[Senate Hearing 110-854]
[From the U.S. Government Publishing Office]
S. Hrg. 110-854
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2008
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
FEBRUARY 28, 2008
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania MEL MARTINEZ, Florida
JON TESTER, Montana BOB CORKER, Tennessee
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Roger Hollingsworth, Deputy Staff Director
Aaron Klein, Chief Economist
Dean V. Shahinian, Senior Counsel
Julie Chon, International Economic Adviser
Mark Oesterle, Republican Chief Counsel
Peggy Kuhn, Republican Senior Financial Economist
Mike Nielsen, Republican Professional Staff Member
Dawn Ratliff, Chief Clerk
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, FEBRUARY 28, 2008
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Bunning
Prepared statement....................................... 45
Senator Dole
Prepared statement....................................... 45
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 6
Prepared statement........................................... 46
Response to written questions of:
Senator Shelby........................................... 50
Additional Material Supplied for the Record
Monetary Policy Report to the Congress dated February 27, 2008... 62
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2008
----------
THURSDAY, FEBRUARY 28, 2008
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:11 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order.
I am pleased to call the Committee to order this morning.
Today, the Committee will hear the testimony of Federal Reserve
Chairman Ben Bernanke on the outlook of the Nation's economy,
the Fed's conduct of monetary policy, and the status of
important consumer protection regulations that are under the
Fed's jurisdiction. This is Chairman Bernanke's second
appearance before the Committee this year. Mr. Chairman, it is
good to have you with us, and, again, it is 2 weeks ago and now
again today here. You are becoming a regular here, and so we
appreciate your appearance before the Committee.
When Chairman Bernanke was first before the Committee 2
weeks ago, I laid out the facts of what I consider to be our
Nation's very serious, if not perilous, economic condition.
Growth is slowing, inflation is rising, consumer confidence is
plummeting, while indebtedness is deepening. And just as
ominously, the credit markets have experienced significant
disruptions. Consumers are unable or unwilling to borrow.
Lenders are unable or unwilling to lend. There is a palpable
sense of uncertainty and even fear in the markets with a crisis
of confidence that has spread beyond the mortgage markets to
markets in student loans. And I noted this morning--by the way,
2 weeks ago I pointed out that Michigan was indicating some
serious problems with student lending, and this morning I am
reading where Pennsylvania today--you may have seen the
article--may decide to also curtail student loans as a result
of this growing economic situation. We have also seen the
problem with credit cards, government bonds, and corporate
finance.
Unfortunately, the crisis of confidence does not just exist
by American consumers and lenders. It increasingly appears that
there is a crisis of confidence among the rest of the world in
the United States economy. Yesterday, the dollar reached its
lowest level since 1973, when the dollar was first allowed to
float freely. And the Fed's own monetary report details an
alarming fact. Foreign entities have not only stopped
purchasing U.S. securities; they have actually been selling
them because they have lost, it appears, confidence in their
value. Now, I am going to be raising some questions, Mr.
Chairman, about that, and I will be interested in your
observations about these reports in the Monetary Policy Report.
As I have said previously, the catalyst of the current
economic crisis I believe very strongly is the housing crisis.
Overall, 2007 was the first year since data has been kept that
the United States had an annual decline in nationwide housing
prices. A recent Moody's report forecast that home values will
drop in 2008 by 10 percent to 15 percent, and others are
predicting similar declines in 2009 as well. This would be the
first time since the Great Depression that national home prices
have dropped in consecutive years. We have all witnessed in the
past where regionally there have been declines in home prices,
but to have national numbers like this is almost unprecedented,
certainly in recent history.
If the catalyst of the current economic crisis is the
housing crisis, then the catalyst of the housing crisis is the
foreclosure crisis. This week, it was reported that
foreclosures in January were up 57 percent compared to a year
ago and continue to hit record levels. When all is said and
done, over 2 million Americans could lose their homes as a
result of what Secretary Paulson has properly and accurately
described as ``bad lending practices.'' These are lending
practices that no sensible banker, I think, would ever engage
in. Reckless, careless, and sometimes unscrupulous actors in
the mortgage lending industry essentially allowed banks--
rather, essentially allowed loans to be made that they knew
hard-working, law-abiding borrowers would never be able to
repay.
Let me add here very quickly, because I think it is
important to make the point here, that we are not talking about
everyone here at all. We are talking about some who engaged in
practices that I think were unscrupulous or bad lending
practices. But many institutions acted very responsibly, and I
would not want the world to suggest here that this Committee
believed that this was an indictment on all lending
institutions. And engaged--those who did act improperly engaged
in practices that the Federal Reserve under its prior
leadership, in my view, and this administration did absolutely
nothing to effectively stop.
The crisis affects more than families who lose their homes.
Property values for each home within a one-eighth square mile
of a foreclosed home could drop on an average as much as
$5,000. This will affect somewhere between 44 to 50 million
homes in our country. So the ripple effect beyond the
foreclosed property goes far beyond that and has a contagion
effect, in my view, in our communities all across this country
beyond the very stark reality of those who actually lose their
homes, the effect of others watching the value of their
properties decline, not to mention what that means to local tax
bases, supporting local police and fire, and a variety of other
concerns raised by this issue.
I certainly want to commend the Fed Chairman--I said so
yesterday publicly, Mr. Chairman; I do so again this morning--
for candidly acknowledging the weakness in the economy and for
actively addressing those weaknesses by injecting liquidity and
cutting interest rates. I also am pleased that the
administration and the Congress were able to reach agreement on
a stimulus package, and our hope is--while some have argued
this is not big enough or strong enough, our collective hope is
this will work, will have some very positive impact on the
economy. Certainly this will have some support, we hope, for
working families who are bearing the brunt of these very
difficult times.
However, I think more needs to be done to address the root
cause of our economic problems. Any serious effort to address
our economic woes should include, I think, an effort to take on
the foreclosure crisis. And, again, there are various ideas out
there on how we might do this more effectively, and certainly
the Chairman and others have offered some ideas and
suggestions. Senator Shelby and I have been working and
talking--and Mel Martinez and others who are involved in these
issues--about ways in which we can in the coming days do
constructive things in a positive way to indicate and show not
only our concern about the issue but some very strong ideas on
how we can right this and restore that confidence I talked
about earlier.
We on this Committee have already taken some steps to
address these problems. We have passed the FHA modernization
legislation through the Committee and the Senate and continue
to work to make it law. We had a very good meeting yesterday, I
would point out, Senator Shelby and I and the leadership of the
House Financial Services Committee, I say to you, Mr. Chairman,
in hopes that we can come to some very quick conclusion on that
piece of legislation and move it along here.
We appropriated close to $200 million to facilitate
foreclosure prevention efforts by borrowers and lenders, and I
want to commend Senator Schumer and others who have been
involved in this idea of counseling and ideas to minimize the
impact of this problem as well.
In addition, the recently enacted stimulus package that I
mentioned already includes a temporary increase in the
conforming loan limits for GSEs to try to address the problems
that have spread throughout the credit market and the jumbo
mortgage market. And while this temporary increase is helpful,
we still need to implement broad GSE reform. And as I have said
previously, I am committed to doing that, and we will get that
done.
I have spoken about my belief in the need for additional
steps to mitigate the foreclosure crisis in a reasonable and
thoughtful manner. These steps include targeting some community
development block grant assistance to communities in a targeted
way to help them to counter the impact of foreclosed and
abandoned properties in their communities. And they include
establishing a temporary homeownership loan initiative, which I
have raised and others have commented on, either using existing
platforms or a new entity that can facilitate mortgage
refinancing.
But it is not just the Congress that needs to do more, and,
again, the Fed needs, in my view, to be as vigilant a financial
regulator as it has been a monetary policymaker. That includes
breaking with its past and becoming more vigilant about
policing indefensible lending practices. And, again, I commend
the Chairman of the Federal Reserve--we have talked about this
here--on the proposed regulations that you have articulated
that would follow on the HOEPA legislation. And while I have
expressed some disappointment about how far they go in certain
areas here, the Chairman and I have talked about this a bit. We
will be involved in the comment period here and are looking
forward to finalizing those regulations, and hopefully at least
shutting the door on this kind of a problem re-emerging in the
coming months and years.
So I want to thank you, Mr. Chairman, and your colleagues
and urge them to consider some of the stronger measures, and we
will offer some additional comments on them.
Despite these unprecedented challenges, I think all of us
here on this Committee, Republicans and Democrats, remain
confident in the future of the American economy, and our
concerns that will be raised here this morning should not
reflect anything but that confidence in the future. We may need
to change some of our policies, regulations, and priorities,
but we strongly believe that the ingenuity, productivity, and
capability of the American worker and the entrepreneur ought
never to be underestimated in this country. And we remain firm
and committed to doing everything we can to strengthen those
very points.
So I look forward to working with my good friend, Senator
Shelby, and other Members of the Committee to do what we can
here to play our role in all of this in a constructive way, to
work with you, Mr. Chairman, and the Federal Reserve, the
Secretary of the Treasury, and others of the financial
institution regulators to see what we can do in the short term
to get this moving in a better direction.
So, with that, let me turn to Senator Shelby for his
opening comments, and then we will try to get to some
questions. And I will leave opening comments for the go-around
and question period so we can get to a question-and-answer
period here to make this as productive a session as possible.
But we thank you again for being with us.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Chairman Dodd.
Chairman Bernanke, we are pleased to have you again before
the Committee to deliver the Federal Reserve's Semiannual
Monetary Policy Report. I will keep my remarks brief this
morning as we are all here to hear your views on the U.S.
economy and other related issues. We also have the benefit of
having read about your remarks before the House yesterday.
Chairman Bernanke, the Federal Reserve has taken a number
of steps over the past 6 months to address the tightening of
credit markets and the slowdown in economic growth. In a bid to
improve interbank liquidity, the Federal Reserve established
the term auction facility in December of last year and has
conducted, as I understand it, six auctions to date.
Since last August, the Federal Open Market Committee has
reduced the Federal funds target a total of 225 basis points,
taking the target from 5.25 percent to 3 percent.
Mr. Chairman, since monetary policy works with a lag, the
full impact of this boost to the economy is not yet clear to
you or to us. I know that we will spend time this morning
discussing the length and the depth of the housing correction
that Senator Dodd alluded to, and I think we should. I also
want to make sure, however, that this Committee focuses on the
risks associated with increasing inflation.
The Labor Department, Mr. Chairman, reported this week, as
you know, that wholesale price inflation hit a 26-year high in
January. The January rise in the Consumer Price Index meant a
12-month change in the overall CPI of 4.3 percent, twice the
pace of a year ago. In addition, gold and oil are at all-time
highs. These numbers certainly raise questions, Mr. Chairman,
as to how much more room the Federal Reserve will have to
provide further monetary accommodation without threatening
long-term price stability, which is very important to all of
us. While it is difficult to see our Nation's economy
experience minimal growth, the consequences of failing to
restrain inflation will be far more painful and more difficult
to unwind.
Chairman Bernanke, we are pleased to have you with us this
morning, and we look forward to your thoughts on this and other
issues.
Chairman Dodd. Thank you very much.
Let me correct myself. The tradition has been, Mr.
Chairman, if Members do want to make some opening comments at a
moment like this, and I do not want to break that tradition. So
I am going to ask if any Members would like to make any opening
comments at this point, I would be happy to entertain them. I
realize that has been the tradition of the Committee, and I do
not want to violate the traditions of the Committee. Does any
Member want to be heard, some opening comments to make at this
point? If they would like to, I would be happy to entertain----
Senator Bunning. Let me ask a question. If we do not make
them now and we make them during our timeframe, does that limit
how many questions we can ask?
Chairman Dodd. Well, that is the idea. I mean, I do not
want to limit your time, but----
[Laughter.]
Chairman Dodd. So if you would like to----
Senator Shelby. Make your opening statement.
Senator Bayh. That would make Chairman Bernanke happy.
Chairman Dodd. I understand that, and that is why you get
the gavel after 27 years. But if you would like to make an
opening comment----
Senator Bunning. OK.
Chairman Dodd. All right. Anyone else who would like to be
heard?
Senator Shelby. Why don't you add a minute and do both?
Chairman Dodd. We will add a minute. Why don't I add a
minute to the time here? Instead of having 5 or 6 minutes, we
will make it 7 or 8 minutes. And I have never tried to be too
rigid about that, and so we will do it that way if that is all
right. That will move things along. Is that OK with everyone?
Thank you very much.
Mr. Chairman, we welcome you to the Committee.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you. Chairman Dodd, Ranking Member
Shelby, and other Members of the Committee, I am pleased to
present the Federal Reserve's Monetary Policy Report to the
Congress. In my testimony this morning, I will briefly review
the economic situation and outlook, beginning with developments
in real activity and inflation, and then turn to monetary
policy.
Senator Bunning. Mr. Chairman, would you please move that
microphone a little closer so we can all hear you?
Mr. Bernanke. How is this?
Senator Bunning. That is good.
Mr. Bernanke. I will conclude with a quick update on the
Federal Reserve's recent actions to help protect consumers in
their financial dealings.
The economic situation has become distinctly less favorable
since the time of our July report. Strains in financial
markets, which first became evident late last summer, have
persisted; and pressures on bank capital and the continued poor
functioning of markets for securitized credit have led to
tighter credit conditions for many households and businesses.
The growth of real gross domestic product held up well through
the third quarter despite the financial turmoil, but it has
since slowed sharply. Labor market conditions have similarly
softened, as job creation has slowed and the unemployment
rate--at 4.9 percent in January--has moved up somewhat.
Many of the challenges now facing our economy stem from the
continuing contraction of the U.S. housing market. In 2006,
after a multiyear boom in residential construction and house
prices, the housing market reversed course. Housing starts and
sales of new homes are now less than half of their respective
peaks, and house prices have flattened or declined in many
areas. Changes in the availability of mortgage credit amplified
the swings in the housing market.
During the housing sector's expansion phase, increasingly
lax lending standards, particularly in the subprime market,
raised the effective demand for housing, pushing up prices and
stimulating construction activity. As the housing market began
to turn down, however, the slump in subprime mortgage
originations, together with a more general tightening of credit
conditions, has served to increase the severity of the
downturn. Weaker house prices in turn have contributed to the
deterioration in the performance of mortgage-related securities
and reduced the availability of mortgage credit.
The housing market is expected to continue to weigh on
economic activity in coming quarters. Home builders, still
faced with abnormally high inventories of unsold homes, are
likely to cut the pace of their building activity further,
which will subtract from overall growth and reduce employment
in residential construction and closely related industries.
Consumer spending continued to increase at a solid pace
through much of the second half of 2007, despite the problems
in the housing market, but it appears to have slowed
significantly toward the end of the year. The jump in the price
of imported energy, which eroded real incomes and wages, likely
contributed to the slowdown in spending, as did the declines in
household wealth associated with the weakness in house prices
and equity prices.
Slowing job creation is yet another potential drag on
household spending, as gains in payroll employment averaged
little more than 40,000 per month during the 3 months ending in
January, compared with an average increase of almost 100,000
per month over the previous 3 months. However, the recently
enacted fiscal stimulus package should provide some support for
household spending during the second half of this year and into
next year.
The business sector has also displayed signs of being
affected by the difficulties in the housing and credit markets.
Reflecting a downshift in the growth of final demand and
tighter credit conditions for some firms, available indicators
suggest that investment in equipment and software will be
subdued during the first half of 2008. Likewise, after growing
robustly through much of 2007, nonresidential construction is
likely to decelerate sharply in coming quarters as business
activity slows and funding becomes harder to obtain, especially
for more speculative projects. On a more encouraging note, we
see few signs of any serious imbalances in business inventories
aside from the overhang of unsold homes. And, as a whole, the
nonfinancial business sector remains in good financial
condition, with strong profits, liquid balance sheets, and
corporate leverage near historical lows.
In addition, the vigor of the global economy has offset
some of the weakening of domestic demand. U.S. real exports of
goods and services increased at an annual rate of about 11
percent in the second half of last year, boosted by continuing
economic growth abroad and the lower foreign exchange value of
the dollar. Strengthening exports, together with moderating
imports, have in turn led to some improvement in the U.S.
current account deficit, which likely narrowed in 2007--on an
annual basis--for the first time since 2001. Although recent
indicators point to some slowing of foreign economic growth,
U.S. exports should continue to expand at a healthy pace in
coming quarters, providing some impetus to domestic economic
activity and employment.
As I have mentioned, financial markets continue to be under
considerable stress. Heightened investor concerns about the
credit quality of mortgages, especially subprime mortgages with
adjustable interest rates, triggered the financial turmoil.
However, other factors, including a broader retrenchment in the
willingness of investors to bear risk, difficulties in valuing
complex or illiquid financial products, uncertainties about the
exposures of major financial institutions to credit losses, and
concerns about the weaker outlook for economic growth, have
also roiled the financial markets in recent months. To help
relieve the pressures in the market for interbank lending, the
Federal Reserve--among other actions--recently introduced a
term auction facility, through which prespecified amounts of
discount window credit are auctioned to eligible borrowers, and
we have been working with other central banks to address market
strains that could hamper the achievement of our broader
economic objectives. These efforts appear to have contributed
to some improvement in short-term funding markets. We will
continue to monitor financial developments closely.
As part of its ongoing commitment to improving the
accountability and public understanding of monetary
policymaking, the Federal Open Market Committee--or FOMC--
recently increased the frequency and expanded the content of
the economic projections made by Federal Reserve Board members
and Reserve Bank presidents and released to the public. The
latest economic projections, which were submitted in
conjunction with the FOMC meeting at the end of January and
which are based on each participant's assessment of appropriate
monetary policy, show that real GDP was expected to grow only
sluggishly in the next few quarters and that the unemployment
rate was likely to increase somewhat. In particular, the
central tendency of the projections was for real GDP to grow
between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\
percent to 2\3/4\ percent projected in our report last July.
FOMC participants' projections for the unemployment rate in the
fourth quarter of 2008 have a central tendency of 5.2 percent
to 5.3 percent, up from the level of about 4\3/4\ percent
projected last July for the same period. The downgrade in our
projections for economic activity in 2008 since our report last
July reflects the effects of the financial turmoil on real
activity and a housing contraction that has been more severe
than previously expected. By 2010, our most recent projections
show output growth picking up to rates close to or a little
above its longer-term trend and the unemployment rate edging
lower; the improvement reflects the effects of policy stimulus
and an anticipated moderation of the contraction in housing and
the strains in financial and credit markets. The incoming
information since our January meeting continues to suggest
sluggish economic activity in the near term.
The risks to this outlook remain to the downside. The risks
include the possibilities that the housing market or the labor
market may deteriorate more than is currently anticipated and
that credit conditions may tighten substantially further.
