SPEAKERS CONTENTS INSERTS
Page 1 TOP OF DOC
FEDERAL PAYMENT SYSTEM
TUESDAY, SEPTEMBER 16, 1997
House of Representatives, Subcommittee on Domestic and International Monetary Policy,
Committee on Banking and Financial Services,
The subcommittee met, pursuant to call, at 1:30 p.m. in room 2128, Rayburn House Office Building, Hon. Michael N. Castle, [chairman of the subcommittee], presiding.
Present: Chairman Castle; Representatives Metcalf, Ney, Weldon, Cook, Flake, C. Maloney of New York, Bentsen, and Jackson.
Chairman CASTLE. The hearing will come to order. We thank all those who are participating today and all of those who are kind enough to spend time with us today. We particularly appreciate the Vice Chairman of the Fed, Ms. Rivlin, being with us here today.
The order or procedure is that I will make an opening statement. Anybody else who is present, which consists of the Ranking Member, Mr. Flake, at this time, will be afforded 5 minutes to make an opening statement, after which time, we will go to our panels of witnesses.
The first of those, as it turns out, will be Ms. Rivlin and we will hear from her. She will have whatever length of time she needs. The other witnesses will be limited to 10 minutes, which they know in advance. There are little lights there; if they work properly, sometimes they do, it will be green for 9 minutes, yellow for 1 minute, and then red.
Page 2 PREV PAGE TOP OF DOC
When it goes to red, that means the bomb underneath the seat is getting ready to go off, so you will have to wrap up your statements at that point. With that, I will make an opening statement.
The subject matter of our hearing today is the Federal Reserve and its involvement with payment system. The paperless payment system that has been predicted for many years, while check writing has steadily grown, may now be visible on the horizon. This subcommittee has been studying the development of the mainly electronic technologies that threaten the preeminence of the paper check. Our hearings on the Future of Money and Vice Chairman Rivlin's Committee on the Federal Reserve and the payments mechanism have both covered a bit of the same ground. Her committee studied five scenarios ranging from liquidation of the Fed's role and withdrawal from the payment system to a future with electronic payments as the norm.
This latter scenario intrigues me, even though I understand that the working group spent little time on either of these outlying positions. Part of the basic problems with the current payment system is that actual costs are not reflected in the products. Most people who prefer to use paper checks, do so in the belief that they are ''free.'' Every time a ''free'' check is written and cleared through the system, it costs upward of $2.50. Rather than assess everyone the actual cost of writing a check, the system buries this cost in a ''prime'' lending rate that is higher than it otherwise might be and a savings rate that is lower than it otherwise might be. It may also be showing up in odd places like ATM fees, which with ''Alice in Wonderland'' logic, subsidize ''free'' checks and other services. Under the fifth scenario, the Fed would serve as a catalyst for moving the payment system rapidly toward its seemingly inevitable electronic future.
Page 3 PREV PAGE TOP OF DOC
Whatever happens, the Federal Reserve System is bound to retain a major role, as bankers and consumers look to it to assure the safety and soundness of the system, and, ultimately, the value of the money that enables the economy. Even though explosive growth is projected for emerging payment technologies such as stored valued cards, electronic banking and financial transactions made over the Internet, Americans still wrote an estimated 64 billion paper checks last year. The Federal Reserve both oversees and competes with private companies as a service provider. It clears and transports checks and regulates the safety and soundness of the other participants. As the Fed is the dominant player in the payment system, it is especially important that this subcommittee and the full committee should periodically examine its various roles.
Today we will concentrate primarily on the retail sector. The retail payment sector is made up of small-value, large-volume payments, such as paper checks for consumer purchases, paychecks, Social Security fund transfers, and other payments made via an automated clearing house, ACH. Much of the controversy about the Fed and the payment system derives from the anomalous position they occupy in the area of clearing and transporting canceled paper checks. There, they are simultaneously contractor and service provider, competitor with the private sector and regulator of the safety and soundness of the payment system. Congress has placed them in this position and Congress may someday relieve them from the problems that have resulted. More probably, technology will ride to the rescue. Electronic presentment and electronic banking may permit even the most rural and isolated small bank to offer their customers services that rival the largest banks.
In the meantime, and this might take the rest of this generation, we will have to make due with a compromise system that has served the public pretty well. Both the Credit Union National Association and the Independent Bankers Association of America have served notice that they will be submitting testimony for the record that supports the present Fed roles.
Page 4 PREV PAGE TOP OF DOC
Chairman CASTLE. We will now have several panels of witnesses, three, specifically.
Senator Harry Reid of Nevada was to have testified, but he will be occupied on the Senate floor this afternoon and will submit his testimony for the record.
First, we will hear from the Vice Chairman of the Board of Governors of the Federal Reserve System, Alice Rivlin. She will tell us about a project she has directed for the Board over the past year that has been looking into the future roles that new technology and new competitive realities may hold for the Federal Reserve System.
The second panel will have three members. Gerard F. Milano is Executive Director of the California Bankers Clearing House; Eric P. Roy is the Chairman, Association of Bank Couriers; and Elliott C. McEntee is the President and CEO of the National Automated Clearing House Association, known as NACHA. Each has a wealth of experience and a particular point of view regarding the Fed and the payment system to share with us today.
Finally, at the request of the Minority Members, we will hear from three employees of the Interdistrict Transportation System, a Federal Reserve entity that operates out of the Federal Reserve Bank of Boston to arrange for the transportation of an average of $10 billion in canceled paper checks across the country each night, Monday through Thursday. ITS planes make about 200 flights each night, and ITS also contracts with freight forwarders who transport checks during the day using commercial airlines and private air freight carriers. The Federal Reserve is required by the Monetary Control Act of 1980 to match its revenues with its costs over the long run so that the prices for the services it sells are not subsidized. Mrs. Maloney and Mr. Metcalf, with others, have sponsored H.R. 2119, The Efficient Check Clearing Act of 1997, that would require cost-revenue matching for a specific Fed-provided service. There is some dispute about Fed pricing of check transportation and this panel should help to focus that dispute.
Page 5 PREV PAGE TOP OF DOC
The ITS employees are Thomas W. McFarland, Manager, Transportation Operations, ITS, Federal Reserve Bank of Boston; Thomas Hunt, Senior Systems Analyst, ITS Federal Reserve Bank of Boston; and Charles Fazio, ITS Transportation Analyst.
With that, let me turn to our distinguished Ranking Member, Mr. Flake, for his opening statement.
Mr. FLAKE. Thank you very much. Mr. Chairman I would ask unanimous consent that at the conclusion of my statement, that I be permitted to submit written questions that would go to the House as soon as I have completed this statement, if you will permit me.
Chairman CASTLE. Without objection.
Mr. FLAKE. Thank you very much. Thank you, Mr. Chairman, for convening this afternoon's hearing on the Federal payment system.
Last year, Mr. Gonzalez' staff produced a report that called into question certain practices in the Federal Reserve System with regard to the Interdistrict Transportation System. The report suggests that the Fed, in violation of the Monetary Control Act, subsidizes its automated clearing house activities. It suggests that an accounting and pricing policy hides this subsidy, and that private sector competition is being thwarted. Notwithstanding this report, the Federal Reserve System maintains that it has not violated the Monetary Control Act's instructions in this area.
Page 6 PREV PAGE TOP OF DOC
Mr. Chairman, Representative Maloney of New York and a bipartisan list of cosponsors have drafted legislation to correct this alleged abuse. The number of various Members on the bill suggests that the issue is ripe for review by this subcommittee. We also have Mr. Greenspan on record as saying that if subsidies are being used it is wrong. Toward that end, the Fed has stated that certain practices have been changed in response to Mr. Gonzalez' report. Our task today, therefore, is to determine whether any remaining issues arise from differences of opinion, or clear Fed contravention of the law. To the extent that this afternoon's hearing brings to light any unresolved waste of taxpayer dollars, I look forward to hearing suggestions as to how we can correct the problem. This could come legislatively by Mrs. Maloney's legislation, or by further internal policy changes by the Federal Reserve itself.
Thank you, Mr. Chairman, and I yield back the balance of my time. And I shall return if I can finish this appointment quickly. Thank you.
Chairman CASTLE. Mr. Flake, we wish you well with the House physician, sir.
Mr. FLAKE. If you do not want me to return
Chairman CASTLE. But you know once you miss the courseI do not know.
Mr. FLAKE. He said do not give it to me, so I am going back.
Page 7 PREV PAGE TOP OF DOC Chairman CASTLE. Well, thank you, sir.
Mrs. Maloney is here with us, who is the sponsor of the legislation which I identified in my opening statement, and we will certainly allot her time to make an opening statement.
Mrs. MALONEY. Chairman Castle, first of all, I want to thank you for holding this important hearing on the Federal Reserve's payment system. Congress and the Banking Committee need to continue to exercise their oversight authority on Government bureaucracies competing with the private sector, especially since we have found significant problems in the operations of the Nation's central bank.
Mr. Chairman and Members of the subcommittee, we are not here today to attack the Federal Reserve. We are here to seek the truth about the check clearing services that the Fed sells to all depository institutions. I want to make it very clear that in no way do I wish to challenge the independence of the Fed when it comes to monetary policy. I believe the Federal Reserve should be commended for our current strong economy. Our country has experienced 25 consecutive quarters of economic growth since the recession ended in the first quarter of 1991. Our economy is the envy of the world.
Instead, I would like to examine another aspect of the Fed's operations. Most people do not realize that of the Fed's 25,000 employees, only 1,600 of them play a role in formulating the Nation's monetary policy. This is only 6.4 percent of the Fed's employees. The other 23,400 Federal employees are devoted to other Fed projects.
Page 8 PREV PAGE TOP OF DOC
I became interested in the Fed's check clearing operations when the Fed proposed, only 9 months ago, in December of 1996, to increase the time the Federal Reserve holds checks from a maximum of 2 to 3 days. Their reasoning was that they were trying to combat fraud.
Congressman Henry Gonzalez and I argued that in this age of technological innovation, the Fed should be looking for ways to make consumers' funds available to them sooner, rather than later. We succeeded in defeating the Fed's proposal to hold consumers' checks an extra day.
Now, we must examine the Fed's inefficiency in its check clearing system, brought to our attention by long time Fed employees, who will be testifying here today.
The Banking Committee should resolve the following questions regarding the Federal Reserve Bank of Boston's operation of its Interdistrict Transportation System:
First, is the Fed following the law in the way it prices its services, both on paper and in spirit?
Two, are these services being run efficiently?
Three, what safeguards are in place to prevent mismanagement of these services?
Four, should this part of the Fed's work be as independent from outside scrutiny as its monetary policy operations?
Page 9 PREV PAGE TOP OF DOC
Under the Monetary Control Act of 1980, the Fed is required to recover 100 percent of the cost of providing services. The intention of this Act was to promote competition and innovation. Absolutely necessary components to take the Nation's banking system into the 21st century.
I would like to state for the record that I strive for corrections in the ITS to ensure honest competition in the check clearing business. I believe the Federal Reserve, as the Nation's central bank, should serve as a role model in the manner it provides these services to the private sector.
To ensure the Fed is pricing its services competitively, I introduced the Efficient Check Clearing Act of 1997. I look forward to hearing your views on this legislation and look forward to your support.
Because the Fed approves its own budget and does not have to ask Congress for authority to spend money, it does not go through an oversight process, which other agencies are subjected to in a normal budgeting process. Maybe this lack of scrutiny is appropriate for those areas of the Fed dealing with monetary policy, but, as we will hear today, other activities of the Fed warrant the same Congressional scrutiny as other agencies of Government. One result of this lack of oversight of the Federal Reserve is that it does not publish adequate accounting records. As witnesses will tell us, this has enabled the Fed to issue false information on the subsidies it pays for the transportation of paper checks.
The Fed's annual budget in 1996 was approximately $2.1 billion. From selling its priced services, the Fed received $1 billion in revenue. From interest on the Treasury securities it holds, it received $23.9 billion. The $20.1 billion that was left over after expenditures and additions to its surplus and payment of its 6 percent dividend to member banks, was returned to the United States Treasury. This means that when the Fed saves a dollar, it is saving taxpayers' dollars.
Page 10 PREV PAGE TOP OF DOC
The oversight of the Fed's total expenditures is performed solely by the Senate and House Banking Committees. The benefits of Congressional oversight are illustrated in a January, 1996, investigative report ordered by the House Banking Committee's Ranking Democrat, Representative Henry B. Gonzalez. The report, ''Waste and Abuse in the Federal Reserve Payment System,'' can be found on the Internet on the House Banking Committee's Democrat web site.
Many serious problems in the ITS were uncovered in the report. Since 1990, $14 million was awarded to a private vendor without competitive bidding, even though 85 percent of the services were for unskilled manual labor; $2 million was paid for spare airplanes, which were not always available; $8 million was paid for lump-sum payments, much of which served mainly to exhaust the ITS budget at the end of the year, a practice known as ''budget dumping.''
ITS, under the orders of officers of the Federal Reserve Bank of Boston, knowingly paid an air courier for service that was never performed, because it had permanently been grounded by the FAA. These problems increased the cost of operating the ITS.
The committee report included statements by the Fed's own employees that the Fed only recovered about 75 percent of its costs in delivering paper checks. The operations of the ITS were subsidized. Thus, the taxpayers footed the bill, or the Fed raised its prices on other services, ultimately, at the expense of the consumer.
Since the committee issued its report in January of 1996, some of the problems at the ITS have been corrected. One manager for the ITS will testify today that phasing out the ''no-bid contract'' will save $500- to $600,000-per-year for ITS. That is good news and shows the benefits of Congressional oversight. The other witnesses from ITS will tell us today what additional problems remain.
Page 11 PREV PAGE TOP OF DOC
I would like to convey my gratitude to the ITS witnesses today, Thomas McFarland, Thomas Hunt, and Charles Fazio, for taking the time and effort over the last several years to correct the inefficiencies in the Federal Reserve's Interdistrict Transportation System. I thank you. The Fed should thank you, and the American taxpayers thank you.
Chairman CASTLE. Thank you very much, Congresswoman.
We will now turn to the distinguished gentleman from Washington State, Mr. Metcalf.
Mr. METCALF. Thank you, Chairman Castle. I want to thank you for calling these hearings today and I want to thank our witnesses for coming, especially Federal Reserve Vice Chair, Alice Rivlin. I look forward to your testimony in the question period following. We have heard from critics of the Fed's check clearing system, and I appreciate the opportunity to look further into this matter.
First, we recognize that our check clearing process is, as Congresswoman Maloney stated, the envy of almost every Nation in the world. The short time it takes for billions of dollars in checks to work through our complicated financial system is nothing short of amazing. But let us not forget that time is money, and the longer the float of the check, the higher the cost for the system and for the banks.
Of great and critical importance to me is the potential impact of commercial check processing and the transportation of checks has on many of our smaller institutions.
Page 12 PREV PAGE TOP OF DOC
Clearly, smaller banks do not have the capital to process checks like the larger institutions. Yet, these small institutions represent many customers and their business is dependent on providing fast and efficient service to stay competitive with the in-house operations of larger institutions.
I would oppose legislation that would negatively impact these smaller institutions. Today everyone would agree that we do not clearly understand this complicated check clearing system. However, there are charges that the system is archaic and does not operate with logical market realities.
Some of us have talked about privatization. We have heard that the system is not fully privatized, and that the Fed operates with a subsidy, that is, perhaps, contrary to law. Yet, conversely, the Fed contests that it operates within the balance of law.
Today my hope is that we can resolve that question. We in this body have an important role in seeing that competition is on a level playing field and is consistent with the intent of the Monetary Control Act of 1980, which gave the Fed this authority.
We must be certain that the check delivery system, as presently operated, is within the scope of this Act, and we must understand how these operations impact the entire marketplace. The Fed has handled this service for many years now. There is, at present, the consideration of allowing someone else, not only to transport the checks, but possibly to provide the service of tracking, cataloguing and crediting billions of dollars flying around our country.
Page 13 PREV PAGE TOP OF DOC This is a major concern, not only for us as the overseers, but very definitely for the financial institutions that depend daily on this service. It is no wonder that they have some concern. I look forward to our witnesses comments and the answers to our questions. Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Metcalf. We appreciate your statement. And we have now been joined by Mr. Jackson of Illinois, if he would like to make a statement.
Mr. JACKSON. Mr. Chairman, I do not have an opening statement. I will just submit my statement for the record.
Chairman CASTLE. OK. Thank you. Without objection, it will be submitted.
Dr. Weldon of Florida is with us, if he wishes to make an opening statement.
Dr. WELDON. Thank you, Mr. Chairman. I would just like to briefly thank you for calling this hearing. I am getting conflicting input on this issue, whether the Fed's role should be expanded or diminished. So, I am interested to hear what our witnesses have to say today. Thank you very much.
