Page 1       TOP OF DOC


House of Representatives,
Subcommittee on Domestic and International Monetary Policy,
Committee on Banking and Financial Services,
Washington, DC.

    The subcommittee met, pursuant to notice, at 1:00 p.m., in room 2222, Rayburn House Office Building, Hon. Michael N. Castle, [chairman of the subcommittee], presiding.

    Present: Chairman Castle; Representatives Lucas and C. Maloney of New York.

    Chairman CASTLE. I guess I shouldn't apologize for starting a hearing on time, but around here it's so unusual that I'll comment on it. As you all know, we have floor activity. We may have a series of votes here at some point that could go on for some time. It's not yet worked out, up to 17 votes. That's 2 1/2 hours worth. If it gets down to 5-minute votes, we're really going to be in some trouble. So I wanted to start the hearing and get in as much as we could because of the departure day today, because of the religious holidays coming up. There we go. We are probably going to have people coming and going. So, we are going to have to do this on a sort of come-and-go basis. I apologize in advance for that.

 Page 2       PREV PAGE       TOP OF DOC
    I will make an opening statement. If Mr. Flake is able to be here, he will make an opening statement, but that will be the limit on the opening statements. Then we will go directly to the testimony. We have also limited the witnesses to those who we think can tell this story in its fullest so that we can move forward rapidly.

    The purpose of today's Monetary Policy Subcommittee hearing is to review the circumstances surrounding the printing of the first batch of the newly redesigned $50 Federal Reserve notes. The Department of the Treasury is currently undertaking a critically important redesign of our Nation's paper currency. The new designs include state-of-the-art security features to deter counterfeiting.

    U.S. currency is the standard for the world. In the United States and in virtually every other nation, individuals and businesses look to the United States currency as an unimpeachable standard of value and security. For that reason, it is vitally important for United States currency to be resistant to the constant efforts by criminals here and abroad to counterfeit our currency.

    The Department of the Treasury and the Bureau of Engraving and Printing have launched an ambitious program to issue redesigned currency with the latest security features. The new $100 note was successfully issued in March of 1996. The new $50 note is planned for this month. The next step would be a new $20 note a year from now, and possibly a new $10 note after that. The production of the first new $50 notes is what brings us here today.

    The first phase of the new $50 bills delivered to Federal Reserve banks around the country contained flaws in the form of gaps in the concentric fine lines surrounding the portrait of President Grant. While it appears that these gaps would not make the bills any more susceptible to counterfeiting, the flaws are a problem because the fine concentric lines are one of the features the Treasury Department will be telling the public to look for in determining whether they are receiving an authentic bill. I point out that in this particular brochure, which is a very nice brochure I might add. On page number two of it, it refers to the concentric fine lines. It refers to the fact the fine lines printed behind both the portrait and the building are difficult to replicate, which is correct. But of course they have to be done correctly as well. It is prominently demonstrated as I have just indicated.
 Page 3       PREV PAGE       TOP OF DOC

    The Federal Reserve made the correct decision when they determined that the blocks of notes containing a percentage of defective notes could not be accepted for distribution as part of the introduction of the new $50 bills. It seems clear that a brand new note must be free of flaws if it is to gain public acceptance and ensure public confidence. Therefore, these notes were put aside in safe keeping at Federal Reserve sites and after considerable hard work, the printing anomalies appear to be largely corrected. A new run of acceptable notes has been printed for the introduction of the bill which will still take place as previously announced in late October.

    The BEP, the Bureau of Engraving and Printing, is undertaking important and technically challenging work. We support them in that effort. At the same time, the flaws in the first phase of the new $50 bill raised some serious questions. We need to know why the flawed bills that were initially produced were even sent to the Federal Reserve, and what steps were ultimately taken before they were finally held as not adequate for circulation.

    We need to know the answers to the following questions: One, a timeline of how the problems arose and came to light; Two, how many flawed notes were produced?; Three, why these defective notes were delivered to the Federal Reserve. Did anyone think the anomalies were within the acceptable range? If so, who made this determination? Four, how did the Federal Reserve learn of the flaws? Five, why was suspending distribution a close call when the Government's own plan was to emphasize to the public that the concentric lines around the portrait must be clear. Six, what steps are being taken to ensure that there will not be more problems with the $50 bill and that these and other problems will not arise in the far more critical, far more widely circulated $20 bill?
 Page 4       PREV PAGE       TOP OF DOC

    We are not seeking to place blame for the difficulties in the production of a new and technically challenging note. This hearing is intended to be an appropriate examination of a decisionmaking process that finally worked in a difficult situation. The subcommittee is concerned about the appearance that some may have thought that a production of 20 percent or higher rate of imperfect notes was ''good enough for Government work.'' It is clearly not acceptable for U.S. currency.

    We have one panel today. We'll limit opening statements to the Chair. I'll amend that right now because if Mr. Lucas wishes to make an opening statement, we'll allow him to do so, since he is one of the great attendees at these meetings and is very knowledgeable, and the Ranking Member, in an effort to finish by 3:00 this afternoon when the Rosh Hashana recess begins.

    The panel will have testimony from Larry E. Rolufs, Director of the Bureau of Engraving and Printing; Theodore Allison, Assistant to the Board of Governors of the Federal Reserve System; and Bernard Ungar, of the General Accounting Office. Each of you are free to call upon your aides or to direct questions to them when they possess the necessary expertise to provide questions. There was a time when we thought that we might have other witnesses. Instead, we are going to use them as a backup in this circumstance.

    We are down to 10 minutes before this vote. I want to turn to Mr. Lucas and see if he wishes to make an opening statement.

    Mr. LUCAS. No. I have no opening comment, Mr. Chairman.

 Page 5       PREV PAGE       TOP OF DOC
    Chairman CASTLE. OK. This is decisionmaking time. This is what Members of Congress are paid the big bucks to do.

    Let me ask this: Is there anyone who believes they can make their presentation in 7 minutes or less who would like to go first? I have read all the testimony. It is of no great difference to me as to who might go first. Is anyone willing to volunteer?

    Does it concern staff if we don't do it in the order specified?

    Mr. ROLUFS. I don't know that I can make it in 7 minutes, but if you want, I'll try.

    Chairman CASTLE. How about you, Ted.

    Mr. ALLISON. Mine is pretty brief.

    Chairman CASTLE. Yes. I read yours. It's the briefest I thought. Why don't we start with you. Do you mind? Then we'll at least get one in before we have to go vote.

    Mr. ALLISON. If I may be sure to include the full statement, I'll skip over a few things.

    Chairman CASTLE. Yes. Without objection, your full statement will be included in the record. You may summarize as you see fit.
 Page 6       PREV PAGE       TOP OF DOC


    Mr. ALLISON. Let me just start by saying then that we appreciate being here and I thank you for calling the hearing. The Federal Reserve takes very seriously its stewardship of the Nation's currency. We strive to issue notes, both new notes and used notes, that are quite high quality, mainly because we believe that quality reinforces security.

    The security features are most effective in deterring counterfeiting and in inspiring confidence in genuine notes when the notes in circulation are of good quality and when those security features are maintained throughout the life of the note.

    As you know, and as you have indicated, some notes were produced at the Bureau of Engraving and Printing and have been delivered to the Federal Reserve that contain printing anomalies that don't meet our expected high standards. I have some examples of notes over here and can show you those if you would like. The public educational material identifies those concentric fine lines, as you indicated, as one of several new security features that should be present in the form intended in a genuine note, and we do not plan to issue those notes.

    The note that John has shown—number four—is the worst of the four examples I brought along. Number three contains a single missing line. We consider that note of borderline quality. We would prefer not to issue that note. We would certainly prefer not to issue number four.
 Page 7       PREV PAGE       TOP OF DOC

    Chairman CASTLE. John, could I ask you to point to what Mr. Allison is speaking of, the concentric lines? I have been educated but maybe unfortunately all the people that are here can't see this on the angles we have.

    Mr. ALLISON. The ink has been either pulled out altogether or put down only very lightly. Some of the concentric lines on that portrait and in one concentric line around the portrait of President Grant on that illustration, the one that John is holding, is a good rendition. There is an intermediate panel there with a little ink missing. That certainly falls within the range of what is acceptable to us.

    A couple of points: Since September 8, the production at the Bureau of Engraving and Printing is of a quality that we consider issuable. Notes have been shipped to 13—or at least as of Monday—had been shipped to 13 Federal Reserve offices. We have inspected notes at each of those 13 offices. We are satisfied that those notes are suitable for circulation.

    The Bureau also is printing notes in quantities that will ensure that we will have a more than adequate supply of notes on hand well ahead of October 27, which is the date at which the new notes will be released to the public for the first time. Consequently, this really hasn't interfered with our operations at all.

    Now as to the disposition of the notes we have. There are 217 million $50 notes produced before September 8, some portion of which appear not to be of issuable quality. Fifty-nine million of those have been shipped to the Federal Reserve banks and branches. One hundred-fifty-eight million are being held at the Bureau of Engraving and Printing.
 Page 8       PREV PAGE       TOP OF DOC

    The worst case is that we would destroy all of the notes and have them replaced with new notes. The cost of doing that would be $7.6 million. We are looking at an alternative that would enable us to retrieve the better notes from that inventory at a lower cost to the public. We're looking into that very carefully. If we can do it, we will. We don't have the cost estimates necessary to even remotely make a decision at this stage, but we have already undertaken the work to do that. We hope to have the study done by the end of the year. So the $7.6 million should be viewed as an upper limit, with the possibility that the actual cost will be lower.

