[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
UNWINDING EMERGENCY FEDERAL RESERVE
LIQUIDITY PROGRAMS AND IMPLICATIONS
FOR ECONOMIC RECOVERY
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
MARCH 25, 2010
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-118
U.S. GOVERNMENT PRINTING OFFICE
56-764 WASHINGTON : 2010
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
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Page
Hearing held on:
March 25, 2010............................................... 1
Appendix:
March 25, 2010............................................... 57
WITNESSES
Thursday, March 25, 2010
Ball, Laurence, Professor of Economics, Johns Hopkins University. 47
Bernanke, Hon. Ben S., Chairman, Board of Governors of the
Federal Reserve System......................................... 6
Goodfriend, Marvin, Professor of Economics, and Chairman of the
Gailliot Center for Public Policy, Tepper School of Business,
Carnegie Mellon University..................................... 45
Meyer, Laurence H., Vice Chair, Macroeconomic Advisors........... 42
Taylor, John B., Mary and Robert Raymond Professor of Economics,
Stanford University............................................ 44
APPENDIX
Prepared statements:
Paul, Hon. Ron............................................... 58
Watt, Hon. Melvin............................................ 59
Ball, Laurence............................................... 63
Bernanke, Hon. Ben S......................................... 69
Goodfriend, Marvin........................................... 76
Meyer, Laurence H............................................ 82
Taylor, John B............................................... 90
UNWINDING EMERGENCY FEDERAL RESERVE
LIQUIDITY PROGRAMS AND IMPLICATIONS
FOR ECONOMIC RECOVERY
----------
Thursday, March 25, 2010
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Waters, Velazquez,
Watt, Sherman, Meeks, Moore of Kansas, Capuano, Baca, Lynch,
Miller of North Carolina, Green, Cleaver, Bean, Perlmutter,
Donnelly, Foster, Minnick, Adler, Grayson, Himes, Peters;
Bachus, Royce, Paul, Hensarling, Garrett, McHenry, Marchant,
McCotter, Posey, Jenkins, Lee, Paulsen, and Lance.
The Chairman. The hearing will come to order, which means
the photographers will get out of the way. This is an important
hearing. We have had for some time now the Federal Reserve
System under the leadership of Chairman Bernanke playing a very
active role in dealing with the problems generated by the
financial crisis of 2008 or that culminated in 2008. I believe
the Federal Reserve has played a very constructive role in
providing liquidity in ways that helped diminish the negative
effects, and I believe the chairman and the system have also
been responsible in making clear that they are aware of the
need to undo this in a way that is protective of the taxpayers
but also is not going to damage the economy and is not done
prematurely.
The chairman of the Subcommittee on Domestic Monetary
Policy, the gentleman from North Carolina, Mr. Watt, has been
closely monitoring this. I think he has been playing a very
constructive role, and I will be turning over the job of
presiding over this hearing to him, because he has taken the
lead in this. And as we said, the Federal Reserve has a dual
role, which is to make sure that it continues to be supportive
of the economy, but that it also gets back to a more normal
status in a way that does not cause damage.
I will repeat publicly now what I have mentioned privately
to Chairman Bernanke. Part of my job here as chairman is to
hear from other members about what their current concerns are.
Not surprisingly, in a bipartisan way, I have heard concerns
from a number of members about commercial real estate and the
impending problems with commercial real estate, with loans that
have to be rolled over with problems of valuation, people
concerned that loans that are fully performing in terms of the
income may be jeopardized. One of the facilities that we are
talking about here that's due to expire has a role in
commercial real estate, so while I will not be able to stay for
the whole hearing, Mr. Chairman, I hope you will be addressing
what we can do about commercial real estate. I appreciate the
fact that you, as well as other regulators, had sent some
members of your staff here to talk to us about what could be
done. Some of the members on this committee--Ms. Kosmas of
Florida, Mr. Minnick of Idaho, Mr. Klein of Florida, and Mr.
Gutierrez of Illinois--have various proposals both to the
regulators and that could be legislated to deal with this. I
think there's general agreement that dealing responsibly with
the commercial real estate is very important.
One of the things that occurs to me again to stress is some
of this has to do with concerns over the accounting, and I
would reiterate the position we have been taking. I don't think
we should be telling the accounting board what to do or trying
to, but we can, I think, urge the regulators to show some
discretion and flexibility as they act on what the accounting
rules require.
So with that, I am now going to recognize the gentleman
from Alabama for 2 minutes, according to the Minority's list,
and the remainder of the hearing will be under the chairmanship
of the gentleman from North Carolina.
Mr. Bachus. Thank you, Mr. Chairman. Thank you for holding
this hearing, and I thank you, Chairman Bernanke, for your
testimony. The Federal Reserve, with a trillion-and-a-half
dollars of additional liquidity in the system, is faced with a
very difficult problem--how to vacuum that money out fast
enough to avoid hyperinflation, but to do so without stalling a
recovery.
Chairman Frank, an exit strategy is made necessary in the
first place due partially to a series of interventions by the
Fed and the Treasury that were both unprecedented and highly
controversial, the most questionable of which was the use of
13(3) authorities to rescue individual firms and their
creditors under the doctrine of ``too-big-to-fail.'' Of course,
House Republicans have rejected the concept of ``too-big-to-
fail'' in the long term.
Now is the time for the Federal Government and the Fed to
get out of the bailout business. As I have said previously, the
term ``intervention'' implies that the government is
interfering with the economy and market forces. An intervention
creates an artificial condition in which the system becomes
increasingly dependent on government action. You see that with
the GSEs. As with any addiction, an altered state is created
where the only choices are permanent addiction or somewhat
painful withdrawal.
That is why a centerpiece of the Republican regulatory
reform solution is not only to end ``too-big-to-fail'' but to
rein in the Fed's 13(3) authorities consistent with that goal.
To his credit, Chairman Frank has incorporated several of these
ideas in the regulatory reform bill that passed the House in
December. While there was much that we disagree with, the need
for limitations on the Fed's authority to conduct large-scale
bailouts of individual firms was one area in which there was
bipartisan consent.
In conclusion, withdrawing excess liquidity and returning
the Fed to its more traditional monetary policy role will be
difficult. If done incorrectly, it may negatively impact the
economic recovery and result in higher borrowing costs for
individuals, corporations and the U.S. Government. But this
transition must take place.
Thank you, Mr. Chairman.
Mr. Watt. [presiding] The gentleman's time has expired, and
I will yield myself--I think the balance of the time is 5
minutes.
In response to the global economic crisis, the Federal
Reserve injected over $2 trillion into the economy through
various liquidity initiatives, including the Term Asset-Backed
Securities Loan Facility, the Commercial Paper Funding
Facility, and the Fed's commitment to purchase about $1.25
trillion of mortgage-backed securities.
The immediate result of the Fed's action was to expand this
balance sheet dramatically and to put an unprecedented volume
of money into the banking system. These steps were designed to
unfreeze the domestic credit markets, and many economists
credit the decisive steps taken by the Fed with saving the U.S.
economy from collapse and staving off an economic downturn that
might have equalled or exceeded the Great Depression.
The central issue of today's hearing is how the Fed will
decide the proper timing and sequencing of unwinding these
emergency liquidity programs. The Fed must withdraw this
liquidity while keeping inflation in check and encouraging job
growth, all without hurting the fragile economic recovery that
is under way. Every analysis I have seen has suggested that
this is a delicate balancing act that will have to be done just
right to avoid significant damage to the economy. If recent
history is any guide, any decisions the Fed makes to carry out
this delicate balancing act, regardless of what these decisions
are, will be second-guessed by the Congress and the public, and
this could also lead to questions about the independence of the
Fed.
I'm hopeful that we can use this hearing to understand
better the policy options available to the Fed to unwind these
programs and the potential policy implications of these various
options. At the same time, I think we should be careful not to
infringe on the Fed's ability and willingness to exercise its
independent judgment about which options will be the most
desirable and effective.
So I view this hearing as an effort to educate members of
our committee, not as a forum for us to try to intimidate or
browbeat the Fed into pursuing specific options. We have asked
the witnesses to provide information about specific monetary
policy tools and options that are available to the Fed,
including paying interest on reserves, entering reverse
repurchase agreements, utilizing the recently introduced Term
Deposit Facility, conducting direct asset sales of the market-
backed securities it has purchased, and any other options that
might be appropriate.
We need to understand the projected advantages and
disadvantages of each option so we'll understand better what
the Fed is doing when it uses particular options, and perhaps
even be in a position to explain to our constituents why
particular steps are being taken.
I look forward to Chairman Bernanke telling us how the Fed
can effectively unwind its emergency liquidity programs while
reducing inflationary fears, encouraging job growth, and
managing the fragile economic recovery, knowing full well that
we all expect him to be the master conductor who will wave the
magic wand and lead our economy to play sweet music again.
With that, I will submit the balance of my statement for
the record, and I will recognize Mr. Paul of Texas, the ranking
member of the Domestic Monetary Policy Subcommittee, for 3
minutes.
Dr. Paul. I thank you, Mr. Chairman, and welcome, Chairman
Bernanke. On February 24th, we had our Humphrey-Hawkins meeting
here, and I asked some questions about some of the things the
Fed had done in the past, and the comments you made included
the fact that you considered this rather bizarre, what I was
saying. Chairman Frank followed up with sending a letter and
asking to get some clarification for you to look into it, and
even suggested that you and I get together so I can present
exactly what my concerns are and see if we can resolve it. And
I'm certainly open to that, so I hope that we can follow up on
that and the suggestions of Chairman Frank.
But I also wanted to make a comment about the March 19th
ruling at the U.S. Court of Appeals in Manhattan, because once
again, the Federal Reserve lost their case against the--I guess
it was Bloomberg filing for a Freedom of Information Act for
information dealing with the $2 trillion of loans during the
crisis.
Of course, that was ruled in a lower court, and the Court
of Appeals has upheld this, and the main argument the Fed uses
in the court as well as here in the hearings is that if we knew
so much about these banks and where these loans are going, it
would stigmatize these companies and banks and do harm to their
reputation and make our problems worse. I sort of understand
that argument, even though I don't agree with it, because in a
way, that challenges the whole notion of what the SEC exists
for. They want accounting procedures. They don't want to hide
information. And if they do, if it's not out in front, it
deceives the investors. So in a way, the SEC is fighting to get
information to notify investors, and if they don't do it right,
they get charged with fraud. But it seems to be perverse that
the Federal Reserve takes a different position that if a
company is in trouble or a bank is in trouble, what we don't
want to do is let the customers know. So I find that rather
challenging, because I think revelation of what's going on, and
what's going on especially now with the financial crisis, is
what the American people want.
I'm also interested in finding out someday whether or not
you will appeal this case that was ruled on March 19th, and I
think the taxpayers would like to know how much does the
Federal Reserve really spend on their legal counsels? I'm sure
there are a lot of lawyers, and I know you don't have to come
to the Congress to get an appropriation for this. So I would
like to know how you pay these bills and how much you pay.
So these are the things that we need to talk about, but
also in the question-and-answer session, I do want to bring up
some specifics about the challenges that you have for someday
maybe shrinking the balance sheet, but I will pursue that in
the question-and-answer period. Thank you.
Mr. Watt. The gentleman's time has expired. The gentleman
from Texas, Mr. Hensarling, is recognized for 1\1/2\ minutes.
Mr. Hensarling. Thank you, Mr. Chairman. On Sunday night,
the Nation's fiscal future went from grim to grimmer. If one
takes out the Bernie Madoff accounting gimmicks like the timing
shift, the unpaid-for doc fix, the raid on Social Security, and
the double accounting for the half a trillion dollars of
Medicare cuts, the true cost of the government health care
takeover bill is $2.3 trillion, or another $20,000 per American
family.
This is on top of the fact that our deficit has increased
tenfold in the last 2 years. The President has submitted a
budget that will triple the national debt over the next 10
years, a budget that even his own OMB Director says is
unsustainable. Spending as a percentage of the economy is 24.7
percent of GDP, the highest since World War II. This has caused
CBO Director Doug Elmendorf to say, ``The outlook for the
Federal budget is bleak. U.S. fiscal policy is on an
unsustainable path.''
Economist Robert Samuelson has said about our spending
patterns, ``It could trigger an economic and political death
spiral.'' Unless the Congress and the President have a sudden
epiphany of fiscal sanity, this story does not have a happy
ending. It ends in either job-crushing, family-budget-crushing
tax increases, or skyrocketing interest rates as we beg the
Chinese to buy more of our debt. Our level of inflation will
make us look longingly and nostalgically upon the Carter era.
Clearly, the actions of the President, the Congress, and the
blurring of the lines with the Federal Reserve between fiscal
and monetary policy will have much to do with the future, and I
look forward to the chairman's testimony.
Mr. Watt. The gentleman's time has expired. The gentleman
from New Jersey, Mr. Garrett, is recognized for 1\1/2\ minutes.
Mr. Garrett. Thanks, Mr. Chairman. Today, obviously we're
going to be discussing the Fed's exit strategy from the
unprecedented propping up of the economy due to the financial
crisis.
Back on February 10th, you were here, and you talked about
one of the tools that you now have, and that's paying interest
on reserves held at the Fed. I would think, and experts seem to
tell me that trying to use this and other tools is going to be
a real challenge for the Fed in order just to get it all right.
And that's not just me saying that. Renowned Fed historian Alan
Meltzer said, for instance, that he believes that the Fed's
anti-inflationary exit strategy will fail. He asserts that the
efforts to reduce inflation back during the 1970's failed
because, as the chairman points out, if you do it prematurely,
if it ends prematurely. And if it ends prematurely, it's
because of public pressure, pressure from the public, pressure
from Congress, from the Administration, and they complain
loudly because, well, these things affect the employment rate
or the unemployment rate.
We're sort of in the same situation today with high current
and prospective unemployment, and so you may be facing, as you
realize, a similar dilemma. So, here you have these political
obstacles, and I'm wondering if the Chairman and others at the
Fed have concerns about the political ramifications if the Fed
were to, say, hold reserves on the balance sheet of around a
trillion dollars, interest rates go up to say around 5 percent
that you're paying out on those, and in effect, the Fed will be
paying out, at that rate, $50 billion every year with that
balance sheet and the interest rates stayed at that level. Some
might say, then, well, the Fed would be paying $50 billion to
banks not to lend. So I'll be curious to see how the Fed will
be able to deal with that political ramifications.
Mr. Watt. The gentleman's time has expired. We are pleased
today to have again the Chairman of the Federal Reserve,
Chairman Bernanke, and we will now recognize the Chairman for
his statement.
STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you, Chairmen Frank and Watt, Ranking
Members Bachus and Paul, and other members of the committee and
subcommittee. I appreciate the opportunity to discuss the
Federal Reserve's exit strategy from the extraordinary lending
and monetary policies that it implemented to combat the
financial crisis and support economic activity.
As you know, I previously submitted prepared testimony for
a hearing on this topic that was canceled because of weather
conditions. I requested that testimony be included in the
record of this hearing. This morning, in lieu of repeating my
previous prepared statement, I would like to summarize some key
points from the earlier testimony and update the committee on
recent developments.
Broadly speaking, the Federal Reserve's response to the
crisis and the recession can be divided into two parts. First,
our financial system during the past 2\1/2\ years experienced
periods of intense panic and dysfunction during which private
short-term funding became difficult or impossible to obtain
from any borrowers. The pulling back of private liquidity at
times threatened the stability of financial institutions and
markets and severely disrupted normal channels of credit.
In its role as the liquidity provider of last resort, the
Federal Reserve developed a number of programs to provide well-
secured, mostly short-term credit to the financial system.
These programs, which imposed no cost on taxpayers, were a
critical part of the government's efforts to stabilize the
financial system and restart the flow of credit to American
families and businesses. Besides ensuring that a range of
financial institutions, including depository institutions,
primary dealers, and money market mutual funds had access to
adequate liquidity in an extremely stressed environment, the
Federal Reserve's lending helped to restore normal functioning
and support credit extension in a number of key financial
markets, including the interbank lending market, the commercial
paper market, and the market for asset-backed securities.
As financial conditions have improved, the Federal Reserve
has substantially phased out these lending programs. Some
facilities were closed over the course of 2009, and most others
expired on February 1st. The Term Auction Facility under which
fixed amounts of discount window credit were auctioned to
depository institutions, was discontinued in the past few
weeks. As of today, the only facility still in operation that
offers credit to multiple institutions, other than the regular
discount window, is the Term Asset-Backed Securities Loan
Facility or TALF, which has supported the market for asset-
backed securities, such as those backed by auto loans, credit
card loans, small business loans, and student loans.
Reflecting notably better conditions in many markets for
asset-backed securities, the TALF is scheduled to close on
March 31st for loans backed by all types of collateral except
newly issued commercial mortgage-backed securities or CMBS, and
on June 30th for loans backed by newly issued CMBS.
In addition, the Federal Reserve has been normalizing the
terms of regular discount window loans. We have reduced the
maximum maturity of discount window loans from 90 days to
overnight for nearly all loans, restoring the pre-crisis
practice. In mid-February, the Federal Reserve also increased
the spread between the discount rate and the upper limit of our
target range for the Federal funds rate from 25 basis points to
50 basis points.
We have emphasized that both the closure of our emergency
lending facilities and the adjustments to the terms of discount
window loans are responses to the improving conditions in
financial markets. They are not expected to lead to tighter
financial conditions for households and businesses, and hence
do not constitute a tightening of monetary policy, nor should
they be interpreted as signaling any change in the outlook for
monetary policy.
