be found in the 
appendix.] 

The Chairman. Thank you very much, sir. 

Those bells you heard and those two lights indicate we have a 
recorded vote. But if, Mr. Carreker, you could convey your testi- 
mony or message in, I would say, 5 to 7 minutes, we would still 
have time to go and record our vote and come back and pick up. 

Mr. Neal. Mr. Chairman, would you let me say one thing briefly 
before we go? 

The Chairman. Yes, sir. 

Mr. Neal. A couple of sentences. I just want to say that I have 
worked — mostly my staff worked with Mr. Borden earlier on this 
problem, and I personally found it so complicated that I could not 
figure out who I thought was right. And I iust want to commend 
you for your bill in this area, because I think you are on the right 
track. I don't personally think there is any reason why the private 
sector can't do this. I just don't know exactly how to do it. And I 
think you are exactly on the right track, and I appreciate your 
doing it. 

The Chairman. Thank you. I know that you are chairman of the 
Monetary Subcommittee. 

Mr. Neal. Yes. But he contacted us because of our role there. 
The Fed has all — they have the power. You know, a guy — ^he can't 
deal with them. You know what I mean? And I couldn t. 

So anyway, if we are going to get this done, I think something 
along the lines of your suggestion. Whether this is exactly the right 
thing, I don't know. Maybe we will learn. But you are certainly on 
the right track here. And it is a private sector sort of activity, it 
seems to me; so why not get the private sector to do it. 

I thank you very much for letting me say that. I wanted to say 
that because I am not going to be able to come back. And I thank 
you very much. 

The Chairman. I understand. Thank you very much. 

I tell you what, Mr. Carreker. Why don't we see how you proceed. 
I am not going to place any limitation on you. 

STATEMENT OF J.D. CARREKER, CHAIRMAN, J.D. CARREKER & 

ASSOCIATES, INC. 

Mr. Carreker. Thank you, Mr. Chairman and members of the 
committee. 

I am Denny Carreker, chairman of J.D. Carreker & Associates. 
We are a management consulting firm. And for approximately the 
last 25 years or so, I have been working with the top 250 banks 
in the United States on matters related to the banking system, and 
check presentments most recently. 

Our client base includes most of the country's top 100 banks, 
their regional clearing houses, and banking industry associations. 



36 

It has also included Federal Reserve Banks and the staff of the 
Federal Reserve Board of Governors. 

It is in my capacity as executive director of ECCHO, the Elec- 
tronic Check Clearing House Organization, that I have been invited 
to address the committee. 

ECCHO is a nonprofit national organization dedicated to facili- 
tating the private sector's implementation of electronic check pre- 
sentment. As I will describe later, electronic check presentment is 
changing the payment systems in the United States and the rel- 
ative roles of the private sector and the Federal Reserve. 

ECCHO now has 58 members who account for more than 60 per- 
cent of the total domestic deposits for the largest banks — 100 larg- 
est banks in the United States. 

ECCHO has become the central focus for many of the important 
changes currently taking place in the Nation's payment system. 

The committee has asked me to address two questions. First: Is 
it feasible to privatize the Federal Reserve's check-clearing func- 
tions? And, second: What is the fair market value of the Federal 
Reserve's check-clearing operation? 

First, regarding feasibility, not only is gradual privatization of 
the Federal Reserve's check-clearing functions feasible and desir- 
able, it is already occurring. It is ECCHO's belief that the Federal 
Reserve should encourage the prevailing privatization trend and 
the success of private sector initiatives. 

Doing this would involve addressing a fundamental issue and 
that is the basic conflict of interest in the Federal Reserve's dual 
role as both regulator of and competitor in the check collection sys- 
tem. In this dual role, the Federal Reserve can unilaterally and 
without accountability undertake regulatory, service policy, and 
service pricing initiatives to maintain market share and recover 
costs in direct competition with the private sector. 

There was a time when, thanks to nonpar banking, widespread 
unit banking, and manual check operations, and uncertain trans- 
portation that the Federal Reserve's operating role was necessary. 
That is not the case today. 

Three main changes are contributing to the privatization trend. 
The first is consolidation of the banking industry; the second is the 
emergence of electronic check presentment; and the third is the in- 
creasing extent to which the payment information needs of banks' 
customers are directing the payment system. 

Collectively, these three changes are changing the relationship 
between the Federal Reserve and its necessity to play an operating 
role. I would like to elaborate on each of these briefly. 

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

The second change I referred to is electronic check presentment 
or ECP. The essence of electronic check presentment is that it cap- 
tures the checks' information on the bottom of the check, the MICR 
[magnetic ink character recognition] data, and transmits that infor- 



37 

mation electronically, separating the physical handling require- 
ments of checks from the transmission of the data that is needed 
to affect most of the payment operation. 

It is important to note that the Federal Reserve's role with elec- 
tronic check presentment will be changing. The private sector has 
already developed electronic check presentment software, written 
the rules and agreements designed to implement requirements, de- 
velop national standards and formats, definitions, and borne the 
expense and risk connected with all of these efforts. The private 
sector is adapting ECP service and delivering mechanisms to serve 
the thousands of small banks that cannot support their own check- 
clearing operations and helping these small banks reduce their 
check risks and the risks of their customers. 

On the other hand, the Federal Reserve, while explicitly endors- 
ing the concept of ECP is planning to invest in a different approach 
to ECP that will compete with the private sector's investment and 
has already complicated and delayed the private sector's develop- 
ment of electronic check presentment standards. 

There is no reason for the Federal Reserve to duplicate the pri- 
vate sector's ECP efforts. Additionally, competitive ECP activity by 
the Federal Reserve at this juncture will unnecessarily complicate 
the work of the private sector, potentially introducing new systemic 
risk and delaying ECP's benefits for banks and their customers. 

The third change I referred to is the greater customer respon- 
siveness required of the payment system. During the decades that 
have led to this point in time that the Federal Reserve played its 
operating role, the check was pretty much a commodity. Pieces of 
paper were handed from one group to the next to the next. 

With electronic check presentment and the future of the elec- 
tronic check payment system that will be evolving in this country, 
it is important to understand the risk exposure of the various cus- 
tomers in the United States that utilize the payment system. The 
Federal Reserve does not have an awareness of these customer re- 
quirements, since it appropriately does not play a role in interfac- 
ing directly with corporations and consumers. 

The second question I have been asked to address is the fair 
market value of the Federal Reserve check-clearing operations. The 
value of the operations are directly tied to the timing in which, and 
the scope of which, operations would be taken from the Federal Re- 
serve. It is our belief that the operational transition from the pre- 
dominantly Federal Reserve role to a private sector role should 
take place over a significant period of time and that the settlement 
functionality that the Federal Reserve is currently performing 
should continue to stay with the Federal Reserve. 

ECCHO recommends that Congress establish a Payment System 
Advisory Board, comprised of payment system experts drawn from 
private sector. Federal Reserve staff and other parties as appro- 
priate. 

The Payment System Advisory Board would advise Congress or 
its agents on new Federal Reserve pricing initiatives, major Fed- 
eral Reserve investments in check collection, changes in the scope 
of Federal Reserve services, and Reserve compliance with congres- 
sional mandates. 



38 

The Payment System Advisory Board would hold an annual 
meeting and provide Congress with an annual report on these is- 
sues. ECCHO believes that the General Accounting Office could 
play a useful role in this regard. 

In summary, the committee's attention to this issue is particu- 
larly timely. It comes at a time when the private sector check- 
clearing banks are particularly well positioned to provide even bet- 
ter check-clearing services more cost-effectively than ever, with 
greater corporate and consumer value than ever and with even bet- 
ter service for small banks. 

Congress can, with little or no impact on the quality or safety of 
the check collection system, encourage current private sector initia- 
tives, the prevailing trend toward privatization of the check- 
clearing business and the gradual elimination of the Federal Re- 
serve's conflict of interest. 

To ensure the continuity and security of the payment system 
during this transition and beyond. Congress should form a Pay- 
ment System Advisory Board consisting of Federal Reserve and pri- 
vate sector parties. ECCHO is pleased to offer its services in any 
way in the establishment of this Board. 

Thank you, Mr, Chairman. 

The Chairman. Thank you, sir. 

We will stand in recess until after the vote. 

[The prepared statement of Mr. Carreker can be foimd in the 
appendix.] 

[Recess]. 

The Chairman. Mr. Laufifer. 

STATEMENT OF JAMES R. LAUFFER, CHAIRMAN, PRESIDENT, 
AND CEO, THE FIRST NATIONAL BANK OF HERMINIE; PRESI- 
DENT, INDEPENDENT BANKERS OF AMERICA 

Mr. Lauffer. Yes, Mr. Chairman. 

Jim Lauffer, chairman and president and CEO of the First Na- 
tional Bank of Herminie in Irwin, Pennsylvania. I am also presi- 
dent of the Independent Bankers Association of America. 

We appreciate this opportunity to testify on your bill, the Federal 
Reserve Accountability Act of 1993. You have asked us to comment 
on that part of the bill which directs a new commission to study 
the benefits and efficiencies that would result from reducing or 
eliminating the Federal Reserve's role in check clearing. While my 
written statement discusses other issues, I will limit my oral re- 
marks to what you have asked for on the commission. 

IBAA believes that the legislation should call for a study that 
would, or could, ignore crucial factors that must go into consider- 
ation of whether the Federal Reserve should divest check-clearing 
services. It only requires the commission to take into account the 
economic benefits to be derived from and the efficiencies to be 
achieved as a result of the divestment. This would or could result 
in a biased study, since it does not clearly require the commission 
to consider any of the disadvantages of reducing or eliminating the 
Federal Reserve's check-clearing role. 

The bill should require the commission to consider the indirect 
cost to the public if reasonably priced check clearing is no longer 
available to financial institutions serving small and rural commu- 



39 

nities; the adverse effects of these communities, if they lose access 
to prompt and efficient payment services; and the value of having 
the services retained by the Federal Reserve. 

Individuals and small businesses throughout the Nation expect 
reasonably priced banking services: Checking accounts, interest- 
bearing checking accounts, and savings accounts. The availability 
of the Federal Reserve services gives community banks — collec- 
tively the largest private sector market for the Federal Reserve set- 
tlement and clearing services — access to affordable correspondent 
services designed to meet the needs of their customers in rural 
America. 

For many community banks, particularly in the rural areas, the 
Federal Reserve is the only provider offering check-clearing serv- 
ices. The Federal Reserve ensures that all financial institutions, 
approximately 30,000, have universal access to its services. 

In the last 3 to 4 years, several private entities have formed or 
expanded to provide national correspondent services, including 
check clearing. Although these services are available on a national 
basis, they are not universally available to all institutions. 

In 1992, Huntington Bancshares and two nonbank partners 
formed the National Clearinghouse Association, a nationwide 
check-clearing network. Its membership requirements effectively 
exclude small institutions by establishing a $200 million minimum 
capital level for their participants. That $200 million would equate 
to about a $2 billion asset-sized bank. And there are 10,000 banks 
in this country that are under $150 milHon in assets and under $15 
million in capital. So effectively, in their system, they would be 
frozen out. 

I would like to make a comment that is not in my statement con- 
cerning Huntington Bancshares. Lee Hoskins, who was president of 
the Federal Reserve Bank of Cleveland for a number of years, left 
about a year ago. Now I would suspect — we are in the Cleveland 
district, so I know Lee. And he went to Huntington Bancshares, 
and within months, came up with a decision to spend millions of 
dollars on this clearing house. 

Now, I ask you, Mr. Chairman, a president of the Federal Re- 
serve Bank of Cleveland for a number of years, if he thought that 
the Federal Reserve pricing system was too low and uncompetitive, 
why would he go to an institution and form something to compete 
against the Fed immediately? I would just like to add that to my 
comments. 

The Visa Automated Clearing House has identified the top 100 
ACH originators as its niche. Community banks need not apply. 

The top 100 banks again. And there are 10,000, 11,000 banks in 
this country. 

Electronic Check Clearing House Organization was formed in 
1990 to provide private sector national electronic check present- 
ment. The ECCHO membership includes many of the country's 50 
largest banks. I think it was mentioned 58 is what they have. 

Late last year, ECCHO added a new associate membership cat- 
egory to attract members that might not otherwise be available to 
afford regular membership. Unless it has recently changed, the an- 
nual cost of associate membership is $10,000. This effectively ex- 
cludes smaller banks. 



40 

These examples indicate that the private sector has neither the 
capacity to absorb the Federal Reserve's check volume, about 30 
percent of the total — I heard 50, our figures show 30 — nor the will- 
ingness to provide the services to all segments of the industry, 

I have heard it said that you will do it through your correspond- 
ent bank. In most major banks, a lot of major banks have gotten 
out of the correspondent business. In fact, the Independent Bank- 
ers Association of America has helped establish 16 bankers' banks, 
including 1 in your State of Texas, to handle correspondent services 
because the big banks have gotten out of correspondent services. So 
unless there is a high-profit margin in check clearing, smaller 
banks are not going to have access to that service. 

If the Federal Reserve abandons these services to the private sec- 
tor, community banks would likely experience increased operating 
costs. In today's environment, community banks would have to 
pass these on to the consumers, or they would have to make less 
profit. 

I think the commission should study that. In other words, if it 
costs me $10,000 to get into the clearing house, that will be 
$10,000 off my profit; that would be $3,400, at a 34-percent tax 
rate, that the government would not receive, unless I pushed the 
cost on to my customers. 

In addition to ensuring that all financial institutions have uni- 
versal access to check-clearing services, the Federal Reserve is the 
catalyst for improvements in the payments system, including 
check-clearing operations. 

Unlike any private sector provider, the Federal Reserve has re- 
sponsibility for regulation and improvement of the payments sys- 
tem. The Expedited Funds Availability Act of 1987 strengthened 
this requirement. As a result, the Federal Reserve has a nation- 
wide — number one, nationwide, two, long-term perspective, not just 
a short-term, regional or niche perspective as so many in the pri- 
vate sector do. 

The IBAA understands that the Federal Reserve is strongly com- 
mitted to remaining in the check-clearing business and improving 
the efficiency of the Nation's check-clearing system. The Federal 
Reserve's 7-year research and development effort in check image 
technology and the development of electronic check exchange serv- 
ice are prime examples. The Federal Reserve's leadership role in 
both of these areas prompted software and hardware vendors to de- 
velop systems much sooner than private sector markets would 
have. The Federal Reserve cannot continue to improve our pay- 
ments system if it no longer offers services in that system. 

Any study must factor in the benefits of the Federal Reserve's 
dual role as regulator and service provider committed to serve all 
financial institutions. 

Some may contend that community bankers should not worry 
about this proposed study since, after all, it is just a study. We dis- 
agree. Studies, particularly biased studies, can lead to dangerous 
legislative proposals. 

For example, section 1001 of the 1989 savings and loan legisla- 
tion directed the Treasury to study the Federal deposit insurance 
system. That section focused on ways to cut back on deposit insur- 
ance to reduce loss to the government. It failed to require the 



41 

Treasury to study any benefits of keeping deposit insurance, in 
keeping it where it was. 

The result was a Treasury recommendation that deposit insur- 
ance coverage be greatly curtailed. 

Mr. Chairman, I know you favored those recommendations, and 
we strongly opposed them. But certainly we can agree that the bat- 
tle over deposit insurance coverage that grew out of the Treasury 
study was hard fought and highly significant. 

The fact that the 1989 law did not require the Treasury to con- 
sider any positive aspects of deposit insurance put a tremendous 
burden on those of us who opposed deposit insurance cutbacks. Be- 
cause of that experience, we will continue to closely scrutinize pro- 
posals to "just study" topics of concern to community banks and 
light to eliminate bias. 

We ask, Mr. Chairman, at the least, on your appointment — ^the 
appointments to this commission — that there be members from 
rural America who have an understanding of how these changes in 
the payments system would impact their banks on main street and 
rural America. 

We thank you for the opportunity to testify, and we would be 
glad to answer any questions. 

The Chairman. Thank you very much. 

[The prepared statement of Mr. Lauffer can be found in the 
appendix.] 

Mr. Wentworth. 

STATEMENT OF HOWARD B. WENTWORTH, SENIOR VICE 
PRESIDENT, PHILADELPHIA NATIONAL BANK 

Mr. Wentworth. Mr. Chairman and committee members, my 
name is Howard Wentworth, senior vice president with CoreStates 
Financial. 

CoreStates Financial is a multibank, Philidelphia-based holding 
company with assets over $23 billion. We are one of the Nation's 
largest correspondent banks and, as a result, are in direct competi- 
tion with the Federal Reserve for priced services. We are also the 
Federal Reserve Bank of Philadelphia's largest customer. 

I would like to thank the committee for the opportunity to com- 
ment on the issue of privatization of Federal Reserve price services. 

As documented in the 1989 General Accounting Office report, 
"Check Collection: Competitive Fairness is an Elusive Goal," the 
Federal Reserve is engaged in almost $800 million a year business 
of providing priced services, activities that the Federal Reserve pro- 
vides for a fee, such as check collection, wire transfer, and so forth, 
in direct competition with banks and other service providers. 

At the same time the Federal Reserve also regulates its competi- 
tors. The dual roles of regulator and service provider effectively sti- 
fle private sector competition for price services. Competition is cur- 
tailed in several ways. 

The Federal Reserve enjoys legal advantages that no private sec- 
tor provider can match. Among these are the ability to present to 
any paying bank as late as 2 p.m., the ability to compete on a na- 
tional basis, and the ability to spread costs over a variety of prod- 
ucts, including some products where the Federal Reserve enjoys a 
virtual monopoly position. 



42 

As the manager of the payment system, the Federal Reserve ex- 
ercises its tactical rulemaking abilities, granted under regulation 
CC, in ways that frequently appear to have, as their primary moti- 
vation, improvement of the Federal Reserve's competitive position 
at the expense of the private sector providers. A recent example 
would be the establishment, by the Federal Reserve, of a 6:30 p.m. 
deadline for the settlement of same-day settlement presentments. 
The late deadline, which applies only to private sector present- 
ments, compares to a deadline as early as 11 a.m. for Federal Re- 
serve presentments. The early deadline reduces Federal Reserve 
risk, while the late deadline increases private sector risks and 
costs. 

Although the time under which payment can be delayed may ap- 
pear to be unimportant, the distinction could effectively negate the 
cost avoidance opportunities for some of the very banks that same- 
day settlement was supposed to benefit. 

Finally, it is important to appreciate that banks view the Federal 
Reserve primarily as a regulator. As a result, banks frequently are 
reluctant to challenge Federal Reserve actions related to price serv- 
ices because of their concerns related to the Fed's regulatory role. 

The net effect is that the dual powers that Congress has granted 
to the Federal Reserve sets up a governmental agency with unfair 
competitive advantages over the private sector. Although it is now 
seen as a cliche, it is nevertheless true that the FAA doesn't fly air- 
planes since it would place them in the conflicting roles of regu- 
lator and operator. This is a truth that the current Federal Reserve 
structure does not reflect. 

Privatization of the Federal Reserve price services functions is 
the most effective way to resolve the actual and perceived conflicts 
of interest which the government has created in allowing the Fed- 
eral Reserve to function in its dual roles. 

Three approaches to privatization of the Federal Reserve's price 
services functions should be considered. 

One, the Federal Reserve should sell their operating units on a 
regional basis to private sector providers. 

Two, priced service activities could be spun off from the Federal 
Reserve on a local basis. The new charter would be to operate as 
a private company with profits to be paid to the Treasury. This ap- 
proach would result in approximately 46 separate companies being 
created. Each new company would be subject to the same regula- 
tions as the private sector providers. 

And, three, the Federal Reserve could return to its historic role 
as a processor of last resort providing those services that the pri- 
vate sector elects not to deliver. 

Each of the three alternatives provides benefits and challenges. 
Additional work would be required to install any one or a combina- 
tion of the above solutions. However, each would appear to success- 
fully eliminate the conflict in the dual roles of the Federal Reserve 
without jeopardizing the safety and soundness of the payment 
system. 

Thank you for your attention. I would be pleased to answer any 
questions. 

The Chairman. Thank you very much. 



43 

[The prepared statement of Mr. Wentworth can be found in the 
appendix.] 

The Chairman. Well, let's see now. Mr. Borden, if I understood 
correctly, you don't favor the creation of a congressional study 
committee? 

Mr. Borden. Mr. Chairman, we feel that a committee approach 
or a GAO approach would both end up with going for the same 
goal. 

It was our position that the GAO, having had some previous ex- 
posure and experience in looking at this question with the Fed, 
might have a headstart on that process. 

The Chairman. Well, Mr. Lauffer, you heard the other testimony 
and also Mr. Borden's. As I interpret it, you are suggesting that 
private enterprise would not satisfactorily provide the check-clear- 
ing services, particularly, the smaller and either what you call com- 
munity or rural. 

But now the thrust of your presentation with respect to the study 
was not so much against the creation of a committee as to what 
the parameters should be prefixed for that committee to work 
within. 

But I don't interpret yours to be in opposition to an inquiry or 
a study or the creation of the committee as such. 

Am I correct? 

Mr. Lauffer. Well, as long as there were representatives on 
there that would take into consideration the rural banks. 

You see, with the big clearing houses, volume is the name of the 
game. And they already stated — ^how much volume do you have 
now in the total market, 85 percent or something. It doesn't pay 
them to provide services to the smaller banks with that low vol- 
ume. And that is why Fed has always been a good provider that 
we know is going to be there. 

Correspondent banks, the issue is, OK, get it through your cor- 
respondent. A lot of correspondent banks have gone out of all kind 
of business. Like I said, we helped 16 bankers banks around the 
country in 16 States because the correspondents said to the little 
banks, forget it, we don't need vour business, there is not enough 
volume in it, whether it has oeen safekeeping or a number of 
things. 