    As for the future, we have jointly, with the Bureau of Engraving and Printing, established standards for the new electronic inspection system that's being used at the Bureau. We have agreed with the Bureau that we will regularly monitor production, both production coming off of the presses and production coming out of the new electronic inspections system, and if changes are needed we'll encourage that changes be made.

    We have put in place the same steps for the $20 notes and the lower denominations, and will keep this as an active part of our joint relationship. I do think that these steps will ensure both the economy of that system, of our currency system and its security.

    Chairman CASTLE. OK. We appreciate your testimony. We will hold questions until everybody has had a chance to testify. I did want to mention one thing. Maybe Mr. Rolufs can comment on it, but the importance of these concentric circles as part of the security features I think needs to be touched on to some degree. At least it's been explained to me that that's a significant part of it. Also it is a very difficult printing mechanism. I think we need to hear about that, not now, but in your testimony you might touch on those things. We think that is important.
 Page 9       PREV PAGE       TOP OF DOC

    I don't know how these votes are going to go, but if I see a gap and the possibility of coming back for 10 more minutes of testimony, I am going to do that. So anybody who is here, Members might want to tell other Members that we may have to have a very interrupted hearing, but I want to try to press this through as rapidly as we can. So we'll go over and take our votes and then come back and go from there and hold all the questioning until we're through with the testimony of all of you. So we'll stand adjourned, hopefully very temporarily.


    Chairman CASTLE. Depending on how you look at it, we've got a break. There's an adjournment vote, about the 100th one of the week I think. So we actually have a 15-minute break. We have 10 more minutes in that vote, and then sometime in the next vote we might be able to get in at least one, and maybe two more witnesses.

    So, Mr. Rolufs, let's go to you and your testimony please, sir.


    Mr. ROLUFS. Thank you, Mr. Chairman. Thanks for inviting us here this afternoon to testify before the subcommittee. I want to thank you for holding this hearing and providing us with the opportunity to correct certain misconceptions that have resulted from recent stories in the media concerning the production of the new $50 currency. Before I get into the details of my testimony, allow me to stress strongly and emphatically that the Bureau of Engraving and Printing, in close cooperation with our partners, the Federal Reserve, has a demonstrated commitment to maintaining the quality of the Nation's currency. Only notes meeting mutually agreed to rigorous quality standards will be distributed to the public.
 Page 10       PREV PAGE       TOP OF DOC

    We perhaps suffer from our success in this endeavor as our errors are so rare and infrequent that they are deemed newsworthy.

    Please allow me to introduce Ms. Carla Kidwell behind me, Associate Director and Chief Operating Officer, and Mr. Thomas Ferguson, Associate Director of Management at the Bureau. Both of these officials will be available to answer any questions you or the Members of the subcommittee may have after my remarks.

    The production of a secure currency in the last decade of the 20th century has moved from an art form to an innovative blend of tradition and technology. We are faced with the challenge of producing billions of documents that are easily recognized and yet cannot be copied, simulated or duplicated in an age of rapidly expanding reprographic technology. The advent of high-resolution color copiers and computer scanners and printers has placed the potential to counterfeit within the reach of virtually everyone. No longer do you require the skills of a printer or expensive equipment to counterfeit. In response to this challenge, the Bureau began producing a new series of currency that pushes printing technology in an effort to make it much more difficult to counterfeit and to maintain the public confidence that U.S. currency enjoys. This effort has also made it more difficult for us to print, and has presented us with new challenges to overcome on the production floor.

    In addition to the challenges faced in printing the new design currency, new technologies are required to inspect all the new features. The production of the Series 1996 $100 note was a tremendous success, due in large part to the dedication and resourcefulness of the Bureau's production and technical staffs. However, the experience of producing the $100 note taught us that we could no longer rely on our traditional visual inspection, as many of the new features such as the watermark, were not visible under normal lighting. We accelerated the procurement and operation of a new electronic inspection system that could examine all the new features, such as the watermark, as well as the printed image.
 Page 11       PREV PAGE       TOP OF DOC

    The Bureau introduced new inspection equipment early in 1997. It is the result of a 10-year effort to develop high speed accurate inspection equipment capable of examining currency. This one-of-a-kind system provides us with a tremendous resource and capability, but because it is new equipment, there is a learning curve and adjustments need to be made to the equipment and how the equipment is operated. This equipment was used to inspect the last portion of the $100 note production and virtually all of the $50 production.

    I have provided this background information to describe the production environment into which we introduced the new design. Production began in June 1997. Typical startup problems were encountered in the press area as the operators adjusted to the new features and the idiosyncracies of the new design. Coupled with the press startup, the inspection equipment had to be tuned and adjusted to deal with the new note. This process is a delicate balance between assuring that defective notes are removed and that good notes are not discarded. It is in this process that notes with defects got through the system and into our finished goods inventory.

    The blowups of the $50 portrait background illustrate the type of defects that were produced during the initial phases of production. The defect, known as a ''pull-out,'' is caused by the ink being wiped out of the fine lines of the plate prior to printing. The Bureau has instituted changes to the engraved plates which provide small dams in the bottom of the lines that hold the ink during the wiping process. These changes have been instituted in all production plates and greatly reduce the pull-out problem.

    With your indulgence, I would like to go into a little more detail in this and also talk a bit about the fine lines. As Mr. Allison indicated earlier, this is a good illustration of the perfect portrait and the way Mr. Grant hopefully would appear in perfect color.
 Page 12       PREV PAGE       TOP OF DOC

    This illustration, which you should be able to see fairly graphically from where you are, shows some of the pull-outs that we received as we started into the production process. You see them on this side, and you can see them on this side. If you were to be closer to this, you would also see that instead of what appears to be a stark white spot from where you are, and to someone not examining the note closely, that there is actually ink in these pull-outs. That was the crux of the problem with the examining equipment. The examining equipment operates on a pixel basis of is there ink there, and what's the grayscale of that ink, or is there not ink there? We were not completely aware of what that impact would be.

    Now, how do we go about fixing this?

    Chairman CASTLE. This is a fairly small group. Let me interrupt you to just ask a question about that. Does that mean that there was enough ink there so that the inspection machine was not finely-tuned enough that it would discriminate between the total concentric circle being filled in and the residue of ink that was still there? So therefore, it passed on it?

    Mr. ROLUFS. In an overview perspective, that's 100 percent true. But it based it on the average of what's here instead of looking precisely at a background, which we have now changed.

    Now how do we go about fixing this so that we do not get the pull-out again? If you look here, you can see a depiction, a magnification of the grooves that are in this portrait where the ink is deposited. What we did was put small dams in here in the engraving process. If you look at these small dams on the plate, the seal of the engraver is such that you can't see them even sometimes with a magnifying glass, unless you know what you are looking for there in the bottom of the engraved line.
 Page 13       PREV PAGE       TOP OF DOC

    This is a blowup using an electron microscope, showing that dam. You can see it quite graphically. I'll be glad to pass these around if you want to see them closer. How did that work, and how did we go about fixing this? To depict that, it's almost a case of where you have to try and get an idea of what's there. If you were to look at one of these lines on a plate, it looks something like that. The way the intaglio process works, you take the plate and you completely ink it in with ink. Then you use a wiping technique and take the ink off of everyplace where you don't see black on these. OK, so the ink goes in here. Then under pressure, heat, you put the paper and the plate together and the ink actually comes off on the paper under great pressure. That's a shearing process that takes place with the ink. This became very important in this particular aspect, the wiping and the shearing of the ink.

    This is what the plate would look like. For the engraving to work, you have to reverse this process and work on something we call an ''alto.'' So it would look something like this. Then what the engraver did, if this were the line to go back like this—you can tell I am a real artist—he or she actually cut down into this like this. Then when you went back to a plate, what it gave you was a dam like that. That gave us enough holding power for the ink to stay in those lines.

    Now, let's talk about the concentric lines for just a moment because you asked about them. The concentric lines are important from the perspective that if you're going to deter counterfeiting, you need some visual ways to do that for the person on the street, and you need to make it difficult for the counterfeiter. These lines were designed not so much from the perspective of the fineness of the lines, although that helps a great deal. They were designed so that if you put them—this note, in a copying machine, or you laid it in front of a camera for lithographic purposes, you would get what we call a ''moire effect,'' which actually means that the lines will do strange things, and instead of looking concentric like this, they may actually turn and look something like that, or they may wiggle like that. That's a first line of defense against a counterfeiter, particularly the person who is going to make a color copy, or even a black and white copy, or a simple lithographic print. I hope that answers your question.
 Page 14       PREV PAGE       TOP OF DOC

    Chairman CASTLE. I think it answers my question, and also makes me realize how hard it must be to counterfeit all this, which is good.

    Mr. ROLUFS. We hope it is. Returning to the written testimony, the Bureau produced a total of approximately 217 million $50 notes from June through September 8. During this period, iterative corrections and improvements were made to the process and in early September, these new plates with the dams were produced, which provided a significant improvement in the quality of the notes. The notes produced after September 8 and delivered to the Federal Reserve are good and will be issued to the public.