The second part of the Federal Reserve's response to the
crisis and recession, besides the provision of liquidity to the
financial system, involves both standard and less conventional
forms of monetary policy. After reducing short-term interest
rates nearly to zero, the Federal Open Market Committee
provided additional monetary policy stimulus through large-
scale purchases of Treasury securities, agency mortgage-backed
securities, and agency debt. All told, the Federal Reserve
purchased $300 billion of Treasury securities and will conclude
purchases of $1.25 trillion of agency MBS and about $175
billion of agency debt at the end of this month.
The Federal Reserve's purchases have had the effect of
leaving the banking system highly liquid, with U.S. banks now
holding more than $1.1 trillion of reserves with Federal
Reserve banks. A range of evidence suggests that these
purchases and the associated creation of bank reserves have
helped improve conditions in mortgage markets and other private
credit markets and put downward pressure on longer-term,
private borrowing rates and spreads.
At its meeting last week, the FOMC maintained its target
range for the Federal Funds Rate at zero to one-fourth percent,
and indicated that it continues to anticipate that economic
conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation expectations are
likely to warrant exceptionally low levels of the Federal Funds
Rate for an extended period.
In due course, however, as the expansion matures, the
Federal Reserve will need to begin to tighten monetary
conditions to prevent the development of inflationary
pressures. The Federal Reserve has a number of tools that will
enable it to firm the stance of policy at the appropriate time.
Most importantly, in October 2008, the Congress gave the
Federal Reserve statutory authority to pay interest on balances
that banks hold at the Federal Reserve banks. By increasing the
interest rate on banks' reserves, the Federal Reserve will be
able to put significant upward pressure on all short-term
interest rates, as banks will not supply short-term funds to
the money markets at rates significantly below what they can
earn by holding reserves at the Federal Reserve banks. Actual
and prospective increases in short-term interest rates will be
reflected in turn in higher long-term interest rates and in
tighter financial conditions more generally.
The Federal Reserve has also been developing a number of
additional tools it will be able to use to reduce the large
quantity of reserves currently held by the banking system.
Reducing the quantity of reserves will lower the net supply of
funds to the money markets, which will improve the Federal
Reserve's control of financial conditions by leading to a
tighter relationship between the interest rate paid on reserves
and other short-term interest rates.
Notably, to build the capability to drain large quantities
of reserves, the Federal Reserve has been working to expand its
range of counterparties for reverse repurchase operations
beyond the primary dealers and to develop the infrastructure
necessary to use agency MBS as collateral in such transactions.
In this regard, the Federal Reserve recently announced the
criteria that it will be applying in determining the
eligibility of money market mutual funds to serve as
counterparties in reverse repurchase agreements.
As an additional means of draining reserves, the Federal
Reserve is also developing plans to offer to depository
institutions term deposits which are roughly analogous to
certificates of deposit that the institutions offer to their
own customers. A proposal describing a Term Deposit Facility
was recently published in the Federal Register, and the Federal
Reserve is finalizing a revised proposal in light of the public
comments that have been received. After a revised proposal is
reviewed by the Board, we expect to be able to conduct test
transactions this spring and to have the facility available if
necessary thereafter.
The use of reverse repos and the deposit facility would
together allow the Federal Reserve to drain hundreds of
billions of dollars of reserves from the banking system quite
quickly should it choose to do so.
When these tools are used to drain reserves from the
banking system, they do so by replacing bank reserves with
other liabilities. The asset side and the overall size of the
Federal Reserve's balance sheet remain unchanged. If necessary,
as a means of applying monetary restraint, the Federal Reserve
also has the option of redeeming or selling securities. The
redemption or sale of securities would have the effect of
reducing the size of the Federal Reserve's balance sheet as
well as further reducing the quantity of reserves in the
banking system. Restoring the size and composition of the
balance sheet to a more normal configuration is a longer-term
objective of our policies.
In any case, the sequencing of steps and the combination of
tools that the Federal Reserve uses as it exits from its
currently very accommodative policy stance will depend on
economic and financial developments and our best judgments
about how to meet the Federal Reserve's dual mandate of maximum
employment and price stability.
In sum, in response to severe threats to our economy, the
Federal Reserve created a series of special lending facilities
to stabilize the financial system and encourage the resumption
of private credit flows to American families and businesses. As
market conditions and the economic outlook have improved, these
programs have been terminated or are being phased out.
The Federal Reserve also promoted economic recovery through
sharp reductions in its target for the Federal Funds Rate and
through large-scale purchases of securities. The economy
continues to require the support of accommodative monetary
policies. However, we have been working to ensure that we have
the tools to reverse at the appropriate time the currently very
high degree of monetary stimulus. We have full confidence that
when the time comes, we will be ready to do so.
Thank you, Mr. Chairman.
[The prepared statement of Chairman Bernanke can be found
on page 69 of the appendix.]
Mr. Watt. I thank the Chairman for his statement, and we
will now recognize members for 5 minutes each. I will recognize
myself initially for 5 minutes.
Chairman Bernanke, I guess one thing I usually am pretty
aggressive about is the balance between unemployment and
inflation or an emphasis on unemployment, and again there seems
to be more emphasis in your statement about making sure we
counter inflation than on the employment side. So I guess my
first question would be, how should the high unemployment rate
factor into the Fed's timing and sequencing decisions? And if
you could elaborate on that a little bit more.
Mr. Bernanke. Certainly. Of course, as you know, we have a
dual mandate from the Congress to pursue both maximum
employment and price stability, and we intend to do that. The
two are mutually reinforcing, in particular maintaining stable
inflation over the longer term increases economic growth and
improves employment potential in that respect. So it's very
important that we pay attention to both sides of the dual
mandate, and we will do so.
Currently, the employment situation is very weak, as you
know. The unemployment rate is close to 10 percent, and about
40 percent of the unemployed have been unemployed for a long
term. In response to that, the Federal Reserve has been
maintaining extremely accommodative policies. We have lowered
the interest rate almost to zero. We have increased the size of
our balance sheet, as I described, to $2.3 trillion, 2\1/2\
times what it was before the crisis. So, we are producing some
very substantial support for the economy. And as we have
indicated in our statements, we believe that the overall
configuration of resource utilization and inflation will be
such that accommodative policy will be justified for an
extended period. And so we are certainly not ignoring that side
of our mandate.
Mr. Watt. I'm sure my ranking member may think that I'm
throwing you a softball when I ask this question, but I seem to
detect in your statement a greater emphasis on transparency at
the Fed, particularly on page 4 where you say that the Federal
Reserve recently announced the criteria that it will apply to
determine the eligibility of money market mutual funds to serve
as counterparties. That's something that you are announcing
pretty far in advance. And then a proposal describing a Term
Deposit Facility was recently published in the Federal
Register, and the Federal Reserve is finalizing a revised
proposal. Am I misreading that you all seem to be putting a
greater emphasis on providing more transparency to the public
and to the people that you deal with about how the Fed is going
to play this out?
Mr. Bernanke. We have been very much committed to
maintaining high transparency. We will continue to explain and
communicate as clearly as possible our criteria and how we're
going to forward with withdrawing stimulus. And we'll be
providing information, as we already are, for example, on the
specifics of our asset purchases and what we hold.
As I mentioned in my testimony, we have just recently
phased out, and with the TALF in June we will have phased out
all of our 13(3) facilities that we created to support troubled
financial markets. And as I mentioned in my Humphrey-Hawkins
testimony before this committee, we are quite open to a very
full auditing of those facilities by the GAO, including with an
appropriate delay the names of all the firms to which we made
loans. So we understand the importance of transparency, and I
promise you that we will continue to do that.
Mr. Watt. And you have announced closing dates for a
couple--at least one of the facilities--March 31st and June
30th. Are there potential specific impacts that we could see
from closing those facilities? Could you elaborate on whether
there may be specific impacts in doing that?
Mr. Bernanke. Mr. Chairman, these facilities were created
under the 13(3) emergency authority because conditions were
unusual and exigent. The markets were highly disrupted, and
highly dysfunctional. In substantial part because of our
interventions, those markets are now working quite normally. So
there's no longer a justification for holding those facilities
open. And as I mentioned, we had closed most of them as of
February 1st, and so far we have seen no adverse circumstances.
In the case of the asset-backed securities market, which is
the one remaining area where we are providing support, while
that market has not completely returned to normal, we have seen
considerable improvement. For example, the spreads between the
ABS yields and the Treasury yields have come in considerably.
Those markets are now exhibiting issuances without any kind of
Fed support. And so, you know, we believe that it's appropriate
as those markets are returning to a more normal condition that
we withdraw that support.
Mr. Watt. Thank you. My time has expired and I'll recognize
the gentleman from Alabama, Mr. Bachus.
Mr. Bachus. Thank you. Chairman Bernanke, I want to
acknowledge that you have been talking about transparency for
several years, and you have been an advocate on the Board, and
I appreciate that. I think there are distinctions we draw
between transparency when it comes to the 13(3) actions and
monetary policy, and I think there's a consensus on the 13(3)
programs, and some of the extraordinary things, and I think
that we can get there on the monetary policy.
As part of your quantitative easing strategy, you're going
to stop purchasing mortgage-backed securities at the end of
this month. Does that indicate that you believe that maybe
housing has reached a sustainable level?
Mr. Bernanke. Well, the housing market, Congressman, as we
all know, is still quite weak, and we have just seen some very
weak sales numbers in the last few days. But we do believe that
the mortgage markets are performing better and mortgage rates
are quite low from a historical perspective, and moreover, our
purchases of mortgage-backed securities were also intended to
create better conditions in private credit markets more
broadly. And we're seeing, for example, record issuance in the
corporate bond market. So we think that our program has been
effective.
We announced quite a while ago that we were going to stop
those purchases, taper off those purchases at the end of this
quarter. When we did that, we of course were concerned that
when we stopped that, mortgage rates might pop back up or we
might see some fallback in financial conditions. We'll of
course continue to watch that situation, but so far, there
seems to be very little negative reaction, which is
encouraging, and that would allow us to stop our purchases
without concerns about the implications for the economy.
Mr. Bachus. I guess that is some indication that you
believe we may have reached sustainable prices in housing or at
least the short-term prospects for housing are more stable?
Mr. Bernanke. As I have said in the past, knowing the
correct value for any asset is a difficult challenge, but many
economists have pointed out that the ratio of house prices to
rents, for example, is very much in a normal range, and between
low mortgage rates and the decline in house prices,
affordability of housing for people who want to buy homes is
now at a very good level.
Mr. Bachus. All right. Thank you. I appreciate that some of
the actions that were taken in the financial markets by the Fed
were a result of an economy that was under extreme stress. I'm
not sure the American people realize the challenges, and they
were somewhat unprecedented. And so I think some of the actions
that were taken were, because of financial markets, in what I
have said was a heart attack or a stroke condition almost.
Having said that, we want to avoid that in the future. And
my concern as we're talking about regulation, we're talking
about tools to deal with this, but--and I would like your
thoughts on this. I don't believe that even with all the tools
and all the regulations, if we don't get our fiscal house in
order, the Congress, you're not going to be successful. I think
reining in the growth of debt is simply going to be impossible
for you to do your job if we don't do ours. And I have listed
budget reform, entitlement reform, tax reform.
I think--do you agree that those--it's critical for
Congress to take action and do that now to avoid another
catastrophic event, whether it's 2 years, 5 years or 10 years
from now?
Mr. Bernanke. Congressman, we have very high deficits this
year and next year, and given the severity of the recession,
it's unlikely we could get a balanced budget in the next year
or two. And I think we all understand that.
But my concern is that our projections, whether they come
from the Administration or from Congress or from outside
analysts, still show deficits between say 2013 and 2020 of
between 4, 5, 6, and 7 percent of GDP, which, if that happens,
would cause the ratio of debt outstanding to our GDP to rise to
very high levels. I think while that's still sometime in the
future, the risk exists that even today investors, creditors
might become concerned about our ability to maintain a
sustainable fiscal position.
So I think it is very important that the Congress try to
develop a plan, a program, an exit that will be a credible plan
for returning to a sustainable fiscal situation over the next
few years.
Mr. Bachus. Thank you.
Mr. Watt. The gentleman's time has expired. The gentlelady
from California, Ms. Waters, is recognized for 5 minutes.
Ms. Waters. Thank you very much, Mr. Chairman. I would like
to thank Mr. Bernanke for being here today. The last time he
was here, we had a limited discussion about the Federal funds
rate. There's going to be some testimony here today by Dr. Ball
of Johns Hopkins, where he says the Fed should not raise the
Federal funds rate in the near term. His exact quote is,
``Someday the economy will recover and the Fed should raise the
Federal funds rate, not soon but someday.'' Would you agree
with this assessment? How long would unemployment have to go in
order for you to think it was appropriate to raise the Federal
funds rate? Do you agree with Dr. Ball's assessment that the
Fed should give greater weight than usual to unemployment when
deciding how to set rates?
I raise this question because, as you know, the National
Urban League released its State of Black America report for
2009 yesterday. We know that last month, Blacks were unemployed
at nearly twice the rate of Whites, 15.9 percent to 8.8
percent. The gap since 1974 is just barely closing. In
considering the question on the Federal funds rate, do you
consider this wealth and employment gap to be a serious
problem? Do you think that a rising tide for the overall
economy will actually reduce the gap? Based on your experience
as an economist, should we be targeting stimulus to the
communities with the greatest needs? On and on and on. I guess
I have been talking to you and others about the unemployment
rate among African Americans, Latinos, and the rural poor for a
long time. I hear nothing about what we can do in terms of
targeting. I hear no plan coming forth about how we can involve
these communities in opportunities that would reduce the
unemployment. Can you help me out with this in some way today,
in talking about the Federal funds rate or any other aspect of
your responsibility to help us understand what we can do?
Mr. Bernanke. Certainly. First, we are in complete
agreement that the high unemployment rate is a tremendous
social and economic problem in the United States today, and
just a quick look at the figures verifies that minority
immigrant populations suffer from much higher unemployment
rates than the average.
And that's bad for social integration, it's bad for
progress in the communities, so I absolutely agree with you
that's a very severe problem, particularly when you have as you
have today a lot of long-term unemployment. Because it's one
thing to be out of work for a month or two, but if you're out
of work for 6 months or a year, then you begin to lose your
skills, you begin to become very unattractive to employers, and
it's clearly a long-term negative and not just a short-term
negative.
As I have said to Chairman Watt, the Federal Reserve takes
very seriously its responsibility to try to induce maximum
employment, and that's precisely why we have done these
extraordinary things to go beyond zero interest policy to
expanding our balance sheet and providing as much stimulus as
we can to get the economy moving again, and we consider that to
be very important.
As we exit at some point, of course, we'll try to pay
attention--we will pay attention to employment and how that's
evolving. We will not be able to wait until things are
completely back to normal, because monetary policy takes some
time to operate, and given those lags, we're going to have to
anticipate to some extent the return of the economy back to
normal conditions. But we certainly want to be sure that the
economy is on a sustainable growth path and that jobs are being
created as we begin to withdraw some of the--
Ms. Waters. Excuse me, Mr. Chairman, I don't want to
interrupt you. Do you have any ideas about what we could do
about the extreme unemployment in these communities, rural
poor, African Americans, Latinos?
Mr. Bernanke. Sure.
Ms. Waters. I understand what you're saying, and you
correctly described the problem, reiterating what we all know,
but what plans, what ideas do you have about how we can target
these communities to get rid of this unemployment?
Mr. Bernanke. Well, I was talking about the Federal
Reserve's role, but there are certainly a number of things that
Congress can consider.
Ms. Waters. Well, now I really do want to know the Federal
Reserve's role. Is there anything that you can recommend?
Mr. Bernanke. I can recommend things. For example, I met
yesterday with Community Development Financial Institutions,
CDFIs--I'm sure you're familiar with those--who are taking
funding and bringing it to underserved communities to try to
create economic opportunities. I think that's a very valuable
direction.
I know Congress is looking at education and training
issues, and I think given the long-term unemployment issues,
trying to make sure people can either retain their skills or
get new skills is going to be very, very important. There are a
number of proposals out there for job creation through fiscal
measures. I think it's really up to Congress to decide what
combination of actions to take, but certainly there are things
that you can do through the States, for example, to try to
increase employment. But many of those programs are fiscal, and
therefore are the appropriate province of the Congress.
We at the Federal Reserve have a lot of economic analytical
capability, and as you know, we are always willing and
interested to provide technical assistance to any
Congressperson working on a program. We have worked with
Treasury on their employment programs, and we stand ready to
provide any kind of help we can, and if you have some specific
things you would like us to work with you on.
Mr. Watt. That might be one of those issues that we want to
pursue outside the context of this hearing. The gentlelady's
time has expired, and the gentleman from Texas, Mr. Paul, is
recognized.
Dr. Paul. I thank the gentleman for yielding. I imagine
everybody agrees that the increase in the monetary base in this
last year-and-a-half is probably historic. I don't think we
have much in our history to look back at as a precedent. So I
would assume that we can't look back too easily and look at
trying to solve a problem like this and what we have to do and
how much the monetary base has to shrink.
As we talk about this, I think most people assume that
they're waiting for a signal from you when the balance sheet
might shrink. But even in the Depression, when it shrunk 16
percent, it wasn't done purposely; it was the way the system
was working back then. Can you give me a rather quick answer on
this? Do you have any idea what percentage the base should
shrink or might shrink, or is that something that you don't
even want to address?
Mr. Bernanke. No. I think we would like to bring the
balance sheet back to something consistent with where it was
before the crisis, which means enough to accommodate Americans'
demand for currency plus a modest amount of reserves in the
banking system, and that would suggest something under a
trillion dollars I think would be--
Dr. Paul. A trillion dollars?
