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Statements to the Congress.

Statements to the Congress Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, in Chicago, Illinois, before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, May 14, 1990.

I am pleased to appear before the submcommittee this morning. The issues you are raising are both wide-ranging and of immense importance to the evolution of the financial system. I could not possibly do justice to all of them this morning. What I will attempt to do, and what I hope will be useful to you, is first to describe the global environment in which U.S. financial firms are likely to be operating over the foreseeable future. Against this background, I will comment on the effectiveness of U.S. banks' competition today and will then discuss some policy implications. I will also comment briefly on competition in securities and financial futures markets and on proposals to change regulatory jurisdiction in these markets.


Globalization and interdependence are becoming the dominant elements of word finance. Foreign-based financial intermediaries play an increasingly prominent role in U.S. financial markets, and foreign investors are adding to their already significant holdings of U.S. financial and other assets. The volume of transactions by foreigners in U.S. securities markets has increased even more dramatically than foreign holdings. For example, foreign purchases and sales of U.S. Treasury securities surpassed $4 trillion on a gross basis in 1989, up from $100 billion to $200 billion early in the decade. Similary, foreign purchases and sales of U.S. corporate stocks and bonds have been running dramatically above rates eearly in the decade. U.S. purchases and sales of foreign stocks and bonds also increased sharply during the 1980s, as did the activities abroad of U.S. financial intermediaries. This surge in cross-border financial transactions has paralleled a large advance in the magnitude of cross-border trade of goods and services.

A key factor behind these trends in international trade and securities transactions is a process that I have described elsewhere as the "downsizing of economic output." By this I mean that the creation of economic value has shifted increasingly toward conceptual values with decidedly less reliance on physical volumes. Today, for example, major new insights have led to thin fiber optics replacing vast tonnages of copper in communications. Financial transactions historically buttressed with reams of paper are bieng progressively reduced to electronic charges. Such advances not only reduce the amount of human physical effort required in making and completing financial transactions across national borders, but facilitate more accuracy, speed, and ease in execution.

Underlying this process have been quantum advanced in technology, spurred by economic forces. In recent years, the explosive growth in information-gathering and processing techniques has greatly extended our analytic capabilities of substituting ideas for physical volume. The purpose of production of economic value has not changed and will not change. It will continue as before to serve human needs and values. But the form of output increasingly will be less tangible and hence more easily traded across international borders. It should not come as a surprise, therefore, that in recent decades the growth in world trade has far outstripped the growth in domestic demand for goods and services. This development, or necessity, implies that on average the share of imports as a percentage of gross domestic product has grown dramatically worlwide. Since irreversible conceptual gains are propelling the downsizing process, these trends almost surely will continue into the twenty-first century and beyond.

New technology--especially computer and telecommunications tecnology--is boosting gross financial transactions across national borders at an even faster pace than the net transactions supporting the increase in trade in goods and services. Rapidly expanding data processing capabilities and virtually instantaneous information transmission are facilitating the development of a broad spectrum of complex financial instruments that can be tailored to the hedging, funding, and investment needs of a growing array of market participants. These types of instruments were simply not feasible a decade or two ago. Some of this activity has involved an unbundling of financial risk to meet the increasingly specialized risk management requirements of market participants. Exchange rate and interest rate swaps, together with financial futures and options, have become important means by which currency and interest rate risks are shifted to those more willing to take them on. The proliferation of financial instruments, in turn, implies an increasing number of arbitrate opportunities, which tend to boost further the volume of gross financial transactions in relation to output and trade. Moreover, these technological advances and innovations have reduced the costs of managing operations around the globe and have facilitated international investment.

Investment considerations also are playing an important role in the globalization of securities markets. As the economy of the United States become increasingly intertwined with foreign economies, it is to be expected that both individual investors and institutions will raise the share of foreign securities in their investment portfolios. Such diversification provides investors a means of protecting against the prospect of depreciation of the local currency on foreing exchange markets and against domestic economic disturbances affecting asset values on local markets. As international trade continues to expand more rapidly than global output and as domestic economies become even more closely linked to those abroad, the objective of diversifying portfolios of international securities will become increasingly important. Moreover, since the U.S. dollar is still the key international currency, such diversification has been, and may continue to be, disproportionately into assets denominated in the dollar. For the same reason, many foreign financial institutions find it beneficial to be represented by banking offices in this country so that they can play an intermediary role based in dollars.

Another factor facilitating the globalization of capital markets and the growth of foreign investments in the United States has been deregulation here and abroad. Technological change and innovations that have tied international economies more closely together have increased opportunities for arbitrage around domestic regulations, controls, and taxes, undermining the effectiveness of these policies. Many governments have responded by dismantling increasingly less effective domestic regulations designed to allocate credit and by removing controls on international capital flows, relying more heavily instead on market forces to allocate capital.

The globalization of capital markets offers many benefits in terms of increased competition, reduced costs of financial intermediation benefiting both savers and borrowers, more efficient allocation of capital, and the more rapid spread of innovations.


A proper assessment of how well U.S. banks are competing today in the new globally competitive setting must recognize several points. First, U.S. banks are not all alike. In particular, only a very small subset of U.S. banks is active internationally. Second, among those internationally active banks, the extent to which they are competitive varies across products and over time. Third, particularly with the considerable intermediation involving foreign lenders and borrowers in this country and U.S. lenders and borrowers abroad, it follows that simple measures of competitiveness based on gross assets of national banking systems must be interpreted with care. Let me elaborate on these points.

We have nearly 10,000 banking organizations in this country--treating a multibank holding company as one firm. They vary significantly in terms of size, the nature of their business, and the areas they serve.

The great bulk of U.S. banking organizations, by number, are fairly small, functioning as intermediaries largely between local savers and local household and business borrowers. However, some of these local banks have become quite large and have evolved into sizable regional banks. The regional, or superregional, banks draw on a large base of core retail deposits and serve needs of retail borrowers in their regions, but they also do a large and growing corporate business. These banks generally are strongly capitalized and so can support growth in their portfolios. It is these banks that have experienced the fastest growth in the United States over the past decade, benefiting importantly from existing interstate banking compacts.