Consumer price inflation has increased since our previous
report, in substantial part because of the steep run-up in the
price of oil. Last year, food prices also increased
significantly, and the dollar depreciated. Reflecting these
influences, the price index for personal consumption
expenditures--or PCE--increased 3.4 percent over the four
quarters of 2007, up from 1.9 percent in 2006. Core price
inflation--that is, inflation excluding food and energy
prices--also firmed toward the end of the year. The higher
recent readings likely reflected some pass-through of energy
costs to the prices of core consumer goods and services as well
as the effect of the depreciation of the dollar on import
prices. Moreover, core inflation in the first half of 2007 was
damped by a number of transitory factors--notably, unusually
soft prices for apparel and for financial services--which
subsequently reversed. For the year as a whole, however, core
PCE prices increased 2.1 percent, down slightly from 2006.
The projections recently submitted by FOMC participants
indicate that overall PCE inflation was expected to moderate
significantly in 2008, to between 2.1 percent and 2.4 percent--
the central tendency of the projections. A key assumption
underlying those projections was that energy and food prices
would begin to flatten out, as implied by quotes on futures
markets. In addition, diminishing pressure on resources is also
consistent with the projected slowing in inflation. The central
tendency of the projections for core PCE inflation in 2008, at
2.0 percent to 2.2 percent, was a bit higher than in our July
report, largely because of some higher-than-expected recent
readings on prices. Beyond 2008, both overall and core
inflation were projected to edge lower, as participants
expected inflation expectations to remain reasonably well
anchored and pressures on resource utilization to be muted. The
inflation projections submitted by FOMC participants for 2010--
which ranged from 1.5 percent to 2.0 percent for overall PCE
inflation--were importantly influenced by participants'
judgments about the measured rates of inflation consistent with
the Federal Reserve's dual mandate and about the timeframe over
which policy should aim to achieve those rates.
The rate of inflation that is actually realized will, of
course, depend on a variety of factors. Inflation could be
lower than we anticipate if slower-than-expected global growth
moderates the pressure on the prices of energy and other
commodities or if rates of domestic resource utilization fall
more than we currently expect. Upside risks to the inflation
projection are also present, however, including the
possibilities that energy and food prices do not flatten out or
that the pass-through to core prices from higher commodity
prices and from the weaker dollar may be greater than we
anticipate. Indeed, the further increases in the prices of
energy and other commodities in recent weeks, together with the
latest data on consumer prices, suggest slightly greater upside
risks to the projections of both overall and core inflation
than we saw last month. Should high rates of overall inflation
persist, the possibility also exists that inflation
expectations could become less well anchored. Any tendency of
inflation expectations to become unmoored or for the Fed's
inflation-fighting credibility to be eroded could greatly
complicate the task of sustaining price stability and could
reduce the flexibility of the FOMC to counter shortfalls in
growth in the future. Accordingly, in the months ahead, the
Federal Reserve will continue to monitor closely inflation and
inflation expectations.
Let me turn now to the implications of these developments
for monetary policy. The FOMC has responded aggressively to the
weaker outlook for economic activity, having reduced its target
for the Federal funds rate by 225 basis points since last
summer. As the Committee noted in its most recent post-meeting
statement, the intent of those actions has been to help promote
moderate growth over time and to mitigate the risks to economic
activity.
A critical task for the Federal Reserve over the course of
this year will be to assess whether the stance of monetary
policy is properly calibrated to foster our mandated objectives
of maximum employment and price stability in an environment of
downside risks to growth, stressed financial conditions, and
inflation pressures. In particular, the FOMC will need to judge
whether the policy actions taken thus far are having their
intended effects. Monetary policy works with a lag. Therefore,
our policy stance must be determined in light of the medium-
term forecast for real activity and inflation as well as by the
risks to that forecast. Although the FOMC participants'
economic projections envision an improving economic picture, it
is important to recognize that downside risks to growth remain.
The FOMC will be carefully evaluating incoming information
bearing on the economic outlook and will act in a timely manner
as needed to support growth and to provide adequate insurance
against downside risks.
Finally, I would like to say a few words about the Federal
Reserve's recent actions to protect consumers in their
financial transactions. In December, following up on a
commitment I made at the time of our report last July, the
Board issued for public comment a comprehensive set of new
regulations to prohibit unfair or deceptive practices in the
mortgage market, under the authority granted us by the Home
Ownership and Equity Protection Act of 1994. The proposed rules
would apply to all mortgage lenders and would establish lending
standards to help ensure that consumers who seek mortgage
credit receive loans whose terms are clearly disclosed and that
can reasonably be expected to be repaid. Accordingly, the rules
would prohibit lenders from engaging in a pattern or practice
of making higher-priced mortgage loans without due regard to
consumers' ability to make the scheduled payments. In each
case, a lender making a higher-priced loan would have to use
third-party documents to verify the income relied on to make
the credit decision. For higher-priced loans, the proposed
rules would require the lender to establish an escrow account
for the payment of property taxes and homeowners' insurance and
would prevent the use of prepayment penalties in circumstances
where they might trap borrowers in unaffordable loans. In
addition, for all mortgage loans, our proposal addresses
misleading and deceptive advertising practices, requires
borrowers and brokers to agree in advance on the maximum fee
that the broker may receive, bans certain practices by
servicers that harm borrowers, and prohibits coercion of
appraisers by lenders. We expect substantial public comment on
our proposal, and we will carefully consider all information
and viewpoints while moving expeditiously to adopt final rules.
The effectiveness of the new regulations, however, will
depend critically on strong enforcement. To that end, in
conjunction with other Federal and State agencies, we are
conducting compliance reviews of a range of mortgage lenders,
including nondepository lenders. The agencies will collaborate
in determining the lessons learned and in seeking ways to
better cooperate in ensuring effective and consistent
examinations of, and improved enforcement for, all categories
of mortgage lenders.
The Federal Reserve continues to work with financial
institutions, public officials, and community groups around the
country to help homeowners avoid foreclosures. We have called
on mortgage lenders and servicers to pursue prudent loan
workouts and have supported the development of a streamlined,
systematic approach to expedite the loan modification process.
We also have been providing community groups, counseling
agencies, regulators, and others with detailed analyses to help
identify neighborhoods at high risk from foreclosures so that
local outreach efforts to help troubled borrowers can be as
focused and effective as possible. We are actively pursuing
other ways to leverage the Federal Reserve's analytical
resources, regional presence, and community connections to
address this critical issue.
In addition to our consumer protection efforts in the
mortgage area, we are working toward finalizing rules under the
Truth in Lending Act that will require new, more informative,
and consumer-tested disclosures by credit card issuers.
Separately, we are actively reviewing potentially unfair and
deceptive practices by issuers of credit cards. Using the
Board's authority under the Federal Trade Commission Act, we
expect to issue proposed rules regarding these practices this
spring.
Thank you. I would be pleased to take your questions.
Chairman Dodd. Thank you very much, Mr. Chairman.
We will make these 7 to 8 minutes, and, again, I will not
be rigid about the time constraints.
Let me begin, Mr. Chairman, by going back to that old
question that was asked more than, I guess, 30 years ago. I
will sort of paraphrase on it, and that is, are we better off
today to respond to this situation than we were--in this case I
want to ask 7 years ago. The question that Ronald Reagan asked,
I think, in 1980 in that campaign, Are we better off today than
we were yesterday? And the reason I raise that is because I
have been struck by the similarities between 2001 and that
period going into, potentially falling into a recession, and
here we are in 2008.
The parallel seems striking to me in some ways, and I want
you to comment on this, if you could. At both moments in this
7-year period, we are on the brink of a recession--at least it
seems so. The Fed was cutting interest rates very aggressively.
A major asset bubble--in this case, it was the high-tech
community rather than housing--was bursting. Yet despite those
similarities, the differences in the basic economic information
seems to be very, very different as well. Americans had just
experienced the greatest economic boom in a generation. Real
wages had gone up substantially. Income inequality had
narrowed. The Federal Government was in a surplus. In fact, on
this very Committee, your predecessor came to a hearing--I do
not know who else was on the Committee in those days, but he
came and talked about the things we ought to think about by
retiring the national debt entirely. There were some downsides
to that, and we actually had a very good hearing with Alan
Greenspan about that very question in 2001. The dollar was at
record highs as well, and, of course, today we are in the
opposite position, with the dollar at its lowest level since we
began floating currencies in 1973. Inflation is at a 17-year
high. Real wages are falling, and we are faced with record
Government debt and deficits. A very different fact situation
than was the case in 2001.
In 2001, as well, one might argue that there were
deliberate actions taken by the Federal Reserve to deal with
rising inflation. So the steps were in response to inflation
here. Obviously, what is provoking, I think, the action--and
you can certainly comment on this--is a different fact
situation.
So the question appears in a sense: Are we in a--what would
be your analysis? Are we in a--comparing these two periods in
time of history, relatively close to each other, faced with
similar situations, it would appear to me that we are not in as
strong a position to respond to this as we were in 2001. And so
the question is, Are we better off? And if so, I would like you
to explain why. And if not, what should we be doing and what
different steps should we be taking if we cannot rely on these
basic underlying strengths that occurred in 2001 that helped us
at that time as opposed to where we are today?
Mr. Bernanke. Mr. Chairman, there are certainly some
similarities with the 2001 experience, most obviously the sharp
change in asset price. In the previous case, it was the stock
market, the tech stocks; in this case, it is home prices. But
there are some important differences as well, as you point out.
The decline in home prices is creating a much broader set of
issues, both for borrowers and homeowners, but also for the
credit markets. And so we have a sustained disruption in the
credit process which has gone on now since last August and is
not yet near completion. That is a continuing drag on the
economy and a continuing problem for us as we try to restore
stronger growth.
The other problem is that we do have greater inflation
pressure at this point than we did in 2001, and that is coming
from oil. In 2001, the price of oil was somewhere around $20.
Today it is $100.
Chairman Dodd. Right.
Mr. Bernanke. The increase in commodity prices around the
world as the global economy expands and increases demand for
those commodities is creating an inflationary stress which is
complicating the Federal Reserve's attempts to respond.
In some other ways, things are different. You pointed out
the dollar was very strong in 2001. That was in part reflective
of a large trade deficit at that time. It has since
depreciated. But, on the other hand, part of the effect of that
depreciation has been that we are at least seeing some
improvement in that trade deficit, which is a positive factor.
On the fiscal situation, I agree we are in a less
advantageous situation than we were. The deficit is certainly
higher, and perhaps even more seriously, we are now 7 years
further on toward the retirement of the baby boomers and the
entitlements, and those costs that are certainly bearing down
on us as we speak.
So it is a difficult situation, and there are multiple
factors. I think there are some similarities, but as a Russian
novelist once said, ``Unhappy families are all unhappy in their
own way,'' and every period of financial and economic stress
has unique characteristics.
Chairman Dodd. Well, do you have any recommendations, then,
differently here? If we are responding in a very similar way
with different underlying economic fact situations, are there
other things we ought to be doing here, taking any kind of a
different approach? Or are we secure in feeling that the
present course of action being taken by the Fed and by the
administration is going to produce the desired results? That
period of recession lasted about 8 months. There are fears that
this one, if it takes hold, could be far more long-lasting for
the very reasons we have outlined in the underlying problems
economically that exist.
Mr. Bernanke. Well, to some extent, the private sector is
going to have to work through the problems in the financial
markets. That is something that they will have to do with the
help and guidance of the regulators and the supervisors, which
we are certainly doing. We are reviewing our practices and our
policies and trying to see how we can improve them.
With respect to the broader economy, of course, we have
both monetary and fiscal policy action now underway, which I
hope will, and we project will, lead to stronger growth in the
second half of this year. An important issue, as you have
already alluded to, is the effects of the home price declines
on consumers and, in particular, the delinquencies and
foreclosures which we are now seeing.
I have described briefly in my remarks some of the things
that we have done in calling on private servicers and lenders
to scale up their activities, to use more streamlined
processes. I think it is important for us and for the servicers
to move beyond temporary palliatives that they are using in
many cases with delinquent borrowers and try to find more
permanent, sustainable solutions in terms of restructuring
mortgages or refinancing into the FHA or other mechanisms.
Congress has already taken some steps, as you mentioned,
and would urge you to continue to work on FHA modernization and
GSE reform.
Chairman Dodd. Right.
Mr. Bernanke. Those are two areas that can help us meet
these challenges.
Additional steps may be necessary in the future, but at
this point, I think we have taken a number of useful steps. We
need to keep thinking about possible future options, but I do
not have any additional recommendations right now.
Chairman Dodd. I do not want to put words in your mouth,
obviously, at all here, but I am looking at--obviously the
housing burst or bubble, the burst of that bubble is, I think,
far more dangerous than a high-tech problem, as you make those
comparisons. Inflation and trade deficits are worse. Am I
hearing you correctly that we are actually in a worse position
today to respond to this than we were 8 years ago? Is that how
I hear what you are saying?
Mr. Bernanke. I think that is fair in that both fiscal and
monetary policy face some additional constraints. Many people
owned stocks, too, of course, and so that affected their wealth
and their willingness to spend. But, in fact, the effects of
the stock market declines in 2001 were primarily on investment
firms than on consumers. In this case, the consumers are taking
the brunt of the effects.
Chairman Dodd. That is a good additional point. I did not
make that.
Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Bernanke, as I noted earlier, wholesale prices
rose by 1 percent in January and 7.4 percent over the past
year. This is the fastest increase in 26 years. In your opening
statement, you noted greater upside risks to both overall and
core inflation than we saw previously. Additionally, the most
recent minutes of the Federal Open Market Committee gave
anecdotal evidence that in some instances these price increases
were passed on to consumers. The FOMC also noted a risk that
inflation expectations could become less anchored.
Do you have any concern at all that the 225 basis-point cut
to the Federal funds rate has limited the options that can be
used to combat the upside risk of inflation?
Mr. Bernanke. Well, Senator, to answer that question, the
PPI, the Producer Price Index, that you referred to mostly
reflects the effects of large increases in prices of energy and
other commodities. We live in a world where energy and metals
and other commodities are globally traded, food as well, and
demand of emerging market economies and a growing global
economy has put pressure on the available supplies of those
resources and has driven up those prices. And as I mentioned,
the price of oil has quintupled or more.
Senator Shelby. Do you see that abating?
Mr. Bernanke. In 2007, the price of oil rose by about two-
thirds, and I suspect--and the futures markets agree--that it
is much more likely that oil prices, while remaining high, will
not increase by anything like that amount going forward. If oil
prices and food prices do stabilize to some extent, even if
they do not fall, that will be sufficient to bring inflation
down as we have projected.
Now, you are correct, though, that we do have to be very
cautious. While we cannot do much about oil prices or food
prices in the short run, we do have to be careful to make sure
that those prices do not either feed substantially into other
types of prices, other goods and services produced
domestically, and that they do not dislodge inflation
expectations or make the public less confident that the Federal
Reserve will, in fact, control inflation, as we will.
So we do have to watch those things very carefully, and
will watch them very carefully.
Senator Shelby. Is that what some of us would talk about,
the psychology of inflation?
Mr. Bernanke. Well, that is another way to put it. But,
yes, inflation expectations essentially are measured many
different ways, and I think the evidence is that they remain
pretty stable. If you look at forecasters' long-term inflation
expectations, consumer surveys, and even the financial markets,
they show that inflation expectations remain reasonably well
anchored. But it is certainly something we have to watch very
carefully.
Senator Shelby. Do you believe that setting a Fed funds
rate target lower than the inflation rate--that is, a negative
real rate of interest--can be an appropriate response to an
economic slowdown? In other words, how long can the Fed run a
negative real rate before inflationary pressures grow to
dangerous levels?
Mr. Bernanke. Well, Senator, there are different ways to
measure the real interest rate. The one that is relevant is the
one that is looking forward, and, again, if oil prices do not
continue to rise at this pace they have, I think we would still
be on the positive side of the real interest rate.
Now, in the past, the Fed has for short periods lowered the
rate to a negative level, but as you point out, that is not
something you want to do for a sustained period.
Senator Shelby. The Fed cannot ignore price stability, can
it, when you are making these decisions to have more liquidity
in the financial market?
Mr. Bernanke. Senator, we are facing a situation where we
have simultaneously a slowdown in the economy, stress in the
financial markets, and inflation pressure coming from these
commodity prices abroad. And each of those things represents a
challenge. We have to make our policy in trying to balance
those different risks in a way that will get the best possible
outcome for the American economy.
Senator Shelby. Would you be trying to avoid stagflation,
as some people call it?
Mr. Bernanke. I do not anticipate stagflation. I do not
think we are anywhere near the situation that prevailed in the
1970's. I do expect inflation to come down. If it does not, we
will have to react to it, but I do expect that inflation will
come down and that we will have both return to growth and price
stability as we move forward.
Senator Shelby. Do you still believe that the fundamentals
of our economy is still robust, is strong, other than the
housing market and some of the financial challenges that we
have coming out of that?
Mr. Bernanke. Senator, I realize my testimony was not the
most cheerful thing you will hear today, and I was thinking
very much about the short-term challenges that we face in terms
of the financial markets and growth and inflation. But I do
very much believe that the U.S. economy will return to a strong
growth path with price stability. We have enormous resources,
resilience, productivity, and I am quite confident in the
American economy and the American people that we will have
strong economic growth in the next few years.
Senator Shelby. Mr. Chairman, a commonly watched measure of
inflation, as you well know, is the core CPI. Housing
constitutes, I understand, almost a third of the core CPI. To
what extent has the recent decline in housing prices moderated
recent increases in the core CPI? As housing prices go down,
inflation, you know, should play here in a negative way, should
it not?
Mr. Bernanke. Well, Senator, not necessarily. You can get
actually a perverse effect, which is that as house prices----
Senator Shelby. And how would that work?
Mr. Bernanke. As house prices fall, people will become more
reluctant to buy a house because they are afraid that the house
price will keep falling, so they rent instead. And that puts
pressure on rents and actually could drive up the rent.
Senator Shelby. Good for the landlords and bad for the
sellers.
Mr. Bernanke. It can be, and the way the Bureau of Labor
Statistics calculates the cost of homeownership, it uses a lot
of information from measured rents. So you can actually get--as
we did last year--a period where the cost of homeownership as
measured by the BLS actually went up, even though house prices
were coming down, because of the fact that people were renting
more and rental costs were going up. That effect has moderated
somewhat recently, and that has helped to keep down----
Senator Shelby. What would be the trend from your
perspective in the core CPI if house prices were excluded?
Mr. Bernanke. House prices are not included----
Senator Shelby. I know they are not, but what if you did
exclude them? What would be the trend in the core CPI?
Mr. Bernanke. I am sorry. House prices are not included in
the----
Senator Shelby. OK, they are not.
Mr. Bernanke. In the CPI. What is included----
Senator Shelby. They are excluded.
Mr. Bernanke. The measure of shelter costs is related to
rents drawn from various sources.
Senator Shelby. One more question, Mr. Chairman.
What do you judge to be the threat of slow growth
continuing with inflation remaining above the Federal Reserve's
comfort level? What would you say to that? In other words, what
do you judge to be the threat of the slow growth continuing
with inflation remaining above your comfort level?
Mr. Bernanke. Well, we are certainly aiming to achieve our
mandate, which is maximum employment and price stability. We
project that that will be happening. We are watching very
carefully because there are risks to those projections. One of
the risks, obviously, is the performance of the financial
markets, and that again, as I mentioned before, complicates the
situation.