We have a bank in Pittsburgh that had a data center, that has, 
I forget how many participants, hundreds, maybe 1,000, that they 
were always going to be in that business and their correspondent 
banks joined. Well, they sold it 6 months ago. 

And so you have the big banks always moving to where the profit 
is going to be the greatest, and that is fine. That is what they 
should be doing in a free enterprise system. But if we do something 
to take away the rural bank's only way of clearing, or they have 
to pay a correspondent or pay $10,000 a year just to belong, be- 
cause as I said in the statement, the Huntington one, they required 
$200 million in capital; thereby, they are not interested in the 
10,000 other banks. They are only interested in the top 100 that 
produce the volume. 

That is just how it is going to come down, because that is how 
a profit margin is going to come down. Sure, they might provide 
them but at what cost to the individual banks? And what cost to 



44 

the consumers? Because it is just like the nationwide banking 
trend. 

As they consoHdate, you find them closing branches in rural 
areas because it doesn't pay them to have one that far — it is too 
far to move the material. Material can move electronically now, but 
the cost to a $10 million bank or a $30 million bank or a $50 mil- 
lion bank would be unreal. 

My other point that I think is a good point, if Lee Hoskins, who 
was president of Fed Cleveland for a number of vears, thought that 
the Fed's pricing was noncompetitive in the market, why would you 
go to a large bank and form this to compete against the Fed? 

I can't find a rational reason why that would happen. Because 
these other three gentlemen are saying that the Fed has a competi- 
tive edge, they have a competitive advantage. I mean here is a man 
who worked for Fed and then started one of the biggest deals that 
we have in the Nation right now. 

Mr. Wentworth. Mr. Chairman 

The Chairman. Either he should have stuck to being the Fed 
president, or he knows something we don't know. And maybe per- 
haps we can have some comment from the respective witnesses. 

Mr. Wentworth. 

Mr. Wentworth. Yes. Thank you, sir. 

As a point of clarification, CoreStates is not a member of the Na- 
tional Association of Clearing Houses; however, I am familiar with 
their operations. 

I believe the record will indicate that the $200 million require- 
ment was established by the Federal Reserve as part of the nego- 
tiations that went on oetween Huntington Bank and the other 
partners in order to get the settlement facilities that were nec- 
essary for that organization's operation. So that limiting member- 
ship was never an objective of the organization. It was a require- 
ment placed by the Fed. 

Second, I think it is interesting that we have heard testimony 
about the withdrawal of correspondent banks from the marketplace 
or of major banks from the marketplace. 

I think that is absolutely accurate. But the root cause of that 
withdrawal is the predatory pricing of the Federal Reserve as they 
move to try to offset the other elements that are happening simul- 
taneously within the marketplace such as the consolidation of 
banks. 

The statements that addressed the reduction in transit activity 
are exactly right. As transit volume declines, the Federal Reserve 
has movea to retain its market share by ratcheting down prices, as 
they have the ability to do that and have exercised their ability to 
do that. 

The profit incentives that are left for banks has been eliminated 
so that there is a cause and effect here and an interrelationship be- 
tween all of these activities. 

Mr. Carreker. I would like to make just two points. First, back 
when the Monetary Control Act came about, the Federal Reserve 
started losing volume significantly because it, for the first time, 
was having to price its services; and its volume levels were such 
that, since the check operations are very volume oriented, its cost 
of services were too high. 



45 

The Federal Reserve, taking advantage of its national delivery 
system and its ability to regulate implemented something called 
"noon presentment" which forced all banks across the United 
States to receive deposits from the Federal Reserve individually 
until 2 p.m. so it changed the entire structure across the country. 

And then it put in place a national transportation system that 
made it possible for the Federal Reserve to intercept transit checks 
in remote national locations around the country and to funnel those 
into the Federal Reserve and out of the private sector. 

As a result of that, a number of the clients that we work with 
that had spent millions of dollars building large correspondent 
bank operations found their volume going away to the Federal Re- 
serve. As a result, their unit costs went up. As a result, when they 
started looking at their ability to compete with the Fed, they exited 
the business, resulting in the problem that Mr. LaufiFer is referring 
to. 

It is a perfect example of how the Federal Reserve has, in fact, 
used its regulatory authority to change the playing field and to 
compete in a way that disrupts the ability of the private sector to 
predict the return — reasonable return on investment that it can re- 
alize from its check operations. That is the first point I wanted to 
make. 

The second point I wanted to make is that all of our discussions 
have focused on the check collection system in the United States 
as we thought of it historically. The check collection system in the 
United States is undergoing a change like it has not seen since the 
earlv sixties when MICR was invented. 

Electronic check presentment and the advent of image tech- 
nologies will position the United States to move forward in dra- 
matically reducing fraud, which is growing exponentially, which 
will allow it to reduce the processing costs dramatically, wnich will 
allow it to compete much more effectively on a global basis around 
the world. 

To do that, the private sector, who is aware of the opportunities 
to reduce costs, fraud, and deliver improved payment systems serv- 
ices to corporate America, has to take the leadership and make the 
investment necessary to move our payment system forward. 

If the private sector constantly has fear that the Federal Reserve 
can come in and regulate a playing field that disrupts their ability 
to predict a return on that investment, they will withdraw. That 
has occurred in the past, and it will occur again in the future. 

This is a crucial time for the private sector to take leadership, 
even the Fed acknowledged that; and that is why we feel it is so 
important that a connectivity between the private sector and the 
Fed, like never before, be established through this advisory board 
so that the Fed can't unilaterally move to try to optimize its cost 
recovery market share and those kinds of things. 

This is not the time for that kind of behavior. 

The Chairman. Mr. Borden. 

Mr. Borden. Mr. Chairman, I would like to comment on a few 
things. And I think maybe an overall comment that while there are 
several proposals coming from this table, I think that the general 
spirit is in the same direction that there is something that needs 
to be addressed. That does not mean that we need to attack the 



46 

role of the Fed in providing services to the independent community 
banks. I don't think that is the intention at all. 

I think that the root comment that we are looking at here is that 
if we have a competitive process that, as Mr. Carreker said, has 
that level playing field aspect, then you would find a lot of the com- 
petitive inequities that maybe are falling at the lap of the commu- 
nity banks removed. 

And to take that further, I would like to go into the automated 
clearing house world where it is a little different than checks; but 
there you have an organization like VISA who is an operator of an 
ACH, just as the Fed is an operator of the ACH. 

VISA, for years, has been working with the Fed to get a settle- 
ment agreement in place. When they finally did get the settlement 
agreement in place with the Fed, it was less than satisfactory. 
Ajid it definitely favored, as Mr. Wentworth said, the larger 
organizations. 

So we have the Fed, in effect, set a policy on the use of settle- 
ment in several examples — one, a check clearing house and the 
other an automated clearing house — that is biased toward the 
larger player. 

And in that regard, I think that the IBAA comments are right 
on target. It is not that these organizations do not want to service 
the independent or smaller bank at all. It is because they are con- 
strained in what they are dealt by the Fed as to how they can oper- 
ate that business. 

And I would go further to say that in my clearing house and in 
my ACH we have membership that goes down to the credit unions 
which open 1 day a week, and you can't get much smaller than 
that in terms of being a financial institution, so that we have all 
of these players that are in the same process together. 

There are differences between the large ones and the small ones. 
The small ones cannot afford to have certain kinds of services and 
activities. They can't afford the capital to buy the equipment. But 
they have access throughout this process. And it is the access, I 
think, that we are worried about. And if we have a competitive, 
level playing field, the access will take care of itself 

Thank you. 

The Chairman. Now, are you saying that Mr. Lauffer's point 
about the market for banking services and check clearing are not 
functioning well for small banks, but that is because of Fed 
policies. 

Mr. Lauffer, what do you say about that? 

Mr, Lauffer. I would disagree with that. I contend that the Fed 
is the only national player across the Nation. If we were close to 
Kansas City and able to use Mr. Borden's clearing house, that 
would be one thing. But you have banks in Montana, Wyoming, 
and parts of Texas, as you well know, that aren't close to a regional 
situation. And I don't think — I mean I have to rest part of my case 
on the Huntington Bancshares and go back to what you said. The 
gentleman must know something more than we know of that be- 
cause, why would you start a venture and invest millions of dollars 
and go after this big market if you didn't think that you had a com- 
petitive edge against the Federal Reserve from where you came? 



47 

It just, to my mind — and I have never asked Lee that question; 
but since it came up here today, that is a good question to ask. If 
there is no competitive advantage, I mean, why would you go out 
and become CEO and go into something that is so unique as this, 
and only few in the country, if you knew that the Federal Reserve 
is going to undercut you, you wouldn't make a profit? 

You know, I rest with you saying somebody knows something we 
don't know. 

The Chairman. Mr. Wentworth. 

Mr. Wentworth. Sir, the National Clearing House Associates, 
which is the organization that Huntington is linked with, is a not- 
for-profit corporation. It is an association of banks who have come 
together without a profit motivation in order to reduce their clear- 
ing costs. The Huntington involvement is an element called Chexs, 
which is a for-profit company that provides settlement services ex- 
clusively for the members of the national clearing house. 

So to make a comparison of the motivation that Huntington had 
vis-a-vis traditional correspondent check clearing house activities, 
I would categorize as being inaccurate. Huntington does not proc- 
ess checks, Huntington provides a settlement service, which is a 
net settlement service, through the books of the Cleveland Fed. 

The Chairman. Yes, Mr. Carreker. 

Mr. Carreker. Mr. Chairman, relative to the comment that was 
made about making payment system services available through re- 
mote or rural banks. In Canada, the Federal Reserve equivalent 
there does not perform check operations. Instead, what it has is, 
in effect, a committee, if you will, that is an ongoing group where 
the banks that have met certain qualifications to play the role of 
intermediary bank come together with the policy regulatory author- 
ity, which is the Fed equivalent up there, and the Fed, in effect, 
interacts with those larger banks in Canada to ensure that the 
payment system is sound, safe, and cost effective. 

The banks, then, implement the operations and carry those out, 
and while the largest banks are involved in that interaction with 
the Federal Reserve equivalent, there are many banks in more 
rural locations than we have here in the United States that are 
served in the Canadian model. Similar models exist in other indus- 
trialized countries. 

So it is not a direct conclusion that a private sector approach 
under the regulation and authority of the Federal Reserve cannot 
deliver cost-effective services. It has in the past and it could do it 
in the future. There would be many issues that would have to be 
thought through and dealt with, but given the opportunity, that 
could be done. 

Mr. Lauffer, Mr. Chairman, I want to put something else in the 
record here one of my colleagues gave me. We have asked the Fed 
people a number of times about the $200 million capital limitation, 
and they have denied saying that they ever set any capital limita- 
tion. I don't know who is right and who is wrong, but that is what 
they have told us. 

The Chairman. Well, we intend to follow through and we will 
have another hearing at which time of course we would expect to 
have the Fed, and that is why it was important for us to hear from 



48 

you first so that we would be able to follow through and pinpoint 
some of these issues. 

[The information referred to can be found in the appendix.] 

The Chairman. But coming back, I am going to ask some of the 
other witnesses, Mr. Carreker and Mr. Wentworth, to respond to 
Mr. Lauffer's speculation about the venture of this former reserve 
president going into a business if the Fed is so preemptive in its 
dual role as regulator and competitor. 

Mr, Carreker. Well, there are many situations, I think, where 
over time, as various payment systems, innovations have come 
about where the Federal Reserve has been found to not be the cost- 
effective solution, and to not be the best price in town. And I think 
what the national clearing house organization has done is to iden- 
tify a way for the private sector to come together and to create a 
structure between banks that is less costly than going through the 
Federal Reserve. That is innovative and that is a creative thing to 
do. 

I think the point that I really want to drive home, because of the 
need for investment in the payment system today, is that the Fed- 
eral Reserve can change the rules. They have done it in the past 
and they are not some black cloaked outfit out to do damage or 
anything like that, they simply have a conflict of interest. They are 
required to maintain a certain market share and a certain cost re- 
covery if they are going to stay in operation, and so they tend to 
do the things necessary to accomplish that. 

If you were an enterprising organization out to get a good return 
on investment for your investors, you would not invest in things 
when there was inordinate risk. And in the payment system of the 
United States, when the Federal Reserve can unilaterally change 
the rules, that deters investment. And that, to me, given the time 
period that we are in in this country, is a very, very serious and 
sad situation to be in. It needs to be dealt with. 

The Chairman. Mr. Wentworth. 

Mr. Wentworth. If I may, Mr. Chairman. I think representing 
correspondents in general, which is a mantle I am taking unto my- 
self, our position would be that service enhancements and quality 
are assured as the result of competition, competition between the 
private sector and the Federal Reserve. 

I think the numbers from our market, the third Federal Reserve 
district, perhaps are symbolic of the problem. The best numbers 
that we have is that the Federal Reserve enjoys about a 55 percent 
market share. We enjoy about a 35 percent market share, meaning 
that all of the rest of the banks in the districts split up about 10 
percent between them. 

Should CoreStates decide for profit motivation reasons to with- 
draw from this business, there will be no competition for price serv- 
ices in the third district, and I cannot imagine any elements of the 
banking industry that over time would benefit from that situation. 

Mr. Lauffer. Mr. Chairman, I am a little confused. I think I just 
heard you said that this was an enterprising thing going on and 
knowing that private enterprise, the private sector, could be more 
competitive than the Fed on pricing; and then I know I heard that 
the Fed has a competitive advantage on pricing. So I am not sure 
what that leads to. 



49 

On one hand we are sa3dng here that the private sector can go 
out and do a better job and cut costs under Fed, and on the other 
hand, we are hearing everybody say the Fed has competitive ad- 
vantage now. It cannot go both ways. 

I am sure it could go both ways, or in different factors, in dif- 
ferent facets of Fed's operation, but it cannot go both ways. You 
cannot say the private sector will do a better job and cut costs and 
the reason why you are going to let them do that is because they 
are going to be able to cut costs, but then on the other hand say 
we want to do this because the Fed has a competitive advantage. 

The Chairman, It seems to me that the thrust of the statements 
with respect to the Fed's dual role or capacity, that is as a regu- 
lator over the same entities and banks, and also the provider of 
services was providing a backdrop in which competition could, at 
any time, be susceptible to elimination. That is what it seems to 
me. 

I don't know what your opinion is as to this very basic argument 
for privatization or what is labeled here as an even playing field, 
competitive playing field. Is it your interpretation that the Federal 
Reserve Board does not indulge at times in a switch role, one from 
the other, in this clearing process? 

Mr. Lauffer. I am not sure I understand the question. I think 
you are saying or are you saying that they may have a competitive 
advantage in one area and they are subsidizing it from another 
area? Is that what you are 

The Chairman. Well, I was trying — I think the best thing to do 
is ask Mr. Carreker and Mr. Wentworth or Mr. Borden because 
they are from the private sector, to interpret what I was trying to 
poorly evaluate as the thrust of their main reason for an enhance- 
ment or encouragement of privatization based on a competitive and 
fair playing field. And that is that the Fed, as a prime regulator 
of banks, does not lose control of that power when it comes to the 
providing of check-clearing services. 

But I think the best thing would be to clarify that by having Mr. 
Carreker, Mr. Wentworth, or Mr. Borden elaborate or extend a lit- 
tle more on what they have already stated. 

Mr. Wentworth. Sir, the Monetary Control Act required the 
Federal Reserve to act as if it were a private sector provider, and 
to establish a kind of Chinese wall between its regulatory activities 
and its price services activities. Events have proven that the Chi- 
nese wall frequently appears to disappear when it is in the interest 
of price services volumes. 

The Federal Reserve prices are based upon its ability to change 
payment rules to their exclusive advantage at the expense of all 
the other alternatives. We can cite a number of examples where 
the Federal Reserve has unilaterally made major changes in the 
payment system in conflict with their own pricing policies having 
to do with such things as competitive impact studies, where they 
have stated that they would not make a major change in a pay- 
ment system that would have an adverse effect on the competitive 
environment without doing an extensive competitive impact study. 

The fact is that these studies are frequently not done at all or 
done in ways which provide no benefit at all to the process. 



50 

I think Mr. Carreker said earlier it is not our intention to pass 
the image of the Federal Reserve as being ill-intended people. I be- 
lieve that the basic policy that Congress has established which sets 
up this dual role has left them in an untenable position. You can- 
not be both a regulator and an operator, it just does not work. 

The CHAraMAN. Do you have any comment, Mr. Lauffer, in view 
of that explanation? 

Mr. Lauffer. I have a couple of comments. It has worked since 
1912 or whatever it has been and, of course, the Constitution of 
this country has worked a lot longer than that. 

But one point I want to make to Mr. Wentworth; how much of 
the market did you say you have in Philly or eastern Pennsylva- 
nia? 

Mr. Wentworth. We have 35 percent of the market's share. 

Mr. Lauffer. And Fed has 50? 

Mr. Wentworth. Fifty-five. 

Mr. Lauffer. I submit to you, Mr. Chairman, you take the Fed 
out of the business in the Philadelphia district and this one bank 
will have 85 percent of the market share. 

Mr. Wentworth, And we are not recommending, sir, that that 
be the result. What we are simply asking for is to have the Federal 
Reserve operate on the same level playing field, if you will, as the 
rest of us. 

Privatization does not translate into a monopoly of a single pro- 
vider, which is the end result of the current practices of the Fed- 
eral Reserve. Privatization gives the opportunity to have multiple 
players. 

Mr. Lauffer. Mr. Chairman, one other question or one other 
statement. The Canadian illustration, I think, is a very poor illus- 
tration in comparing our system to theirs. They have five or six 
large banks with branches all over Canada. Very few community 
banks. We are dealing with 10,000 banks in the United States. 

So to compare that to the same system, you know, we get this 
thrown in our face as community bankers all the time. We do not 
need all you guys, England only has three banks, Canada only has 
four. Well, we are serving somebody out there or we would not be 
there, and all we want to make sure is that we do not get fi*ozen 
out of the payment system or priced out of the payment system, so 
that we cannot afford the price, that it ups our cost and ups our 
cost to our customers. 

That is what we want to do, we want to make sure the Commis- 
sion is not biased; that they are looking at where our banks are 
and what we have to deal with and will these private sector provid- 
ers provide us that service at a reasonable cost. 

The Chairman. Yes, Mr. Carreker. 

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



51 

So I don't think that is what we are deaHng with. I think what 
we are deaHng with is the fact the Federal Reserve does have a 
basic conflict of interest. There is a basic issue there that is deter- 
ring the ability of the U.S. payment system and the banks that 
make it up to move forward in a manner that is important for this 
country. 

And I think that an advisory board or some group that can en- 
sure that the initiatives between the Federal Reserve and the pri- 
vate sector are well dealt with in a very visible and open way, be- 
fore the Fed has a unilateral opportunity to continue to operate in 
the dual role, is an important thing that needs to occur at this 

time. 

Mr. Lauffer. I would respond to that, Mr. Chairman, in saying 
that I don't have any problem with them being a regulatory body 
plus being in check clearing. In fact, I think there is an advantage 
there because the Fed's ultimate goal is to keep this country, the 
economy, and failures, and the whole thing on as even keel as it 
can. Taking the volume outside their system takes them out of that 
loop to know that there might be something that should be dealt 
with. 

So I don't look to, and I don't think the community bankers look 
to that being a problem at the Fed. The Fed regulates them plus 
providing clearing or whatever services they do. It might be a prob- 
lem for the big banks but I am not sure it is a problem for us. 

The Chairman. I believe that the issue here is the wisdom or 
lack thereof of the creation of an evaluative or study commission. 
And we can conjure all kind of peers, but the basic premise is that 
this is an area that needs clarification as to policy, where the na- 
tional policymaking body, the Congress, has a responsibility. 

So unless any one of you gentlemen has an additional remark or 
question to raise, we will proceed on the basis that this has been 
a most effective presentation and that we are very much in your 
debt. 

This is an issue that does agitate us on this committee. We do 
not want to do what has happened so often in the immediate past 
three decades where you have these burgeoning issues coming up 
and Congress apparently not aware or at least not confronting 
them. So we do, of course, intend to have the Federal Reserve and 
others testify on this particular section of this bill. 

So thank you very much, gentlemen. You have been most pa- 
tient. We have gone right through the lunch period. 

And I am going to request, as is customary and as I have been 
asked, unanimous consent that all members, including myself, be 
provided the privilege of submitting written questions to you; ques- 
tions that you should receive by the time you get a transcript of 
the proceedings of today's hearing. 

There are so many things going on right now, including business 
on the House floor. But, more importantly, the quite unexpected 
visit of the President and his wife this morning and the consequent 
change in the schedule of the House and its business today, which 
accounts for so many members being out and a few of those that 
did come in only having to leave. 



52 

But everyone has a copy of your testimony and some will be sub- 
mitting questions in writing as well as I. But thank you very much, 
gentlemen. 

The committee will stand adjourned until further call of the 
Chair, which will be tomorrow at 10 o'clock in this hearing room. 

[Whereupon, at 1:15 p.m., the hearing was adjourned, to be re- 
convened 10 a.m., October 28, 1993.] 



53 

APPENDIX 



October 27, 1993 



54 



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

HR 28 



Today, the Banking Committee begins the fourth day of hearings 
on issues involved in HR 28, the "Federal Reserve System 
Accountability Act of 1993." I welcome Charles Bowsher, the 
Comptroller General of the General Accounting Office (GAO) and look 
forward to his testimony. He will tell us about the legal 
limitations the GAO faces in examining Federal Reserve operations. 