Mr. Bernanke. Or less, yes.
Dr. Paul. Okay. Of course, that would be very
unprecedented. During the crisis that Paul Volcker had to deal
with from 1979 to 1982, it was considered a major problem. The
inflation got out of hand at 15 percent and he had to come in
and do something. And I guess the question is, how much did he
have to shrink the balance sheet during those 3 years?
Mr. Bernanke. Well, not very much. He was focused on money
growth in particular. So he wasn't clearly in a situation where
we are now where there are these large, unused balances. I
would point out that he was focused on M1 and M2 growth. M1 and
M2 are not doing anything now. They're very flat. It's just the
base, as you point out.
Dr. Paul. Excuse me, but the truth is, is during that time,
which was considered very tight money, the monetary base was
still growing, during those 3 years, the monetary base grew 31
percent. So my suggestion is, it might not be so easy to cut
back, because even in the midst of an inflationary crisis like
that, because maybe in 6 months or a year from now when you
decide to do something, maybe there will be an increase in M1
and M2, and then it will be a different ball game when you're
dealing with this.
But I have another question dealing with something you said
on page 4 when you talked about one tool that you will have.
Because quite frankly, I think if we get into a situation where
this housing crisis reemerges, which I believe it is, it is
going to be difficult for you to do what you say, because
that's why you have been obviously hesitant to do anything.
But you said one of your tools will be to pay interest on
the balances, and that will cause banks to do different things
and borrowers to do different things. And of course, I see that
as a method of price fixing. In the early part of the last
century, the free market economists said that socialism
couldn't work. It wouldn't work. It would fail. And socialism
and communism would fail because of pricing. And I assume that
you would endorse this principle that wage and price controls
aren't necessarily the best way to handle rising prices. Is
that a safe assumption?
Mr. Bernanke. Absolutely.
Dr. Paul. Okay. My question and concern in economic policy
is, isn't fixing interest rates in order to get the economy to
do something a form of price fixing? The importance of prices
in a free market is to tell the businessman and the consumer
what to do. If the price is too high, they don't buy, and the
businessman responds to supply and demand. Why is that not true
in money? Money is one-half of every transaction. So if we're
working on this false assumption that you're exempt from the
market forces and you have some type of unique ability to say,
ah, interest rates are different. I know what is best. I know
what they should be. They should be zero percent for 15 months
instead of 16 months. Why does that logic not apply to fixing
interest rates?
Mr. Bernanke. Because if you believe that wages and prices
are not perfectly flexible, and there are many that are not,
then the economy can get pushed away from full employment, as
it obviously is today. And economists of all stripes, including
Milton Friedman and others, agree that using monetary policy,
monetary policy can be a useful tool to try to create growth
and stability. In this particular case, low interest rates
create more demand and can help bring the economy back to full
employment.
Now obviously there are limits to that, and we recognize
those limits, but changing the interest rate is really just the
other side of changing the quantity. Quantity and price are two
sides of the same equation, as you know. So we can either
change the quantity or we can change the price. By changing the
price, we affect economic activity and try and achieve the
objectives that the Congress has given us.
Dr. Paul. Well, my fear is--
Mr. Watt. The gentleman's time has--
Dr. Paul. --that your results will be the same as wage and
price controls.
Mr. Watt. The gentleman's time has expired. The gentlelady
from New York, Ms. Velazquez.
Ms. Velazquez. Thank you, Mr. Chairman. Good morning,
Chairman Bernanke.
Mr. Bernanke. Good morning.
Ms. Velazquez. The Central Bank is currently in the process
of winding down the TALF facility which provided vital
liquidity for commercial real estate and small business
lending. Many experts have expressed concern that these lending
sectors remain vulnerable to further losses. Without the TALF,
what will the Fed do in the event that instability returns in
the CRE or small business lending markets?
Mr. Bernanke. Let me put aside just for a moment the CRE.
In the other categories, credit cards and auto loans and
student loans and small business loans, we have seen the
secondary market, asset-backed securities market, coming back
pretty well, and we have been seeing spreads that are normal.
We have been seeing issuance outside the Fed's facility. So
it's not 100 percent normal, but we have seen considerable
improvement in those asset-backed securities markets.
Now CRE is a difficult problem, as you know, and the basic
reason at this point is that the prices of commercial real
estate across the country have dropped, in many areas 40
percent or more, which obviously makes the creditworthiness or
their credit risks much greater, and has made it much more
difficult to obtain credit.
We have been attacking that issue from a number of fronts
at the Federal Reserve. The TALF is just one dimension. The
commercial mortgage-backed securities market is not completely
normalized, but it has improved, and those spreads have come
in. And we believe that it's getting more and more difficult
for us to justify our unusual and exigent emergency powers in
the context of a market that is improving.
But we recognize there are a lot of issues still, and
that's why we have, for example, issued guidance to the banks
about how to manage their CRE portfolios, and in particular how
to make sure that they provide credit where the borrowers are
creditworthy, and try to help them work out loans that are
troubled and find ways to solve that problem.
So we're working more through the banks now at this point
than through the MBS market or CMBS market. But that is a
troubled, certainly one of the most difficult areas right now.
Ms. Velazquez. Mr. Chairman, we continue to hear that small
businesses are facing a problem of accessing credit. In your
view, is the lack of liquidity the root cause of credit for
small businesses? What is it?
Mr. Bernanke. Well, there are a lot of reasons. There has
certainly been a big drop in the demand for credit from small
businesses because of weakness of the economy. And in some
cases, small businesses have had financial reverses, which make
it much more difficult to lend to them. But all that being
said, there certainly are creditworthy small businesses that
cannot obtain credit, and again, that has been an important
priority of the Federal Reserve, and we have worked with the
Congress and the Treasury as well to try to support small
business lending.
Once again, we have issued guidance to the banks about
encouraging lending to small businesses and have trained our
own examiners to take a balanced perspective, that they not
over-penalize loans to small businesses. We are trying to get
as much feedback as we can. For example, we have inserted
questions in the NFIB survey to get back more information from
small businesses about their credit experience. And currently,
our reserve banks around the country are holding meetings with
small businesses, banks, and community development groups to
try to understand better what the issues are and how we can
improve small business lending.
So it's a tough problem. I think there are some proposals
from Treasury that I think are worth looking at, but we are
certainly working with the banks on this issue.
Ms. Velazquez. Can we talk about the $30 billion proposal
from Treasury for a moment? Should regulators be concerned that
the banks who participate in this program may stretch to make
imprudent loans in an effort to reach lending levels that
deliver higher interest rate incentives?
Mr. Bernanke. There are various ways to structure the
program, but all the ones that I understand basically make the
bank have some skin in the game. That is, they share in the
loan, and if the loan goes bad, then they'll lose at least part
of the loss. And I think that's the reason to try to use the
small banks in particular to make these loans, because they
have the information and the expertise to make them. So as long
as the banks have sufficient incentive to make good loans
because they'll lose money if they don't, then I think that
will reduce that risk considerably.
Ms. Velazquez. And do you think that without any strings
attached to the $30 billion that the banks will make small
business loans?
Mr. Bernanke. There should be strings attached in terms of
being able to report that they increased their lending by a
certain percentage.
Mr. Watt. The gentlelady's time has expired.
Ms. Velazquez. Thank you.
Mr. Watt. The gentleman from California, Mr. Royce.
Mr. Royce. Chairman Bernanke, I think most economists
believe that creating a massive new entitlement, the health
care entitlement bill that we passed, is going to add to our
deficit. I do not think anyone in here believes that we are
going to cut half a trillion dollars out of Medicare, as we say
we are in the bill, in order to help pay for it. So, Congress
is adding to the deficit. And on that note, in recent weeks,
Brookshire-Hathaway and Proctor and Gamble, and Lowes, and
Johnson and Johnson's debt traded at lower levels, lower
yields, than Treasuries of similar maturity.
And essentially, the market is saying it is now safer to
loan to Warren Buffet than it is to the United States
Government. Now, Mr. Geithner disagreed with that conclusion or
that assessment. I would just ask you your view, because I do
not know what else it could mean, and I would also ask if you
have ever seen this in the bond market? What does this say
about our fiscal outlook?
Mr. Bernanke. It is very unusual, certainly. There are a
number of possibilities. The one you raised, I guess, is one
possibility, although if the U.S. Government is not paying off,
then there's going to be a huge amount of economic dislocation
that would affect everybody.
I think one of the issues recently has been, and this would
be consistent with what you are saying, that the U.S.
Government's very large debt issuances have been very big
auctions with lots of borrowing going on, has put some pressure
on the normal purchasers of that debt and they have had a
preference for diversifying into corporate debt, as you
described. So--
Mr. Royce. But, let me ask you about that because the
Federal Reserve in one analysis I saw purchased a staggering 80
percent of the $1.5 trillion of debt issued by the Federal
Government last year. If we run a trillion and a half deficit
here, somebody has to buy it. And I think it was the PIMCO
analysis that said that 80 percent of that was bought by the
Federal Government.
I know there was some opposition from some people within
the Fed in terms of doing that, but you have pundits quipping
that, in essence, this is like a Ponzi scheme. So, with
yesterday being the worst day since last July for 10-year U.S.
Treasuries, is the Federal Reserve considering getting back
into the business of buying U.S. Treasuries or are we laying
off of that approach for awhile?
Mr. Bernanke. Well, Congressman, that number is not
correct. We purchased last year $300 billion in Treasuries,
which was much less than 80 percent and that total number
brought us back to $790 billion which is about where we were
before the crisis. So, at this point, the Fed owns the smallest
share of U.S. Government debt as it had for many, many years.
We are not monetizing the debt and we have no immediate plans
to do so in the future.
Mr. Royce. Let me ask you another question. I appreciate
your analysis on that, and I was struck when I read the
analysis from PIMCO and I do not know how they perceived the
amount of government intervention into the market here, but let
me ask you one last question. The Dallas Fed president, Richard
Fisher, said of the easy money policy during the most recent
housing boom, rates held too low for too long during the
previous Fed regime were an accomplice to the reckless
behavior.
Now, I remember The Economist, the British magazine,
arguing at the time when we lowered the Fed funds rate to what
effectively was below inflation, that we were going to face a
boom, a bubble in the housing market. And they also argued that
because Europe would have to follow suit to be competitive, it
was going to cause a bubble there, as well.
And year after year after year that rate was held that low.
I would just ask you, given the Fed's track record, what
assurances do we have that the Fed will be any more vigilant
when the next bubble begins to form? Is it even possible to
take away the punch bowl, as they say, just as the party is
getting started?
Mr. Bernanke. I do not want to rehash history, but I think
there is a lot of conventional wisdom out there about the
earlier episode, and we have published a paper looking at the
evidence, and I think it is much less clear than some people
would make it.
But, putting that aside, we recognize that the very low
interest rates we have today, that a number of people have been
concerned about the possibility of creating a bubble in some
asset class, I am not clear which one, and all I can say is
that we agree that it is important to monitor what is happening
in financial markets. We are doing that and although it is very
difficult to know whether an asset is appropriately priced or
not, we do not see at this point any major mispricing in
important asset classes right now.
Mr. Royce. Thank you, Chairman Bernanke.
Mr. Watt. The gentleman's time has expired. The gentleman
from California has deferred until later in the process, so the
gentleman from New York, Mr. Meeks, is recognized for 5
minutes.
Mr. Meeks. Thank you, Mr. Chairman. Chairman Bernanke, it
is good to see you again. I just want to make sure that first,
let me get an understanding with the talks in reference to
interest rates. I know that at the last FMOC meeting, the
President of the Federal Reserve Bank of Kansas City, Tom
Hoenig, dissented in regards to the use of language about low
rates for an extended period of time. He basically made the
argument that does not give the Fed the flexibility that it
would need in case the recovery happens at a quicker pace and
that people are starting to build on expectations into the
market place because of the low interest rates.
So, do you, I am just asking you, first of all, can you
have the flexibility that you need and then if the economy
improves at a quicker rate, can you be flexible without
shocking markets that are building in the expectations about
the low interest rates?
Mr. Bernanke. Yes, we can. Mr. Hoenig's specific concern
was the same one I talked to Mr. Royce about, which was about
bubbles and asset imbalances, and as I say, we are looking at
that issue. But, I think it is very important to keep in mind
that when we talk about an extended period, we are not saying a
fixed period of time, we are saying a period of time which
depends on how the economy evolves. And our statement very
specifically says it depends on the level of resource
utilization or unemployment, it depends on what inflation is
doing, and it depends on inflation expectations.
So, if those things begin to move, then obviously that is
going to lead us to respond appropriately.
Mr. Meeks. I'll tell you what my concerns are just in the
housing market, for example, in that regard. What takes place,
or what is taking place in America in a lot of communities, is
a lot of people are underwater right now with their mortgages.
And some are okay, they are making their payments if they have
these adjustable rates because the interest rates are low. And
so, they are not concerned because they are making it now, but
if those interest rates suddenly jump up, then they are going
to have a problem paying their mortgage, you know, that shock
and where we go.
Now, Bank of America has recently, I just want to ask this
question, has said that they are going to, as opposed to just
reducing interest rates, they are going to reduce principal by
as much as 30 percent. So, I would like to know: (a) do you
think that would have a significant impact on reducing
foreclosures in the future, because I'm concerned about
foreclosures going up in the future; and (b) what is the Fed
doing, if anything, to encourage other banks to lower the
principal as opposed to just reducing interest rates?
Mr. Bernanke. Well, I think one thing we are learning is
that when it comes to addressing foreclosures, one size does
not fit all. There are people with different types of problems.
There are people who have a payment which they cannot afford
and a lot of the programs we have seen so far, like the HAMP
program, are about getting the payment down.
Then, you have people who are unemployed for a period of
time. Maybe they can afford their house in a longer term, but
for a period of time, they do not have the income and they need
temporary help.
Then, you have a lot of people around the country who are
underwater, as you say, and the Federal Reserve has argued for
several years that one strategy is to help people who are
underwater to build up equity again so that they will have an
incentive to stay in the home and continue to make the
payments.
Going forward, I think it is useful to have all these
different strategies, because each different type applies to a
different group of people. I don't know that much about Bank of
America's specific approach. A lot depends on the details. But,
I am glad to see that they are including this strategy. The
industry was very reluctant to use principal reduction for a
long time. And I am glad to see that they are opening up now
the idea of using that as one tool to address foreclosures.
The Federal Reserve, as a bank regulator, we put out
guidance in November of 2008, and we are certainly strongly
urging banks to be responsible in restructuring of their
mortgages where necessary, and in particular, in participating
in the Administration's and Congress' plans to help underwater
borrowers.
Mr. Meeks. Do you see or do you have the concerns that I
have, that we could have another foreclosure crisis, though,
given the way that the markets are and the interest rates right
now, especially those that are still in adjustable rates,
especially those who are underwater, because they cannot
refinance their mortgage to get a fixed rate and thereby--
Mr. Watt. The gentleman's time has expired, so the Chairman
will perhaps answer that question.
Mr. Bernanke. Later?
Mr. Watt. Later or briefly.
Mr. Bernanke. Okay. We control the very short-term rates.
There are very many fewer adjustable rate mortgages out there
now than there were a few years ago. Most people have fixed-
rate mortgages, and so they would not be affected very much by
our policy.
Mr. Watt. The gentleman's time has expired. The gentleman
from Texas, Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman. Good morning,
Chairman Bernanke. Yesterday, we had a hearing, yesterday or
the day before, with Secretary Geithner regarding the GSEs. In
a line of questioning from my colleague from New Jersey, Mr.
Garrett here, the Secretary first said that the debt of the
GSEs was, ``as I said, it is not sovereign debt.'' And he also
said, ``we are going to make sure that these institutions have
the resources they need to meet their commitments past and
future,'' which may be a distinction without a difference on
whether or not the GSE debt is sovereign debt.
Clearly, as your balance sheet has inflated, a lot of this
is agency MBS, a lot of it is clearly GSE paper. As I
understand your current strategy, the program to purchase the
agency MBS is about to wind down, or has wound down. Is that
correct?
Mr. Bernanke. At the end of March, yes.
Mr. Hensarling. At the end of March? So, literally in a
matter of days. But, you still have a lot of this on your
balance sheet. As I understand it, your strategy is to retain
most of it, although you, to hold to maturity, although you
hold open the option of perhaps selling it when market
conditions improve. Do I understand the strategy of the Fed
correctly?
Mr. Bernanke. We would like to get back to an all-Treasury
portfolio within a reasonable amount of time. So, we are
currently letting GSE paper that redeems, that matures, we're
letting it roll off. And I anticipate that at some point we
will, in fact, have a gradual sales process so that we can
begin to move our balance sheet back to its pre-crisis
condition.
Mr. Hensarling. There was an article in The American Banker
yesterday concerning your strategy. I will read from a portion
of it. It talks about when you announced that you would slow
your MBS purchases, cease them by the end of the first quarter,
that mortgage bankers winced.
``They fear that without the Fed to prop up such,
securities would sink causing their yields relative to
benchmarks like Treasury bonds to soar. Such an increase would,
in turn, cause mortgage rates to jump, sapping demand for home
loans in an already weak market, but it appears that the
industry's worst fears were unfounded. Market participants
point to several reasons for the relative stability. For one,
their traditional MBS buyers that were pushed to the sidelines
when the Fed came in are ready and waiting for their chance to
get back into the market.''
Would you agree with the assessment of that American Banker
article?
Mr. Bernanke. Broadly speaking, yes.