As events unfold--and certainly there are many things that
we cannot control or cannot anticipate at this point--we are
simply going to have to keep weighing the different risks and
trying to find an appropriate balance for policy going forward.
Senator Shelby. As a bank regulator, too--this will be my
last question, Mr. Chairman--do you fear some bank failures in
this country? I know there are big risks where they are heavily
involved in real estate lending. Does that bother you as a bank
regulator?
Mr. Bernanke. Well, I believe the FDIC and the OCC have
recently provided some information. There probably will be some
bank failures. There are, for example, some small or in many
cases de novo banks that are heavily invested in real estate in
locales where prices have fallen, and, therefore, they would be
under some pressure. So I expect there will be some failures.
Among the largest banks, the capital ratios remain good,
and I do not anticipate any serious problems of that sort among
the large internationally active banks that make up a very
substantial part of our banking system.
Senator Shelby. Do you see some of those larger banks
seeking additional capital to bolster themselves?
Mr. Bernanke. They have already sought something on the
order of $75 billion in capital in the last quarter.
Senator Shelby. Is that enough?
Mr. Bernanke. I would like to see them get more. They have
enough now certainly to remain solvent and to remain above,
well above their minimum capital levels. But I am concerned
that banks will be pulling back and not making new loans and
providing the credit, which is the lifeblood of the economy. In
order to be able to do that, they need in many cases--not all
cases, but in some cases at least--they need to get more
capital.
Senator Shelby. Thank you.
Chairman Dodd. Thank you very much, Mr. Chairman.
Let me just say to the Chairman, I said this to him
privately, but I really appreciate your candor in all of this.
Your job is not to be a cheerleader but to lay out for us
exactly how you see things. And I for one, anyway--I do not
know if other Members feel likewise, but I am very appreciative
of the fact that you are very clear and very straightforward on
your assessment of these matters, and that is important.
Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman. And,
Chairman Bernanke, welcome. I will say first that you bring to
this very challenging job great intellect and great integrity,
and I appreciate it very much. And it is a daunting moment in
our economic history.
You said in rather unemotional terms, characteristically
talked about the squeeze that families are feeling. What I have
heard in Rhode Island is exactly the same thing: increased
costs for practically everything you need, flat wages, and then
the housing problem taking away that sense of well reserve if
something goes wrong.
In fact, I was particularly struck by comments that were
related to me about the bakers in Rhode Island, the family
bakeries who have seen the price of wheat go up 200, 300, 400
percent. It is unprecedented, frankly. And if that continues,
we are going to have real serious, serious problems, as you
alluded to.
The Fed has two major responsibilities: monetary policy but
regulation of large financial institutions. And in that latter
category, I alluded to this in our last conversation in the
Committee about your take on, frankly, how well you have
activated your regulatory responsibilities in these last few
years.
We have seen major institutions write off billions of
dollars, and mostly because of off-balance-sheet transactions.
And it is quite clear that the Fed is there on a daily basis in
all the institutions. I think the former Chairman of the CEA,
Martin Feldstein, wrote, ``The Fed's banking examiners have
complete access to all the financial transactions of the banks
that they supervise and should have the technical expertise to
evaluate the risks that those banks are taking.''
Well, it seems quite clear now, with the restatement of
balance sheets that these banks are taking lots of risks that
they did not really see as risks.
Are you satisfied that you have in place the regulatory
procedures? And are you--I do not know what the right word is--
disappointed that your regulatory apparatus did not alert the
banks or monitor the banks more closely over the last several
months?
Mr. Bernanke. Well, Senator, you raise some important
questions. First of all, we and our fellow regulators, both in
the United States and around the world, are engaged, as you
might imagine, in a very serious review of what has happened
and what we can do better in the future. The Federal Reserve
itself is looking at our own practices and staffing and all
those issues. The President's Working Group is working on a set
of recommendations looking broadly at the financial markets and
the problems that arose. And all of those discussions and
information will be feeding into an international analysis--the
Financial Stability Forum, the Basel Committee, international
groups of financial regulators, central banks, Finance
Ministers, and so on--which will try to determine, what the
problems were, where we can do better, and what we have learned
from this episode. So we are certainly doing a lot of stock
taking and trying to determine where there were problems.
In terms of the banks it should be emphasized that we do
work very closely with the other regulators--the OCC, the FDIC,
and others, depending on the type of bank. Our focus, I think
of necessity, is for the most part on things such as the
overall structure of risk management, the practices and
procedures that the banks follow.
It is very difficult for us to second-guess the specific
asset price or asset purchase decisions that they make. I think
going forward we do need to look in a much tougher way at the
risk management and risk measurement procedures that the banks
have. But, again, it is very difficult for us to tell a bank
that--when they make a certain investment that they think it is
a good investment, and they have done all the due diligence--
that it is a bad investment. That is not usually our role.
Senator Reed. Let me follow up with two questions and ask
for a brief response. First, when do you anticipate sharing
with this Committee the results of this analysis you are doing
of your regulatory position within the next several months in a
detailed basis?
Mr. Bernanke. Well, the President's Working Group and then
the international bodies--the Financial Stability Forum, the
Basel Committee--are anticipating sharing these reports within
the next couple of months. The Financial Stability Forum has
already issued a preliminary interim report trying to identify
the areas of weakness and problems.
Senator Reed. Another question, and this goes back to sort
of the level of detail. Do your examiners look at what is
happening on the trading desks of these large institutions in
real time and then compare it to what is happening on the asset
side? I mean, there has been a suggestion in some institutions
that while they were being booked, some of these investments,
at a reasonably high price, the traders were selling at a deep
discount. Is that something that you did or propose to do in
the future?
Mr. Bernanke. Well, again, we cannot look over the shoulder
of every trader on every trade, but what we can try to do is
ensure that the systems exist so that the bank is ensuring that
the appropriate markdowns are taking place so that they are
consistent between the trade and the booking. So we do look at
the systems and the risk management systems to try to determine
if they are properly managed.
Senator Reed. Well, you know, I think we have a problem
here, frankly, maybe because--and, again, you can take a
systematic procedure, see that the procedures are all in place,
but if the procedures are missing a major point or the
assumptions underlying the procedures are outdated--and I would
hope that your review would be prompt and timely and allow us
to see details of what you have been looking at.
Let me ask a question. You brought up Basel II. One of the
aspects of Basel II, to my understanding, is a reliance on
ratings and rating agencies. In fact, it has been reported that
Northern Rock, the British institution that failed that has now
been nationalized by the British Government, was able to lower
their risk-weighted assets by 44 percent under Basel II. The
CEO at the time described it as the ``benefits of Basel.'' I
suspect he is not describing it as that--certainly the Prime
Minister is not describing it as the ``benefits of Basel'' now.
Does that give you pause with respect to rushing forward
with Basel II?
Mr. Bernanke. Well, Basel II, I still believe, is the right
direction. It is based on properly measuring risk and relating
capital to the amount of risk that you are taking. I think in
the case of Northern Rock, the real, most serious problems were
not in the asset quality but, in fact, were due to a lack of
liquidity planning because they did not have sources of
liquidity when the run occurred, essentially. And we in our
implementation of Basel II here in the United States do make
liquidity planning an important part of our analysis.
You mentioned credit ratings. It is true that credit
ratings do play a role in some of the Basel II risk
evaluations. They do not play a unique role. It is generally
the case that banks are expected to make independent
evaluations along with taking information from the credit
ratings. However, this is certainly one of the areas where the
Basel Committee, in reviewing the lessons of the recent events,
is looking carefully on how or whether to use credit ratings in
the risk measurement process.
Senator Reed. Thank you, Mr. Chairman.
Thank you, Chairman Dodd.
Chairman Dodd. Yes, excellent questions. And, Mr. Chairman,
just picking up on Jack Reed's questions here, it may be
worth--I had not thought about the Basel implications. We have
looked at this thing, obviously, in a more parochial way, but I
might ask the Chairman of the Fed to give us--we had one
hearing on this. Senator Shelby cares deeply about this issue,
as I do as well, the rating agencies. It is a complicated
issue. But I think all of us would be deeply appreciative of
some ideas from the Fed to us. If there is any need here for
legislative action at all in this area, we would be very
interested in hearing your thoughts and ideas on that as well.
Mr. Bernanke. Senator, the Basel Accord is implemented by
regulation, and we have determined a joint action by the four
bank regulators. We are working together through regulation to
try to make improvements. We will certainly take a lot of
advice from the Basel Committee and the changes and suggestions
that they make.
We have a very conservative process in place for
introducing the Basel II system, which includes several years
of transition floors that will not allow capital to decline
very much, and a lookback study that will review the experience
both here in the United States and elsewhere to try to
understand and make sure that we are confident that the system
is going to develop appropriately and provide enough capital
for banks.
So we will be taking the lessons of the recent experience
very much to heart and incorporating them in the system. Basel
II has the virtue of being flexible enough that it can adjust
when you make changes like this. So I do not think at this
point that legislation is necessary.
Chairman Dodd. OK. Well, I am pleased to hear that, and as
I said, it is an excellent question that Senator Reed has
asked.
Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman, and
welcome, Chairman Bernanke. I trust you saw the piece in this
morning's Wall Street Journal, the op-ed piece by Allan
Meltzer.
Mr. Bernanke. Yes.
Senator Bennett. ``That 1970's Show.'' I will give you an
opportunity to comment on that.
Mr. Bernanke. Well, Mr. Meltzer, who is an excellent
economist and indeed who is a historian of the Federal Reserve,
is concerned that the current situation will begin to look like
the 1970s, with very high inflation and high unemployment. I
would dispute his analysis on the grounds that I do believe
that monetary policy has to be forward looking, has to be based
on where we think the economy and the inflation rate are
heading. And as I said, the current inflation is due primarily
to commodity prices--oil and energy and other prices--that are
being set in global markets. I believe that those prices are
likely to stabilize, or at least not to continue to rise at the
pace that we have seen recently. If that is the case, then
inflation should come down, and we should have, therefore, the
ability to respond to what is both a slowdown in growth and a
significant problem in the financial markets.
He is correct, however, that there is some risk, and if the
inflation expectations look to be coming unmoored, or if the
prices of energy and commodities begin to feed into other costs
of goods and services, we would have to take that very
seriously. I mentioned that core inflation last year was 2.1
percent, so it is food prices and energy prices, which are
internationally traded commodities, which are the bulk of the
inflation problem.
Again, we do have to watch it very carefully, but I do not
think we are anywhere near the 1970s type situation.
Senator Bennett. Thank you. I wanted to get that on the
record.
As I look at the housing market and talk to some of my
friends who are in the housing market, they tell me that the
inventory is not monolithic, the inventory overhang--that is
that the bulk of the overhang is in the higher-priced homes,
because home builders wanted to build places where they would
get the highest margin return, and if they built houses in the
moderate housing area or affordable housing, their margins were
not nearly as great and there were plenty of speculators
willing to buy the bigger homes. And, indeed, they tell me that
for affordable housing, there is, frankly, not a sufficient
supply right now.
They are urging me to do something on fiscal policy to
stimulate people to build cheaper houses, that the housing
construction would begin to catch up--not catch up.
Construction levels would begin to pick up, whereas now they
are dormant, waiting for the overhang to be worked off.
Do you have any data that supports that anecdotal report?
Mr. Bernanke. Well, we do have some data on investor-owned
properties, and that has been increasing quite a bit. And my
recollection is that among the mortgages that are having
problems, something on the order of 20 percent of them are
investor-owned; therefore, it is not a family that is being in
risk of losing their home. So that is a significant
consideration, and I think that in those cases investors who
make a bad investment should bear the consequences.
Senator Bennett. That is my own attitude as well. But we
are having conversations about stimulus packages around here,
and it had not occurred to me, until I had this information
from people in the housing market, that if we could stimulate
people to buy the lower-priced houses, and those are the people
who need the shelter, anyway, and there is not a surplus of
inventory there, that that would have a very salutary effect
both in terms of taking care of people's needs and on the
economy, because home builders would start to build again, they
just would not be building in that portion of the housing
market where there is an oversupply. But you do not have any
specific data as to where the price points are in the inventory
overhang?
Mr. Bernanke. I could probably obtain such data. I am not
sure that directly trying to stimulate specific types of house
construction is necessarily the most efficient way to go about
it. Probably the better thing is to try to ensure strong
employment so people have the income and they can purchase the
home they want to have, or they can rent if they prefer. But I
do not have the data with me.
Senator Bennett. Well, I would appreciate it if we could
get some because I find this an intriguing idea. I know in
Utah, which has not been hurt as badly by the housing problem
as some other States--because we generate something like 30,000
new families every year that need houses. But in Utah, above a
certain level, around $400,000, there is a glut of houses on
the market and, therefore, nobody in that market or above can
sell their house. But for houses in the $200,000 area, which we
would now begin to think of as an affordable housing range,
there does seem to be something of a shortage.
So if you have any data on that that you could share with
us, I would appreciate it. Because as we formulate the stimulus
package, Mr. Chairman, this is something I think we ought to
look at. It is a little more sophisticated and has drilled down
through the data to a more granular level. But anything we can
do to get the construction business started--you say, well, it
is maybe too long term out, but there are a lot of jobs that
people can get in the construction business if they are
building the lower-priced houses that right now the
construction workers do not have anything to do.
Mr. Bernanke. Senator, one thing that is certainly true is
that a lot of the big house price declines are taking place in
high-priced areas like California and Florida, Nevada, Arizona,
where prices went up a lot before, and now they are coming back
down.
Senator Bennett. That is the price range that it is hitting
in Utah as well.
Thank you, Mr. Chairman.
Chairman Dodd. Not at all. And I might have missed this in
your point here, but seemingly one of the issues we are
grappling with here is the oversupply. And you are raising a
different question. Where is that oversupply occurring? But one
of the concerns I have is that allowing the market to take over
here, if your supply increases and demand is not keeping pace,
then obviously your ability for the market to really help
stabilize this problem here is going to be de minimis, it seems
to me.
Senator Bennett. My point is that the market is not
monolithic. There is an oversupply at the high range, but I am
being told that in the lower range----
Chairman Dodd. Well, that is a good question and one we
ought to--if you have the ability to give us some information
on that, I would be very interested in that as well, Mr.
Chairman.
Let me turn to Senator Menendez.
Senator Menendez. Thank you.
Thank you, Mr. Chairman, for your testimony and your
service. It seems to me--and I am sure all of us--that the
central bank is faced increasingly with the contradictory
pressures of the slowing economy and rising consumer prices--
gas prices, food prices, energy prices as a whole, to name a
few. Isn't revving up a slow economy far easier than slowing
inflation once it has become entrenched?
Mr. Bernanke. As you say, if it becomes entrenched, if
inflation expectations were to rise and that were to lead to a
wage-price spiral, for example, or, non-energy, non-food prices
rising more quickly, that would be more of a concern. As I
said, we are concerned. I do not wish to convey in any way that
we are not concerned about it. We are trying to balance a
number of different risks against each other.
With respect to inflation, as I said, our anticipation is
that inflation will come down this year and be close to price
stability this year and next year. If it does not, then what we
will be watching particularly carefully is whether or not
inflation expectations or non-energy, non-food prices are
beginning to show evidence of entrenchment, of higher
inflation, as you point out. That would certainly be of
significant concern to us and one that we are watching very
carefully.
Senator Menendez. Let me ask you, with consumers reluctant
to spend and businesses reluctant to invest and lenders
reluctant to lend and home prices going downwards, is the lower
interest rates, do you believe, going to be enough to do the
trick?
Mr. Bernanke. Well, I think it is certainly helpful, and we
also have a fiscal package, as you know. A lot is going to
depend on the underlying resilience of the economy itself and
of the financial system to work through these problems and to
bring us back to a situation where we can grow in a normal way.
Senator Menendez. How about something that you do not have
control over, which is the foreign confidence in the American
dollar? Isn't your ability to continue to cut rates to some
degree restrained by the willingness of foreign countries to
continue to finance the current account deficit?
Mr. Bernanke. Well, it is a complex question. We----
Senator Menendez. Can you give me a simple answer?
Mr. Bernanke. I will try. It is important for the U.S.
economy to be strong and an attractive place for investment.
And I think we are better off in the medium term trying to
ensure good, strong growth in the economy to attract foreign
investment than we are falling behind and allowing the economy
to drop into a severe decline.
So there is a balance there. We have to think about the
short-term return, which is partly related to our interest rate
decisions, but we also need to think about the medium term,
where we want to make sure the economy is growing in a stable
and healthy way which will attract foreign investment.
Foreign investment, I should emphasize, continues to be
strong. We are not seeing any significant shifts of out of
dollars among official holders, for example. And I anticipate
that we will continue to have the capital inflows we need, in
part, going back to my earlier comments, because I do think
that the world recognizes that the U.S. economy has underlying
strengths and resilience that will bring us back to a strong
growth path within the next couple of years.
Senator Menendez. If then the Fed's decision at this point
in time--of course, it always depends upon the point in time--
is that dealing with the slowing economy is the present
priority, and as the Chairman has said on more than one
occasion, that if there is a great challenge in the economy, it
stems from the mortgage meltdown, the housing market meltdown,
are we--I have a real concern. You know, in March of last year,
I and a few others said we are going to have a foreclosure
tsunami, and everybody pooh-poohed that and said that is an
overexaggeration. And, unfortunately, we are well on our way,
and we have not even seen the totality of it.
The question is, when I see the Center for Responsible
Lending say that basically the present administration's plans
will only deal with 3 percent of the properties, removing them
from foreclosure, and I see Moody's saying that the experience
of 2007 is largely around 3.5 percent of workout, at the end of
the day is a 97-percent market correction something that we are
willing to accept and something that we need to accept? Or is
that a percentage that is far too high?
Mr. Bernanke. Senator, there have been about four or five
studies reviewing the experience of servicers and lenders and
trying to work out mortgages, and, unfortunately, we are still
getting a very mixed and fuzzy picture about exactly what is
happening. One of the benefits, I think, of some of the recent
actions associated with the Hope Now Alliance, for example, is
that I hope we will be getting better, more up-to-date, and
more consistent data on what is actually happening in the
field.
I do agree that while the servicers seem to have made some
progress in scaling up their activities, they are not yet to
the point where they can deal with what you called the
``tsunami of foreclosures,'' which is already well underway.
And for that reason, we continue to urge them to expand their
efforts further, to work toward more permanent solutions.
Senator Menendez. But if that were to be the figure, is
that an acceptable market correction figure, 97 percent of the
couple of million families in this country ready to lose their
home? Is that what we are willing to accept, both in the
context of public policy as well as in the context of our
economy?
Mr. Bernanke. Well, even under regular circumstances,
unlike what we have today, the number of foreclosure starts
that actually ends in an eviction or a sale is well less than
97 percent. So I am not quite sure what to compare it to.
Obviously, the more people who are able and desire to stay in
their home, the more we can help, the better that is going to
be. And I strongly support increased efforts by the servicers
and lenders to address this issue.