In testimony during these hearings on October 13, 1993, 
Federal Reserve Chairman Alan Greenspan told us, "GAO, in the 1978 
Act, could audit all aspects of the Federal Reserve System with the 
exclusion of those which refer to the question of the deliberations 
related to monetary policy." Was he trying to mislead us? 

Let me tell you some areas of Federal Reserve operations that 
the GAO cannot investigate. Most people do not know that when the 
Federal Reserve changes the money supply, it does so from its New 
York Federal Reserve Bank in an auction separate from the U.S. 
Treasury auctions used to borrow money for government operations. 
Each morning around 10 a.m., the Federal Reserve Bank of New York 
holds a 30-minute auction with approved bank and non-bank dealers 
in order to change the monetary base of the United States. By 
buying or selling securities, usually very short-term repurchase 
agreements, the Fed takes money out of circulation or puts money 
back into circulation. There is little information on this 
auction. We know there is no market clearing price as was recently 



55 



introduced for Treasury auctions. Thus, accepted bids or offers are 
transacted at different prices. Is this the most efficient way to 
run this market? Why are the bids and offers not published? Is 
there any possibility of exploiting inside information, especially 
since participants can meet at the Federal Reserve Bank shortly 
before the auctions? Can the GAO send in a team of experts to 
uncover the answers? 

The second example concerns the Federal Reserve's intervention 
in foreign currency markets. We know from the minutes of the 1962 
FOMC meetings that the Federal Reserve gave itself a fund for 
intervention without adequately notifying the Congress or the 
public. That fund is now $30.1 billion. The Treasury, on the other 
hand, has a fund similar to that of the FED, called the Exchange 
Stabilization Fund, but its budget is approved by the Congress. 

According to a description published by the Federal Reserve 
Bank of New York in the 1970s, the Federal Reserve uses commercial 
banks to initiate some of the transactions involved. For example, 
an intervention by the Federal Reserve to sell German marks to 
increase the relative price of U.S. dollars includes the sale of 
marks to commercial banks, a request for a SWAP transaction to the 
Bundesbank, and a two-day settlement period. Can the GAO send in a 
team of experts to discern the propriety of these procedures? 

I believe the answer to both situations is "No." Is it out-of- 
bounds for the American public to learn about these transactions? 
Again, this has nothing to do with FOMC deliberations or micro- 
management of daily Federal Reserve operations. The Fed just wants 
to keep the curtains closed and keep any outside eyes from 
reviewing how well — or how bad — its biggest policies are 
implemented. Who knows whether the Fed's engine needs a tune-up if 
no one will let the mechanic look under the hood? 



56 



3 
Now let's discuss another grey area where the GAO would be 
appropriate. Earlier this year, I was informed that New York 
Federal Reserve Bank personnel were accepting hospitality at 
expensive restaurants and gifts from the very banks they have 
authority to regulate. On May 18, 1993, I received this astounding 
reply from E. Gerald Corrigan, former president of the New York 
Federal Reserve Bank: 

"Our review indicates that in the limited number of 
instances where Bank officers have been guests at meals 
hosted by regulated institutions at what would be 
considered an expensive restaurant, they have been acting 
within Bank Guidelines and their conduct does not call 
into question the ethical standards of the Federal 
Reserve Bank of New York." 

That surely says something about the ethical standards of the 
New York Federal Reserve Banks because such gifts would be illegal 
for government agencies using appropriated funds. President 
Corrigan also rationalized the acceptance of tickets for sporting 
events from regulated banking institutions when he said: 
"There were a literal handful of instances 
involving attendance at sporting events in 
which bank officers were guests of 
acquaintances who work at regulated 
institutions. " 
But with no outside review, we don't know how many cases there 
were. Maybe this is like the "rough notes" of FOMC meetings that 
turned out to be tape recordings and transcripts. 



57 



4 

The question I have for the Comptroller General is whether the 
GAO can investigate the receipt of hospitality from regulated banks 
by Federal Reserve employees if the employees say, "We were 
discussing monetary policy during our free meals provided by the 
XYZ bank in an expensive restaurant"? As I understand it, in this 
case, the Federal Reserve must give its permission for any GAO 
examination. Doesn't the public have the right to monitor possible 
conflict of interest situations? 

Finally, the reason GAO has such limitations is because the 
Fed conducted an elaborate campaign to prohibit any audit bill from 
passing and succeeded for many years. In fact, it was not even 
approved by the Banking Committee but by another committee, in 
1978. 

I am happy to have the Comptroller General here today to 
discuss the GAO limitations in examining the Federal Reserve. Mr. 
Bowsher, please introduce your associates who will assist you in 
your testimony, for the record, and then proceed. 



58 



statement for Second Panel 

Chairman Henry B. Gonzalez 

Committee on Banking, Finance and Urban Affairs 

U.S. House of Representatives 

Fourth Day of Hearings 

October 27, 1993 

on the Issues Involved in 

the "Federal Reserve System Accountability Act of 1993" 

HR 28 



I want to welcome William J. McDonough, Vice Chairman of the 
Federal Open Market Committee (FOMC) and President of the Federal 
Reserve Bank of New York, and Governor Wayne D. Angell of the 
Federal Reserve Board. I would like to hear your views on the GAO 
audit limitations and to know if you think they are justified. 

Before turning to that, I have a very serious matter to 
address. As you know, in my bill, the Federal Reserve System 
Account2a>ility Act of 1993, HR 28, there are provisions that 
require the release of any policy change within a week and a 
videotape of FOMC discussions within 60 days. You both know that I 
inquired of all the Federal Reserve Bank presidents and the 
governors in my letter of October 22, 1992 about minutes of FOMC 
meetings. Chairman Greenspan wrote the following to me on December 
24, 1992: 

"...Members felt that making a tape or literal 
transcript public would have an especially 
restrictive effect in discussions..." 

For the hearing last week on October 19, 1993, I asked each 
Federal Reserve official to include in his or her testimony, any 
knowledge of notes or records made by others at FOMC meetings. Vice 
Chairman McDonough, although you did not appear, you submitted 
testimony as follows: 



59 



"I have no personal knowledge of any other 
notes or records that others may have made at 
FOMC meetings ..." 
Yesterday, I received a letter from Chairman Greenspan saying 
that there have been tape recordings made at FOMC meetings since 
1976, that the FOMC has unedited transcripts, and staff notes from 
transcripts exist back to 1983. In addition, the meeting room for 
the FOMC has a compete setup for tape recording including: 

"A green light on top of the meeting table near its head 
is lit when the recording system is in use." 

How could anyone not know what that green light meant and fail 
to tell the Congress or report that there were no literal 
transcriptions? 

I also must say I have some trouble with Chairman Greenspan's 
statements that he knew about the taping when he first assumed 
office and he also knew about unedited transcripts, but just 
forgot. 

"Indeed, until a staff member jogged my memory in the 

last few days, I had been under the impression that I 

first learned only about a year ago that transcripts were 

being retained." 

If I were sitting in front of a green light lit up every time 

I talked, I think I would have been a little bit more inquisitive 

about what was going on. It would jog my memory. I hope they didn't 

think that when the green light went on it meant "raise interest 

rates . " 

Now that we know that Chairman Greenspan initiated a 
conference call and informed the governors and presidents about the 
tape recordings, why did they give the testimony we received last 
week on October 19? 



60 



I want to thank Governor Angell for testifying that he knew 
about the transcripts several years ago. However, if that is the 
case, why did you join in the misleading reply sent to me from 
Chairman Greenspan on October 26, 1993? 

This is a time in our nation's history when the public demands 
accountability from its government officials. There are many 
citizens who are losing their trust in government. The less than 
truthful response to my requests by the senior officials of the 
Federal Reserve about minutes and their testimony last week raises 
serious questions. Why all the discrepancies? We held these 
hearings to encourage greater accountability of the Federal 
Reserve. The outrageous deception of the last few days shows, 
precisely why greater accountability is needed. 

Now, as for the GAO audit, I can paint no better case for a 
GAO audit than the outcome of the inquiry I made on the acceptance 
of hospitality and gifts by the Federal Reserve of New York Bank 
officials from the very banks they regulate. Evidently, from the 
opening statement that you sent us. President McDonough, this 
practice has not ended. You have yet to establish what you call a 
"paper trail." This is not an adequate response when such 
hospitality is illegal for other government employees. I expect you 
to stop these practices and to establish an arms-length 
relationship with those you regulate just as other regulators have 
always done. Nothing less will satisfy me or the American public. 



61 



STATEMENT OF CONGRESSMAN JAMES A. LEACH 

COMMITTEE ON BANKING, FINANCE & URBAN AFFAIRS 

October 27, 1993 

Mr. Chairman, as you know, I have previously stated my support for relatively 
modest reforms to remove certain indefensibly undemocratic elements of the Federal 
Reserve System. I am also sympathetic to a greater degree of accountability for Fed 
decision making which might include a somewhat more timely release of FOMC 
policy directives. However, I have reservations about the potentially more draconian 
action of expanding GAO investigation, some call it audit, authority to the monetary 
policy functions of the Federal Reserve. 

In this regard, lest there be any misunderstanding, it should be noted that in 
the government the term audit has two distinct meanings. The GAO conducts 
financial audits -- so-called dollars and cents audits of balance sheets; and 
performance audits -- or reviews of programs and the implementation of laws. 
Performance audits are akin to audits of the decision making process. 

The issue of GAO audit or review of the Federal Reserve's conduct of 
monetary policy is not an issue of first impression. Indeed, beginning in the early 
1950's the more general issue of GAO audit of the Federal Reserve, including the 
monetary policy function, was widely debated on Capitol Hill. The eventual outcome 
of this 25-year debate was passage of the Federal Banking Agency Audit Act in 1978. 
That act, for the first time, authorized the GAO to conduct both financial and 
performance audits of the Federal Reserve, exclusive of the monetary policy function. 
The monetary policy function was excluded from the purview of GAO review at that 
time in recognition of the special political vulnerability of a central bank because of 
the opposition that may be generated, particularly when it imposes monetary restraint. 

The Congre.ss concluded in 1978 that Congress had a host of very adequate 
techniques at its disposal, including statutory requirements for semi-annual reports to 
relevant committees by the Chairman of the Federal Reserve Board, to assess Federal 
Reserve monetary policy. In this context, it was further concluded, I believe wisely, 
that frequent congressionally directed performance audits would lead to a greater 
politicization of the Federal Reserve System and ill-serve the country's economic best 
interests. 

There was also, and I believe still is, an awareness of the extreme sensitivity of 
the confidential nature of the information provided by foreign central banks and 
governments ~ information critically needed in the formulation and implementation of 



73-435 0-94-3 



62 



monetary policy. It is not unreasonable to assume that public knowledge that an arm 
of Congress, the GAO, had review powers and access to such information would have 
a chilling effect on the Fed's relationships with foreign governments and central banks. 
Indeed, two years ago when this Committee subpoenaed all records held by the 
Federal Reserve relating to the BCCI scandal, an action I supported, this issue was 
raised, albeit in the context of bank supervision. In that case, the covered records 
included confidential documents supplied to the Federal Reserve by the Bank of 
England. The Bank of England was prohibited by British law from releasing those 
documents to its own Parliament and indicated that if the Fed were compelled to 
produce them pursuant to this Committee's subpoena, it would decline to share such 
information with the Fed in the future. 

The formulation of monetary policy is a decision making process that involves 
confidential interchanges with a host of foreign governments and central banks. Just 
as information sources are not infrequently protected for reasons of political security 
in certain foreign policy agencies of our government, an analogously compelling 
argument exists that in a world of economic competition and friction certain financial 
and economic information provided to the Federal Reserve should be protected for 
reasons of national economic security. It is conceivable that even the hint of a 
possibility of the release of such information could jeopardize existing relationships 
between foreign monetary authorities, the Federal Reserve and the United States 
Treasury, thus aggravating our nation's international finance relationships. 
Confidentiality may be the best protection for national economic security, and the best 
protection for taxpayers who would bear the brunt of any losses resulting from the 
compromise of policies caused by untimely disclosure. 

Indeed, in a financial world in which huge sums of money are now, in effect, 
being wagered everyday in currency markets. Congress would be opening itself up to 
the potential of economic espionage against itself by American as well as foreign 
nationals if an institution aligned to Congress had timely access to market sensitive 
information. The relevant question is need to know on a long-term policy basis, not 
micro-information gathering of a nature not immediately relevant to the legislative 
process. Here, the analogy is to the Chairman of the Joint Chiefs of Staff. He or 
she needs to know that an adequate second strike deterrent is at sea. He or she 
doesn't need to know the precise location of all our submarines at any point in time. 
That knowledge is very narrowly delegated within the Armed Services. Likewise. 

2 



63 



Congress needs to know policy direction; we don't need to know all market sensitive 
information. 

In the end, the Congress has no choice but to say that the Fed must, and 
indeed is, being audited in a balance sheet way, and that the Fed must be, and 
indeed is, subject to performance reviews of its implementation of bank supervisory 
policies. But there is a compelling argument for confidentiality in the conduct of 
monetary policy. That confidentiality is central to the continued integrity of our 
central bank and its capacity to exercise independent judgment free from external 
pressures. It is also central to helping ensure that government resources are not 
needlessly at risk to insider speculation. 

As Arthur Burns said in his valedictory speech before the National Press Club 
(January 30, 1978): "...substantial independence in exercising power over money 
creation is not something that Federal Reserve officials have arrogated unto 
themselves, nor is it something that others have conferred because of a belief that 
central bankers have unique insight that sets them apart from other people. Rather, 
the ability of the Federal Reserve to act with some independence from the Executive 
Branch, and also with immunity from transient Congressional pressures, was 
deliberately established and has been deliberately maintained by the Congress in the 
interest of protecting the integrity of our money." 

In conclusion, I would like to re-emphasize that the fundamental question in 
the issue of GAO auditing of the Federal Reserve's monetary policy function involves 
an understanding or misunderstanding of the word "audit." Unfortunately, the word 
"audit" carries connotations that are misleading. The common usage of the term in 
everyday life is an accounting of the income and out-flow of dollars. In this sense, 
there is already a 100 percent audit of the Federal Reserve. But what we are talking 
about here is fundamentally a review of the information and decision-making process 
which raises implications more of data sources and timeliness than it does of dollars 
and cents. As this Committee well understands, the Federal Reserve makes a profit 
every year (over $16 billion in 1992) that goes to the Treasury. To the degree that 
market sensitive information is released in an untimely manner that profit is 
jeopardized. The greater protection provided the Federal Reserve System, the better 
off the taxpayer. 
Thank you. 



64 



United States General Accounting Office 



GAO 



Testimony 

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



Release oo Delivery 
Expected at 
10:00 am. EDT 
Wednesday 
October 27, 1993 



FEDERAL RESERVE 
SYSTEM AUDITS 



Restrictions on GAO's Access 



Statement of Charles A. Bowsher 
Comptroller General of the United States 




GAO/T-GGD-94-44 



65 



Mr. Chairman and Members of the Committee: 

We are pleased to be here to discuss the limits of our audit 
authority over the Federal Reserve System. My remarks 
principally will concern the provisions of section 3 of H.R. 28 
which would remove all restrictions on our authority to examine 
Federal Reserve activities. Currently, we lack audit authority 
over the Federal Reserve's monetary policy, foreign transactions, 
and Federal Open Market Committee (FOMC) operations. 

In responding to the Committee's request, I will first describe 
our existing authority and some of the work we have done under 
this authority. I will then examine the implications of removing 
all restrictions on our authority, with specific reference to 
several topics the Committee asked us to address. Finally, I 
will discuss certain safeguards that we feel would be appropriate 
to adopt if restrictions on our authority are to be removed. 

The question of whether to lift the statutory constraints on our 
authority to audit the Federal Reserve System ultimately depends 
on what Congress wants us to do. Our access needs to be 
commensurate with the types of audits Congress expects us to 
perform. 



66 



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

We derive our Federal Reserve audit authority from the Federal 
Banking Agency Audit Act of 1978. This act was passed after we 
did a special congressionally mandated study of the supervisory 
activities of all of the federal bank regulatory agencies. 
Before the act, our work at the Federal Reserve was mainly 
limited to audits of the fiscal agent functions performed by 
Federal Reserve banks for the Department of the Treasury. We did 
this work under our authority to audit the Treasury. 

Although the act significantly expanded our access to the Federal 
Reserve System and the other bank regulatory agencies, it 
precluded us from auditing activities related to monetary policy, 
foreign transactions, and the FOMC. The exact wording of the 
limitation is set out in Appendix 1. The act also prohibited us 
from disclosing certain information identifying open financial 
institutions and customers. Appendix 2 describes these 
prohibitions in greater detail. 

The act does not require us to perform any particular type of 
audit. This means, as is true with most of our work, that our 
audits are determined largely by specific congressional requests, 
or by our discretion under our basic legislative authority. As 



67 



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

Notwithstanding the limitations on our authority, in the 15 years 
since the act was passed, we have audited many aspects of the 
Federal Reserve System in areas in which our access has not been 
restricted. I would like to mention some of the studies we have 
done in a few key areas: 

-- Bank supervision and regulation . Much of our work 

in this area has included the Federal Reserve along with the 
other federal bank regulators. For example, our analysis of 
bank failures and supervisory efforts to deal with problem 
banks led to our recommendations that legislative efforts were 
needed to require prompt corrective action and other 
regulatory reforms. More recently, our work on examinations 
of banks and bank holding companies has underscored the need 
for the Federal Reserve and other regulators to strengthen 
their efforts to assess the quality of the management systems 
banks use to monitor and control risk. We have also studied 
how risk-based capital standards have been implemented in 
different countries around the world. Work that is unique to 
the Federal Reserve has included studies documenting the scope 
of the activities of the securities subsidiaries of bank 
holding companies that are supervised by the Federal Reserve 
under section 20 of the Glass-Steagall act. In a recent 



68 



study, we pointed out that the Federal Reserve had not yet 

implemented the mandate in the Foreign Bank Supervision 

Enforcement Act of 1991 to charge for its examinations of 

foreign banks operating in the United States. 

-- Payment system activities . We have conducted several studies 
of Federal Reserve pricing of payments services under the 
Monetary Control Act of 1980. Our recommendations have, I 
believe, increased the Federal Reserve's awareness of how it 
competes with private sector banks in providing these 
services. We have also evaluated the implementation of the 
legislation on accelerated collection of checks and have made 
recommendations on ways to improve security procedures in Fed 
wire transactions. 

-- Government securities activities . Work we have done on the 
government securities market has, I believe, contributed to 
greater openness in the primary dealer system, particularly 
concerning the disclosure of price information. Our audits 
have also contributed to pending legislation that would help 
protect customers and maintain the integrity of this very 
important market. 

Our current work that involves the Federal Reserve, either 
exclusively or as part of a study of all bank regulatory 
agencies, includes (1) studies of regulatory burden, (2) 



69 



implementation of major provisions of the Federal Deposit 
Insurance Corporation Improvement Act of 1991, (3) analysis of 
the risks and benefits of interstate banking, (4) the regulation 
and supervision of derivative products, (5) an analysis of the 
banking industry's activities in mutual funds, (6) loan loss 
reserving by banks, (7) review of efforts to ensure a safe and 
sound international banking system through coordination among 
national regulators, and (8) analyses of the expenses and 
revenues of the Federal Reserve System as they affect the federal 
budget . 

IMPLICATIONS OF H.R. 28 

As I have indicated, section 3 of H.R. 28 would remove all of the 
restrictions on our authority to examine Federal Reserve 
activities. This would provide us with full access to FOMC 
transactions; to transactions for or with foreign central banks, 
governments, and international financing organizations; and to 
deliberations, decisions, and actions on monetary policy matters, 
including discount window operations, member bank reserves, and 
open market operations. 

In considering the implications of removing restrictions, it is 
useful to look more closely at the types of work we do. Our 
audit work can be viewed as falling into two broad categories-- 
financial audits and performance audits. A financial audit 



70 



basically sets out to verify the financial reports of an entity, 
including its balance sheet, income statement, and cash flows. 
Our financial audits also assess the systems of internal controls 
established by the audited institution and the institution's 
compliance with specific financial requirements. Performance 
audits are designed to assess whether an entity is achieving its 
stated goals, and include questions of efficiency, effectiveness, 
and compliance with related laws and regulations. Appendix 3 
describes these types of audits in more detail. 

Turning first to financial audits, the nature and volume of 
transactions associated with the day-to-day operations of the 
Federal Reserve System make financial auditing extremely 
important. For example, in providing services to the banking 
system in 1992, the Federal Reserve processed 

— 20 billion checks with a value of $14 trillion; 

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

— 68 million electronic fund transfers for $199 trillion; and 

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



71 



In 1992, the FOMC also purchased, sold, or exchanged 
approximately $350 billion of securities, engaged in over $750 
billion in repurchase agreements, and conducted almost $3 
trillion in matched transactions.^ All told, about 90 percent 
of the $368 billion in assets on the combined balance sheet of 
the Federal Reserve banks consist of assets acquired as a result 
of FOMC or foreign exchange operations.^ Passage of H.R. 28 
would allow us access to the full range of Federal Reserve System 
transactions. 

The nature and extent of auditing that presently takes place 
within the Federal Reserve System is a factor that Congress may 
want to consider in deciding whether to expand our authority. 
The Board of Governors examines the 12 reserve banks and the FOMC 
annually. Such examinations, which involve both financial 
statement audits and compliance reviews that concentrate on 
financial controls, are conducted by the Division of Federal 
Reserve Bank Operations. The Board's financial examination 



'Repurchase agreements essentially are transactions by which the 
Federal Reserve buys or sells securities for specified periods of 
time, typically overnight or short terms. The agreements are 
used by the FOMC to adjust the level of reserves in the banking 
system. According to Federal Reserve officials, in matched 
transactions the Federal Reserve essentially executes 
transactions that have no net effects on bank reserves or the 
balance sheet of the FOMC. Matched transactions are conducted 
principally with foreign central banks. 