Chairman CASTLE. Thank you, sir. I think that concludes all of the opening statements.
Page 14 PREV PAGE TOP OF DOC
And at this time, Vice Chairman Rivlin, we will turn to you for your statement.
STATEMENT OF HON. ALICE M. RIVLIN, VICE CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Ms. RIVLIN. Thank you, Mr. Chairman. I will summarize my statement fairly briefly, and hope that it may be included in the record in its entirety.
I am very pleased to have a chance to discuss with the subcommittee the payment system and the Federal Reserve's role in it. It is an important and a timely subject. Payments are important in all of our daily lives. We all write checks and make payments every day, but we do not think about it very often.
Payments are also a very important part of the responsibility that the Congress has given to the Fed, but they are not often the subject of hearings or public attention. Most of the attention focuses on monetary policy, so I am very glad that you are having this hearing.
As you do not need to be reminded, there are huge changes going on in the banking system: technology changing very rapidly, consolidation of banks, interstate banking, merging of financial services firms. These changes could effect the payment system profoundly.
With that in mind, Chairman Greenspan, almost a year ago now, created a committee to help the Federal Reserve think about these kinds of changes, how they affect the payment system, and how they might affect our role in it.
Page 15 PREV PAGE TOP OF DOC
I would like to discuss briefly, first, the evolution of the Fed's role in payments, especially non-cash retail payments, that is, checks and automatic clearing house, or ACH; the work of the committee I have been chairing; what we have learned from forums we have held around the country; and a few preliminary conclusions.
And, finally, I would like to make a few remarks about the Interdistrict Transportation Service or ITS, which, though it is a small part of our check processing operation, has certainly attracted a lot of interest.
The payment system, as you said, Mr. Chairman, is divided into wholesale or large dollar payments, which are very important, but not very controversial, and I will not refer further to those; and, second, retail payments, the smaller dollar transactions.
Most transactions that we make every day are in cash. But, in fact, cash only accounts for about 1 percent of the value of transactions. Another big item for transactions are checks. Checks are very popular in the United States, much more popular than they are in most industrial countries.
As you said, Americans wrote about 64 billion checks last year. That is a lot of pieces of paper, and the volume of checks is still growing. It is growing slowly, about 2 percent per year, but it is still growing. Credit cards, debit cards and home banking are growing much faster, but have not yet reversed the growth of checks.
It is really kind of remarkable in an electronic age that we are transporting so many little pieces of paper around the country, when this information could go more rapidly and cheaply by electronic means. We are, however, moving toward the electronics. One way we are doing that is a greater use of the automatic clearing house or ACH, now a fully electronic system.
Page 16 PREV PAGE TOP OF DOC
Payment systems are a parta big partof the reason that the Congress created the Federal Reserve. The panic of 1907, which all of us, fortunately, are not old enough to remember, created a very serious situation which affected the payment system. Many checks were not accepted for payment, and that exacerbated the crisis, and it raised Congressional concern. Also, checks in that era were not circulating at par. Hence, in 1913, when Congress decided that it should create the Federal Reserve under the Federal Reserve Act, it gave the Fed authority to clear checks, required that they clear at par, and required that we not pay presentment fees.
Subsequent legislation did two things: The Monetary Control Act in 1980 gave the Fed the explicit mission of improving the efficiency of the system by competing with private sector payments providers on a fair basis. The Act said that we should charge for our services and we should recover the cost, including imputed profit and taxes, things that would be paid if we were a private sector competitor, and we have done that.
Second, the Expedited Funds Availability Act of 1987 gave the Federal Reserve power to set rules for check payments generally, not just those processed by the Fed, with a view to ensuring the access of all depository institutions to the payment system.
Congress has given the Fed the mission of ensuring the integrity, accessibility, and efficiency of the payment system, and has given us two kinds of tools to do it, regulatory tools, and our role as a competitor in the system.
In the check clearing market, the Federal Reserve now clears about one-third of interbank checks. We compete with other providers of check collection services. We serve all depository institutions, including small institutions, community banks, and those remote from the money centers.
Page 17 PREV PAGE TOP OF DOC
Many of our competitors in the check processing market use the Federal Reserve to present checks to those smaller and more remote institutions. If you have ever looked at this operation of check clearing, it is a pretty fascinating one. It goes on mostly at night. Checks are sorted by machine. They are trucked and flown all over the country. The Interdistrict Transportation ServiceITSis a vital, but a small part of this operation of getting checks from one place to another. It represents about 4 percent of the total cost of check processing done by the Federal Reserve.
The Federal Reserve has used its role in the payment system to move the system more toward electronic payments, specifically, in the check area for fostering electronic check presentment. We have also tried to expand the role of the ACH. The Fed is the dominant player here, having 80 percent of the interbank market. We move to make the ACH fully electronic and more useful to its customers.
The fact remains that the retail payments system, as a whole, is still heavily paper-based. Checks are convenient and familiar to people. I think as a Nation we need to think very hard about how to make electronic payments equally convenient and familiar, because they are more efficient.
In the face of all of these changes, our committee was created to examine the role of the Federal Reserve in the payment system of the future. As an aid for doing that we constructed five scenarios, which laid out very different roles for the Federal Reserve in retail payments in the future.
Page 18 PREV PAGE TOP OF DOC These scenarios had quite a wide range. One had the Federal Reserve getting out of both check processing and the automated clearing house in an orderly way, letting the private sector fill the gap. We also considered privatizing the check and ACH operations of the Fed as a block, selling them to a private sector bidder. That aroused very little interest, actually, and we did not pursue it very far.
Then we considered the Fed staying in the check and ACH market, but on a rather passive basis, just to ensure the access of all institutions, including small ones, to this process. That was generally thought to be a slow exit scenario.
We considered a scenario of staying in and competing more vigorously with a view to enhancing efficiency, and a scenario of really concentrating heavily on moving the system more rapidly to electronics. These were not exactly policy options. They were to provoke discussion, and we first estimated how we thought these different scenarios would affect the price, the availability, and the structure of the system, how they would affect public confidence in payments, and the rapidity of technological change.
We did not want to rely solely on our own analysis, so we moved out around the country to consult participants in the payment system. We held ten national forums and 52 regional forums, which included many kinds of organizations, large and small banks, clearing houses, vendors, regulators, consumer groups.
We got a diversity of opinion and very lively discussions, but a few main themes emerged. One was that there was actually very little sentiment, I think less than we expected, for Fed withdrawal from the check and ACH systems.
Page 19 PREV PAGE TOP OF DOC
Community banks depend on the Federal Reserve. They are worried about being at the mercy of big providers, many of whom are their competitors. They worry about the availability of service in a financial crisis. They worry that the prices to them would be higher if the Fed were not in the market.
We were not surprised by that, but we were a little bit surprised by the attitude of large banks. A few of them would like to remove the Fed as a competitor, but many stress that they would not; that they were not interested in returning to serving remote locations; that they consider check clearing a low-profit business that is on its way out.
We got mixed views of whether technology would move faster with the Fed in or out of the market. The Fed getting out, some thought, might hasten the move to electronics. Many others thought it would just be disruptive and slow things down, that the banking system in this era of change has a great many things to worry about and a great many investments to make, and does not need to be burdened further by a disruption of the payment system.
We heard very strong voices for more Federal Reserve leadership, although often different definitions of what that meant. We heard voices that wanted the Federal Reserve to work more intensively with the industry to improve the efficiency of check collection and ACH, and to figure out how to move on to the next generation of payments.
Many urged the Fed to work to remove the legal impediments to electronic payments; to help set standards to educate the public;, to provide incentives for moving more rapidly to electronic payments.
Page 20 PREV PAGE TOP OF DOC
The committee is still weighing what it has learned. We have not formulated specific recommendations to bring to the Board and the rest of the Federal Reserve System. We are looking forward to working with Congress on these next steps in ensuring the integrity, and efficiency, and accessibility of the payment system.
Finally, let me make a few comments on the ITS.
First, what is it? It is a network of air and ground couriers that the Fed uses to transport the checks that the Fed is processing from one Federal Reserve office to another. Other major processors of checks also have networks that perform this function. The ITS is a small part of the Fed's check processing operation, but it is a vital part. It is also a small part of the check transportation network nationally.
The Federal Reserve uses private couriers. It does not own any airplanes. In 1996, the ITS cost about $36.1 million and the contracts were $35.5 million of that. So, it is a private sector operation managed by the Fed.
The ITS has generally performed very well. Its costs since inception have increased about 1 percent per year, which is very good. It has cut the float, which Congressman Metcalf referred to as very costly. It has increased on-time delivery.
The Gonzalez report, to which reference was made earlier, raised some questions about the management of the ITS. Management of a complicated, fast-paced operation like ITS can, I think, often be second-guessed. But the Gonzalez report pointed to some problems, and many of them, as someone said earlier, we believe have been fixed. We now believe that the ITS is functioning very well.
Page 21 PREV PAGE TOP OF DOC
The Federal Reserve is clearly in the check collection business, but we do not regard ourselves as being in the check transportation business. We only transport the checks of our customers whose checks we are actually collecting. We do not offer this service generally.
From that point of view, it is not useful to price the transportation of checks separately, and adjust those prices to recover the specific costs of transportation or sorting, or whatever else goes into the whole process of handling checks. Our competitors do not do that, and we do not think we should do that.
Finally, we believe that H.R. 2119 would make operating the Federal Reserve check processing system more complicated and less fair. By making us price every different component of a service separately, it would place a burden on us that is not placed on our competitors. If we were in the check transportation business, then we would be in a different business and we would serve all comers, not just our own customers.
Thank you, Mr. Chairman. I would be delighted to answer any questions on any part of this.
Chairman CASTLE. Well, thank you very much, Ms. Rivlin. I will start the questioning. And I will tell you that we have a GAO report, which I have not read, about 300 pages. I challenge anybody here to see if they have really read all of it. And I have read some of your writings and preliminary testimony on this, but it is a confusing subject to all of us. I would just like to ask some basic questions, if I could. And then maybe we can get into more details later on.
Page 22 PREV PAGE TOP OF DOC
First of all, I would like to affirm something thator have you put in your words, I guess I should saysomething which I said in my opening, which is: It is estimated that the costs of doing this, all of which are hidden costs, obviously, to the consumer is $2.50, how real are these? And then I want to eventually compare that to electronic payment costs.
Has anyone actuallyyou mention this at the end, but has anybody actually evaluated what these costs of actually handling a check from beginning to end are to a system, if not to an individual?
Ms. RIVLIN. We have attempted to find such estimates or to make them. The $2.50 sounds astonishingly high, and I do not know the source of that number. There are two kinds of costs. There are the direct costs of processing a check through the system. And then I think how you get to much larger numbers is if you put in the time that people actually spend writing checks, the postage, and all of those things.
I think the point is clear if you are sending information about payments from one place to another, a payment instruction, it is cheaper to do it electronically than to do it by paper check, which has to be transported around.
Chairman CASTLE. I imagine when you start to estimate these things, one does not know if it is $2.50 or $1.89, or what. But I am just trying to get some sort of a relevant factor. So, let me ask you another comparison question first.
Page 23 PREV PAGE TOP OF DOC When you say ''electronic'' payment, to what are you referring specifically? Let me tell you why I ask that question. For example, I have a money market account with a mutual fund-type thing, and they do not send the checks back. They send an image of the check back to me, which I assume has some sort of cost savings in it, when I use one of their checks. But I do not think that is what you mean by electronic payment, per se. And then you have things like credit cards and ''smart'' cards. Smart cards get into electronic-type payments.
Can you tell us what you mean by the ''electronic payment,'' so we can distinguish between the two?
Ms. RIVLIN. Yes, by ''electronic payment,'' I meant one of any number of different kinds of payments that go over a computer network. Putting a debit card in a machine at my grocery store is a good example of that. That payment information is sent over an electronic network directly to my bank and the payment for groceries is debited from my account. There is no paper at all.
Chairman CASTLE. By the way, the $2.50 came from one of your own people. As it turns out, Louise Roseman. Is that correct? A Federal senior staff member last year in a Senate meeting gave that cost. So, I do not know. I am not holding anybody to it.
Ms. RIVLIN. Louise is terrific and I will go back and ask her about it.
Chairman CASTLE. OK. She must know more than I do, at least. But, in any event, the bottom line is in all of these other forms of transaction are less expensive than the check writing which we have. What prevents us from just stating that we are going to eliminate paper checks?
Page 24 PREV PAGE TOP OF DOC
I am playing devil's advocate here, because there is probably a lot of politics to all of this if I had to guess.
I say that because I know that in Europe and various other places in this world, they have gotten very close to doing that, and, yet, we in American still persist in having these dozens, or even hundreds, of flights every night, checks going all over, tremendous hidden costs, which ultimately come out in costs to all of us, as we know, in the way of interest or some other forms of costs.
Why do weI mean, is it just the American system in a democratic way to allow the public to tell us what to do in these circumstances, or should we be stepping in some way and indicating a solution, which would ultimately save everybody money?
Ms. RIVLIN. That is a question which my committee has wrestled with, and we all need to wrestle with. There are two questions really. If we were going to move to electronics, should we dictate it, or should we create some incentives to encourage it, which is a bit more in the American tradition?
There may be a lot of reasons why Americans like checks so much. We are a very large country with a lot of small banks and small towns, and a lot of people who are not in the electronic network yet. ATMs are a good example. A lot of older people, especially, said ''That's not for me. I do not want to use one of those machines. I want to go into the bank and get my check cashed.'' Now, some of them have come around to thinking the ATM is really quite convenient. So, if we are going to move faster on this we need a public education campaign. We need to figure out what the resistance is and how to get around it.
Page 25 PREV PAGE TOP OF DOC
Chairman CASTLE. Let me ask one very quick follow-up question. I want to stay to the 5-minute rule today, although we may have a second round with you, so that we can get everybody's questions in.
What about a system that used images or photocopies of checks, so that you would have written out the check, and then you would have the image of it coming back to you? Would that be a savings of any kind, or is that not worth exploring?
Ms. RIVLIN. Well, we are exploring that right now at the Federal Reserve. I think, in general, if you do not have to transport the check, the image goes over an electronic network, then it seems to be a more efficient system.
On the other hand, the investment in the equipment that allows you to both send and receive those images is quite considerable. If checks are going to phase out entirely over the next decade or so, it might not make sense to invest very heavily in making checks more efficient.
Chairman CASTLE. Just to follow-up, you said ''sending and receiving.'' I assume that the senderI would be the sender and I would send the check out, and then the ultimate receiver would be a bank or something of that nature, who would then do the photocopying, and then send that back out as paper, at some point, at the end of the month, or something of that nature?
Ms. RIVLIN. That is right, but not all banks. Your bank has to have both the sending and the receiving equipment, or they have to designate an intermediary that has it.
Page 26 PREV PAGE TOP OF DOC
Chairman CASTLE. OK.
Ms. RIVLIN. Like the Federal Reserve.
Chairman CASTLE. OK.
Ms. RIVLIN. And, certainly, not all small banks have this at the moment.
Chairman CASTLE. All right. OK. Thank you.
Mrs. MALONEY. Thank you, Mr. Chairman. First, I would like to welcome Alice Rivlin and congratulate her on her long and distinguished record of public service, and we appreciate very much your coming here today, and I appreciate your answering my questions. We have received responses yesterday.
I also received another long-awaited response yesterday from Chairman Alan Greenspan, which I would like to submit to the record. In this Mr. Greenspan informed me that, indeed, ITS has been operating at a loss. This completely contradicts what the Fed has maintained for the past several years, that the ITS recovers 99 percent of its costs.
I would like to read directly from Alan Greenspan's letter: ''The loss on ITS is really a fiction, because the value itITScreates to accomplish broader efficiencies and the check services far exceeds the amount that our internal records reflect as a loss.'' I would like to put that in the record.
Page 27 PREV PAGE TOP OF DOC
I would also like to put in the record again some statements from Alan Greenspan at the Humphrey-Hawkins hearings that we held on July 22, 1997. There he said, ''If ITS was being subsidized it would be wrong.'' I am really pleased that Chairman Greenspan has finally admitted that there is a loss at ITS, as the three ITS personnel have said for several years, and will say again today.
Now, we should move on to the next step. I would just like to know, will the Fed now agree to end the subsidy for transporting paper checks?
Ms. RIVLIN. A loss is not necessarily a subsidy. That is, I think, what is hanging us up here. I do not think there is any question about the fact that as we do the accounting, the ITS has in the last couple of years not covered its full costs. The 99 percent comes from some prior year. It depends on which year you are talking about. This is not a question of admission. No one says that the ITS in the last couple of years has covered its costs.