International banking--that is, involving transactions that extend across geographic borders--has not been an important business for regional banks. International assets typically have been less than 5 percent of a regional bank's total assets. Instead, international banking is, and has been, concentrated in a small number of U.S. banks. Four out of the 10,000 U.S. banking organizations account for roughly half of international assets; ten of them account for a little more than 80 percent.

For those banks involved in it, the nature of international business has changed. As I noted previously, technological innovations, as well as the need for large investors and borrowers to protect themselves against the increased volatility in asset prices that we experienced in the 1980s, have led to an unbundling of financial products. With this unbundling and the more efficient dissemination of information, the value of the banking franchise--to the extent that it was based on a unique role in evaluating credit risks--has eroded. The international role of the banks has changed from one of simply extending credit to one of facilitating transactions. Partly for this reason, and partly also to economize on costly equity capital, U.S. banks have tended to cut back on those activities that result in assets that must be booked on a balance sheet. For example, they have chosen to reduce drastically their interbank lending business, which is essentially a high-volume, low-spread business. U.S. banks have devoted their resources instead to banking services that often do not result in assets held by the bank. These activities, such as risk management involving relatively high-tech, sophisticated products, are also the areas in which U.S. banks remain among the world's leaders.

Outside the banking arena, our markets for securities and securities derivatives--most notably futures and options--also have become part of a globally integrated marketplace. In these areas, especially in the financial futures markets, we have been world leaders, developing new and highly popular risk-shifting instruments along with generally sound clearing and settlement systems. Today, most major international financial markets depend on futures and options for enhancing liquidity and, in the case of futures, price discovery. In the period just ahead we are likely to remain in the vanguard of financial innovation, especially through the introduction of new electronic trading systems such as the Globex and Aurora systems being developed by the Chicago Mercantile Exchange and the Chicago Board of Trade respectively. However, as in the area of banking, global competition has become intense in the markets for securities and derivatives, and we cannot be assured that our lead in these markets will be preserved.

It has become commonplace to express concern about the increasing share of U.S. banking markets that is controlled by foreign banks or the declining standing of major U.S. banks in international rankings of the world's largest banks. However, measures of total assets, or market shares related to particular national markets, can be very misleading as measures of international competitiveness, partly for reasons I have already mentioned: Only a handful of U.S. banks are internationally active, and a significant element of their international business does not show up on their balance sheets. Moreover, banks' operaitons can be booked at locations throughout the world, and the large businesses that borrow from foreign banks in the United States themselves operate around the world and can and do borrow from the same lenders at many spots on the globe.

Nevertheless, some have argued that U.S. banks are becoming less competitive as a result of the increasing relative size of their foreign banks rivals. While it is important to make sure that we understand why foreign banks have grown relatively quickly, there is no evidence in the professional literature that the size of an internationally active bank by itself has a significant bearing on a bank's costs or efficiency. To be sure, that literature has not specifically addressed the possibility that some economies of scale could be realized by extremely large banks. But even if so-called economies of superscale exist, such economies would need to be of significant magnitude to draw inferences about competitiveness among major internationally active banks. Our research suggests that cost controls and differences in management across banks of the same size are more relevant for competitiveness than any economies of superscale are likely to be.

Having said that, I hasten to confess that I cannot offer you satisfactory alternative measures of competitiveness. Conceptually, I believe that profitability, as measured by rates of return on equity or assets, is a proper measure of competitiveness. In practice, it is difficult to obtain comparable, up-to-date data on banks from various countries or to adjust the data we do have for differences in tax or accounting systems. It would be necessary also to adjust realized rates of return for risk; banks can realize higher rates of return at least over some period of time by engaging in riskier activities, but of course those returns are likely to be more volatile.

However, rather than dwell on comparing the competitiveness of U.S. banks versus foreign banks, I suggest that it is more important to focus on the performance of U.S. banks themselves. From the perspectives of the U.S. financial system, of shareholders of U.S. banks, and, most important, of U.S. consumers of financial services, it is desirable that U.S. banks be operated in as low cost and efficient a manner as possible, subject to concerns about their safety and soundness. This would be true even if U.S. banks already were the most competitive banks in the world. If we get bogged down in struggling to make comparisons of competitiveness, policymakers risk losing sight of the fundamental need to ensure that government policy does nto hinder but rather enhances in an absolute sense the competitiveness of U.S. banks and other financial firms.


What, then, can the government do to enhance the competitiveness of U.S. banks? Perhaps the most important thing to do is to reduce the cost of capital to U.S. banks. By the cost of capital, I mean broadly the cost to a bank of raising equity and debt, or more precisely the real pretax rate of return that it must pay to attract debt and equity funds to finance its portfolio of assets. It is often argued that U.S. banks are at a competitive disadvantage because their cost of capital is more than that of their foreign rivals.

For example, the Japanese stock market places very high price-earnings ratios on Japanese equities, and some have argued that the resulting lower cost of equity capital gives Japanese firms a competitive edge over U.S. firms. However, the use of different accounting conventions in Japan tends to understate Japanese firms' earnings relative to earnings of U.S. firms and hence to overstate price-earnings ratios in Japan. Minority interests are not completely consolidated in Japanese financial statements. Japanese firms issue the same report for tax purposes and for stockholders, so that their financial statements fully reflect the maximum deductions from earnings for such items as depreciation that can be taken for tax purposes; in contrast, U.S. firms issue different reports for tax purposes and for stockholders. Japanese share prices also reflect considerable cross-holdings of equities and of land, both of which have risen sharply in value in recent years without contributing commensurately to reported earnings. It remains to be seen whether the weakening earlier this year in Japanese stock markets is signaling an end to such increases, but in any event the benefits of such holdings will not be captured in earnings unless the assets are sold.

However, even after adjusting for accounting differences, one is left with real economic differences. Besides Japanese firms' holdings of equities and land, analysts point to the high Japanese savings rate, an expectation of strong growth of earnings, and more generally, the overall macroeconomic performance of Japan. These latter economic differences are under the influence of the policymakers. I, among many others, refer often to the substantial decline in the national savings rate in the United States. All other things being equal, our lower savings causes a higher real interest rate, raising the cost of capital in the United States and lowering private investment. Although higher real interest rates themselves may encourage more private savings, reducing our fiscal deficit would be a more certain way to add to savings available for private investment, lower the cost of capital, and thereby increase the potential competitiveness of U.S. financial and nonfinancial firms.