^The assets, with amounts as of December 31, 1992, in billions of 
dollars shown in parentheses, are as follows: U.S. Treasury 
securities ($302), federal agency obligations ($6), and assets 
denominated in foreign currencies ($22). 



72 



program involves a full-time staff of about 22 people at an 
annual cost of approximately $2 million. Each Federal Reserve 
bank also has an internal audit department, which — in the case of 
the New York Federal Reserve Bank--includes examination of the 
activities of the FOMC. 

The Board's financial examination program has been subject to 
some outside scrutiny by public accounting firms. Each year, the 
Board contracts with an outside accounting firm to review the 
examination program's operations. In the last letter the Board 
received, the outside accounting firm said that the financial 
examination program was effectively meeting its objectives and 
made some suggestions for improvement.^ 

The Federal Reserve's Office of Inspector General, which has an 
annual budget of about $3 million, is authorized to conduct its 
own financial and performance audits, although the Inspector 
General has indicated to Congress that there are some limitations 
on the office's ability to gain independent access to the reserve 
banks. The Inspector General has just completed a report on the 
Board's financial examination program. This report raises some 
fundamental questions about the comparability of the financial 
examination program to an outside audit that Js geared toward 



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

8 



73 



certification of financial statements.* The report also 
contains recommendations for improving the financial examination 
program. 

For some time, the financial statements of the Board of Governors 
itself have been audited by an outside public accounting firm. 
For 1993, the Board also contracted with independent accounting 
firms for audits at the Kansas City and Cleveland Federal Reserve 
Banks. As a part of this latter experiment with engaging outside 
auditors, the firms were asked to comment on those aspects of the 
Board's financial examination program concerned with both audit 
of financial statements and of compliance with board policies and 
controls. We understand that the reports from the outside 
auditors for 1993 have just recently been presented to the Board. 

According to Federal Reserve officials, in the Kansas City and 
Cleveland Reserve Bank audits, some access issues were negotiated 
with the accounting firms. Although these audits did not involve 
a full-scale audit of the System Open Market Account or foreign 
accounts, we understand that the auditors required some testing 
of the systems in these areas to determine if the allocations of 
assets to the particular reserve banks were appropriate. 



*Office of the Inspector General, Board of Governors of the 
Federal Reserve System, Report on the Au dit of the Board's 
Financial Examination Program . September 30, 1993. 



74 



Section 3 of H.R. 28 proposes that all Federal Reserve banks, as 
well as the Board of Governors, be audited annually by an 
independent public accounting firm. I am inclined to believe 
that this outside review would be beneficial for both the Federal 
Reserve and the general public. If the restrictions on our 
access were removed, we would be better able to assess the 
quality of financial controls and auditing in the Federal Reserve 
System and make recommendations for improvements . 

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

-- the daily government securities auctions at the New York 

Federal Reserve Bank, which the Federal Reserve uses to manage 
the money supply; 

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

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

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

10 



75 



actual transactions. Although it would be necessary for us to 
consider the actual scope of a request before reaching a 
judgement in any particular case, we must recognize that the 
restrictions in the law are quite explicit. Therefore, with 
performance audits, as with financial audits, the major question 
is really what Congress wants us to do. 

SAFEGUARDS 

If Congress decides to remove the existing restrictions on our 
audit authority, we believe certain safeguards should be included 
in the legislation. These safeguards, which are similar to those 
that already exist under our present authority, should 

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

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

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

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

11 



76 



safeguards we could not use our expanded authority to undertake 
contemporaneous reviews of the Federal Reserve's monetary policy 
decisionmaking functions. Also, immediate disclosure of 
information about Federal Reserve decisions in a situation such 
as the stock market break of October, 1987, might not be in the 
public interest because it could disrupt the financial markets. 
Our role should be to make after-the-fact assessments of the 
Federal Reserve's performance, both in general and in problem 
situations. 

SUMMARY 

In summary, we have been able to do significant audits of the 
Federal Reserve, despite the existing limitations of our 
authority. Congress obviously must decide whether our audit 
authority should be expanded. However, if our authority is 
expanded, we believe measures should be included to protect 
against release of confidential documents and to prevent undue 
interference with the Federal Reserve's ongoing policymaking 
functions. 

This concludes my prepared statement. My collegues and I would 
be pleased to answer questions. 



12 



77 



APPENDIX 1 APPENDIX 1 



Restrictions on GAP Audits Contained in the Federal Banking 

Agency Audit Act ' 

Audits of the Federal Reserve Board and Federal Reserve banks may 
not include 

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

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

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

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



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

13 



78 



APPENDIX 2 APPENDIX 2 



Provisions in the Federal Banking Agency Audit Act Concerning 
Disclosure of Information and Safekeeping of Records ^ 

Except as provided in this subsection, an officer or employee of 
the General Accounting Office may not disclose information 
identifying an open bank, an open bank holding company, or a 
customer of an open or closed bank or bank holding company. The 
Comptroller General may disclose information related to the 
affairs of a closed bank or closed bank holding company 
identifying a customer of the closed bank or closed bank holding 
company only if the Comptroller General believes the customer had 
a controlling Influence in the management of the closed bank or 
closed bank holding company or was related to or affiliated with 
a person or group having a controlling Influence. 

Except for the temporary removal of work papers of the 
Comptroller General that do not identify a customer of an open or 
closed bank or bank holding company, an open bank, or an open 
bank holding company, all work papers of the Comptroller General 
and records and property of or used by an agency that the 
Comptroller General possesses during an audit, shall remain in 
the agency. The Comptroller General shall prevent unauthorized 
access to records or property. 



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



79 

APPENDIX 3 APPENDIX 3 

Types of GAP Audits^ 

FINANCIAL AUDITS 

Financial statement audits determine (a) whether the financial 
statements of an audited entity present fairly the financial 
position, results of operations, and cash flow or changes in 
financial position in accordance with generally accepted 
accounting principles, (b) whether the entity has complied with 
laws and regulations for those transactions and events that may 
have a material effect on the financial statements, and (c) 
whether the internal controls were effective and met standards. 

Other financial audits include determining (a) whether financial 
reports and related items, such as elements, accounts, or funds 
are fairly presented, (b) whether financial information is 
presented in accordance with established or stated criteria, and 
(c) whether the entity has adhered to specific financial 
compliance requirements. 

Financial audits include an assessment of internal control risks 
related to the scope of the audits. In the internal control 
phase, the auditor should obtain evidence about the effectiveness 
of internal controls to (1) form an opinion on internal controls 
as of the end of the audit period and (2) assess control risk and 
the effectiveness of budget and compliance controls during the 
audit period. Control risk is a factor in determining the 
nature, timing, and extent of substantive procedures for the 
testing phase. 

PERFORMANCE AUDITS 

Economy and efficiency audits include determining (a) whether the 
entity is acquiring, protecting, and using its resources (such as 
personnel, property, and space) economically and efficiently, (b) 
the causes of inefficiencies or uneconomical practices, and (c) 
whether the entity has complied with laws and regulations 
concerning matters of economy and efficiency. 

Program audits include determining (a) the extent to which the 
desired results or benefits established by the legislature or 
other authorizing body are being achieved, (b) the effectiveness 



'These definitions are taken from Government Auditing Standards , 
U.S. General Accounting Office, 1988 revision, and the GAO 
Financial Audit Manual . June 1992. 

15 



80 



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



16 



81 



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



Statement by 
Wayne D. Angell 



Governor, Board of Governors 
of the Federal Reserve System 



before the 



Committee on Banking, Finance 
and Urban Affairs 



U.S. House of Representatives 



October 27, 1993 



82 



I am pleased to have this opportunity to speak on the 
General Accounting Office's authority to audit Federal Reserve 
operations and the changes to that authority that would be made 
by H.R. 28 "The Federal Reserve System Accountability Act of 
1993." President McDonough is addressing the scope of GAO audit 
authority from the perspective of the Federal Reserve Bank of 
New York. 

At the outset, I would like to dispel the notion I have 
frequently heard that the Federal Reserve is not subject to GAO 
audit. In 1978 the Federal Banking Agency Audit Act gave the GAO 
broad authority to audit most of the operations of both the 
Federal Reserve Board and the Federal Reserve Banks. Since then, 
the GAO has completed more than 100 reports on various aspects of 
System operations, as well as numerous other reports that 
involved us less directly. At present, the GAO has roughly 2 5 
audits of the Federal Reserve under way and maintains several of 
its staff in residence at the Board and at selected Reserve 
Banks . 

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



83 



and employees of the Federal Reserve System related to these 
matters and transactions. By excluding these areas, the Act 
attempts to balance the need for public accountability of the 
Federal Reserve through GAO audits against the need to insulate 
the central bank's monetary policy functions from short-term 
political pressures and the need to ensure that foreign central 
banks and governmental entities can transact business in U.S. 
financial markets through the Federal Reserve on a confidential 
basis . 

The precise line differentiating those Federal Reserve 
specific operations and activities that are subject to GAO audit 
under the Banking Agency Audit Act and those that are exempt from 
audit is difficult to draw in the abstract. Over the years since 
the passage of the Act, the Federal Reserve has worked with the 
GAO to define those limited areas that are not subject to audit 
on a case by case basis in the context of individual audits. In 
those cases, the Federal Reserve has worked with the GAO to 
further the GAO's audit objectives while honoring the statutory 
exemptions designed to ensure the independent conduct of monetary 
policy and the confidentiality of foreign transactions. In the 
future, we will continue to work with the GAO to address its 
concerns consistent with the mandate of the Act. 

Expanding the GAO's audit authority over the Federal 
Reserve into the exempt areas would be contrary to the public 
interest. Such an expansion could adversely affect Federal 
Reserve effectiveness in the conduct of monetary policy. As the 



84 



Banking Agency Audit Act recognized, such a change could reduce 
the central bank's insulation from day-to-day political 
pressures. Even what appears to be a very limited audit of the 
efficiency of monetary policy operations could in fact turn into 
pressure for a change in monetary policy itself. For exan^le, 
the questions posed to Comptroller Bowsher in connection with 
these hearings as to whether the magnitude of our open market 
operations reflects unnecessary buying and selling of government 
securities are monetary policy questions, not efficiency 
questions. The number of transactions that the Open Market Desk 
completes in carrying out the FOMC's directive correlates 
directly with the substance of the policy in place. Indeed, a 
comprehensive audit of these operations would likely require a 
comparison of the actual results of the operations with intended 
results. 

GAO scrutiny of policy deliberations, discussions, and 
actions also could impede the process of formulating policy. A 
free discussion of alternative policies and possible outcomes is 
essential to minimize the chance of policy errors. The prospect 
of GAO review of formative discussions, background documents, and 
preliminary conclusions could have an adverse effect on the free 
interchange and consensus-building that leads to good policy. 

Transactions made under the direction of the FOMC 
include foreign exchange operations. The efficacy of these 
operations is crucially dependent on confidentiality. Important 
daily contacts and exchanges of information with foreign monetary 



85 



authorities are an integral part of these operations. They now 
take place in a candid and constructive atmosphere. The 
possibility of a GAO audit of our foreign exchange operations 
would reduce the willingness of foreign authorities to share 
information with us and would thereby reduce the effectiveness 
and efficiency of our operations which are frequently coordinated 
with foreign authorities. This caution also applies to the 
exemption for transactions that the Federal Reserve carries out 
as agent for foreign entities; however, there the principal issue 
is one of sensitive proprietary information about foreign 
governments, foreign central banks, and international financial 
organizations . 

The benefits, if any, of broadening the GAO's authority 
into the areas of monetary policy and transactions with foreign 
official entities would be small. With regard to purely 
financial audits, the Federal Reserve Act already requires that 
the Board conduct an annual financial examination of each Reserve 
Bank. The Federal Reserve places great importance on both the 
Reserve Banks' internal audit responsibilities and the Board's 
responsibilities for examination of Federal Reserve Banks, in 
part because it recognizes that its ability to police Federal 
Reserve Bank operations is critical to public and congressional 
confidence in the Federal Reserve System. 

The process of conducting annual financial audits is 
reviewed by a public accounting firm to confirm that the methods 
and techniques being employed are effective and that the program 



86 



follows generally accepted auditing standards applicable to the 
audit of Federal Reserve Banks. These examinations are 
complemented by extensive Board oversight and supervision of 
Federal Reserve Bank activities, including Board operations 
reviews of Reserve Bank effectiveness and efficiency, as well as 
by comprehensive audits conducted by each Reserve Bank's 
independent internal audit function. Oversight and supervision 
of Federal Reserve Bank activities include review of Federal 
Reserve Bank budgets and expenditures as well as personnel and 
operating policies. 

The Board's annual financial examinations of Federal 
Reserve Banks, operations reviews, and its oversight and 
supervision of Federal Reserve Bank activities specifically 
include examinations, operations reviews and oversight of open 
market and foreign transactions. The annual financial 
examinations include review of all accounts for accuracy, 
compliance with internal controls, and confirmation that balances 
reflected on the books agree with the records of account holders. 
Operations reviews for effectiveness and efficiency of open 
market and foreign operations are conducted by multi-disciplinary 
teams, including economists familiar with FOMC operations, and 
specialists in data and physical security, automation, 
communication, accounting, and secondary market trading and 
settlement. These operations reviews also include the Federal 
Reserve Bank of New York's internal audit attentions to the open 
market account . 



87 



Further, a private accounting firm audits the Board's 
balance sheet, and the Board's Inspector General audits the 
effectiveness and efficiency of Board programs and operations 
under the Inspector General Act of 1978 as amended. 

The Board has continually reviewed its procedures for 
examinations and oversight of Federal Reserve activities. For 
example, recently the Board has contracted for independent 
private audits of two Federal Reserve Banks (Kansas City and 
Cleveland) in order to provide an independent evaluation of the 
Reserve Banks' control environments and the Board's examination 
procedures and to determine the feasibility of substituting, from 
time to time, outside audits for financial examinations by the 
Board's examiners. These audits have indicated that previous 
financial examinations of these Reserve Banks were at least as 
thorough as the outside audits, that those Reserve Banks were 
well controlled, and that financial controls may be regarded as 
satisfactory from an audit perspective. Indeed these audits have 
indicated that many policies are uniquely applicable to Federal 
Reserve Banks and that in these areas the Board's examiners have 
a significant advantage in auditing for Reserve Bank compliance. 

The Board is strongly committed to ensuring that its 
examinations, both internal and external, oversight and 
supervision of the Federal Reserve Banks, as well as its own 
internal audit function and external audits, are as effective as 
possible and will continue to review these functions with an eye 
to ensuring their future effectiveness. 



88 



Finally, and more broadly, Congress has, in effect, 
mandated its own review of monetary policy by requiring 
semiannual reports to Congress on monetary policy under the Full 
Employment and Balanced Growth Act of 1978 (also known as the 
Humphrey-Hawkins Act) and by holding hearings on various monetary 
policy issues as they arise. In addition, there is a vast and 
continuously updated body of literature and expert evaluation of 
U.S. monetary policy. In this environment, the contribution that 
a GAO audit would make to the active public discussion of the 
conduct of monetary policy is not likely to outweigh the 
disadvantages of expanding GAO audit authority in this area. 

In sum, we believe that the Board's supervision and 
oversight of Federal Reserve Bank activities and the Board's own 
audit functions have served the public interest well, 
particularly in the area of confidentiality of monetary policy 
information. In this regard, Mr. Chairman, you have asked about 
the security checks on personnel involved in the monetary policy 
process and incidents of so-called insider trading by Federal 
Reserve officials. Attendees at FOMC meetings are now required 
to have "secret" or higher clearances and, over the years, there 
have been only three known incidents where monetary policy 
information may have been used for private gain. In the first 
instance, in October 1979, there were errors in the deposit data 
reported by a large New York commercial bank. These errors were 
technical or clerical and were not intentional on the part of the 
bank. The Federal Reserve's screening procedures flagged the 



89 



data as possible errors, but the bank stated that the numbers 
were correct as reported. The data therefore resulted in 
overstatements of the estimates of the money supply published by 
the Board. Subsequent data submitted by the bank indicated that 
the deposit data were indeed incorrect; as a result the bank 
revised its deposit data and the money supply figures were 
revised downward correspondingly. At the request of the House 
Committee on Banking, Finance and Urban Affairs, the Board 
conducted an investigation to determine if any institution or 
individual had improperly profited from the errors. 

In order to ensure objectivity in the investigation, 
the Board engaged the services of a private law firm to conduct a 
complete inquiry and prepare a report. That firm, with the 
Board's concurrence, in turn engaged a private accounting firm to 
review trading activity. The report concluded that neither the 
bank that had made the reporting error nor persons connected with 
it, the Board, or the Federal Reserve Bank of New York had 
improperly and knowingly profited from the erroneous estimates or 
revision of the erroneous money supply estimates. Nor did the 
report find that any other institution or individual had 
improperly and knowingly profited from that error. 

Nevertheless the report did identify one transaction 
that gave rise to an appearance of a conflict of interest in 
which an officer of the Federal Reserve Bank of New York who had 
knowledge of the impending revision of the money supply data had 
purchased units of a municipal bond fund immediately after the 



90 



revised data had become publicly available. That officer 
resigned from the Reserve Bank shortly thereafter. 

In the second incident, in 1982, an ex-employee of the 
Board managed to gain telephonic access to confidential money 
supply data stored in the Board's computer system shortly after 
the employee had left the Board to work for a private firm. This 
access was identified quickly and the matter was referred to the 
Federal Bureau of Investigation promptly. The individual 
ultimately pleaded guilty to one count of wire fraud and received 
one year's probation. Subsequently additional security measures 
were implemented to prevent a recurrence of similar data security 
violations . 

In the third incident, in 1986, in connection with the 
United States Attorney's investigation of allegations of 
securities fraud and tax evasion by former principals of a failed 
government securities dealer, the U.S. Attorney's office 
contacted the Federal Reserve Bank of New York concerning a 
former director of that Reserve Bank. After further 
investigation by both the Reserve Bank and the U.S. Attorney's 
Office, the U.S. Attorney's Office brought a criminal proceeding 
against the former director. In 1989, the former director 
pleaded guilty to charges of bank fraud based on the illegal 
disclosure of sensitive, non-public information regarding changes 
in the discount rate and was sentenced to a jail term, probation 
and community service. Again, Board and Reserve Bank procedures 
were revised after this event to prevent a recurrence. 



91 



We believe that the paucity and nature of the incidents 
that have occurred over the eighty-year history of the Federal 
Reserve System is strong evidence of the integrity of the Federal 
Reserve monetary policy process. Further it is doubtful that any 
of these incidents would have been prevented by a broadened GAO 
audit authority. 

For these reasons and the reasons stated previously, we 
believe that enactment of the provisions of H.R. 28 that would 
expand the GAO's audit authority by removing the current 
exception for monetary policy matters; transactions made under 
the direction of the FOMC; and transactions with, or for, foreign 
official entities would be counter to the public interest. 



92 



TESTIMONY BY 

WILLIAM J. MCDONOUGH, PRESIDENT 
FEDERAL RESERVE BANK OF NEW YORK 

BEFORE THE 
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS 

OF THE 

UNITED STATES HOUSE OF REPRESENTATIVES 

OCTOBER 27, 1993 



93 



I welcome the opportunity to appear before the 
Committee today to provide my views on the provisions of H.R. 28, 
the Federal Reserve System Accountability Act of 1993, which 
relate to the audit of Reserve Banks by the Government Accounting 
Office. H.R. 28 would eliminate the exemptions in the Federal 
Banking Agency Audit Act for foreign central banks and government 
transactions, monetary policy deliberations, decisions, and 
actions, and Federal Open Market Committee transactions. 
Governor Angell will be addressing the concerns of the Board of 
Governors on this legislative proposal. I will focus on the 
implications of the proposal for the actions taken by the Federal 
Reserve Bank of New York in implementing FOMC decisions and 
carrying out activities for our foreign accounts. 

I want to comment on the scope of the current exemption 
and to make clear to the Committee my appreciation and respect 
for the audit process. Also, I would like to take this 
opportunity to note steps that can be taken to ensure further the 
effectiveness of GAO audits of the Bank, within the GAO's current 
authority. In my opinion, that authority provides sufficient 
scope to address many of the concerns you have asked me to 
discuss today. 

I believe that the elimination of the current exemption 
would interfere with the Fed's ability to formulate and execute 
an optimal monetary policy. It would introduce the unmistakable 
potential for political influence; every movement and nuance of 
policy would then have to be examined in light of that potential. 
At the core of my concern is the fact that the process by which 



73-435 0-95-4 



94 



we implement monetary policy is inextricably entwined with the 
policy itself. For example, questions regarding the volume of 
open market operations on the surface may appear to be questions 
of efficiency. In fact, they relate to the policy intent to 
avoid undue volatility in the markets. The idea that the process 
of executing open market operations may be audited without 
imposing judgments about the policy itself is simply not 
realistic. 

Simply put, optimum monetary policy is achieved only 
when the public and the markets perceive no short-term political 
influence. This is not a new issue, nor a new conclusion on my 
part. I have had plenty of opportunity to consider the import of 
the exclusion of the GAO from auditing monetary policy in my 
former role as manager of both the domestic and foreign open 
market accounts. I have no doubt that the potential for damage 
to a credible and effective monetary policy would be very real if 
the exclusion were to be lifted. This potential for damage 
clearly would outweigh any possible benefit to the public from 
GAO audits of monetary policy operations. 