Senator Menendez. Well, my concern is we were behind the
curve in trying to deal with the issue, and my concern is now
we seem to be continuing behind the curve in stemming the
hemorrhaging that is going on.
One last question. The central bank has always seen its
core mission as safety and soundness. Consumer protection I
hope is going to increasingly be something that you will
consider a core mission as well. And I heard your remarks at
the very end of your testimony.
Is it your intention--when you talk about issuing something
on unfair and deceptive practices, is that in relation to
credit cards, mortgages, to REITs? Is it cross-cutting?
Mr. Bernanke. We have already issued the HOEPA rules, which
address unfair, deceptive acts and practices relating to
mortgages, for comment. We are currently receiving comments on
those.
The new rules, which I alluded to, for the spring are under
the FTC unfair, deceptive acts and practices code, and they
would apply to credit cards, and possibly other things, but
primarily credit cards.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Allard.
Senator Allard. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke.
Mr. Chairman, we have to, I think, remind ourselves exactly
what is involved in a recession. I hear the reporters, I think
erroneously, reporting a recession when actually we are having
an economic slowdown. I would like to have you define for the
Committee what would constitute a recession.
Mr. Bernanke. Well, recessions are generally called, so to
speak, by a committee called the Business Cycle Dating
Committee, which is part of the National Bureau of Economic
Research--a committee of which I was once a member, by the
way--which looks at a wide variety of indicators to see
essentially if the economy contracted over a period of time. It
is a somewhat subjective decision, and it is often made well
after the fact because of the revisions of data and so on.
A more informal but widely used definition of recession is
two consecutive quarters of negative growth. That would be an
alternative that people use.
Senator Allard. There was a newspaper article or report
that came out, I think in the last day or two, suggesting that
somehow or other the Federal--or you and the Fed may be running
out of tools to control inflation. Do you have a comment on
that comment?
Mr. Bernanke. Well, as I said, we are trying to use our
principal tool, which is the Federal funds rate, to balance the
various risks that we see in inflation and growth and financial
stability. We do not really have additional tools on inflation.
We do have additional tools to deal with financial problems,
such as, the term auction facility, which we are currently
using, and other steps that we have taken or could take.
With respect to inflation, I think our principal tool would
be the interest rate.
Senator Allard. Now, the Congress, through public policy, I
think on a macro scale, may have some impact on the economy.
And in general terms, if the Congress was to increase spending,
what do you feel would--what kind of an impact would that have
on the economy? And then look at the other side. Suppose
Congress would increase taxes. What kind of an impact would
that have perhaps on today's economy where we are standing?
Mr. Bernanke. Well, from a short-term aggregate demand
viewpoint, spending tends to add to demand, and if the economy
is at a point where its resources are not being fully utilized,
it could lead to more increased utilization of resources;
whereas, higher taxes in a short period of time, if it reduces
consumer spending, for example, could lead to less use of
resources.
The Congress has passed a fiscal stimulus package which
tries to address the issues of aggregate demand and sufficient
demand for utilization of resources. I would urge the Congress,
in looking at additional spending and tax plans, to think about
the underlying effects on the efficiency and effectiveness of
the economy, that is, not to make decisions based on short-term
demand considerations but to think about how these spending
programs or tax programs affect how well the economy will grow
over the long term.
Senator Allard. So you are thinking about Social Security,
Medicare, and Medicaid primarily on those costs, I would
assume?
Mr. Bernanke. Well, and from a fiscal perspective in the
longer term--and by longer term, I means only a few years from
now because we are coming very close to the point where the
baby-boom generation is going to begin to retire in large
number. By far, the biggest issue is entitlements, particularly
the Medicare part, but Social Security as well.
Senator Allard. Yes, I appreciate those comments.
The other thing, you talk about, you know, inflation being
pushed by energy and food costs. What is offsetting that? There
must be some--to come out with an average of 2 percent, a
little over 2 percent, there must be somewhere over here where
we are getting a lesser amount that is offsetting those
increases. Where do you see that happening?
Mr. Bernanke. Well, what we saw in 2007 was about 2-percent
inflation excluding energy and food. When you add on the energy
and food, you get something more like 3.5 percent by our
preferred indicator, which is obviously a high rate of
inflation and we are not comfortable with.
Senator Allard. So you do not see a sector of the economy
that is being driven down in a way that it has an offsetting
effect. You are just seeing this just averaging out as a part
of the average. OK.
We have on ethanol, for example, on energy, we have a
really high tariff. It is 51, 52 percent. And energy builds
into the whole economy. It is a fundamental driver.
What do you think about us looking at reducing some of
those high tariffs like that? What kind of an impact would that
have on our economy?
Mr. Bernanke. Well, Senator, as you know, I favor open
trade, and I think that allowing Brazilian ethanol, for
example, would reduce cost in the United States.
Senator Allard. And is that--when you look at the food--the
way I look at it is when you have an ethanol--you have your
food products being diverted to ethanol production, it has an
impact on both food as well as the cost of energy and whatnot.
Is it a significant enough part of the economy that we need to
look at that more seriously?
Mr. Bernanke. I do not have an estimate of the overall
effect. I think it would be hard to do. But it is the case that
a significant portion of the corn crop is now being diverted to
ethanol, which raises corn prices. And there are some knock-on
effects; for example, some soybean acreage has been moved to
corn production, which probably has some effects on soybean
prices, too. So there is some price effect on foodstuffs coming
through the conversion to energy use.
Senator Allard. Well, you know, the wheat farmers in my
State are saying that wheat is at a historic high for them, and
so I wonder just, you know, how much of that--I suppose, again,
that is a dryland crop, but there is some conversion to dryland
corn. But, again, that seems to have some impact on the grains
in general, and the poultry people and the livestock people--
well, all livestock people--swine, poultry, and beef in
particular--all have concerns about that. So I was curious to
see how you were evaluating that policy in respect to the total
economy, and obviously you do not have too much to say on that
because you do not think it is too big a part of the economy.
Is that right?
Mr. Bernanke. Well, again, I do not know quantitatively how
big the effect is, but there is some inflationary pressure
coming through foods, including corn and soybeans, and
obviously other crops like wheat which have suffered various
supply problems in the last year.
Senator Allard. Yes, OK. Well, Mr. Chairman, I see my time
has run out.
Chairman Dodd. Great questions, too, and we will come back
to those maybe in a little bit. Senator Reed was raising with
me privately the issue as well, and I think it is worth
exploring. The issue of the question of the value of the
dollar, the rising price of oil, the dollar denomination oil
pricing, whether or not that can shift in these commodities
generally is an interesting issue.
But let me turn to Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman.
Mr. Bernanke, thank you for you--Chairman Bernanke, I
should say. Thank you for your presence today, and thank you
for your service to our country. I think you have your
priorities right. You mentioned that the risks in the forecast
are to the downside and that our principal concern at this
moment--you have to strike a balance, but our principal concern
should be avoiding an economic downturn of severity and
duration while continuing to focus on inflation in the longer
term.
As you and some of my colleagues have pointed out, the
genesis of much of this originated in the housing sector,
particularly with some of the subprime type mortgages. And it
seems to me that you, in setting monetary policy, erred on the
side of--not erred, but you have been more aggressive than less
and tried to minimize the downside risk to the economy. And
that is as it should be.
My question to you is: Should not Congress do the same in
addressing the housing problem? The President has the voluntary
Hope Now initiative you have outlined. I think it would be
charitable to say that the results of that have been modest to
date. You indicate there is not a lot of data, but it certainly
does not seem as if it has had much of an impact.
There are some proposals, fairly narrowly circumscribed
ones before us, that would focus on this issue, allowing
bankruptcy courts, only with regard to outstanding subprime
mortgages, to revisit some of these issues, only when the
borrowers have passed a strict means test. The interest rates
would be set at prime plus a risk premium, and if the homes
were ever resold, the lenders would participate in the upside,
any potential upside, if the property would revalue.
Now, the President has threatened to veto this initiative,
and some have claimed that it would add as much as 2 percent to
the cost of a mortgage. I find that to be not a credible
analysis when it, by definition, does not apply to future
mortgages. This is a one-off event, the greatest housing
downturn in the last 50 years, fairly narrowly circumscribed.
So my question to you is: Just as you have emphasized being
more aggressive at this moment, should not we? And as an
economist, is it credible to think that this would add 2
percent to the cost of a mortgage moving forward in this
narrowly circumscribed manner?
Mr. Bernanke. I do not know how much it would add. I think
it would probably add something because the collateral would be
less secure.
Senator Bayh. This only applies to past loans, by
definition, not future ones.
Mr. Bernanke. Well, then the question is raised: Will this
happen again?
Senator Bayh. Well, every 50 years when we have a calamity
like this, maybe so.
Mr. Bernanke. You know, I see concerns on both sides of
this, and I understand the rationale for wanting to make those
changes. I also see some concerns about the effects on the
marketplace and, for example, on holders of current loans, how
they would react.
Senator Bayh. There are some implicit risks in the more
aggressive monetary policy you have pursued.
Mr. Bernanke. Monetary policy is my domain, and I----
Senator Bayh. My point is and the question I am raising,
just as you have been more aggressive--and appropriately so--
should not we?
Mr. Bernanke. I think there is an argument for being
aggressive in general, but I would just decline, if you would
permit me, to endorse that particular action. I am really at
this point focused on FHA and GSE reform as being two useful
steps in the direction of helping the housing market. And we
should continue to think about alternatives. But at this point
I do not have, good additional measures to suggest to you.
Senator Bayh. Well, I do not want to put you in the
business of getting into the debate between the legislative and
executive branches here, but I do think at this moment, as we
have all recognized, this is a perilous moment for the economy.
It seems to me that there are risks on either side, but the
balance here, it seems to me, lies on being a little more
aggressive than less. And that ought to apply to all aspects of
our policy, not just one particular subset.
We have had a big discussion here about inflation versus
growth. Again, I think you have your priorities right in that
regard. You have pointed out that the core rate, while modestly
above target, has--the principal thing driving this in the near
term has been food and energy costs, and that you do not see
any persistent rise in the core over the longer term.
My question, Mr. Chairman, is: What indicia of economic
stability or greater growth would alleviate your concerns and
would allow you to then perhaps pivot and focus on the
inflation concern more than we currently are?
Mr. Bernanke. Well, Senator, first, I do not want to leave
the impression that we are looking only at one----
Senator Bayh. No, no. You were very balanced.
Mr. Bernanke. We are always trying to balance these risks
and always trying to continually re-weight our thinking about
the different risks to the economy.
Senator Bayh. Maybe a better way to put my question would
be: When will the risks be back in equilibrium as opposed to--
what indicia will you look at to reassure yourselves that the
economy is stabilized and growth is resumed at an acceptable
level?
Mr. Bernanke. One of the concerns that I have is that there
is some interaction between the credit market situation and the
growth situation--that is, if the economy slows considerably,
which reduces credit quality, that worsens potentially the
condition of credit markets, which then may tighten credit
further in a somewhat adverse feedback loop, if you will. I
think that is an undesirable situation. I would feel much more
comfortable if the credit markets were operating more nearly
normally and if we saw forecasted growth--not necessarily
current growth but forecasted growth--that looked like it was
moving closer toward a more normal level.
So what I would like to see essentially is a reduction in
the downside risks which I have talked about, particularly the
risk that a worsening economy will make the credit market
situation worse.
Senator Bayh. Well, let me ask you--but I have got only 1
minute so I am going to need to hurry. I did have two
questions. What aspect of the credit markets will you look to?
And, in particular, I have been interested--you talked about
the flight from risk. There have been some aspects of the
credit market that seem to me to be almost without risk, and
yet people are fleeing from those as well. These auction rate
securities, very short term, the underlying assets,
particularly in the municipal sector, virtually no risk of
default, and yet that seems to have seized up as well.
What do you think will lead people to begin to assume
rational levels of risk again? And what indicia will you look
to in the credit markets to reassure yourself that this
situation is beginning to work itself through?
Mr. Bernanke. Well, there is reluctance to take risk, and
there are also concerns about understanding exactly what a
particular financial asset consists of. And there are still
some issues of transparency and so on that need to be worked
out.
I think that a stable situation would be one in which good
quality credits like, major municipal borrowers would not have
difficulty in getting credit, and the issue would be the same
for good quality credits of firms and households as well.
So when you see a pulling back, and seeing the problem
spread through a variety of markets, which is interfering with
the normal flow of credit, then obviously that is not a normal,
healthy situation.
Senator Bayh. Mr. Chairman, I have just one--my final
question. Mr. Chairman, it has been visited by a couple of my
colleagues; particularly Senator Reed I thought was excellent
in his questioning. It has to do with the credit agencies. We
had a couple of very capable individuals come before our caucus
to focus on some of these economic concerns, and the issue of
the rating agencies came up. And one of them, in response to my
question about--markets can operate efficiently, but that
presumes they have access to accurate information. In this
case, you know, clearly that was not always so. And this is the
problem with the credit markets in part you have pointed out
here. So what can we do to avoid this again? You have mentioned
that you and your people are looking at that.
But when I asked the question, this individual said,
``Well, I am not sure any additional action by the Government
is necessary. The market will work this out. These rating
agencies, their share prices will be punished and, therefore,
they will have an incentive to not do this again.''
But whether it is in regard to certain types of Latin
American credit or other areas, it seems that the markets have
a way of forgetting the lessons of history, focusing on short-
term decision making, every 7, 8, 10 years or so, and we kind
of end up in some of these problems again. And the consequences
to the broader economy here have been so profound and so great,
it seems to me, that in addition to relying on the market,
perhaps there should be some parameters to ensure that we do
not end up in this situation again, which leads us to either
regulatory or legislative action.
So, just broadly speaking, do you think that some
additional actions, either regulatory or legislative, may be in
order to ensure that this situation does not repeat itself in
the future and that we do not just simply rely upon the
punishment of the market to prevent this in the future?
Mr. Bernanke. Well, regulatory action is already being
contemplated. The Securities and Exchange Commission, which has
authority over the credit rating agencies, is reviewing the
situation, and seeing whether additional steps need to be
taken. Of course, the Congress already gave the SEC some
powers, which they have begun to implement.
The fault lies on both sides of the equation, if you will--
with the credit rates, but also with the investors, who over-
relied on those ratings and did not do sufficient due
diligence. In that respect, as I mentioned before, the Basel
Committee is looking at the use of ratings in risk measurement
for banks, and I would encourage the regulators of pension
funds and other investors, for example, to ensure that
investors do due diligence over and above simply looking at the
rating and assuming that is all you need to know.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very, very much. Again,
some very, very good questions.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman. My opening
statement I will submit for the record.
Chairman Dodd. By the way, I should have made that point.
All opening statements and any supporting documents people want
to have will all be included in the record, and I appreciate
you raising that.
Senator Bunning. Chairman Bernanke, can you explain what
information or event caused the Fed to change its view on the
conditions of the economy and the financial markets and led to
the January 21 intermeeting rate cuts?
Mr. Bernanke. Yes, Senator. First of all, as you know, we
cut rates by about 100 basis points during the fall, reacting
to the drag on the economy arising from the housing markets and
from the credit market situation. Around the turn of the year
and early in January, the data took a significant turn for the
worse, and it seemed clear that the economy was slowing, and
slowing more than anticipated, and that the credit market
condition situation was continuing.
On January 9, I called a meeting of the Federal Open Market
Committee by video conference to discuss the situation. It was
agreed by the committee that some substantial additional cuts
in the Federal funds rate were likely to be necessary. The
thought at the time of that meeting was that it might be worth
waiting until the regular meeting at the end of the month where
we could have a fuller discussion and see the revised forecast
and so on, taking into account the possibility that we could
also move intermeeting, if necessary.
On January 10, I gave a speech where I informed the public
that I thought that substantive additional action might well be
necessary, thereby signaling that the conditions had changed
and that further rate cuts were likely to happen.
In the days that followed that speech, the tone of the data
deteriorated considerably further, which made me think that the
outlook was, in fact, much weaker and the risks were greater.
That was showing up both in the data and in the financial
markets. We were seeing sharp declines in equity prices. We
were seeing widening of spreads. And we were also seeing,
again, adverse data.
On January 21, I became concerned that the continued
deterioration of financial markets was signaling a loss of
confidence in the economy, and I felt the Fed, instead of
waiting until the meeting, really needed to get ahead of that
and take action. So I called an FOMC conference call, and we
agreed at that point to cut the Federal funds rate target by 75
basis points.
There was an understanding at that meeting that further
additional action was very likely to be needed, but we felt
that we could wait another 10 days until the regular meeting to
determine exactly how much additional action. At the meeting at
the end of January, we had a full review, discussion, forecast
round and so on and determined that an additional 50 points was
justified.
Looking back, as the data have evolved, I think that the
125 basis points was appropriate for the change in the tone of
the economy, and I think it was the right thing to do.
Senator Bunning. Are the days of constant and gradual Fed
rate changes over? In other words, are large and intermeeting
rate changes going to become a regular part of the Fed toolbox
now?
Mr. Bernanke. I cannot make any guarantees, Senator, but in
general, we prefer to move at the regularly scheduled meetings.
As I said, that is a chance to get together in Washington and
to have a full briefing by the staff and to have all the
information made available to us.
Senator Bunning. How about which do you see as a greater
threat to the economy, a credit crunch now or higher inflation
in the future as a result of efforts to stop a credit crunch?
Mr. Bernanke. Senator, we have to keep balancing those
things. As I said, our current view is that inflation will
moderate this year as oil and food prices do not rise as much
this year as they did last year. We are also watching very
carefully to make sure that higher oil and food prices do not
feed into other costs and into other prices or that inflation
expectations do not become unanchored. If those developments
began to happen, that would certainly force us to pay very
serious attention.
At the moment, I think the greater risks are to the
downside--that is, to growth and to the financial markets; but,
again, we are always vigilant on all of our objectives and are
always trying to balance those risks against each other.
Senator Bunning. You read the Wall Street Journal. I am
very sure of that. Today, in the Wall Street Journal, ``Report
on profits a bright spot in the gloom. The Dow Jones Industrial
Average has gained 6 percentage points since the first day of
the year.'' In the Standard & Poor's index, 462 corporations
have reported their earnings for the fourth quarter; 62 percent
of those that have reported topped their earnings estimates--62
percent. If you drop out financials, carve out financials,
which were 12 percent lower, the gloom and doom that I have
heard here today is not gloom and doom. Are you going to tell
me that these same corporations that reported--and we had a
really low growth rate in the fourth quarter--are going to be
worse in the first quarter? Or are we also going to have the
same kind of reporting in the first quarter of 2008 that this
profit report on the Standard & Poor's and the Dow is not as
accurate in the first quarter as it was in the fourth?
Mr. Bernanke. Well, Senator, you are absolutely correct
that profits at the nonfinancial firms have remained pretty
good. I do not have with me an estimate of the profits for the
first quarter. But firms seem to be indicating concerns about
the future. For example, if you look at the ISM survey of non-
manufacturing industries, it dropped very significantly a few
weeks ago, suggesting a good bit more pessimism on the part of
firms.