Government policy also has a constructive role to play in avoiding macroeconomic instability. If investors think that U.S. banks, for example, face a more risky macroeconomic environment, they will expect lower or less stable earnings and, therefore, will be willing to pay less for each dollar of such earnings.

Beyond changing the macroeconomic environment, the government should consider structural policies that could also help the competitiveness of U.S. banks. For example, there is reason to believe that the opportunity for a bank to diversify the products or services it offers or to diversify geographically may, in some cases, raise its rate of return and lower its risk. In addition, our laws greatly inhibit the ability of U.S. banks to evolve along with technological and other changes and to achieve the synergies that come from producing multiple, but similar, products and services. Particularly burdensome in this regard is the Glass-Steagall Act. There has been some liberalization in recent years both in geographic restrictions, through regional banking compacts, and in securities activities, through section 20 securities subsidiaries. But the ad hoc nature of this process of liberalization is not a desirable way of approaching significant structural reform. The Federal Reserve has supported, and continues to support, congressional efforts to address these matters in a more systematic way.

We also are facing important regulatory issues in the area of securities markets, in particular jurisdiction over securities and their financial futures and option derivatives. Some have argued that existing split jurisdiction over securities and derivatives--with the SEC having regulatory authority over securities and securities options and the Commodity Futures Trading Commission (CFTC) having regulatory authority over financial futures and options on such futures--has added to volatility in these markets. The Board has not found convincing evidence to support this view nor have we found convincing evidence that differences in margin treatment across these instruments--another frequent assertion--have contributed to price volatility. However, as I have noted in other congressional testimony, we do see a role for federal oversight of margins on equities index futures and equity-related options to ensure that margins are maintained at levels that are adequate for prudential purposes.

All of the frequently mentioned proposals for jurisdictional reform in this area--transferring equity index products to the SEC, transferring all financial futures to the SEC, and merging the two agencies--have important costs that must be weighed carefully against any potential benefits. For our part, we are concerned about any jurisdictional restructuring that would limit innovation, a danger that rises as jurisdiction becomes concentrated in a single regulatory authority. We also are concerned about existing impediments to innovation in this area, in particular, the so-called exclusivity provision of the Commodity Exchange Act. As the Board has already noted, we favor changes to this provision that would enhance the process of financial innovation without compromising the original objectives of the act.

Competitiveness of U.S. financial firms and markets also is affected by those rules and regulations that can impinge on costs. Examples include noninterest-bearing reserve requirements, deposit insurance premiums, capital standards, antitrust laws, consumer protection laws, and laws to deal with money laundering. I am not suggesting that they be abandoned simply because they impose costs on banks. What I am suggesting, however, is that we be cognizant of such costs when we weigh the benefits of our policies in terms of our other objectives. Social and regulatory policies are not free, no matter how desirable they may be perceived to be.

On the bank supervisory side, we are proceeding with the implementation of the risk-based capital standards that were negotiated in Basle. Efforts also are under way to coordinate other aspects of supervisory policy, with respect to both banking and other financial services. As banking and other financial services become increasingly indistinct, banking and securities supervisors must work more closely together. The aims of such coordination are basically twofold. One is to monitor and ultimately guard against risks to the financial system--risks that are becoming increasingly global and complex in nature. The other is to minimize the extent to which legitimate prudential concerns distort the opportunities for different kinds of financial firms, from different countries, to compete fairly with one another.

That leads me to my final point. We should continue our informal and formal, bilateral and multilateral, efforts to open domestic markets abroad to U.S. and other foreign banks, both in terms of access and scope of activities. Much progress has been made in this area over recent years, in large part, I believe, because the worldwide process of financial integration I discussed earlier is forcing a liberalization of markets. In some instances, diplomatic initiatives on our part may also have affected the nature of that progress or its timing; such efforts should continue.

In this regard, however, it would clearly be counterproductive to close our own markets to foreign competition merely because foreign markets are less open than we would like. Such an action would invite retaliation and would not be very effective in any case. The globalization of financial markets means that most of the business that foreign banks do with U.S. customers could alternatively be done offshore. To the limited extent that closing of our markets to foreigners was effective, and that U.S. firms were thereby protected from foreign competition, the result would be reduced pressure on U.S. banks and on U.S. policymakers to implement the policies and management procedures necessary to improve the underlying competitiveness of U.S. banks. In the long run, this would clearly be harmful to the best interests of both U.S. consumers and U.S. producers of financial services.

Chairman Greenspan presented similar testimony before the Task Force on the International Competitiveness of U.S. Financial Institutions, Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, April 4, 1990.

Statement by John . LaWare, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Consumer and Regulatory Affairs of the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, May 16, 1990.

Thank you very much for this opportunity to speak to the subcommittee in follow-up to our testimony on mortgage lending discrimination last October. I am pleased to report to you on the progress made on initiatives envisioned at that time, as well as other activities developed more recently through the Federal Reserve System's ongoing programs to ensure equal access to housing credit and to promote private sector reinvestment in low and moderate income communities.

On an interagency level, our efforts have been focused for the past several months on two major fronts, both of which have important implications for our work in enforcing fair housing and fair lending laws. The first involves changes in the Community Reinvestment Act (CRA), under which the agencies have been charged with encouraging financial institutions to help meet the credit needs of their entire communities, for example, for housing, small business, and rural economic development, and with assessing their performance in doing so. Traditionally, those CRA assessments, like all other findings reached by the agencies during the course of examination, have been kept strictly confidential as part of the supervisory dialogue between us as regulators and the institutions we supervise.

Starting the examinations conducted on or after July 1 of this year, that tradition will be broken in a dramatic way. Provisions contained in the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) require the agencies to preparde and to make public written evaluations of institutions' CRA performance, based on our examination findings, along with the ratings assigned using a descriptive, fourtiered rating system. This mandate makes clear the need for a concerted effort by all four agencies, under the umbrella of the Federal Financial Institutions Examination Council (FFIEC), to take a uniform approach to assigning ratings, presenting the evaluations in a consistent, readily understandable manner and ensuring that the public has access to these evaluations.

That is precisely what we have tried to do, through the efforts of the FFIEC. The FFIEC spearheaded the development of draft guidelines for implementing the CRA changes, which were issued for public comment last December. In light of input received from community organizations, financial institutions, members of the Congress, and others, the guidelines were finalized by the FFIEC last month, and it is currently putting on an extensive training program and revising the interagency examination procedures for CRA.