That does not say that there is a subsidy to the Fed's check service. Check processing, as a whole, has covered its costs in total over the last decade quite substantially. As the law requires, it covers not only its direct costs, but these imputed costs of the profit and the taxes that the Federal Reserve would have to pay if it were a private sector competitor. That is what the law says and that is what we do.
We do not, nor do any of our competitors, force ourselves to cover every individual component of the service, such as sorting the checks. If you looked at sorting the checks, that is one component. Accounting within the Federal Reserve System is presumably, another component. Our transporting of the checks is a component of the service that we provide to banks who want to process their checks with us. The whole check processing operation covers its costs very well.
Page 28 PREV PAGE TOP OF DOC
Mrs. MALONEY. Well, data that was submitted to the subcommittee shows that the Fed claims that they covered their costs by 100 percent through 1995, and, indeed, another one of Mr. Greenspan's letters states, ''The average through 1994 exceeds 99.3 percent of recovery.''
Ms. RIVLIN. 1994?
Mrs. MALONEY. That is 1994. Yet, today, we will hear testimony from people who work for the Federal Reserve who say otherwise. I would also really like to comment on something you said in your opening statement. You said ''ITS is a private company, because it awards contracts to private couriers.'' I would like to respectfully disagree.
Government often awards private contracts to private entities. ITS operates out of the Federal Reserve Bank of Boston. ITS personnel in that office, including the manager of ITS who will testify today, are employees of the Federal Reserve. These personnel plan all airline routes and details of ITS operations. Officials of the Federal Reserve Bank of Boston approve the surcharges for the cost of carrying checks. They set the conditions for all contracts with private vendors, and they award all of the contracts.
Ms. RIVLIN. Oh, absolutely. I do not think there is any dispute about that. The Federal Reserve of Boston operates the ITS. What I said was that it is largely a contract operation. People sometimes say, ''Why not privatize it?'' Well, privatizing it means using private sector couriers and other operators. That is what ITS does. It is managed by the Fed, but the people who actually do the work of transporting the checks are private sector couriers more or less mom and pop operations around the country; small air couriers.
Page 29 PREV PAGE TOP OF DOC
Mrs. MALONEY. Well, then the misunderstanding was use of words. I believe you said ITS was a private company. I believe that is what you said in your testimony. It obviously is not, if it is Federal Reserve employees. And, oftentimes, in the Federal Government, we have private contracts, most of which are competitively bid.
I would like to submit the remainder of my questions in writing. I have quite a few more, but in the interest of time and the fact that we have many other panels, I thank the Chairman very much for his time and for calling this hearing.
Chairman CASTLE. Well, thank you very much, Mrs. Maloney. We appreciate your testimony and there may be other Members who wish to submit questions and you are probably used to that. We, hopefully, can get a response sometime.
Mr. METCALF. Thank you, Mr. Chairman. Just for the record, I have a question for the witness here.
I want my checks to come back to me. I paid for them. They are mine, and the bank should not keep them from me. I just had my last statement from the little Whidbey Island bank. It was a picture, a piece of paper with a picture of my checks on it. I will tell you the next time I get back to my District on a weekday, I am going to be in that bank and we are going to reach an understanding. So, just for the record, I want my checks back. They are mine. I paid for them.
Page 30 PREV PAGE TOP OF DOC
Ms. RIVLIN. There are a lot of people who feel that way.
Mr. METCALF. Yes, there are.
Chairman CASTLE. If the gentleman would yield, I guess that is why we have not made any changes. Is that correct?
Mr. METCALF. Well, I would like to ask this question. It is said that the system is privatized. My question is: Is the bidding a completely open and competitive process on the rates for all specified check transportation routes? Is it open and competitive, really open and competitive?
Ms. RIVLIN. Yes, it is. Now, occasionally, you will find some part of the country where there is only one courier, but the general practice is competitive bidding.
Mr. METCALF. OK. Getting back to the subsidy issue, and I think that is a pretty critical one, and it is still unclear in my mind thus far. Is there a potential conflict between the requirements of the Monetary Control Act and the Fed's future role in check clearing?
That is, the Monetary Control Act said that, essentially, as I understand it, that you cannot have a subsidy. Mr. Greenspan said in his letter that the loss is really a fiction, but still it shows up as a loss, and that, I guess I would like to ask you to clarify that.
Page 31 PREV PAGE TOP OF DOC
Is there a conflict in the requirements of the Monetary Control Act in this area?
Ms. RIVLIN. I do not think so, but then it depends on what services you are looking to package together. The Monetary Control Act says that the Federal Reserve shall recover the costs of its priced services in the aggregate.
Now, we have interpreted that a little bit more narrowly. We have put the rule to ourselves that we cover the cost of major services individually. In other words, check collection covers its costs. ACH covers its costs.
One could raise the question of whether that is a good idea. We have thought about it in the committee. If we wanted to move the system more toward electronics, it might make sense to under-recover the costs of electronic systems for awhile until they get more accepted and to over-recover checks.
Now, we have not done that. I do not want to raise a red herring in here, but one could think about that, of pricing the electronic services differentially so they would be more attractive.
Mr. METCALF. One other thing that you did mention, you said your loss is not a subsidy. I guess I would have to askand I do see I think what you are driving atbut, if the loss is not a subsidy, who pays that loss?
Page 32 PREV PAGE TOP OF DOC Ms. RIVLIN. Well, the check processing operation as a whole does not make a loss. It more than recovers its costs. So, checks are not subsidizing anything else and not being subsidized.
The question raised by Mrs. Maloney is: Let us not think about the total check operation. Let us think about a small piece of the check operation, namely, check transportation. She could as well have said check sorting, or some other part of it. She would like to require that each individual piece of the check operation recover its costs directly in their entirety. That is not a rule that any of our competitors impose on themselves, and it is not one that we have imposed on ourselves.
Mr. METCALF. OK. If the private clearing houses increasingly attract the most profitable business, leaving the most costly business to the Fed, might not the Fed eventually be unable to meet its legal requirements to recover its costs, or is that related to your last answer?
Ms. RIVLIN. Yes, we worry about that, and that again depends on what role the Fed plays, but I mention these scenarios. If the Fed were, in the future, to play a very passive role and say, ''OK. We will not get in there and compete heavily with the big correspondents. We will just keep our doors open so that the little banks will have some place to go.''
Then I think our competitors would take all of the good business in the very heavily populated areas of the country and we would be left a bit like the Post Office with the smaller outlying areas, and it would be impossible to cover the costs.
Page 33 PREV PAGE TOP OF DOC
Chairman CASTLE. Thank you very much, Mr. Metcalf.
Mr. BENTSEN. Thank you, Mr. Chairman. Mr. Metcalf reminds me, with all due respect, of my late grandfather, who told me that he never liked it when they moved from bearer bonds to book entry bonds, but the country is still here. These changes are taking place.
Ms. Rivlin, I have a question, a couple of questions. First of all, from your testimony and some other things I have read, it would appear that the Fed is clearing about one-quarter of all checks?
Ms. RIVLIN. Well, we clear about one-third of interbank checks. A large and increasing number of checks are so-called ''on us'' checks
Mr. BENTSEN. Right.
Ms. RIVLIN.That are the same bank. But we clear about one-third of the interbank checks.
Mr. BENTSEN. So, one-third of the banks are on us, and so those just never see the light of day, basically?
Page 34 PREV PAGE TOP OF DOC Ms. RIVLIN. Right.
Mr. BENTSEN. And then one-third go through the Fed's clearing house. And so, the other one-third are now being done through other private entities, either bank clearing house associations, or through private contractors?
Ms. RIVLIN. Yes, we have one-third of the interbank market. Clearing houses have about one-quarter I think, and other big banks have about one-quarter, and the rest are directly presented.
Mr. BENTSEN. Do you know what the growth has been in the non-Fed check transfer market since the 1980 Monetary Control Act? I mean has it been fairly dramatic, or in recent years has it been more dramatic? Is the Fed losing market shares?
Ms. RIVLIN. In recent years, the Fed has lost market share, although it has stabilized in the last couple of years, but our market share is now lower than it was.
Mr. BENTSEN. The Expedited Funds Act of 1987, I believe, gave the Fed authority over all check clearing to regulate check clearing. Based on that and the fact that the Fed has been losing market share up to a point where I guess it is now flat, why is the Fed still in this business? Why should not perhaps the Fedand this is perhaps more of a philosophical question. But perhaps the Fed should not be in this business, if we see a private market is taking over.
Page 35 PREV PAGE TOP OF DOC Now, I understand why the Fed is in the wire transfer business. I think that is a little bit different. Is there an argument to be made for the Fed to still be in the check clearing business?
Ms. RIVLIN. Well, that is exactly the question that my committee was created to think about, and I think it is a good question. As we look forward, what is the role of the Fed in the check clearing business?
The principal argument for the Fed staying in the check clearing business, I think, is that it is always there and serves a very wide variety of banks, but especially community banks. Your part of the country has a lot of them.
Mr. BENTSEN. In my part of the country, most of the banks are owned by banks that are outside of the State, so it is not quite what it once was.
Ms. RIVLIN. Not quite, but there are still a lot of small banks in Texas. I think the question of what would happen if the Federal Reserve got out of the check clearing business is, in large part, a question of what would happen to the availability of services to community banks and banks in remote locations. Would there be anyone to serve them and at what price?
When we did these forums, we found a lot of community bankers very worried that there would not be service available to them at a price that they could afford.
Mr. BENTSEN. And that is an important question. I just wonder whether or not the market is going to drive that, and whether or not also the Expedited Funds Act would give the Fed the authority to ensure that there is still a market? You can answer that for the record, if you would. But I think that is a question that you need to look at further, because I wonder whether you should be there.
Page 36 PREV PAGE TOP OF DOC
[Vice Chair Rivlin subsequently submitted the following response to Congressman Bentsen for inclusion in the record:
[While we would not have the authority under the Expedited Funds Availability Act to require private firms to provide check and ACH services to all depository institutions, we do have the authority under the Act to increase the economic attractiveness of providing those payment services by, for example, improving the legal rights of banks to present checks to paying banks. Thus, we would be able to take regulatory steps to help achieve a continuation of the provision of an adequate level of service nationwide.]
Mr. BENTSEN. I would also ask for the record, as to whether or not, with the advances in check clearingand this hearing is not about this today, but is it time for Congress to go back and look at the 1987 Expedited Funds Act, with respect to the fact that I can write a check and deposit it in a credit union downstairs on a Texas bank and it shows up in that Texas bank tomorrow, but I am not sure when the funds availability would be on that check that was written here? Perhaps, that is something that Congress ought to take a look at. But if you could address that for the record, I would appreciate it.
Ms. RIVLIN. I would be happy to.
Chairman CASTLE. Thank you, Mr. Bentsen.
Page 37 PREV PAGE TOP OF DOC Mr. NEY. Thank you, Mr. Chairman. The question I wanted to ask Vice Chairman Rivlin is, a 1996 GAO report determined that the Fed uses its employees' pension surplus to offsetor lower, if you want to call it lower, the true cost of what is necessary to provide certain payment services. I wonder if you had a comment on that, using the pension? That was according to the report.
Ms. RIVLIN. That is a complicated issue and I would be happy to answer that for the record, if I may.
Mr. NEY. So, you will be answering later you mean?
Ms. RIVLIN. Right.
Mr. NEY. OK. So, you do not know how long this has been going on, or how long that type of a subsidy has been going on?
Ms. RIVLIN. I do not want to say that there is a subsidy until I look into it, Congressman.
Mr. NEY. OK. These days with the issues of pension, I was particularly, keenly interested in that.
Ms. RIVLIN. OK. We will get back to you.
Mr. NEY. Has the Federal Reserve ever had a policy of matching cost with the revenues, regarding the transportation in the ITS, matching the cost and the revenues?
Page 38 PREV PAGE TOP OF DOC
Ms. RIVLIN. Well, we look at the cost and the revenues, but we have not felt it was necessary to match the cost to the revenues in the same way that we do for the whole check service. That is a subpiece of check service. We do not look at every individual subpiece.
Mr. NEY. Was that done at one particular time, do you know, by the Fed Reserve?
Ms. RIVLIN. No, it was not.
Mr. NEY. It was not done by the Reserve. The one thing I would like toand I think it might have been Mr. Metcalf, or it might have been Mrs. Maloneyhad basically, been looking toward the line of questioning about offsets. I think your comment was that you did not look at this as a subsidy. But really, is the system, as it is designed, overcharging, in a sense, the Treasury and in a way that does become a subsidy? If it goes up, it charges the Treasury. It is a subsidy, in my opinion, of particularly one or two businesses. I do not know the exact setup, but rather than the open competition for the system.
Ms. RIVLIN. No, I do not think so. We do transport checks for the Treasury. What you may be referring to is something in the Gonzalez report that said we were not accurately allocating costs. We priced by weight, and that we were not very accurately weighing those checks.
We were using estimates. Now we use the actual weight and that is better. I do not think we subsidize the Treasury. We are the fiscal agent for the Treasury. We have to do what they want us to do.
Page 39 PREV PAGE TOP OF DOC
Mr. NEY. No, I do not think you would beI agree. I do not think you will be subsidizing, but I think you would be overcharging.
Ms. RIVLIN. Overcharging? No. Well, we do not think we are.
Mr. NEY. Why? I mean, in the sense that if an unrealistic low price, and, in fact, there is a loss, in a sense, is that not loss? I mean, that is what we have been talking about now. Is that loss not a type of subsidy, in that it is charged to the Treasury?
Ms. RIVLIN. No. Remember, the kind of operation that the ITS is. It basically has large fixed costs, because transporting checks involves having a long-run contract with an air courier, and so forth. The incremental costs, the costs of putting an extra ten checks on this airplane that is already going, is quite low.
And so, while we do not make it available generally, we certainly make it available to the Treasury, and the Treasury gets a pretty good deal out of this, as do our internal users. I mean, we use it for interoffice mail and we charge ourselves. But the extra costs, once you got the system of carrying some extra mail, or some extra checks, is quite low.
Mr. NEY. Let me ask this final question. What would be wrong with just saying, ''Look, we are going to open this system up, and there are carriers who are out there. We are going to open and do a bid, and competitive pricing, and let the market take its course''?
Page 40 PREV PAGE TOP OF DOC Ms. RIVLIN. We do that. The air courier services that we use bid competitively and we do not have a lot of trouble finding people who are willing to bid on these contracts. We competitively bid them.
Chairman CASTLE. Thank you, Mr. Ney.
Mr. JACKSON. Thank you, Mr. Chairman. I just have one question, and then I would like to yield the balance of my time for the gentlelady from New York.
Today we found out that Mr. Chairman Greenspan sent Congresswoman Maloney a letter last night admitting that the Fed's airplane fleet was operating, and running, at a loss. The Federal Reserve employees who manage that operation and will testify today have submitted testimony which says that the loss is substantial, and that it covers many years. If this is true, then it has been a fiction for many years.
At the same time, I learned that Congressman Gonzalez received a letter from Chairman Greenspan on April 28th, 1997, saying that there was more than a 99.3 percent cost recovery at ITS, and that numbers being sent to the subcommittee were accurate. The Fed appears to have a credibility problem that we should immediately remedy.
I think it is time to strongly support the portion of Congresswoman Maloney's bill, the Efficiency Check Clearing Act of 1997, H.R. 2119, that will require the General Accounting Office to check the Fed's cost revenue records and verify that they are complying with the Monetary Control Act of 1997.
Page 41 PREV PAGE TOP OF DOC
My question to Vice Chairman Rivlin is simply this: Do you think this kind of investigation is necessary, is needed? Would you be willing to support it?
Ms. RIVLIN. I thought we were having an investigation. That is why we were having this hearing and we are happy to supply any information. I do not think there is any inconsistency in our numbers. The cost and revenues vary in different years. If you choose different years, you can get different numbers. That is clearly right and we can clear that up, as to which years the numbers refer to.
Let me have another try at the question of subsidy, because I think that is what is hanging us up. We provide check processing services to banks under the Monetary Control Act, and we cover the costs of those check processing services. We run this interdistrict transportation network for the small part of the checks that go from one Federal Reserve office to another. That is a necessary part of the check service.
We cover the marginal costs when that network is used. The prices cover the marginal costs. In some years, we have not covered the full transportation cost, but what that means, we are over-recovering on some other cost, like sorting, for example. The cost of check processing, as a whole, is covered. So, I do not see the problem here.
Mr. JACKSON. Let me yield the balance of my time to the gentlelady from New York.
Mrs. MALONEY. Thank you. I thank the gentleman for yielding.
Page 42 PREV PAGE TOP OF DOC
I, too, would like to go back to your statement, on page 7 that we have been discussing. And I quote from you and your statement ''The taxpayers do not subsidize the costs of the Federal Reserve's check transportation.'' Again, along with my colleague, Mr. Ney, on the other side of the aisle, and my colleague on this side of the aisle, I would like to take issue with that point.