Mr. Hensarling. Let me ask you this, Mr. Chairman, then. As
you are aware, the Administration has not put forth a plan in
dealing with the long-term future of the GSEs. Neither has
Congress heretofore. I personally have introduced my own bill
to deal with the GSEs that, over a 5-year period, would
essentially send them back to a competitive marketplace by
slowly ratcheting down their portfolio holdings, their
conforming loan limits, raising their capital standards to that
of insured depository institutions. You know, it's at last a
plan.
I guess my question for you, Mr. Chairman, is, I do not
believe anybody believes that we can do without the GSEs in the
short term, but as you have said in earlier testimony, it is
important for us to show a sustainable fiscal path for the
future. How important is it that the future of the GSEs be
included in that sustainable fiscal path, and if we do not do
it, what are the implications for you unwinding your balance
sheet?
Mr. Bernanke. Well, I think, as I said last time, if we can
begin to map out a future for the GSEs sooner rather than
later, even if we do not execute that immediately, it will
remove some uncertainty from the mortgage market and it will
also help give confidence about the future of the Federal
budget because it will give clarity about what obligations,
implicit or explicit, the Federal Government is taking on.
Mr. Hensarling. Mr. Chairman, if I could, I hate to be
rude, but I see my time is winding down. I am going to attempt
to slip in one more question. In the next panel, we are going
to be hearing from economist Dr. Taylor. I read part of his
testimony and if I could quote from it:
``Whether one believes that these programs worked or not,
alluding to the Federal Reserve programs, there are reasons to
believe their consequence going forward are negative. First,
they raise questions about Fed independence. The programs are
not monetary policy as conventionally defined, but rather
fiscal policy or credit allocation policy or mundustrial
policy, a word that has not been previously in my vocabulary,
because they try to help some firms or sectors and not others
and are funded through money creation rather than taxes or
borrowing.''
Perhaps you could comment upon that in writing, on whether
or not you agree with that assessment. Thank you.
Mr. Watt. The gentleman's time has expired and we will
allow subsequent written responses. The gentleman from Kansas,
Mr. Moore, is recognized for 5 minutes.
Mr. Moore of Kansas. Thank you, Mr. Chairman. Chairman
Bernanke, looking at how debt and leverage have been used in
the past decade by financial firms, non-financial businesses,
consumers, and the government, we seem to have developed an
unhealthy dependence on the use of credit cards, overleveraged
balance sheets, and massive deficits to seek economic growth
and prosperity.
Analysis by Morgan Stanley shows total credit outstanding,
including households, financial firms, businesses, and
government, amounted to roughly 350 percent of GDP at the end
of 2008. Clearly, this is unsustainable. And the McKinsey
Global Institute noted that the leveraging can last a painful 6
to 7 years after a financial crisis.
Do you believe that we are too dependent on debt and
leverage, Mr. Chairman? And if so, how should we encourage and
restore fiscal responsibility and restraint in the use of
credit and debt across-the-board? And most importantly, for the
financial sector but also for government, for businesses, and
for individuals and families?
Mr. Bernanke. I think there are debt concerns and they
affect different sectors differently. For the banking sector,
for example, there was too much leverage and that is part of
the reason why we had the financial crisis. The Federal Reserve
and other agencies are working internationally to try to
develop higher, more rigorous capital standards, which we will
try to phase in slowly so as not to disrupt the recovery too
much. But, going forward, there needs to be higher capital, and
lower leverage in the financial system.
More generally, we need to have a better balanced economy.
We need more saving by consumers and we need a better fiscal
situation, as we have discussed already several times. And
that, in both cases, that would involve less debt by the public
and private sectors. On the other hand, we need to make sure
that there are sources of growth going forward. And if it is
not going to be consumer spending, then what is it going to be?
One area certainly is capital investment, which increases
productivity and leads to long-term growth. And another is net
exports. We have a current account deficit, a trade deficit,
and we are borrowing to finance that. That is another form of
debt. We would like to have an economy that has a better
balance in our trade so that exports would be a source of
demand, a source of growth for our economy.
So, yes, debt and lack of saving is an important issue. It
is a somewhat different issue for the financial sector, private
sector, government, and the trade sector, but in each of those
areas, I think we need to work to a more balanced situation.
Mr. Moore of Kansas. Thank you. Mr. Chairman, I am
interested in learning more about the repurchase agreements, or
repos and reverse repos that the Fed is utilizing to safely
unwind the emergency programs set up to deal with the crisis.
In particular, I feel like we have not given enough attention
to the short-term financing market that Wall Street firms and
others have depended on for their financing. In addition to the
repo market, I am thinking about the commercial paper and money
markets, as well.
When we learned about Lehman using repo 105 to conceal its
leverage, I wonder if this short-term financing market is
another shadow market where there is not a lot of transparency
by its very nature. It provides an opportunity for more shady
financial activity in the future.
Would you explain, Mr. Chairman, how the Fed itself uses
these repos and then share any thoughts you have on improving
financial stability in terms of how the short-term debt and
liquidity markets function, especially in a crisis?
Mr. Bernanke. Well, I would like particularly to address
the functioning of that tripartite repo market, which is a
short-term market that allows money market mutual funds,
pension funds, and others to park their money for short
periods. It is a huge market, it is two and a half trillion
dollars, or so. And the Federal Reserve has been very much
engaged in trying to make that market stronger, more resilient.
We were very concerned back in the crisis, one of the
reasons we were so worried about the failures of Bear Sterns
and Lehman Brothers was that we thought it might lead to a
collapse of this critical market and so, in recent quarters,
the Fed, the private sector, and others have been working
together to try to improve how those markets function, and in
particular, that we would have a set of protocols that we could
have used in case a major player failed, a major firm were to
fail.
So, we want to make those markets stronger. That,
indirectly, helps with the ``too-big-to-fail'' problem because
if we feel that the system is strong enough, there is less need
or danger in allowing a firm to fail.
So, we are very much interested in strengthening those
markets. The Fed is very active in the repo market now, but in
order to help reduce reserves in the system, we are looking to
broaden the people we trade with to include not just the
primary dealers whom we deal with on a daily basis, but also a
wide range of other short-term money providers like money
market mutual funds, that we have already worked with.
We are expanding that so that we will be able to drain
reserves effectively as we come to the point where we need to
tighten monetary policy.
Mr. Moore of Kansas. Thank you, Chairman Bernanke. And Mr.
Chairman, I yield back my time.
Mr. Watt. The gentleman's time has expired. The gentleman
from New Jersey, Mr. Garrett, is recognized for 5 minutes.
Mr. Garrett. Thanks, Mr. Chairman. Chairman Bernanke, you
made the comment, and you said it here as well, and everybody
agrees, that you want to try to shrink back the balance sheet
to just the prior date, which is, everybody here agrees, a good
thing. But, the economy was really big then, too, and since
that time, things have changed. You have lost, sort of, the
shadow banking system that is really not there anymore. The
huge multiplier effect that is out there, the money supply,
that is not there anymore, the leverage ratios that we have had
in the past, they are not there anymore.
So, with all that gone, which was really making the economy
grow at a good pace, with those things gone now, and if you do
the good thing and go back to the smaller balance sheet, would
that not have a negative impact or see the economy shrink
because of that, or not shrink, but not grow to the levels that
we saw before, and would not that play into your decision-
making as far as how soon you want to shrink your balance
sheet? And is there some sort of, I guess, metrics, that you
are going to have to use in that sense of setting the timeline
or establishing your balance sheet shrinkage?
Mr. Bernanke. I think that you are right, that shrinking
the balance sheet is akin to a monetary tightening. You sell
mortgages on the market, you are going to tend to raise
mortgage rates, for example, and that will tend to tighten the
housing market and slow the economy--
Mr. Garrett. Plus, you have all this other tightening going
on, too.
Mr. Bernanke. And others, as well. You are absolutely
right. We should not even want to hold this stuff 30 years, so
the key here I think is to, when we do come to the point we
want to sell assets, is to do it in a gradual and predictable
way so it has minimal impact.
Even when we get back to the pre-crisis balance sheet, we
will still be able to manage the short-term interest rate, the
Federal funds rate, much as we have in the past, so if the
economy needs stimulus, we will still be able to do that. But,
we just would not be doing it through the--
Mr. Garrett. So do you target the size of the balance
sheets sort of the same way you target the funds rates now?
Mr. Bernanke. You could think about it as a two-step
procedure. First, we bring the funds rate down as far as it can
go, then we cannot do that anymore, that is as far as it can
go, and then the balance sheet is a secondary tool. When we get
back to normal, we hope the balance sheet will be back to
normal, and we will be going back to where we were before,
which is just using the short-term interest rate as our basic
tool.
Mr. Garrett. And you will be back to where you were before
the economy just cannot be back there because of those
multiplier effects.
Mr. Bernanke. I think that the economy will be able to
recover as long as we make these adjustments in a gradual way.
Mr. Garrett. Okay. Second question. Walk me through. I
threw out some numbers before. If you try to pay the interest
on reserves here, and I threw out the number, if you had a
trillion dollars set on reserves and if the interest rates go
up, because a lot of people expect them to, to say, 5 percent,
to use round numbers in my head, that is $50 billion that you
will be paying out. That is, in essence, a capital version of
how it works, right?
Mr. Bernanke. Yes.
Mr. Garrett. Okay. So then, if you did that, starting
tomorrow, let us say, how long can the Fed do that? How long
can the Fed hold a trillion dollars here on your books, pay out
$50 billion in interest payments, can you do that this year,
and the next year, and the next year? How does that work?
Mr. Bernanke. We can, for the following reason, that there
are two sides to our balance sheet. The reverse repos,
reserves, whatever, are financing. On the other side, agency
MBS, which pay about 4\1/2\ percent. So, from the point of view
of the seignorage, or the revenue we give to the Treasury, the
money we're paying to banks from say, interest on reserves, is
more than compensated by the income received from the mortgage-
backed securities.
And so, in fact, for the next few years, we anticipate and
we already have seen this, that the Fed will be sending to the
Treasury an unusually large amount of money because the returns
on the mortgages so much exceed the cost of funds to the Fed.
So, because of the two sides of the balance sheet, it will not
be costing the taxpayer any money.
Mr. Garrett. Okay, and it is not just the cost to the
taxpayer, but it could go on into, I do not want to use the
word in perpetuity, but you can do it indefinitely, is what you
are saying?
Mr. Bernanke. Well, because half of our balance sheet is,
we are paying right now 12 basis points and the other half we
are paying zero because it is just cash, so we have very little
cost of funds and so obviously we can go a long time.
Mr. Garrett. And with just a short time left, what is the
technical term, what are technical indicators you look to with
regard to inflationary rates or otherwise, as far as your
tightening policy?
Mr. Bernanke. Well, we look obviously, at current inflation
numbers including a variety of indicators like trim means, and
core measures, and overall measures and so on, but we also look
at things like the break-even rate in the inflation protected
securities market, survey numbers, because expectations are as
important as the level of inflation, itself. Because if people
think inflation is going to be high, then they are going to
demand higher wages, and prices, and that will create an
inflation spiral. So, we look both at expectations and at
current prices.
Mr. Garrett. Okay. And there is the red light, so thank
you, Mr. Chairman.
Mr. Watt. The gentleman's time has expired. The gentleman
from California, Mr. Sherman, is recognized for 5 minutes.
Mr. Sherman. Yes. To the ranking member's opening
statement, indeed there has been an enormous and controversial
multi-trillion dollar expansion of the Fed balance sheet and
this has been part of an overall process called bailouts. As
lawmakers, we would ask, well, under what law was this done?
And the answer is, 13(3) of the Federal Reserve Act which gives
the Federal Reserve Board unlimited authority which they have
used to the tune of trillions of dollars, and I remember last
year asking Chairman Bernanke whether he would accept a $12
trillion limit. Being a man of modesty, he agreed to that, and
then this committee adopted on voice vote a $4 trillion limit
and no other limit was proposed, though I proposed a $4
trillion limit, nobody else said, well, why not three or two or
six?
And I would like the acting ranking member to indicate
whether he thinks it is better that we have a $4 trillion limit
on section 13(3) or no limit at all? I yield to the gentleman.
But I realize there are other--
Mr. Watt. If the gentleman is yielding, and my choices are
$4 trillion or indefinite, I prefer $4 trillion.
Mr. Sherman. Thank you. I would hope that the senior
leadership on the Republican side would correct some of the
misleading press releases that have gone out from some
Republican members attacking those who voted for a $4 trillion
limit and implying that a $4 trillion limit was a grant of $4
trillion of power to the ever-modest Chairman Bernanke, when in
fact, that was indeed our choice--$4 trillion is what was in my
amendment. The alternative is to stick with the present
statute, which is absolutely unlimited.
Those who propose limits should not be attacked as those
who are calling for the removal of limits.
With that in mind, we have a little problem in the 10
biggest real estate markets in the country, including
especially Los Angeles. Right now, the conforming loan limit
and the FHA limit is $729,750. End of this year, it drops, the
GSE limit drops in L.A., and most of these other markets to
$417,000, a precipitous drop. This country is still dependent
for its wealth, its consumer confidence, on home prices and is
still dependent on the GSEs for supporting the mortgage market.
Chairman Bernanke, do you think it would have a bad effect
on home prices in those 10 markets and the national economy if
we were to see a sudden, precipitous, and massive drop in the
GSE limit?
Mr. Bernanke. At this point, there is really no private
label mortgage market around and the availability of credit for
so-called jumbo loans and so on is very restricted, so it would
certainly reduce availability of mortgages and increase the
rate paid for mortgages above that new limit. Now, I think
people should be concerned and make sure they are comfortable
with any costs that might imply for the GSEs, given the money
that the government is using to support the GSEs right now.
But, I think it is certainly clear that if that happens, it
will raise interest costs and reduce prices in those areas.
Mr. Sherman. And I would point out for the record that the
GSEs actually make a profit on those loans between $417,000 and
$729,000, and I'll move on to my next question.
It is often said that you are supposed to take away the
punch bowl when the party gets going. This is the dullest party
I have ever been to and I am an accountant. Thus, you do not
need to be talking about how to make this party more dull or to
keep it from getting going, at least in the foreseeable future.
We do, however, need to focus on what flavor of punch. You
have mentioned that you have lowered the interest rates. You
have expanded your balance sheet, not so much by buying
Treasuries, as buying private sector debt. The question is, why
should taxpayers, assuming you should have the expanded balance
sheet and I think that is a good assumption for the present,
why should we expose taxpayers to the relatively small risks of
the high quality private sector debt you have purchased? Why is
your balance sheet not all Treasuries, rather than the various
other investments you have made?
Mr. Bernanke. At this point, about $100 billion out of $2.3
trillion is related to bailouts. And given AIG's recent sales,
we hope that would soon be down to $50 billion. We are moving
down on that. So, this is not really about bailouts. It is
about buying primarily mortgage-backed securities. And from our
perspective, the Fed's perspective, these are Fannie Mae,
Freddie Mac, and Ginnie Mae MBS, which are explicitly or
implicitly guaranteed by the U.S. Government and so we are not
adding any credit risk, whether we are holding it or somebody
else, it is still a liability of the U.S. Treasury and we are
not adding to the taxpayers' risk by buying them.
Mr. Watt. The gentleman's time has expired. The gentleman
from Texas, Mr. Marchant.
Mr. Marchant. Thank you, Mr. Chairman. Mr. Bernanke, banks
are also experiencing an historically low cost of funds, are
they not?
Mr. Bernanke. Yes.
Mr. Marchant. And in this recent raise from a 1/4 of a
point to a 1/2 point, actually, many banks are, their cost of
deposits is much less than that. At what point will the banks
decide that they are better off turning back to loans rather
than placing their money, keeping their money liquid and
placing it, perhaps, in short-term Treasuries, where they are
making a very, not risk free, but relatively risk free yield?
At what point does the Fed have a plan or an idea, at what
point? Or is it an objective to wean the banks off the lower
costs, at least from the Fed, and begin to put that liquidity,
which is massive, back into traditional loans and then the
economy will come up with it?
Mr. Bernanke. We are supplying liquidity, we are not
blocking its use in any way. Our increase in the discount
window rate applies to a very small amount of money, basically
the cost of funds in the markets for banks remains very, very
low. So, we are not doing anything to prevent them from
lending. The reason they are not lending is either they are
concerned about their capital, or they do not believe they have
good lending opportunities. And our view is that if we provide
continued support to the economy with low interest rates, that
the economy will begin to grow, will see more strength, and
yields remain low, and that, in turn, should make increased
opportunities for banks to make profitable loans. And when they
see profitable loans to make, they will go ahead and make them.
So again, we are just simply supporting a low cost of funds
for banks, which makes, everything else being equal, it easier
for them to raise cash to make loans. But there is a little bit
of pushing on a string here in that unless banks feel that
there are good opportunities out there, and right now we are
still recovering from this very deep recession, they are going
to be very cautious. And they are very cautious.
But, going forward, I think I am safe to say we are already
beginning to see some improvement in banks' outlook and their
willingness to make loans and I suspect we will see improvement
going forward this year.
Mr. Marchant. The other thing that I hear from constituents
at town hall meetings, other than health care, there are a few
other concerns, is that a large portion of our population
depends on their CD rates, or the amount of money that they
have been saving all these years, for part of their income. And
now that the income is not there, they are not spending. And
so, another part of the economic puzzle is that if the rates
that they can get for their money come back, they will begin to
spend again.
And so, at what point do you feel like the banks will not
rely on this increased liquidity that you are providing and
they will begin to put the loans out, raise their rates, and
put the money back into the economy?