At the same time, work proceeded on equally significant changes to the Home Mortgage Disclosure Act (HMDA), which expand the coverage of the act to include mortgage lenders not affiliated with depository institutions or holding companies--effectively bringing all types of mortgage lenders in the United States under the act. The scope of data collected has also been expanded to include the race, sex, and income of borrowers and loan applicants, as well as the disposition of applications (approval, denial, or withdrawal by the applicant). These provisions should better equip us to determine whether mortgage credit standards are being fairly applied, and to judge a given lender's efforts in the context of a more complete picture of the entire mortgage market. Because the Federal Reserve Board has rulewriting responsibility for the regulation-implementing HMDA, Board staff members worked closely with staff members from the FFIEC agencies and from the Department of Housing and Urban Development (HUD) to draft the regulatory amendments and to develop a new loan register format designed to make the increased reporting requirements less cumbersome for lenders. After receipt of public comment, final amendments to HMDA were issued by the Board last December and became effective on January 1, 1990.

Our job with respect to implementing the new HMDA provisions has yet another phase, however. For the many years since HMDA's enactment in 1975, the Board has acted as the agent for the FFIEC to compile and aggregate the data and to produce tables that present lending patterns by factors such as the racial composition and income characteristics of the neighborhood as well as the age of the housing stock. Anticipating a significant increase in the volume of data to be reported next year for 1990, we are working to enhance our data processing capabilities, to encourage electronic submission of data from lenders through our Federal Reserve Banks to expedite its ultimate availability to the public, and to develop new disclosure formats to give a concise presentation of lending patterns using the new data.

These changes to both the CRA and the HMDA represent a considerable challenge for us. We are very much aware that the public disclosure provisions make the CRA examination process subject to greater scrutiny than ever before. It will be incumbent on our examiners to discuss each of the assessment factors relating to the state member bank's performance--including the assessment factor relating to discrimination or other illegal credit practices--and to show how each factor affects overall performance. They must fully justify their conclusions and assigned rating, without divulging the institution's financial condition, information about its employees or customers, or anything elese the law instructs us to keep confidential. The new HMDA data promise to be valuable in the rating process, but usefulness will largely depend on the examiners' ability to analyze it and to draw appropriate conclusions from it.

A major step toward meeting the challenge is the interagency examiner training program being carried out this month at four locations nationwide. It involves eight sessions for approximately 800 examiners from the bank regulatory agencies. The training gives examiners guidance on how the disclosures should be prepared, how the rating system should be applied, and it emphasizes the rating system should be applied, and it emphasizes the importance of thorough, insightful, and well-supported evaluations.

While the spotlight is sure to fall on the work of our examiners after July 1, to an even greater degree the attention will fall on financial institutions themselves, and how well they are, or are not, helping to meet local credit needs. The new CRA and HMDA provisions come at a time when public concern for affordable housing, the adequacy of financial services within reach of the less affluent, the problems of economic development and growth, and the need to assure fair lending practices run high. Their combined impact in puttting more information in the public domain will, we hope, foster a more open and productive dialogue about such concerns between financial institutions and the people they serve. We are also hopeful that the impact will bolster institutions' awareness of both their image and record as a fair lender and will further our efforts to promote compliance withe the letter and spirit of the antidiscrimination laws.

Putting in place the changes mandated by FIRREA and the examiner training sessions has consumed a great deal of the agencies' staff time, especially those having experrise in the fair lending and fair housing arena. Nevertheless, we have moved ahead on other interagency initiatives that I outlined when I last appeared before the subcommittee.

Through the FFIEC, the agencies have begun to take a close look at the concept of mortgage review boards, which bring together lenders and community representatives to provide an appeals mechanism in cases in which applicants feel that they have been unfairly denied credit for purchasing a home. As a first step, inquiries were made through the agencies' field offices around the country to determine the extent to which mortgage review boards exist. Follow-up visits were then made to Massachusetts and Michigan (the two states in which functioning boards were identified) to learn how they operate, the kinds of support they require, and the degree of success that each has achieved. The FFIEC is reviewing the information gathered to explore whether, and how, the information of such boards should be encouraged on a wider scale. Initially a matter of concern is the very small number of appeals that have been brought forward in the experience of both states, and whether other, quite different localities around the country would be receptive to the notion.

In the course of its study, the FFIEC's attention was drawn to a somewhat similar vehicle that may have favorable prospects for replication in other communities. Under the Philadelphia Mortgage Plan (PMP), a group of large commercial banks agreed to refrain from rejecting mortgage applicants until the credit committee representing all PMP lenders has an opportunity to review the case and, if possible, place the loan with one of the other participating lenders. The lenders also offer "creative" mortgage products by providing some flexibility in underwriting criteria, such as considering rent receipts, landlord references, and utility bill payments to help establish credit histories. In its fifteen years of existence, the plan has secured loans for 13,000 families totaling $180 million, and was expanded to cover the entire Delaware Valley in January of this year. The FFIEC is committed to exploring this approach, as well as others that have worked well in widening access to mortgage credit in lower income and minority neighborhoods.

Another focus of our initiatives is education--for consumers as well as for lenders--on their rights and responsibilities under the law. Federal Reserve Board staff members are in the process of drafting a brochure designed to better acquaint potential homebuyers with the mortgage origination process, the factors lenders usually consider in determining whether a person is creditworthy, and the statutory protections and agency procedures that provide recourse to those who believe they have been subjected to unlawful discrimination. The FFIEC has also approved plans to produce a brochure targeted to mortgage lenders discussing how to avoid practices that may, even unintentionally, result in unfair lending patterns, or the appearance of them. We anticipate that both brochures will be ready for distribution in the second half of this year.

The emphasis on consumer education stems, at least in part, from our concern about the very small number of complaints that we and our sister agencies have received over the years alleging illegal credit discrimination. in an effort to make our work in investigating and responding to such complaints more visible, we have written to several hundred fair housing and civil rights-oriented groups to reacquiaint them with our role in enforcing the legal protections afforded loan applicants, and to seek their cooperation in referring complainants to us.