As an expert in budgeting, you know that Congress regards the failure to fully recover costs in any operation of the Government as a loss. In the case of ITS, it may have only recovered less than 60 percent according to Federal Reserve employees, of its costs in 1996.
The loss would either have to be made up by returning less money to the Treasury, which increases the deficit, or by taking more money from another Federal Reserve Service, which means prices on these other services would have to be raised.
Vice Chairman Rivlin, in the special studies done by the Federal Reserve in 1996, corresponded banks and check couriers notified the Fed that the bundling of ITS costs provided the Fed with an unfair competitive advantage. The subject of cross-subsidizing ITS revenues from other Fed services was discussed.
Would you make sure that the subcommittee is provided with a special review of the Federal Reserve check collection system that was written at that time? I would like to be able to put that in the record. That was in 1982.
Could you just comment further on any problems that you see in cross-subsidizing? Do you feel that it is not wrong to cross-subsidize ITS operations? I mean, Chairman Greenspan says it operates at a loss. If it operates at a loss, then that loss is made up with a cross-subsidy, or extra money, or whatever you want to call it.
Page 43 PREV PAGE TOP OF DOC
Maybe you do not want to call it a subsidy. Extra money is shifted over there. It gives the Fed an unfair advantage when they compete with the private sector. The private sector does not receive a cross-subsidy from other services out there. They are only, in this particular case, providing one particular service. As you well know, my original bill covered all services of the Federal Reserve.
Following up on the questions raised by my distinguished colleague, Mr. Bentsen. When I was questioning why we should be in all of these other services, as opposed to just monetary policy, which is so important, the Fed said it was too broad, that it should come down to one small area, which is what I did.
I responded to some of the Fed's requests and arguments on my original bill. I put in a bill on one particular service, the transportation of paper checks. Now, maybe I am wrong. We will hear from the private sector later. But I believe the private sector provides just one service, transportation of paper checks. They are not cross-subsidized. Therefore, they believe they are at a disadvantage.
Federal employees, who work for the Federal Reserve, say they are at a disadvantage, and that there is a cross-shifting. Maybe you do not want to call it a subsidy, but there is a cross-shifting of money to the ITS. Even the distinguished Chairman Greenspan today admitted that it operates at a loss, which is what three employees have been saying for several years to the Banking Committee.
Ms. RIVLIN. Well, two points. One is if the check service as a whole is covering its costs, and some particular component within that, which we are not selling generally, is making an accounting loss, then we are getting an accounting profit on something else. Maybe we are making a profit on sorting the checks. I do not know. That is all internal accounting, and I do not think that you can do the accounting in a different way.
Page 44 PREV PAGE TOP OF DOC
Second, we are not in the service of generally selling check transportation to people at large. We only provide check transportation to our own customers, those who process the checks at the Federal Reserve. That is a small piece of the market, and those people get their checks processed in an entirety. We are not selling the check transportation to the market generally, and do not manage the business as if we were.
Now, maybe you would like us to. That is a very different story. If you would like the Federal Reserve to get into general check transportation markets, maybe that is something that we should talk about and offer this service to everybody, not just our own customers.
Mrs. MALONEY. As you well know, we are just looking at the management and whether or not there is a subsidy, a loss, that we were looking at the management of this particular area. Earlier, you said that the private sector did not have a disadvantage. Yet, if they are not receiving a cross-subsidy, I would argue they are at a disadvantage.
As you know, my original bill included all of the so-called bundle services. At the Fed's request, I narrowed it down to one specific area. That is the one specific area that we are beginning to look at. And, as you know, we have come forward with testimony and letters that say that, in fact, they have been operating at a loss, which means there has been a shifting of money from elsewhere to that particular area.
Ms. RIVLIN. I do not know which private sector people you are talking about. If you are talking about other couriers who would like this business, they are free to bid on the Federal Reserve business. If they can do it for less, we are very happy to have them.
Page 45 PREV PAGE TOP OF DOC
Mrs. MALONEY. But, respectfully, the private sector does not receive the subsidy at that point. That is the point that I am trying to makeor the extra money, or whatever you want to call it.
Chairman CASTLE. Time has expired for this particular Congresswoman to ask questions, but you may respond if you wish. And then we may have time for additional questions, after everyone has had an opportunity.
Ms. RIVLIN. Well, our private sector vendors are not receiving a subsidy. We are employing them to carry the checks. If there is somebody else who can do it for less, we would be happy to have them there.
Chairman CASTLE. Thank you, Mrs. Maloney.
Mr. COOK. Yes, Thank you, Mr. Chairman. It is a real pleasure to have you with us, Vice Chairwoman Rivlin. I thank you for your testimony today. I am fortunate to have a Federal Reserve Bank branch office right across the street from my District office there in Salt Lake City.
Just a few months ago, I enjoyed a very educational tour of that facility. I was particularly impressed with the check clearing operation, the machinery, and so forth was quite interesting. It is rather incredible technology. I cannot remember all of the numbers, but the speed at which checks are processed is rather breathtaking.
Page 46 PREV PAGE TOP OF DOC
As I think about that more, I am probably a little more amazed at how archaiceven with them taking out as far as we can move it, the check processing capabilityhow archaic that whole system is in the age of computers and electronics, and the fact that America still writes 64 billion checks a year. I think that number is still going up.
Ms. RIVLIN. Right.
Mr. COOK. The GAO has indicated the reluctance of many banks, and I am not sure which size banks, but many banks, to invest in the technology for the electronic system is the reason why it is not moving forward. But also, obviously, there must be a real consumer preference problem.
I would like to ask you which of those factors, either banks not investing in the technology, some banks, or the fact that consumers still want that check returned? Which of those is the most important impediment to moving us toward the more electronic system? Are there other impediments to the development of that?
Ms. RIVLIN. Well, I think it is both. Many consumers, like Congressman Metcalf, do want to get their checks back. It might be that if they had to pay moreand some banks are moving in this directionpay more to get their checks back, they would decide, well, they did not really want them that badly. They would just as soon have the information as they get for a credit card.
Remember that here we are, only talking about electronifying, if that is a word, the check system itself. You would still be writing a paper check and sending it through the mail, only you would not get it back. Now, that really is a small step toward electronic payment.
Page 47 PREV PAGE TOP OF DOC
If you could pay your bills from your home computer, or some other way that is fully electronic, and there was not any paper at all, it would be even more efficient. But there are a lot fewer people that are equipped for that today and want to do it.
Mr. COOK. I do hear from constituents who are concerned about this whole thing. There is a concern that maybe the Federal Government is going to requiregoing to use a little compulsion, in terms of this movement toward a more electronic system.
Does the Federal Reserve have a a goal, a set timetable? Orand I guess equally important, do they have any kind of educational programs designed to alleviate some of these consumer concerns?
Ms. RIVLIN. Those are two things which the committee I referred to has been talking about very actively. We have a general plan to move toward more electronic presentment in checks, and that has been happening, actually. But our committee has been talking about, should we take steps working with the industry to make it happen faster, and what would those steps be? And there could be some kind of mandate, but I think it would also be pricing so that it would be more attractive.
On education, we have also thought a lot about that. I think, without predicting where we will come out, I think that we will recommend that the Fed work, again, much more actively with the industry to promote electronic payments, particularly the ACH, which a lot of people do not even know about. I mean, that you can go to your bank and have them send an ACH payment. People know that they can get their check deposited directly in their account, which is an ACH function, but not enough people do it.
Page 48 PREV PAGE TOP OF DOC
Mr. COOK. Thank you.
Chairman CASTLE. Thank you, Mr. Cook.
We have two other panels. What I would like to do, I would like to ask one or two more questions, but I hope that the various Members who may want to ask additional questions can try to limit the extent of their questioning, and we can move on as quickly as possible, so that it will give everybody else an opportunity. We may have votes, at some point here. Various things could happen.
For better or for worse, I just would point out one thing that was pointed out to me by staff. Under the Federal Reserve Actmaybe we should all read itSection II (A)(C)(3), which gives pretty broad parameters in terms of how the Federal Reserve actually can administer this check payment system, it concludes, ''. . . except that the pricing principle shall give due regard to competitive factors and the provision of an inadequate level of services nationwide.'' A little bit broader, perhaps, than I had thought before, and it may be a worthwhile exercise for all of us to read that.
I do have some questions, which I will probably submit in writing, because we simply cannot ask all of them now. My understanding is, and I always have to look up the name of this up here, the committee that you are working on, the Committee on the Federal Reserve in the Payments Mechanism, which you have been working on. My understanding is that that is a work in progress.
Page 49 PREV PAGE TOP OF DOC Ms. RIVLIN. Yes.
Chairman CASTLE. That you are still meeting and you are, I guess, starting to reach conclusions and you will issue a report at some point in the next few weeks or months. Is that right?
Ms. RIVLIN. Yes, I think the next thing that we want to get out is a report that will summarize what we learned from these payment system forums. I gave you a little bit of the flavor today. But we will have a longer document that we will get out in a couple of weeks.
Chairman CASTLE. I am just sort of picking out bits and pieces from your testimony in answering various questions. What my impression is, you are not going to make recommendations of any sweeping changes. You may be able tomaybe you do not even know, but you could either affirm that or not. If you could give us some sort of a preview of what you think may be in the report, or the direction of the report? Again, maybe you can or cannot.
Ms. RIVLIN. It depends what you mean by ''sweeping.'' I think first, we have not fully finalized our recommendations. But I think it is fair to say, as I have suggested in the testimony, that we are not going to recommend that the Federal Reserve get out of check processing, or ACH, because we just did not find a strong support for that, or a strong rationale for that as we moved around the country.
We will recommend that we work much more closely with the payment system industry in pushing ahead toward electronic payments, considering both use of the electronic systems that we already have and improving servides like ACH and electronic check presentment? But, really focusing on how we move toward the payment system of the future, and how do we work with the industry, including the computer industry, to further a more truly electronic payment system?
Page 50 PREV PAGE TOP OF DOC
Chairman CASTLE. OK. Thank you.
Ms. RIVLIN. Thank you.
Chairman CASTLE. Does any other Member have any further questions they wish to ask?
Mrs. MALONEY. I just would like to follow up with our last exchange and really put into the record right now a statement from Thomas McFarland, who is the Manager of the Federal Reserve Bank of Boston's Interdistrict Transportation System. And I quote from his testimony, ''Does the fact that the ITS set per-item fees for ITS transportation below the per-item prices needed to fully recover ITS costs, give the Federal Reserve an unfair advantage over private check carriers?'' The answer to this question is a qualified, yes. I would like to put it into the record now.
Ms. RIVLIN. I respectfully disagree with Mr. McFarland, but you will hear from him later.
Mrs. MALONEY. Thank you.
Chairman CASTLE. One other question, Ms. Rivlin. If I understand correctly, credit card transfers for the most part are done outside the Fed system. Some are done through the Automated Clearing House, but not all. Is that correct?
Page 51 PREV PAGE TOP OF DOC
Ms. RIVLIN. The credit card companies have established their own networks to process credit card transactions. The Federal Reserve does not process credit card transactions and we are not aware that any of these transactions are being cleared through the ACH system.
Chairman CASTLE. Second, cash management accounts, or mutual fund accounts, which are I guess mutual fund deposits, now exceed the demand deposits in banks and thrifts. Are those generally non-Fed interbank transfers that occur when someone writes a check on their Fidelity account, or their Merrill account, or whatever? Does the Fed clear those?
Ms. RIVLIN. Those checks are cleared somewhere, and the final settlement is done on the books of the Fed. The same is really true of credit cards. They vary, and they have their own networks. But in the end, the final settlement has to be made on the books of the Fed, as between different banks.
Mr. BENTSEN. But that would be true
Ms. RIVLIN. Of anything.
Mr. BENTSEN. Of any, yes.
Ms. RIVLIN. Yes, right.
Mr. BENTSEN. Of member banks and how
Page 52 PREV PAGE TOP OF DOC
Ms. RIVLIN. Right.
Mr. BENTSEN.They are treated. But in terms of the transported checks or of the credit card slips, that is
Ms. RIVLIN. The credit card people do their own.
Mr. BENTSEN. Do their own?
Ms. RIVLIN. But they do not transport.
Mr. BENTSEN. Yes.
Ms. RIVLIN. They send it over the electronic network. They got out of the transport business.
Mr. BENTSEN. But do you know for certain with the mutual funds, the cash management accounts, whatever, the non-bank checking accounts, if you will, does the Fed handle those directly, or are those handled outside the Fed?
Ms. RIVLIN. Let me answer that for the record. I do not know exactly how that works.
[Vice Chair Rivlin subsequently submitted the following response to Congressman Bentsen for inclusion in the record:
Page 53 PREV PAGE TOP OF DOC
[Such checks are drawn on or payable through banks and are cleared through the same collection channels, including the Federal Reserve, as other checks.]
Mr. BENTSEN. Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Bentsen.
Mr. Jackson has some questions. I think, at this point, we can thank you very much for your participation, Ms. Rivlin. You exhibited a mastery of the arcane detail of some of this very difficult subject matter, and we appreciate that, and look forward to your report, at which time it is issued. Thank you very much for being here today.
Ms. RIVLIN. Thank you very much, Mr. Chairman.
Chairman CASTLE. Thank you.
We will now form the second panel. We will do this all with about a 2-minute standing in recess here. Your names will be put in the various slots.
Chairman CASTLE. If you could assume your positions, we will try to move forward as rapidly as possible.
Page 54 PREV PAGE TOP OF DOC We are at that point now. We are going to start voting. We are going to have people coming and going. So, it is going to be confusing, but we are going to have to very carefully hold you to 10 minutes or less on this one, so that I can go vote at least. But if you would do us the honor of starting off this panel, we would appreciate your testimony.
STATEMENT OF GERARD F. MILANO, EXECUTIVE DIRECTOR, BANKERS CLEARING HOUSE
Mr. MILANO. Mr. Chairman, I will go as quickly as I can. Thank you. Thank you very much.
Chairman Castle, Members of the subcommittee, my name is Jerry Milano. I am the Executive Director of the California Bankers Clearing House Association. The Bankers Clearing House is a non-profit cooperative serving more than 100 commercial banks, credit unions and savings associations in the western States. Our mission is to exchange and settle payments among members and to promote safe and sound banking practices. We have a long history of service to our members, helping them to promote economic growth and assisting them in times of financial crisis, social unrest and natural disasters.
Bankers Clearing House appreciates the invitation to testify before the subcommittee today and to hear Governor Rivlin's preliminary report on the future role of the Federal Reserve in the payment system. In May, we told Governor Rivlin's special task force that our members do not seek a change in the role of the Federal Reserve or reductions in the services it provides. We have enjoyed many collaborative efforts with the Fed over the years and hope similar efforts will continue for many years to come.
Page 55 PREV PAGE TOP OF DOC
Our members want to ensure, however, that private payment service providers like us have the ability to compete fairly with the Reserve banks. Some years ago, the General Accounting Office studied the competing services offered by Reserve banks and titled its report, ''Competitive Equity: An Elusive Goal.'' We hope this subcommittee will investigate whether current conditions show that competitive fairness is still elusive. And, if so, the subcommittee will use its oversight authority to take corrective action.
My formal testimony is focused on our long-standing negotiations with the Fed for equal access to interdistrict settlement services supporting check exchanges among our members. Bankers Clearing House testified in 1983 that both Reserve banks and private clearing organizations like us should use the same settlement process for check collections to eliminate any possibility of unfair competition. In 1994 when the Board of Governors finally authorized same-day settlement, it still lacked direct settlement against reserve accounts for private clearing organizations under the same terms and conditions used by Reserve banks to settle their competitive check collections.
Settlement for check activity occurs at the time the bank of first deposit receives good funds from the paying bank. In other words, as Chairman Rivlin said, when the reserve accounts of the banks are posted for the dollar values of the checks exchanged. This process is described in more detail in the June 1997 report of the GAO, ''Payments, Clearance and Settlement, A Guide to the Systems, Risks, and Issues.''
We believe that secure settlement is a key aspect of the evolution of new payment services and merits special attention by the subcommittee. If the process by which competitors obtain secure settlement through the Federal Reserve is flawed in either design or implementation, and these flaws effect the ability of those private companies to compete with the Reserve banks, we believe the subcommittee should use its oversight authority to identify those flaws and to ask the Fed to make necessary corrections.
Page 56 PREV PAGE TOP OF DOC
We also believe there should be clear guidelines for the process by which new settlement services involving reserve accounts can be requested and the criteria which the Board of Governors will use to evaluate such requests.
Bankers Clearing House acknowledges that we compete with the Reserve banks and that our judgment of events and motivations may not always be impartial. So, we ask the subcommittee to review the facts and we pledge our full support to the effort.
