[Senate Hearing 111-772]
[From the U.S. Government Publishing Office]
S. Hrg. 111-772
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2010
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
ON
RECEIVING THE FEDERAL RESERVE'S SEMI-ANNUAL MONETARY REPORT TO THE
CONGRESS AND DISCUSSING MONETARY POLICY AND THE ECONOMIC OUTLOOK
__________
FEBRUARY 25, 2010
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Marc Jarsulic, Chief Economist
Drew Colbert, Legislative Assistant
Misha Mintz-Roth, Legislative Assistant
Lisa Frumin, Legislative Assistant
Mark Oesterle, Republican Chief Counsel
Jeff Wrase, Republican Chief Economist
Andrew Olmem, Republican Senior Counsel
Chad Davis, Republican Professional Staff Member
Rhyse Nance, Republican Professional Staff Member
Laura Swanson, Professional Staff Member
Kara Stein, Professional Staff Member
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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THURSDAY, FEBRUARY 25, 2010
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statement of:
Senator Shelby............................................... 3
WITNESSES
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 50
Response to written questions of:
Senator Shelby........................................... 109
Senator Brown............................................ 117
Senator Merkley.......................................... 122
Senator Bunning.......................................... 125
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2010
----------
THURSDAY, FEBRUARY 25, 2010
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:08 a.m. in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd, Chairman
of the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order.
Let me welcome all who are here this morning for the
Committee hearing, the hearing on the semiannual monetary
report to Congress by the Chairman of the Federal Reserve, and
we welcome you once again, Mr. Chairman, to the Banking
Committee. I will make a brief opening statement, turn to
Senator Shelby for any comments he may make, and then we will
turn right to you for your opening comments and get to some
questioning. But we thank you once again for joining us here
this morning.
Today, as you testify before us, Mr. Chairman, it is worth
taking a moment to recognize that our economy is showing signs
of emerging from this recession. During the last two quarters,
GDP has shown positive growth, as has gross private domestic
investment, and financial markets have stabilized enough to
allow the Fed to wind down nearly all the liquidity facilities
it established in response to this crisis.
But that does not mean, of course, that our economy is out
of the woods, as we all know. And more importantly, it does not
mean that the situation of working families has improved
dramatically either. Households and small businesses dependent
on banks for financing continue to have trouble getting the
loans that they need. Commercial real estate losses continue to
mount, and combined with losses on home mortgages, they are
making the credit crunch even worse.
Outside of securities guaranteed by the Federal Government,
the residential and commercial markets for mortgage-backed
securities are practically non-existent. Foreclosures continue
to plague our communities at greater and greater rates, and the
large inventory of foreclosed homes continues to suppress the
housing market and discouraging new construction.
And worst of all, Mr. Chairman, the job market continues to
suffer from the losses incurred during the recession. We have
lost 8.4 million jobs since December of 2007. The unemployment
rate stands at 9.7 percent, although many of us would argue
here that that number is actually vastly in excess of that in
many areas of the country. And it is widely expected that it
will remain high for several years to come. An astonishing 6.3
million American workers have been out of a job for a half a
year or more, and that is a record in our Nation.
The state of our economy as a whole may be improving, but
if we are talking about the situation of ordinary American
families, I think I can sum up this recovery in three words:
Not good enough. I think most would agree.
The longer we go without resolving these problems, the
worse off, of course, we all will be. Unemployed Americans will
continue to lose their health insurance and their homes. Their
skills will begin to deteriorate, leaving us less competitive
in the global economy. Those who do have jobs will see their
wages stagnate. Our country will suffer as a result.
This Congress has a role to play in putting people back to
work, and we have a responsibility to put protections in place
to make sure that a crisis like this never threatens our
financial system again. Our Committee has made important
progress toward that end, and my hope is that we will have a
financial reform bill ready in the coming days.
Mr. Chairman, you also have a role to play in all of this,
as you know, and I have been impressed by your leadership,
keeping the American economy from falling into the abyss, and
you deserve a great deal of credit, in my view, for having
contributed so significantly to that result. But now it is time
as well, as I am sure you will agree, for you to show the same
kind of leadership in helping us and American families along
with those of us on this side of the dais to achieve the same
fate, to come out of this abyss and get back on our feet again.
So I look forward to working with you in the coming days--I
know all of my colleagues will--work on your ideas and how
monetary policy can help our constituents emerge from this
recession.