I feel equally strongly about the impairment of our 
policy implementation if the exclusion were to be lifted on the 
foreign side. Foreign. exchange intervention is conducted not 
only in conjunction with the Treasury, through the Exchange 
Stabilization Fund which is exempt from GAO audit, but also 
frequently with or on behalf of foreign central banks and 
monetary authorities. 



95 



We hold a very large amount — over $300 billion at 
present — of marketable U.S. Government securities, -representing 
dollar reserves of these official foreign entities. I cannot 
presume to gauge the response of all of these central bank 
governors and finance ministers, but I can tell you with absolute 
certainty that there is some number of them, and perhaps a large 
number, who would question the appropriateness of their reserve 
activity being scrutinized by the GAO and the Congress. This 
would almost certainly be damaging to the relationships that are 
so central to international monetary cooperation and, perhaps, to 
the role of the doll^lr. Certainly, it would impair the ability 
of the U.S. monetary authorities to conduct their foreign 
exchange intervention policies on a coordinated basis with the 
same effectiveness and efficiency we enjoy today. 

Having said that, I want to reiterate that I do not 
have some sort of reflexive distaste for auditors or the audit 
process. To the contrary, as someone who has had managerial 
responsibility for large organizations in both the public and 
private sectors, I have a keen appreciation for the role of 
auditors and the improvements they bring to the table in the form 
of operational quality and effectiveness. 

I view auditors as an important asset for management. 
There is a long tradition at the Fed of recognizing the value of 
independent oversight. Indeed, I believe we subject ourselves to 
an extraordinarily rigorous series of performance and operational 
appraisals. Within each Reserve Bank there is an independent 



96 



audit function that reports directly to the board of directors 
and performs comprehensive audits of all aspects of that Bank's 
work. 

At the New York Fed, we have had a constructive and 
positive relationship with the GAO for almost 15 years. We 
supply the GAO permanent space in the Bank and have assigned 
staff as liaison in order to assist them in the orderly 
completion of their tasks. In addition, we take seriously their 
findings and are responsive to their suggestions for 
improvements. While I do not want to wax too poetic and imply 
that we love the result of each and every audit, I do want to 
make clear that we have a great appreciation for the role of 
auditors. 

The conduct of Bank personnel with responsibility for 
monetary policy matters is subject to the Bank's rules of 
conduct, stringent standards regarding outside financial 
interests and potential conflicts stemming from family and other 
personal relationships. The GAO always has had full audit 
authority over Reserve Banks' personnel policies and practices, 
disclosure statements, and the like, and, thus, has been able to 
assure itself and Congress of the ethical standards and practices 
of all our employees. 

We are not, however, resting on our laurels. There are 
always ways to enhance the effectiveness of operations, and 
audits by GAO can contribute significantly to that process. I 
plan to call Comptroller General Bowsher from time to time to 



97 



offer suggestions as to how the GAO might be even more useful to 
the Bank. 

I now would like to respond to matters raised in 
Chairman Gonzalez' October 21 letter to me regarding our policy 
on meals and entertainment and our ethics officer. As I have 
noted, there is no limitation on the GAO that prevents its 
looking at ovir meals and entertainment practices or policy. 
Moreover, we do not impart information on monetary policy or our 
foreign account relationships to any outsiders, at luncheons or 
elsewhere. To the contrary, we use meetings with knowledgeable 
people to gain information about market conditions that is 
helpful in our monetary policy deliberations. 

The Chairman asked a question regarding the cost of 
meals at expensive restaurants hosted by regulated institutions. 
Because others paid for these approximately two dozen meals that 
were identified as having occurred over a period of a year and a 
half, we do not have that cost information. We are however, very 
sensitive to the appearances of such things, and our internal 
rules specifically caution against accepting inappropriate 
entertainment, lavish meals or frequent meals from a particular 
institution. Further, we concluded that we do not have an 
adequate audit trail. Therefore, we are about to issue a policy 
requiring that all business meals paid by regulated institutions 
or vendors be documented as to restaurant, purpose, and 
attendees, to provide an audit trail for us, the Board of 
Governors, and the GAO going forward. 



98 



Finally, as the Chairman noted, we recently named an 
ethics officer. That does not mean this role was not being 
performed previously within the Bank. That function was 
fulfilled by the Bank's First Vice President, its General Counsel 
and the Personnel officers. He concluded that we would focus 
those responsibilities in a single individual, a senior vice 
president of the Bank. Since his appointment as ethics officer, 
he has responded to inquiries from members of the Bank's staff 
regarding ethics and conflict of interest questions. He also has 
participated in redrafting our rules of conduct, which should be 
concluded by year end, and other documents which will be helpful 
to the Bank's staff in their compliance with these rules. He 
regard his efforts as a continuation and refinement of the 
policies we have already put in place. As far as I am concerned, 
GAO staff has access to those policies and procedures, and I look 
forward to receiving GAO's input on them. 

I appreciate this opportunity to participate in this 
hearing and look forward to answering any further questions the 
Committee members may have. 



99 



STATEMENT OF 

JOHN P. BORDEN 

PRESroENT, 

GREATER KANSAS CITY CLEARING HOUSE 

ON BEHALF OF THE 

NATIONAL ORGANIZATION OF CLEARING HOUSES 

BEFORE THE 

U.S. HOUSE OF REPRESENTATIVES 

COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS 



OCTOBER 27, 1993 



100 



My name is John P. Borden. I serve as President of the Greater Kansas City 
Clearing House Association in Kansas City, Missouri; and as President and CEO of the Mid- 
America Payments Exchange (MPX). The Greater Kansas City Clearing House provides 
check clearing services to over 100 financial institutions in the greater Kansas City area. 
MPX, which was founded in 1975, is the largest of the 29 regional automated clearing house 
associations in the United States. 

I am here today on behalf of the National Organization of Clearing Houses (NOCH), 
which I serve as President. NOCH was founded in 1989 to promote and support the 
important role of check clearing houses in the U.S. payments system. In addition to Kansas 
City, NOCH's member clearing houses serve the regional check clearing needs of financial 
institutions in Arizona, California, Connecticut, Illinois, New York State, Oregon, 
Pennsylvania, Puerto Rico, and Texas. Our members also include the two national private 
check clearing organizations.' 

With this testimony, NOCH will provide its perspective on the role of the Federal 
Reserve System in providing check clearing services. Our sole purpose here today is to 
promote the goal of a competitive payments system. 



The Goal is Balanced Competition 

NOCH does not believe that it is necessary to establish a congressional commission 
charged with evaluating the fair market value of the Federal Reserve's check collection 
operations for the possible purpose of privatizing these operations. We do, however, believe 
that the concerns NOCH has with the Federal Reserve's competitive role may be reflected in 
the intent of this provision in Section 8 of H.R. 28, the "Federal Reserve System 
Accountability Act of 1993." 

NOCH believes that Congress should focus its attention on the goal of the 
Monetary Control Act of balanced competition, and do so with the understanding that 
the Federal Reserve System's complete withdrawal from check collection is not a 
precondition to achieving this goal. NOCH also believes that to pursue this goal 
properly, a combination of active Congressional oversight through existing means and 
greater public involvement in the review of Federal Reserve System check collection and 
other payments practices is appropriate and necessary. Unfortunately, many decisions are 
made by the Federal Reserve that have significant impact on private sector check clearing 
service providers without the benefit of public comment. 

It is clear to NOCH that the current check collection environment does not reflect 
the competitive environment envisioned by the Monetary Control Act. The Federal 
Reserve System accounts for roughly 50 percent of all interbank check clearing volume, 



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



I 



101 



whereas no single competitor of the Federal Reserve accounts for more than about 3 
percent.^ 

Much of the Federal Reserve System's dominant market share may be attributable to 
its ability to take advantage of a nationwide network and the many resultant opportunities 
for economies of scale. In the current environment, these same economies of scale are 
unavailable to most private sector providers, which tend to be focused on serving local or 
regional markets. Even large bank holding companies that might otherwise have access to 
similar economies of scale are constrained because of interstate branclung restrictions. 

Complicating the private sector's ability to effectively challenge the Federal Reserve 
System's market share is the Federal Reserve's dual role as a dominant competitor and 
regulator. Since the Federal Reserve regulates the payments system in general, its policies as 
regulator often inadvertentiy affect the abilities of private sector service providers to 
compete. 

A final complicating factor in the competitive relationship between the Federal 
Reserve and the private sector is that the very same service providers that choose to compete 
against the Fedei^ Reserve must rely upon setUement services provided by the Federal 
Reserve in order to offer their own check collection services. In short, as a private sector 
clearing organization, perhaps the most important benefit you can offer — setUement in 
immediately available funds — is controlled by your largest competitor. 

While the Federal Reserve currenUy dominates the check collection market, NOCH 
believes the goal of a more balanced competitive environment is attainable. In this 
environment, a large number of competitors would operate, with no one competitor — 
including the Federal Reserve System ~ enjoying more than a modest share of the market. 
NOCH believes that Congress, in passing the Monetary Control Act, recognized that the 
market forces operating in such an environment would do a better job of holding down costs, 
fostering technological enhancements, and contributing to even greater efficiencies than are 
currentiy present. 



The Competitiveness Issue is as Old as the Federal Reserve Itself 

Given the unique role and construction of the Federal Reserve System, it is no 
surprise that friction exists with the private sector. This friction dates back all the way to the 
establishment of the Federal Reserve System in 1913, but really began to take hold following 
passage of the Monetary Control Act in 1980. With the passage of this Act, the Federal 
Reserve's role in check collection was fundamentally changed from one of serving member 



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



102 



banks exclusively (by law), to one of competing directly with the private sector and serving 
all depository financial institutions seeking check clearing services. ' This change in the 
competitive balance led Congress ~ largely through the General Accounting Office (GAO) ~ 
to become actively involved in exploring whether the Monetary Control Act was resulting in 
a level playing field as intended. The most recent work on this issue was the GAO's May 
1989 report to this Committee and its counterpart in the Senate entitled Check Collection: 
Competitive Fairness is an Elusive Goal. The purpose of the report was to evaluate private 
banks' ability to compete with the Federal Reserve Banks in the provision of check collection 
services as directed by the Competitive Equality Banking Act of 1987. 

The May 1989 report does not stand alone, however, with several other studies 
having been conducted by the GAO and two different Committees of the House of 
Representatives. The common theme among all these initiatives has been the establishment 
of a true competitive balance between the Federal Reserve and the private sector as 
envisioned by the Monetary Control Act. For example, a 1984 report by the House 
Committee on Government Operations concluded that "the objective of public policy must 
be, among other things, to strike a balance that provides a fair and full opportunity to 
compete to both the Fed and the private sector suppliers."* 

A report by the House Banking Committee's Subcommittee on Domestic Monetary 
Policy reached similar conclusions: 

The Monetary Control Act did not envisage, nor does the Subcommittee accept the creation of a 
theoretically pure and perfect competitive setting if the result is to drive the Federal Reserve out of 
the payments system and thus weaken the safety, security, and accessibility of the system. 
However, the Subcommittee would also not accept, nor did the Monetary Control Act intend, a 
situation in which the Federal Reserve through its actions drives the private clearing banks out of 
check clearing.^ 

NOCH shares the views expressed by both reports that the Monetary Control Act 
does not specifically require the Federal Reserve to leave check collection entirely to the 
private sector as a measure of compliance with the Act's intent of a balanced competitive 
environment. On the other hand, we do believe that a single service provider owning fuUy 
one-half of the entire check clearing market in the United States is completely 
inconsistent with any reasonable definition of what constitutes a "balanced competitive 
environment." In short, we believe the payments system should not be structured so as to 
promote the interests of the Federal Reserve System as a provider of services at the expense 



' The Monetary Control Act does not mandate that the Federal Reserve System provide check collection services, 
but that, if it chooses to, it must make such services available to all depository financial institutions. 

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

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



103 



of the private sector. 

At the time it was conducted, the May 1989 GAO report built upon these conclusions 
and many of the concerns that remained regarding the Federal Reserve's unique competitive 
advantages. The report concluded with specific recommendations aimed at the Federal 
Reserve: 

[T]o ensure that competitive fairness issues are appropriately considered, the Federal Reserve 
needs to (1) better define what is meant by its policy commitment to competitive fairness as a 
means of providing clear decision-making criteria and (2) establish better procedural controls to 
further payments system changes that promote competitive fairness while providing strengthened 
safeguards against potential conflicts of interest. It should then apply these policies and procedures 
to the development of a same-day payment regulation.* 

Since the release of the GAO's May 1989 report, the Federal Reserve has taken steps 
to address the specific recommendations of the GAO. Most importantly, the Federal Reserve 
has amended Regulation CC mandating same-day settlement for checks without the 
imposition of fees, subject to certain reasonable conditions. Until these amendments were 
approved, only Federal Reserve Banks were exempt from paying presentment fees. 

Also subsequent to the May 1989 report's release, the Federal Reserve revised its 
policy statement entitled "The Federal Reserve in the Payment System" to require, among 
other things, that a competitive impact analysis be performed for "proposed changes that 
would likely have a substantial effect on payments system participants."' 



Do Federal Reserve Policies and Practices Now Reflect Congressional Intent? 

While the Federal Reserve has taken actions to address the GAO's recommendations, 
at least two questions remain: 

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

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



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

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

4 



104 



NOCH believes these important questions must be resolved before full industry 
confidence in the Federal Reserve's adherence to fair competitive principles can be restored. 
Furthermore, the evidence to date strongly suggests that the answer to both questions is that 
the Federal Reserve has neither thoroughly addressed the competitive fairness issue in its 
payments system policies, nor has it adequately enforced existing competitiveness polices in 
its approval of Reserve Bank check collection services and prices. If this posture is 
permitted to continue, the balancing of competitive opportunities promised by actions such as 
same-day settlement will be lost. 

For example, the Federal Reserve recently implemented changes to its Payments 
System Risk Reduction Program (PSRRP) which included a change in the schedule by which 
check transactions are posted to a depository institution's reserve account. Because of this 
change, credits for checks cleared through the Federal Reserve are now available to the 
collecting institution much earlier in the day than is possible for checks collected privately 
under same-day settlement. This is an important distinction since, as part of the PSRRP, the 
Federal Reserve is preparing to price "daylight overdrafts" in a depository institution's 
reserve account. As such, the timing of proceeds from check and all other payment 
transactions will be very important to depository institutions as they control their overdraft 
levels. 

The impact of the risk reduction policy changes on the competitive playing field 
represents a perfect example of how the Federal Reserve's dual role as regulator and 
payment services provider can operate to the detriment of the private sector. In trying to 
reduce the Federal Reserve's risk in the payments system, the Federal Reserve has set in 
motion forces that will specifically discourage migration of check volume under same-day 
settlement to the private sector.' 

In addition to the Federal Reserve's compromise of the attractiveness of same-day 
settlement due to the change in the check posting schedule, allow me to provide another 
example of what NOCH views as a deviation from the principle of competitive fairness 
intended by the Monetary Control Act. Recently, the Federal Reserve Board approved a 
Federal Reserve Bank's request to offer a new check collection service dependent upon a 
unique pricing mechanism. Known as a "payor service group sort" (PSGS), this service is 
now being offered by over eleven Federal Reserve offices around the country (more have 
recently announced that they too will add such a service). The service was approved by the 
Federal Reserve without the benefit of public review, despite the determination by the 
Federal Reserve Bank applicant that its proposal should be treated as "non-routine" because 
the pricing mechanism represented a departure from Federal Reserve pricing policies in place 
at the time. 

This new pricing mechanism relies on revenues received from paying banks to offset 



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



105 



the prices charged by the Federal Reserve to collecting banks for check deposit services. 
According to the Federal Reserve Board staffs document approving the new service, the 
pricing mechanism would "assess a fee to both the depositing bank and the payor bank for 
deposits of checks in a Payor Service Group Sort. "' In short, the paying bank is paying a 
portion of the collection costs for checks presented to it through this service, allowing the 
Federal Reserve to offer a corresponding discount to the collecting bank choosing to use the 
service. 

The power of this pricing incentive should not be understated. Typically, a bank's 
determination of check collection method depends on price more than any other single factor. 
Therefore, as NOCH sees it, the PSGS service is purposely structured to subsidize collecting 
banks as an incentive for them to collect checks through the Federal Reserve System, instead 
of through private banks that do not have the capability to link paying and collecting bank 
services and prices. 

Moreover, until this new pricing mechanism was approved, the Federal Reserve's 
pricing policies for check collection services had always been to assess fees only on only 
those banks directly benefitting from the provision of the service. In short, the price borne 
by the collecting bank for a collection service fully reflected the Federal Reserve's cost of 
providing the collection service plus a private sector adjustment factor. With the PSGS 
service, when revenues from paying banks are factored out of the cost recovery equation, 
NOCH questions whether this pricing mechanism is even recovering the marginal cost of 
collecting checks through this service. 

Between the recently implemented check posting changes under the Payment System 
Risk Reduction Program and the Payor Service Group Sort pricing mechanism, NOCH fears 
that the same-day settlement amendments to Regulation CC might be rendered meaningless. 



The Solution: More Congressional Oversight and Greater Public Involvement 

No one relying on the U.S. payments system stands to realize any benefits if one 
group of organizations (e.g., the Federal Reserve and its Reserve Banks) is perceived as 
dominant in a strictly one-sided game. Sooner or later in this situation, the private sector 
might simply decide to stay home. Therefore, the perception that competition in the 
payments system is one sided cannot be permitted to continue. The perception — and indeed 
the reality ~ must be that the competitive playing field is level; the officiating fair and just. 
This, in NOCH's view, was the intent of the Monetary Control Act. 

The Importance of Public Opinion : In evaluating the Federal Reserve System's dual role as 



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



106 



regulator and dominant national payments service provider, NOCH can only state that when 
public opinion has been sought before the Federal Reserve enters into a new or different 
service, or a new or different pricing methodology for such a service, the resulting outcome 
has been to the benefit of the banking industry, its customers, and the national payments 
system as a whole. When the Federal Reserve has not subjected price or service proposals 
from Federal Reserve Banks to public review, questions and confusion have all too often 
been the result. This has particularly been the case when the approved price or service 
change has ultimately been adopted by other Reserve Banks around the country. 

Frequently, proposed changes to a price or service by an individual Reserve Bank 
have received Federal Reserve approval without the benefit of public comment because the 
change might only have a limited effect on other local service providers. Meanwhile, 
subsequent similar changes by Reserve Banks serving other regions are generally subjected to 
only the most basic review process by Federal Reserve Board staff because, presumably, the 
Board of Governors and its relevant committees have already reviewed the competitive 
impact of the original application. The problem that exists is that a particular price or 
service change in one region may indeed have only a limited impact on competition with 
local private sector providers, whereas, on a national or multiregional basis, the competitive 
position of many other private sector service providers might ultimately be undermined by 
the subsequent adoption of the change in their Federal Reserve districts. Since local changes 
frequently have national repercussions, NOCH believes that virtually all changes to 
Federal Reserve priced services should be viewed by the Federal Reserve as potentially 
having "significant longer run effects on the Nation's payments system" — thus 
triggering public review requirements under policies adopted by the Federal Reserve 
pursuant to the Monetary Control Act and the Administrative Procedures Act. 

NOCH would like to add that not only does the Federal Reserve approve many 
controversial services without the benefit of advance public comment, but even when the 
public seeks more information about a service and its approval process, the response from 
the Federal Reserve can be less than forthcoming. As an example, I have attached for the 
record several documents NOCH received from the Federal Reserve in response to a request 
under the Freedom of Information Act for information regarding approval of the payor 
service group sort. A quick review of these documents reveals that a substantial amount of 
information contained within has been deleted as not for public consumption. 

The message here should be clear. All proposed changes to Federal Reserve prices 
and services should be issued for public comment. Providing the public the opportunity to 
review changes to Federal Reserve prices and services not only elevates the Federal Reserve 
Board above any reasonable suspicion of conferring competitive advantages upon the Federal 
Reserve System, but also permits private sector providers of payment services to respond 
with the potential effects such a service would have in the region or regions they serve. 
Even if the proposal is generated by an application of a Reserve Bank that is not directly in 
competition with a particular commenter, as part of the public record, the^e comments can 
serve as a guide to the Federal Reserve and its staff when reviewing similar changes 



107 



proposed by other Federal Reserve Banks. 

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



Active Congressional Oversight : Issuing proposed Federal Reserve price and service changes 
for public comment in advance would greatly enhance the ability of the banking industry and 
the Federal Reserve Board to fully review the full competitive impact of these types of 
proposals before they are approved and implemented. However, the numerous questions 
that continue to surround the Federal Reserve System's role and market dominance in 
the payments system strongly suggest that this role must be further evaluated by a 
knowledgeable, non-biased third party. 

Given the GAO's substantial involvement in evaluating the Federal Reserve's role in 
the payments system, NOCH would recommend that the GAO be commissioned to re- 
evaluate the current competitive role of the Federal Reserve System given changes in the 
competitive environment since the research for the May 1989 report was compiled. Of 
particular interest would be the degree to which same-day settlement and changes to Federal 
Reserve policies have addressed the recommendations in the May 1989 report and the intent 
of the Monetary Control Act. As it evaluates the effects of recent Federal Reserve actions, 
the GAO should also review what, if any, changes have been made by the Federal Reserve in 
either its regulation of, or in its role as provider of services to the payments system that have 
worked to compromise same-day settlement's levelling of the playing field. 