Our testimony last October voiced the belief that much could be gained by the agencies sharing among themselves the information obtained through interviews with community contacts--including consumer advocacy and housing organizations, local business people, trade associations, realtors, government officials, and many others--during the course of CRA examinations. Their perceptions about the state of the local economy, what types of credit would most help the community grow nad prosper, the role played by financial institutions in addressing credit needs, and whether credit is available to minority and low- and moderate-income persons have proved valuable to examiners in making a balanced assessment of CRA performance. I am pleased to say that the FFIEC has approved going forward with procedures for facilitating that flow of information.

We believe that we should aim not only to share the information we develop among fellow regulators but also to communicate effectively with institution management about what we find in analyzing their lending data. This effort takes on particular importance in light of the recently expanded HMDA requirements and the additional insight regarding lending patterns that the data should provide. With this in mind the FFIEC has approved an initiative to make better use of the HMDA data. Additionally, we are working to develop what might best be termed an "executive summary" of HMDA data--a succinct presentation of a given institution's mortgage and home improvement lending patterns broken down by demographic factors such as race and income, and compared with the record of lenders as a whole in the community. This summary could be conveyed to institution management during a CRA examination. By providing such a profile, we hope to draw management's attention to market segments the institution may be failing to reach, and to prompt a thorough self-assessment of geographic lending patterns and th ereasons for them. Because it is being developed in tandem with the computer applications to accommodate the new HMDA data, the summary probably will not be completed until 1991, although Board and Reserve Bank staff have been testing for several months the use of a very preliminary model. We have also revised the FFIEFC publication, A guide to HMDA Reporting: Getting it Right!, to facilitate accurate reporting under the law's new requirements.

Besides these interagency initiatives, the Federal Reserve System has, on its own, been utilizing various avenues to strengthen our enforcement efforts and to bring constructive approaches to resolve fair lending concerns to the forefront of public attention. For example, the Federal Reserve Board has continued to monitor closely developments in Atlanta, Detroit, and Boston. This effort has taken several forms. First, the Board has updated the statistical analysis presented in the Atlanta and Detroit newspapers to take account of the availability of more recent HMDA data. The 1987 and 1988 HMDA data continue to show dispartiies in home mortgage and home improvement lending. As before, predominately white middle-income neighborhoods received more home purchase loans per single family housing unit than did predominately minority middle-income areas, whiel the opposite pattern holds for home improvement loans. However, as we have indicated in prior testimony, while these patterns are suggestive of lending problems in the home purchase area, they do not allow one to conclude whether discrimination exists or not.

The Board, with the assistance of Reserve Bank staff, has also begun work on a new on-line consumer complaint and inquiry tracing system to be implemented in early 1991. We envision that the new tracing system will enhance the Board's ability to monitor and analyze its consumer complaint and inquiry data, including data involving allegations of illegal credit discrimination. We expect that the new system's reporting capabilities will enable us to spot more easily trends that might involve such practices.

We are using the resources of our Reserve Banks in a number of ways. The Federal Reserve Bank of Atlanta has developed a computer model that illustrates how various lending parameters affect the affordability of home loans in connection with the lending consortium established for low- and moderate-income residents of Atlanta. The Federal Reserve Bank of Boston, together with the Boston Federal Home Loan Bank, recently cohosted a symposium of the National Association of Affordable Housing Lenders attended by more than 300 lenders from New England as well as others from throughout the country. Last year the Federal Reserve Bank of San Francisco was instrumental in the creation of the California Community Reinvestment Corporation (CCRC), a lender consortium pooling more than $100 million to provide long-term loans for affordable housing development throughout the state. With the California consortium off to a successful start, senior management and staff members of the Reserve Bank have been invited to Hawaii and Nevada to help bankers and community organizers launch similar programs in those states. Late last year, the federal Reserve Bank of Chicago convened a seminar with some 250 area bankers to discuss specific CRA-related policies and activities that have worked well in that Federal Reserve District. In Philadelphia, the Federal Reserve Bank is planning to produce a video that will share some of the experiences and lessons learned relating to the CRA. This is but a sample of the activities of Reserve Banks undertaken in the past six months to promote sound and creative lending that is responsive to the special needs of low and moderate income communities. At the Board level, besides the initiatives discussed above, Board staff members have been participating in a series of HUD seminars dedicated to fair housing-fair lending issues at law schools.

We have also enlisted the help of the Federal Reserve's Consumer Advisory Council. In selecting new members this year, we gave special attention to adding council members who have expertise in the civil rights area. One of the new members, Bernard Parker, testified of your hearing last October. He is executive director of Community Resource Projects, a human services organization based in Detroit that helps economically depressed individuals. Mr. Parker is also Chairman of the Ad Hoc Coalition on Fair Banking Practices in Detroit, which was actively involved in a recent financial settlement with banks calling for reinvestment in low-income neighborhoods.

The Board also appointed to the council George C. Galster, Professor of Economics at the College of Wooster. Professor Galster is widely recognized as an expert in discrimination issues. He has been an expert witness and consultant in fair housing disputes and currently is a research consultant for the Metropolitan Milwaukee Fair Housing Council. He also serves on the advisory board for the HUD National Housing Discrimination Survey.

A special committee of the Consumer Advisory Council is looking into various aspects of the issue, including mortgage review boards, examination processes and examiner training, the use of testers, additional studies, and brochures that give guidance to lenders. Over the years we have often received helpful input from the council, and we feel fortunate to have this resource to assist us in this difficult area.

We have also sought to draw on the expertise of individuals and groups outside the bounds of the federal financial regulatory framework to gain a fresh perspective on our enforcement activities. Members of our staff have been in contact with representatives of the National Fair Housing Alliance to arrange for a briefing on their experience with credit discrimination cases. I have personally met with representatives from a civil rights group from Boston that was active in working with the Massachusetts bankers Association on an ambitious housing and economic developmetn program that is an outgrowth of the Federal Reserve bank of Boston's mortgage discrimination study. We have consulted with the Department of Justice about its experiences in civil rights enforcement and its investigation, now in progress, of housing lending practices in Atlanta.