Mr. Bernanke. You are right that savers are hurt by a
situation like this in that the yields they can get are lower
and there is no question about it. The reason we have kept
yields low is because we are actually trying to encourage
investment and spending that will get the economy moving again.
And there is a trade-off there, I agree. As I said before, we
want the banks to have access to liquidity. We have worked with
the banks through our stress test to try to increase the
capital they have.
That gives them the raw materials to make loans, so to
speak, and when they see opportunities and the economy is
strengthening, then they should be willing to make loans. At
that point, it will be safe for the Fed to consider raising
rates, as the economy strengthens, and we will try to get back
to more normal situation.
Mr. Marchant. Thank you, Mr. Chairman.
Mr. Watt. The gentleman's time has expired. The gentleman
from Massachusetts, Mr. Capuano, is recognized for 5 minutes.
Mr. Capuano. Thank you, Mr. Chairman. Chairman Bernanke,
you have only said one thing this morning that really gets me
concerned and I want to make sure I understand it. You said
something about the asset-backed securities market returning to
normal. My definition of the word normal is not a good thing in
the ABS and I just want to make sure that your definition of
normal is the new normal, not the old normal.
Mr. Bernanke. Yes, it is the new normal, and I am talking
about traditional ABS, like credit card securitizations and so
on, I am not talking about structured credit products and all
the things that got us in trouble.
Mr. Capuano. That's what I hoped you meant, but I just
needed to hear it. I did not want to get all worked up over
nothing. I do want to talk a little bit about the gradual sales
process that you have talked about, about the securities that
you do hold. And I am just curious, have you started making any
decisions as to where you are going to start--are you going to
start with Federal agency paper, or are you going to use a
light method, are you going to go with whatever ones have the
biggest losses, any decisions at all?
Mr. Bernanke. No, we are continuing to discuss it in the
Forum C. We have not come up with a specific plan. The only
thing we have done so far is to agree to allow both agency debt
and agency MBS that mature to just expire and we are not
replacing it. We are not rolling it over. So that, in itself,
will actually reduce the portfolio over time.
Mr. Capuano. Because, maybe I am wrong, but as I see it,
these sales, if and when they start taking place, are really
the first time between the whole financial crisis that this
country might see, well, realize or recognize, a loss. Up until
now, we may have losses on paper that we have not recognized or
realized, but this might be the first opportunity, the first
situation where we actually experience one. Is that a fair
reading of the current situation?
Mr. Bernanke. That is possible, but on the other hand, as I
have discussed earlier, we are making an awful lot of income
right now and that should be set against any losses that we
might take in the future.
Mr. Capuano. Okay, I appreciate that. I mean, obviously, as
you go forward, we are all interested in decisions you make.
The last item I want to talk about is actually something
that came up when Secretary Geithner was here the other day,
and that is Fannie and Freddie. As I read the December report
that you have, roughly about $1.8 trillion, give or take, in
secured assets, roughly how much of that, and I have the
numbers here, I am not playing games. I just want to make sure
I am reading it right.
How much of that is Fannie and Freddie assets, roughly? Am
I reading it right that it is around $200 billion?
Mr. Bernanke. I even have the numbers, if you would like.
Mr. Capuano. No, I am not trying to get you. I am trying to
make sure I am reading it right.
Mr. Bernanke. We have about $1.3 trillion or so in agency
debt and securities, roughly, of which about $175 is debt and
the rest is MBS. And I think the biggest chunk is from Fannie
and then Freddie and then finally, Ginnie.
Mr. Capuano. The reason I ask is obviously because, just to
tell you where I come from. I come from the position that
Fannie and Freddie might have been engaged in some
inappropriate activity over the last several years, but no more
so for the most part than private entities. And as I read these
sheets and a lot of the stuff that you are dealing with is
also, you know, private MBS between this and the PPIP and other
things you are doing.
And it just strikes me, is that a fair assessment that
Fannie and Freddie, though may be engaged in certain unwise
decisions for the last couple of years, was not doing in any
more excessive manner than private agencies? The Goldmans and
the others?
Mr. Bernanke. They surely made mistakes and that is why
they are losing money, but I do not think their delinquency
rate is any higher than the private sector, and I think, I
would just add for the record that since most of our purchases
are of relatively new MBS, I think the standards have been
actually much tighter in the last couple of years.
Mr. Capuano. Good. Yes, and the reason I asked that is
because there has been a lot of wailing and gnashing of teeth
about how terrible Fannie and Freddie are. And I will tell you
that historically, not within the last couple of years,
historically, I have seen them as a positive thing for this
country, creating the middle class by allowing people to buy
homes, for the most part.
And I guess, in general, because my time is running out,
would you submit, would you suggest that we end Fannie and
Freddie and simply go back to private mortgage or do you think
that, again, with some of the tweaks that we might have to do
and some of the fixes, some of them may be extreme, who knows,
but the concept of government involvement in the mortgage
industry is a good concept or a bad one?
Mr. Bernanke. I wouldn't go back to the status quo ante,
but I think that, and I gave a speech on this a couple of years
ago, where I laid out some alternatives. I do think there are
some scenarios where a backstop government guarantee, which is
fully paid for, for housing, for mortgages, would be a
reasonable strategy.
Mr. Capuano. Great. Thank you, Mr. Chairman. Thank you,
Chairman Bernanke.
Mr. Watt. The gentleman's time has expired. The gentleman
from North Carolina, Mr. McHenry.
Mr. McHenry. Thank you, Chairman Watt, and thank you,
Chairman Bernanke, for being here today. I certainly appreciate
your leadership of the Fed and trying to get our economy back
on track. But, as we know, and as you have discussed before,
there are two houses: monetary policy, which you and the Fed
control; and fiscal policy, which Congress has authority over.
And so it is certainly a challenge for you to control your dual
mandates, being only able to control half of the quotient of
this.
And so with that, you know, the budget deficit. Being over
10 percent last year, 10 percent of GDP, last year, this year,
next year, and only subsiding just barely, the following year.
Is this price, this high deficit, and the long-term view of
where the deficits are going under this President's budget, is
that priced into Fed policy and outlook?
Mr. Bernanke. It affects Fed policy in several ways. In the
short term, it affects overall economic activity and that
affects our monetary policy strategy to some extent. If there
is a loss of confidence about the ability of the government in
the medium and longer term to achieve a sustainable fiscal
balance, then the risk which we have seen a little bit of, I
think, even yesterday, there was just a bit of concern, is that
interest rates might rise because of a lack of confidence by
creditors in the long-term fiscal stability of the government.
And that, in turn, would tend to endanger the recovery because
high interest rates tend to slow the economy.
So, it would certainly be good for the Fed and for the
country, for the economy. As I said before, it is not a
practical goal to achieve a balanced budget this year or next
year, but certainly there needs to be some plan for exiting
from the current very high deficit prospects to give something
that is more sustainable over the medium term. And that would
be very helpful, even today, as the Fed tries to plan how we
are going to exit our accommodative policies.
Mr. McHenry. So, in terms of major legislation that was
just signed into law 2 days ago, the health care policy, and
the cost of that, was that priced into the Fed's outlook over
the medium/long term?
Mr. Bernanke. I know it is very controversial exactly what
the fiscal implications of that are and I am not going to try
to second guess the CBO or others who have priced it, but
clearly everybody agrees that the overall fiscal outlook for
the U.S. Government is somewhat dark over the medium term. And
it would be very useful if there could be a bipartisan,
concerted effort to explain, demonstrate, and decide, how the
government is going to achieve a more sustainable fiscal
trajectory.
Mr. McHenry. Would you say that enacting that bill has
negatively or positively changed the Fed's outlook on the
economy over the medium and long term?
Mr. Bernanke. No, I could not say. It depends on your
assessment of the fiscal implications and, as I said, the CBO
and others have come up with a wide variety of estimates of the
possible fiscal implications.
Mr. McHenry. What about the expiration at the end of this
year of a whole variety of tax cutes put in place in 2001 and
2003? Are the expiration of those tax cuts, priced into Fed
policy over the short, medium, and long term for the Fed's
outlook on the economy?
Mr. Bernanke. To some extent. I mean, we try to make
forecasts and our forecasts are typically 18 months ahead and
we try to factor in our expectations of fiscal policy the best
we can. But, of course, we recognize that there is a lot of
uncertainty about what the implications will be for the
economy, where the economy will be a year from now, or 18
months from now. But, we do try to factor in all the aspects of
fiscal policy to the extent that we can, you know, ascertain
where we think it is going to be.
Mr. McHenry. So, certainly this adds to the high wire act
that you are performing right now, trying to unwind with the
fiscal policy, as well?
Mr. Bernanke. Certainly, a part of the difficulties of
forecasting the economy, certainly.
Mr. McHenry. Thank you.
Mr. Watt. The gentleman's time has expired. The gentleman
from Massachusetts, Mr. Lynch, is recognized for 5 minutes.
Mr. Lynch. Thank you, Mr. Chairman. I certainly appreciate
the difficulty we are in. I know a lot of the members have
recalled that the Federal balance sheet before the crisis was
about $800 billion, and now it is somewhere around $2.1
trillion. I generally agree and understand the idea of the Term
Deposit Facility, and also the reverse repurchase agreements to
soak up all this liquidity that is sloshing around in the
economy in which makes the economy less responsive to your
interest rate decisions. As you say, pushing on a string.
Do you think that those two mechanisms will be sufficient
to reattach or make the economy more responsive to interest
rate controls that are traditionally used?
Mr. Bernanke. Yes, I think so. We have really a belt and
two pairs of suspenders at this point. We have a basic tool
which is the interest we pay on reserves to banks, which by
itself ought to move the whole complex of interest rates up as
we raise that rate. There could be some slippage between that
rate and general market rates, and those tools you mentioned
will be able to drain reserves and tighten up that relationship
and so that will be a second tool that assists us in managing
interest rates. But then, if it were absolutely necessary, we
could also sell some of our securities and that would certainly
tighten up--
Mr. Lynch. That is what I want to talk about. That part I
guess I am less confident in. Do we get into trouble here in
selling assets? And I know these are all government issues, so
the risk part of this is already there. But for some time now,
the whole market has been fed by--the mortgage-backed security
market has been fed by the GSEs and I believe the Federal Home
Loan Banks, I do not know if you have included that as well,
but I am just concerned about selling assets into a very poor
economy and a very poor market. And whether we might sustain
considerable losses in those sales, and then have the
compounding insult of having others who might buy those at
distressed rates do very well.
And then we end up with a similar argument we had during
the resolution trust corporation sale of assets after the
savings and loans bailout where some folks came in afterwards
and capitalized greatly on the timing. When I first read your
remarks surrounding the purchase of these assets, I thought it
was clear that this was going to be passive ownership and
investment and long--we are going to hold these long term. And
that was only last March, so has there been something that has
changed our position on this? Or can you explain that?
Mr. Bernanke. We have had a good bit of time to discuss all
the aspects of this exit strategy, and I think the FOMC is not
comfortable withholding all of these securities until they
mature, some would be 30 years and we want to move more quickly
than that back to the pre-crisis balance sheet. But again, my
expectation is that sales would be a slow gradual announcement
in advance and would not create undue market impacts. You
mentioned adding insult by selling into a weak market, of
course in a situation where we would be selling this would be
one where we were actually trying to tighten policy because the
economy was back on a growth track and we were trying to avoid
future inflation risks. So, we wouldn't be doing that in a
really weak economy.
Mr. Lynch. Well, you know, I appreciate that is the only
mechanism of the three that actually shrinks the size of the
Fed balance sheets, so I know we have to do something. I am
just very concerned about the timing of this and what the end
result might be, but I appreciate your comments and thank you.
Thank you, Mr. Chairman.
Mr. Watt. The gentleman yields back. The gentleman from New
Jersey, Mr. Lance, is recognized for 5 minutes.
Mr. Lance. Thank you very much, Mr. Chairman. Good morning
to you, Chairman Bernanke. Thank you as always for being here.
My principal concern, as I have indicated on many occasions in
this committee, with many different witnesses, continues to be
levels of Federal spending and the overall Federal debt now at
$12 trillion and rising rapidly.
As I understand it, Mr. Chairman, the ratio of national
debt to GDP has shot up from 37 percent before the crisis to
approximately 60 percent in Fiscal Year 2010. And the
President's budget indicates that it may be headed towards 77
percent of GDP by the end of the decade. As you well know
better than almost anyone in America, except for World War II,
the debt has never been higher as a percentage of GDP.
Your thoughts, Mr. Chairman, on what the growth rate would
have to be here in the United States in order to pay the
Federal debt over the course of the next generation, perhaps
the next 25 or 30 years?
Mr. Bernanke. Well, the 77 percent doesn't capture the
entire problem in that there is an awful lot of which might
call off balance sheet, obligations, future Medicare, and
Social Security and so on, and other obligations that are not
fully accounted for in our debt. So, in some sense, the burden
is greater than what you describe, and I would have to say
looking at it from that perspective and recognizing that we are
an aging society and those costs are going to be coming down
the pike, I don't think there is a realistic growth rate. I
don't know what number to tell you, but it would certainly be a
very high number, probably not realistic, so I don't think that
just growing out of this will be a solution.
Mr. Lance. Nor do I. And since that is clearly not the
solution, your thoughts on what the solution would be.
Presumably, it is somehow to rein in levels of Federal spending
over time and certainly to get our national expenditures as a
percent of GDP back to a historic average as I understand it.
Since the end of World War II, the historic average has been
roughly 20 percent of GDP, it is now 25 percent.
I personally am one of the co-sponsors of a constitutional
amendment sponsored by Mr. Pence and Mr. Hensarling that would
address this constitutionally. Your thoughts as to what level
you would suggest long term, given the historic average being
20 percent for the last 60 years?
Mr. Bernanke. There are tradeoffs there that really are up
to the elected representatives to make. The only thing I would
say is that we need to enforce in some sense a consistent
perspective, so those folks who believe that low tax burdens
are very important need to also specify how they are going to
cut spending, and those who see much benefit in spending need
to sort of specify what their revenue source is going to be. So
if we can force people to recognize that there are two sides to
this, that is the way to ultimately bring down the deficits.
Mr. Lance. What would you suggest, based upon your obvious
extensive knowledge of the area, would be a good range as a
percentage of GDP? And based upon your experience as a
historian of these subjects, particularly related to the
Depression?
Mr. Bernanke. There is quite a range of debt to GDP and
government spending to GDP across the developed world, and a
lot of that depends on decisions that are being made about what
parts of the economy will function through the government and
which parts will be entirely private, decisions about health
care for example. So those are very broad decisions about how
you want to structure your economy and your society which
again, go beyond simple fiscal issues, and I do not feel well-
placed to make those decisions for the American people or for
the Congress.
With that being said, obviously we are going to have to
make some tough decisions. There is this tendency that nobody
wants to cut and nobody wants to raise taxes. At some point, we
are going to have to make some unattractive and tough
decisions, and I don't envy Members of Congress who have to
grapple with this problem, but one way or another, there needs
to be some greater balance between revenues and expenditures.
Mr. Lance. Thank you, Mr. Chairman. My own view is that it
is the fundamental issue of our time, and whether or not
America will continue to be the preeminent society in the world
in this century is based upon whether or not we can get our
fiscal house in order. Thank you, Mr. Chairman.
Mr. Watt. Gentlemen, as time has expired, the gentleman
from North Carolina, Mr. Miller, is recognized for 5 minutes.
Mr. Miller of North Carolina. Thank you, Mr. Chairman. I am
also concerned about the deficit and long-term debt. At the
beginning of the decade, your predecessor worried that we might
spend the debt down too quickly and it might be disrupting the
economy. That proved not to be so much of a problem in the last
decade. And it appears that a couple of my best folks here were
against Bush tax cuts and against the prescription drug plan
that was more of a giveaway to the insurance industry and the
pharmaceutical industry than it was for seniors on Medicare,
and was not paid for.
What is the kind of distribution of the current deficit?
How much of it is structural, the extent to which our revenue
and our expenditure simply do not match up and would not match
up even if we were growing at 3 or 4 percent a year and had
unemployment at 3 or 4 percent, so that the existing program is
not anything new? How much is the result of the recession
itself, the decline in revenues and the additional expenditures
required for unemployment, for Medicaid, for childhood
insurance, or any other kind of entitlement program that
depends upon income? And to what extent is it because of what
we are doing in response to the recession to try to get the
economy going? I have heard that it is roughly 50-40-10. But
about what is the allocation?
Mr. Bernanke. Well, the way I would think about it is that
again, if you look out from say 3 years from now out to 2020,
that longer period where the forecasters are assuming something
more normal--a more normal economy--the estimates of deficit to
GDP are sort of 4, 5, 6 percent, that kind of range. So, since
that would be something where the economy is close to its
potential, then that say 5 percent would be the structural
component.
Mr. Miller of North Carolina. I am sorry, say that again?
Mr. Bernanke. About 5 percent of GDP would be the
structural component.
Mr. Miller of North Carolina. But how much of that, of the
deficit is that?
Mr. Bernanke. Sorry, 5 percent of the deficit. The deficit
is 5 percent of GDP. So today, the deficit is 10 percent of
GDP, and what I am saying is that looking at the perspective
deficit 5 years from now, that suggests that of that 10 percent
today 5 percent is related to the recession and the other 5
percent or so is related to structural issues, and that is
looking at the next decade or so. It is probably going to get
worse after that because of the aging of the population,
increased medical costs, and so on. So, we are looking at even
in the medium term, I think we need to have a goal of something
in the order of 2 or 3 percentage points of GDP improvement in
the structural deficit to get to something which is more
sustainable, at least over the next decade.