To measure progress towards the ultimate goal of achieving balanced 
competition, NOCH would like to close its remarks by recommending that the GAO 
follow up the comprehensive report described above with annual progress reports until 
such time as the Congress may conclude that the competitive environment has reached 
the stage of maximum fairness as envisioned by the Monetary Control Act. Congress 
may therefore assure the public that continuous progress is being made towards this goal. To 
this end, NOCH offers whatever assistance is requested of us to support any such GAO 
reporting initiative. 



108 



TESTIMONY BEFORE THE U. S. HOUSE OF REPRESENTATIVES 
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS 

on 

"The Federal Reserve System Accountability Act", HR 28 



delivered by 

J. D. Carreker 

Chairman, J. D. Carreker and Associates, Inc. and 

Executive Director, Electronic Check Clearing House Organization 

October 27, 1993 



109 



PREFACE 



Introduction Thank you, Mr. Chairman and Members of the Committee. 

I am Denny Carreker, Chairman of J. D. Carreker and Associates. We 
are a management consulting and technology company, serving the 
banking industry in matters of the payment system, bank operations, 
check processing, and electronic check presentment. 

Our client base includes most of the country's top 100 banks, their 
regional clearinghouses, and banking industry associations. It has also 
included Federal Reserve banks and the staff of the Federal Reserve 
Board of Governors. 



ECCHO 



It is in my capacity as Executive Director of the Electronic Check 
Clearing House Organization, or ECCHO, that I have been invited to 
address the Committee. ECCHO is a non-profit national organization 
dedicated to facilitating the private sector's implementation of electronic 
check presentment, or ECP (Exhibit 1). As I will describe later, ECP is 
changing the payment system and the relative roles of the private sector 
and the Federal Reserve. 



ECCHO now has 58 members, who account for more than 60% of the 
total domestic deposits of the 100 largest banks in the U. S. ECCHO has 
become a central focus for many of the important changes currently 
taking place in the nation's check payment system. 



Purpose 



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



page 1 



no 



FEASIBILITY 



Introduction First, regarding feasibility. Not only is gradual privatization of the 

Federal Reserve's check clearing functions feasible and desirable, it is 
already occurring. 

It is ECCHO's belief that the Federal Reserve should encourage the 
prevailing privatization trend and the success of private sector initiatives. 

Doing so would involve addressing a fundamental issue, and that is the 
basic conflict of interest in the Federal Reserve's dual role as both 
regulator of and competitor in the check collection system. In this dual 
role, the Federal Reserve can, unilaterally and without accountability, 
undertake regulatory, service policy, and service pricing initiatives to 
maintain market share and recover costs, in direct competition with the 
private sector. 

There was a time when, thanks to non-par banking, unit banking, and 
uncertain transportation conditions, the Federal Reserve's operating role 
was necessary. It is not necessary today, as Congress indicated in the 
Monetary Control Act of 1980, and the private sector is meeting the 
needs of the check collection system. 

To address this conflict of interest, Congress should consider the example 
of other countries such as Canada, and establish an entity to ensure that 
the Federal Reserve's conflict of interest is eliminated and the check 
collection system evolves as Congress intends. 



The 

Privatization 

Trend 



Three main changes are contributing to the privatization trend 
(Exhibit 2). 

One, the continued consolidation of the banking industry. 

Two, the emergence of electronic check presentment, or ECP 

Three, the increasing extent to which the payment information 
needs of banks' customers are directing the payment system. 

Collectively, these three changes amount to the formation of an 
"electronic umbrella" (Exhibit 3) covering all parties in payment 
transactions. And collectively, they serve to diminish the importance of 
the Federal Reserve's check clearing role and to increase the importance 
of the private sector's efforts to invest in further improvements without 
the current fear of unpredictable and disruptive regulatory or pricing 
changes by the Federal Reserve. 

I would like to elaborate on each of these three changes. 



page 2 



Ill 



FEASIBILITY (continued) 



1. First, consolidation. As banks consolidate, the nature of check clearing 
Consolidation volumes changes. Intra-bank checks increase, while inter-bank, or 

"transit" checks decrease. The Federal Reserve's check clearing role is 
in transit checks. As a result, consolidation continues to diminish Federal 
Reserve check volumes, and correspondingly, the required role of the 
Federal Reserve in the check collection system. 

2. The second change I referred to is ECP. The essence of ECP is that it 
Electronic captures checks' payment information for electronic transmission, thus 
Check separating checks' most time-critical information from the paper item 
Presentment itself. For the first time, the speed of check processing is not limited to 
(ECP) the speed at which a piece of paper can be handled and transported 

(Exhibit 4). For banks and their customers, ECP represents a 
tremendous opportunity to reduce check risk and losses. 

It is important to note that the private sector formed ECCHO and 
invested in ECP in order to reduce the risk exacerbated by Regulation 
CC. Thanks to this private sector initiative, there is less risk and more 
efficiency in today's check collection system. 

ECP has substantial implications for the Federal Reserve's future role in 
the payment system. For most of this century, the basic check clearing 
system was a daunting physical sorting and transportation challenge. 
Banks were unit banks, many in remote or rural locations, and 
transportation was slow (Exhibit 5). 

This situation constituted a clear need for a national entity to provide a 
standard sorting and transportation service at a reasonable price. It was 
logical for the Federal Reserve to assume this dual role of regulator and 
operator, which it performed conscientiously and well, helping to create 
the world's most efficient check clearing system. 

But now that the private sector is implementing ECP, physical 
transportation and sorting is less time-critical. The private sector has 
already developed ECP software, written the rules and agreements, 
designed the implementation requirements, developed national standards, 
formats, and definitions, and borne the expense and risk connected with 
all these efforts. The private sector is adapting ECP service and delivery 
mechanisms to serve the thousands of small banks that cannot support 
their own check clearing operations, helping these small banks reduce 
their check risk and that of their customers. 



(continued) 



page 3 



112 



Electronic 
Check 

Presentment 
(continued) 



FEASIBILITY (continued) 



On the other hand, the Federal Reserve, while explicitly endorsing the 
ECP concept, is planning to invest in a different approach to ECP that 
will compete with the private sector's investment and has already 
complicated and delayed the private sector's development of ECP 
standards. 



There is no reason for the Federal Reserve to duplicate the private 
sector's ECP efforts. Additional competitive ECP activity by the Federal 
Reserve at this juncture will unnecessarily complicate the work of the 
private sector, potentially introducing new systemic risk, and delaying 
ECP's benefits for small banks and their customers to ECP's benefits. 



3. The third change I referred to is the greater customer responsiveness 

Customer required of the payment system (Exhibit 6). During the decades that the 

Participation Federal Reserve was expanding its role in the check collection system, the 

system was not especially customer-oriented. Check services were largely 

commodities, and customers did not demand differentiation. 

That situation has changed. Now customers desire extensive payment 
information along with payment transactions, and now they expect to see 
services designed with the particular needs of their companies or 
industries in mind. 

For example, studies by J. D. Carreker and Associates and our bank 
clients have shown that ECP has tremendous potential for providing 
corporations with better payment handling and information, and reduced 
payment risk. As a result, corporations are now taking steps toward 
developing corporate ECP applications. 

There are many other such examples that involve both corporate and 
consumer customers, including electronic data interchange, home 
banking, telephone bill paying, and ATM services. 

In none of these examples is the involvement of the Federal Reserve as 
a service provider required. As corporations and consumers increasingly 
demand more responsive payment services, the opportunity for effective 
participation by the Federal Reserve diminishes. The Federal Reserve, 
appropriately, does not have customer relationships with these parties, 
nor does it have the market-driven experience of the private sector. 



page 4 



113 



FAIR MARKET VALUE 



Factors The second question I've been asked to address is the "fair market value" 

of the Federal Reserve's check operations. Clearly, if the Federal 
Reserve were to relinquish its check clearing role, it would forsake a 
large investment in payment system capacity. 

The most important factor affecting the value of the Federal Reserve's 
check clearing business would be timing. The business is valuable today, 
but the value will diminish. I have just recounted for you the continuing 
transition from paper to electronics. The Federal Reserve's check 
collection system mechanism was designed to support a paper check 
system, not an electronic one requiring a national data communications 
network. It was designed before the large-scale nationwide consolidation 
of the banking industry and before the large-scale responsiveness to 
corporate and consumer customers. 

Thus the value of the Federal Reserve's investment diminishes daily as 
these trends continue. Its "fair market value", then, is tied to how soon 
it is extracted. 

The value of the business would also be affected by the scope of the 
functions involved and the scale of the business. The combination of 
settlement and check collection functions is clearly more valuable than 
check collection alone, and the national scale of the total Federal 
Reserve business is more valuable than several regional businesses would 
be. 



page 5 



114 



FUTURE FEDERAL RESERVE ROLE 



Overview Having asserted that the early rationale for the Federal Reserve's dual 

role no longer exists, that the private sector is pursuing effective check 
collection improvements in the form of ECP, and that the Federal 
Reserve's dual role jeopardizes private sector initiatives, the question 
remains how the check collection transition should be managed. 

ECCHO believes that Congress should encourage the prevailing trend 
toward privatization by: 

A. Establishing an entity to ensure accountability for Federal Reserve 
check collection initiatives, and 

B. Taking steps to eliminate the Federal Reserve's conflict of 
interest, as other countries such as Canada have done. 



Recommenda- ECCHO recommends that Congress establish a Payment System Advisory 
tion Board, comprised of payment system experts drawn from the private 

sector, Federal Reserve staff, and other parties as appropriate. 

The Payment System Advisory Board (Exhibit 7) would advise Congress 
or its agents on the following: 

New Federal Reserve pricing initiatives 
Major Federal Reserve investments in check collection 
Changes in the scope of Federal Reserve services 
Federal Reserve compliance with Congressional mandates 

The Payment System Advisory Board would hold an annual meeting and 
provide Congress or its agents with an annual report on these issues. 
ECCHO believes that the General Accounting Office could play a useful 
role in this regard. 

An additional role of the Payment System Advisory Board would be to 
provide a forum for discussing issues related to the evolution of the U.S. 
payment system. 



page 6 



115 



SUMMARY 



Summary In summary, the Committee's attention to this issue is particularly timely. 

It comes at a time when the private sector check clearing banks are 
particularly well positioned to provide even better check clearing services 
than ever, more cost-effectively than ever, with greater corporate and 
consumer value than ever, and with even better service for small banks. 

In other words. Congress can, with little or no impact on the quality or 
safety of the check collection system, encourage current private sector 
initiatives, the prevailing trend toward privatization of the check clearing 
business, and the gradual elimination of the Federal Reserve's conflict of 
interest. 

To ensure the continuity and security of the payment system during the 
transition and beyond. Congress should form a Payment System Advisory 
Board of Federal Reserve and private sector parties. ECCHO is pleased 
to offer its services in any way in the establishment of this Board. 

Thank you for the opportunity to testify on behalf of ECCHO. This 
concludes my prepared remarks. 



page 7 



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123 



TESTIMONY OF 



JAMES R. LAUFFER 

CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER 

OF THE FIRST NATIONAL BANK OF HERMINIE 

AND PRESIDENT 



of the 
THE INDEPENDENT BANKERS ASSOCIATION OF AMERICA 

before the 



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



on the 



"FEDERAL RESERVE SYSTEM ACCOUNTABILITY ACT OF 1993" 



OCTOBER 26, 1993 



124 



Mr. Chairman, my name is James R. Lauffer, and I am Chainnan, President and 
CEO of the First National Bank of Herminie in Irwin Pennsylvania. I am also President 
of the Independent Bankers Association of America, which is the only national trade 
association that exclusively represents the interests of community banks. 

We appreciate this opportunity to testify on your bill, the Federal Reserve System 
Accountability Act of 1993 (H.R. 28). You have asked us to comment on the provision 
of that bill that authorizes the formation of a commission to study, among other subjects, 
the fair market value of the Federal Reserve's check clearing system and the advisability 
of further privatizing check clearing. While we have a strong interest in that provision, 
we also have serious reservations about other aspects of H.R. 28. We believe that this 
bill would imdermine the independence of the Federal Reserve System and politicize its 
conduct of monetary policy. This statement will outline our views on all of these 
provisions. 

Federal Reserve Accountability Commission 

The Study Would Ignore Key Factors 

The IBAA believes that section 8(b)(3), as written, calls for a study that would 
ignore crucial factors that must go into any consideration of whether the Federal Reserve 
should divest check clearing services. It only requires the commission to take "into 
account the economic benefits to be derived from, and the efficiencies to be achieved 
as a result of, the divestment." This would result in a biased study, since it does not 
clearly require the commission to consider any of the disadvantages of reducing or 
eliminating the Federal Reserve's check clearing role. 

Therefore, section 8 should be expanded to require the commission to consider 
the indirect cost to the public if reasonably priced check clearing is no longer available 
to financial institutions serving small and rural communities; the adverse effects on those 
commimities if they lose access to prompt and efficient payment services; and the value 
of having the services retained by the Federal Reserve. 

The Vital Role of Federal Reserve Senrices 

Individuals and small businesses throughout the nation expect reasonably priced 
banking services -- checking accounts, interest-bearing checking accounts and savings 
accounts. The availability of Federal Reserve services gives community banks - 
collectively the largest private sector market for Federal Reserve settlement and clearing 
services -- access to affordable correspondent services designed to meet the needs of 
these customers. 

For many community banks, particularly in rtiral areas, the Federal Reserve is the 
only provider offering check clearing services. The Federal Reserve ensures that all 
financial institutions, approximately 30,000, have universal access to its services. 



125 



Historical Background 

Prior to 1916, the Federal Reserve was involved only in a voluntary check 
collection arrangement in which member banks voluntarily paid checks at par and 
received immediate credit for checks deposited at a Reserve Bank. This voluntary 
approach was a failure since most banks gained more by operating outside this system, 
paying checks on a non-par basis. At that time, paying banks regularly charged "an 
exchange fee" to the bank presenting the check for payment. Checks often were routed 
in ways that delayed payment. 

The Federal Reserve promulgated its first rules on check collection in July 1916, 
requiring member banks to send checks for collection directly to the bank on which they 
were drawn. Member banks were also required to clear at par. 

Over the years, the Federal Reserve has endeavored to improve the efficiency of 
the check collection system, sometimes at the request of the Congress. Most recently, 
in 1 987 the Congress directed the Federal Reserve to implement the Expedited Funds 
Availability Act to provide depositors with more prompt access to their funds. This new 
law required the Federal Reserve to implement numerous changes to improve the 
efficiency of the check collection system. The Federal Reserve had to ensure that checks 
were collected and returned in a timely manner to help protect banks against the risk 
that they would pay checks that were drawn against insiifficient funds. 

Recent Developments 

In the last 3 to 4 years several private entities have formed or expanded to 
provide national correspondent services, including check clearing. Although these 
services are available on a national basis, they are not universally available to all 
financial institutions. 

In 1992, Huntington Bancshares and two non-bank partners formed the National 
Clearinghouse Association (NCHA), a nationwide check clearing network. The 
membership is comprised of large regional banks, including NationsBank. The NCHA 
membership requirements effectively exclude smaller institutions by establishing a $200 
million minimum capital level for all participants. 

Similarly, the Visa Automated Clearing House has identified the top 100 ACH 
originators as its niche. Community banks need not apply. 

The Electronic Check Clearing House Organization (ECCHO) was formed in 1 990 
to provide private-sector national electronic check presentment. The ECCHO 
membership includes many of the co\mtry's 50 largest banks. Late last year, ECCHO 
added a new membership category - associate member -- to attract members that might 
not otherwise be able to afford regular membership. Unless it has recently changed, the 



73-435 0-94-5 



126 



annual cost of associate membership is over $10,000. This effectively excludes smaller 
banks. 

The membership requirements or niche strategies of the national private-sector 
service providers make clear that most smaller institutions will continue to depend on 
the Federal Reserve. Thus, they will not be able to obtain private sector services that 
could produce cost savings for their customers. 

New technology has emerged that will enable some private-sector entities to offer 
some services nationwide. One of these entities is represented here today. However, 
no single entity will provide universal, reasonably priced services to all of the nation's 
financial institutions. 

The private sector has demonstrated neither the capacity to absorb the Federal 
Reserve's check volume - about 30 percent of the total volume nor the willingness to 
provide the services to all segments of the industry. The two private sector initiatives 
by Visa and Huntington both demonstrate the willingness of the private sector to serve 
only high-volume users. Capacity and willingness must be key considerations when 
valuing the Federal Reserve services. 

If the Federal Reserve abandons these services and the private sector is the only 
correspondent service provider, many community banks would likely experience 
substantially increased operating costs. In today's cost-cutting environment, community 
banks would be forced to pass related fee increases on to consumers in various forms -- 
increased or new service charges and/or activity fees and lower rates of interest for 
interest- bearing accounts. Consumers, small businesses, farmers, and ranchers would 
bear the bnint of these fee increases. 

Under current law, community banks already pay competitive fees. The Monetary 
Control Act of 1980 requires the Federal Reserve to price its check services as though 
it was a private sector player. The Federal Reserve calculates its cost for each 
individual product which adso includes a Private Sector Adjustment Factor (PSAF). The 
Monetary Control Act also mandated that the Federal Reserve System match its costs 
and revenues in the long run, while giving due consideration to competitive factors and 
the continuation of an adequate level of services on a nationwide basis. 

To date, the Federal Reserve has played a critical role in ensuring that 
community banks, and their customers, have access to adequate payment systems. The 
Federal Reserve must remain active in this role, as no other institution appears to be 
willing or able to replace it. The study commission created by H.R. 28 must take these 
factors into account. 



127 



Improving the Payments System 

In addition to ensuring that all financial institutions have universal access to 
check clearing services, the Federal Reserve is the catalyst for improvements in the 
payments system, including check clearing operations. 

Unlike any private-sector provider, the Federal Reserve has responsibility for 
regulation and improvement of the payments system. As I indicated earlier, the 
Expedited Fimds Availability Act (EFAA) of 1987 directed the Federal Reserve to 
improve the payments system. According to section 609(c)(1): 

. . . "The Federal Reserve System shall have the responsibility to regulate: 

(A) any aspect of the payment system, including the receipt, payment, collection, 
or clecu±ig of checks; and 

(B) any related fimction of the payment system with respect to checks." 

Given this responsibility, the Federal Reserve has a nationwide, long-term 
perspective -- not just a short-term, regional or niche perspective characteristic of 
private-sector providers. 

The Federal Reserve's current role enables it to offer services which will assist in 
executing its regulatory responsibilities. The EFAA, among other things, directed the 
Federal Reserve to prescribe regulations resulting in an automated system for the return 
of unpaid or dishonored checks. If the Federal Reserve did not provide a nationally 
available return item service, this mandate would not have been met. The Federal 
Reserve's role has greatly improved the return-check process - a benefit to both 
depository institutions and most importantly, their customers. 

The IBAA understands that the Federal Reserve is strongly committed to 
remaining in the check clearing business and improving the efficiency of the nation's 
check clearing system. The Federal Reserve's seven year research and development 
effort in check image technology and the development of an electronic check exchange 
service are prime examples. The Federal Reserve's leadership role in both of these areas 
prompted software and hardware vendors to develop systems much sooner than private- 
sector market forces would have. The Federal Reserve cannot continue to improve our 
payments system if it can no longer offer services to facilitate these improvements. 

Any study must factor in the benefits of the Federal Reserve's dual role as a 
regulator and service provider committed to serve all financial institutions. 

Role of Studies in Legislation 

Some may contend that community bankers should not worry about this provision, 
since, aiter all, it is "just a study." I strongly disagree. Studies, particularly biased 



128 



studies, can lead to dangerous legislative proposals. For example, section 1001 of the 
1989 savings and loan legislation directed the Treastiry to conduct a study of the 
federal deposit insvuance system. That provision focused on ways to cut back on deposit 
insxurance coverage or reduce the deposit insvirance fxinds' losses. The section failed to 
require the Treasury to study any benefits of deposit insurance. 

The end result was a Treasury recommendation that deposit insurance coverage 
be greatly curtailed. Mr. Chairman, I know you favored that recommendation, while we 
strongly opposed it. But certainly we can agree that the battle over deposit insurance 
coverage that grew out of the Treasury study was hard-fought and highly significant. 
The fact that the 1 989 law did not require the Treasury to consider any positive aspects 
of deposit insurance put a tremendous burden on those of us who opposed deposit 
insurance cutbacks. Because of that experience, we will continue to closely scrutinize 
proposals to "just study" topics of concern to community banks and fight to eliminate 
bias. 



Other Provisions of H.R. 28 

We strongly agree with Federal Reserve Chairman Greenspan's earlier testimony 
before this committee on the other provisions of H.R. 28. Whatever their stated intent, 
their effect would be to vmdermine the independence of the Federal Reserve. 

Presidential Appointment of Reserve Bank Presidents 

The bill's first major provision would require that Reserve Bank presidents be 
appointed by the President of the United States and confirmed by the Senate. Chairman 
Greenspan has effectively outlined a number of very strong argimients io favor of the 
current system and against the change proposed by H.R. 28. We see no need to repeat 
those points in this testimony, but do want to add several points. 

The Chairman and Vice Chairman of the Board of Directors of the Federal 
Reserve Banks are not bankers. Second, the banking industry is not monolithic and the 
non- bank directors represent a diverse constituency. Third, the Board of Directors at any 
Reserve Bank does not have a carte blanche selection mandate - in selecting Federal 
Reserve Bank Presidents there is an interface with the Federal Reserve Chairman and 
the Board of Governors. The Board holds an effective veto. 