In line with the subcommittee's questions regarding our enforcement program (our detailed responses to the committee's questions accompany our testimony), we have taken a close look at our examination and consumer complaint experience over the past three years. In particular, we have completed a detailed analysis of System enforcement activity involving serious violations of the Fair Housing and Equal Credit Opportunity Acts by reviewing our examination and consumer complaint data bases. Additionally, we have asked experienced staff at the Reserve Banks for the types of problems that they are seeing involving the Fair Housing and Equal Credit Opportunity Acts and mortgage lending in particular. As we said at the October hearing, state member banks do not play a major role in the granting of mortgage credit in the United States. Examiners routinely review available mortgage lending data, including lending standards and appraisal practices. While we find violations during examinations and receive a few complaints involving the fair lending statutes, they typically involve marital status issues, such as improperly required spousal signatures. Only in very isolated cases do we find practices that involve racial discrimination in lending. From our discussions with examiners we know that they take their work and the issue of possible racial discrimination very seriously. They have been, and will continue, evaluating quite closely any questionable lending practices that could "effectively" result in subtle discrimination. We will continue to monitor our enforcement and complaint activities to ensure that practices involving possible racial discrimination are addressed and that corrective action is taken as needed. The new data and procedures I have mentioned above will help us in this effort.

In short, we have had our hands full in the past few months completing a number of major initiatives. And although we are in the early stages of development with others, we believe that they have considerable promise and will be pleased to report to you further on their progress.

Statement by Clyde H. Farnsworth, Jr., Director, Division of Federal Reserve Bank Operations, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, May 18, 1990.

I am pleased to appear before the Committee on Banking, Housing, and Urban Affairs to comment on proposed legislation related to money laundering.

The Federal Reserve places a high priority on supporting efforts to attack the laundering of proceeds from illegal activities. We provide all available currency flow data, at any level of detail, to all federal law enforcement agencies, upon request. Every month, we send cash flow reports to relevant Treasury and Justice Department organizations for use by their investigative and intelligence experts. Individual Federal Reserve offices have also been providing additional detailed depository institution data to the Customs Service, Internal Revenue Service, Drug Enforcement Administration, and others with a need to know. Also, we continually engage in a dialogue with federal law enforcement officials to ensure that the Federal Reserve's contribution to the government's efforts to combat money laundering activities is maximized.

In the regulatory area, financial institutions under our jurisdiction are continually subjected to Bank Secrecy Act compliance audits as part of our examination process. Besides enforcement actions we may initiate as a result of violations of the Bank Secrecy Act, we provide quarterly reports to the Department of the Treasury, which detail all Bank Secrecy Act violations discovered during the examinations of the financial institutions. Additionally, financial institutions under our jurisdiction are required to file a Criminal Referral Form when criminal activity, specifically including Bank Secrecy Act money laundering violations, is suspected. The Criminal Referral Forms are forwarded to the appropriate law enforcement agency for further action.

I am emphasizing the System's active role to illustrate how strongly the Federal Reserve is in accord with the same objectives that the Congress has in combating money laundering. We have reviewed the various legislative proposals, and we appreciate the opportunity to provide you with comments.



The Federal Reserve recognizes that it is necessary for financial institution regulators and depository institutions to take an aggressive role in the battle against money laundering. S.2327, as well as the legislation passed by the House, addresses charter revocation or insurance termination of depository institutions convicted of money laundering or a cash transaction reporting offense. We have previously stated that any proposed sanctions should take into consideration the nature of the violation and the effect of the sanction on the depositors and creditors of the institution, as well as ensuring that procedures for imposing any such sanctions take into consideration requirements for due process. S.2327 and the legislation passed by the House have addressed the concerns raised by the Federal Reserve.

When the Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, federal bank regulators were given significantly enhanced enforcement powers. An expansion of these enforcement powers as proposed in S.2327, coupled with the banking regulators' traditional cease and desist and removal authority, should assist banking regulators in their efforts to eliminate the ability of persons and institutions to continue the illegal practices and to deter others from engaging in illegal activities.


The Federal Reserve believes that it is important to oversee the activities of providers of financial services, including money transmitters, to ensure that they do not serve as a vehicle for avoiding the controls applicable to financial institutions. Nevertheless, the form of oversight must recognize the importance of these services to those segments of the community that might choose not to use banking services and ensure that the requirements do not discourage the availability of legitimate services. For example, Senator D'Amato's bill would prohibit banks from transferring funds for unregistered money transmitters. This prohibition may discourage banks from providing funds transfers for individuals or legitimate businesses when the bank is unsure as to whether the individual or business is engaged in the business of transmitting funds. When a bank is aware that a customer is engaged in that business, it will be unable to effect funds transfers before checking with the Treasury Department to determine whether the customer has registered with the Treasury.


The design of wire transfer recordkeeping requirements is a very complex and technical undertaking, with potentially significant ramifications on the efficiency of large-dollar wire transfer systems. If the Congress does adopt requirements in this area, we concur with the approach taken by both Senator D'Amato in his bill and by legislation passed by the House of Representatives. Section 7 of Senator D'Amato's bill directs the Department of the Treasury to adopt rules governing records of international wire transfers that would have a high degree of usefulness in government investigations and proceedings. The Board believes that a regulatory, rather than a statutory, approach provides the flexibility that is most often needed to adapt requirements to an evolving environment.

We believe that a particularly important element of the wire transfer provisions in both Senator D'Amato's bill and the House legislation is the direction to the Treasury to balance the regulation's usefulness to law enforcement with the effect of the ensuing requirements on the cost and efficiency of the payments system. These considerations should result in requirements that target those classes of international wire transfers that are most likely to be used in money laundering and that focus on the completeness of information that can be accommodated in existing wire transfer formats.


In closing, let me state that we realize that the Congress faces a difficult task of improving the ability of the law enforcement authorities to detect money laundering activities while, at the same time, protecting the public from overly intrusive and potentially harmful laws. Please be assured of the Federal Reserve's commitment to deter money laundering and to cooperate fully in providing assistance to law enforcement officials who are charged with the very important task of uncovering money laundering wherever it may exist.

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, U.S. House of Representatives, May 24, 1990.