Mr. Miller of North Carolina. My view is that the most
important thing we can do to address the deficit is to get the
economy going to put America back to work. Do you agree with
that?
Mr. Bernanke. In the short term, that is absolutely
correct. The share of revenue as the share of GDP has fallen
from its historical 19 percent down to 15 percent, so just
getting tax revenues back up to historical norms would take a
good chunk out of the deficit. So that is absolutely correct,
but that doesn't solve the very long-term issues, as you know.
Mr. Miller of North Carolina. Sure. As to mortgages, there
has been a good deal of discussion about the conflicts of
interests, the various ways in which mortgages were divided
into tranches and the tranches' interests were different, and
especially the different interest between first and seconds. I
understand about two thirds of all servicing mortgages is
controlled by the four biggest banks. And those same four banks
also hold $477 billion in second mortgages. Do you see a
conflict of interest there, and is that something we should
allow going forward?
Mr. Bernanke. There is a problem there which is that under
current rules and under current practices, the same bank might
hold the second and the first and not be aware that those two
go together. So, it is not uncommon for a homeowner to pay
their second and be delinquent on their first, and so the bank
would therefore count the second as fully current even though
the first is delinquent. So, I think we would get, first of
all, a better understanding of banks' financial position in
their losses in the mortgage space if there were better
connections between the first and the second.
But very importantly, efforts to restructure mortgages and
keep people out of foreclosure would be facilitated if the
first and seconds were linked together and perhaps negotiated
jointly rather than separately, so that there could be one
solution to the whole problem. And the Treasury is working on
that. There is a program called the 2MP Program where a lot of
those large banks you referred to have signed up and the basic
premise of this program is to try to link up the first and
seconds, and when doing mortgage restructuring to do them
jointly rather than separately.
Mr. Watt. The gentleman's time has expired. The gentleman
from Texas, Mr. Green, is recognized for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. Thank you, Mr.
Bernanke, for appearing today. I would also like to take a
moment if I may and thank Bank of America. If what I am reading
in the newspaper is correct, I would like to thank them for
producing a principal reduction program. And I am referencing
this because we have not yet resolved the question of
foreclosures. It is a serious question and it is one that I
think we have to get a handle on before we can conclude that we
are out of the woods, to borrow a phrase. My question, Mr.
Bernanke, is this: how important is it for us to resolve the
question of foreclosures that the, just the unusual number that
actually have now gone into persons who are not blessed with or
cursed with, depending on how you look at it, with adjustable
rate mortgages. We have persons now who clearly qualify for the
mortgages that they have, but their mortgages are now
underwater. So how important is it for us to get a handle on
this to avoid a double dip recession?
Mr. Bernanke. It is certainly a risk to the economy for a
number of reasons. One obvious reason is that in recent
periods, as much as 30 or 40 percent of the new housing coming
on the market is foreclosed housing, so foreclosures generate a
supply of housing which dries down prices in the housing
market, lowers the wealth of consumers or homeowners, increases
the rates of delinquencies in losses in banks, and weakens the
incentives to build new homes. So for all of those reasons,
foreclosures besides being obviously a tragedy for homeowners
who would like to stay in their homes, has negative effects for
the economy and the financial system more broadly.
And so, I certainly encourage efforts to avoid preventable
foreclosures. Having said that, of course it is a very, very
difficult problem, and a lot of people have been working on it,
and unfortunately we are still looking for, I think, a
significant number of foreclosures in 2010 and probably into
2011 as well.
Mr. Green. Mr. Chairman, you said you encourage, and I am
going to ask, are you permitted to encourage other institutions
comparable to Bank of America to do a similar thing? And I ask
because I am not sure what the protocols are with reference to
your office. I know that you try as best as you can to make
sure that you don't encroach upon the province of Congress and
others, but are you permitted to and can you encourage other
institutions to take similar action?
Mr. Bernanke. I think the way to proceed is to try to
encourage banks to be in touch with troubled borrowers and to
try to work out some solution, whether it is a principal
reduction or some other solution; that is something that we do
very much encourage.
More specifically, we encourage banks to participate in the
government programs like the HAMP and so on. As you know, the
HAMP program has been focused on payment, on a monthly payment,
as opposed to on principal reduction. I know they are looking
at alternative ways of addressing foreclosures through
principal reduction, through assisting unemployed homeowners
and so on. And as they develop these programs, then we would
certainly encourage banks, particularly the large servicing
banks, to fully participate in those programs. We can't tell
them to participate in something that doesn't quite exist yet,
so we are hoping that Congress will develop some viable
programs that will be attractive to the servicers to
participate in, and we will encourage that.
Mr. Green. Well, thank you. And I will say this, that I
think we will do what we can and we should, but I would also
hope that other institutions will of their own volition decide
that they too have a role to play in this. This is why I
compliment Bank of America, because they of their own volition
it appears, unless there is something going on that I am not
privy to, they have decided to engage in principal reduction.
Reducing interest rates, I think that is a great thing to
do, and I think that can be helpful, but principal reduction
based upon payments made is an inducement to a person to keep
your home and also know that you will not be underwater perhaps
at some point in the future. Thank you for your comments, and I
yield back, Mr. Chairman.
Mr. Watt. Thank you. As time has expired, I would remind
them that is the bank that is based in my congressional
district.
[laughter]
Mr. Watt. Maybe there is some causal connection.
Mr. Green. But Mr. Chairman, I know that good things happen
whenever you show up.
Mr. Watt. The gentleman from Missouri, Mr. Cleaver, is
recognized for something good to happen.
Mr. Cleaver. Thank you, Mr. Chairman. I have no questions.
Mr. Watt. Oh, you yielded back already, or are you
deferring? The gentleman from Illinois, Mr. Foster, is
recognized for 5 minutes.
Mr. Foster. I won't deal with that, Ed.
[laughter]
Mr. Foster. Let's see, I would like to follow up on
Representative Waters' line of questioning having to do with
unemployment and your offer of analytic and technical help.
Mr. Watt. Let me apologize to Mr. Perlmutter. I thought we
went to the other end.
Mr. Foster. I will proceed. There is some discussion in the
world of economists about the breaking of Okun's Law that may
have happened in 2009. And this is very troubling to us because
we had all of these predictions that if we went ahead past the
stimulus and so on, all the people who run macro models said
that the GDP would recover and that unemployment would recover.
And if you look, roughly speaking, GDP and business
profitability and so on, did recover as predicted by all these
models; unemployment did not. And it is my impression, though I
am not an expert on these models, that basically uses changes
in GDP and then back-calculates what the change in unemployment
should have been. And if that link broke Okun's Law, broke in
the last year, that means that we no longer have a predictive
policy tool in these models, and it is a very painful way for
it to break since of course having unemployment. So, I was
wondering your take on this. It appears in your textbook and I
presume I can get some expert advice on how we should go
forward from a policy point of view if our model's unemployment
are no longer predictive.
Mr. Bernanke. I think it is too strong to say they are no
longer predictable. It is just that given the depth of the
recession, the unemployment increase was even worse than you
would have anticipated which may be a one time thing we hope,
obviously.
There are a number of possible explanations for it. One
might be that in fact the GDP numbers were too optimistic. It
could be that if you look at alternative measures of output
like gross domestic income as opposed to product, that was a
deeper recession, maybe that explains it. But the more
conventional story is that as the economy dropped very sharply
at the end of 2008, beginning of 2009, firms became very--
employers became very concerned and they cut very deeply,
perhaps more deeply than normal. And that may be why the
unemployment rate went up faster. And so going forward the
question is, is there enough confidence that employers will now
begin to rehire those people that they let go during the depth
of the crisis?
One issue, interestingly enough, is productivity. The firms
cut very deeply and still managed to maintain production, and
as a result, the productivity numbers have been extraordinary.
Mr. Foster. And this is the IT theory, that people bought
computer systems that allowed them, in principle, to lay off a
bunch of workers. They weren't comfortable doing that in the
good times and then, but did grow comfortable with the computer
systems, and when it was time to cut they were able to keep
shipping products--which is a plausible theory. My general
question was, do you think that you have to put more effort
into modeling the effect on the labor market? That is the
approach that you have been, that is taking on the macro
models, I am saying is it all about GDP if we get GDP right,
the labor market is automatically dealt with correctly? That
you need a more sophisticated modeling so that we understand--
Mr. Bernanke. Certainly, absolutely. And we do look at the
labor market separately and in great detail.
Mr. Foster. Did you see this coming? The break in the
Okun's Law?
Mr. Bernanke. No, no we did not.
Mr. Foster. Does the modeling reproduce the breaking in
Okun's Law?
Mr. Bernanke. Well, again, as I said there, we sort of have
two explanations. One is that maybe the recession was deeper
than we thought. The other is that the productivity gains were
greater than we thought they would be when firms were able to
cut their work forces and still maintain output. All that being
said, I think that as the economy comes back and as we see job
creation, I see no reason to think that we won't see declines
in unemployment on the way up just as we saw increases on the
way down.
Mr. Foster. So you would view this as a one-time occurrence
and we should stay back--we should return to the--
Mr. Bernanke. It is too strong to say that we just have to
throw out everything we know, that is certainly not the case.
But it is an episode that we economists in general are going to
want to understand better and look at for a long time. A
related issue is participation rates, which have moved around a
lot. A number of people who are looking for work and are in the
labor force--that has been going down for a while because of an
aging society, but we saw it rise for a period perhaps because
people when they saw their 401(k)s, you know, being hit by the
stock market decline, said look, we have to work harder, and
work longer. So, there were a number of factors, a number of
issues that were unexpected and we need to understand better,
certainly. Thank you and I yield back.
Mr. Watt. The gentleman from Colorado, Mr. Perlmutter.
Mr. Perlmutter. Thank you, and just following up really on
Mr. Foster's questions, and I'm looking at pages 20 and 21 of
your monetary report. There are three very interesting charts
there, and the first one is your chart 27, which shows net
change in private payroll, and from the beginning of 2008 to
the beginning of 2009, that's about as close to falling off a
cliff in terms of employment as you can have.
Now you used, when Mr. McHenry was asking you questions,
you used going forward the situation is somewhat dark. Those
were your words, somewhat dark. How would describe what
happened from the beginning of 2008 to the end of 2008? Would
you say absolutely black?
Mr. Bernanke. I was talking about a different set of
issues. But certainly, the recession in the latter part of
2008/beginning of 2009, not only in the United States but
around the world, was extraordinarily sharp. Absolutely.
Mr. Perlmutter. And this drop in employment reflects that.
Mr. Bernanke. Certainly.
Mr. Perlmutter. And then, since the beginning of 2009, we
are almost back to zero in terms of job losses.
Mr. Bernanke. In terms of job losses.
Mr. Perlmutter. Okay. And we have another chart. This one
is not from your monetary report, but it is the Bureau of Labor
Statistics, sort of the job losses that occurred in 2008 and
the job losses as they sort of shrunk in 2009.
But it relates to about 8 million jobs, if I am correct. So
we still--even though things--the rate of job losses is pretty
much stopped, we still have 8 million people who lost their
jobs between 2008 and through 2009.
So, you know, then you have another very interesting--and
you were talking about productivity, your chart No. 30 in your
report. I mean, this one basically shows America to be the most
productive it has been per person in 60 years.
So, I mean, there are--looking at it in that light, that is
great news, except that we have 8 million people who are
unemployed. So in this process of--you know, Mr. Lance, I agree
with him. We have to deal with the debt. But we also have to
get 8 million people, in my opinion, back to work.
So it is, step one, get people back to work. Step two,
grapple with this debt that exists. By getting people back to
work, you help the revenue side of the balance sheet; dealing
with the debt, you take care of the expense.
Where are you in terms of the Federal Reserve in terms of
sort of your ideas as to getting people back to work? If you
start tightening the money supply, what do you expect to happen
to our effort to get people back to work?
Mr. Bernanke. Well, first, on the fiscal side, just to make
sure you understand my position, you have to look at two
different periods of time. In the very near term, there is a
reason for the big deficit, and I don't think it is either
desirable or possible to get rid of it in the next year or two.
Down the road, when the economy is operating more normally,
then if we can convince creditors that, in fact, we will have a
more stable, sustainable situation, that will actually improve
interest rates today and support the growth process today.
From the Federal Reserve's perspective, we are recovering
from a very deep recession, and monetary policy is just about
as supportive and accommodative as it has ever been. Interest
rates are close to zero, and we have more than doubled our
balance sheet and used all these other policies to try to get
markets working again and try to increase capital in the
banking system.
So we are taking very seriously the unemployment situation,
and we take seriously that part of our mandate, for maximum
employment.
Mr. Perlmutter. And I would just say, in looking back at
this unemployment chart, that the coupling of the monetary
policy with the fiscal policy that began in early 2009 reversed
what was freefall in this economy.
So, personally, we have to deal with the first thing,
employment. Then we deal with the second thing, debt. To the
degree we can deal with them together, wonderful.
I think the other chart that is really interesting on page
20 is the savings chart, that people in this country who had
not been saving now are saving at a pretty good clip. The
Federal Government is not saving, but they are having to deal
with a lot of folks who have needs because they have been laid
off, they needed insurance, whatever it might be.
But, you know, Mr. Chairman, again, we have been visiting a
lot over the last 2 years, and I just thank you for your
service.
Mr. Bernanke. Thank you.
Mr. Watt. The gentleman's time has expired and--oh, Mr.
Adler--he is hiding down there--is recognized for 5 minutes.
Mr. Adler. Mr. Chairman, thank you.
Chairman Bernanke, I want to follow up on Mr. Perlmutter's
comments. I also want to thank you in a broad sense, but
actually in a narrow sense as well. The first time I spoke to
you a year ago, I asked you to consider including in TALF auto
fleet leasing.
You weren't sure whether it was in it or was going to be in
it. You said you would get back to me in a couple of days. And
2 days later, you publicly announced that auto fleet leasing
would be included in TALF.
For my district, which has two of the four or five biggest
auto fleet leasing services in the country, it saved hundreds
and hundreds of jobs, great private sector companies that
couldn't get liquidity. You did a good thing for them. So you
used your head with a great heart, and it really did help
people; the sort of things Mr. Perlmutter is talking about,
employment, you saved lots of jobs. That was a great thing.
Following up on Mr. Perlmutter's comments, I heard Mr.
Lance and you in a dialogue regarding deficits some minutes
ago. And I sort of share the view that we have to deal with
deficits some time soon, not some time in the distant future.
And I am wondering what sort of hope you can think in terms
of, within a certain period of time, we could realistically
start grappling with deficits because while I recognize that we
don't have inflation now, I worry that big deficits with rising
inflation could be very, very expensive for the American
taxpaying public.
Mr. Bernanke. Well, it is never too soon to start planning.
We have--we know pretty much what is going to happen to our
population, and we know what has been happening to costs, both
health care costs, defense costs, and a whole variety of
things.
I know that the President created this commission, and both
parties have nominated people to be part of that. I hope that
is an effective way of putting out some options that Congress
will consider seriously.
But anything we can do to, at the same time that we are all
very concerned about the current situation and looking at how
to get the economy moving again, you know, with one eye, we
should be also looking at the next 5 years, the next 10 years,
and using whatever methods we can to try to develop a plan that
we can all agree on to restore greater balance in our fiscal
situation.
So it is a difficult problem, but I don't think there is
any reason why we can't start working on that more or less
immediately.
Mr. Adler. Thank you. I know on the Senate side, while they
are voting on health care right now, I suspect very, very soon
they will take up a bill or a series of bills on regulatory
reform to try to get our financial house in order.
I wonder if you could comment a little bit on the sense
that I have, and that maybe other people have, that the
business community, the lending community, is sort of frozen
right now, waiting to invest but not certain what the ground
rules are going to be going forward.
So at least I am hearing from business people in my
district, from around the country, that they really want a new
structure in place so that they know what the rules are going
to be, so they can have some predictability, some certainty,
almost, where possible before they can really move forward and
help us recover as a private sector economy.
Mr. Bernanke. And we hear exactly the same thing, that
policy uncertainty, economic uncertainty, is a real drag
because, you know, you are trying to make a decision about
where to locate your plant or hire a bunch of parallel or
undertake a new line of business, and you don't know what the
economic environment, the policy environment, is going to be.
It makes it much more difficult.
So from the perspective of financial firms in particular,
even though they may be concerned or oppose certain elements of
the reform bill, I think, all else being equal, they would like
to see--whatever happens, they would like to see it get done
because then they would at least have--you know, have some
certainty about what the environment is going to be, and they
could plan better and be more willing to make investments and
loans, I hope.
Mr. Adler. I thank you. I yield back the balance of my
time.
Mr. Watt. It appears that all of the members who might
second-guess you in the future about how you withdraw from this
liquidity situation have not shown up. So we thank you so much
for your testimony and, as I say, we consider you the master
conductor, so we know that you will deal very well with the
decisions going forward, with the brain trust you have behind
you, of course.
So we thank you, and we will consider this part of the
hearing completed, and call up the second panel of witnesses so
that we can start the second panel.
Mr. Bernanke. Thank you.
Mr. Watt. There may be follow-up questions in writing from
some of the members. And of course, we will accommodate that at
the end of the hearing.
Has anybody seen Mr. Goodfriend? He was here earlier. So we
will search for him just for a second, and then we will try to
figure out--
[pause]
Mr. Watt. We presume he will show up shortly, so let's
convene the second panel so as not to back ourselves into a
time conflict with votes.