    During normal consultations, the Bureau raised the issue of pull-outs with the Federal Reserve. This is a process that we go through constantly with the Federal Reserve, in terms of not the quality of the notes, but in terms of consulting about distribution and things like that. The Federal Reserve indicated that they had concerns with some of the $50 notes that had been produced prior to mid-September. In consultation with the Federal Reserve, the U.S. Secret Service and the Department of the Treasury, it was determined that in order to absolutely assure the quality of the notes going into circulation, all $50 notes produced prior to September 8 would be held in abeyance pending a review. Only the post-September 8 notes would be issued at this time.

    The Federal Reserve and Secret Service have reviewed the current production and have approved it for release. The Bureau is in production and we will meet the Federal Reserve's requirements for both quantity and quality. The first day of circulation, as indicated earlier, has been announced for October 27 in New York.
 Page 15       PREV PAGE       TOP OF DOC

    Since the reexamination of the pre-September notes has not been completed, the portion of the work with these defects is as yet not clear. But I want to assure you that none of this work will reach the public until we are sure that it's acceptable. Again, our objectives are to assure that all notes reaching the public are good, and to recover all the good notes from early production in a cost-effective manner to mitigate any potential cost implications. We are working with the Federal Reserve to cost-effectively identify notes of questionable quality and assure that they are destroyed.

    Mr. Chairman, in closing I want to express my regret that this startup production issue may detract from the truly important aspects of this note. The new $50 design is far more secure and it will deter and reduce counterfeiting. It also contains the first feature ever added to the U.S. currency to assist the low vision and aging communities. This feature will aid millions of people who use our currency every day of their lives. It's a good note, and should serve the public well into the 21st century.

    This concludes my statement. I would be pleased to address any questions.

    Chairman CASTLE. Thank you, Mr. Rolufs.

    Before we get to the questions, at least the formal questions, we'll go to the gentleman who is going to testify from the GAO, Mr. Ungar. I would like to thank you and your organization. I believe you did this at our request on rather short notice. We talk about Government not reacting well. You reacted extremely well. I think you have a very thorough and comprehensive report, which you are about to testify to us about. So we do appreciate that and we look forward to your testimony. Then we'll try to ask questions of the panel.
 Page 16       PREV PAGE       TOP OF DOC


    Mr. UNGAR. Thank you, Mr. Chairman. I certainly appreciate the opportunity to be here. As you mentioned, it was quite a tight timeframe, but we certainly are pleased to be able to report to you what we did find in the time that we did this. I would like to mention that part of our audit team is here to help answer questions. Mr. John Baldwin, assistant director in our group, and Ms. Tammy Conquest, and Bill Reinsberg, who are senior evaluators. They will be available to answer questions.

    Chairman CASTLE. Let me just say to all of you, if we ask questions in which somebody who is with you knows the answer more precisely than you do, don't be afraid to bring them up to answer the question.

    Mr. UNGAR. I would like to summarize my statement, Mr. Chairman. I would like to address four issues that we covered in our review.

    The first issue had to do with the number of notes that were flawed. The basic answer to that question is at this point, nobody really knows the total number that are flawed. There have been, as has been mentioned, about 217 million notes produced up until about September 8, which BEP and the Federal Reserve refer to as Phases I and II.

 Page 17       PREV PAGE       TOP OF DOC
    There have been some limited inspections of those notes, but none of those inspections have yielded a statistically projectable or a scientific sample that would enable one to project.

    Chairman CASTLE. I've just been told it's a 5-minute vote. I thought it was going to be a 15-minute vote. I think we have no choice unfortunately, but to suspend your testimony, Mr. Ungar, and go over and vote again. I have talked to Mr. Lucas about this. To the extent that we think these votes may take more than 5 minutes, then maybe we could run back and finish your testimony between a couple of these votes if we really hustle. So we may do that. I don't know if we can do the questioning that way, but at least we can get through the basic testimony and get ready for the questioning. So I do apologize. I think we better run.


    Chairman CASTLE. The floor situation is that there is a motion to adjourn on the floor, which has 10 more minutes in it. There are some who are speculating it might actually win. I don't know if it will or not, but in any event, regardless we have hopefully enough time, Mr. Ungar, to finish your testimony if you can remember where you were. We have enough time to finish your testimony at least. It may be that we do adjourn, at which point we can go to the questioning and try to start to wrap things up.

    Mr. UNGAR. Sure. Thank you, Mr. Chairman.

    As I mentioned, I would like to address four issues. The first of which is how many flawed notes are there, or how many have been produced? As I had mentioned, at this point, neither the Bureau of Engraving and Printing, the Federal Reserve or we know that. We do know that there were over 217 million redesigned notes produced before September 8, 1997. That is the point at which the Bureau actually, as Mr. Rolufs pointed out, was in a position to have its inspection equipment more finely-tuned and calibrated to detect this type of flaw that was occurring with the concentric lines.
 Page 18       PREV PAGE       TOP OF DOC

    To give some perspective of the number, it might be helpful to think about the total number produced in three phases as relates to changes, or significant changes, that the Bureau had made in its production process. As Mr. Rolufs mentioned, the Bureau had been making changes continuously, but there were two significant changes which broke up these phases. From June on, the first phase took place. Around the first of August the second phase started. That is when the dams were introduced into the process. Up to that point, about 160 million of the new notes were produced.

    Phase II went from the first part of August to around September 8. Then at that point, the inspection equipment was recalibrated. So in Phase II, after the dams were made, there were about 57 million notes produced. Now at this point, the inspection equipment was not yet finely-tuned. Then after the inspection equipment was tuned, which would have been on September 8, about 16 million notes had been produced.

    So, in the three phases, we have 160 million in Phase I, about 57 million in Phase II, and over 16 million now in Phase III. In terms of how many of those notes were flawed, again overall, it's not certain.

    To get some idea of how many were flawed in Phase I, we—in conjunction with the Federal Reserve—did some limited inspections. We looked at some of the notes that had been shipped to Richmond and Philadelphia. There, we found out of a very small sample that about 45- to 55-percent or so of the notes were flawed, meaning that they did not meet the standards that the Treasury and the Federal Reserve had agreed would be the threshold for circulation to the public.
 Page 19       PREV PAGE       TOP OF DOC

    I would like to point out that both the Federal Reserve and BEP plan to do more scientific sampling of those notes to get a better read on what the proportion and number of flawed notes are. We have not looked at any of the Phase II notes at this point in time, so we are not sure about those 57 million. Of course, we really can't make any definitive statements about the first phase as well.

    In terms of Phase III, which are the notes that are now being produced after the inspection equipment has been more finely-tuned, we also have done two limited samples. One of those samples was at the Richmond Federal Reserve Bank. There we looked at 1,000 notes and found that 2 percent of those did not meet the threshold that we had mentioned. That's a sample we did in conjunction with the Federal Reserve.

    Chairman CASTLE. While you are on the subject, my understanding is that these various notes were distributed amongst many more Federal Reserve Banks than just Philadelphia and Richmond. You just happened to look at those two as a sampling process? Is that correct?

    Mr. UNGAR. Yes, sir. We did a purely judgmental sample. We did not do a scientific sample. We picked Richmond and Philadelphia because of their proximity to Washington. We only had yesterday basically to do it. So that's why. But I think a total of 16.

    Mr. ALLISON. Sixteen offices received the notes?

    Mr. UNGAR. Sixteen received the Phase I notes. Yesterday, we did another limited sample at the Bureau. We looked at some of the notes as they were coming off the production line. Now again, this would be Phase III notes. We looked at about 1,600 notes and found that 12 percent of those would not meet the standard. Now again, that was a very small sample and it was quite judgmental. We certainly could not make any projections based on that.
 Page 20       PREV PAGE       TOP OF DOC

    I would like to point out that in all the samples we looked at, we found a great deal of variability among the notes that we were looking at. At the Federal Reserve Banks, we were looking at straps of $50's. Each strap contained 100 $50-notes. The range of flawed notes by strap went from 20 to, for example, 90 in one case. Now these again were Phase I notes. So again, there is a great deal of variability. Our sample was small and judgmental. So we certainly couldn't make any projections there. Again, I think it is important to note that I think that the Federal Reserve and the BEP plan to do more to look at those notes.

    How did the flaw in production occur was the second issue that I would like to briefly discuss. As has been mentioned, of course, the key problem there was a technical problem with the printing in connection with getting the ink from the plate around the portrait on the note. That issue was discussed by Mr. Rolufs.

    In terms of the other factors that allowed this to happen or were present, we identified at least three. One was that the Bureau was aware of the problem from the start, according to our discussions with both management and folks right on the factory floor, if you will. They noted that they had seen this problem immediately and brought it to appropriate folks' attention within the Bureau. It was discussed. They came to the conclusion that while they knew that the note was flawed, they felt that it would be acceptable for circulation and distribution to the Federal Reserve. That was a judgment call that the Bureau officials had made.