Mr. Chairman, in my written testimony, I have detailed the extended history, beginning in 1995, of the so-far unsuccessful attempt of our Clearing House to obtain a more robust settlement service that would accommodate our members as they branch across State boundaries, and, thus, expand across Federal Reserve district lines. While I will not attempt to review that history in my oral testimony, I can tell you our members are very frustrated by the process we have been through, and that process continues today.
It is also important to recognize that the same check collection laws apply equally to Federal Reserve banks and to private check clearing arrangements like ours. As a result, our members ask a simple question: If competing public and private check clearing organizations handle the same payments, between the same customers of the same institutions under the same laws, how can the risks be so different? In other words, we do not understand how the risks can be so great that Bankers Clearing House is not qualified to settle check collections for current members in multiple Fed districts in the same manner as Reserve banks?
Moreover, we are equally concerned that when private clearing organizations like ours propose to offer new payment services in the future, the Board of Governors will apply different risk standards in evaluating how we will be permitted to provide the necessary related settlement services and when they evaluate the requests of Reserve banks.
Page 57 PREV PAGE TOP OF DOC
When we ask for settlement services using our members' own reserve accounts with their permission, we should be able to obtain those services on the same terms and conditions as the Reserve banks obtain in connection with their competing payment services. We believe that access to different settlement services impedes the ability of private clearing organizations like ours to compete with Reserve banks. After all, separate settlement arrangements simply may not be equal.
Mr. Chairman, just last Thursday, the Board of Governors issued new regulations that will help Reserve banks to offer their check collection services to banks with interstate operations by simplifying the settlement process for the Reserve banks. In issuing the new regulations, the Fed acknowledged that the direct settlement capability of Reserve banks is a competitive advantage over private organizations like Bankers Clearing House. Perhaps, in recognition of this competitive advantage, the Board suggested in this same release that it may now be willing to accommodate clearing houses such as ours to improve their interdistrict check clearing by allowing us to continue to use our existing net settlement arrangements as we service our members' operations in other Reserve districts.
While the rules may have changed for both the Reserve banks and private organizations like ours, we apparently will still operate under different rules than the Reserve banks. Bankers Clearing House would appreciate any assistance the subcommittee could provide in determining when the Federal Reserve will actually be prepared to offer settlement services in a completely neutral manner.
Mr. Chairman, one final point: In 1989 when the GAO last made recommendations on this subject, it recommended that the Federal Reserve adopt a policy and implementing procedures under which collecting banks have the same abilities to provide check collection service to their customers as Reserve banks, unless the safety, soundness, or efficiency of the payments system demand otherwise. Mr. Chairman, that was what we were asking for in 1983. That is what the GAO recommended in 1989, and that is all we are asking today.
Page 58 PREV PAGE TOP OF DOC
We appreciate the opportunity to appear before the subcommittee on this very important issue and would be pleased to try to answer any questions at this time.
Chairman CASTLE. Thank you very much, Mr. Milano. We appreciate your testimony and obviously questions will evolve from that, but we will have to take a break now.
We will have a 15 minute vote, which will go on for 20 minutes at least, and then a 5 minute vote, which will go on for 10 minutes at least.
So, I would imagine we probably will not reconvene. I am sure we will not reconvene before 3:30, maybe even 3:35 or 3:40. But even if there is another subsequent vote, I am inclined to come back and get in as much testimony as we can, so you are not testifying at midnight tonight, and try to get as many Members as we can to possibly come back over.
So, we will take a recess to some time between 3:30 and probably 3:40. We will resume with Mr. Roy's testimony.
Chairman CASTLE. After being promised we would have an hour, we have another vote immediately. So, we now have 15 more minutes to get back to voting. I realize that people have schedules here which they have to meet, in terms of flights or whatever.
Page 59 PREV PAGE TOP OF DOC What I would like to do is Mr. Roy, get in your testimony, if we could, before I go over and vote again. And then I think after I return from that, hopefully, we will get a little more of a distance between votes. Having said that, we are having procedural problems. People get upset and they call for votes willy-nilly.
By the way, I do not care what order we go in. Does that suit both of you? Do either of you have to go? I know Mr. Milano has to leave early. Then we may never get to your questions. Hopefully, we will. In that case, why do we not go to you, Mr. Roy, and then we will go from there.
STATEMENT OF ERIC P. ROY, CHAIRMAN, ASSOCIATION OF BANK COURIERS
Mr. ROY. Thank you. Mr. Chairman and Members of this distinguished subcommittee, my name is Eric Roy and I am the Chairman of the Association of Bank Couriers. The Association represents the interests of the private sector air and ground couriers who compete against the Federal Reserve System, FRS, in the provision of priced services to the banking community.
I appreciate the opportunity to appear before you today on behalf of these private sector companies, to seek the assistance of Congress in ensuring our ability to compete fairly and openly against the FRS for the provision of services like the transportation of checks to the banking community.
We do not advocate nor do we seek the removal of the FRS from the payment services arena. Indeed, we welcome the chance to compete against them on a level playing field. Unfortunately, as my written testimony establishes, fair and open competition by the private sector is almost impossible today, because the Federal Reserve fails to comply with the Federal law that should protect us from unfair competition from our own Government.
Page 60 PREV PAGE TOP OF DOC
Moreover, you will hear testimony from myself and others that cast suspicion on the accounting practices that the Federal Reserve uses to create the illusion of compliance with that statute. Finally, you will receive firsthand evidence of waste, fraud and mismanagement within some of the FRS operations that creates doubt as to its ability to conduct itself in an appropriate manner.
Today, the payment system provides the essential function of clearing the approximately 60 billion checks written annually in this country. The FRS competes against the private sector in providing payment services, such as check sorting, check clearing, check transporting, and a host of related products. The FRS handles more check volume than any other single private sector provider.
Critical to the efficient operation of the payment system, is the transportation of canceled checks from one bank to another, the more efficient and timely the transportation, the smoother the functioning of the payment system.
The FRS operates a ground and air force known as the Interdistrict Transportation Service. ITS is part of the operational or ''priced services'' functions of the FRS. Through the ITS, the Federal Reserve competes directly against private sector companies like mine for the ability to offer transportation services to the banks.
Federal law, known as the Monetary Control Act of 1980, governs the terms of competition between the FRS and the private sector. In enacting this law, Congress sought to ensure that the FRS not take advantage of its dominant position in the banking system to drive out private sector competitors who also wanted to offer payment services.
Page 61 PREV PAGE TOP OF DOC
The law requires the FRS to price each of the services it provides at a level that fully recovers the costs incurred. Congress, intending the 1980 Act to promote fairness in competition, sought to provide a degree of transparency in FRS pricing by requiring the FRS to carefully match costs with revenue and specific service lines, including check clearing and collection.
Although the FRS has charged for its services since enactment of this law, we believe the evidence presented before you today indicates that it has not given up the practice of providing free services. Specifically, we do not believe that the Federal Reserve's pricing currently recovers the costs incurred in transporting canceled checks.
We already know from a 1996 U.S. General Accounting Office report that the FRS has violated the Monetary Control Act of 1980 by failing to recover its cost associated with check clearing. The data in my written testimony clearly suggests that a large portion of this lender-discovery is likely attributable to the phenomenon that the transportation is given away below cost.
The Monetary Control Act certainly contemplates the recovery of costs associated with the transportation of checks. The FRS hides the true cost of transportation, however, by bundling it with other services, thus providing an interlocking network of subsidies and cross-subsidies, as detailed in my written testimony.
When Chairman Greenspan appeared before this subcommittee in July, he stated that if such a subsidy existed it would be ''wrong.'' Well, Mr. Chairman, such a subsidy does exist and Mr. Greenspan is right. We believe it is wrong.
Page 62 PREV PAGE TOP OF DOC
The Federal Reserve attempts to circumvent Federal law by using questionable accounting practices to grossly understate the cost of priced services. Let me look at just a few.
One way is to miscount the FRS employees' defined benefit pension plan. Due to the performance of the stock market in recent years, a surplus or ''wealth benefit'' has built up in this pension plan.
Our analysis of FRS data reveals that the FRS has used this surplus to offset certain additional costs of providing priced services by allocating a portion of the overfunding to priced services. Interestingly, the 1996 GAO report reached the same conclusion. Not only does this misuse of the pension surplus to reduce costs distort competition with the private sector, we believe it cheats the taxpayer, since taxpayer money was the ultimate source of the pension funds in the first place.
The second way that the FRS distorts pricing is an accounting technique surrounding something called a ''private sector adjustment factor'' or PSAF. Federal law requires the FRS to add a PSAF to its pricing calculations, so that the Government does not gain an unfair advantage over the private sector because it is not subject to tax and other expense burdens.
Our analysis of FRS data reveals that the FRS understated the PSAF in a number of ways in 1996. The aggregate of this understatement allowed the FRS to lower its PSAF figure by $50.6 million in 1996. This does not even include the cost of applicable insurance.
Page 63 PREV PAGE TOP OF DOC Although my written testimony and appendices reveal additional examples of questionable accounting, along with details of those I have just mentioned, suffice it to say that none of us in the private sector have the luxury of resorting to these same tactics. We must absorb the same costs that the FRS incurs, while providing exactly the same type of services.
A recent trend is that the role of the FRS in the payment system has diminished. As a consequence, it has been forced to take aggressive steps to maintain market share and to prevent migration of the check clearing business to the more efficient and effective private sector ventures, especially clearing house operations.
The FRS has designed specific product lines, like something called the ''Nationwide City Sort,'' or NCS, to regain market share lost to the private sector. While good old-fashioned competition is certainly always welcome. Why is an entity of the Government engaging in what we believe to be unfair competition to the disadvantage of the private sector, even to the extent of practicing predatory pricing?
When seeking the approval of the FRS Board to offer NCS, internal FRS memoranda made it clear that some under-recovery of costs associated with the specific clearing activity will occur. In fact, as our analysis of the FRS data indicates, costs are under-recovered in all cases. Please let me be clear on this point.
The costs associated with the provision of NCS are always greater than the price the FRS is charging for the service. Since the transportation of checks in bulk is a major feature of this service, and promotional materials advertising this new service boast about the price, including all outbound transportation costs, it is evident the transportation cost of this service are being given away for free.
Page 64 PREV PAGE TOP OF DOC
We believe this is predatory pricing with no recourse possible from a private sector competitor. This type of hidden subsidy is a violation of the Monetary Control Act and we believe it should be stopped.
Mr. Chairman, I understand my time is limited this afternoon. Let me say this: For the members of my Association, the central issue comes down to the credibility of the FRS and its conduct in the area of payment services. For years the FRS has maintained that it does not compete against transportation companies like mine.
The staff of the Federal Trade Commission concluded in 1991 that they indeed do, yet nothing in the FRS's behavior has changed.
For years the FRS tells us, as well as other private sector competitors and Congress, that that is complying with the Monetary Control Act of 1980 and that revenues for priced services equal the costs. The GAO concludes differently. The FRS merely shrugged this off by stating that ''the GAO is wrong.'' Again, nothing has changed.
For years, many of us in private industry have heard rumors about questionable activities in the operation of the ITS. In 1996, the House Banking Committee Democratic staff issued an investigative report containing evidence of waste, fraud, and abuse on such a scale that the rest of us in the private sector would be concerned to have been part of such an organization. The FRS merely responded that ''mistakes were made,'' and that it ''will not happen again.''
Page 65 PREV PAGE TOP OF DOC Today, using their very own data, we can conclusively prove that the FRS's numbers just do not add up, and that what they are telling us, the public, and you, the Congress, is highly suspect, if not just plain false.
In July, Chairman Greenspan promised to put all of the facts on the table and let them speak for themselves on these issues. Unfortunately for the FRS, these numbers just do not seem to be able to stand the light of day. Unfortunately, for the rest of us, the FRS's facts raise far more questions than they provide answers.
Today, Mr. Chairman, we ask Congress to help shine a brighter light on the check clearing and processing operations of the FRS by passing further legislation like H.R. 2119. It is straightforward bill that clarifies the intent of the Monetary Control Act. It calls for an independent audit of the FRS books to ensure compliance with Federal law.
Indeed, why should not the books and records of FRS' payment services operations not be subject to this scrutiny? Thank you very much, Mr. Chairman. I will be pleased to answer any questions at the appropriate time.
Chairman CASTLE. Thank you, Mr. Roy. You got in just under the wire. You did a great job. It is interesting to hear your testimony.
Again, I apologize. Hopefully, this will be the last vote for awhile. So, I intend to go vote and get back here right away, maybe within 10 minutes or so. We will resume as soon as I can get back.
Page 66 PREV PAGE TOP OF DOC Having said that, you get over there and things start to happen. But, hopefully, this will end the vote and we can get to the questions, finish up this panel, and get to the next panel. So, we will take a short recess.
Chairman CASTLE. Mr. McEntee, I think we are ready for your testimony, sir.
STATEMENT OF ELLIOTT C. McENTEE, PRESIDENT AND CEO, NATIONAL AUTOMATED CLEARING HOUSE ASSOCIATION
Mr. MCENTEE. Thank you, Mr. Chairman, and distinguished Members of this subcommittee. My name is Elliott McEntee and I am the President and CEO of the National Automated Clearing House Association, also known as NACHA.
NACHA is the banking industry's largest not-for-profit association, representing over 13,000 banks and credit unions. NACHA's most important responsibility is to develop and maintain operating rules for electronic payment programs. These programs include the Automated Clearing House Network, Electronic Benefit Transfer Systems, and emerging electronic commerce and Internet applications. We also promote the use of electronic payments and electronic commerce.
My presentation today is in four parts: A brief overview of the ACH Network; a discussion of the relationship between the Federal Reserve and NACHA; a brief analysis of the competitive relationship between the Federal Reserve and the private sector ACH operators; and an overview of a new payment application that has the potential to save billions of dollars.
Page 67 PREV PAGE TOP OF DOC
Last year, over four billion ACH payments, valued at over $12 trillion, were processed. The network is used by over 20,000 financial institutions, 500,000 businesses, and 60 percent of all households. The ACH Network supports numerous types of payment applications, including direct deposit, consumer bill payment, and corporate trade transactions. The Federal Government remains the largest user of the ACH Network. The volume of commercial ACH payments has been growing at an annual rate of about 15 percent.
Studies have shown that using an ACH payment instead of a paper check saves financial institutions and their customers an average of between $1.31 and $1.94 per-transaction. NACHA estimates that this year financial institutions and their customers will save over $6 billion using ACH payments.
Despite these impressive growth and cost savings statistics, there are still over 15 times more checks processed than ACH payments. There are several reasons for this large disparity. Consumers and businesses find the check system to be convenient, because the check is readily accepted in commerce. Another reason is that more of the costs to operate the check system are borne by the party collecting the check, not the check writer. There is still another important reason, and I will get to this in one minute. That is, the banking industry and the ACH operators do not commit enough resources to promote the use of electronic payments in this country.
The Federal Reserve is one of four ACH operators. The four operators and their 20,000 financial institution customers adhere to the same operating rules and standards established by NACHA. This unique relationship allows any financial institution in the country to exchange electronic payments with any other institution under a common set of rules and formats. This also means that Members of this subcommittee, for example, can select any financial institution in the country to receive their pay by direct deposit. I am assuming that every Member of this subcommittee gets paid by direct deposit. Regardless of what financial institution is selected, the payment will be processed in a timely and accurate manner.
Page 68 PREV PAGE TOP OF DOC
When Congress approved the Electronic Fund Transfer Act in 1978, it limited the scope of the law to consumer protection matters. All other matters regarding the handling of electronic payments were left to the private sector to resolve. By relying on the private sector to establish the rules, the ACH Network has been able to respond quickly to marketplace demands to support new payment applications.
Because the Reserve banks comply with the NACHA rules and require their ACH customers to do the same thing, Federal Reserve representatives participate in the development of NACHA rules. This allows the Federal Reserve to influence the development of rules, but not to control their final outcome.
NACHA also works closely with the Federal Reserve, and the other ACH operators to help develop new services and applications. For example, NACHA has completed its Vision 2000 plan to prepare the ACH Network to serve the needs of financial institutions and their customers well into the next century. The ACH operators, including the Federal Reserve, will have to develop several new services under this plan.
Eight years ago, NACHA launched its most successful marketing program to promote direct deposit of payroll. Today over 55 percent of all full-time employees in the private sector receive their pay by this method. Two years ago, the Federal Reserve and NACHA began to work together to promote the use of the ACH Network. Last year, the Federal Reserve actually committed more resources to this effort than NACHA. However, both organizations understand that more resources need to be committed in the future. A significant portion of these resources will be used to promote consumer electronic bill payment services and electronic corporate trade payments. The reason for this is that participation rates for these applications are considerably lower than the participation rate in direct deposit. For example, less than 10 percent of all consumer bill payments, and less than 5 percent of all corporate trade payments are made electronically.