We are pleased today to have four distinguished members--
three of whom are present--on this panel: Mr. Larry Meyer, vice
chair of Macroeconomic Advisors; Mr. John B. Taylor, Mary and
Robert Raymond professor of economics at Stanford University;
Mr. Marvin Goodfriend, professor of economics, and chairman of
the Gailliot Center for Public Policy, Tepper School of
Business, Carnegie Mellon University--your timing is exquisite;
and Mr. Laurence Ball, professor of economics at Johns Hopkins
University.
Each of you will be recognized for 5 minutes and, of
course, the full content of your written statements will be
made a part of the record. We would ask you to summarize your
statements in the 5-minute window.
The lighting system there will alert you. The green light
will be on for 4 minutes, a yellow light will be on for 1
minute, and then we would ask you to wrap up. We obviously
won't cut you off in mid-sentence, but we do try to stick to
that timeframe as closely as we can.
So with that, Mr. Larry Meyer, vice chair of Macroeconomic
Advisors?
STATEMENT OF LAURENCE H. MEYER, VICE CHAIR, MACROECONOMIC
ADVISORS
Mr. Meyer. Chairman Watt, Acting Ranking Member Paul, and
the other members of this committee who have decided to stay
for this panel, I am particularly grateful to you--
Mr. Watt. I suspect other members will wander in and out
during the course of it. Make sure your microphone is on.
Mr. Meyer. Yes, it is. Thank you for giving me this
opportunity to discuss questions about the Fed's exits from its
emergency liquidity facilities and from its extraordinary
accommodative monetary policy.
As the chairman explained to you today, but really more in
his earlier testimony, the Fed has already closed its emergency
liquidity facilities. They were no longer needed. These
facilities basically closed on their own. Borrowing declined
and virtually stopped as markets healed. Then the Fed just
closed the door.
The increase in the discount rate was just the last step in
liquidity normalization. In executing aggressive easing, the
Fed raised the level of reserves by $1 trillion, lowered the
fund's rate to near zero, and doubled the size of its balance
sheet to about $2 trillion.
Exit from the Fed's extraordinarily accommodative monetary
policy involves actively withdrawing reserves, raising the
policy rate, and shrinking the balance sheet. Each step has one
or more tools designed explicitly for it.
The Fed will withdraw reserves by executing reverse repos
and offering term deposits to depository institutions. It will
raise the policy rate by increasing the interest rate on
reserves. And the balance sheet will passively shrink by
runoff, and the Fed appears to intend eventually to sell MBS.
Sequence is about the order in which these steps will be
taken. In his earlier testimony, the Chairman provided you with
an outline of the likely order. The Fed in this case would
likely withdraw reserves first, later--but not much later--
raise rates, and still later sell MBS.
Reducing reserves first will help the next step, raising
interest rates, reinforcing the role of interest on reserves.
While the Fed is operating in uncharted waters so there is a
lot of uncertainty about this exit, I believe that the tools
are sufficient to accomplish each step, and the sequence is
very well designed.
The Fed can avoid unwanted inflation by exiting at the
right time. The right time depends in part on the evolving
outlook and forecasts, and in part on the strategy that links
the forecast to appropriate monetary policy. I think that
strategy is also well thought out.
And given both our and the FOMC's expectation that the
unemployment rate will remain quite elevated for some time, and
that inflation will remain subdued, there is no reason to begin
to raise the policy rate any time soon. I expect the first
increase will not come until mid-2011.
There is very little chance that the Fed's policies could
lead to unwanted inflation over the next few years. Now, it is
interesting nevertheless that some worry that inflation will be
very high over the medium term, and some even believe we are
headed to hyperinflation.
There are only two ways that this can happen: a colossal
and almost inconceivable policy error by the Fed; and your
taking away the Fed's independence. In my judgment, the risk of
very high inflation comes from you, not the Fed.
Inflation and long-term inflation expectations would soar
if you forced the Fed to monetize deficits to avoid the very
sharp rise in interest rates that would otherwise occur at some
point from continued unsustainable deficits. This won't happen
if you take steps to put the deficit on a sustainable course,
and it cannot happen if you respect the independence of the
Fed.
Now, the FOMC is at a zero rate only because it cannot
lower the rate further into negative territory. If they could,
they would. In this case, the Fed has done as much as it can
with conventional policy. The only option at this point was to
implement unconventional policies, and in this case credit-
easing policies.
The Fed was by far the most aggressive central bank in
pursuing these policies, and as a result, we will have the most
challenging exit. Credit-easing policies involve buying longer-
term illiquid assets in markets where the flow of credit is
impaired as a result of the financial crisis, or buying long-
term Treasuries to lower long-term rates relative to this near-
zero funds rate.
The effectiveness of these credit-easing policies is
controversial. I agree qualitatively with a recent New York Fed
staff study that estimates that purchases of long-term
Treasuries in MBS had important effects, lowering long-term
rates, and especially mortgage rates, although I don't think
the effects were as large as they estimate. Nevertheless, I am
skeptical that the Fed can do much more, for example, if the
economy slips into a double dip recession.
Once the Fed is driven to near zero rate, the burden of
further stabilization shifts to you. Sizable and timely fiscal
stimulus was both needed and now viewed quite effective. The
desirability of further stimulus, however, is understandably
limited by concern about current and prospective deficits.
The severe limits on monetary policy and fiscal policies in
the case of an even weaker-than-expected economy is a further
reason for keeping the policy rate extraordinarily low for an
extended period. Thank you.
[The prepared statement of Mr. Meyer can be found on page
82 of the appendix.]
Mr. Watt. Thank you so much.
Next, Mr. Taylor, Mary and Robert Raymond Professor of
Economics, Stanford University.
STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR
OF ECONOMICS, STANFORD UNIVERSITY
Mr. Taylor. Thank you very much, Mr. Chairman, and Ranking
Member Paul. I am going to address my comments to the things
that were requested in the letter of invitation which is,
first, an assessment briefly of the extraordinary measures the
Fed has taken, and second, an exit strategy from those.
I have been studying these extraordinary measures for
several years now using empirical methods and looking at the
data, trying to think of counterfactual hypotheses. I think it
is most useful to divide this period of the financial crisis
into three parts to answer the questions: the first is, if you
like, the pre-panic period from August 2007 until the panic in
the fall of 2008; the second is the panic period itself, which
is the fall of 2008; and the third, I call the post-panic
period, since then.
It seems to me, if you look at the extraordinary actions
taken in the pre-panic period, they did not work very well and
were harmful in certain cases. The term ``auction facility''
did little to reduce tension in the interbank markets during
this period. And as I testified in this committee 2 years ago,
based on my research, it had very little effect--in fact, I
think drew attention away from--the counterparty risks in the
banking sector, which were apparent way back then.
Most important, I think, was the extraordinary bailout
measures, which began with Bear Stearns. They were most
harmful, in my view. The Fed's justification for the use of
Section 13(3) of the Federal Reserve Act in the case of Bear
Stearns led many to believe that the Fed's balance sheet would
again be available in case of another similar institution, such
as Lehman Brothers, failing.
But when the Fed was unsuccessful in getting private firms
to help rescue Lehman over the weekend of September 13-14,
2008, it surprisingly cut off access to its balance sheet.
Then, the next day, it reopened its balance sheet to make loans
to rescue the creditors of AIG. Then, it was turned off again,
and the balance sheet was not able to make loans in the next
event.
It seems to me that this on again/off again bailout
measures were an integral part of the generally unpredictable
and confusing government response to the crisis which, in my
view, led to the panic.
What about action taken during the panic itself? It seems
to me this is the most difficult period to analyze because so
many other things were taking place, so many other government
actions. But I believe, based on conversations with traders and
market participants, that the actions taken in the commercial
paper market and the actions taken with respect to the money
market mutual funds were helpful in rebuilding confidence
during this difficult period.
Finally, the post-panic actions. It seems to me that, of
course, the biggest measure taken in this period was the MBS
program. We also had the TALF as well, which has not really
amounted to very much.
But my assessment of the MBS program, again based on
empirical work looking carefully at these data, is that once
one controls for prepayment risk and default risk, they had
very little impacts on mortgage interest rates. I emphasize
these estimates are uncertain.
Now, what about exiting from these strategies? The chairman
has listed the tools that are available. I think it is
important to exit as soon as is practically possible. What I
would emphasize is, in addition to the tools that he has
listed, that there be some emphasis on a strategy for using the
tools.
In other words, an exit strategy is more than just simply a
list of instruments. It is a policy describing how the
instruments will be adjusted over time until the monetary
framework which we are looking for is reached.
In my testimony, the written version, I have outlined a
possible strategy. I call it an exit rule. It is one in which
the Federal Open Market Committee's decisions about the
interest rate increases, which will come at some point, are
linked to decisions to reduce the level of reserves.
In other words, when the FOMC decides to start increasing
the Federal funds rate target, it would also reduce reserve
balances. It seems to me such an exit rule or exit strategy
could be announced to the markets with whatever degree of
precision the FOMC thinks is appropriate.
The biggest advantage of such an exit strategy like that is
it is predictable. It would reduce considerable uncertainty
about the Fed's unwinding of these huge programs while
providing, in my view, enough flexibility to adjust if the exit
appears to be too rapid or too small.
Thank you very much.
[The prepared statement of Professor Taylor can be found on
page 90 of the appendix.]
Mr. Watt. Thank you very much, Professor Taylor.
Next, Professor Marvin Goodfriend of the Tepper School of
Business, Carnegie Mellon University.
STATEMENT OF MARVIN GOODFRIEND, PROFESSOR OF ECONOMICS, AND
CHAIRMAN OF THE GAILLIOT CENTER FOR PUBLIC POLICY, TEPPER
SCHOOL OF BUSINESS, CARNEGIE MELLON UNIVERSITY
Mr. Goodfriend. Thank you, Mr. Chairman. I am especially
gratified to be invited to testify before the House Financial
Services Committee today because I have spent 25 years at the
Federal Reserve Bank of Richmond working on monetary policy,
thinking about other aspects of the Federal Reserve's
operations.
The recessions and credit turmoil led the Fed into
uncharted waters. While pushing short-term interest rates
nearly to zero, the Fed more than doubled the size of its
balance sheet and created roughly a trillion dollars of bank
reserves, which it used to finance the purchase of a variety of
non-Treasury securities to fund loans to financial institutions
through a variety of liquidity facilities.
In my view, the economy is likely to recover slowly, and it
may be some time before it is appropriate for the Fed to raise
short-term rates or shrink its balance sheet. But the point is,
in the meantime, I think the Fed ought to position itself to
deal flexibly and credibly with whatever comes by doing two
things: one, taking the opportunity to improve its actual and
perceived independence on monetary policy; and two, taking
actions to strengthen the mechanical capability to raise
interest rates in case it cannot first shrink its balance
sheet.
In my testimony, I suggest how the Fed can do these things
by talking in terms of three distinct aspects of central
banking: monetary policy; credit policy; and interest on
reserves policy.
In my classification, monetary policy involves open-market
operations that expand or contract high-powered money, that is,
bank reserves or currency, by buying and selling only Treasury
securities, U.S. Treasury securities. Until the recent credit
turmoil, the Fed satisfied virtually all of its asset
acquisition needs in support of monetary policy by purchasing
Treasury securities, a policy known as ``Treasuries only.''
By adhering to Treasuries only, the Fed passes all the
revenue from money creation back to the Treasury and leaves all
the decisions regarding the use of that revenue to the fiscal
authorities. Hence, and this is the first point of my
testimony, returning to Treasuries only would strengthen the
Fed's independence on monetary policy by narrowing the
potential for conflict with the Treasury and Congress on fiscal
policy.
In my terminology, credit policy undoes Treasuries only.
Credit policy uses the proceeds from selling Treasury
securities to finance discount window loans and the purchase of
non-Treasury assets by the central bank. Credit policy has no
effect on the Federal funds rate because it doesn't change bank
reserves.
Credit policy works by interposing the government's
creditworthiness between private borrowers and lenders, and
exploiting the government's creditworthiness to lower private
borrowing costs. All central bank credit policy initiatives
carry some risk and involve the central bank, and ultimately
taxpayers, in potentially costly and controversial disputes
regarding credit allocation.
Hence, when a central bank extends its credit policy reach
in scale, maturity, collateral to unsupervised nondepository
institutions, and the purchase of non-Treasury securities, that
central bank policy infringes increasingly on the fiscal policy
prerogatives of the fiscal authorities and properly draws
Congress to scrutinize the Fed.
In so doing, expansive credit initiatives undermine the
central bank's independence. And here is the second point of my
testimony. In order to preserve its independence on monetary
policy and credit policy, too, the Fed should confine its
credit initiatives to conventional last resort lending, that
is, lending to illiquid but solvent depositories. Temporary
lending to supervised solvent depositories on a short-term
basis against good collateral has multiple layers of protection
against loss, with minimal allocative effects.
Last resort lending narrows the scope for conflict between
the central bank and the fiscal authorities sufficiently, in my
opinion, to be compatible with independence.
Moving on, Chairman Bernanke, in his written testimony for
the July 2009 report to Congress, expressed the view that the
power of interest on reserves to put a floor under the Federal
funds rate is perhaps the most important tool, enabling the Fed
to raise the Federal funds rate without shrinking its balance
sheet. I agree.
However, the Federal funds rate slipped below interest on
reserves in the fall of 2008 because large lenders--Fannie Mae,
Freddie Mac, and the Federal Home Loan Banks--are legally
ineligible to receive interest on balances that they hold at
the Fed.
And here is my third point. I believe that the Treasury and
Congress should help the Fed to secure the interest on reserves
floor by modifying regulations for the Federal funds market so
as to exclude all but depository institutions from lending in
that market, or by allowing all institutions eligible to lend
to earn interest on deposits at the Fed.
I say this because I believe the alternative options to
raise the Federal funds rate by draining or immobilizing excess
reserves have serious drawbacks.
First, the Fed would likely have to drain hundreds of
billions of dollars of reserves over a span of time to have
much effect on the Federal funds rate at all.
Second, the use of large-scale reverse repurchases to drain
reserves would expose the Fed to substantial counterparty risk.
My opinion is that the Fed should not be exposed to
counterparty risk on private arrangements, should not be
dependent on that sort of counterparty risk to do its job.
And third, term deposits issued by the Fed to drain
reserves would compete with Treasury bills, and again create
friction with the fiscal authorities.
And my very last point is this: More generally, the use of
what I would call managed liabilities by our central bank would
turn the Federal Reserve into a financial intermediary and
potentially jeopardize its independence by facilitating the
perpetual funding of credit policy independently of monetary
policy. Thank you.
[The prepared statement of Professor Goodfriend can be
found on page 76 of the appendix.]
Mr. Watt. Thank you so much for your testimony.
Next, Professor Laurence Ball of the Johns Hopkins
University.
STATEMENT OF LAURENCE BALL, PROFESSOR OF ECONOMICS, JOHNS
HOPKINS UNIVERSITY
Mr. Ball. Chairman Watt, Ranking Member--
Mr. Watt. Your microphone may not be on.
Mr. Ball. Is it on now? All right. So I will get it right.
Chairman Watt, Ranking Member Paul, I am very grateful for
the chance to participate in this hearing.
The eventual unwinding of the Fed's emergency policies
raises many issues. I am going to focus on the set of issues
that I believe are most important, which is the prospect of an
eventual increase in the Fed's target for the Federal funds
rate.
This issue has two parts. One is a technical question of
how the Fed will be able to raise the Federal funds rate when
it decides it is the right time to do so. And the other is the
policy question of when will be the right time for the Fed to
raise interest rates.
The technical question, I think, is actually quite easy,
and Chairman Bernanke has explained it very well. The Fed has
several tools, including interest on reserves. And to make a
long story short, I am very confident that the Fed has the
capability to raise interest rates whenever it decides the time
is right.
So let me concentrate on the harder question of when the
time will be right. When will we know that the Fed should be
raising interest rates again?
The first thing I want to say about that is that a lot of
the debate about when the Fed should raise interest rates is
about how long it should be in time. Some people say it should
be 6 months. Some people say it should be 2 years. I think that
is a little bit misplaced because the right time to raise
interest rates is defined by economic circumstances. We should
raise rates when there is a sufficient economic recovery.
And there is enough uncertainty about the course of the
economy over the next few years that it is very hard to know in
what month or year it is going to be time. We have to just wait
and see when the circumstances are right for the interest rate
to rise.
So what are the right circumstances? This, I believe, has a
fairly simple answer. Interest rates should start rising at
some point when there is substantial progress in reducing
unemployment.
I think everybody in the room would agree that the current
10 percent unemployment rate is a terrible problem for the
United States. And I believe policy should remain very
accommodative and do everything it can to help with reducing
unemployment until it is clear that unemployment is falling and
is on a path towards something much closer to what we used to
consider normal unemployment of 5 percent or so.
Now, probably the most important point I want to make is
that in my view, as long as unemployment remains high, the Fed
should not start increasing interest rates because it is
concerned about inflation.
A number of people, including a number of presidents at
Federal Reserve banks, have suggested that there may be a risk
of inflation, that maybe the Fed needs to raise interest rates
sooner rather than later to head off the risk of inflation. And
in my personal view, I strongly disagree with this, for two
reasons.
First, I think there is very little risk of inflation in
the near future. Second, even if eventually there is a moderate
increase of inflation, let's say to 3 percent or 4 percent,
that is probably, on balance, a good thing, not something to be
feared. So let me address those two points.
Why is there little risk of inflation? If one notices that
the Federal funds rate is zero, and the monetary base has risen
at tremendous rates, that gives one a reason to fear inflation.
But the reason that such accommodative monetary policy causes
inflation is that usually it sparks an economic boom.