Senator Bunning. But isn't one of the real signals that we
really have to watch the unemployment rate in the United States
of America? And that moved from 4.9 to 5 percent in the fourth
quarter. And where is it now? Where do you estimate it to go in
the first quarter of 2008?
Mr. Bernanke. It jumped in December from 4.7 to 5.0, which
is a pretty significant jump, and it was certainly something
that we looked at. And----
Senator Bunning. Well, that was kind of indicated by the
low growth rate and the reasonable expectation that the job
rate would be higher, unemployment in the fourth quarter. I am
asking about 2008.
Mr. Bernanke. Well, I reported our projections for the
fourth quarter, which were 5.2 to 5.3 percent in the fourth
quarter. We are seeing unemployment insurance claims rising,
which I think is consistent with the somewhat higher
unemployment rate going forward.
Senator Bunning. What are you telling me?
Mr. Bernanke. That the unemployment rate is likely to go up
from here.
Senator Bunning. How bad? Are you saying 5.6, 5.7?
Mr. Bernanke. The baseline projection we have made for the
fourth quarter is 5.2 to 5.3, but there are downside risks.
Things could get worse than that. We do not know. But it is not
our main projection. It is just a risk that we see out there.
Senator Bunning. Then does that bode well with the lowering
of interest rates and the higher rate of unemployment? That
indicates to me that someone in the Journal today that talked
about stagflation might be talking more sense than we might
anticipate.
Mr. Bernanke. Well, again, Senator, we are just trying to
balance the risk of growth, inflation, and financial stability.
Monetary policy works with a lag, and, therefore, we have to--
--
Senator Bunning. Well, I understand that very clearly. We
should have lowered rates earlier, and all of a sudden we
lowered them 2.25 points--225 basis points in less than--
what?--6 weeks, 8 weeks.
Mr. Bernanke. It was 125.
Senator Bunning. 125.
Mr. Bernanke. Yes, Senator.
Senator Bunning. Well, if you count the fourth quarter of
last year, what was the total?
Mr. Bernanke. We lowered 50 basis points in September, 25
in October, 25 in December, and 125 in January.
Senator Bunning. Then it was 225.
Mr. Bernanke. Not in the fourth quarter.
Senator Bunning. No, no. Total. Total since the last----
Mr. Bernanke. That is right.
Senator Bunning. That is considerable, and the market
conditions indicated that that was absolutely necessary.
Mr. Bernanke. I think so. The housing market decline and
the weakness in the credit markets were suggestive of----
Senator Bunning. Well, the weakness in the credit markets,
Chairman Bernanke, were signaled last year, early in the year.
I mean, it was not--it did not take a rocket scientist to
figure that out. And I know with all the great economists that
you have on the Federal Reserve and your members of the Federal
Open Market Committee are a lot sharper than the people sitting
up here at this table. And you had a big heads-up signal that
the housing market was in the tank early last year.
Mr. Bernanke. But the housing market was not affecting the
broad economy. When we lowered interest rates on the last day
of October, that morning we received a GDP report for the third
quarter of 3.9 percent, which was subsequently revised to 4.9
percent, and inflation was a problem. So, in fact, I think if
we look back on this episode, we will see that the Fed lowered
interest rates faster and more proactively in this episode
probably than any other previous episode.
As you point out, the unemployment rate is still below 5
percent, and----
Senator Bunning. I lived through the Greenspan years. I
know exactly what you are talking about.
Thank you.
Chairman Dodd. Thanks very much.
Senator Schumer.
Senator Schumer. Mr. Chairman, with your and the
Committee's permission, Senator Tester has to be somewhere at
noon and so do I, so I volunteered to split my time with him
and let him ask the first question and leave, and then I will--
if that is OK with you and the rest of the Committee.
Chairman Dodd. Fine.
Senator Tester. Thank you, Senator Schumer, and thank you,
Mr. Chairman, and thank you, Chairman Bernanke. I appreciate
your forthrightness today and always.
I want to talk about commodities for a little bit. I am a
farmer. I am happy when commodities go up. But as was earlier
pointed out today, oftentimes this can end up potentially like
it was in the 1970s when we saw a big commodity raise; we saw
the inputs that went into agriculture go through the roof; we
saw food prices on the shelf go up because commodity prices
were higher; and then commodity prices fell back. Those inputs
that went into production agriculture stayed up, and the food
on the shelf stayed up, too, because they said there was not
enough wheat in a loaf of bread to make a difference after they
raised the prices because commodities went up.
My question to you is: Do you see that playing out the same
way? I mean, we are going to see food prices go up probably, it
would be my guess. We already have. And we have already seen
inputs go up on the farm for production agriculture. I
anticipate this commodity price will not stay where it is at
forever. They usually do adjust, and they usually adjust down.
And food prices will stay up, inputs will stay up. Do you see
that same thing happening again? And is there anything we can
do if it is that way?
Mr. Bernanke. If commodity prices come down, including
energy prices and raw food prices, I would expect to see,
perhaps with a lag, finished food prices come down as well. As
we have been discussing, the commodity prices, both food and
energy, have been the primary source of the recent inflation.
If they stabilize, even if they remain high, then inflation
will moderate. And I expect that would happen, at least over
time, at the finished level as well as at the raw level.
Senator Tester. OK. Thank you very much, and I want to
thank Senator Schumer again. Thank you very much.
Senator Schumer. My pleasure.
Two questions, Mr. Chairman. The first involves these sort
of combination, creating problems now, of marking to market and
the credit crunch, freeze, call it what you will. You know,
when I first got here on the Banking Committee, banks really
did not mark to market, and we regarded it as great progress
that they now have to mark to market, like securities firms and
others always did. It is a proper valuation of their assets.
The problem here is nobody knows how to mark to market
because there is no market. In too many areas, no one is
buying. And so you do not know what they do when they make a
valuation. I have heard from many people that that valuation
is--they make it artificially low, and that further
exacerbates. It is a vicious cycle because then they do not
have the capital, they cannot do any more lending, and
everything is frozen up.
Is there a way to deal with that problem now? Is there a
way to say, yes, you have to mark to market, but in these
unusual circumstances you can do it 6 months from now, or
something to that effect, quarterly, yearly?
I am not an expert here, but I do know it is a real
problem. How do you mark to market when there is no market? And
because there is no market, rare, almost never occurred in such
large parts of the credit market before, is this an unusual
circumstance where this does not work?
And my second question--and I will ask you to answer both--
is this: The worry I think people have--and we have seen some
questions on this--is that it is a lot easier to get the
economy going than to shut inflation off. And the worry is that
we go back to the situation in the late 1970s where the economy
was stalling, rates were lowered, and then there was nothing
that the Fed could do other than very late and drastic action
to curb inflation. It was a difficult struggle. We went through
it in the 1980s, and I remember paying 21 percent on my
mortgage when I first signed my mortgage in 1982.
Do we have better tools now that can control, you know, if
inflation should start going beyond what you imagine for all
the--we are global economy. You have less experience and less
tests in this interconnected world than you did 20 years ago.
Do we have better tools? Are you worried that if inflation
really starts chugging along, that even a quick raise in
interest rates will not be able really to head it off without
really severe damage to the economy?
So those are my two questions.
Mr. Bernanke. Thank you, Senator. On the first one, you
raise a very good point. The Federal Reserve has long had sort
of a mixed view about fair-value accounting. We think that
market-traded assets should be valued at the market price and
that investors are entitled to know what that price is. But we
have always recognized--and we had in mind things like bank
loans, for example, that are relatively illiquid--that it might
be difficult to value them on a fair-value basis and that there
could be problems arising there.
As you point out, we now have a situation where some assets
which are normally tradable are perhaps not generally tradable.
The accounting profession has created a system which, attempts
to get around that problem. There are these three different
levels where you have a market valuation or a model valuation
or a judgment valuation.
I think that is one of the major problems that we have in
the current environment. I do not know how to fix it. I do not
know what to do about it. I think the accountants need to make
the best judgment they can.
Senator Schumer. Some have suggested, you know, delaying a
mark to market, even using this system until there is a market
and letting the--because you really do not know the value of
the asset. And if you undervalue it, you may be hurting things
as much as if you overvalue it.
Mr. Bernanke. I understand your concern, Senator, but the
risk on the other side is that if you do too much forbearance
or delay mark to market, that the suspicion will arise among
investors that you are hiding something.
Senator Schumer. Right. What about a rolling average that
takes into account 6 months back?
Mr. Bernanke. Senator, I have not worked through any
proposals like that. This is really an Accounting Board
responsibility. I agree there is a severe problem. It is
difficult to change the rules in the middle of a crisis.
Senator Schumer. I know.
Mr. Bernanke. It is one of those things that we are going
to have to put on the list of issues to evaluate as we try to
learn the lessons from this experience.
Senator Schumer. But you do admit it is a serious--it is
one of the nubs of the problem now, even though it has not been
talked about that much.
Mr. Bernanke. And the direction of how to fix it is not at
all clear.
Senator Schumer. OK. Second question.
Mr. Bernanke. On your second concern, I think we are better
off now than we were in the 1970s in that there is a much
broader recognition of the importance of price stability and
greater confidence that central banks will deliver price
stability. The indicia of inflation expectations, where some of
them have moved a bit, are basically stable. We have not seen
any major shift in views about inflation and where inflation is
likely to go. The Federal Reserve has emphasized the importance
of maintaining price stability and has indicated that we will
watch very carefully and make sure that we do not see any
deterioration in either broad measures of inflation
expectations or increased pass-through of food and energy
prices into other prices. We will watch those carefully and we
will respond----
Senator Schumer. But do you believe if you miscalculate and
inflation starts coming out of the box more quickly than you
think, do you have tools to deal with that or is that still a
very difficult area, once inflation rears its head, it is very
hard to put the genie back in the bottle? Or are we much better
at it now than we were 20 years ago?
Mr. Bernanke. Well, if higher inflation were to become well
embedded in inflation expectations and wages and other parts of
the economy, it would be difficult, and we do not really have
new methods. It is a risk, and we take it very seriously, and
we are monitoring it very closely. But as I have said several
times, we are dealing with a number of different concerns here,
and we are trying----
Senator Schumer. I know. It is not easy.
Mr. Bernanke. ----the risks as best we can.
Senator Schumer. Thank you, Mr. Chairman, and I thank my
colleagues.
Chairman Dodd. Well, thank you very much, Senator, very
much.
Senator Dole.
Senator Dole. Thank you.
Mr. Chairman, I do not have to tell you that my State of
North Carolina has lost a lot of manufacturing jobs over recent
years, and you and I have had discussions about job retraining
programs. I am very pleased that Congress has now begun to
debate the best way to reform the Trade Adjustment Assistance,
the TAA Program. And I would like to ask your opinion about
what you feel the impact would be of congressional
reauthorization and if there are any particular aspects of
reform that you would want to suggest for the workforce of the
21st century.
Mr. Bernanke. Well, Senator, as I have argued in a number
of speeches, for example, globalization and trade have a lot of
benefits, but they also have some costs. They cause
dislocation. They cause loss of jobs. And my view is that the
best way to deal with that problem is not to shut down trade
but, rather, to help those who are affected adjust to their
circumstances.
Senator Dole. Right.
Mr. Bernanke. And so as a general matter, we should look
for ways to help people through skill acquisition or other
kinds of assistance that allow them to take advantage of the
new opportunities to replace the ones that they lost.
I do not want to comment on specific elements. I know there
are some competing TAA bills being considered, and I think that
is really up to Congress to make those detailed decisions. But
I do think that it is much better than shutting down trade to
try to help people adjust to the effects of trade.
I had the opportunity recently to speak in Charlotte, and
one of my themes there was although North Carolina certainly
has lost a lot of manufacturing jobs, if you look at the city
of Charlotte and how it has reinvented itself to become a
financial center, a services center and a center for the arts
and many other things, there is a tremendous opportunity in a
dynamic economy, as the one we have, to find new opportunities,
to find new businesses and industries.
And so rather than try to freeze the industrial structure
the way it is, we are better off helping people move to the new
opportunities, and TAA is one potential way of trying to assist
that process.
Senator Dole. Thank you. Mr. Chairman, let me ask you about
Sarbanes-Oxley. Some smaller banks appear to be clearly
overburdened by compliance with Sections 404 and 302. These
financial institutions are already highly regulated, and it has
become increasingly apparent that these regulations, while they
were well intended, only increased the cost of doing business.
I would really appreciate your comments on what needs to be
done here.
Mr. Bernanke. Well, it has been recognized that Section
404, in particular, imposes a lot of costs. It does have some
benefits and helps improve internal controls. The Securities
and Exchange Commission and the PCAOB have recently issued an
audit standard which tries to take a more balanced, risk-
focused approach to enforcement of 404. And I hope as a general
matter that that will reduce the costs while preserving the
benefits of Sarbanes-Oxley.
In the case of banks in particular, there is a good bit of
overlap, obviously, already with some of the rules that they
have to follow under existing bank regulations. And I think it
would be useful to consider where there are redundancies or
overlaps that could be reduced in the future.
Senator Dole. Thank you, Mr. Chairman. Over recent months,
much has been written in the financial press regarding whether
or not key worldwide central bankers--the Bank of England, Bank
of Japan, European Central Bank, and the United States, et
cetera--should become more coordinated in their monetary policy
efforts. Proponents of such efforts point to the current spread
between various key country lending rates.
What is your reaction to this debate?
Mr. Bernanke. Well, Senator, first of all, the major
central banks do cooperate on many things. We meet quite often.
I see my colleagues at international meetings here and in other
countries very frequently. We are on the phone together, and we
try to keep each other apprised of what is happening in our own
economies and in the global economy, what we are planning, what
we are thinking.
We have worked together on some measures recently. In
December, when we introduced the term auction facility, we did
that in a coordinated way with the ECB, the Swiss National
Bank, the Bank of England, and the Bank of Canada--who also
undertook various liquidity options at that time. So there is a
lot of coordination and cooperation in that respect.
With respect to monetary policy per se, although we keep
each other apprised, each economy is in a different place, in a
different situation, and there is no necessity that each
country has to have the same policy. I think the policy that is
chosen depends on the particular circumstances of that country
or that region. And so that is one of the benefits of having
flexible exchange rates to provide some insulation, some
ability for countries to run independent monetary policies.
And so it has been our practice, as you know, for each
major central bank to run an independent monetary policy, and
while we keep each other apprised, I do not expect to see any
extensive coordination in the near future.
Senator Dole. Thank you very much.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Corker.
Senator Corker. Mr. Chairman, thank you, and I thank you
for your testimony. I listened carefully to what you had to say
because I know you choose your words carefully. You need to
because everybody in the world is listening to what you have to
say. But I did notice that, you know, you mentioned that in
every other sector of our economy, we are doing well except in
the financial area. And I noticed that you have mentioned not
to make--we shouldn't make decisions for the short term, that
as it related to the housing issue itself, that you knew of no
good additional measures, that you are focused on GSE reform
and FHA reform. And I know the Senator from Indiana talked
about on our side being aggressive. I would say that what we do
ends up being a law that cannot be changed. What you do can be
changed at the very next meeting, and so you have a great deal
more flexibility to really look at indicators and make changes
than we do. Our changes usually stay there for a long time.
I was up at the New York Stock Exchange last week and
noticed that they are trying to put in place the ability for
people to know quickly what the value of their credit
instruments are, that there is not the transparency there that
we have in the equity markets. And my sense is because there is
no transparency today, that even if we did not have the
subprime issue, because people are making money packaging
things and selling them off to the next person, that even if
the subprime market had not tanked the way that it had, we
still would have had writedowns because people were making so
much money off of fees.
Is that a fair assessment?
Mr. Bernanke. Well, I think the subprime crisis sort of
triggered these events. But it is true that investors have lost
confidence in a lot of different assets at this point,
including, it was mentioned, some student loans and other
things as well. And part of the problem--not all of the
problem, but part of the problem--is that in these complex
structured credit products, it is very difficult for the
investor to know exactly what is in there and what derivative
support or credit liquidity support is involved.
Senator Corker. So, in essence, the subprime issue that has
occurred has caused us to look at those in a more healthy way,
and hopefully the market will create some mechanisms for us to
actually value those in real time and create a way for us to
have some transparency there. Is that correct?
Mr. Bernanke. I hope so. But, again, as Senator Schumer
suggested, if the accounting industry or the regulators can be
of help there, I think we ought to try to be of assistance.
Senator Corker. You mentioned that leverage was at all-time
lows in other sectors, and, you know, I still am shocked that
when we had a credit problem, it was our wisdom to sprinkle
money around America in an America that already had an
incredibly low savings rate and ask them to spend it as quickly
as possible. And I get concerned about actions that we might
take here that, in essence--I know you mentioned at the last
meeting several times the word ``correction.'' I know Chairman
Dodd somewhat chastised me at the end because I was pressing
for an answer. But do you still believe that--and he did so in
a very amicable way. I appreciate that. But, in fact, do we
have a crisis right now in housing, or do we have a correction?
The reason I ask, I look at delinquencies over 30 days.
Everything is over 30 days, all the way through foreclosure.
And even though I know we are having some extreme issues in
some of the higher-cost housing, it really is not very much
different than it has been over the last 30 years, only about a
percent and a half different as far as delinquencies go. Is
this a correction or is this a crisis as it relates to housing
itself?
Mr. Bernanke. Senator, I do not know what terms to use. The
housing market certainly has come down quite a bit, down to
less than half the amount of construction that we had a couple
years ago. Prices are falling. Foreclosures are up probably
this year about 50 to 75 percent over last year. So, you know,
there are certainly some major things going on in the housing
market, and they have created some problems in the credit
markets and the rest of the economy as well.
Senator Corker. Is this the kind of thing, though, that the
market can take care of itself? You know, you do not seem to
have any other ideas legislatively that we might come forward
with to deal with this problem. Is this something the market
itself can deal with?
Mr. Bernanke. Well, the first line of defense for dealing
particularly with foreclosures is to have servicers and lenders
work with the borrowers to try to restructure their mortgages
or otherwise find a solution. And the Treasury, the Fed and
other regulators and the Congress certainly have encouraged the
private sector to ramp up their efforts as much as possible to
try to deal with as many people as possible, because there
certainly is a significant increase in the number of troubled
borrowers.
I have suggested other things--and things that this
Congress has undertaken, like FHA modernization and GSE
reform--that could be helpful in bringing the housing market
back.
Senator Corker. And, obviously, we have two instruments--
either monetary policy or fiscal policy. You are dealing with
the monetary side. I guess on our side we deal with the fiscal.
What I am taking away from what you are saying--a very
intelligent person who certainly has a much broader view of
what is happening not only here but also in the world--is that
you know of nothing today, you have no additional ideas
legislatively or fiscally for us to deal with other than GSE
reform and FHA reform. You know of nothing else today other
than the existing efforts by the marketplace itself to work out
some issues between lenders and borrowers. You know of nothing
else today that we might do constructively to solve this
problem.