Page 69 PREV PAGE TOP OF DOC
We are discussing with the Federal Reserve and other ACH operators the best means to fund this increased effort. We are optimistic that an agreement will be reached on the appropriate method in the near future.
Today, the Federal Reserve's market share for processing ACH payments is approximately 80 percent. This high market share can be attributed to several facts: The Federal Reserve was the first ACH operator; it was the first to offer ACH services nationwide; and the Reserve banks also process ACH payments in a highly efficient and reliable manner.
However, there is another important contributing factor and that is certain Federal Reserve practices make it difficult for the private sector ACH operators to compete effectively. The other ACH operators have brought these concerns to the attention of the Federal Reserve and we understand that the Federal Reserve is studying solutions to these problems.
Major improvements will be made to ACH services and more resources will be committed to marketing these services in the future, yet tens of billions of checks will be written each year into the foreseeable future. A new payment application is being developed by the private sector that would allow consumers and businesses to retain the convenience of writing checks, while allowing businesses and financial institutions to achieve most of the cost savings associated with the use of electronic payments. Pilot programs are now underway that test converting paper checks into electronic payments at the merchant's checkout counter. Initial results of these tests have been very favorable in terms of consumer acceptance and cost savings. To ensure that the consumer is completely protected during this conversion process, all of the safeguards built into both the check and the electronic payment systems are available for this application.
Page 70 PREV PAGE TOP OF DOC
For this concept to be used for other check applications, such as when a check is mailed to a company to pay a bill, changes to Federal Reserve regulations may be necessary. We are currently working with the Federal Reserve to identify those changes.
The United States is a recognized world leader in embracing electronic technology for thousands of applications. Unfortunately, sending and receiving payments is not one of these applications. As pointed out by you, Mr. Chairman, in many countries electronic payments are used more frequently than checks.
Developing new ACH applications and services and promoting the use of electronic payments more aggressively are necessary if the United States is to catch up with many of the countries that we compete with in the marketplace.
In summary, NACHA has an excellent working relationship with the Federal Reserve and we are optimistic that the Federal Reserve will be responsive to the changes that are needed to improve the Nation's payment system, including the changes we just discussed.
One last sentence, if you do not mind. I want to thank you for inviting NACHA to share its views on this important matter to the subcommittee. I will be glad to provide any additional information, or to answer any questions you may have. Thank you.
Chairman CASTLE. Thank you, Mr. McEntee. We appreciate your testimony.
Page 71 PREV PAGE TOP OF DOC I do not have the faintest idea what all of those bells meant just then. We are trying to figure it out. The board recessed until 5:00. This is the best thing that has happened to us today.
Let me ask a couple of questions. By the way, for the benefit of Mrs. Maloney, Mr. Metcalf, Mr. Milano had to leave. We let him leave. He has a plane he had to get, but we appreciate Mr. Roy. Mr. McEntee is staying. We will try to run these questions fairly rapidly, so that we can get onto the next panel, which has been waiting patiently on the sidelines.
I have a couple of general questions and some technical questions, which are written out here.
Mr. Roy, did you have any relationship at all with the Rivlin study that is going on now? I mean did they talk to you, or did you testify, or anything of that nature?
Mr. ROY. One of the officers of Airnet Systems, the company I work for, participated in that process, a gentleman by the name of Glen Miller, our Vice President of Operations.
Chairman CASTLE. By participating, do you mean was part of the group that sat down and went over things, or testified, or supplied testimony, or something of that nature?
Mr. ROY. No, he was involved in one of the ten groups that got together and discussed the five scenarios.
Page 72 PREV PAGE TOP OF DOC
Chairman CASTLE. OK. So your organization, and ones like it, did have some input into that?
Mr. ROY. Some input, yes, sir.
Chairman CASTLE. Maybe you even liked the outcome. I do not know. My understanding isand maybe I have this wrong, of the available market, that companies like yours have 87 percent of the market. Am I correct, or am I mixing apples and oranges here?
Mr. ROY. That number seems extremely high to me, as compared to what we believe the Federal Reserve's market share is. But we do not really have complete information for me to speculate as to what the total number would be, but I would guess that the private sector's percentage would be closer to 70-75 percent.
Chairman CASTLE. Probably not worth arguing over the percentage. I just got it from Ms. Rivlin's statement, which said ''In 1996, only 13 percent, or approximately 4.8.'' The checks were not processed by depositing banks, local Federal Reserve offices or shipped on ITS. Remaining 87 percent of these checks were shipped by the other private sector couriers.
I am not too worried about the percentages, but based on your statement I was just trying to determine why your company would have the significant percentage of the business you have, if there are these cost differential factors involved?
Page 73 PREV PAGE TOP OF DOC
In other words, you seem to think you are operating at ayou are prejudiced by what the Federal Reserve can offer in the way of costs, which they do not completely expose, as I understand your testimony.
Mr. ROY. Yes, we believe that in some areas where the Federal Reserve directly competes with our company, that they do have a cost advantage based on the things that I refer to in my testimony. A significant amount of the work that we currently carry is not part of the Federal Reserve's network, if you will, and that we handle the work for the corresponding banking industry. So, that really is outside that envelope.
There is no question that our company has obtained a good percentage of market share over the past several years, as have the other members of the Association of Bank Couriers. We like to think that it has simply been through providing appropriate levels of service. Our only concern is to try and ensure that the Federal Reserve, to the extent they compete with our organizations, adhere to the guidelines of the Act.
Chairman CASTLE. Mr. McEntee, a recent article in The American Banker, which I am sure you saw.
Mr. MCENTEE. Yes, I did.
Chairman CASTLE. The front page, as I recall, suggested that NACHA wants to finance promotions, subtract payroll deposits and other ACH services through small surcharges on standard processing fees, while the Fed evidently opposes surcharging, but supports reducing the volume of paper checks.
Page 74 PREV PAGE TOP OF DOC
Is the article accurate, first of all? I always wanted to ask that question. And, if so, is the disagreement between the Fedand not just simply over means, how best to promote electronic payment and not ends?
Mr. MCENTEE. I think most of the article was accurate. Unfortunately, the headline was not very accurate, and the headline was not consistent with the rest of the article. I am not here to bash the press. I think the press has been bashed enough over the last few weeks. But, certainly, the headline was not accurate.
We do believe that the Federal Reserve has made a commitment to expend more resources to promote electronic payments, and our organization has done the same thing. What we are discussing with the Federal Reserve now, and the private sector ACH operator, is how to best fund the new resources that will be needed to promote electronic payments more aggressively.
What we are proposing is to pretty much do what the other retail electronic payment systems do, basically, take part of the transaction fee that the bank pays to the operator, use part of that fee for marketing of ACH services and we are right in the middle of discussions with the Federal Reserve on that issue right now.
The Federal Reserve has not come back to us yet to say, ''We will support that idea,'' or ''We will be opposed to the idea.'' We think we will receive some response from the Federal Reserve within the next, oh, I would say, 6 to 8 weeks.
Chairman CASTLE. It is your understanding, I would guesslet me restate that. It is my understanding, based on listening to the three of you, and the two of you that are here, that this is a world which is changing, or could potentially change rather rapidly here in the next few years, where the electronic payment systems, as compared to the old, just pure transportation systems, which existed.
Page 75 PREV PAGE TOP OF DOC
Is that your view of it, too? Do you have any desire to stonewall that change at all, or to encourage it? I mean, what are your views on that?
Mr. MCENTEE. Well, I think you are absolutely right, Congressman Castle. There are a number of forces underway that are going to change the payment system quite dramatically. For many, many years, the banking industry has struggled with trying to get consumers and corporations to use electronic banking more frequently and we are now starting to see some interesting growth rates, some new products and services being launched in the marketplace.
I think the legislation that Congress passed last year on mandating that Government payments be made electronically is going to really help convert business-to-business transactions. I know we talk a lot about consumer transaction. But about 25 percent of all checks are business-to-business transactions.
I think requiring all businesses to accept Government payments electronically is going to lead these businesses into accepting commercial and making commercial payments electronically, as well?
We are also starting to see a lot of changes in the way payments are processed. I think looking over the next 2 to 3 years, you are going to start seeing a significant number of payments that start off as checks, actually, processed and collected as electronic payments.
Page 76 PREV PAGE TOP OF DOC Some of the pilot programs that we are working on with some of the major retailers show an awful lot of promise. And I will hope not too many consumers responded the same way that Congressman Metcalf responded, and would want all of their paper checks back.
We actually think that there are a lot of advantages to the check writer by getting their information presented to them on their statement. For example, the name of the payee. That is the party that the consumer wrote the check to, the date that the check was written, the amount of the check, and the date of the check was paid. All of that information may be more convenient for the consumer to obtain by simply looking at the statement, rather than going through looking for individual checks.
Chairman CASTLE. I want to keep moving here. But just as a hypothetical, what if I wanted to go along with the system that you outlined, some sort of a simplified system of return of checks just for convenience, and Mr. Metcalf insists on his earlier position, which he articulated so well?
Would it be cost feasible to do a choice system for people in that circumstance, or does it have to be all or nothing, in terms of how you handle this accounting, or can you move partially to an electronic system, or a partially electronic system for some people and not others?
Mr. MCENTEE. I think it depends upon the application that you are talking about. For example, if the check is written at the point of sale and it is handed to the merchant, under the pilot programs the check is converted at the point of sale, the check is canceled basically and handed back to the consumer.
Page 77 PREV PAGE TOP OF DOC
So, the consumer gets that canceled check right there at the retail establishment. I think that satisfies the need for most consumers. That type of system probably will not work when you are mailing a bill to the utility company, or a mortgage company, or the like, because you cannot hand the check back to the consumer right there at the point of sale.
There are a couple of things that are being looked at: One is the utility company can simply notify the consumer that in the future you would not be getting your check back, unless you check this box off and mail the postcard back. If you do that, you will continue to get the check back from your bank.
Another possibility is to ask the consumer to sign an authorization. Another possibility is get the Federal Reserve to change their regulations and allow the utility company to process the check as an electronic payment, as long as they notify the consumer in advance that that transaction would be processed as an electronic payment.
I think at the minimum, the consumer would always be notified, or, possibly, you could require a consumer authorization before that conversion takes place. We are still trying to sort all of these different alternatives out in these pilot programs.
Chairman CASTLE. I am going to leave the follow-up, if any, on that to Mr. Metcalf when it is his turn. For now, we will turn to Mrs. Maloney.
Mrs. MALONEY. Thank you, Mr. Chairman. I would like to ask Mr. Roy, since he represents the competitors to the ITS. But, certainly, I would like Mr. McEntee to add any comments that he would like to add.
Page 78 PREV PAGE TOP OF DOC
First of all, is there any cross-subsidy to your businesses, or the businesses that you represent?
Mr. ROY. No, absolutely not. The private sector certainly does not have the opportunity to participate in any form of a subsidization, which certainly was discussed a little bit earlier, both in my testimony, and then the earlier part of this hearing.
There is no question that it has been mentioned by people of the ITS to members of our Association that somehow the private sector had the opportunity to price certain business lines below cost on an ongoing basis, and that is part of their operation and part of the private sector's competitive advantage.
I can assure you that we are not interested in doing business below cost, to the extent that we have the lines of our business or routes in our network that did not contribute to profitability, we do not operate them any longer.
Mrs. MALONEY. As you know, earlier we put into the record a letter from Mr. Greenspan that said ITS was operating at a loss. Can you run your businesses at a loss?
Mr. ROY. Absolutely not.
Mrs. MALONEY. What is the effect on any private firm wishing to sell banking services in competition with the Federal Reserve, or finding out today that the Fed has issued wrong numbers about its cost recovery at ITS, and that it will simply cross-subsidize operations such as ITS, which run at a substantial loss? How can we correct this situation?
Page 79 PREV PAGE TOP OF DOC
Mr. ROY. That is a cause for concern for the members of our Association. We have been discussing this issue, in particular, since 1996 when Congressman Gonzalez' investigation brought some things to light to my organization, as well as others, that were a cause for concern, that possibly the Federal Reserve may not be operating the ITS in a manner that we would believe to be consistent with the Monetary Control Act.
That is our sole purpose of discussing this issue, is to try and eliminate the subsidy, if, in fact, there is one, and to try and make sure that the Federal Reserve competes in a manner that has been outlined by Congress. At that point in time, with the Federal Reserve as a competitor on a level playing field, the forces of competition will simply take over.
Mrs. MALONEY. Well, I am trying to take steps to correct that with my legislation that I have submitted, that would really prohibit the Fed from subsidizing the ITS operations, and I would appreciate it if you would look at it and get back to me.
Mr. ROY. We are certainly in support of its passage.
Mrs. MALONEY. Thank you very much. I have no further questions.
Chairman CASTLE. Thank you, Mrs. Maloney.
Mr. METCALF. Thank you, Mr. Chairman. There is a question I asked earlier, but I would like to have you comment. Because I am worried that the system is not really fully privatized. So, here is the question: Is the bidding a completely open and competitive process on rates for all specified check transportation routes?
Page 80 PREV PAGE TOP OF DOC
Mr. ROY. That is a difficult question for me to answer, because I do not know all of the routes that the Interdistrict Transportation System has as part of its network. That information has not been made available to our company that I am aware of. So, it is hard for me to respond.
We have bid, our organization, speaking only for ourselves, on a couple of ITS routes in the past. We have done some limited amounts of transportation for the Federal Reserve. They have not been significant. I do not know if the routes that we were not awarded were because of pricing or any other factors. I am not aware of that.
Mr. METCALF. But you are not uncomfortable about the question of whether or not it is really an open and fair competitive bidding process?
Mr. ROY. I do not know. I do not know. I do not have enough information to be able to answer that question.
Mr. METCALF. OK. Thank you.
Chairman CASTLE. Well, gentlemen, let me thank you for being here. We may want to submit written questions to you. As usual, we do not have enough time to go through all of the development of lines that we would like to. But I think your testimony is very interesting and very instructive for what we are trying to do.
And, again, I apologize for this sort of disjointed way we had to handle the panel and the voting. It is never the best way to do business, but it is a way sometimes you have to do business in Congress. So, we thank you for being here and we will move on to the next panel.
Page 81 PREV PAGE TOP OF DOC
Mr. ROY. Thank you very much.
Chairman CASTLE. You are more than welcome.
Gentlemen, I introduced you so long ago, probably people have forgotten who you are, may have forgotten why you are here at this point. But we have, basically, the Manager of the Transportation Operations of ITS Federal Reserve Bank of Boston, Mr. McFarland, who will testify; and Mr. Thomas Hunt, who is a Senior Systems Analyst in the same organization; and Mr. Fazio, who is the ITS Transportation Analyst also.
So, with that, Mr. McFarland you can start it off, sir.
STATEMENT OF THOMAS W. McFARLAND, MANAGER, TRANSPORTATION OPERATIONS, INTERDISTRICT TRANSPORTATION SYSTEM, FEDERAL RESERVE OF BOSTON
Mr. MCFARLAND. Chairman Castle and Members of the subcommittee, before I present my oral testimony, I would like to submit my written testimony for the record.
Chairman CASTLE. Without objection, any written testimony you wish to submit will be accepted and we thank you.
Mr. MCFARLAND. My name is Tom McFarland. I am the Manager of the Federal Reserve Bank of Boston's Interdistrict Transportation System, the ITS. For the past 12 years, I have been involved in all day-to-day operational functions and most administrative functions within the ITS, including aircraft route design, preparation of bid proposals, contract negotiations with vendors, budget analysis, and the like.
Page 82 PREV PAGE TOP OF DOC
I have been an employee of the Federal Reserve Bank of Boston for 25 years. To provide background to my brief oral testimony, I have submitted written testimony to the subcommittee that explains in detail my opinions of the potential impact that proposed cost recovery legislation will have on the ITS, on private check carriers, and on the Nation's small banks.
The issue at hand is whether the Federal Reserve System's ITS is subject to the Monetary Control Act. And, if so, if it is competing unfairly with the private check carriers because the ITS does not fully recover all of its costs through its fees. While the application of the Monetary Control Act to the ITS is beyond my area of expertise, I do have knowledge of the cost recovery of ITS, and a somewhat biased opinion on the competitive position of the ITS.
The Federal Reserve's ITS Network is not, and for the past few years has not, fully recovered its costs. The most recent ITS volume data indicates that for 1997, ITS revenues will fall short of ITS costs by over $5 million. The base cost recovery rate of the ITS for 1997 will be approximately 75 percent. This base rate is before the interest on clearing balances are added to the ITS revenues and the application of the Private Sector Adjustment Factor. Just how I believe the ITS got to the present base cost recovery rate of only 75 percent is explained in my written testimony to the subcommittee.