    They explained that obviously it's a very complicated process. They were at the beginning of the process. They felt that they would be able to improve over time. But again, they felt these notes met their standard of acceptability.
 Page 21       PREV PAGE       TOP OF DOC

    The Federal Reserve was not aware of this problem until around September 1, when the Bureau brought it to its attention and mentioned to the Federal Reserve officials that they wanted them to take a look at some of these notes. The Bureau knew it was having a problem and wanted to get the Federal Reserve's view. When the Federal Reserve officials looked at these at the first part of September, they did feel that many of them did have the flaw, and that the flaw was of such a nature that they did not believe it ought to be circulated, and of course mentioned that to the Bureau.

    At that point, the Bureau agreed, of course, not to circulate those notes until further consideration was given, and that they would not be released, because some of them had already been shipped to the Federal Reserve Banks. As we'll note, at this point there was no formal systematic process established by which the Federal Reserve would inspect initial production of new notes. In discussing this with both the Bureau and Federal Reserve officials, there were a number of reasons for this. Basically it boiled down to the Bureau's production, in the Federal Reserve's opinion, of very high quality notes in the past. Reserve officials had no reason to believe that there would be a problem. The $100 note had been introduced and felt to be quite high quality. There were a few problems, but certainly nothing of this nature.

    Third, notes have not in the past been redesigned with great frequency. So there was not a lot of change in production process, design concepts, and so forth. So, Federal Reserve officials didn't feel as though there was a need for any kind of involvement early-on in the production process.

    Finally, as has been mentioned, the Bureau had just recently installed and began to operate more sophisticated inspection equipment. The Bureau had been working on getting this equipment tuned and calibrated. The equipment certainly was capable of identifying this problem with the concentric lines, but it took some time, according to the Bureau, to get the system up and operating. Of course, it wasn't until September, after the Bureau had met with the Federal Reserve, that they had come to agreement on a set of very clear standards which the Bureau could then program into the scanning equipment. That's what basically launched the third phase, the introduction of the standards into the scanning equipment.
 Page 22       PREV PAGE       TOP OF DOC

    What actions are planned and what are the associated costs of those actions are the fourth issue. Mr. Allison mentioned already that there were three options that are being considered.

    One is to destroy all the notes in terms of the Phase I and Phase II notes, which would be about 217 million notes. The cost of that is estimated at about $7.6 million at this point.

    The second option would be to replace only the notes of that 217 million that are flawed. The costs of that option are not yet known, because it's not clear how many of those notes are flawed to the point that they shouldn't be released. It's not clear at this point how much it would cost the Federal Reserve to acquire from a vendor and install and operate equipment that would be able to scan the notes that have been in Phase I and Phase II to determine how many were unacceptable.

    I might point out that the equipment that the Bureau uses looks at these notes in sheets of 32, whereas at this point all the money, the notes that have been printed and given to the Fed and are also in the vault, are in individual notes. So the Bureau's machines will not inspect the notes in that form. The inspection devices that the Federal Reserve has will inspect individual notes, but they are not yet fitted with equipment that could detect this kind of problem with the concentric lines. So that would have to be done.

    A third option would be to wait a few years after the new notes have been introduced, and then introduce the 217 million notes. According to the Federal Reserve, this is not a likely option, not a high probability at this point that that option would be taken. I might point out that a number of the notes that we did observe were fairly significantly flawed, much more so than some of these examples. So, there would have to be some careful consideration to that particular option.
 Page 23       PREV PAGE       TOP OF DOC

    Finally, I would like to talk about lessons learned. I think given the experience of this introduction——

    Chairman CASTLE. Let me see what this is all about. We have to move quickly. We just made the last vote by five seconds or so. We did not adjourn. We have a 5-minute vote. Again, we'll try to come back. Mr. Ungar, if you can try to think about how to succinctly finish your testimony and then we'll go to questions when we return. We'll get back as soon as we can. Again, I apologize.

    Mr. UNGAR. Sure. One minute is all I need.

    Chairman CASTLE. OK.


    Chairman CASTLE. The hearing will come to order. Hopefully, Mr. Lucas will be able to join us momentarily. But I do want to continue. I think we're through with the disruptions, temporarily at least.

    Mr. Ungar, you were getting ready to summarize.

    Mr. UNGAR. Sure. Mr. Chairman, I promised a minute or less. Hopefully I'll be able to do that. I would like to conclude by just pointing out the three recommendations that we think would be appropriate and that we're making to the Federal Reserve and to the Secretary of the Treasury as a result of our review.
 Page 24       PREV PAGE       TOP OF DOC

    One, we feel that the Federal Reserve, the Bureau, the Secret Service, and other appropriate Treasury officials should be involved early in the production process of new notes, to inspect the new notes that are coming off the presses, and to agree on the acceptable level of quality.

    Second, that the production of new notes in terms of the numbers of notes that are produced should be limited until all the stakeholders involved have reasonable assurance that all the production problems are resolved.

    Third, that the Bureau, the Federal Reserve, and other appropriate Treasury officials should explore the design of the concentric fine lines to see if anything can be done to lessen the likelihood of future production problems, given that the plans call for future denominations to be printed in 9- to 12-month intervals. With that, I would like to conclude.

    Chairman CASTLE. Thank you, Mr. Ungar. Thank you again for responding to all this in a very very timely fashion. We do appreciate that. Hopefully it has been helpful to all of us because the thrust of this hearing is to try to prevent problems in the future and solve the problems we have, not to worry about exactly what all the causes were. Let me be part of the analysis of trying to improve the future.

    Mr. Allison, do you have any comment on the recommendations that Mr. Ungar just ended with in his one minute?

 Page 25       PREV PAGE       TOP OF DOC
    Mr. ALLISON. Yes. The part that most affects the Federal Reserve is recommendation number one. In principle, we have already begun that. We have agreed to—we have been involved in—setting the quality standards and will be hereon involved.

    Chairman CASTLE. Just for the record, that's the one that says formalizing agreement to have Federal Reserve, BEP, Secret Service and other relevant Treasury officials involved early in the currency production processes for future redesigned notes to inspect production and agree on the acceptable level of quality. Is that what we're talking about?

    Mr. ALLISON. That's been done in an informal way and that will be formalized, can be formalized. I see no reason why it wouldn't be formalized in writing.

    Chairman CASTLE. How about the other two, which are fairly general?

    Mr. ALLISON. The other two are probably more for Mr. Rolufs to comment on, but we certainly would agree with them.

    Chairman CASTLE. Mr. Rolufs, do you agree with those as well?

    Mr. ROLUFS. I agree with them. I have a couple of comments. One is that the recommendations, particularly number two, I think we have to have some caution there in that, for instance, if we were to say that we have to come to agreement within 20,000 sheets or something like that, we may have a real difficulty. The intaglio process is an extremely complex printing process. I have been in the printing production business for over 45 years. In that time, I have never seen one that requires more craftsmanship and at the same time has so many variables in it as this process. So, I think we need to have enough flexibility in the process so that we don't prematurely cut off a good design or a good process.
 Page 26       PREV PAGE       TOP OF DOC

    On point three, I think it's particularly interesting that we have already begun that process and that those will certainly be some of the options that will be available.

    Chairman CASTLE. I wasn't going to start here at all. I suppose it was the summary at the end that sort of caught my attention. But do either you, Mr. Allison or Mr. Rolufs, have other recommendations that you can state firmly here as to ways to prevent this from happening again or improving the circumstances beyond those which are stated here? You may have stated them in your testimony. Perhaps this is a good time to restate them if any of you can recall.

    Mr. ALLISON. Representatives of the Federal Reserve, along with the Secret Service and officials from the Treasury Department have met specifically on the inspection standards for the $50's. We'll monitor production of $50's and monitor the inspection results. We'll make changes or encourage changes as appropriate. We'll do that for the $20's and $10's and so on into the future. I think that's all incorporated, at least within the spirit of number one.

    Chairman CASTLE. Mr. Rolufs, do you have any additional?

    Mr. ROLUFS. I could do nothing more than agree. I think this has been a process in which we have learned a great deal and has brought our two agencies closer together in terms of how to better manage the production process.

    Chairman CASTLE. Thank you. I am going to also go to another question. I did not intend to ask—initially I had some other things I wanted to do in a preliminary sense, but that was the statement that one of you made. I saw it in print before. I guess probably it was you, Mr. Ungar, if I had to guess. That is that, in fact it was you, that 12 percent of the bills which you inspected most recently since the what is it, September 8 date when we thought that——
 Page 27       PREV PAGE       TOP OF DOC

    Mr. UNGAR. Yes.

    Chairman CASTLE. That most of the printing problems were corrected and most of the inspection problems were corrected. I realize this is all a little bit arbitrary in terms of what is not up to standards and what is, but you concluded that 12 percent of the bills that you saw on a very small sampling were not up to standards. That concerned me. I can understand the problem. We may not like it, because those things happen. Perhaps we can deal with it. But obviously, I think everybody here is concerned about going with that into the future. I would be interested in your comments on that. Mr. Ungar, you may or may not have to speak to it, unless you want to clarify what the 12 percent meant, but the other two perhaps should comment on that.

    Mr. UNGAR. Only to point out again, it was a very small sample of a little over 1,600 notes. We certainly couldn't make any projections based on that. After these folks speak, if you like us to comment any further, we will.