Now, as many of my colleagues know, having filled in the
seat for Ted Kennedy as Chairman of the Health, Education, and
Labor Committee, I have another place to be this morning--at
the White House--to sit there and resolve health care, which I
am confident we are going to do this morning, I would say to my
colleagues. I do not see any smiles around the table on hearing
that prediction. And so I am going to be leaving shortly, but I
want to take--I am going to abuse my chairmanship for a minute.
I am going to ask you a question because I will not get a
chance in the normal process.
In light of what is happening in Greece, Mr. Chairman, I
wanted to raise an issue because matters have arisen, and I
will raise this and you can either respond quickly to it and I
will go right to Senator Shelby. But if I indulge my colleagues
by doing this--I have not done this before, but given that I
have got the problems this morning where I have to be.
The debt crisis, Mr. Chairman, in Greece is shedding light
on the role of derivatives in the financial markets. According
to news reports this morning and over the last several days,
banks and hedge funds are using credit default swaps to bet
that Greece will default on its debt. The rising price of these
contracts contributes to an atmosphere of crisis, making it
even more difficult for the Greek Government, in my opinion, to
borrow. Since there is no requirement that purchasers of credit
default swaps actually own any of the underlying debt, we have
a situation in which major financial institutions are
amplifying a public crisis for what would appear to be private
gain.
I want to ask you here whether or not you think there ought
to be limits on the use of credit default swaps to prevent the
intentional creation of runs against governments. Do you have
any quick comments on that?
Mr. Bernanke. Yes, Senator. I just want to say first of all
that we are looking into a number of questions related to
Goldman Sachs and other companies and their derivatives
arrangements with Greece and on this issue as well. As you
know, credit default swaps are properly used as hedging
instruments.
Chairman Dodd. I agree.
Mr. Bernanke. The SEC, of course, has been interested in
this issue. Obviously, using these instruments in a way that
intentionally destabilizes a company or a country is
counterproductive, and I am sure the SEC will be looking into
that. We will certainly be evaluating what we can learn from
the activities of the holding companies that we supervise here
in the United States.
Chairman Dodd. Well, let me just make the request of you
here, and we will make the similar request to the SEC. I am
sure all of us on this Committee would like to hear very
quickly what the response is going to be, if any, either from
your or recommendations you would make as well as from the SEC.
I will make that formal request this morning. I think it is a
critical issue for all of us.
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you. Thank you, Chairman Dodd.
Welcome to the Committee, Chairman Bernanke, again.
As our financial markets began to show signs of
improvement, many of the Fed's temporary lending facilities
have been allowed to expire, and monetary policy has begun to
normalize. And while use of the temporary lending facilities
wane, expanded purchases by the Fed of Federal agency debt,
mortgage-backed securities, and longer-term Treasury securities
have kept the size of the Fed's balance sheet unusually large.
As of last week, it is my understanding that the banks had
over $1.2 trillion in reserve balances at Federal Reserve
banks. That is more than 100 times the average level of such
balances in 2006.
This morning I am interested in hearing, Mr. Chairman,
plans for reducing the size of the Fed's balance sheet,
withdrawing extraordinary liquidity support from the banking
system, and continuing the normalization of monetary policy. In
addition, I believe, Mr. Chairman, you should tell us how the
Fed plans to use interest on reserves as a monetary policy tool
and how you intend to use reverse repurchase agreements to
address reserves in the banking system.
Finally, the Committee, I believe, should gain a better
understanding of how the Fed and the Treasury Department intend
to manage the Fed's balance sheet, and I think this is
especially relevant given Tuesday's announcement by the
Treasury that it anticipates selling securities and injecting
around $200 billion into the Department's supplemental
financing account at the Fed over the next 2 months.
Mr. Chairman, while there are signs of improvement in the
economy, conditions remain weak, especially in labor markets.
Too many Americans are unemployed or underemployed. Because
credible plans for fiscal balance and monetary policy are
essential for economic recovery, we need to have transparency
and clarity about the Federal Reserve's plans. My hope this
morning, Mr. Chairman, is that you will provide that clarity.
Thank you.
Chairman Dodd. Mr. Chairman, the floor is yours.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you. Chairman Dodd, Ranking Member
Shelby, and other members of the Committee, I am pleased to
present the Federal Reserve's semiannual Monetary Policy Report
to the Congress. I will begin today with some comments on the
outlook for the economy and for monetary policy and then touch
briefly on several important issues.