Super-easy monetary policy causes the economy to overheat
and grow too quickly, and that is what causes inflation. And
having the economy overheat and grow too quickly is the last
thing we have to worry about right now. So inflation is not a
serious danger, in my opinion.
Now, eventually the economy will recover, and eventually
there may be some increase in inflation along the way. But
again, if we have a moderate increase in inflation, let's say
to 3 percent or 4 percent rather than the implicit target of 1
to 2 percent over the last decade or so, that would probably be
a good thing.
The reasons are somewhat complex and discussed in my
testimony. But briefly, somewhat higher inflation will imply
somewhat higher nominal interest rates, which is a good thing
because it gives the Fed more room to cut interest rates the
next time there is a recession and we are less likely to hit
the zero bound problem we hit in this recession.
And then also, briefly, in my view there is no evidence
whatsoever that 3 or 4 percent inflation causes serious damage
to the economy. When Paul Volcker conquered inflation, that
meant reducing inflation to 3 or 4 percent. That was considered
perfectly acceptable at the time, and no evidence since then
has contradicted that. Thank you.
[The prepared statement of Professor Ball can be found on
page 63 of the appendix.]
Mr. Watt. I thank all of you gentlemen for your outstanding
testimony. We will now go to member questions, and reward Mr.
Perlmutter for skipping over him earlier by recognizing him
first.
Mr. Perlmutter. Thank you, Mr. Chairman, and thank you,
gentlemen, for your testimony.
I just want to follow up with Professor Ball. Based on your
experience and your research and your analysis of all this,
when do we want to start tightening up?
And Mr. Meyer, I thought you were saying, well, we are not
in a position of inflation or hyperinflation right now. But
just from your background, talking to me as a policymaker, as a
layman, what should I be looking for just in terms of when are
we going to start tightening things up?
You heard me on the unemployment piece. That is where I am.
I have a lot of people I have to put back to work. So if each
of you would respond?
Mr. Meyer. Okay. Well, I am going to answer that in terms
of the spirit of the ``Taylor Rule'' that John has done. I
don't use exactly that one. But we know the Fed has two
objectives, full employment and price stability. Okay? So the
question is: How much does the unemployment rate have to fall,
and where should inflation be?
I believe the unemployment rate is going to be above 9
percent at the end of this year, 1 percent, and likely to be 1
percent for the next couple of years. You can't convince me
that it is time for the Fed to begin to tighten.
So we can talk about how low the unemployment rate should
be. Certainly, inflation has to stabilize, from 1 percent
probably has to begin to turn up. And the unemployment rate has
to get down to--you know, it is hard to judge this, but in our
case, close to 8\1/2\ percent.
Even then, it is hard to make a really strong case for
tightening under those circumstances because the unemployment
rate will be higher than the Fed has ever tightened that, and
the inflation rate will be lower than the Fed has ever
tightened that. So I will say the middle of 2011 or later.
Mr. Perlmutter. And Mr. Taylor? Professor?
Mr. Taylor. I agree that it depends on what happens with
inflation and GDP growth and employment. I do think that the
Fed has to be ready in case we get a surprise, an unfortunate
increase in inflation. It has to also be ready if we are more
pleasantly surprised with a stronger recovery. And in both
cases, some interest rate increases will be required. I think
it depends on when they occur.
But I would just say briefly, remember, one of the
theories--which has been discussed a lot, one I advocate--is
that the reasons we got into this crisis and the reasons we
have, therefore, this high unemployment rate was the Fed held
interest rates too low for too long for several years.
So don't think that it is an automatic help for
unemployment to delay the interest rate increases. It could
very well help prevent another downturn later.
Mr. Perlmutter. You heard it, and I would like Mr.
Goodfriend, or Professor, to answer on this--but you heard Mr.
Foster's question about this Okun's Law. And, I mean,
productivity is really something that is at historic highs,
which is wonderful.
But people don't get back to work because you are getting
it all done and you are making a lot of money and you are doing
it with a lot fewer people. Does that factor into anything? Do
you believe this Okun's Law, whatever the heck he was talking
about, is broken?
Mr. Goodfriend. Well, part of the productivity is cyclical.
This happens when people's employment--you know, it goes down
and the economy starts to recover. It is very typical. So I
don't think that is a permanent thing.
Mr. Perlmutter. This seems to be double pretty much
anything in the last 60 years. And I was only going to ask one
question, and I am sorry, Mr. Chairman. But Mr. Goodfriend?
Mr. Watt. You have a minute and 20 seconds to go.
Mr. Goodfriend. Yes. Where I come out on this comes from
the lessons that I have learned studying the Volcker
disinflation and the period of the Great Inflation before that.
And the first thing that occurs to me to say is that the Fed,
the government, is not in control of the public's beliefs. The
public's beliefs are out there, and you have to stay ahead of
those.
I don't like to start talking about these issues in terms
of what we think about the unemployment rate or the natural
rate of unemployment. I was at the Fed for 25 years, and I
learned this, if nothing else, that in environments like we
have, the public could get very nervous and raise inflation
expectations in long-term bond rates, if we wait too long on
this. And if that happens, interest rates go in the wrong
direction, we go into a double dip.
So in the limited time that I have to talk about this, I
would urge everyone here to do what I have been saying in my
testimony. Do whatever you can to create confidence in the
public's mind about the fiscal authorities and the central bank
being on the same page so we can anchor those beliefs. And that
gives us a little more time to think about how to do these
things with respect to the unemployment rate.
Mr. Perlmutter. Thank you. Professor, anything else?
Mr. Ball. Yes. My basic answer is that it is time to ease
when unemployment is substantially lower. Chairman Bernanke
talked about the Fed's dual mandate. Professor Taylor, if I
understood, talked about there are inflation risks. There are
unemployment risks. That sounds very reasonable and balanced.
I think in current circumstances, we have to be somewhat
unbalanced. The economy has a crisis in unemployment, and it is
essential to do something about that. Relative to that, whether
inflation is 1 percent or 2 percent or 3 percent or 4 percent
is really a minor issue, in my opinion.
Mr. Perlmutter. Thank you very much.
Mr. Watt. The gentleman's time has expired.
The gentleman from Texas, Mr. Paul, is recognized for 5
minutes.
Dr. Paul. I thank the chairman for yielding.
I have a comment for Professor Ball first because you made
the statement that it would be a good thing to get at a 4
percent inflation rate. That type of language happens to scare
me a whole lot because I think it is so detrimental, and in
many ways immoral.
Because what you are saying is the purpose of the
government is to depreciate the currency, depreciate the value
of the money. And who suffers the most from that? Well, the
poor people do because their prices go up. And the older people
who are on retirement, they suffer a lot as well. The wealthy
people seem to be able to handle inflationary problems a lot
better than the average person.
And a characteristic of inflation is that you eventually
wipe out the middle class. And, quite frankly, we do have a lot
of inflation right now because there is an inflationary factor
in medical care. That is the main complaint.
Could you give me a brief answer on that, if you would
like? Because I want to ask Mr. Taylor a question as well.
Mr. Ball. Well, those are complicated issues. Briefly and
very respectfully, I disagree with what you are saying.
Research suggests that the effects of inflation are distributed
fairly evenly across different income groups, whereas the
effects of unemployment are very heavily concentrated on lower-
income people.
And more generally, I think, just the costs to anybody of 3
or 4 percent inflation, there has just been no documentation
that they are important; whereas it is pretty obvious how
costly unemployment it.
Dr. Paul. Okay. Thank you.
For Professor Taylor, you have this exit rule. If the
economy doesn't get back to growth, as a matter of fact stays
where it is or starts down again sharply like it might--some
people suspect that the housing market is still in a major
crisis--does your rule just not happen? Does it not kick in?
You don't worry about reducing the balance sheet if the economy
suddenly takes a downturn?
Mr. Taylor. What I like about this proposal that I made is
that it is very similar to the decision about increasing or not
increasing the interest rate. So if the economy languishes, the
interest rate will not increase, just as we discussed. If the
economy picks up, then it will increase the interest rate.
My proposal on reserves, it is very much like that. It is
tied into it, so that as the Federal funds rate is increased,
if it is, reserves will come down at a similar pace. And the
idea is by the time the Federal funds rate reaches 2 percent,
then reserves will be roughly at the level where the interest
rate can be--
Dr. Paul. So it is on automatic. I get you.
Professor Meyer suggested that there is not much left for
the Fed to do. You can't lower interest rates much lower. So we
get into trouble. And the suggestion is that we just need more
fiscal stimulation. And I think that is correct.
Well, anyway, there is a lot of desire for more fiscal
stimulation. We have had a lot. And even today Chairman
Bernanke said, ``We are not in the business of monetizing
debt.'' Of course, they just bought $300 billion worth of debt,
and if push comes to shove, they do monetize debt.
But wouldn't it be safe to say that if a bank can get cheap
money--you know, 1 percent, 0 percent--and take it, because it
is available through the Federal Reserve system, and they buy
Treasury bills, even though that might not go on the balance
sheet, isn't that indirectly monetizing debt?
Mr. Taylor. I think the thing to look for in terms of
monetizing the debt is how much the Fed--
Dr. Paul. Actually buys?
Mr. Taylor. --purchases. Yes. I think--and also, it is not
an easy thing. Remember, we think about the monetization that
occurred in the great inflation; it occurred gradually in the
late 1960's and 1970's. There was a lot of support for that
inflation.
Dr. Paul. Did Professor Meyer have a comment on that?
Mr. Meyer. Well, I have a comment on a lot of things you
said.
Just with respect to fiscal policy, I don't think that--I
doubt anybody in Congress, or there certainly would be a
majority, who would want to have a significant fiscal stimulus
today when there is uncertainty about, one, whether the economy
needs it, and when the budget is in such terrible shape going
forward.
With respect to a rule, yes. I mean, I use a rule to sort
of follow what policy does. And, you know, the Fed is going to
reduce reserves as it raises the funds rate. And that is what
Chairman Bernanke sort of emphasized, when as you raise the
interest on reserves, you could have managed reserves very
carefully, withdraw them to keep the funds rate close to the
interest on reserves. So that is inevitable, and that is really
in the game plan.
Mr. Watt. The gentleman's time has expired. I will
recognize myself, unless somebody else comes in, as the last
questioner.
It seems to me that the bulk of the conversation in this
panel and in the questions that have come up to this point have
kind of gone beyond the 13(3) authority, and assumed that we
are back into a situation where we can deal with monetary
policy. We are speculating about when monetary policy ought to
be changed, the interest rates adjusted.
And I am more interested in the 13(3) steps that the Fed
has taken, and the withdrawal from them. Do you get to--well,
let me frame this a little bit further.
One of the witnesses on the panel that was originally
scheduled, who got snowed out, took the position that the
United States was currently in a balance sheet recession, and
that we ought to be very careful in withdrawing these emergency
steps lest we get to the point that Japan ended up in.
Now, what I am interested in is the intersection between--
not so much when you raise the interest rates; I think that is
way out there, I believe. Is that beyond getting out of all of
this 13(3) steps, or can we even get to the discussion about
raising interest rates without going through the discussion
about how you withdraw the 13(3) authority? I guess that is the
question I want comments on.
Mr. Meyer. Okay. So first of all, you have three things
going there. One is the 13(3). One is rates. And the first one
was what do you do with sort of liquidity programs. These are
completely separate.
The liquidity programs were put into place when there was a
panic. Okay? The panic is over. Nobody was using those
facilities. They closed on their own. Gone. History. Okay?
With respect to 13(3), it is a very different animal. And
the Federal Reserve Act says that they could only be used when
there are unusual and exigent circumstances. Now, that is a
very high hurdle. I believe it existed when the Fed put these
into place. I think it clearly doesn't exist today. And the
Fed--this is not its choice. The Fed has no choice here. It
must close those facilities.
Mr. Watt. So you are just assuming that all of this
discussion is taking place post-13(3). Now, Mr. Taylor said we
are beyond the panic. One of the questions I wrote down is,
``Are we there yet?'' I am not sure. I am not sure we are there
yet, but I would like your opinion on that.
Mr. Taylor. Yes. Well, first of all, I think the use of
13(3) actually caused some damage the way it was used.
Remember, it was used even before the panic with respect to
Bear Stearns. And I think that caused a lot of confusion, and I
have written about it extensively.
So I would like to see a return to a monetary policy, which
13(3) is almost never used. And I think that would be a much
better sort of standard monetary policy. I also think that it
is very important to be more transparent about 13(3).
Mr. Watt. But let's--maybe I need a better understanding of
what 13(3) is. You put it into three different categories.
Mr. Meyer. Well, the 13(3) was used for the funds to bail
out Bear Stearns.
Mr. Watt. So none of the other two options, the liquidity
options or the interest rate options, should be employed at all
until the 13(3) steps have been completely terminated? Is that
what you are saying?
Mr. Meyer. Well, I just would--I would just add one thing.
Some of those emergency liquidity authorities were put in place
using 13(3).
Mr. Watt. All right. But then I don't have the capacity to
distinguish those. If they were put in place under 13(3)
authority, then I have to treat them as part of the 13(3).
Mr. Meyer. No. They are very different.
Mr. Watt. You know, maybe we are being semantic here. But
the question--and that was what was confusing me because you
all had gone on to talking about only interest rates. That is
monetary policy. That is not 13(3) authority. Can you even get
there, is my question, before you deal with the 13(3)
withdrawal?
Mr. Goodfriend. Could I just--I want to say something.
Mr. Watt. Mr. Goodfriend?
Mr. Goodfriend. I talked extensively about something I
called credit policy, which is very distinct from monetary
policy. Monetary policy was reserves, buying Treasuries only.
Credit policy undoes Treasuries only. Credit policy is 13(3).
Mr. Watt. But if credit policy was implemented under
13(3)--
Mr. Goodfriend. That's right. But the two are distinct.
Mr. Meyer. Could I just make a point? Regular reform bills
all make a distinction between two parts of 13(3). One is
bailouts of individual institutions, and the other are broad-
based policies like the primary deal at credit facility that
was just about injecting liquidity into the system, but
injecting it through a wider base.
These are very separate, and I understand that legislation
will take 13(3) authority away from the Fed with respect to
individual institutions, but leave it with respect to these
broad-based.
Mr. Watt. Go ahead, Professor.
Mr. Goodfriend. I was going to say, for me, I have a
particular take on these questions. There is the mechanical
question of what you want to do in terms of sequencing the
withdrawal of different 13(3) programs, and how that will
affect the unemployment rate, and what is your view about how
soon to do that sort of thing.
But to me, I always think that there is a signaling effect
of these kinds of withdrawals that has to do largely with the
potential beliefs of the public as to what the long-term
prospects are for inflation expectations.
And I think it is very important to kind of get 13(3)
behind us; if not in fact, at least create a roadmap or rule,
like John is saying, so the public sees that the Federal
Reserve is regaining its independence from the fiscal
authority, and also that the fiscal authority is working well
with the Federal Reserve, that the government works.
I mean, we had a huge panic in the fall of 2008, I believe,
because the public thought that the government wasn't working.
Mr. Watt. But necessarily get 13(3) credit authority behind
us before we go to the interest rate thing, or--
Mr. Goodfriend. No. No, I think the discussion should be
had so that there is a sense in the public mind of what the
intentions are as to how to move forward to get out of 13(3).
The point being is the public, I think, is going to be
naturally nervous about the Federal Reserve's independence and
commitment to stabilize the inflation rate. And that has to be
job one. If we don't stabilize the inflation rate, the long-
term interest rate will spike up and we'll get--that, to my
mind, is the greatest risk of a double-dip recession, a loss of
credibility, so to speak, on inflation expectations.
And so I believe this discussion you are having is central,
but I think it is central for a slightly different reason, that
to have this discussion about 13(3) openly that clarifies the
Fed's independence vis-a-vis the fiscal authorities in Congress
is a way of signaling to the public: The government is serious
about doing the right thing about inflation, and that will keep
long-term rates low.
Mr. Watt. Okay. The only person I haven't heard from on
this issue is Mr. Ball, and then we will close.
Mr. Ball. Okay. Well, if I understand the question, I think
one can view interest rate policy and the unwinding of the
other programs as separate issues. And the reason they can be
separated is that the Fed has the tool of interest on reserves
to manipulate market interest rates regardless of what is
happening to the balance sheet.
So I think we can separate those issues. I think probably
the Fed will and should be unwinding the various programs
slowly because we will want to unwind them eventually, but we
don't want to take the risk of jarring markets by dumping a lot
of securities at one time or anything like that.
So I think the Fed is on a proper course of gradually
unwinding the unorthodox policies. And then there is the
separate issue of when interest rates should be increased.
Mr. Watt. I am not sure I am clear on it, but I probably
won't ever be clear because this is complex territory. I am
sure you all understand it better, and that is why we have
these hearings, for us to try to understand it better so we can
make better decisions.
We are extremely appreciative of your patience and your
presence and your testimony. Let me do a couple of housekeeping
things here.
I ask unanimous consent to insert in the record a statement
from Janis Eberly entitled, ``Unwinding Emergency Federal
Reserve Liquidity Programs, and Implications for Economic
Recovery.''
Your entire statements will be made a part of the record.
The Chair notes that some members may have additional questions
for this panel, or for Chairman Bernanke, which they may wish
to submit in writing. Without objection, the hearing record
will remain open for 30 days for members to submit written
questions to these witnesses and to place their responses in
the record.
I think that completes all of our business, with our
thanks, and the hearing is adjourned.
[Whereupon, at 1:10 p.m., the hearing was adjourned.]
A P P E N D I X
March 25, 2010
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