    Chairman CASTLE. I guess my concern is that I know this is a difficult process and we're proving that. That also is why counterfeiting is so extraordinarily difficult, which is good. On the other hand, we would hope that we were getting this refined to the point that we're down to something, you know, .0003 percent or something, as opposed to 12 percent. I am a little—maybe I'm wrong. Maybe I should be correct on that. But to me, that sounds like it's still a high number if it is an accurate number. So that is why my question was prompted.

 Page 28       PREV PAGE       TOP OF DOC
    Mr. UNGAR. Yes. The only thing I would add, Mr. Chairman, is that there is a lot of judgment. I think we feel very comfortable with the 12 percent in terms of what we looked at. Now of that 12 percent, I think Mr. Allison pointed out he has four different examples. I think about one-half of that 12 percent would fall in the example he probably labeled ''definitely not issue or circulate.'' The other 6 percent would probably fall somewhere between there and the OK grouping.

    So again, I think if different people looked at the same notes, they might come to a slightly different percent, but it would still be enough to say it's more than 3- or 4-percent.

    Chairman CASTLE. Let's get the other comments on this.

    Mr. Allison.

    Mr. ALLISON. Let me address it from a slightly different angle, because we asked people at each of the 13 Federal Reserve offices that have received the new production, the post-September 8 production, to look at 1,000 or more of their notes. The results are as follows: six of those 13 offices said, ''We don't see any problems in these notes.'' Seven of the offices had a comment that indicated some anomalies. I think that this will explain the gap. Probably 2 percent of the notes that were looked at, and that range ran from 0 to 2 percent—2 percent is the upper limit, but I'll use 2 percent just to stay on the conservative side—would be in a range between the top panel on the middle easel and the bottom panel on the middle easel. The far left panel is a perfectly good note. The examples on the far right are, I think, not good notes. I have said the top one contains some minor pull-outs, but is clearly issuable. The bottom panel on the second easel contains a pull-out that I would prefer not to issue, but is clearly borderline.
 Page 29       PREV PAGE       TOP OF DOC

    Our people put 2 percent of their notes in the range close to the top chart, and felt that about .1 to .2 percent would have exceeded the bottom panel in the second chart on the second easel. None would have been as bad as the two panels on the right. So we're confident that our inventory contains essentially none, no notes like these on the right. Point-two percent in the neighborhood of the bottom chart here, 2 percent somewhere in between those two. Ninety-eight percent in the neighborhood of that top panel or better.

    Chairman CASTLE. OK. Mr. Rolufs, I am going to ask you to answer the same question.

    Mr. Ungar, I am going to ask you to comment on their answers after they both finish, just so you can be thinking about that.

    Mr. ROLUFS. It occurs to me that one of the pieces here is a confidence level in the electronic inspections system, how well is it doing its job after we have tuned it to the point where it is now?

    Chairman CASTLE. Can I interrupt you for a minute?

    Mr. ROLUFS. Sure.

    Chairman CASTLE. I know most people in this room probably already understand that, but maybe we should take a moment to explain the inspections system you have gone to.
 Page 30       PREV PAGE       TOP OF DOC

    Mr. ROLUFS. Sure.

    Chairman CASTLE. My understanding is that you had the sheets, which I think are in 32 or something. They were inspected visually by human beings. Now you have gone to an electronic system?

    Mr. ROLUFS. That's correct.

    Chairman CASTLE. It did some of the $100's and it's now doing all of the $50's?

    Mr. ROLUFS. That is correct. What this inspection does at this particular juncture and time is it looks at the notes, particularly seven areas on the face of the note and three zones on the back of the note, to assure us that it is meeting the quality standard. On the face of the note, it looks at the 32 notes at one time and compares it against a ''golden image'' kind of situation to make sure that it works properly.

    We believe we have the inspection system tuned to the point where it's now doing its job. But, let's say for the sake of argument, that that isn't the case. We need some way to check against that. It occurs to me that the best way to do that is to create a random sampling system behind it to take a look at the notes, to give ourselves that assurance. I will certainly speak with my people as to the feasibility of doing that.

    I think what we have here is again, one of the situations where because of new processes, new equipment, we need to use some techniques that come out of the statistical world to give us the kinds of reassurances we need. I am certainly willing to do that.
 Page 31       PREV PAGE       TOP OF DOC

    Chairman CASTLE. But an important issue here is that the inspection machine itself is a sensitive instrument which can be tuned and probably programmed to do different things and then tuned differently in terms of what it does. So you are still dealing with that a little bit because of its relative newness.

    Mr. ROLUFS. That's correct. We know that we can tune this system to the point where it can literally reject everything. So it's a matter of finding that point in which we're getting the best result.

    Chairman CASTLE. Let's go back to the original question, which is the 12 percent finding as to the notes since the problems were discovered and the inspections put in place. You heard Mr. Allison's comments. I'll be interested in your comments about that in terms of the extent of the problem and how you view it.

    Mr. ROLUFS. I view it primarily as something that the sampling has shown, although it is a very small sample. I want to determine whether it's true or not. So that's the reason that I would like to go to this post-inspection system to find out.

    I think that it's one of those cases where at least the small evidence we have says there may still be a problem there. I think we have to attack it and find out for sure. Whether there's a problem there or not, I don't know.

    Chairman CASTLE. OK, Mr. Ungar, any comments on that?

 Page 32       PREV PAGE       TOP OF DOC
    Mr. UNGAR. Yes, sir. I think we would certainly agree for sure with—I've talked to all our staff who have looked at the notes and there's no question that the notes produced in the third phase are certainly much better and have far fewer flaws proportionately than in Phase I. What I would like to do is ask Ms. Tammy Conquest, our senior evaluator, who actually inspected the notes yesterday at the Bureau, to give you a summary of what she did look at and what she did find so you can get it firsthand.

    Chairman CASTLE. Certainly.

    Ms. CONQUEST. What I did is I looked at approximately 1,664 notes. The notes were not individual notes. They were still in sheets. They were in sheets of 16. We looked at, like I said, 1,664.

    What I found was is that some of the notes had multiple lines surrounding the portrait. There were occasions where the gaps were at least one-half inch or longer. Those were essentially the criteria that we were using.

    Chairman CASTLE. The gaps being similar to the white, what I see as white?

    Ms. CONQUEST. Right. The gaps, right. The gaps were at least one-half inch or longer. There were multiple lines surrounding the portraits, particularly around Grant's ear area and around the shoulders is where we noticed that there were——

    Chairman CASTLE. Now is the one-half inch gap, anybody can answer this, I mean, we're talking about a one-half inch gap on a bill, not on something this size. Is that a problem in terms of issuance?
 Page 33       PREV PAGE       TOP OF DOC

    Mr. ALLISON. Probably not. It would depend on how much ink is there. In my view, the question, the essential question is will it confuse the intended recipient of the note, will it divert the intended recipient's attention away from the portrait, which is one of the best indicators of genuineness? Will it raise questions about whether the note is genuine? Probably a blank of one-half inch or less would not. We don't want that, and I think we need to continue to improve that.

    Chairman CASTLE. Tammy, you weren't finished. I interrupted.

    Ms. CONQUEST. Yes. We found about 200 incidents where there were either the gaps were one-half inch or longer or where there were multiple lines surrounding the portrait. That was I believe some of the criteria that the Fed and BEP were using in their sampling as well.

    Chairman CASTLE. OK. This is all obviously a work in progress. I guess there's maybe no final answer to it all, but I can't say I'm concerned, because I probably wouldn't pick up any of these things looking at a bill, but I think we do worry about the integrity and sanctity of American money. We want to make sure this is corrected. This is not an investigative type hearing. It's an informational hearing. I think you are extremely professional people. But I would hope that we're very focused on that, and nobody is sort of glossing over that we're focused on, the fact that this money—which I think you are from our conversations in my office and here, but I want to make absolutely sure that we're continuing to work to make sure these bills are as perfect as they can be.

 Page 34       PREV PAGE       TOP OF DOC
    One question, I don't know if Mr. Lucas is going to get back or not, but we discussed this on the way over once. It's a different subject, but the currency is printed in both Washington, DC. and in Fort Worth, Texas. Are they the only two places? Is that correct?

    Mr. ROLUFS. Yes.

    Chairman CASTLE. Were these particular bills printed in both places or just one place?

    Mr. ROLUFS. These particular notes were printed only in Washington, DC. In fact, the high denomination notes that we have, $50's and $100's, are only done in Washington. That's not to say that that will continue to be the case into the future, but that's the way it is right now.

    Chairman CASTLE. So no $50's or $100's are being printed in Fort Worth at all?

    Mr. ROLUFS. That's correct.

    Chairman CASTLE. Even now?

    Mr. ROLUFS. That's correct. Fort Worth began doing $20's two years ago. So, they now do $1's through $20's. At some point in the future, it may very well be, that they are perfectly capable of doing these notes.

 Page 35       PREV PAGE       TOP OF DOC
    Chairman CASTLE. Are the printing processes identical in Fort Worth and in Washington?

    Mr. ROLUFS. The printing processes are identical. The equipment is not identical. Fort Worth has a newer press there which is capable of higher speeds than the ones in Washington.

    Chairman CASTLE. Does it tend to be more, in your judgment, and I know this is a little bit subjective, but does it tend to be more accurate? Is it less inclined to have problems such as these white problems than the printing presses in Washington?