Mr. Bernanke. Senator, I see no harm in trying to think
about other alternatives, and there are things that have been
suggested. But at this point, I am not prepared to support any
additional----
Senator Corker. I am all for us thinking. I am a little
worried there is a package that is actually coming to the
floor, and that moves something into law. But I just appreciate
your testimony, and I want to say that just in general I do
think that sometimes when issues occur here, our hair gets on
fire to act in ways that I think can actually create other
problems down the road. And my sense is that what you are
saying is we are doing the things that we know to do today that
make sense. And I hope that what you are also saying is that
before we take any other action, we will think about those
fully and look at the long-term implications of the market, not
just trying to deal with something in the short term. I think
that is what--thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator, and I
appreciate that, and I appreciate the Chairman's response to
your questions as well. And as he points out, and I pointed
out, back a year ago we--in fact, I feel very strongly that the
best line of defense is exactly what the Chairman has said, and
that is, hopefully the servicers and others can work out things
here so that you do not have to engage in extraordinary steps
to try and minimize these problems. And that is the first line
of defense, and we are very hopeful that will produce some
results.
I also just want to point out quickly to my good friend
from Tennessee here, Residential Fixed Investment, the GDP
component that includes spending on housing, plunged by 25.2
percent in the fourth quarter, a bigger drop than the earlier
23.9 percent; third quarter spending fell by 20.5 percent. To
give you some sense of proportionality, that is the worst
plunge since the fourth quarter of 1981. This is a larger issue
than just a correction problem. I say that respectfully, but I
think it is bigger than that is the case.
Senator Corker. If I could respond to that, I would say,
too, that is coming off of an extreme high. I mean, we have had
an exuberance in the housing market, and I think we should
measure those drops off of a mean, if you will, versus a high.
I think that the housing industry has enjoyed extreme free
credit for many, many years. We have had an exuberant market
that we have known for some time--as a matter of fact, I would
say that actually a few years ago we were concerned in
California, for instance, that housing prices were going up so
rapidly. And so I would say that that drop is off an extreme
high, and I thank you for pointing that out to me.
Chairman Dodd. Let me, if I can, Mr. Chairman, I want to
raise a couple of questions, if I can for you, and some of them
have been touched on. I do not want to take a long time here
with you, but I am just intrigued by the correlation of some of
these issues. Sometimes we cite a bunch of statistics and
wonder what the correlations are between them.
There are two factors that I want your thoughts on, if I
can, that contribute to this huge run-up in commodity prices
that we heard Senator Tester talk about and others. Oil is the
first thing I think about, but obviously, if you are a farmer
or a baker in Rhode Island, it can be the cost of wheat and
others. The first is the increase in the demand for these
goods. That is obviously one set of issues. The second is that
these goods are priced in dollar terms. Sometimes we pass over
that idea, but we talked about the price of oil a barrel, it is
in dollar terms. And to what extent is the decline in the value
of the dollar driving this? And beyond that concern, is that
decline in the dollar--does that decline represent a decrease
in confidence in the U.S. financial system?
As the Fed report indicates--and I mentioned this at the
outset--there was a net sale of U.S. securities by private
foreign investors in the third quarter of 2007, the first
quarterly net sale in more than 15 years. And I wonder how is
that loss of confidence in the U.S. by foreign investors
leading into a decline in the dollar, which leads to the rising
commodity prices. I am trying to connect these questions, if at
all.
I was talking to a friend of mine in Europe this morning
who is involved in the financial services sector--a totally
different matter--and I told him I was going to be having the
hearing this morning with you. And he was saying that one of
the problems we have got is the fact that Europe is not cutting
its interest rates at all, and so you are getting that
comparison as well, which probably exacerbates this problem to
some extent, at least in that market.
And I was curious, because we have had a lot of questions
of you--and I will come back to this in a minute--on the
sovereign wealth funds, and I was trying to get some sense of
proportionality about private investment versus sovereign
wealth funds. And I do not minimize the importance of the
sovereign wealth funds issues, but I asked staff to give me
some sense of the proportionality of numbers. And out of the
estimated $150 trillion in global capital stock, $2.2 trillion
is held by sovereign wealth funds. And while sovereign wealth
funds are about double the size of hedge fund assets, they
represent less than 5 percent of global assets. And while
China's sovereign wealth fund hold is about $200 billion in
assets, the size of China's foreign exchange reserves is about
$1.3 trillion.
And so you have got--putting aside that for a second, the
private investment sector here is an important one, and maybe
I--am I making too much of this bar graph I saw in the Monetary
Report Fund where you see for the first time that looks like a
selling off here? And I noticed in your response to one of
the--I forget who it was raised the question earlier. At least
I thought I heard you say this was not as--that foreign
investment is still coming in and that is a source of some
confidence here.
Anyway, could you try and connect those things for me? Is
it a false connection? But I am curious how that relates to the
decline in the dollar, the rise in commodity prices, and
whether or not there is some connection here.
Mr. Bernanke. Well, I do not think that foreign investors
have lost confidence in the United States by any means. The
data you are referring to shows some desire by foreign
investors to shift out of corporate credits and other credit
products and into treasuries. That is the same shift that
American investors are making. They are getting away from what
they view as risky credits toward the safety of U.S. Government
debt. And, indeed, U.S. Government debt is still the safest,
most liquid, desired asset in the world.
There is some effect of the dollar on commodities. Oil and
other commodities are traded globally. You can think of the
price as being set by global supply and demand. If the dollar
depreciates a bit, then you would expect to see commodity
prices rise to offset that depreciation. But it is important to
understand that, for example, oil has risen in euros as well as
in dollars. I mean, it is not simply an issue of currencies. It
also has to do with global supply and demand for the commodity.
So the European Central Bank is concerned about food and energy
inflation as well.
With respect to the sovereign wealth funds, that is just
another indication that foreigners have not lost confidence in
the U.S. economy and that there has been a good bit of inflow.
In particular, about something close to half of the capital
that financial institutions have raised in the last few months
has come from sovereign wealth funds, from other countries.
I think that, in general, that is quite constructive. If we
are confident, as I think we are in this case, that the
investments are made for economic reasons and not for political
reasons or other noneconomic reasons, and there is no issue of
national defense, which the CFIUS process takes care of, then
that inflow of investment is good for our economy and certainly
is helping, in this case, the financial system. At the same
time, allowing inflows of foreign capital through reciprocity
gives us more opportunities to invest abroad.
I know that Congress is very interested in sovereign wealth
funds, and you should certainly take a close look at it.
International agencies, like the International Monetary Fund
and the OECD, are developing codes of conduct. The basic idea
there is that sovereign wealth funds should be as transparent
as possible. We should understand their governance and their
motivations, and, in particular, we should be confident that
they are investing, again, for economic rather than political
or other purposes. If we are confident in that, then it is in
our interest to keep our borders open and to allow that capital
to flow in. And I think it will continue to flow in.
Chairman Dodd. You raise a good point here and one I wanted
to raise with you. This is a statement you made yesterday as
well before the House Financial Services Committee, talking
about it. And I do not disagree. It is quite constructive. And
I think there has to be a sense of balance in how we look at
sovereign wealth funds, and I think we run the danger of
becoming a pejorative without understanding the value of it. So
we have to be careful about it.
And you pointed out, and you did again here just now, you
mentioned CFIUS, which, of course, we developed good
legislation, I think, out of the Committee on that, the IMF,
the OECD, and looking at these investments from their various
perspectives in terms of these issues, which are a very
legitimate point.
But what is the Fed's role in a sense? I mean, this is, it
seems to me, while all these other institutions have an
important role to play, I would make a case here that the Fed
also has an important role. They are investing in bank holding
companies. This is the jurisdiction of the Federal Reserve
Board, and it seems to me you did not mention the Federal
Reserve's obligation to be looking at these questions as well.
And, obviously, we have had major investments here in bank
holding companies. So tell me what you think is--what is the
Fed doing about this, and what is the responsibility of the Fed
in looking at this issue as well?
Mr. Bernanke. You are quite correct, Senator. I should have
mentioned that.
Well, first, of course, we are very involved with the banks
themselves, and we are very interested in their capital-raising
efforts and making sure that they raise enough capital to meet
the well-capitalized standards and to remain safe and sound.
And so that whole process is something we pay very close
attention to.
We have statutory responsibilities. If the investment by
any single person or group, whether it is a sovereign wealth
fund or someone else, reaches certain levels that, imply a
significant degree of control, then we have to look at that,
make sure it is appropriate.
Chairman Dodd. Is that a sort of objective test rather than
a subjective test?
Mr. Bernanke. I believe that 25 percent is the threshold.
Chairman Dodd. But I was looking and thinking--I am just
curious to get your reaction to this. And, again, I do not want
to overdramatize this point, but I was curious in one of
these--and you will know which one I am talking about. One of
these major investment houses, when the decision was made as to
who the new CEO was going to be, there was a flight I think
occurred that went to a country that was making major
investment to get the OK in a sense. Now, the amount invested
would represent an amount far smaller than the 25-percent
threshold. But clearly, at least, if you will, the visuals of
going over and getting sort of a sign-off indicated that there
was more of an influence than the dollar amount would indicate.
I mean, does that trigger something? Or should it trigger
something?
Mr. Bernanke. Well, I think if the investor is making that
big an investment, they need to understand what is going on. I
am not sure whether it was a case of their deciding who was the
CEO or just simply being informed of the plans of the company.
In the cases that we have seen, the investments have been
significant in absolute terms, but small in percentage of
equity terms. And in most cases, the amount of control--rights,
board of directors, membership and so on--has been quite
limited. So there has not been any significant change in the
control of these institutions. If there were, then the Federal
Reserve would want to----
Chairman Dodd. No, absolutely. I understand that. And,
again, I am not trying to expand your portfolio here by
suggesting an earlier intervention, but it would seem to me
that there may be some signals here that may fall short of the
25 percent. I would rather have you taking a look at those
things where--and come to me and say, ``I think this is''--not
to me necessarily, but to say we think we ought to take a look
at this, it may fall short of that absolute trigger. That is
why I say objective/subjective kind of analysis as to what this
could mean, so look at that.
Is there any chance, any worry you have at all--coming back
to the first question I raised with you, the declining value of
the dollar, the 24-percent decline, the lowest since 1973,
compared to the six other major currencies. Is there any chance
in your mind that we would watch something moving away from a
dollar denomination in these areas, in these commodities, such
as oil going to the euro, for instance? Do you see any danger
in that? Or is it--do you worry about that at all?
Mr. Bernanke. I know of no plans of that, but the
denomination, as I said, is of second-order importance. There
is some importance in the willingness of foreigners to hold
dollar assets, which is a different matter entirely. And as I
said, I know of no evidence that there is any reduction in
interest.
Chairman Dodd. Would that concern you if that happened? I
mean, is there----
Mr. Bernanke. If there was a change in denomination?
Chairman Dodd. Yes, if they moved all of a sudden, went
from the price of a barrel of oil measured not in dollars but
in euros, what does that say about us and our economy? Does
that have--I mean, it seems to me that would be rather a
dramatic piece of news.
Mr. Bernanke. Well, it might be symbolic. It might have
symbolic value. But from an economic point of view, it is a
global market, and foreign currencies are traded all the time.
You know, if I want to buy a barrel of oil, I can do it in euro
or yen or any other way I like. So from a fundamental sense
point of view, it is not significant. There might be some
symbolic value to it if that happened.
Chairman Dodd. I was going to ask you a question to follow
up on Senator Menendez who asked questions about the housing
issue. But I think your answers in response to Senator Corker
were good ones in thinking about this issue. And I sense in
your comments here today that this housing issue is a serious
one. And I am not going to try and put words in your mouth
again, but I realize you put an adjective on this, and that
becomes the headline. But it is serious and warrants serious
thought as to what we can do to minimize this and to try and
keep people in their homes, minimize this from happening again,
and dealing with related issues. And I appreciate those
comments. And we are going to continue talking with you about
these various ideas that we have. And I certainly appreciate,
having been here long enough to know, that sometimes actions,
however well intended, can have unintended consequences, and so
you need to think through things carefully. And so we are going
to want to be in touch with you during that process.
But we also want to make sure we are not looking back and
wondering if we could have done some things here that would
have minimized this from getting worse. So it is important.
I will leave the record open for a couple of days here.
Members who did not make it here may have some additional
questions for you. You have been before this Committee a lot
now in the last couple of weeks, and we are grateful to you for
that, and we will continue working with you.
The Committee will stand adjourned.
[Whereupon, at 12:32 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR JIM BUNNING
Thank you, Mr. Chairman.
The health of our economy and financial markets is a concern to
everyone here today. Growth has slowed and we have been through a rough
patch in the credit markets. Everyone wants to see stability and growth
return. Congress has acted to restore confidence in the economy. The
Fed has taken steps to thaw the credit freeze. We hope that these
policy actions will head off further damage, but no policy can reverse
the busting of the housing bubble and we are not going to regulate away
problems in the economy.
While I have supported actions taken to respond to our economic
problems, I fear they will have unintended consequences. I am most
concerned about inflation and the fall of the dollar. We need to think
beyond what we have already done and take steps to encourage long term
growth. Congress can give taxpayers, businesses, and investors
certainty that their taxes are not going to go up. Congress can knock
down roadblocks to growth such as artificial limits on our energy
supply. Congress can make it more appealing for corporations to stay in
the United States by easing regulations and lowering the corporate tax
rate. Only with long term permanent policies can we ensure a healthy
economy for our grandchildren.
I look forward to hearing from the Chairman.
______
PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
Thank you, Chairman Dodd and Ranking Member Shelby for holding this
very important hearing today. Chairman Bernanke, I join my colleagues
in extending you a warm welcome.
Since last August, our financial markets have experienced
tremendous uncertainty. Credit and capital markets around the world
have struggled to comprehend the ramifications of the U.S. subprime
lending and housing crisis. Fortunately, the Federal Reserve has been
quick to act, lowering the federal funds rate from 5.25 percent to 3
percent. Congress also is working to help boost our economy.
Several recent reports have highlighted ongoing economic
challenges. Such as last week, the Wall Street Journal said that the
``leading economic indicators'' fell for the fourth straight month.
Since its July 2007 high, the index has fallen by 2 percent, which is
the largest 6-month drop since 2001. Additionally, for the week ending
on February 16, the 4-week average of initial unemployment claims rose
by 10,750 to 360,500, pointing to a softening of the labor market.
Furthermore, by the third quarter of 2007, household debt rose to
$13.6 trillion from $7.2 trillion in 2001, a 10-percent annual
increase. Over this same time period, mortgage borrowing more than
doubled. As a result, one out of every seven dollars of disposable
income earned by Americans goes towards paying down debt.
Fears loom of higher inflation and more ``pain at the pump.'' The
price of a barrel of oil has hovered around the $90 mark and recently
closed above $100 per barrel. If these higher gas prices and
inflationary pressures continue, coupled with the well-known weakness
in across our housing sector, I--like many folks I hear from--am very
concerned that future economic growth could be hindered.
No question, the health of our economy is influenced by many
complex issues and expected and unexpected events. That said, I would
like to highlight a few areas where I am focused to help spur growth
and job creation.
I strongly support Trade Adjustment Assistance, which helps ensure
that displaced workers have the ability to train for new careers. In
recent years, my home state of North Carolina has undergone a difficult
economic transition, as our state continues to evolve from a
manufacturing and agriculture-based economy to a more services-oriented
economy. In North Carolina and across the country, there is a need to
address the growing gap between skilled and unskilled workers. Senator
Cantwell and I have introduced legislation that would allow more
workers to receive TAA benefits, including training, job search and
relocation allowances, income support and other reemployment services.
Additionally, with respect to current regulation of financial
institutions, it has come to my attention that some smaller banks are
overburdened by compliance with Sections 404 and 302 of the Sarbanes-
Oxley corporate accountability law. Mr. Chairman, these financial
institutions are already highly-regulated, and it has become
increasingly apparent that these regulations, while well-intended, only
increase their costs of doing business. I hope this committee will soon
consider legislation that would provide true regulatory relief for all
financial institutions.
Chairman Bernanke, thank you again for being here today. I look
forward to hearing from you--and working with you--on these and other
important issues.
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman,
Board of Governors of the Federal Reserve System
February 28, 2008
Chairman Dodd, Ranking Member Shelby, and other Members of the
Committee, I am pleased to present the Federal Reserve's Monetary
Policy Report to the Congress. In my testimony this morning I will
briefly review the economic situation and outlook, beginning with
developments in real activity and inflation, then turn to monetary
policy. I will conclude with a quick update on the Federal Reserve's
recent actions to help protect consumers in their financial dealings.
The economic situation has become distinctly less favorable since
the time of our July report. Strains in financial markets, which first
became evident late last summer, have persisted; and pressures on bank
capital and the continued poor functioning of markets for securitized
credit have led to tighter credit conditions for many households and
businesses. The growth of real gross domestic product (GDP) held up
well through the third quarter despite the financial turmoil, but it
has since slowed sharply. Labor market conditions have similarly
softened, as job creation has slowed and the unemployment rate--at 4.9
percent in January--has moved up somewhat.
Many of the challenges now facing our economy stem from the
continuing contraction of the U.S. housing market. In 2006, after a
multiyear boom in residential construction and house prices, the
housing market reversed course. Housing starts and sales of new homes
are now less than half of their respective peaks, and house prices have
flattened or declined in most areas. Changes in the availability of
mortgage credit amplified the swings in the housing market. During the
housing sector's expansion phase, increasingly lax lending standards,
particularly in the subprime market, raised the effective demand for
housing, pushing up prices and stimulating construction activity. As
the housing market began to turn down, however, the slump in subprime
mortgage originations, together with a more general tightening of
credit conditions, has served to increase the severity of the downturn.
Weaker house prices in turn have contributed to the deterioration in
the performance of mortgage-related securities and reduced the
availability of mortgage credit.
The housing market is expected to continue to weigh on economic
activity in coming quarters. Homebuilders, still faced with abnormally
high inventories of unsold homes, are likely to cut the pace of their
building activity further, which will subtract from overall growth and
reduce employment in residential construction and closely related
industries.
Consumer spending continued to increase at a solid pace through
much of the second half of 2007, despite the problems in the housing
market, but it appears to have slowed significantly toward the end of
the year. The jump in the price of imported energy, which eroded real
incomes and wages, likely contributed to the slowdown in spending, as
did the declines in household wealth associated with the weakness in
house prices and equity prices. Slowing job creation is yet another
potential drag on household spending, as gains in payroll employment
averaged little more than 40,000 per month during the 3 months ending
in January, compared with an average increase of almost 100,000 per
month over the previous 3 months. However, the recently enacted fiscal
stimulus package should provide some support for household spending
during the second half of this year and into next year.
The business sector has also displayed signs of being affected by
the difficulties in the housing and credit markets. Reflecting a
downshift in the growth of final demand and tighter credit conditions
for some firms, available indicators suggest that investment in
equipment and software will be subdued during the first half of 2008.
Likewise, after growing robustly through much of 2007, nonresidential
construction is likely to decelerate sharply in coming quarters as
business activity slows and funding becomes harder to obtain,
especially for more speculative projects. On a more encouraging note,
we see few signs of any serious imbalances in business inventories
aside from the overhang of unsold homes. And, as a whole, the
nonfinancial business sector remains in good financial condition, with
strong profits, liquid balance sheets, and corporate leverage near
historical lows.