The Federal Reserve is now taking steps to bring the ITS to full cost recovery. However, to do this, in my opinion, will take approximately 1 1/22 years, and require a change to the ITS price structure to include both a fixed and variable fee. Again, this is explained more fully in my written testimony.
Page 83 PREV PAGE TOP OF DOC
Finally, I would like to say that, while it was unnerving at times to participate in the Minority staff's House Banking Committee inquiry, I do not share the opinion of many of those within the Federal Reserve that Representative Henry Gonzalez and the economist for the Minority staff, Robert Auerbach, were out to discredit the Federal Reserve. In my opinion, they both acted in good faith to represent the interests of the public and have found legitimate areas within the ITS where practices and procedures could be improved. I am certain that their efforts will result in a more cost-effective and responsive ITS.
Chairman CASTLE. Thank you, Mr. McFarland.
We will turn now to Mr. Hunt.
STATEMENT OF THOMAS HUNT, SENIOR SYSTEMS ANALYST, INTERDISTRICT TRANSPORTATION SYSTEMS, FEDERAL RESERVE OF BOSTON
Mr. HUNT. Before I give my opening statement, I would also like to submit to the subcommittee an analysis of cost recovery worksheet that I use to try and explain where our status is between 1995 and 1997.
Chairman Castle and Members of the subcommittee, my name is Thomas Hunt, Senior Systems Analyst, at the Federal Reserve Bank of Boston's Interdistrict Transportation System, or ITS. For the past 9 years, I have been responsible for the data processing systems within the Interdistrict Transportation System.
Page 84 PREV PAGE TOP OF DOC
For the past 14 years, I have maintained the integrity of the Cash Letter Monitoring System or CLMS, which is a system-wide data base that contains a history of all check-related cash letters handled by the Federal Reserve System. I am also responsible for the billing system of the ITS, which is the reason I have been invited to this hearing by Chairman Castle and Representative Carolyn Maloney.
I have agreed to attend this hearing for two reasons only: There are those within the FRB who believe that my previous answers to questions posed by the House Banking Committee were inaccurate or untrue. For that reason, I am here to defend my previous answers and answer any questions from the subcommittee today; and second, to refute the accusations that the ITS staff, including myself, are disgruntled and malcontents.
I have been an employee of the FRB for nearly 24 years and my term of service has been exemplary. In 1995, I received a second Presidential award for outstanding achievement, and in 1996, I received a promotion to my position of Senior Systems Analyst.
I would also like to make it clear from my position only that I am not necessarily here to support any pending legislation before Congress. Thank you.
Chairman CASTLE. Thank you, Mr. Hunt.
STATEMENT OF CHARLES FAZIO, TRANSPORTATION ANALYST, INTERDISTRICT TRANSPORTATION SYSTEM, FEDERAL RESERVE OF BOSTON
Page 85 PREV PAGE TOP OF DOC
Mr. FAZIO. Chairman Castle and Members of the subcommittee, thank you for inviting me here today to speak before you. My name is Charles Fazio and I came here primarily to help the subcommittee better understand the issues concerning me and the ITS staff during the House Banking Committee Democrat staff inquiry.
This October, I will have completed 25 years of faithful service to the Fed, 15 of those years in the ITS department after stints in the Money and Banking Structure departments. Of all of my job assignments, the ITS has been the most interesting one. I feel that the ITS is second-to-none for the efficient movement of checks, primarily because of the excellent ground and pilot crews who work night-after-night in a difficult environment under tight time constraints.
The Federal Reserve family has been very good to me. I have no axe to grind with it, in general. The circumstances which bring me here today involve my responses to questions from the House Banking Committee inquiry regarding business decisions made by former officers of the ITS. I was not eager to get involved with the inquiry, and initially felt it was none of my concern, but I have since decided it was the right thing to do.
As the House Banking Committee's inquiry developed it soon became apparent to me that the ITS staffers and senior management had differing opinions of events. I found myself in the unthinkable and untenable position of having to present statements that at times contradicted those of the senior management of the Federal Reserve Bank of Boston. In my initial involvement in August 1995, I, along with the other ITS staffers, was asked to respond to a question regarding the expenditure for an aircraft of questionable value, which was given to one of our contract carriers; a very uncomfortable situation, to say the least, in light of the fact that I knew my response would not be viewed within the Fed as being favorable. I was dismayed by the way a protective curtain was being drawn around the officers while the ITS staff was being left to fend for themselves, and I felt that the senior management's only answer to some of these questions was to try to concentrate on discrediting the ITS staff. I believe that is why the ITS staffers turned to each other for support and decided to respond forthrightly to the committee inquiry, without regard to the consequences.
Page 86 PREV PAGE TOP OF DOC
I also believe that we, at times, were seen in some quarters as recalcitrant employees who misunderstood the intentions of the Congressional inquiry and that we really did not have a grasp of the issues and why certain business decisions were made. Let me emphasize that we are not recalcitrant individuals with poor attitudes against the Fed. For my part, I never had any intention of speaking ill of the Fed; especially in public. I am just one of five guys who just wanted to do what was right, but was drawn into a battle not of my choosing; by events beyond my control. Without the protection of Congress, I believe that I, and the other ITS staffers, would have paid dearly for not supporting the Fed's position or for just trying to remain neutral and not give any opinions.
A document from Representative Maloney of New York to the Honorable Alice Rivlin, dated September 5, 1997, contains a statement to the effect that certain ITS staffers were coming to the hearing because they were frustrated with the waste and abuse and the operations of ITS. That is not entirely accurate. While I was frustrated by the lack of candor in the responses of the Fed, my initial involvement was only to respond to questions posed by the committee. I was particularly uncomfortable about having to submit my responses to senior management for their review before they answered the same questions themselves. Then, when control of Congress shifted from one party to the other, I feared that the findings enumerated in the report,''Waste and Abuse in the Federal Reserve's Payment System,'' along with the honest responses on which I and the other ITS staffers risked our positions and staked our reputations, would never see the light of day.
I was not originally scheduled to be here today, and was not too enthusiastic about appearing before this subcommittee, lest it could be construed as supporting those who opposed the Fed. I do not support anyone opposed to the Fed, and I am glad I showed up and was given the chance to present my position, and also to give you, the Members of the subcommittee, a chance to see me in person instead of just reading faceless words on paper. Of course, the repercussions of my appearance today remain to be seen.
Page 87 PREV PAGE TOP OF DOC
In conclusion, many good things have come about as a result of the House Banking Committee's inquiry. We have a new department officer, who is highly regarded by all of us and who has willingly pitched in to get the ITS back on track after a crippling 2 1/2 years, in which virtually nothing except the running of day-to-day operations was being accomplished. Changes have already been implemented to correct the problems which surfaced during the inquiry and to make us a more efficient and forward-moving operation. Someday, even the old morale may be fully restored.
To paraphrase an old Navy song, ''Shipmates stand together in fair and foul weather.'' That has been the code of the ITS staffers through this whole episode.
Chairman CASTLE. Thank you, Mr. Fazio.
Let me start the questioning. Do any of you believe that the Federal Reserve may have violated the Monetary Control Act of 1980 by underpricing its check punch in cost. In particular, the transportation component of these costs, and why or why not? And then your answer.
Mr. MCFARLAND. I am not really sure that any of us are really qualified to answer that question. We do know that the ITS does not fully recover its costs through its fees; that we can be sure of. But the fact is that only 16 percent, approximately, of the ITS revenues are derived from transportation services that directly compete with the private sector.
Page 88 PREV PAGE TOP OF DOC
I do not know if that is a mitigating factor or not, and if it is not, maybe we are in violation. If it is, then it is a fact that 84 percent of ITS service really does not directly compete as ITS is part of a bundled check service. If that mitigates the need to comply, I am not sure.
Chairman CASTLE. You have sort of answered this question. With regard as to how one interprets the requirements of the Monetary Control Act. To what extent do you believe the Fed effectively subsidizes the costs of its ITS operations?
Mr. MCFARLAND. I think Tom Hunt would be best to handle that.
Mr. HUNT. All right. What was the question?
Chairman CASTLE. The question is: Regardless of how one interprets the requirements of the Monetary Control Act, to what extent do you believe the Fed effectively subsidizes the costs of its ITS operations?
Mr. HUNT. Oh, yes. Well, based on our analysis, it would be about 25 to 30.
Chairman CASTLE. I am sorry, 25 to 30 percent?
Mr. HUNT. 25 to 30 percent.
Page 89 PREV PAGE TOP OF DOC Chairman CASTLE. OK. To your knowledge, have ITS staff ever been ordered to manipulate the data to project higher costs revenue ratios?
Mr. HUNT. Is this in the recent past?
Chairman CASTLE. Well, no, anytime to your knowledge. Identify the time if it is not recent.
Mr. HUNT. I would say that there were some manipulations in the pre-1995 ITS calculations in determining new pricing. On a biennial basis, there was some shifting of numbers to give us a more favorable position in the cost revenue recovery.
Chairman CASTLE. To your knowledge, the Federal Reserve Bank of Boston officers supervising ITS paid millions of dollars to private companies without any competitive bidding?
Mr. HUNT. OK. I am actually in the data processing, so I have not really made much of an attempt to answer those types of questions which deal with operations.
Mr. MCFARLAND. Actually, you are talking about SANTA Express, and the fact is that we have awarded a contract, a couple, maybe three, to SANTA over the years, which
Chairman CASTLE. Can you explain who they are and what they do?
Page 90 PREV PAGE TOP OF DOC Mr. MCFARLAND. Well, SANTA Express actually performs two operations for us. One is the central control function. That function is really a critical part of our business. What they do essentially is oversee all of the flight segments of ITS each night. This is particularly important when we have problems at night, such as weather diversions or aircraft mechanicals, where we need someone that can redirect aircraft, so that we can exchange check work at another location, or do something of that sort.
So, it is critical. It is a critical operation and SANTA's people are probably the only source of that type of expertise. The second portion of this contract is the groundor hub ground services. That portion, which is probably 80 to 85 percent of SANTA's total cost, is pretty much manual labor, driving of trucks, and sorting bags. That work itself is what is being questioned. Whether or not that work could be construed as necessary to be put out to bidor rather, whether that could be construed as being sole source.
Chairman CASTLE. So, you are suggesting that the first part could be sole source because of the unique aspects of their knowledge and abilities to deliver that service?
Mr. MCFARLAND. I believe it is, yes.
Chairman CASTLE. But, the second partI am gleaning this from what you are sayingthe second part is a lot more dubious, in terms of being sole source? That could be a competitive bidding situation, which it should be, if it could be a competitive bidding situation? Is that correct, or am I wrong about that statement?
Page 91 PREV PAGE TOP OF DOC Mr. MCFARLAND. When we initially gave SANTA the contract, we intended, after 2 or 3 years, to put it out to bid. That kind of fell through the cracks and we never did get around to it, even though at that time, in 1989, we recognized that there were others out there that could bid on that portion of the contract.
Chairman CASTLE. To your knowledge, has the FRBB ever circumvented the competitive bidding process by making prior arrangements to pay favored low bidders additional funds after the contracts were awarded?
Mr. MCFARLAND. That is a tough question. I was involved in a meeting where we had talked about a spare aircraft to be provided for ITS pursuant to a contract that was to be awarded. That we would share in the cost of the aircraft. At the time, at that meeting, I felt that it was probably a decent deal for both ITS and the carrier, and did not really see any problem with the deal.
When we finally did sign the contract, I thought the wording of the contract was fine and everything was covered. Subsequent to that, it turned out that the true meaning of the contract had changed and approximately a year after the initial contract, we doubled the contract payments and I was not aware of why or under what circumstances. But I did, in fact, find another corresponding written contract 6 months after it was effective, and there was nothing in it that made sense. It really was not an accurate portrayal of what services were being purchased.
Chairman CASTLE. Let me ask one more question and I will turn it over to Mrs. Maloney, who may have another round of questions. I just want to get the time sequence a little more set in my mind. Now, I am sort of compiling together testimony of all of you here. But, it is my understanding that some of the problems that you are discussingexposing here today, are things which happened before a management change in more recent years. These things may have happened 2 or more years ago. Is that more-or-less correct?
Page 92 PREV PAGE TOP OF DOC
Mr. MCFARLAND. Yes.
Chairman CASTLE. And at what point and time-line did things start to change, so that these problems no longer existed, if you could give us that?
Mr. MCFARLAND. Well, I would probably say within 3 months of the House Banking Committee's report, we slowly began to start changing things, and now we have a new ITS officer and senior officer of ITS, and both of them are committed to righting the ship and turning everything around.
Chairman CASTLE. Can you put a date on that, the 3 months of the House investigation?
Mr. MCFARLAND. I would say it was probably June, 1995.
Chairman CASTLE. OK. I thank you for your testimony. Let us turn to Congresswoman Maloney.
Mrs. MALONEY. Thank you, Mr. Chairman. First of all, I would like to applaud each and every one of you for your testimony and for coming here today. Likewise, I would like to applaud you for your 25 years of faithful service to the Federal Reserve, and also to let you know that it is a Federal crime to intimidate, in any way, a Federal employee who testifies before this subcommittee. I hope you will let us know if anyone tries, in any way, to intimidate you for having come forward with your testimony today.
Page 93 PREV PAGE TOP OF DOC
First of all, I would like to ask Mr. Hunt, as a senior systems analyst, if you could explain the ITS cost recovery percentage in 1996, and, thus far, in 1997?
Mr. HUNT. We produced a chart that basically we applied what we had.
Mrs. MALONEY. Mr. Chairman, may we put the chart in the record please?
Chairman CASTLE. OK.
Mrs. MALONEY. Fine, go ahead.
Mr. HUNT. OK. On this chart, we put the estimated cost recovery from the CLMS database, which is the source of the information we used for billing. Then we developed a cost revenue match by applying the revenue from billing against the total cost for ITS. The first two columns show what the cost recovery was month-by-month for 1995 and 1996 respectively, as indicated by the database. We then knew that for 1997, we had increased prices and anticipated that we would receive an 11 percent increase in revenue. So, using that 11 percent against 1996, without any adjustments for increased or decreased volume or costs, we determined what the actual cost recovery for 1997 should be, which is indicated in column three.
In column four we have the actual recovery, which is considerably lower than we had expected by our calculations of 1996, even with an 11 percent increase in revenue.
Page 94 PREV PAGE TOP OF DOC
Column five shows the difference between what we expected to recover in 1997 and what we actually recovered for the first 7 months of 1997.
Column six reflects the correction for volume and cost changes in 1996 versus the 1997 estimate, taking into account any growth in volume or costs; or non-growth in volume or costs. We were then able to determine what percentage would allow for an even playing field by subtracting the numbers in column six from the numbers in column five, which resulted in the numbers shown in column seven.
The seventh column shows the corrected cost recovery overstatement in 1997 versus 1996. The same scenario which we used to arrive at the actual cost recivery, from database, for 1997 was applied to the estimated ITS recovery, from database, for 1996; resulting in the corrected cost recovery percentage for 1996, which is shown in column eight. Basically, we used the first 7 months of 1996, with corrections, to determine that the cost recovery would be 70.89 percent for 1996. As of the first 7 months of 1997, the cost recovery stands at 75.38 percent.
Mrs. MALONEY. Therefore, operating at a loss?
Mr. HUNT. Absolutely.
Mrs. MALONEY. Mr. Hunt, Mr. McFarland, I would like both of you to answer this question. Did the Fed give this committee the wrong cost recovery numbers during the Congressional investigation?
Page 95 PREV PAGE TOP OF DOC Mr. HUNT. First, I would like to make clear that all of the numbers that I am dealing with are raw data. It is raw costs. It is raw revenue. The recovery that we show on our reports does not include either the PSAF, Private Sector Adjustment Factor, or the interest on clearing balances.
So, when they provide you a number, they are claiming that the number would contain this interest on clearing balances and this Private Sector Adjustments Factor. How they make that calculation, I do not know. So, I can only say that
Mrs. MALONEY. But would that not make it lower?
Mr. HUNT. If somebody could teach me, which no one in the FRBB has done, the proper use of the PSAF and other factors that are used to create this, I would certainly be able to give you a more qualified answer. I would say, based on what I am reading here, and based on what other people have done recently to educate me regarding these particular calculations, I would say the cost recovery numbers would be even less than what this chart indicates.
Mrs. MALONEY. Mr. McFarland, would you comment? Did the Fed give this committee the wrong cost recovery numbers during the Congressional investigation?
Mr. MCFARLAND. Well, I think the numbers that were given to the committee were in fact the internal numbers of the Federal Reserve that were calculated for those years.
Page 96 PREV PAGE TOP OF DOC Mrs. MALONEY. But were they wrong?
Mr. MCFARLAND. They were wrongwell, now we know they were wrong. But at that time, there was not anybody who was really aware of what the conversion rate was of checks to pounds, nor was anybody really aware of how much fluff was in the check bags that was not accounted for and not attributable to any function.