    Mr. ROLUFS. That's one of the things that we have tried to determine recently. In fact, we ran experimentally both $100's and $50's in Fort Worth. What we have found is that the operator controls on the presses in Fort Worth are finer and give the operator a bit more control over the process. Both of them are very capable of doing high quality work, but the operator controls are better on the presses in Fort Worth.

    Chairman CASTLE. Again, this is something we have discussed in my office and this is not the subject of this hearing, but I think in other hearings we have had, and just in general scuttlebutt, there's been discussions of the antiquity, if you will, of the Washington operation. I guess it's in an older fashioned building. I have not been there and I do intend to get there. But an older building. There have been words of union problems in the past. I don't know about the machinery issues. In your judgment, is any of this contributing to all of this? Should we be looking at going to a site someplace and starting over again? The printing of currency is pretty important to this country, but on the other hand, starting over again is pretty expensive too.
 Page 36       PREV PAGE       TOP OF DOC

    Mr. ROLUFS. I agree.

    Chairman CASTLE. So I want to get a sense of which way we should be going here.

    Mr. ROLUFS. Let me just discourse for a moment. First, we would be delighted to have you come to both of the facilities so that you can see the difference. The Fort Worth facility is probably the most modern currency printing facility in the world. Laid out by its employees, it has very short distances to go between processes, things like that.

    The Washington facility is 82 years old. It's in a multi-story building which does not lend itself well to a modern production process. We are in the throes right now of a study in which we're due to report back to the Congress if the current legislation passes some time next year. I think it's May 1, is the way it was phrased, as to what our economic findings were about the process itself, whether it would be better in a one-story building, for instance, than the building we have now.

    The interesting thing about the building we have now is that the upkeep on that building is expensive. It becomes a question of where should we better invest our money? In the upkeep of the old building, modernizing it, or going to another one-story facility someplace?

    So yes, I think that has some impact on particularly the cost of producing currency for the Nation. I don't believe it has significant quality impacts though.

 Page 37       PREV PAGE       TOP OF DOC
    Chairman CASTLE. At some point we may want to go into it more extensively. I think I would be better versed to do that if I did tour at least one, if not both facilities.

    Mr. ROLUFS. How about next week?

    Chairman CASTLE. So I'll hold my questions. I'm going to Philadelphia, by the way, to look at some things that the Fed is doing, so I'll know more about flying checks around the country.

    Mr. Rolufs, I'm sort of getting back to where I wanted to begin now. That's the bad news. But a couple of things in your testimony that I had just noted. Early-on in the testimony, you said only notes meeting, and I put in quotes, you didn't, ''Issuable standards will be distributed to the public.'' Is there any confusion, well, I guess there's ''issuable standards.'' You know, we have had a description of a one-half inch gap. Some may say, ''Well, there was some discussion that you can't issue these new $50 bills now, we could do it later when people are used to them,'' or something of that nature. We need to get into this issue. It seems to me that BEP passed these notes onto the Fed banks. Then at some point after the fact, the issue was raised that ''Gee, maybe these aren't perfect.'' Then all the subsequent inspections seemed to have taken place. So, maybe there was a different level of thinking at BEP about what an ''issuable standard'' is, than there was at the Fed. I think actually one of the first recommendations addresses that issue. That everybody ought to be looking at these things together earlier.

    But, I am sort of interested in this whole determination of ''issuable standards'', and make sure that we're all reading out of the same prayer book early-on in this process.
 Page 38       PREV PAGE       TOP OF DOC

    Mr. ROLUFS. Mr. Chairman, I am afraid I blindsided you a little bit here, in that I changed the actual statement on the way up here to ''mutually agreed-to rigorous quality standards.''

    Chairman CASTLE. I'm sorry I didn't follow it that carefully. So ''mutually agreed to——''

    Mr. ROLUFS. ''——Rigorous quality standards.''

    Chairman CASTLE. That assumes the fact that—the ''mutually agreed to'' is the part that interests me. I mean, you are all going to start talking about this a little more?

    Mr. ROLUFS. Absolutely.

    Chairman CASTLE. Am I right then, in terms of the issue with respect to—let me welcome another Member who has been over busy voting, Mrs. Maloney.

    Mrs. MALONEY. Mr. Chairman, how are you?

    Chairman CASTLE. Good.

    Am I right then that there seems to have been a different viewpoint of what these standards should be? Tell me about BEP's passing these onto the various Fed banks around the country before it became a crisis and the decision was made by the Fed that ''some of these maybe should not be issued, maybe eventually all of them should not be issued, we don't know.''
 Page 39       PREV PAGE       TOP OF DOC

    Mr. ROLUFS. Well, I think we got into the situation where we believed that we had something that would be issuable. The problem I think occurred in two places. One is that we forgot to consult our customer on this issue because it was a new note and everybody would be looking at it a lot more carefully.

    Second, I think we believed that our automatic inspection systems were doing a better job than they were doing. We did not realize, in fact, how they had to be tuned in the significant areas that they should be looking at. We didn't realize how they were actually working at that particular juncture and time. More of the objectionable work was going through than we realized.

    Chairman CASTLE. Further on, and maybe you changed your testimony again on me, I don't know. But further on in your testimony in what I had before, and that's what I am relying on, it says ''During normal consultations, the Bureau raised the issue of the 'pull-outs' with the Federal Reserve. They indicated they had concerns with some of the $50 notes that had been produced prior to mid-September.'' That obviously probably came after they had been distributed to the various Fed banks?

    Mr. ROLUFS. That's correct.

    Chairman CASTLE. A month later, or something like that, I would assume.

    Mr. ROLUFS. I think it was a shorter timeframe than that, but that's true. It was after they had been shipped. We were confident enough at this point that we felt for the first time ever perhaps, we would be able to arrive at standards that we could all understand, because it was now an electronic standard. Whereas before, it was always a standard that we set, but it was subject to the interpretation of the human eye. In fact, 257 sets of human eyes. So there was a lot of variability in that. If you were a currency examiner watching sheets go by in excess of around 108 sheets a minute, trying to make a decision about a currency standard, it is very difficult, although these people were very very good at it. But you did get variability.
 Page 40       PREV PAGE       TOP OF DOC

    We felt now we could go to the Federal Reserve and that we would have a point at which we could set the standard and we would be rid of that variability.

    Chairman CASTLE. So you are satisfied with the electronic inspections system? I think we can agree here it's not yet perfected. But you are satisfied this will ultimately be an improvement over the human inspection system that was used heretofore?

    Mr. ROLUFS. Absolutely.

    Chairman CASTLE. Let me just say we weren't imposing time limits, Mrs. Maloney, because there is nobody else here. Let me ask a few more questions. I am going to let you ask questions for a while if you wish.

    Mrs. MALONEY. I just have one question just from the testimony, if I could just throw it in real quick.

    Chairman CASTLE. Throw it in. If you have one question, just throw it in real quick.

    Mrs. MALONEY. The testimony earlier of Mr. Ungar was that the GAO explained that the Bureau of Engraving and Printing determined that the flawed bills were acceptable. Yet when the bills were sent to the Federal Reserve, they found that the notes were unacceptable. What is the reason that two agencies had such differing views of the bills? Could you just expand a little bit on that?
 Page 41       PREV PAGE       TOP OF DOC

    Chairman CASTLE. Let me just say that they have been commenting on that sort of. Perhaps you can summarize because this Representative didn't hear it. She should hear it. She should know the answer to that.

    Mr. UNGAR. Mrs. Maloney, from our perspective, and what we understand from our work, is that the Bureau officials had their view of what was acceptable and had not consulted with the Federal Reserve during the initial production, which started in June. Bureau officials noted that there was a problem with the note, with the concentric lines right away, but they felt that it was still within the realm of being issuable.

    Then, around the first part of September, Bureau officials were having discussions with Federal Reserve representatives over the issue of note production and quality in general. They, at that point, invited the Federal Reserve representatives to inspect the notes and discuss the problem. It was at that point where the Federal Reserve representatives said they believed that many of these notes would not be of a high enough quality to be issued, particularly at this time. This was because much of the promotional and educational material that was being disseminated with respect to the newly designed $50 note, was emphasizing greatly the high quality of the note, specifically the feature of the clear concentric lines. They thought this might be a mixed signal that the public might be getting.

    Mrs. MALONEY. Thank you. I really didn't mean to interrupt. I didn't want to repeat questions you have already asked. I would like to put my opening statement in the record, if I could.

 Page 42       PREV PAGE       TOP OF DOC
    Chairman CASTLE. Without objection, your statement is placed in the record.

    Chairman CASTLE. We appreciate your attendance.

    Mrs. MALONEY. Thank you.

    Chairman CASTLE. I think your question was very relevant too.

    My next question, Mr. Rolufs, out of your testimony is you state, ''We are working with the Federal Reserve to cost-effectively identify pre-September notes of questionable quality and assure that they are destroyed.''

    What are you doing, precisely what are you doing about that? We have heard testimony about some of these bills. Mr. Ungar's percentages seem to be a little bit higher than your percentages. We have heard statements all the way from, ''Well gee, later we can put them in the mix and it won't make any difference,'' to ''We need to destroy them all.'' I don't know, because these bills are now divided into individual bills I guess, and no longer can be visually inspected. I don't even know if they can be electronically inspected. So, I don't know if there is an inspection system which applies to this. Are we just fooling ourselves, or has the time come to spend the $7.6 million and just be done with this whole process and start over again? Is it worth actually going through these and trying to figure it out? I don't know. I don't know the answer to that.