We would be remiss if we did not point out that the advise and consent process 
is not working that well for banking agency appointees. Extending this process to the 
Reserve Bank presidents could lead not only to the politicization of the selection process 
but also to serious delays in their appointment. We have not had an FDIC chairman 
since August, 1992. And, since Director C.C. Hope's death -- which caused a vacancy 
which has not been filled -- the FDIC has effectively been nm by the Comptroller of the 



129 



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

GAO Audit of the Monetary Policy of the Federal Reserve 

The GAO is the investigatory arm of the U.S. Congress. Increasing its auditing 
role at the Federal Reserve increases Congressional power over monetary policy. This 
will weaken economic and financial confidence. The GAO has been routinely auditing 
the regulatory and supervisory function of the bank regulatory agencies, including the 
Federal Reserve, since the late 1970s. After 15 years of experience, there is no 
evidence that the GAO understands the difference between an audit and a supervisory 
examination. 

The GAO has no expertise in monetary policy -- it does not attract first-rate 
economists. This is important because monetary policy is an economic specialization, 
not an accounting function. And even its accounting expertise is suspect. The GAO's 
accoimting projections of the prospective losses of the FDIC-BIF are now widely viewed 
as having been wrong. Its projections of future losses did not materialize. Ross Perot's 
projected $100 billion taxpayer hit was a figment of the imagination that started with 
the GAO's faulty projections. These faulty projections were used to secure 
Congressional passage of the FDICIA legislation which many experts, including those 
at the Federal Reserve, regard as a drag on bank lending and the general economy. 

We respectfully invite any member of the Banking Committee to pay a visit on 
one of the 4,000-plus banks under $50 million to ascertain whether FDICIA -- which 
added to previously existing regulations -- has imposed a regulatory burden that 
threatens its survival. The cxmiulative regulatory burden is so onerous that government 
examiners often outnumber these banks' professional staff. 

Legislation giving the GAO second-guessing rights over monetary policy decisions 
serves no useful purpose -- it will only undermine confidence in American economic 
decision making. Our country's fiscal-policy house has not been in order for at least 20 
years and this has put extra-ordinary burdens on monetary policy. Generally, oiu 
central bank has acquitted itself well. It does not need the GAO or this committee fine 
tuning monetary policy. 

These issues are not new to the House Banking Committee leadership and its staff 
nor to the IBAA and its s*aff . They were last seriously fought in the late 1 970s. They 
were rejected then - they should be rejected today. 

Thank you. 



130 



HOWARD B. WENTWORTH 

Mr. Chairman and Committee members, my name is Howard Wentworth. 
I am a Senior Vice President with CoreStates Financial Corp. I 
would like to thank the committee for the opportunity to comment on 
the issue of the privatization of Federal Reserve Priced services. 

As dociamented in the 1989 General Accounting Office report "Check 
Collection Competitive Fairness Is an Elusive Goal", the Federal 
Reserve is engaged in an almost $800 million a year business of 
providing priced services (activities that the Federal Reserve 
provides for a fee such as check collection, wire transfer, etc.), 
in direct competition with banks and other service providers. At 
the same time, the Federal Reserve also regulates its competitors. 
The dual roles of regulator and service provider effectively stifle 
private sector competition for priced services. Competition is 
curtailed in several ways. The Federal Reserve enjoys legal 
advantages that no private sector provider can match. Among these 
are the ability to present to any paying bank as late as 2:00 p.m., 
the ability to compete on a national basis and the ability to 
spread costs over a variety of products including some products 
where the Federal Reserve enjoys virtually a monopoly position. 

As the manager of the payments system, the Federal Reserve 
exercises its tactical rule making abilities, granted under 
Regulation "CC", in ways that frequently appear to have as the 
primary motivation improvement of the Federal Reserve's competitive 
position at the expense of the private sector providers. A recent 
example would be the establishment by the Federal Reserve of a 6:30 
p.m. deadline for the settlement of Same Day Settlement 
presentments. The late deadline, which applies only to private 
sector presentments, compares to a deadline as early as 11:00 a.m. 
for Federal Reserve presentments. The early deadline reduces 
Federal Reserve risk while the late deadline increases private 
sector risk and costs. Although the time under which payment can 
be delayed may appear to be unimportant, the distinction could 
effectively negate the cost avoidance opportunities for some of the 
very banks that Same Day Settlement was supposed to benefit. 

Finally, it is important to appreciate that banks view the Federal 
Reserve primarily as a regulator. As a result, banks frequently- 
are reluctant to challenge Federal Reserve actions related to 
priced services because of their concerns related to the Fed's 
regulatory role. The net effect is that the dual powers that 
Congress has granted to the Federal Reserve sets up a governmental 
agency with unfair competitive advantages over the private sector. 
Although it is now seen as a cliche it is nevertheless true that 
the FAA doesn't fly airplanes since it would place them in the 
conflicting roles of regulator and operator. This is a truth that 
the current Federal Reserve structure does not reflect. 



131 



Privatization of the Federal Reserve's priced services function is 
the most effective way to resolve the actual and perceived 
conflicts of interest which the government has created in allowing 
the Federal Reserve to function in its dual roles. 

Three approaches to privatization of the Federal Reserve's "Priced 
Sex-vices" functions should be considered. 

1. The Federal Reserve could sell their operating units, on 
a regional basis, to the private sector providers. 

2. "Priced services" activities could be spun off from the 
Federal Reser-ve on a local basis. The new charter would be to 
operate as a private company with profits to be paid to the 
Treasury. This approach would result in approximately 46 
separate companies being created. Each new company would be 
subject to the same regulations as the private sector 
providers . 

3 . The Federal Reserve could return to its historic role as 
a processor of last resort providing those services that the 
private sector elects not to deliver. 

Each of the three alternatives provides benefits and challenges. 
Additional work would be required to install any one, or a 
combination of the above solutions. However each would appear to 
successfully eliminate the conflict in the dual roles of the 
Federal Reserve without jeopardizing the safety and soundness of 
the payments system. 

Thank you for your attention. I would be pleased to answer any 
questions. 



132 



The official minutes from a meeting on February 19, 1974, with 
President Frank E. Morris of the Boston Federal Reserve Bank 
suggesting that the board of directors contact the Members of 
Congress to promote the Federal Reserve's position on the GAO audit 
bill. 

The official minutes of this meeting state (p. 95 of Federal 
Reserve Bank of Boston Director's minutes 1972, 1974, 1975, as 
delivered to the House Banking Committee) : 

"Mr. Morris also called attention to the fact that H.R, 10265, 
which would provide for a G.A.O. audit of the Federal Reserve 
System had not died in the House Rules Committee but was expected 
to reach the floor of the House of Representatives on or about 
March 5. He indicated that the System's position was to support an 
amendment, to be proposed by Rep. Ashley of Ohio, which would limit 
the scope of the audit so as to exclude monetary policy actions, 
but to continue to oppose the bill, even if amended, on the final 
vote. The directors were encouraged to let Members of the House 
know their views on the bill." 

On May 23, 1974, Governor George W. Mitchell, then vice chairman of 
the Federal Reserve Board of Governors, appeared at the directors 
meeting of the Chicago Federal Reserve Bank. A description of his 
remarks is presented in the minutes of that meeting as follows: 

"Remarks by Governor Mitchell, (p. 157, Federal Reserve Bank 
of Chicago Minutes of the Board of Directors for 1974, as delivered 
to the House Banking Committee) : 

Governor Mitchell also noted that the GAO audit bill should 
come up for vote next week on the floor of the House. Reserve bank 
directors have been helpful in contacting Congressmen and hopefully 
the bill can be at least amended to restrict the type of audit if 
chances for outright elimination lessen." 

Mr. Robert P. Mayo, President of the Chicago Federal Reserve 
Bank, then called on the directors, who are primarily private 
bankers and businessmen, to conduct a lobbying campaign against the 
GAO audit bill (ibid) . 

"Mr. Mayo commented further on the GAO audit bill, noting that 
it is House Bill number 10265 and should be up for consideration on 
May 29. He then requested each director to make whatever calls 
seem natural to him in order to encourage support for the Federal 
Reserve position. Although basically the System would prefer to 
see the entire bill defeated because of its monetary policy review 
aspects, if that is not possible then the Ashley amendment, 
restricting the GAO to a financial audit is favored." 

Mr. Mayo followed through on his campaign in the June 27 meeting by 
thanking the directors who contacted Members of Congress to secure 
support for the Federal Reserve position. The minutes of this 
meeting reveal the following (ibid, p. 169) : 



1 



133 



"The GAO audit bill recently passed the House of 
Representatives, but was limited to a financial audit. There is no 
prosect of Senate action this session, however, Mr. Mayo thanked 
those directors who were cible to contact Members of Congress to 
secure support for the Federal Reserve position." 

The pattern of organized Fed lobbying is also seen in connection 
with attempts to get the Fed totally exempted from the "Government 
in the Sunshine" bill. On December 11, 1975, the Chicago Fed's 
President Mayo reported to his directors on this legislation. 
After noting the alleged consequences of opening directors meetings 
to the public, he then described the organization of the lobbying 
effort, indicating that Ward J. Larson (Senior Vice President, 
General Counsel and Secretary to the Board of the Chicago Fed) 
would follow up with each director on his lobbying activities (pp. 
318-319, Federal Reserve Bank of Chicago, Minutes of the Board of 
Directors for 1975, as delivered to the House Banking Committee) : 

"Mr. Mayo reported that a 'Government in Sunshine' bill has 
already passed the Senate, requiring all federal agencies headed by 
a body of two or more members appointed by the President to conduct 
business at meetings open to the public. Even in those instances 
where a majority of the mexnbers vote to close the meeting a 
verbatim transcript must be made and retained for at least two 
years . 

"While this bill does not appear to apply to the individual 
reserve banks, it does apply to the Board of Governors and possibly 
to the FOMC, (Federal Open Market Committee) and this application 
concerns us directly as a System. 

"A similar bill, H.R. 11007, will be voted upon soon by the 
Government Operations Committee of the House. We would hope that 
the Federal Reserve System could be totally excluded from the bill 
-- or at least that it be exempt from the requirement that a 
verbatim transcript be made of all closed meetings. 

"Keeping a verbatim transcript would clearly inhibit 
discussion and could cause members to speak only for the record. 
While such a transcript would be svibject to court sxibpoena, even 
more critical to the system would be the scrutiny of the Congress. 
As you can see this legislation is particularly sensitive with 
regard to Board discussions on monetary policy and bank regulatory 
matters, (emphasis added). 

"Mr. Mayo then read a list of Committee members from this 
district. He asked each director to think about possible contracts 
to explain Federal Reserve concern and indicated that Mr. Larson 
would be in touch with each director tomorrow as a follow-up." 
(emphasis added) . 



134 




■■?^^f-' 



BOARD OF GOVERNORS 
OF THE 

FEDERAL RESERVE SYSTEM 

WASHINGTON, 0. C. 20551 



August 19, 1993 



Mr. Ian W. Macoy 

Director, Check Services 

National Organization of Clearing Houses 

Suite 200 

607 Herndon Parkway 

Herndon, VA 22070 

Dear Mr. Macoy: 

This is in response to your letter dated August 3 , 
1993, received by the Board on August 4, 1993, in which you 
request, pursuant to the Freedom of Information Act, 5 U.S.C. 
§ 552, copies of the following documents: 

"1. The FRB's principles, including those pursuant to 
provisions in the Monetary Control Act of 1980 and all 
other applicable PRE polices, for reviewing 
applications for priced services offerings submitted by 
Federal Reserve banks, branches and offices as in 
effect at the time when the Fourth Federal Reserve 
(Cleveland Federal Reserve Bank) District's "Pricing 
Proposal #542" was reviewed by the FRB and approved. 

2. Any additions or changes to the FRB's principles 
for reviewing applications for priced services 
offerings submitted by Federal Reserve banks, branches 
and offices as defined in #1 that are currently in 
effect. 



3. The FRB policy statement entitled "The Federal 
Reserve in Payments System" as issued in March 1990 and 
any other FRB policies currently in effect relating to 
the performance of a "competitive impact analysis" for 
proposals affecting the Federal Reserve System's 
offering of priced services and its Reserve Bank 
operations . 

4. Any policy statement that permits a Federal 
Reserve bank, branch or office to use fees collected 
from payor institutions to offset costs incurred in the 
provision of check deposit services to collector 
institutions . 



135 



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



6. The FRB's statement of approval of Pricing 

Proposal #542 and the date it was approved, the 

This FRB competitive impact analysis accompanying this approval 
response ^^^ ^^^ date it was completed, and all other FRB 
accache documentation supporting this approval. This request 

includes any legal opinions prepared by FRB counsel 

relevant to this approval and any docximentation as to 
why public comment was not recommended or required 
before FRB approval. 

7. Signed agreements between the Federal Reserve 
office and each of those depository financial 
institutions represented as payor institutions for 
inclusion in the group sort for checks deposited 
through the type of service represented by Pricing 
Proposal #542 ("payor service group sort") offered by 
the following Federal Reserve offices: Charlotte, 
Cincinnati, Cleveland, Columbus, Dallas, Helena, 
Indianapolis, Memphis, Milwaukee, Minneapolis and 
Philadelphia. 

8. A list of Federal Reserve offices, if any, 
approved to offer the payor group sort deposit service 
not referenced in #6 and all documentation requested in 
#6 pertaining to these offices. 

9 . Correspondence from any depository financial 
institutions to the FRB and/or their local Federal 
Reserve bank, branch or office seeking to be added to 
or withdrawn from, or seeking more information about a 
payor service group sort deposit option. 
Correspondence from the FRB and/or any Federal Reserve 
bank, branch or office in response to such requests." 

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



136 



The staff's search of Board records has revealed a 
number of documents that are responsive to items (1) through (3), 
(5), (6), (8) and (9) of your request. Some of those documents 
will be provided to you in their entirety. We have determined, 
however, that the remaining documents contain the following kinds 
of exempt information: commercial or financial information 
obtained from a person and privileged or confidential; and staff 
opinions, recommendations, and analyses that would not be 
available by law to a party other than an agency in litigation 
with the agency. Such information will be withheld from you 
under authority of exemptions 4 and 5 of the Act, respectively, 
5 U.S.C. §§ 552(b) (4) and (b) (5). The documents containing the 
exempt information have been reviewed in accordance with the last 
sentence of subsection (b) of the Act, and all reasonably 
segregable nonexempt information will be made available to you. 
With respect to items (4) and (7) of your request, the staff has 
searched appropriate Board records and made suitaible inquiries, 
but has found no responsive documents. Accordingly, we cannot 
provide you with any information with respect to those items. 

Your request for information, therefore, is partially 
granted and partially denied with respect to items (l) through 
(3), (5), (6), (8) and (9) of your request for the reasons stated 
above. All documents being made available pursuant to this 
authorization will be sent to you under separate cover. With 
respect to items (4) and (7) of your request, a determination 
that no responsive records exist is considered to be an "adverse 
determination" under the Act. You may appeal these 
determinations in accordance with section 261.9(d) of the Board's 
Rules Regarding Availaibility of Information, a copy of which is 
enclosed for your information. 



Very truly yours. 




William W. Wiles 
Secretary of the Board 



Enclosure 



137 



BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Excerpts from the Board's Rules 
Regarding Availability of Information 
12 CFR Part 261 
Section 261.9(d) 



(d) Appeal of denial of request for records — (1) 
Request for review; time limits. Any person denied access 
to Board records requested in accordance with this section 
may file with the Board a written request for review of the 
denial by the Board or Board member(s) designated to hear 
such appeal. The request shall be filed within ten working 
days of the date on which the denial was issued, or, where a 
request for documents has been partially approved but access 
to the documents has not been given, within ten working days 
from the date such documents are transmitted to the 
recjuester. The request shall prominently display the word 
"appeal" on the first page. An initial request for records 
may not be combined in the same letter with an appeal. 

(2) Untimely appeals- The Board may consider an 
untimely appeal if: 

(i) It is accompanied by a written request for leave to 
file an untimely appeal; and 

(ii) The Board or designated Board member (s) 
determines , in its discretion and for good and substantial 
cause shown, that the appeal should be considered. 

(3) Decision on appeetl; time limits. The Board or 
designated Board member! s) shall make a determination with 
respect to any appeal within 20 working days of actual 
receipt of the appeal by the Secretary and shall immediately 
notify the appealing party of the determination and the 
right to seek judicial review if the determination upholds, 
in whole or in part, the denial of the request for records. 
Such determination is not subject to review under Section 
265.3 of this chapter which provides for review of actions 
taken under delegated authority. 

(4) Mootness of appeal, (i) I'he Board, a Board member, 
or a staff person designated by the Chairman may declare an 
appeal wholly or partially moot and instruct the Secretary 
of the Board to reconsider the previous denial or to release 
the requested dociiments , where a determination is made that 
intervening circumstances or additional facts not known at 
the time of denial have or may have eliminated any need or 
justification for withholding the requested documents. 

(ii) The Secretary may reconsider a denial being 
appealed if such intervening .circumstances or additional 
facts come to the attention of the Secretary while an appeal 
is pending. 



Effective July 11, 1988 



138 



.•■o°t^f^ 




aOARD OF GOVERNORS 

OF THE 

FEDERAL RESERVE SYSTEM 

WASHINOTON. O. C. iOSSI 



TO TmC •Oano 



JUL 1 M^ 



Mr. William H. Hendricks 

First vice President 

Federal Reserve Bank of Cleveland 

1455 East Sixth Street 

Cleveland, Ohio 44101 

Dear Bill: 



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The Director of the Division of Federal Reserve 
Baink Operations, acting vinder delegated authority, has 
approved your Bank's proposal to implement a Payor Seirvice 
Group Sort. It is understood that the group sort will 
incorp orate t he recently approved" fee structure whei-p.hy 
federal Reserve costs are recover* 



:rom tees as s^aseih t o 
"The i-ayor i>ervice 



both the depositing and payor banks. 

Group Sort may be implemented after the usual thirty-day 
announcement period. Please send a copy of your Bank's 
announcement letter to Ms. Ellen Johnson, Stop 188, at the 
Board of Governors. 



Sincerely yours, 

(Signed) V\/iHiar(i W. Wiles 



William W. Wiles 
Secretary of the Board 



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



,^:,'.-rc or:On?^ 




139 



Board of Governors 

of the 

Federal Reserve System 



OFFICE CORRESPONDENCE 



Date ; July 6. 1990 



To: Clyde H. Farnsvorth. Jr. Subject; Proposed Payor Service 
grom; Thomas Luck Group Sort 






Action Recruested 

a proposal 
by the Federal Reserve Bank of Clevelamd to implement a group sort 
composed solely of bein3cs subscribing to payor services that require 
the opening of fine sort packages. The unique feature of this 
proposal is a new pricing structure, which was recently approved, 
under delegated authority, after endors ement by th e Pricing Policy 
Committee. Under the proposed pricing structure, a fee would be 
assessed to both the depositor and the payor bank for each check 
deposited in the group sort. 
Discussion 

The Federal Reserve Bank of Cleveland proposes to 
implement a Payor Service Group Sort product to improve its check 
operations, which have been affected by the growth in payor 
services and package sort deposits: The proposed new product is 
designed to eliminate a major bottleneck in Fourth District 
operations caused by processing fine sort deposits in order to 
capture the MICR data for payor services. The group sort would 
include only banks that subscribe to the payor services package 
sort option and agree to be included in the program. 



140 



The Fourth District proposes to assess a fee to both the 
depositing bank and the payor bank for checks deposited in the 
group sort. This pricing scheme represents a new structure for the 
pricing of Federal Reserve check collection services. No other 
check product assesses a fee to both the depositor and payor bank 
for the same process. 



141 



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



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

Reconunendation 



73-435 0-94-6 



142 

COMPETITIVE IMPACT AKALY8I8 
PRICING PROPOSAL ifS42 

The Fourth District has requested approval by the Director 
of the Division of Federal Reserve Operations, tinder 
delegated authority, to implement a pricing structure that 
would assess a fee to both the depositing bank and the payor 
bank for deposits of checks in a Payor Service Group Sort- 
Payor banks that receive payor bank services could elect to 
be included in the group sort amd would pay the proposed fee 
for all checks drawn on themselves and deposited via the 
group sort option. 

1. Does the proposed service have a direct and material 
adverse effect on the ability of other service providers to 
compete effectively with the Federal Reserve in providing 
similar services? 

The proposed Payor Service Group Sort does not 
adversely effect the ability of other service providers to 
compete effectively with the Federal Reseirve in providing 
similar services. Both the underlying payor bank seirvices 
and the group sort concept are common Federal Reserve check 
collection services, and conceptually there is no jc;hange in 
the relationship of services being offered by the Federal 
Reserve and its competitors. The proposed fee structure. 



143 



which is new, could be imitated by competitors wishing to 
enter the business of providing payor bank services- 

The proposal will result in lower Federal Reserve 
fees for deposit of certain items that could prove to be 
beneficial to a number of depositors, including some 
depositors not currently using the fine sort deposit option. 
It is expected that the major correspondent banks local to 
the Federal Reserve office will be the primaxy users of the 
Payor Bank Group Sort service. 



144 

Fkdki^ac Reserve Baj^k 

WILUIAM M.mENORICKS Ct.eveL>.MO.OHIO -«-*ioi 



■ w.CC •bIS'OCmt 



aMCA COOC 2<«-S7S-Zu« 



February 14, 1990 

Mr. Clyde Farnsworth, Jr. 
Director, Division of Federal 

Reserve Bamk Operations 
Board of Governors of the 

Federal Reserve System 
Washington, D.C. 20551 

Dear Clyde: 

The Fourth District requests approval under delegated authority to 
implement a new check deposit service. The proposed Payor Service Group 
Sort product is designed to reduce the processing presstires in our check 
operations caused by the high growth rates of our payor services and package 
sort deposits. The propKJsaJ. uses a new pricing approach for recovering check 
"floor" costs. Due to this change in pricing methodology, the proposal should be 
classified as "non-routine". 