In addition, the vigor of the global economy has offset some of the
weakening of domestic demand. U.S. real exports of goods and services
increased at an annual rate of about 11 percent in the second half of
last year, boosted by continuing economic growth abroad and the lower
foreign exchange value of the dollar. Strengthening exports, together
with moderating imports, have in turn led to some improvement in the
U.S. current account deficit, which likely narrowed in 2007 (on an
annual basis) for the first time since 2001. Although recent indicators
point to some slowing of foreign economic growth, U.S. exports should
continue to expand at a healthy pace in coming quarters, providing some
impetus to domestic economic activity and employment.
As I have mentioned, financial markets continue to be under
considerable stress. Heightened investor concerns about the credit
quality of mortgages, especially subprime mortgages with adjustable
interest rates, triggered the financial turmoil. However, other
factors, including a broader retrenchment in the willingness of
investors to bear risk, difficulties in valuing complex or illiquid
financial products, uncertainties about the exposures of major
financial institutions to credit losses, and concerns about the weaker
outlook for economic growth, have also roiled the financial markets in
recent months. To help relieve the pressures in the market for
interbank lending, the Federal Reserve--among other actions--recently
introduced a term auction facility (TAF), through which prespecified
amounts of discount window credit are auctioned to eligible borrowers,
and we have been working with other central banks to address market
strains that could hamper the achievement of our broader economic
objectives. These efforts appear to have contributed to some
improvement in short-term funding markets. We will continue to monitor
financial developments closely.
As part of its ongoing commitment to improving the accountability
and public understanding of monetary policy making, the Federal Open
Market Committee (FOMC) recently increased the frequency and expanded
the content of the economic projections made by Federal Reserve Board
members and Reserve Bank presidents and released to the public. The
latest economic projections, which were submitted in conjunction with
the FOMC meeting at the end of January and which are based on each
participant's assessment of appropriate monetary policy, show that real
GDP was expected to grow only sluggishly in the next few quarters and
that the unemployment rate was seen as likely to increase somewhat. In
particular, the central tendency of the projections was for real GDP to
grow between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\
percent to 2\3/4\ percent projected in our report last July. FOMC
participants' projections for the unemployment rate in the fourth
quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent,
up from the level of about 4\3/4\ percent projected last July for the
same period. The downgrade in our projections for economic activity in
2008 since our report last July reflects the effects of the financial
turmoil on real activity and a housing contraction that has been more
severe than previously expected. By 2010, our most recent projections
show output growth picking up to rates close to or a little above its
longer-term trend and the unemployment rate edging lower; the
improvement reflects the effects of policy stimulus and an anticipated
moderation of the contraction in housing and the strains in financial
and credit markets. The incoming information since our January meeting
continues to suggest sluggish economic activity in the near term.
The risks to this outlook remain to the downside. The risks include
the possibilities that the housing market or labor market may
deteriorate more than is currently anticipated and that credit
conditions may tighten substantially further.
Consumer price inflation has increased since our previous report,
in substantial part because of the steep run-up in the price of oil.
Last year, food prices also increased significantly, and the dollar
depreciated. Reflecting these influences, the price index for personal
consumption expenditures (PCE) increased 3.4 percent over the four
quarters of 2007, up from 1.9 percent in 2006. Core price inflation--
that is, inflation excluding food and energy prices--also firmed toward
the end of the year. The higher recent readings likely reflected some
pass-through of energy costs to the prices of core consumer goods and
services as well as the effect of the depreciation of the dollar on
import prices. Moreover, core inflation in the first half of 2007 was
damped by a number of transitory factors--notably, unusually soft
prices for apparel and for financial services--which subsequently
reversed. For the year as a whole, however, core PCE prices increased
2.1 percent, down slightly from 2006.
The projections recently submitted by FOMC participants indicate
that overall PCE inflation was expected to moderate significantly in
2008, to between 2.1 percent and 2.4 percent (the central tendency of
the projections). A key assumption underlying those projections was
that energy and food prices would begin to flatten out, as was implied
by quotes on futures markets. In addition, diminishing pressure on
resources is also consistent with the projected slowing in inflation.
The central tendency of the projections for core PCE inflation in 2008,
at 2.0 percent to 2.2 percent, was a bit higher than in our July
report, largely because of some higher-than-expected recent readings on
prices. Beyond 2008, both overall and core inflation were projected to
edge lower, as participants expected inflation expectations to remain
reasonably well-anchored and pressures on resource utilization to be
muted. The inflation projections submitted by FOMC participants for
2010--which ranged from 1.5 percent to 2.0 percent for overall PCE
inflation--were importantly influenced by participants' judgments about
the measured rates of inflation consistent with the Federal Reserve's
dual mandate and about the time frame over which policy should aim to
attain those rates.
The rate of inflation that is actually realized will of course
depend on a variety of factors. Inflation could be lower than we
anticipate if slower-than-expected global growth moderates the pressure
on the prices of energy and other commodities or if rates of domestic
resource utilization fall more than we currently expect. Upside risks
to the inflation projection are also present, however, including the
possibilities that energy and food prices do not flatten out or that
the pass-through to core prices from higher commodity prices and from
the weaker dollar may be greater than we anticipate. Indeed, the
further increases in the prices of energy and other commodities in
recent weeks, together with the latest data on consumer prices, suggest
slightly greater upside risks to the projections of both overall and
core inflation than we saw last month. Should high rates of overall
inflation persist, the possibility also exists that inflation
expectations could become less well anchored. Any tendency of inflation
expectations to become unmoored or for the Fed's inflation-fighting
credibility to be eroded could greatly complicate the task of
sustaining price stability and could reduce the flexibility of the FOMC
to counter shortfalls in growth in the future. Accordingly, in the
months ahead, the Federal Reserve will continue to monitor closely
inflation and inflation expectations.
Let me turn now to the implications of these developments for
monetary policy. The FOMC has responded aggressively to the weaker
outlook for economic activity, having reduced its target for the
federal funds rate by 225 basis points since last summer. As the
Committee noted in its most recent post-meeting statement, the intent
of those actions has been to help promote moderate growth over time and
to mitigate the risks to economic activity.
A critical task for the Federal Reserve over the course of this
year will be to assess whether the stance of monetary policy is
properly calibrated to foster our mandated objectives of maximum
employment and price stability in an environment of downside risks to
growth, stressed financial conditions, and inflation pressures. In
particular, the FOMC will need to judge whether the policy actions
taken thus far are having their intended effects. Monetary policy works
with a lag. Therefore, our policy stance must be determined in light of
the medium-term forecast for real activity and inflation as well as the
risks to that forecast. Although the FOMC participants' economic
projections envision an improving economic picture, it is important to
recognize that downside risks to growth remain. The FOMC will be
carefully evaluating incoming information bearing on the economic
outlook and will act in a timely manner as needed to support growth and
to provide adequate insurance against downside risks.
Finally, I would like to say a few words about the Federal
Reserve's recent actions to protect consumers in their financial
transactions. In December, following up on a commitment I made at the
time of our report last July, the Board issued for public comment a
comprehensive set of new regulations to prohibit unfair or deceptive
practices in the mortgage market, under the authority granted us by the
Home Ownership and Equity Protection Act of 1994. The proposed rules
would apply to all mortgage lenders and would establish lending
standards to help ensure that consumers who seek mortgage credit
receive loans whose terms are clearly disclosed and that can reasonably
be expected to be repaid. Accordingly, the rules would prohibit lenders
from engaging in a pattern or practice of making higher-priced mortgage
loans without due regard to consumers' ability to make the scheduled
payments. In each case, a lender making a higher priced loan would have
to use third-party documents to verify the income relied on to make the
credit decision. For higher-priced loans, the proposed rules would
require the lender to establish an escrow account for the payment of
property taxes and homeowners' insurance and would prevent the use of
prepayment penalties in circumstances where they might trap borrowers
in unaffordable loans. In addition, for all mortgage loans, our
proposal addresses misleading and deceptive advertising practices,
requires borrowers and brokers to agree in advance on the maximum fee
that the broker may receive, bans certain practices by servicers that
harm borrowers, and prohibits coercion of appraisers by lenders. We
expect substantial public comment on our proposal, and we will
carefully consider all information and viewpoints while moving
expeditiously to adopt final rules.
The effectiveness of the new regulations, however, will depend
critically on strong enforcement. To that end, in conjunction with
other federal and state agencies, we are conducting compliance reviews
of a range of mortgage lenders, including nondepository lenders. The
agencies will collaborate in determining the lessons learned and in
seeking ways to better cooperate in ensuring effective and consistent
examinations of, and improved enforcement for, all categories of
mortgage lenders.
The Federal Reserve continues to work with financial institutions,
public officials, and community groups around the country to help
homeowners avoid foreclosures. We have called on mortgage lenders and
servicers to pursue prudent loan workouts and have supported the
development of streamlined, systematic approaches to expedite the loan
modification process. We also have been providing community groups,
counseling agencies, regulators, and others with detailed analyses to
help identify neighborhoods at high risk from foreclosures so that
local outreach efforts to help troubled borrowers can be as focused and
effective as possible. We are actively pursuing other ways to leverage
the Federal Reserve's analytical resources, regional presence, and
community connections to address this critical issue.
In addition to our consumer protection efforts in the mortgage
area, we are working toward finalizing rules under the Truth in Lending
Act that will require new, more informative, and consumer-tested
disclosures by credit card issuers. Separately, we are actively
reviewing potentially unfair and deceptive practices by issuers of
credit cards. Using the Board's authority under the Federal Trade
Commission Act, we expect to issue proposed rules regarding these
practices this spring.
Thank you. I would be pleased to take your questions.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM BEN S. BERNANKE
Q.1. Increases in the GSE/FHA Conforming Loan Limits: The
stimulus bill recently passed by Congress includes an increase
in the conforming loan limit amount for mortgages that the
Government Sponsored Entities (GSEs) and the Federal Housing
Administration can guarantee.
Do you believe that increasing these loan amounts adds to
the systemic risks associated with the GSEs' operations?
While these increases are only temporary, some have raised
the idea of permanently increasing the amounts. Are there
additional risks associated with a permanent increase?
A.1. Temporarily raising the conforming loan limit allows the
GSEs to securitize an expanded range of mortgage loans and
likely would increase liquidity in the secondary market for
loans covered by the expansion. The GSEs should be strongly
encouraged to rapidly use this authority, even if it requires
that they raise substantial amounts of capital.
Over a longer horizon, it is important to realize that
raising the conforming loan limits extends the implicit
government-backing of the GSEs into a larger portion of the
mortgage market. While the jumbo mortgage market has
experienced substantial liquidity problems during the past
year, this market historically has operated efficiently and
functioned well without GSE involvement. Moreover, prime
quality homeowners who use jumbo mortgages are, in general, the
highest income and wealthiest members of our society. Extending
the reach of the GSEs to these borrowers would do little to
expand homeownership or to extend mortgage credit to those that
cannot obtain mortgages otherwise.
Thus, raising the conforming loan limit involves the larger
question of how far to extend government guarantees, either
explicit or implicit, to resolve short-term liquidity problems
in secondary asset markets. Temporary expansions of the safety
net, such as those undertaken by the Federal Reserve, can boost
short-term liquidity without distorting private market credit
analysis. In contrast, permanent expansions of the safety net,
such as raising the conforming loan limit permanently, may well
cause greater problems in the long-run. There are many reasons
for the recent breakdown in private market credit analysis, but
it is not clear to me that the best approach to rectify the
current situation is simply to substitute implicit government
guarantees for much needed private market discipline. If
private markets are unable to provide a secondary market for
some assets, we should first endeavor to understand why this is
the case rather than immediately turn to a broader expansion of
GSE guarantees.
Any permanent expansion of GSE guarantees must, be
accompanied by comprehensive GSE reform to mitigate further
systemic risks. In particular, capital standards for the GSEs
must be significantly toughened and clear and credible
receivership procedures for the GSEs should be established.
Moreover, the role and function of the GSE portfolios should be
clearly articulated by Congress. As has been evident in recent
months, this portfolio is managed mainly to meet needs of GSE
shareholders and not to fulfill public policy objectives.
Q.2. International Liquidity Coordination: Chairman Bernanke,
as of the minutes of the last Federal Open Market Committee
meeting, the Federal Reserve reaffirmed their commitment to
working with foreign central banks to coordinate international
monetary policy.
Please describe for us the details of the Federal Reserve's
agreements with foreign central banks, such as the European
Central Bank and the Bank of England for exchanging assets into
dollars.
Why have these agreements been made and are financial
institutions using these tools?
A.2. The Federal Open Market Committee (FOMC) established swap
lines with the European Central Bank (ECB)and Swiss National
Bank (SNB) in conjunction with the establishment of the Term
Auction Facility (TAF) on December 12, 2007. These swap
agreements were requested by the ECB and SNB and allowed them
to draw a maximum of $20 billion and $4 billion respectively,
for a period of up to 6 months. Under the agreements, both
central banks are allowed to purchase U.S. dollars with their
foreign currencies based on the prevailing spot exchange rate,
and they pay interest on the foreign currency received by the
Federal Reserve. Given the strong financial position of the ECB
and SNB, the swap lies involve virtually no credit risk to the
Federal Reserve. The Federal Reserve has also maintained
longstanding swap facilities with the Bank of Mexico and the
Bank of Canada as part of the North American Framework
Agreement. Those facilities amount to $2 billion with the Bank
of Canada and $3 billion with the Bank of Mexico.
The agreements with the ECB and SNB were established to
allow dollar funding problems faced by European and Swiss banks
to be addressed directly by their respective home central
banks. In the absence of such agreements, European and Swiss
banks were believed to be more likely to seek dollar funding in
U.S. markets, potentially increasing volatility and adding to
term funding pressures in U.S. markets. By providing dollars to
the ECB and SNB to use in their efforts to address term dollar
funding problems abroad, the FOMC believed that it would assist
U.S. credit markets.
Both the ECB and SNB have used their swap agreements. The
first use of these swap lines was on Monday, December 17, when
the ECB drew upon $10 billion and the SNB drew upon $4 billion
for a 28-day period. The two central banks used the funds to
auction dollar funding to their eligible depository
institutions; the ECB offered funds to its eligible depository
institutions at the 4.65 percent rate set in the Federal
Reserve's TAF auction, and the SNB auctioned $4 billion at a
weighted average rate of 4.79 percent. The ECB drew upon a
further $10 billion on Thursday, December 20, in conjunction
with the second TAF auction held by the Federal Reserve. At the
expiration of its first use of its swap line, the ECB renewed
its draws in conjunction with the January 14 and January 28 TAF
auctions, offering $10 billion in 28-day dollar funds both
times at a rate equal to the rate set in the TAF auction. The
SNB also renewed its draw of $4 billion on its swap line to
participate in the January 14 auction of dollar funds. On March
11, the FOMC announced that it would increase its temporary
swap line to the ECB from $20 billion to $30 billion and its
line to the SNB from $4 billion to $6 billion, extending the
swap lines through September 30, 2008. Both central banks have
signaled that they would draw upon the lines to offer 28-day
dollar funding in auctions to be held on March 25.
Q.3. Sovereign Wealth Funds and Systemic Risk: Chairman
Bernanke, recently we have seen an influx of capital into our
domestic financial institutions from foreign governments,
specifically sovereign wealth funds. Previous foreign direct
investments have usually been in smaller quantities and from
private investors, rather than governments. These investments
may be under the threshold of control for each sale, but
collectively could represent a large proportion of U.S.
financial services firms.
Is there a danger of systemic risk from one or more
Sovereign Wealth Funds holding noncontrolling stakes many
financial firms?
A.3. The recent prominent equity investments by sovereign
wealth funds in large U.S. financial institutions permanently
increased the capital of these firms, enhancing their soundness
and the soundness of the U.S. financial system. These
investments also support the ability of the financial
institutions to provide credit to businesses and consumers. It
is difficult to envision circumstances under which non-
controlling equity stakes in financial institutions, could
increase systemic risk in a financial system.
Sovereign wealth funds have been relatively stable
investors. The funds generally are neither highly leveraged nor
exposed to liquidity risk arising from investor withdrawals or
redemptions. Sovereign wealth funds often use professional
private fund managers who are tasked with seeking higher
returns and greater diversification--relative to official
reserves--for a portion of a country's foreign exchange assets.
Because sovereign wealth funds are government owned, there
has been concern, however, that these funds have the potential
to be motivated by political reasons To the extent these funds
make only smaller, noncontrolling investments, the ability of a
sovereign wealth fund to have an effect on the operation,
strategic direction or policies of a banking organization are
minimal.
If two or more companies with noncontrolling investments in
a U.S. bank or bank holding company were to agree to act
together in an attempt to influence the operations of a U.S.
bank or bank holding company, the Federal Reserve has the
authority to combine the companies' shareholdings and treat the
group as one company (an ``association'') for purposes of the
Bank Holding Company Act (BHC Act). If the combined
shareholding were significant enough, the association could be
treated as a bank holding company subject to the requirements
of the BHC Act. To date, the Board has not found that sovereign
wealth funds from different countries have in fact acted
together to control a U.S. financial institution.
Another important safeguard applies to the U.S. banking
organization itself. U.S. banking organizations themselves are
subject to the supervisory and regulatory requirements of U.S.
banking law. For example, federal banking agencies are required
under the Federal Deposit Insurance Act to establish certain
safety and soundness standards by regulation or guideline for
all U.S. insured depository institutions. These standards are
designed to identify potential safety and soundness concerns
and ensure that action is taken to address those concerns
before they pose a risk to the Deposit Insurance Fund. Thus,
the Federal banking agencies may monitor and require action by
the U.S. banking organization to maintain its financial health
regardless of the owner of the banking organization.
Q.4. Is there a Bernanke ``Put''? Chairman Bernanke, some
economists speculate that market participants became willing to
take greater risks because monetary policy under Chairman
Greenspan protected investments by cutting interest rates in
response to economic shocks. This phenomenon came to be called
the Greenspan ``put''--referring to the financial instrument
that guarantees its owner a certain return if prices fall below
a specified level. Now critics are wondering if there is also a
Bernanke put, given the recent significant drop in rates.
How do you respond to these observations? How do you
balance responding to slower economic growth while at the same
time allowing the market to follow a normal business cycle?
Do you have any concerns that the 225 basis point drop in
interest rates since last August creates moral hazard for
market participants?