    Mr. ROLUFS. I think it is worth doing a statistical sampling plan on the notes, so that we get a much better fix on what the rate of spoilage is. We are in the process of doing that. We should have answers for the Federal Reserve sometime in early November. So we are going to sample a lot of cash packs, bricks of notes, and do the same thing essentially that was done by the GAO, taking a look, seeing how many meet the criteria, how many don't. Then after we get a scientific sampling, we should be able to project what we think the waste factor is here. I think it is worth doing that and then using that to start basing our decision as to whether to destroy the whole thing or whether to try to save notes out of it.
 Page 43       PREV PAGE       TOP OF DOC

    Chairman CASTLE. Is it helpful to have the GAO, they are not the experts on this, and I am not suggesting that they are, but is it helpful to have them looking at this, or have they served their purpose in this and it's really up to your experts to be able to sample and do it correctly?

    Mr. ROLUFS. From my perspective, it would not be helpful.

    Chairman CASTLE. I understand you don't say that in a pejorative sense. My goal is to make sure the currency is up to everyone's standards, you know, mutual agreement.

    Mr. ROLUFS. I think the interesting thing here is that between the Federal Reserve and ourselves, we will be putting a lot of emphasis on this. We double check each other very well when we get into these situations.

    Chairman CASTLE. I asked this before and it's written here. Maybe I just want to ask it a little more precisely just to make sure I'm comfortable with it. That is, was there a conscious decision to withhold information regarding the extent of the printing problems from the Federal Reserve? That whole, sort of, transition of the bills going out and then calling it to the Federal Reserve's attention. I don't quite follow that.

    Mr. ROLUFS. There was absolutely not a conscious decision to do that. We thought we were improving the process. We thought we were making things better all the time. We also, as I indicated, I don't believe we knew the extent to which we were missing some of the bad work. In fact, for us to do that consciously would be not very smart, because the Fed ends up seeing it, or one of the banks ends up seeing all those notes as they go across their process. So, we would have been caught up to eventually one way or the other.
 Page 44       PREV PAGE       TOP OF DOC

    Chairman CASTLE. Was there any delay in calling it to your attention?

    Mr. ROLUFS. I think in the same way in that I knew about this problem early-on. I knew it was being worked on. Perhaps I am guilty of not tracking it closely enough.

    Chairman CASTLE. Did Treasury know about this problem? They know about it now. I assume they probably read about it in the papers if nothing else. But did they know about it early-on? If so, when and how did they learn about it?

    Mr. ROLUFS. I am not aware that Treasury knew specifically about it. I know that at least my boss was aware that we had the normal startup problems. That's the way I would have characterized them. But I don't think Treasury would have known about the specific pull-out problem or that we were encountering a higher degree of difficulty than one might have thought.

    Chairman CASTLE. OK. Let me try to ask a couple of questions of Mr. Allison through his testimony if I may. The question I had written out before, it's partially answered here, but I am still going to ask it. We heard about the sampling process—not counting all of these bills, and I forget how many there are in the whole collection before September 8, but not counting them all—but doing some sort of a sampling. It reminds me of the census sampling we voted on last night. I don't know if I trust sampling or not, particularly when it comes to money. Are you comfortable that there can be a sampling situation of the presently-issued, but agreed by all of you now to be defective bills, to weed them out? Or is this something where you just have to absolutely look at each one, that there's just no other way of doing it? Maybe sampling is not the right expression.
 Page 45       PREV PAGE       TOP OF DOC

    Mr. ALLISON. It will be easy for us to look at each note on our processing machines that we use for processing incoming deposits. There is always spare capacity on those machines.

    Chairman CASTLE. So we are not talking about sampling. We're talking about an actual inspection of each bill and determination of what standard you would accept or not accept?

    Mr. ALLISON. That can be done in principle. Now whether we get to that point depends on the cost of a detector that would have to be developed for this purpose and bought by us.

    The ballpark thinking about this is that it ought to be feasible. Where we exactly set the line is another matter. That is the hard part. But, it ought to be feasible to develop a detector that will distinguish issuable-quality notes from those that aren't.

    Chairman CASTLE. Is this a detector that could be used? I'm sure developing a detector sounds fine. It's probably a pretty damned expensive piece of equipment if I had to guess. Could it be used otherwise by you or by BEP afterwards? I mean, to have it used beyond just inspecting these notes?

    Mr. ALLISON. It seems possible that we would find a use for this detector as a denominator. It might be that we would find it important to check for the quality of the lines around the portrait as one of the ongoing fitness features in the future. We haven't made that decision. We haven't decided that we need to do that. But that is conceivable.
 Page 46       PREV PAGE       TOP OF DOC

    Chairman CASTLE. A question on the subject that we have already talked about a little bit, but I just want to make sure again I am comfortable. That is, is the Federal Reserve satisfied that the latest versions, since September 8 versions, of the $50 bill are acceptable?

    Mr. ALLISON. Yes.

    Chairman CASTLE. We have heard GAO express concerns with some of these, that they are defective, a 12 percent estimate I think it was, yes, 12 percent. My concern is are you satisfied with what you are seeing now?

    Mr. ALLISON. Let me be clear that 2 percent of our inventory—based on a sample at each of these Reserve Banks—2 percent are on the margin. It may be a bit beyond where we would like to have the margin, but not significantly beyond it. Ninety-eight percent are within the margin. The 2 percent that are beyond the margin are so close to the margin that we're not uncomfortable issuing them. But we want to continue to improve the quality and will continue to work on improving the quality.

    Chairman CASTLE. Even in the best of times, I assume that there has always been a percentage of bills that seem to have some faults. In fact, the collectors just love it when that happens. But is that correct, or do you run off $20 bills flawlessly year after year after year? Or $10 bills, or $5 bills, or $1 bills, or any bills?

    Mr. ALLISON. From our standpoint as the issuer, I don't remember our ever being dissatisfied with the visual quality of the notes that come from the BEP. Yes, there were some that were cut perhaps a little close to the margin, or there were some where the back and the face didn't line up too well. But in terms of a practical level of issuable quality, I don't remember ever being dissatisfied with the BEP production.
 Page 47       PREV PAGE       TOP OF DOC

    Chairman CASTLE. So the problems that we're having here because of the mechanics of the new bill, the security measures that are being put in, the concentric lines, those kinds of things introduced the problems which we're seeing now, which are new as far as the printing of currency is concerned?

    Mr. ALLISON. Exactly.

    Chairman CASTLE. Is the deadline for the introduction of the $50 bill October 27? Is that correct? Is that a fixed date? Is that causing any problems now that this has all happened? Should we be considering what to do with that? Maybe I don't have the date right. I thought I did.

    Mr. ALLISON. October 27 is the date that has been announced as the day for introducing the new note. That is, announcing it publicly and beginning to make those available to commercial banks, at Reserve Banks.

    There is no deadline involved. That simply is the date that we have chosen based on production schedules and availability of people and a whole lot of considerations that go into an event like that. We will have well over a full month's supply of notes, and production will continue, so we will have well over a full month's supply on October 27. That is plenty for our purposes.

    Chairman CASTLE. And this is the least used, I assume, of all the notes out there?
 Page 48       PREV PAGE       TOP OF DOC

    Mr. ALLISON. Other than the $2, yes.

    Chairman CASTLE. I made that mistake in my office. I keep forgetting about the $2 bill.

    Mr. ALLISON. I needed to be consistent. Yes, $50's are about 5 percent of the total number of notes outstanding, and about 3 percent only of Reserve Bank receipts from depository institutions and payments to depository institutions.

    Chairman CASTLE. You stated that, and this is always the financing of Treasury and the Fed and between them is always a little bit complicated, but you say that the consequence of any of the scenarios for correcting the problems with the $50 notes would be a lower payment of Federal Reserve earnings to the Treasury. But does this still not equate to a direct cost to the taxpayer?

    Mr. ALLISON. It does.

    Chairman CASTLE. I have that problem when I try to explain my quarter bill and how a seigniorage can actually save us taxpayers' money, but in reality it's in Treasury accounts, so it's sort of hidden and it gets a little bit complicated to explain.

    Mr. ALLISON. This is really not a seigniorage issue because the total amount of the $50 bills——

 Page 49       PREV PAGE       TOP OF DOC
    Chairman CASTLE. I know it's not, but I was just thinking that as an analogy.

    Mr. ALLISON. Unless there is sort of a collector's demand for $50's, putting that aside, this doesn't affect the quantity of $50 bills, or any other note in circulation. It's just an expense. Our annual expense will be higher if we need to, to the extent that we need to, print more notes than we otherwise would have, in order to replace these.

    Chairman CASTLE. Are you satisfied with the notice given to you by BEP as to these bills, or was there some grinding of teeth when you found out and said, ''Why didn't we learn this sooner?''

    Mr. ALLISON. We would prefer to have been informed earlier.

    Chairman CASTLE. That's part of what you are talking about here in terms of working more closely together in future issuances?

    Mr. ALLISON. Yes.