Although the recession officially began more than 2 years
ago, U.S. economic activity contracted particularly sharply
following the intensification of the global financial crisis in
the fall of 2008. Concerted efforts by the Federal Reserve, the
Treasury Department, and other U.S. authorities to stabilize
the financial system, together with highly stimulative monetary
and fiscal policies, helped arrest the decline and are
supporting a nascent economic recovery. Indeed, the U.S.
economy expanded at about a 4-percent annual rate during the
second half of last year. A significant portion of that growth,
however, can be attributed to the progress that firms made in
working down unwanted inventories of unsold goods, which left
them more willing to increase production. As the impetus
provided by the inventory cycle is temporary, and as the fiscal
support for economic growth likely will diminish later this
year, a sustained recovery will depend on continued growth in
private sector final demand for goods and services.
Private final demand does seem to be growing at a moderate
pace, buoyed in part by a general improvement in financial
conditions. In particular, consumer spending has recently
picked up, reflecting gains in real disposable income and
household wealth and tentative signs of stabilization in the
labor market. Business investment in equipment and software has
risen significantly. And international trade--supported by a
recovery in the economies of many of our trading partners--is
rebounding from its deep contraction of a year ago. However,
starts of single-family homes, which rose noticeably this past
spring, have recently been roughly flat, and commercial
construction is declining sharply, reflecting poor fundamentals
and continued difficulty in obtaining financing.
The job market has been especially hard hit by the
recession, as employers reacted to sharp sales declines and
concerns about credit availability by deeply cutting their
workforces in late 2008 and in 2009. Some recent indicators
suggest that the deterioration in the labor market is abating:
Job losses have slowed considerably, and the number of full-
time jobs in manufacturing rose modestly in January. Initial
claims for unemployment insurance have continued to trend
lower, and the temporary services industry, often considered a
bellwether for the employment outlook, has been expanding
steadily since October. Notwithstanding these positive signs,
the job market remains quite weak, with the unemployment rate
near 10 percent and job openings scarce. Of particular concern,
because of its long-term implications for workers' skills and
wages, is the increasing incidence of long-term unemployment;
indeed, more than 40 percent of the unemployed have been out of
work for 6 months or more, nearly double the share of a year
ago.
Increases in energy prices resulted in a pickup in consumer
price inflation in the second half of last year, but oil prices
have flattened out over recent months, and most indicators
suggest that inflation will likely remain subdued for some
time. Slack in labor and product markets has reduced wage and
price pressures in most markets, and sharp increases in
productivity have further reduced producers' unit labor costs.
The cost of shelter, which receives a heavy weight in consumer
price indexes, is rising very slowly, reflecting high vacancy
rates. In addition, according to most measures, longer-term
inflation expectations have remained relatively stable.
The improvement in financial markets that began last spring
continues. Conditions in short-term funding markets have
returned to near pre-crisis levels. Many (mostly larger) firms
have been able to issue corporate bonds or new equity and do
not seem to be hampered by a lack of credit. In contrast, bank
lending continues to contract, reflecting both tightened
lending standards and weak demand for credit amid uncertain
economic prospects.
In conjunction with the January meeting of the FOMC, Board
members and Reserve Bank presidents prepared projections for
economic growth, unemployment, and inflation for the years 2010
through 2012 and over the longer run. The contours of these
forecasts are broadly similar to those I reported to the
Congress last July. FOMC participants continue to anticipate a
moderate pace of economic recovery, with economic growth of
roughly 3 to 3 \1/2\ percent in 2010 and 3 \1/2\ to 4 \1/2\
percent in 2011. Consistent with moderate economic growth,
participants expect the unemployment rate to decline only
slowly, to a range of roughly 6 \1/2\ to 7 \1/2\ percent by the
end of 2012, still well above their estimate of the long-run
sustainable rate of about 5 percent. Inflation is expected to
remain subdued, with consumer prices rising at rates between 1
and 2 percent in 2010 through 2012. In the longer term,
inflation is expected to be between 1 \3/4\ and 2 percent, the
range that most FOMC participants judge to be consistent with
the Federal Reserve's dual mandate of price stability and
maximum employment.
Over the past year, the Federal Reserve has employed a wide
array of tools to promote economic recovery and preserve price
stability. The target for the Federal funds rate has been
maintained at a historically low range of 0 to \1/4\ percent
since December 2008. The FOMC 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.
To provide support to mortgage lending and housing markets
and to improve overall conditions in private credit markets,
the Federal Reserve is in the process of purchasing $1.25
trillion of agency mortgage-backed securities and about $175
billion of agency debt. We have been gradually slowing the pace
of these purchases in order to promote a smooth transition in
markets and anticipate that these transactions will be
completed by the end of March. The FOMC will continue to
evaluate its purchases of securities in light of the evolving
economic outlook and conditions in financial markets.