So, the numbers that we were computing back in the mid-1980's, all the way through the early 1990's, were in fact based on inaccurate assumptions. I am not aware that anybody really knew that those assumptions were inaccurate, although we never did try to prove the numbers. But recent history has shown that those numbers were and are inaccurate. The basis for those numbers was inaccurate and the cost recoveries were overstated.
Mrs. MALONEY. Thank you. My time is up. I look forward to another round of questioning.
Chairman CASTLE. Thank you, Mrs. Maloney. We will now turn to Congressman Metcalf.
Mr. METCALF. Thank you, Mr. Chairman. I have asked this question a couple of times already today, and I am going to ask it in the same way to see what your comment is. Is the system really fully privatized? Is the bidding a completely open and competitive process on the rates for all of the specific check transportation routes?
Mr. MCFARLAND. We do put out formal RFPs for most of the ITS work. But there are a number of places where there are not any logical alternatives. Where there are only one or two check carriers in the area we could use. For instance, we send work from Dallas to the West Coast and we contract with the only company that flies that way at that particular time. To my knowledge, this carrier was the only company that provided service to those particular Reserve cities to make the availability that we needed. Therefore, we entered into a contract without competitive bidding, but the fact is that there was no one else that could have provided this service at the price that we negotiated. So, I think we received good value. We improved availability, but without a competitive bid.
Page 97 PREV PAGE TOP OF DOC
Mr. METCALF. You said that, ''We have new management now in ITS.'' With the new management are you seeing a more renewed activityor more cognizance of this, what you say is not successfully recovering all of the costs? Is this changing? Are you optimistic about this?
Mr. MCFARLAND. I am very optimistic. As a matter of fact, we have an ITS task force in place, and in working with the group, I am very encouraged. The group seems to be committed to improving ITS, especially the chairman, Terry Roth, from Cleveland. He is committed to getting a handle on the marketing of ITS and in addressing our cost problems by working closely with our office. I am confident that we will be able to turn ITS around and get back to where we think we should have been.
Mr. METCALF. Now, do either of the others have any comments on the questions?
Mr. FAZIO. We are very encouraged about the officer change that did take place. It was a positive step. There is a lot more documentation going on now. We are tracking things a lot more carefully.
Mr. METCALF. Well, I am somewhat concerned about the fact that they continue to say, ''No, we are paying our way,'' and the costs show a loss, ''but it really is not.'' Those look sort of like ''weasel words'' to me, but I am not prepared to say that.
Have you any real concern that there may be consequences to your testimony before and here today? I would like to have each of you comment on that.
Page 98 PREV PAGE TOP OF DOC
Mr. MCFARLAND. Well, my feeling is that up to now the Fed has handled this very well. Initially, the ITS officer we had at that time caused us to be a little concerned because of the hostile tone of his voice and his inflections when he talked to us. But as soon as we brought his behavior to light, the Federal Reserve's senior management stepped right in, and since then I personally have not felt any intimidation. Everybody has been straightforward and fair with me.
Mr. METCALF. Thank you. Any comments?
Mr. HUNT. Well, I feel the same. I believe that they have actually gone the extra step to make us feel that there is no intimidation, while trying not to do anything differently to make us feel that they are going out of their way to appease us. Nor are they doing anything to make us feel uncomfortable.
There is probably, in the best words, a feeling of appeasement right now, that we are just going to carry on. We are part of an overall process involving many areas of ITS, particularly billing, pricing, how we do business with our couriers and how we can improve ITS in the future with the new routes and other areas of ITS that I am not directly involved with. But I think that there seems to be a very strong positive at this point in time.
I think that the House Banking Committee has had a great influence on most everything that is going on, and I think that the Fed is really going forward very strongly with making these changes.
Page 99 PREV PAGE TOP OF DOC Mr. METCALF. We are encouraged by that.
Mr. FAZIO. It was a hair-raising experience, to say the least. It is not every day that a 25-year employee, or a whole department, has to take a position on the other side of the fence, going against senior management's perception of things. Tensions ran pretty high at times and got pretty heated at times, but I think it was a learning experience for management, and certainly for us. I think a lot of people are surprised that we even came this far with it, but here we are.
Mr. METCALF. I was surprised and I commend you for the courage of saying what you really believe.
Thank you, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Metcalf. Let me just ask a couple of follow-up questions. I think each of these I am going to cite to you is taken from the report issued by the Minority which you are familiar with in all of this.
They state here, ''The FRBB has been improperly charged in the U.S. Treasury 67 percent more than it charged the private sector companies for transporting canceled Treasury checks, costing taxpayers millions of dollars.'' Is that an accurate statement, as far as any of you know? Is that within the purview of your knowledge? And I assume that is also historical. It has not happened since 1995.
Mr. MCFARLAND. Well, actually, the methodology that we were using at the time was inaccurate. It was an inadvertent error, but in fact we were overcharging the Treasury. Not because we intended to, but because of the conversion rate of 325 checks per pound and the distribution of costs. As it turned out, the non-commercial check portion of our work, which included Treasury checks, got a higher percentage than should have been allocated. But, while it was true that we were overcharging the Treasury, it was definitely inadvertent.
Page 100 PREV PAGE TOP OF DOC
Chairman CASTLE. I respect your integrity greatly, but 67 percent is a pretty good number for an inadvertent mistake. I mean, why was that not picked up?
Mr. MCFARLAND. Well, I am not sure that it was as much as 67 percent. I think we were charging the Treasury $4.96 per pound, and, in fact, we should have been charging them what everybody else was being charged, which was $3.25 per pound.
Chairman CASTLE. OK. I do not myself know how they got the 67 percent, so I cannot follow up on that. Nevertheless, it has straightened out at this point is your bottom line?
Mr. MCFARLAND. Yes, it was straightened up immediately. As soon as we found out, we straightened it out.
Chairman CASTLE. OK. To your knowledge, has the ITS engaged in ''budget dumping'' by making lump sum payments to contractors toward the end of the year for future services, allowing the ITS to falsely justify its funding and subsequent budgets? A practice, by the way, which I abhor in Government.
Mr. MCFARLAND. Well, in the early years of ITS, the officer at the time had, I believe, every intention of running ITS as streamlined as he could. But, I think the first time he went in with a surplus, he was not greeted very favorably and I remember him coming back and saying, ''You know, if you're not on budget, even if you save money, senior management is not too happy.''
Page 101 PREV PAGE TOP OF DOC
So, that yearI believe it was 1987he decided to pay for some services up-front and expend the budget. At that time, in 1987, some of the services we were purchasing were things that we were going to be acquiring in the following year anyway and the expenditures were probably justified.
But as we went forward, in order to continually meet the budget at the end of each year, we began purchasing things we did not need just to come in on budget. It started innocently enough and kind of snowballed on us over the years.
Chairman CASTLE. I am afraid historically in Governmentit functions probably in the private sector, too. You are not alone, and you were not alone at that point, but it really is a God-awful practice in my judgment.
Again, I thank you for being here. Let me turn to Congresswoman Maloney for any further questions she has.
Mrs. MALONEY. Thank you, Mr. Chairman.
I would like to ask each of youMr. Hunt, Mr. McFarland, and Mr. Fazioeach of you to answer the same question. Starting with Mr. Hunt and going down the line. I would like to ask you, were you told that ITS has 100 percent cost recovery target for its operations? Yes or no?
Mr. HUNT. Yes. I think that goes back to 9 years ago when I came into ITS. First, the officer in charge at that time gave me a number of documents which I have kept all these years. These documents stated that the purpose of ITS consisted of four elements, one of them being a 100 percent cost recovery target. I believe that was in one of my answers to the many questions that we were asked by the House Banking Committee and that answer was true.
Page 102 PREV PAGE TOP OF DOC
Mrs. MALONEY. OK.
Mr. McFarland, I would like to ask you the same question. Were you told that ITS has 100 percent cost recovery target for its operations? And, if so, when were you told that it had?
Mr. MCFARLAND. Well, actually, when I first came to ITS, Bob LaRocca handed me a number of documents.
Mrs. MALONEY. When did you first come to ITS?
Mr. MCFARLAND. In 1984.
Mrs. MALONEY. 1984.
Mr. MCFARLAND. The officer handed me a number of documents to read. Essentially, he wanted me to get some background as to what ITS was, because I was new to the check function. In virtually all of the documents there was mention of 100 percent cost recovery. Over the years, I read additional memoranda that indicated we should have 100 percent cost recovery.
In 1990I believe it was 1991, the year of the Gulf War, because of the cost of the fuel, we had a real bad year in that we were way over budget. At that time, Bob LaRocca said that as long as ITS recovers 100 percent over the long-term, it is still considered to meet the 100 percent cost recovery requirement. At that time, of course, we did not know how inaccurate the recovery numbers were.
Page 103 PREV PAGE TOP OF DOC
The first I heard that we did not have to recover 100 percent of costs was when we were into the House Banking Committee inquiry.
Mrs. MALONEY. OK.
Mr. Fazio, were you told that ITS has 100 percent cost recovery target for its operations?
Mr. FAZIO. No, madam. I was never told that, because I was not really involved in that aspect of the operation. I was told to get out in the field and inspect.
Mrs. MALONEY. OK. All right. OK. I would like to ask again the same question to all three of you, Mr. Hunt, Mr. McFarland, and Mr. Fazio. From revenues from other priced services and the loss would not be a problem, were you ever told that?
Mr. HUNT. No, I was never told it that way.
Mrs. MALONEY. OK.
Mr. MCFARLAND. I was not.
Page 104 PREV PAGE TOP OF DOC
Mrs. MALONEY. When did you learnI guess you, Mr. McFarland, said you learned that it was all right to run at a loss after the House Banking Committee Report. Is that correct?
Mr. MCFARLAND. Well, I learned that it was not necessary that the ITS fees cover the ITS revenues, that ITS was considered a component of the entire check service line.
Mrs. MALONEY. And you were told that after the House Banking Report, correct?
Mr. MCFARLAND. Yes.
Mrs. MALONEY. OK.
Mr. HUNT. I was, also.
Mrs. MALONEY. You were, too, Mr. Hunt?
Mr. HUNT. That is the first time I found out that that was our objective; after the House Banking Committee's questions. When I questioned why we didn't have to be at 100 percent, I was told that we do not have to cost revenue match at 100 percent, because it was now being spread over the long-term, and therefore considered to be meeting the 100 percent cost recovery requirement.
Page 105 PREV PAGE TOP OF DOC
Mrs. MALONEY. OK. Thank you. And, Mr. Fazio, it did not apply to you? OK.
I would like to ask again, the three of you, a question. Are you aware of any correspondence or documents from the Federal Reserve that refer to the need for ITS to achieve 100 percent cost recovery? Are you aware of any correspondence or documents from the Fed that refer to the need for ITS to achieve 100 percent cost recovery?
Again, I would like to ask all three of you, beginning again with Mr. Hunt.
Mr. HUNT. Are we talking in more modern times from 1995 forward, or are we talking going back some period of time?
Mrs. MALONEY. The whole period of time, going back to when you began, the whole period of time.
Mr. HUNT. When I came on board in 1989, I prepared the billing reports on a monthly basis and kept a running tally of what the monthly cost revenues were. It seemed to me that there was a great interest in seeing how we were doing month-to-month with the anticipation of reaching 100 percent at the end of each year.
Mrs. MALONEY. And how were you told that? Was there a manual that told you that?
Page 106 PREV PAGE TOP OF DOC
Mr. HUNT. No, there was no
Mrs. MALONEY. Was there a letter that told you that? What document told you that?
Mr. HUNT. I have some documents that were given to me. But most of those documentsand there are not any current documentswere dated 1982, I believe, and 1984. These documents were from senior management and other high level persons in the Bank. But from the 1984 document and forward, there never was another document that I can remember that specified that it was the objective, as stated in the 1984 document, that we would have to cost revenue match at 100 percent. It was just assumed.
Mrs. MALONEY. OK. But I would like to request copies of the 1982 and 1984 documents. I would like to ask Mr. McFarland the same question. Are you aware that any correspondence or documents from the Fed that refer to the ITS need to achieve 100 percent cost recovery?
Mr. MCFARLAND. The 1982 document that Tom Hunt referred to indicated that one of the problems with the old ITS, before the Network was redesigned in 1993, was that it was not cost revenue matching, and that was referenced in this particular position paper. In that paper, it said that ITS must fully recover 100 percent.
In 1984, there was another document that reaffirmed 100 percent recovery. In 1988, there are numerous documents that I know of that said that there should be 100 percent cost revenue match. In addition to that, there were letters that I saw that were from people in the Federal Reserve to people in Congress, that, in fact, indicated that we were going to cost revenue match at 100 percent. So, I have seen many documents that have indicated that ITS would fully recover costs.
Page 107 PREV PAGE TOP OF DOC
Mrs. MALONEY. Can we have copies of those documents, and which people in the Federal Reserve sent those documents? Who did they come from?
Mr. MCFARLAND. I know one went to Senator Reigle. I cannot remember who it was from.
Mrs. MALONEY. And you have copies of them?
Mr. MCFARLAND. I may have copies. I have a lot of old junk, but I am not sure what
Mrs. MALONEY. OK. Do you remember who the 1982 and 1984 documents came from, the 1988 documents?
Mr. MCFARLAND. Well, the 1982 was part of the work study group that was redesigning the ITS. It was felt that the ITSthe Federal Reserve's Check Transportation Network in 1982 was a mish-mash of disjointed transportation systems throughout the country, and it was costing the Fed about $33 million for this service.
The Federal Reserve decided to put a new system together, which became the current ITS. This new nationwide system, because it was more efficient than the former systems, cost only $25 million to run. That meant the full cost was only $25 million, as opposed to $33 million. So, we had an $8 million cost reduction in check transportation when the new ITS started in 1983. The 1982 document states in part, that the ITS had to become more efficient and had to cost revenue match.
Page 108 PREV PAGE TOP OF DOC
Mrs. MALONEY. OK. Do you remember who it came from?
Chairman CASTLE. Mrs. Maloney.
Mrs. MALONEY. OK. Can I just ask the last man did he remember any documents?
Chairman CASTLE. OK. Let us make that, if we can, the last question. Because Mr. Metcalf wants to ask some questions and we have a vote. Is that acceptable?
Mrs. MALONEY. Sure.
Are you aware of any documents?
Mr. FAZIO. No, ma'am.
Mrs. MALONEY. OK. Thank you. All right. Thank you, Mr. Chairman.
Chairman CASTLE. Thank you. I appreciate your line of questioning.
Page 109 PREV PAGE TOP OF DOC Mr. METCALF. Thank you, Mr. Chairman. I have one question and it is brief, and I would like a brief answer.
I have your sheet here, which says, you know, you total it up 68.17 percent of costs. Because the banks ultimately pay the costs of this, if the ITS were to change to what you would consider a 100 percent cost recovery, what would you estimate the impacts would be, if any, on the smaller banks? I do not care about the big banks. But what is on the smaller banks?
Mr. MCFARLAND. I do not know if you read my written testimony. I tried to answer that in my written testimony. But I believe that it depends on how we reach 100 percent recovery. If we attempt to reach 100 percent recovery with our current structure of just a per-item fee, I believe that it would cause us to lose volume and require us to continually increase fees. It wouldI think it would be harmful to the small banks. If, on the other hand, we adopted a fixed and variable fee structure, I think that we could, over timemaybe 2 years or socost revenue match with nominal fees and not harm the small banks. But it depends on how we do it, and the timeframe we have to do it.
Mr. METCALF. OK. Thank you. Any other comments from any of the others?
Thank you very much, Mr. Chairman.
Chairman CASTLE. Thank you, Mr. Metcalf.
I believe that brings to a conclusion this panel and this hearing. We do thank you. We realize that there is probably duress in this kind of testimony. You have done well. You have been forthright. And, hopefully, it will be helpful in making the Government work better, which is why we are all in this business I hope.
Page 110 PREV PAGE TOP OF DOC
Mrs. MALONEY. Mr. Castle, may I putask themreserve the right to ask them more questions in writing?
Chairman CASTLE. Oh, absolutely.
Mrs. MALONEY. Thank you.
Chairman CASTLE. And I think they understand that they have been through this hearing, so they understand that that could happen anyhow. We all reserve that right, because I have some questions as well.
But, again, we thank you and anyone else who is still here, who participated earlier. And I do apologize for the interruptions that go on during the course of a day. Thank God, we dodged this last bullet, because this was going to go on about 40 minutes I think. So, thank you, and we stand adjourned.
Mr. MCFARLAND. Thank you very much.
Mr. HUNT. Thank you, sir.
[Whereupon, at 5:20 p.m., the hearing was adjourned.]