    Chairman CASTLE. Glad to hear you say that. I would hate to have seen those bills all out there and then have you say that we were perfectly happy with that. It seems a little wasteful.

    Mr. Ungar, the numbers that you found in Philadelphia and Richmond, the two Fed sites you actually physically were able to go to in the short time you had. Are your percentages at least substantially higher than the percentages we heard—that I had heard, and I read your testimony today for the first time—than BEP and the Fed had given us before? Are you satisfied with some of the explanations in terms of why these numbers might be different, or do you feel that there's a problem here that you are really analyzing these things quite a bit differently?
 Page 50       PREV PAGE       TOP OF DOC

    Mr. UNGAR. Particularly for the Phase I notes, I don't think we have any question in our mind. There are a lot of reasons for those differences. First of all, none of these samples were scientifically chosen on a random basis that we could project from. The notes were produced at different times, some early, some later in the production process. Obviously the quality would vary. I do not think there is any question there. I think at both Richmond and Philadelphia, at both locations, we had more than one Federal Reserve representative with us. It was a joint review. Nothing before had been quite that systematic as far as we understand it, on the Phase I notes. So I think we're OK there.

    Phase III in the Richmond location, we got a similar percent as generally Mr. Allison described, 2 percent. We were with a Federal Reserve person there. At the BEP, where we looked at the newer Phase III notes, we didn't have a Federal Reserve representative, although there was a BEP representative there who we actually did show a sample to and said that white spaces appeared around the portrait.

    In terms of the existence of flaws, we feel comfortable with the observation. In terms of the percentage, there could be a lot of reasons for differences. For example, at the BEP for our review of Phase III notes, some of the sheets that we looked at—sheets of 16—had no flaws from our perspective, while the highest number of errors was 6 out of 16. Depending upon how these sheets are then cut and packaged, the distribution of the flaws in straps of 100 notes could vary greatly. So again, because none of the samples was random, we would expect to have variation.

    Chairman CASTLE. OK. You have used a figure of 12 percent in terms of the flaws on the bills since September 8, which concerns me a great deal, because it's the ongoing flaw with these bills. I mean, the problem is a problem, we'll deal with that. But I am worried about that. Your associate Tammy told us about the extent of the flaws, that she saw them. Mr. Allison has indicated yes, some of those are not absolutely perfect, but they are absolutely acceptable too. You are probably dealing with a level of about 2 percent that may be flaws. I know you are not necessarily a currency expert and you have been thrust into this role. But would you have any reason to disagree with that figure or to be concerned about what he has stated?
 Page 51       PREV PAGE       TOP OF DOC

    Mr. UNGAR. I think the best thing would be to have a joint inspection. It's kind of tough to get identical results when different people view the notes, for example, in Philadelphia we had several different Federal Reserve representatives with us and for some of the notes, everybody had the same view—that yes, these were definitely below the issuance standard. In other cases, people had different views as to what category to put the notes in. So it is really tough when different people are looking at the notes, maybe even at different times or in different locations.

    Chairman CASTLE. Maybe this isn't the right question for you. Is the design adopted for the new notes, which clearly is part of the problem here, but I am glad for it, simply too tough for the normal printing process to produce? Are we dealing with something that we're not going to be able to correct based on what we have? Based on this difficult note and the printing processes we have?

    I'll refer that to Mr. Rolufs as well as you.

    Mr. UNGAR. I was going to say that according to Mr. Rolufs, it's very complex. He explained to us that it is a very complex design, particularly in a case like the $50 note, with the configuration of the portrait because of the length of the concentric lines. But I think it would be best for him to probably go into more detail on that.

    Mr. ROLUFS. This is one in which I find myself more comfortable asking Tom Ferguson and Ms. Kidwell to address. So would one of you like to try that?

 Page 52       PREV PAGE       TOP OF DOC
    Mr. FERGUSON. I would say that certainly as you have stated, Mr. Chairman, the goal in counterfeit deterrence is to make it difficult for people to reproduce. That includes unfortunately us. The easier something is to print, the more easy it becomes for people to counterfeit. So we certainly have challenged ourselves with this. I do not believe we have challenged ourselves beyond our capabilities. I think that the notes that are being produced now are, in fact, very much better. Some may disagree as to the degree of that, and to the degree that notes that are defective have been removed, but the improvements have been made and continue to be made. We can't step back from this kind of challenge. We have to face it and go forward and produce the notes that are, in fact, difficult to print. I think we can, in fact, produce this note. Ms. Kidwell, unfortunately, has to produce the note.

    Chairman CASTLE. I want to hear her say, ''I am sure we can do this,'' not that ''we think we can.''


    Ms. KIDWELL. Thank you, Mr. Chairman. I think we can produce the note, but what it requires now is a much longer learning curve for us to be able to do a lot more testing so that we can develop the techniques that will allow us to produce it consistently. That's what we have struggled with. We did that with both the $100 note and the $50 note. We have gone through major learning curves in working with paper that contains threads, watermarks, that contains these concentric lines with some new inks that we have had to work with, all of which have challenged us in many ways. We continue to learn. We'll be doing the same thing as we look at the design of the new $20 and begin to experiment with the best way to produce that as well. So Tom has most assuredly given us a challenge. I think we have met the challenge well in most cases, but unfortunately it has taken longer than we had hoped and we did not start off with as perfect work as we would like.
 Page 53       PREV PAGE       TOP OF DOC

    Chairman CASTLE. Do we have a problem in terms of production press-type speeds, with the $50 being issued on October 27 and with the $100? Are we able to produce and to fulfill the public need with these two bills?

    Mr. ROLUFS. I don't think we have that problem. I believe that we will have a consistently good note out there, that it will meet the criteria we have established, and that we will get better at it. I will be glad to stick my neck out and give you the reassurances that you need. This is a producible note. We will produce it to the quality standards that are needed by the Nation.

    Chairman CASTLE. Just out of curiosity then, the next note is the $20 note?

    Mr. ROLUFS. That's correct.

    Chairman CASTLE. That is the next one you are going to turn to in terms of security measures?

    Mr. ROLUFS. That is correct.

    Chairman CASTLE. What is the production of the $20 in terms numerically, or by ratio, versus the $50 and the $100? I assume it's more than both of them put together, but I don't know that for sure.

 Page 54       PREV PAGE       TOP OF DOC
    Mr. ROLUFS. First year's production on $20's will be about two billion notes.

    Chairman CASTLE. Compared to?

    Mr. ROLUFS. Compared to what we're doing right now is 400 million for the $50.

    Chairman CASTLE. And how many for the $100?

    Mr. ROLUFS. The $100 was about a billion, 1.2 billion I think.

    Chairman CASTLE. So, it's 100 percent, it's more than 100 percent greater than the two combined. We need to make sure that all these things are worked out before we get into that kind of——

    Mr. ROLUFS. Absolutely. What we have done at the Bureau for information sake is, we have created a small group of people that will include folks from the Federal Reserve that begin to look at every aspect of this note, so that as we move through the testing phases, as we move to the point where we actually go into production, we should not have this problem. That group will report to me every two weeks as to what their progress is and what kind of problems they are encountering.

    Chairman CASTLE. OK. Are you, Mr. Allison and Mr. Rolufs, are you willing to give the subcommittee a written explanation when it happens, of the new review process for the currency, the new checks and balances you are going to have based on the recommendations of GAO and your own thoughts about what needs to be done?
 Page 55       PREV PAGE       TOP OF DOC

    Mr. ROLUFS. Absolutely.

    Mr. ALLISON. Absolutely.

    Chairman CASTLE. Rather than necessarily have a hearing, it might be simple to put some of this in writing.

    I think that is all the questions I have. But I may have said something that triggered something you wanted to say, or there may have been something totally omitted, I can't imagine it, in the course of this that you feel needs to be put on the record. So let me just ask if there is anything further you wish to add that has not already been stated?

    Mr. ROLUFS. I am very comfortable with where we are. Thank you.

    Chairman CASTLE. OK. Let me just summarize then. We, first of all again, appreciate you coming in. I can only characterize what a hearing is. I do not characterize this as an investigative hearing, so much as a hearing in which I think public disclosure of facts, because we all deal with money every day. Virtually everybody in this country does, as do people around the world, deal with American money. I think it is very important that we understand what the process is and be secure in terms of knowing that it is going to work. We want to be helpful in making sure that happens. We don't want to impose false deadlines or underfund you in terms of what you need. We need to be very cautious about this and work together with respect to that.

 Page 56       PREV PAGE       TOP OF DOC
    I appreciate your candor in your statements here. I would have preferred, I think we all would have preferred, if the problem may have been discovered a little bit earlier. Obviously we would prefer to have it prevented, and most significantly, we want to make absolutely sure it does not happen again. We need neither the questions of the confidence in our money nor the cost of that happening. Hopefully the measures we have talked about today will be able to address those problems in the future.

    We would be interested in keeping in touch. If you could drop us a note as you develop a process for reviewing money, or you start to deal with some of the problems of the printing and find other solutions, that would be helpful to keep us informed so that we can keep the subcommittee Members informed as well, and hopefully avoid it in the future.

    With that, unless anybody has anything further, we stand adjourned. Thank you.

    [Whereupon, at 3:58 p.m, the hearing was adjourned, subject to the call of the Chair.]