Within the current Fourth District operations, approximately _ 

package sort items each day are reopened and reprocessed for inclusion in 
Fourth District payor services. Due to the nature of the package deposits, this 
processing is occurring during our peak operating windows. The proposed 
Payor Service Group Sort balances the Fourth District operational needs with 
that of the package sort dejjositor and payor service customer. By combining 
revenues from the depositor and payor, the Fourth District "floor" costs are 
fully recovered. 

This proposed Payor Service Group Sort has been supported by both a 
sample of payor institutions and our largest package sort depositors. Other 
Federal Reserve Districts with payor service capacity problems have also 
shown interest in the proposed program. 

Please direct any questions that you or your staff may have regarding 
this proposal to Terrence J. Roth, Assistant Vice President, at (216) 579-2873. 



Sincerely, 



^ae 



William H. Hendricks 

Enclosure 

cc: Mr. -Jack Guynn. Executive Director for Priced Services 
Mr. Willinin Stone. Sv.stem I'roduct Director 



145 



PAYOR SERVICE GROUP SORT 



FEDERAL RESERVE BANK OF CLEVELAhfD 



February 14, 1990 



146 



PAYOR SERVICE GROUP SORT 

Action Requested 

Each office within the Fourth District requests approval under 
delegated authority to implement a new group sort deposit option 
directed at lowering fees and processing costs for the package sort 
depositor and payor customer. The endpoints included in the group 
sort will be only those customers which subscribe to the Fourth 
District's Payor Services Package Sort Option service (Fine Sort 
Inclusion) . The new prograjn is designed to eliminate a major 
bottleneck in Fourth District operations in reprocessing Package Sort 
Deposits. Furthermore, the service is designed to pass finajicial and 
operational benefits to current package sort depositors and payor 
service customers. Due to a new approach to pricing the Payor 
Service Group Sort, the proposal is classified as "non-routine". 

Executive Summary 

Within the Fourth District, Payor Services (including the Package 
Sort Option) and Package Sort deposit services continue to experience 
tremendous success and growth. The exponential growth rates are 
beginning to impact dispatch times at the Cleveland, Cincinnati and 
Columbus offices. 



Payor Service Group Sort - Page 1 



147 



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



148 



Background 
The driving force behind the Payor Service Group Sort is the 
exponential growth of our Payor Service, Package Sort Option and the 
Package Sort Deposit services- The following table summarizes the 
annual 1989 performance compared to annual 1988: 



1988 



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



1989 



X Growth 

28. 3X 

53. 6X 

19. 5X 

^ 0.8X) 



Payor Service GrouD Sort. 



Pace 3 



149 



increased to per day. This represents 23 percent of our 

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



Discussion 
Current Environment 

The Federal Reserve System guidelines governing deadlines and the 
relationship between premium processed, package deposit and dispatch 
times were developed to insure that all service providers had equal 
and timely access to local FRS transportation services. The System 
guidelines stated that the Package Sort deposit program have a cutoff 
time no earlier than three hours before courier dispatch. During 
this three hour period, the Fourth District physically sorts package 
deposits, enters accounting information, and creates/distributes the 
check supplemental accounting statements. 



Payor Service Group Sort - Page 4 



150 



statement 

To the Committee on Banking, Finance and Urban Affairs 

U.S. House of Representatives 

By: Tom C. Frost 

San Antonio, Texas 

November 15, 1993 

As a career banker whose desire is that my work contribute to the 
growth and development of the community that my bank serves, I 
appreciate the opportunity to present to the Committee views on the 
independence of our central bank within government and on the role 
of the presidents of the 12 regional banks in the administration of 
monetary policy. 

Lest my vantage point be misconstrued as purely from the vested 
interest of a commercial banker, let me explain my relationship 
with the Federal Reserve System. Born into a 125-year banking 
tradition the Federal Reserve came into my life early on. My 
grandfather signed the articles of incorporation of the Dallas 
Federal Reserve Bank. My great uncle lobbied for the establishment 
of the San Antonio branch and served on the Federal Advisory 
Council. My father was a director of the San Antonio branch. I 
will have 15 years of service to the Fed - 6 years on the San 
Antonio branch board, and 3 years as a member of the Federal 
Advisory Council. Next month completes my sixth year on the board 
of the Dallas bank. I ask that my views be accepted as from one 
with a practical understanding of the workings of our Central Bank. 
My formal education, the mentoring of my superiors and my direct 



151 



experience have been focused on the Federal Reserve's significant 
role in affecting the well being of each and every individual who 
participates in economic process in this country. 

It is from this conviction that the central bank be an instrument 
of good for all and not by serving any single sector that I address 
my remarks to you as you consider changes in the laws governing the 
Federal Reserve System. 

I have been taught and can testify through experience that the 
independence of our central bank within government is the critical 
element which allows the effective administration of monetary 
policy for benefit and good of the entire nation. It is with much 
satisfaction and great appreciation that the acknowledgement of 
this independence is not basically questioned by those who propose 
to change either the method by which the presidents of the regional 
banks are elected or their participation in the Open Market 
Committee. It is a fact that the level of inflation in a country 
is directly related to the independence of the central banking 
function. The closer a central bank is tied to the political 
process, the greater the inflation tendencies. Conversely, more 
independence is associated with less inflation as shown in Exhibit 
A attached. 

It is my opinion that a lessening of the independence of super- 
vision of monetary policy will have negative influence on the 
standard of living in this country. 



152 



The grace of our system lies in the unique, but most effective 
input of many people directly active and involved in the market- 
place. The participation of a minority of the Open Market 
Committee coming from only five who are not named through the 
political process, who have the daily experience in the "real 
world" and direct participation in the economic process, is a 
factor which makes our system responsive to the actual and current 
needs of the people. 

The contribution of the 12 regional bank boards through their 
presidents is invaluable. If those who reflect that element do not 
have a vote then their input will not be effective. 

Without this direct personified input of experience from the 
market-place, monetary policy might well be deliberated by a 
committee whose members are isolated inside the beltway environment 
reviewing computer printouts of economic trends. 

The principle that such a public enterprise as a central bank be 
controlled by those subject to the democratic process appointed by 
elected officials is not violated since a clear majority of the 
Open Market Committee is appointed by the President of the United 
States and confirmed by the Senate. 

The Board of Governors' influence is far more pervasive in the 
operation of the central bank than just serving as a majority of 



153 



the Open Market Committee. Those appointed by an elected official, 
the President of the United States, form 100% of the governing body 
in all other matters. 

So that the role of the Board of Governors in the naming of the 12 
bank presidents not be overlooked, I would like to relate my parti- 
cipation in the election of the president of the Dallas bank. The 
selection committee of the bank board was named by the chairman of 
the bank who was appointed by the Board of Governors. The Bank 
Board Committee consisted of only one banker or person elected by 
the shareholders (commercial banks) . It was understood and agreed 
that while the board of the regional bank would initiate and manage 
the selection process that no candidate would be presented to the 
board of the bank unless that candidate was approved by the Board 
of Governors of the entire system. This gives practical evidence 
that the office of the president of a regional bank is not outside 
the democratic process. 

Since its inception, the Federal Reserve System has undergone 
change and adaptation. The open market function itself was not 
appreciated or understood at the beginnings in 1914, coming into 
effective existence later. On its own volition more input from the 
marketplace has been sought by the Board of Governors. The Federal 
Advisory Council, set out in the original act to consist of 
bankers, has been joined by similar groups consisting of consumers 



154 



and small business representatives. 

The diversity of the 12 banks' boards and the boards of their 
branches has been expanded significantly through efforts and 
initiatives of the Board of Governors, the regional bank directors 
and the commercial banks who are stockholders of the Fed. It has 
been my privilege to serve with women, members of minority groups, 
and representatives of non-management such as labor leaders. All 
have been effective contributors to the work of the central bank 
and add dimension to the input from the marketplace. The observa- 
tion that this diversity has not reached the presidencies of the 
regional banks reflects the historical source of talent pools and 
not the desire of all who manage and participate in the Federal 
Reserve process. To recognize and be sensitive to the appropriate 
elements of various diverse elements is a major goal of all who are 
part of the central bank. 

To close, I ask you not to change the present process of selecting 
the 12 regional bank presidents or alter their role in the Open 
Market Committee. To do so would be a mistake for a more politi- 
cized central bank leads to additional inflationary tendencies with 
a negative impact on all. Other nations are moving toward more 
independence as a result of our example. (See Exhibit B attached) . 
An independent central bank still managed and operated within 
government will better serve the entire population of this great 
country. 



155 



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157 



Russian-American Enterprise Fund 

33 Liberty Street 
Room 1101 

New YORK, N.Y. 10045-0001 

AREA CODE 212-720-7595 



E. Gerald Corrigan 
Chairman 



October 29, 1993 



The Honorable Henry B. Gonzalez 
Chairman, Committee on Banking, Finance 

and Urban Affairs 
U.S. House of Representatives 
2129 Rayburn House Office Building 
Washington, D.C. 20515-6050 

Dear Mr. Chairman: 

In accordance with the arrangements worked out with your 
staff, I am forwarding to you my statement on H.R. 28, "The Federal 
Reserve System Accountability Act of 1993." As I understand it, 
the statement will be part of the record with regard to the 
Committee's deliberations on this subject. 

I appreciate very much the opportunity to share my thoughts on 
this important matter with you and your colleagues on the 
Committee. 

Sincerely, 





Attachment 



158 



STATEMENT BY 

E. GERALD CORRIGAN 

FOR THE 

COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS 

UNITED STATES HOUSE OF REPRESENTATIVES 

OCTOBER 29, 1993 



159 



Mr. Chairman, members of the Committee, I am pleased to 
have this opportunity to share with you my thoughts on H.R. 28 
"The Federal Reserve System Accountability Act of 1993". As the 
members of this Committee know very well, the basic legal 
framework within which the central bank of any nation operates is 
a matter of great importance. For that reason, any material 
change in that framework must be evaluated with great care and 
with a particular sensitivity to its consequences — and 
potential consequences — over the long term. 

From my perspective, a useful point of departure in 
deliberations that would alter the legal framework of the Fed is 
to reflect briefly on the track record of the Fed with regard to 
its basic responsibilities. Those basic responsibilities — as 
reflected in the preamble of the Federal Reserve Act — relate to 
the Fed's role in the conduct of monetary policy, its efforts to 
help ensure the stability of the banking and financial system and 
its efforts to help ensure the efficiency, safety and integrity 
of the payments system. Because these basic responsibilities are 
so closely interrelated, I have always viewed them as something 
of a central banking trilogy in that each element of the trilogy 
interacts with the other in pursuit of the common theme of 
financial stability — including stability in the purchasing 
power of the dollar. 



160 



In looking at these basic responsibilities, I believe 
most observers would agree that the Fed has a solid record of 
high quality performance in the nation's interest. There is, for 
example, no better, no more efficient and no more trusted 
national payments system in the world than is found in the U.S. — 
and that may understate the case. While the marvel of the U.S. 
payments system is by no means the exclusive product of the Fed, 
there can be no question that the Fed's operations and its 
policies have played a major role in the evolution and 
development of the U.S. payments system. Even the unglamorous 
nuts and bolts are important in this regard. For example, the 
fact that millions of households and small businesses — 
especially those in more remote areas of the country — can have 
their checks and other payments processed with the speed, the low 
cost and the trust that we witness can be traced, in no small 
way, to the Fed's efforts. 

The second leg of the central bank trilogy relates to 
the Fed's role in helping to ensure the stability and safety of 
the banking and financial system. Here, it is interesting to 
note that many central banks — including the Federal Reserve — 
were established more with a view toward this objective than they 
were with a view toward what we would regard as contemporary 
monetary policy. That historical footnote aside, this too, is an 
area in which I believe most observers would agree that the Fed 
has played a highly constructive role — especially in containing 
the many financial disruptions of the past decade. Indeed, in 



161 



many circles — perhaps especially abroad — the Fed is seen as 
having a particularly broad and highly pragmatic base of 
professionalism and expertise in this area — a judgment that is 
conditioned in part from the Fed's working knowledge of financial 
institutions, financial markets and the "plumbing" of the 
financial system. 

The third — and central element — of the trilogy is, 
of course, monetary policy. Recognizing that price stability is 
much more a state of mind than a statistic, I believe that the 
bedrock of any central bank's responsibilities must be the 
preservation of the purchasing power of the currency of the 
nation. That, in turn, is the key to sustained economic growth 
and rising standards of living. It is widely recognized that to 
achieve those objectives requires — indeed demands — an 
intermediate- and longer-term policy perspective that is 
insulated from short-term political pressures. That is why, from 
the very beginning of the history of central banking in the 
United States, care was exercised in providing the central bank 
with a significant degree of "independence within government". 
That is also why we have seen — and are seeing — so many 
countries moving to grant national central banks a greater degree 
of autonomy and political independence. Indeed, governments in 
all parts of the world — in developed and developing nations and 
even in newly emerging market economies — seem to increasingly 
embrace the concept of an autonomous and independent central 
bank. And, in so doing, they often point to and draw on the 



162 



experience of the Fed in the United States. It would be an 
ironic twist if the United States were seen as moving in the 
direction of greater political influence over the central bank at 
just the point in history when so many other countries are moving 
in the opposite direction. 

In suggesting that the Fed has a credible track record 
with regard to the manner in which it has fulfilled its basic 
responsibilities I am not suggesting that the Fed is flawless. 
Human nature and human frailties being what they are, no 
institution can even begin to make such a claim. Nor am I 
suggesting that as an abstract principle it would be impossible — 
working from a clean slate — to conceive some alternate 
structural characteristics that might work as well as those we 
have. But, we are where we are, and where we are is the result 
of almost two centuries of debate and deliberation about the 
structure and functioning of the central bank in a highly 
pluralistic society. 

All of this is not to suggest that we, as a nation, 
should not pause from time to time in order to satisfy ourselves 
that the basic structure of important institutions such as the 
Fed remains in keeping with our national interest and our 
national heritage. By the same token, as we seek to satisfy 
ourselves in that regard, we must recognize that the delicate 
balance that has been struck over the years in the structure of 
our central banking system, and its relationship to the 
government as a whole, is just that — delicate. What may seem 



163 



to be modest or even inconsequential change may bring with it the 
appearance or the reality of major change over time. Thus, while 
I can understand the sentiments that lie behind H.R. 28 and 
related proposals, I do not consider these proposals to be modest 
tinkering. Indeed, I believe that the enactment of H.R. 28 
and/or related proposals almost surely will be interpreted both 
here and abroad as leading to greater political influence over 
the Fed. In that connection, I would caution against minimizing 
the international dimension of this concern, keeping in mind that 
due to our fiscal imbalances we have been and still are importing 
massive amounts of savings from the rest of the world. 

Against that general background allow me to briefly 
summarize the basis of my concerns. At the most general level, 
and granting the very best in terms of intentions, I am extremely 
hard pressed to see how the changes contemplated could be 
interpreted any other way than to point in the direction of 
greater political influence over the Fed and/or making it more 
difficult to formulate and execute monetary policy. 

Take, for example, the whole question of the disclosure 
procedures regarding the deliberations and decisions of the FOMC. 
Here, I would respectfully submit that the main issue is not one 
of openness and disclosure but one of practicalities. That is, 
as a very practical matter, open meetings or verbatim minutes of 
FOMC meetings would surely stifle debate and discussion but such 
arrangements also would mean that essential information received 
from officials abroad could not be introduced into the 



164 



deliberations. Indeed, if such information were part of a public 
record, those foreign officials would simply stop talking to Fed 
officials about matters that are often highly germane to monetary 
policy deliberations. 

At another level, immediate release of the decisions of 
the Committee regarding day-to-day tactics of open market 
operations would, as an entirely practical matter, either result 
in more market volatility and uncertainty or a less effective 
policymaking process, or both. 

Permit me to elaborate briefly. The nature of open 
market operations are such that more often than not the 
directives of the Committee to the trading desk in New York have 
a contingent element. Indeed, if they did not, the flexibility 
that is so essential and so central to this tool of monetary 
policy will be compromised or lost. I would go one step further 
and say that based on my 13 years of experience as a member of 
the FOMC, the contingent nature of the Committee's decisions and 
instructions to the trading desk are an absolutely indispensable 
part of the policy process as it pertains to open market 
operations. Therein lies the heart of the dilemma. 

That is, if the directive must often be conditional, 
its immediate release will surely spur more uncertainty and more 
market volatility, not less. Moreover, in the face of immediate 
release, it will be much more difficult for the policymakers to 
reach an orderly and flexible consensus on policy. In other 
words, immediate disclosure will yield no significant net public 



165 



benefits that I can foresee but it will increase uncertainty and 
financial market volatility and it will work to the detriment of 
the policymaking process as a whole. 

Having said that I should hasten to add that I can see 
little or no downside risks to a revival of the practice whereby 
the FOMC — with an appropriate time lag — would make public 
something along the lines of the "Memorandum of Discussion" that 
was used in the past. If that practice were resumed there would, 
of course, have to be an understanding to the effect that certain 
items — such as references to information relating to 
discussions with foreign officials and information relating to 
individual institutions — would have to be omitted. Subject to 
those stipulations and recognizing that such an arrangement could 
be worked out without legislation, I can see merit to an effort 
on the part of the Fed and the Congress to put in place such an 
arrangement. Assuming that was done, it would represent a 
constructive move in the direction of greater disclosure and 
greater accountability. 

The other major provision of H.R. 28 that I wish to 
address directly relates to its provisions pertaining to the 
appointment and responsibilities of Federal Reserve Bank 
presidents. At one level, the issue that arises in this 
connection is rather straightforward; namely, should "private" 
individuals be a direct party to the monetary policy decision 
making process? I am not a lawyer, much less a constitutional 
lawyer but I am sensitive to history. And, when I look at the 



166 



history of central banking in the United States, what I see is 
that the founding fathers of our nation, who possessed a direct 
knowledge of the intent of the Constitution, were quite prepared 
to vest in "private" individuals a major role in the governance 
of the First Bank of the United States. Perhaps it's an 
oversimplification, but I'm inclined to the view that if it was 
good enough for them, it's good enough for me. 

Even if that historical argument was legally 
compelling, it does not, of course, imply that Congress in its 
wisdom might not opt for some other arrangement, of which at 
least three are now on the table. One would have the Reserve 
Bank presidents appointed by the President and confirmed by the 
Senate; another would remove the presidents from the FOMC leaving 
them with only advisory responsibilities; the third would have 
the presidents appointed by the Board of Governors of the Federal 
Reserve System. 

The first of these clearly carries with it the risk of 
being seen as entailing the threat or, over time, the reality of 
greater political control over the Fed. The second would, as a 
practical matter, substantially undercut the regional character 
of the Fed. Over time, I feel certain that the advisory role of 
the Reserve Bank presidents would drift into little more than a 
ceremonial process. Beyond that, it would fundamentally and 
irreversibly alter the working relationships between the 
institutional components of the Fed thereby undercutting the 



167 



highly constructive interplay between the Reserve Banks and 
Washington. 

Speaking as the only person who has served as the 
president of two Reserve Banks and has worked at the Fed in 
Washington, there is no doubt in my mind that over time such 
arrangements could easily deprive the Fed of important elements 
of its vitality and diversity that grow out of its regional 
character. Such a result, in my judgment simply would not be in 
the public interest. 

The third proposal — having the Reserve Bank 
presidents appointed by the Board of Governors — holds no 
greater attraction for me than the other two approaches. I say 
that for two primary reasons: First, as a wholly practical 
matter the Board of Governors now has complete veto authority 
over the appointment of any Reserve Bank president. Second, and 
given that absolute veto authority, what the proposal in question 
would achieve would be to remove from the process of selecting 
Reserve Bank presidents the formal input of the boards of 
directors of the Reserve Banks. As I see it, the net result of 
this also would be to fundamentally alter the regional character 
of the Fed and the delicate balance of responsibilities and 
interaction within the Federal Reserve. It would also make it 
that much harder to attract the high quality men and women that 
have served the nation with distinction as Reserve Bank 
directors. 



168 



It is never easy to be in a position of rejecting three 
proposals which are put forward in a serious and thoughtful 
manner. But, as a matter of utter conviction I cannot see how 
any of these proposals will work to improve the performance of 
the Federal Reserve relative to its basic responsibilities but I 
can see clear dangers that any or all of these proposals could, 
in subtle but certain ways, alter the character and functioning 
of the Federal Reserve in ways that would not be in the national 
interest. 

In closing, Mr. Chairman, let me return to the concept 
of the Fed's "independence within government", a phrase that I 
believe was originated by William McChesney Martin when he was 
chairman of the Board of Governors. For me, that seemingly 
simple phrase has always had a powerful meaning. In its 
simplicity it recognizes that the Fed cannot be insensitive to, 
much less indifferent toward, the judgments of elected officials 
in either the executive or legislative branches. At the same 
time the phrase also recognizes that the Fed must be in a 
position where it can make the hard decisions required of any 
credible central bank free from the vagaries of short-term 
political pressures. Raising interest rates, for example, is 
never going to be a popular decision but there are times it must 
be done. When those inherently unpopular decisions are made, the 
interplay between the Fed and the executive branch, coupled with 
the Congressional oversight process, provide ample opportunities 
and instrumentalities through which accountability can be, and is 



169 



being, maintained in a manner that is in keeping with the 
tradition of central bank "independence within government" in 
that highly pluralistic society of which I spoke earlier. 
Thank you. 



o 



BOSTON PUBLIC LIBRARY 

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