It is a pleasure to appear on this panel today to discuss issues involving the regulation of securities markets. In my comments this morning, I would like to address the broad economic policy issues raised in your letter of invitation. I would prefer to pass on the questions relating to the more narrow, technical issues under the jurisdiction of the other agencies. I would like to focus my remarks on three major issues: (1) the adequacy of margin requirements on stock index futures as a prudential safeguard and the impact of existing margin-setting procedures and other differences in regulation on market volatility; (2) existing impediments to innovation; and (3) whether there is a need to modify the existing regulatory system for stocks and stock derivatives. My evaluation will be done against the objective of a regulatory structure that, while limiting risks to the system, results in highly efficient and innovative U.S. financial markets that can compete effectively in the global marketplace.

As i will discuss in more detail, the Board does not believe that the existing division of regulatory authority has increased volatility in the securities markets, nor in this regard is it a threat to the capital formation process. We continue to view the primary purpose of margins to be to protect the clearing organizations, brokers, and other intermediaries from credit losses that could jeopardize contract performance. While we think that federal oversight of margins is appropriate for prudential purposes, there are different views among board members on whether that authority is best vested in the Commodity Futures Trading Commission (CFTC) or in the Securities and Exchange Commission (SEC).

On the broader issue of consolidating jurisdiction for stocks and stock index futures (or all financial futures) in one agency, there are good arguments for and against such a consolidation and, accordingly, differences of views on whether such consolidation would, on balance, be beneficial. We believe some changes to the existing regulatory system are necessary to avoid the prospect that jurisdictional disputes among regulators will impede innovation in our financial markets, but consolidated of jurisdiction is not necessary to achieve this objective.


A prominent area of disagreement among those interested in the smooth functioning of our capital markets has been the appropriate level of margins for stock index futures and the need for federal authority over such margins. In part, these disagreements reflect different views as to the purposes of margins and the appropriate objectives of federal margin regulation. Accordingly, at the outset I would like to clarify the position of the Board of Governors on these issues.

We continue to believe that the primary objective of federal margin regulation should be to protect the financial integrity of market participants and thereby ensure contract performance. Margins should be adequate to protect clearing organizations, brokers, and other lenders form credit losses arising from changes in securities prices. As such, they are one important element of a package of prudential safeguards, including capital requirements, liquidity requirements, and operational controls, aimed at limiting the vulnerability of the financial markets to losses or disruptions arising form the failure of one or more key participants. The failure of, or even the loss of public confidence in, a major intermediary in any of the stock, futures, or options markets could immediately place significant strains on other markets, their clearing systems, and on our nation's payment system.

The Board remains skeptical, however, of whether setting margins on stock index futures at levels higher than necessary for prudential purposes will reduce excessive stock price volatility. We, too, are concerned about what seems to be a higher frequency of large price movements in the equity markets, but we are not convinced that such movements can be attributed to the introduction of stock index futures and the opportunities they offer for greater leverage. Although available statistical evidence on the relationship between margins and stock price volatility is mixed, the preponderance of that evidence suggests that neither margins in the cash markets nor in the futures markets have affected volability in any measurable manner. moreover, we are concerend that raising maintenance margins on stock index futures to levels well above those necessary for prudential purposes could substantially reduce futures market liquidity or drive business offshore.

Thus, in the Board's view, the critical question is whether margins on stock index futures have been maintained at levels that are adequate for prudential purposes. Although no futures clearinghouse has ever suffered a loss from a default on a stock index futures contract, certain actions by futures exchanges and their clearinghouses in recent years raise questionss about the adequacy of futures margins from a public policy perspective. Specifically, we have concerns about the tendency for these organizations to lower margins on stock index futures to such a degree in periods of price stability that they feel compelled to raise them during periods of extraordinary price volatility. While such a practice has heretofore protected the financial interests of the clearinghouse and their members, it tends to compound already substantial liquidity pressures on their customers, on lenders to their customers, and on other payment and clearing systems. In the Board's view, somewhat higher margin levels on stock index futures would obviate the need to raise them in a crisis and thereby reduce concerns about the reliability of our market mechanisms, especially clearing and payment systems, in times of adversity.

The Board believes that federal oversight is appropriate to ensure that margins on stocks and stock index futures are established at levels that are adequate under a wide range of market conditions. Futures self-regulatory organizations (SROs) should continue to have primary responsibility for developing and refining margin policies. But the appropriate federal agency should have both the authority to initiate changes in margins on stock index futures and the authority to veto changes proposed by the relevant SRO. That authority should not be limited to emergency authority such as the CFTC currently has over futures margins.

Either the CFTC or the SEC could play this role. The principal argument in favor of assigning oversight responsibility for stock index futures to the CFTC is that it has overall responsibility for prudential supervision of futures exchanges and clearing organizations and futures commission merchants (FCMs). Assignment of oversight responsibility to the CFTC would avoid certain regulatory burdens and potential conflicts that could arise if responsibility for critical aspects of prudential oversight of such entities were divided between the CFTC and SEC.

The principal argument for assigning oversight responsibility for stock index futures margins to the SEC is that it would foster consistency of margins in the stock and stock derivative markets. The Board believes that margins in these markets should be consistent in the sense that they provide comparable protection against adverse price movements. The degree of protection provided by margin requirements depends on the magnitude of potential future price volatility. Although studies of past price movements can shed light on potential movements in the future, the forecasting of future volatility necessarily involves elements of judgment. Because different agencies are likely to come to different judgments, there is a case to be made for having only one regulator with margin authority over all the equity products markets to achieve consistency of margins across these markets.

On balance, the Board does not see a clear basis for choosing between CFTC and SEC oversight of stock index futures margins. The Board feels strongly, however, that authority should not be given to the Federal Reserve because it does not have overall prudential responsibility for any of the futures commission merchants (FCMs), broker-dealers, or clearing organizations that margins are intended to protect. The existing margin authority for stock and stock options assigned to the Board under the Securities Exchange Act of 1934 should be transferred to the SROs and the SEC.


The question of regulatory responsibility for margins is one element of the broader question of regulatory jurisdicton over futures and options markets. In light of the strong linkages among the markets for futures, options, and their underlying instruments, some have argued that the division of oversight responsibilities among agencies may impede the effective regulation and supervision that is essential to ensure sound and efficient financial markets.

One particular concern relates to volatility. It is frequently argued that leveraged trading in stock-index futures and options, encouraged by low margin requirements on derivative products, has led to increased volatility in the prices of the underlying stocks. More generally, it has been suggested that other inconsistencies in market mechanisms involving, for example, circuit breakers and short-selling rules, contribute to market instability. It is feared that increased price volatility, in turn, will reduce the attractiveness of equity markets and could impede the capital formation process. These concerns have prompted calls for one regulator who will take steps to remove inconsistencies that may contribute to sharp price swings.