A.4. In conducting monetary policy, the Federal Reserve is
guided by its statutory mandate to promote maximum employment
and stable prices over time. I do not believe that monetary
policy actions aimed at these goals are a significant source of
moral hazard. To be sure, in carrying out its mandate, the
Federal Reserve takes account of a broad range of factors that
influence the outlook for economic growth and inflation,
importantly including financial asset prices, such as the
prices of equity shares and houses. Financial asset prices are
important for the economic outlook partly because they affect
household wealth and thus consumer spending on goods and
services and therefore ultimately influence output, employment,
and inflationary pressures. Depending on overall circumstances,
declines in asset prices may adversely affect the outlook for
aggregate demand, and consequently the stance of monetary
policy may need to be eased in order to cushion the effect on
aggregate demand. It is important to recognize that such a
response of monetary policy is not designed to support
financial asset prices themselves but to foster overall
economic growth and to mitigate the risks of particularly
adverse economic outcomes. It is also worth noting that past
Federal Reserve efforts to buoy economic growth in the face of
declining asset prices have not insulated from substantial
losses investors who made poor investment choices. This point
is evidenced by the very large losses suffered by investors in
the tech sector early this decade despite considerable monetary
policy easing, and by the losses experienced by investors in
many subprime-related mortgage products more recently even as
the stance of monetary policy was eased.
Q.5. Term Auction Facility: Chairman Bernanke, the Federal
Reserve created a new Term Auction Facility to help ensure that
American banks have adequate liquidity.
What has been the response to the auctions thus far and for
how long will they continue?
What type of collateral are banks posting in these
auctions? What happens if that collateral, particularly AAA-
rated mortgage backed securities, is downgraded?
A.5. The demand for TAF credit from depository institutions has
been ample. All eight auctions conducted to date have been
oversubscribed, with resulting interest rates in each case
above the minimum bid rate. The Federal Reserve will continue
to conduct TAF auctions for at least the next 6 months unless
evolving market conditions clearly indicate that such auctions
are no longer necessary.
TAF borrowing is collateralized by the same pool of assets
as pledged against other types of discount window loans. For
all types of discount window loans, Federal Reserve Banks will
consider accepting as collateral any assets that meet
regulatory standards for sound asset quality. Commonly pledged
assets include residential and commercial real estate loans,
consumer loans, business loans, and a variety of securities.
The standards applied to each type of collateral are available
on the Federal Reserve discount window Web site at
www.frbdiscountwindow.erg. Collateral that is downgraded below
Federal Reserve eligibility standards is given no value and
must be withdrawn. The likelihood that the downgrade of a
portion of a depository institution's collateral will affect a
TAF loan is reduced by the requirement that, at the time of
bidding, the sum of the aggregate bid amount submitted by a
depository institution and the principal amount of TAF advances
that the same depository institution may have outstanding
cannot exceed 50 percent of the collateral value of the assets
pledged by the depository institution.
Q.6. Value of the Dollar: As you know, the U.S. dollar declined
against most major currencies over the past year. The dollar
has lost 10.4 percent again the Euro and 5.7 percent versus the
yen in 2007.
What does it mean for our economy if foreign countries turn
away from holding the dollar as their reserve currency or even
if they diversify, which has already begun?
Are there dangers that we will be more constrained in the
actions we are able to take domestically, including selling
Treasury securities, to finance our deficit?
A.6. The dollar's status as a reserve currency reflects
investor confidence in the sophistication and liquidity of U.S.
financial markets and the relative stability of our
macroeconomic environment. To date, there is little evidence of
a shift in foreign official holdings away from dollar
denominated assets. U.S. data show further growth in foreign
official holdings of U.S. assets. Data reported to the IMF also
show continued growth in dollar assets in foreign official
reserves. While the IMF data show a decline in the dollar share
of reported reserves, this decline is entirely attributable to
the depreciation of the dollar, which has raised the dollar
value of the other currencies held in the reserve portfolios.
In response to a private survey conducted by the Royal Bank of
Scotland, several reserve managers indicated they planned to
increase the weight of non-dollar assets in future investments,
but there was again no evidence of a general shift out of the
dollar on the part of these respondents.
In principle, a shift in foreign appetite away from U.S.
securities toward foreign securities might be expected to lower
the value of the dollar and to raise U.S. interest rates;
however, these effects are difficult to measure and appear to
be modest. Furthermore, while it is true that foreign official
institutions hold a significant fraction of U.S. Treasury
securities outstanding, it is important to note that these
holdings represent less than 5 percent of the total debt
outstanding in U.S. credit markets. As such, U.S. credit
markets could likely absorb a shift in foreign official
allocations away from dollar assets without undue difficulty.
In the event that such a shift were to occur and put undesired
upward pressure on U.S. interest rates, the Federal Reserve has
the capacity to increase available credit to maintain a level
of short-term interest rates consistent with our domestic
economic goals. Any effect of reduced foreign demand on the
term premium between short-term and long-term interest rates
could affect the cost of long-term borrowing by the Federal
Government; however, this impact is likely to be relatively
small and is unlikely to materially constrain the U.S.
government's ability to finance its deficit.
Q.7. Slow Growth and Rising Inflation: Mr. Chairman, there is
some evidence of contradictory forces at play in the economy
right now. In the middle of the present economic downturn,
commodity and food prices have increased.
What do you judge to be the threat of slow growth
continuing, with inflation remaining above the Federal
Reserve's comfort level?
A.7. The FOMC, in the statement released at the conclusion of
its most recent meeting on March 18, noted that the outlook for
economic activity has weakened further in recent weeks and that
downside risks to growth remain. At the same time, inflation
has been elevated, uncertainty about the inflation outlook has
increased The actions taken by the Federal Reserve since last
August, including measures to foster market liquidity, should
help to promote moderate growth over time and to mitigate the
risks to economic activity. However, the Federal Reserve
remains attentive to the risks to the outlook for activity and
inflation, and it will act in a timely manner as needed to
promote sustainable economic growth and price stability.
Q.8. Capital: The ongoing turmoil in our financial markets
vividly demonstrates the wisdom of prudent capital requirements
for our financial institutions. If our financial institutions
hold sufficient capital, they are much more likely to weather
the inevitable economic storms that occur as part of the
business cycle. Because a healthy banking system is one of the
best defenses against a severe economic downturn, one of the
most important responsibilities of our financial regulators is
ensuring that financial institutions are adequately
capitalized.
Chairman Bernanke, what is your assessment of the current
capital levels in our banking system? As part of your answer,
would you explain the steps your agency has taken over the past
year to make sure that our banks are adequately capitalized?
A.8. As you how a bank is deemed to be well capitalized under
Prompt Corrective Action rules if it has a tier 1 risk-based
capital ratio of 6 percent or greater, a total risk-based
capital ratio of 10 percent or greater, a leverage ratio of 5
percent or greater and is not subject to any written directive
issued by the Federal Reserve Board. As can be seen in the
summary table below, the majority of U.S. commercial banks have
substantial buffers over the well capitalized requirements (as
of year-end 2007), which should prove helpful during these
difficult times. However, capital ratios in banking
organizations can erode rapidly during downturns, depending on
the rate of increase and amounts of write-downs and additions
to the allowance for losses and the extent to which these
cannot be offset by the retention of earnings or raising of new
capital.
Summary Average Data for Insured Commercial Banks
------------------------------------------------------------------------
Ratios Avg. 1997-2007 2006 2007
------------------------------------------------------------------------
Equity Capital/Assets............... 9.2 10.2 10.2
Leverage............................ 7.8 8.1 7.9
Tier 1 Ratio (Risk-Based)........... 9.7 9.8 9.4
Total Ratio (Risk-Based)............ 12.4 12.4 12.2
% Deemed Well Capitalized........... 98.3 99.3 98.9
------------------------------------------------------------------------
Source: Summary Profile Report, Dec. 2007, BS&R, Federal Reserve Board
of Governors.
The Federal Reserve Board, together with the other banking
agencies, is currently reviewing several elements of its
regulatory capital requirements to ensure that banking
organizations have sufficient capital levels to weather losses
during difficult times and to ensure a high standard in the
quality of capital (i.e., its ability to absorb losses
effectively) being issued by these organizations. In addition,
our ongoing supervisory activities include monitoring banking
organizations' asset quality, market exposures, quality of
earnings, capital management plans, effectiveness and adequacy
of provisioning, and valuation policies, all of which directly
impact the banking organizations' capital standing.
In December 2007, the Federal Reserve Board, together with
the other banking agencies, approved final rules implementing
the Basel II advanced risk-based capital rules--for large,
internationally active banking organizations--that more closely
align regulatory capital requirements with actual risks and
should further strengthen banking organizations' risk-
management practices. The improvements in risk management under
Basel II will be valuable in promoting the resiliency of the
banking and financial systems.
Under the Basel II rules, banking organizations must have
rigorous processes for assessing their overall capital adequacy
in relation to their total risk profile and publicly disclose
information about their risk profile and capital adequacy. We
will continue to assess the Federal Reserve Board's capital
rules to ensure that banking organizations' capital
requirements remain prudent.
Q.9. Role of Credit Rating Agencies for Capital Requirements:
Many financial institutions and pension funds are only
permitted to hold assets with an ``investment grade'' rating.
Chairman Bernanke, what steps is the Fed taking to ensure
that banks monitor the quality of assets on their balance
sheets and that financial institutions are not outsourcing
their due diligence requirements to credit rating agencies?
A.9. Many investors and financial firms relied too heavily on
ratings assigned by credit rating agencies in their risk
management activities, particularly with regard to structured
credit instruments. The Federal Reserve has long stressed to
bankers the importance of proper due diligence and independent
analysis in making credit risk assessments. A recent analysis
of several global financial institutions by supervisors from
the United Kingdom, Germany, France, and the United States--
including staff from the Federal Reserve--demonstrated that
principle in the current environment. Those institutions that
had developed robust internal processes for assessing risks of
complex subprime-related instruments were able to more quickly
identify declines in value and the heightened risks of these
instruments. Accordingly, these institutions were less
vulnerable to the underestimates of risk made by the credit
rating agencies on these instruments, less likely to
underestimate the volatility of these instruments, and better
able to analyze the effects of changing market conditions on
their credit and liquidity risk profiles. \1\
---------------------------------------------------------------------------
\1\ Senior Supervisors' Group, ``Observations on Risk Management
Practices During the Recent Market Turbulence,'' March 6, 2008.
---------------------------------------------------------------------------
We are reminding institutions that they should conduct
independent, thorough, and timely credit risk assessments for
all exposures, not just those in the loan book. Their processes
for producing credit risk assessments should be subject to
periodic internal reviews--through financial analysis,
benchmarking and other means--to ensure that these assessments
are objective, accurate and timely. Supervisors are also
redoubling efforts to ensure that institutions do not rely
inappropriately on external ratings. We continue to emphasize
that for any cases in which U.S. banks rely on third-party
assessments of credit risk, these institutions should conduct
their own assessments to ensure that they are sound and timely
and that the level and nature of the due diligence should be
commensurate to the complexity of the risk.
In addition, the Federal Reserve and the other members of
the President's Working Group on Financial Markets (PWG) have
recommended a review of existing regulations and supervisory
policies that establish minimum external ratings requirements
to ensure they appropriately take account of the
characteristics of securitized and other structured finance
instruments. The PWG also has endorsed plans by the Basel
Committee on Banking Supervision and the International
Organization of Securities Commissions to reconsider capital
requirements for complex structured securities and off-balance-
sheet instruments that are keyed to ratings provided by credit
rating agencies. The PWG further has recommended changes in the
oversight of credit rating agencies and their required
disclosures to improve the comparability and reliability of
their ratings, and expressed support for recent initiatives by
the credit rating agencies to improve their internal controls
and ratings for structured finance instruments. \2\
---------------------------------------------------------------------------
\2\ The President's Working group on Financial Markets, ``Policy
Statement on Financial Market Developments,'' March 12, 2008.
Q.10. HOEPA Rulemaking: During this period of correction in the
housing market, I believe it is incredibly important that we do
not overreact and restrict access to credit to individuals who
need it the most. In December of last year, the Federal Reserve
produced a proposed rule under its Homeownership Equity
Protection Act (HOEPA) authority. That rule is currently out
for notice and comment.
Mr. Bernanke, can you comment for the record on some of the
steps that the Fed took to ensure that an appropriate balance
was struck between eliminating many of the mortgage market
excesses that created many of the problems we face today while
ensuring that borrowers have adequate access to credit?
A.10. Our goal in proposing new regulations under the authority
of the Home Ownership and Equity Protection Act (HOEPA) was to
produce clear and comprehensive rules to protect consumers from
unfair practices while maintaining the viability of a market
for responsible mortgage lending. To help us achieve this goal,
we gathered substantial input from the public, including though
five public hearings we held on the home mortgage market in
2006 and 2007. We also focused the proposed protections where
the risks are greatest by applying stricter regulations to
higher-priced mortgage loans, which we have defined broadly so
as to cover substantially all of the subprime market.
As an example of the Board's approach, the rules would
prohibit a lender from engaging in a pattern or practice of
making higher-priced loans that the borrower cannot reasonably
be expected to repay from income or from assets other than the
house. The proposal is broadly worded to capture different ways
that risk can be layered even as the practices that increase
risk may change. It would not set numerical underwriting
requirements, such as a specific ratio of debt to income, but
would provide some specific guidance for lenders to follow when
assessing a consumer's repayment ability. For instance,
creditors who exhibited a pattern or practice of not
considering consumers' ability to repay a loan at the fully-
indexed rate would be presumed to have violated the rule.
Another proposed rule would require lenders to verify the
income or assets they rely on to make credit decisions for
higher-priced loans. Creditors would be able to rely on
standard documents to verify income and assets, such as W-2
forms and tax returns. However, to ensure access to credit for
consumers, such as the self-employed, who may not easily be
able to provide traditional documentation, the rule would allow
creditors to rely on any third-party documents that provide
reasonably reliable evidence of income and assets. For example,
creditors could rely on a series of check cashing receipts to
verify a consumer's income.
We believe these proposed rules will help protect mortgage
borrowers from unfair and deceptive practices. At the same
time, we did not want to create rules that were so open-ended
or costly to administer that responsible lenders would exit the
subprime market. So, our proposal is designed to protect
consumers without shutting off access to responsible credit.
Q.11. Housing Market: Chairman Bernanke, the current downturn
in the housing market is not the first that we've seen, and is
unlikely to be the last.
What has been the average length of time from peak to
trough in previous housing market downturns?
How does the current downturn compare to previous ones?
A.11. Although there are considerable differences across
episodes and measures of housing market activity, the trough
usually occurs between 2 and 3 years after the peak. Thus far,
the current downturn in residential investment has lasted eight
quarters, similar to the average of previous downturns. As
measured by single-family housing starts, the decline in
activity so far in this cycle has been greater than average,
although not quite as large as the contraction that occurred in
the late 1970s and early 1980s.
Q.12. Home Prices and Inflation: Chairman Bernanke, a commonly
watched measure of inflation is the core-CPI. Housing
constitutes almost a third of core-CPI.
To what extent has the recent decline in housing prices
moderated recent increases in the core-CPI?
What would be the trend in core-CPI if house prices were
excluded?
A.12. The CPI for owner-occupied housing is not directly
affected by changes in housing prices. The Bureau of Labor
Statistics (BLS) uses a rental equivalence approach to measure
changes in the price of housing services from owner-occupied
units. This approach defies the implicit rent of an owner-
occupied unit as the money that would be received were it to be
rented out (that is, the opportunity cost of owning, as opposed
to renting, the unit). As a result, the BLS uses observations
on tenants' rents (after making adjustments for landlord-
provided utilities) to construct the CPI for owner-occupied
housing. It is reasonable to expect that tenants' rents should
be related over time to the affordability of owner-occupied
housing, which would depend in part on home prices. The BLS
does not publish an index for the core CPI excluding owners'
equivalent rent. However, one can gain some insight with regard
to its limited contribution to core CPI inflation of late from
the fact that the CPI index for all items less food and energy
rose 2.3 percent over the 12 months ending in February 2008,
while the index for owners' equivalent rent of primary
residence increased 2.6 percent.
Q.13. Housing Wealth: Chairman Bernanke, the recent decline in
home prices in many parts of the country followed several years
of extraordinary home price appreciation.
What has been the overall impact of the housing bubble, and
its burst, on household wealth? Is a family that purchased a
home in 2002 or 2003 still better off?
Of those families who purchased homes earlier this decade,
and have seen substantial overall appreciation, how have their
spending patterns been affected by the declining market?
A.13. Nationwide, according to the Office of Federal Housing
Enterprise Oversight (OFHEO) purchase-only house price index,
house prices peaked in mid-2007 and have since fallen about 3
percent; according to the more volatile S&P/Case-Shiller house
price index, house prices peaked in mid-2006 and have since
fallen about 10 percent. Both indexes show major regional
disparities, with house prices peaking earlier, and falling
more, in California, Nevada, some New England states, and
Michigan and Ohio. Indeed, according to OFHEO's measure, home
prices in Michigan have fallen, on net, since 2001. In all
other states, families that purchased their homes in 2003 or
earlier continue to have seen a net appreciation in their
home's value.
According to the Federal Reserve's flow of funds accounts,
housing wealth peaked at $20.3 trillion in 2007:Q3 before
falling about $170 billion in 2007:Q4. Estimates by academic
economists of the direct effect of housing wealth on
consumption vary widely, from as little as 2 cents on the
dollar to as high as 7 cents on the dollar. These effects tend
to be spread out over roughly a 3-year period, so that current
spending is still being supported to some extent by earlier
house price gains, and the effects of the current declines will
only be fully felt over the next couple of years.
In addition to directly affecting spending by reducing
family wealth, falling house prices may affect a family's
spending indirectly through credit market channels. Borrowing
against home equity is often the lowest-cost form of finance
available to a household; falling house prices can decrease the
collateral value of a home, forcing borrowers to turn to
costlier forms of finance, such as credit cards. These indirect
effects, which are extremely difficult to quantify, probably
are a factor that has increased the size of some of the larger
published estimates of the effect of falling house prices on
consumer spending.
Q.14. Covered Bonds: Chairman Bernanke, recently FDIC Chairman
Bair indicated that covered bonds were a ``front burner issue''
at the FDIC as they continued to look for ways to improve
liquidity in the mortgage market. I understand that Europe has
a mature, $2 trillion covered bond market.
Do you think there could be a benefit to fostering such a
market in the United States?
What distinctions do you see between the European market
and the status of the U.S. market?
A.14. As long as banks and their counterparties are safe and
sound, efforts to provide more financing opportunities to banks
and bank holding companies, particularly under current market
conditions, should be taken seriously. Such actions may make it
more likely that the financial markets will be able to provide
the necessary credit to sustain and enhance economic activity.
In general, the European markets appear to be useful additions
to their financial markets, successfully providing liquidity
and credit for some assets under most market conditions.
Covered bonds have been available in Europe for many years,
and such programs differ greatly across countries. Much could
be learned by studying the merits of each country's program and
applying these lessons to creating a unique program in the
United States. Creating a covered bond market in the United
States, however, may be difficult without Congressional
discussion and legislation. Covered bonds raise many issues
related to the safety net provided to banks in the United
States, including issues related to the bank deposit insurance
fund. The legal structure provided for covered bonds in
European countries resolves many of these issues. With regard
to creating a covered bond market in the United States, all
parties should seek to distill the best practices from the
European markets and work towards the establishment of a robust
and well-designed covered bond market that includes safeguards
to ensure that the safety net provided banks would not be
measurably extended further.