were able to turn around their shrinking margins. perhaps the biggest contributor to strong earnings has been steady improvement in asset quality - consistent with a gradually improving economy - that allowed for lower charge - offs and lower provisions. by the end of 2003, problem assets had fallen to 0. 94 percent of loans, down considerably from the peak level for this credit cycle of 1. 27 percent in september 2002. improvement in economic conditions is a key reason for the sustained decline, along with the liquidity and depth of secondary markets for troubled loans. we also think that better risk management - in particular, better diversification - contributed to this decline. with charge - offs and problem assets declining for more than a year, credit quality is on track to improve further, more so as the economy improves. as a result, we can expect that banks will be able to take their provisions still lower and maybe their reserves as well. one area in which bank profits lost ground was securities gains. low interest rates had increased the market value of bank securities holdings, creating the opportunity for banks to sell these securities and take the resulting gains into income. booking such gains significantly enhanced near - term profits, but of course at the price of lowering future net interest earnings. in any case, increases in longer - term interest rates over the summer meant that the opportunities for securities gains - taking faded. so did the current contribution to earnings from securities gains. banks still have not seen significant relief from weak business loan demand. in this business cycle, firms have been reluctant to borrow - in part because of uncertainty about future prospects. the commercial loan business often carries attractive spreads, especially in the middle market. we have seen only the very early signs of recovery in loan demand, including a pickup in bond issuance and syndicated lending. by one indicator, at least, small business confidence appears to be improving ; a development that should be important for community banks. the national federation of independent businesses surveys its members regularly about their sales outlook for the coming three - month period. those surveys show optimism rising since the summer of 2003. in fact, since november the number of firms expecting an increase in sales exceeds those expecting a decline by more than 30 percentage points. the survey hasn't shown that wide a margin with such a positive outlook for four years. at this point, the available indicators suggest that banks'earnings prospects are favorable. the market seems to share that outlook, perhaps one reason why bank stock valuations have been improving. ongoing consolidation in the industry

expired major provisions of the budget enforcement act of 1990, and the act ’ s later modifications and extensions, provided a set of rules that helped translate a general commitment to fiscal discipline into the actions necessary to achieve it. remember that in just five years the first cohort of the baby - boom generation will reach 62, the earliest age at which social security retirement benefits may be claimed and the age at which about half of the prospective beneficiaries choose to retire. in about 2008, the proportion of the working - age population that will retire is projected to begin escalating. almost surely, the social security and medicare benefits that are promised under current law to future retirees cannot be financed with existing tax rates. budget simulations by a broad range of analysts ( including those at the office of management and budget and the congressional budget office ) suggest that the rapid increase in the unified budget deficits that would occur under current law as the baby - boom generation retires could set in motion an unsustainable dynamic in which large deficits result in growing interest payments that augment deficits in future years. such a development could have notable, destabilizing effects on the economy. increased productivity growth, while helpful, does not alter that conclusion, because when productivity growth increases, so do social security obligations and, indirectly, medicare benefits as well. productivity would have to grow at a rate far in excess of the historical average to fully resolve the long - term financing problems of social security and medicare. tax rate increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. the exact magnitude of such risks are very difficult to estimate, but they are of enough concern, in my judgment, to warrant aiming to close the fiscal gap primarily, if not wholly, from outlay restraint. at the same time, the dimension of the challenge, especially in later years, cannot be underestimated. the one certainty is that the resolution of this situation will require difficult choices, and the future performance of the economy will depend on those choices. history has shown that, when faced with large challenges, elected officials have risen to the occasion. in particular, looking back over the past twenty years or so, it has been evident that the prospect of large deficits generally has led to actions to narrow them. i trust that the recent deterioration in the budget outlook and the fast - approaching retirement of the baby - boom generation will be met with similar determination and effectiveness.