The Board does not share the view that split regulatory authority over equity instruments has in any meaningful way contributed to volatility. As I noted earlier, we have found no substantial evidence linking margin levels to price volatility in the cash or the index-product markets. Nor have studies revealed a clear understanding of how circuit breakers and other market rules affect price movements in the different markets.

In a more fundamental sense, we believe that it is counterproductive to lay blame on one sector, in this case the market for stock index derivatives, for the increasing occurrence of wide and rapid price swings in equity markets. Rather, the volatility we observe reflects more basic changes in economic and financial processes prompted by technological advances and the increasing concentration of assets in institutional portfolios. The delegation by the public of the management of a large proportion of its assets to professional managers through pension funds and other institutions and the desire of these managers for low-cost methods to manage risk and adjust portfolios has spurred growth in the new instruments; improvements in telecommunications and computer technology mean that information on economic fundamentals will be received and translated by these managers more quickly into market prices. To the extent that price movements reflect these basic forces, efforts to restrain volatility by imposing more restrictions on particular markets or instruments could have unintended effects, resulting in significant costs on the system and a shifting of transactions activity offshore.

A second issue frequently raised in evaluating the adequacy of our current regulatory system concerns product innovation. Many of the new products being developed on futures and options markets are not easy to classify. They have important similarities to, or are otherwise linked to, a variety of existing instruments subject to different regulators; and, as a consequence, various uncertainties and frictions have emerged about the appropriate exchanges that should trade these instruments and the agencies that should provide regulatory oversight. One recent example involves the "index-participation" or IP contracts that were introduced by several of the stock exchanges, approved by the SEC for securities trading and, in essence, disapproved when the courts ruled that IPs were futures products subject to the exclusive jurisdiction of the CFTC and could not be traded off exchanges regulated by the CFTC.

Under the Commodities Exchange Act (CEA), any commodity contract with an element of futurity cannot be entered into except on a CFTC-regulated exchange. Moreover, this act defines the term "commodity" very broadly to include not only physical commodities, like corn and wheat, but intangible contractual interests, including financial instruments. This restriction, when interpreted broadly, serves to discourage the development of new financial products that might be offered outside of the futures exchanges and tends to stifle the innovation process. In a very general sense, all financial instruments have an element of futuriy in them, in that their value depends on future events. We believe that the CEA can be modified in ways that preserve the public safeguards that motivated this provision, while preventing conflicts in this area from haviang to be dealt with by the courts and without impeding the process of innovation in equity and other instruments. Such modifications might include an exemption for transactions subject to other regulatory safeguards, sophisticated trader exemptions, or more stringent fraud liability.


As I have noted, a case can be made for having only one federal agency with oversight authority over margins in the equity and equity derivative markets. This case rests not on the issue of volatility but on the fact that setting prudential margins requires judgments concerning potential future price volatility in the linked markets for stocks and derivative products. One regulator would provide a single view of potential future volatility in these markets and thereby foster consistency of margins across the various segments of the equity markets. Others would go further and transfer all regulatory authority over stock index futures and options on such futures to the SEC. Such an approach recently has been proposed by the Administration.

This alternative would help achieve consistent prudential regulation across these tightly linked markets for equity instrumetns. However, a measure of this sort would result in two regulators of futures exchanges and futures clearinghouses, and hence would stil require a considerable amount of coordination on the part of the SEC and CFTC. One must recognize that stock index futures are but one of many futures contracts offered by these organizations--indeed, only one of many financial futures contracts. Should losses from stock index futures trading--to be subject to SEC regulation under this alternative--jeopardize the financial integrity of a clearing organization or futures brokerage firm (FCM), it would threaten contract performance on all of the futures traded by the entity, including tangible commodity futures. Similarly, a failure in the commodity futures markets could, because of the effects on the clearing organization or brokerage firm, have consequences for the equity markets. In another area, many exchange rules related to trading and clearing cut acrtoss a wide range of contracts rather than being specific to stock index contracts, and close coordination between the SEC and CFTC would be important in evaluating such rules.

Thus, the SEC would have an important interest in other aspects of futures market regulation while the CFTC would continue to have a strong interest in the regulation of stock index futures. The logic of transferring stock index futures to the SEC because of their tight linkage to the cash market suggests that futures contracts on other instruments also might be regulated differently. That is, Treasury futures would be regulated by the Treasury and Eurodollar and foreign currency futures by the Federal Reserve. Such a change, however, would increase the regulatory fragmentation in the securities markets and would not appear to be a particularly useful realignment. Consequently, the benefits of transferring regulatory jurisdiction to the SEC for purposes of achieving more consistency of regulation across equity instruments must be balanced against these drawbacks, and there is scope for legitimate differences of view on whether such a measure would be a net improvement.

Treasury Secretary Brady earlier this year had suggested much more far-reaching measures to deal with the jurisdictional issue--the transferring of all financial products to the SEC or the merging of the two agencies. We would urge caution in considering these alternatives. A full merger of the two agencies--now embodied in H.R. 4477--would avoid many of the problems just mentioned about overlapping jurisdiction in the regulation of exchanges and clearinghouses, and the transfer of all financial instruments to the SEC might be accompanied by the separate clearing of all financial futures subject to only one regulator. However, these solutions would concentrate a great deal of regulatory authority over the financial system in a single agency and this has been a concern of the Congress for a long time. Besides the potential management difficulties of a larger organization, there is the risk that bureaucratic inertia in a larger agency could be an impediment to the process of innovation. We should not lose sight of the fact that under the existing system of split jurisdiction over financial instruments, our financial markets ahve been the most innovative in the world, with many of the new products spurred by the introduction of index futures and other futures.
COPYRIGHT 1990 Board of Governors of the Federal Reserve System
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Title Annotation:policy statements made by members of the Federal Reserve System
Author:Farnsworth, Clyde H., Jr.
Publication:Federal Reserve Bulletin
Date:Jul 1, 1990
Previous Article:Treasury and Federal reserve foreign exchange operations.
Next Article:Record of policy actions of the Federal Open Market Committee.

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