In response to the substantial improvements in the
functioning of most financial markets, the Federal Reserve is
winding down the special liquidity facilities it created during
the crisis. On February 1, a number of these facilities,
including credit facilities for primary dealers, lending
programs intended to help stabilize money market mutual funds
and the commercial paper market, and temporary liquidity swap
lines with foreign central banks, were all allowed to expire.
The only remaining lending program for multiple borrowers
created under the Federal Reserve's emergency authorities, is
the Term Asset-Backed Securities Loan Facility, or TALF, and it
is scheduled to close on March 31 for loans backed by all types
of collateral except for newly issued commercial mortgage-
backed securities, and it will close on June 30 for loans
backed by newly issued CMBS.
In addition to closing its special facilities, the Federal
Reserve is normalizing its lending to commercial banks through
the discount window. The final auction of discount window funds
to depositories through the Term Auction Facility, which was
created in the early stages of the crisis to improve the
liquidity of the banking system, will occur on March 8. Last
week, we announced the maximum term of discount window loans,
which was increased to as much as 90 days during the crisis,
would be returned to overnight for most banks, as it was before
the crisis erupted in August 2007.
To discourage banks from relying on the discount window
rather than private funding markets for short-term credit, last
week we also increased the discount rate by 25 basis points,
raising the spread between the discount rate and the top of the
target range for the Federal funds rate to 50 basis points.
These changes, like the closure of most of the special lending
facilities earlier this month, are in response to the improved
functioning of financial markets, which has reduced the need
for extraordinary assistance from the Federal Reserve. These
adjustments are not expected to lead to tighter financial
conditions for households and businesses and should not be
interpreted as signaling any change in the outlook for monetary
policy, which remains about the same as it was at the time of
the January meeting of the FOMC.
Although the Federal funds rate is likely to remain
exceptionally low for an extended period, as the expansion
matures, the Federal Reserve will at some point need to begin
to tighten monetary conditions to prevent the development of
inflationary pressures. Notwithstanding the substantial
increase in the size of its balance sheet associated with its
purchases of Treasury and agency securities, we are confident
that we have the tools we need to firm the stance of monetary
policy at the appropriate time.
Most importantly, in October 2008 the Congress gave
statutory authority to the Federal Reserve to pay interest on
banks' holdings of reserve balances at Federal Reserve banks.
By increasing the interest rate on reserves, the Federal
Reserve will be able to put significant upward pressure on all
short-term interest rates. Actual and prospective increases in
short-term interest rates will be reflected in turn in longer-
term interest rates and in financial conditions more generally.
The Federal Reserve has also been developing a number of
additional tools to reduce the large quantity of reserves held
by the banking system, 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, our operational
capacity for conducting reverse repurchase agreements, a tool
that the Federal Reserve has historically used to absorb
reserves from the banking system, is being expanded so that
such transactions can be used to absorb large quantities of
reserves. The Federal Reserve is also currently refining plans
for a term deposit facility that could convert a portion of
depository institutions' holdings of reserve balances into
deposits that are less liquid and could not be used to meet
reserve requirements. In addition, the FOMC has the option of
redeeming or selling securities as a means of reducing
outstanding bank reserves and applying monetary restraint. Of
course, 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. I provided more discussion of these
options and possible sequencing in a recent testimony.
The Federal Reserve is committed to ensuring that the
Congress and the public have all the information needed to
understand our decisions and to be assured of the integrity of
our operations. Indeed, on matters related to the conduct of
monetary policy, the Federal Reserve is already one of the most
transparent central banks in the world, providing detailed
records and explanations of its decisions. Over the past year,
the Federal Reserve also took a number of steps to enhance the
transparency of its special credit and liquidity facilities,
including the provision of regular, extensive reports to the
Congress and the public; and we have worked closely with the
GAO, the SIGTARP, the Congress, and private sector auditors on
a range of matters relating to these facilities.
While the emergency credit and liquidity facilities were
important tools for implementing monetary policy during the
crisis, we understand that the unusual nature of those
facilities creates a special obligation to assure the Congress
and the public of the integrity of their operation.
Accordingly, we would welcome a review by the GAO of the
Federal Reserve's management of all facilities created under
emergency authorities. In particular, we would support
legislation authorizing the GAO to audit the operational
integrity, collateral policies, use of third-party contractors,
accounting, financial reporting, and internal controls of these
special liquidity and credit facilities. The Federal Reserve
will, of course, cooperate fully and actively in all reviews.
We are also prepared to support legislation that would require
the release of the identities of the firms that participated in
each special facility after an appropriate delay. It is
important that the release occur after a lag that is
sufficiently long that investors will not view an institution's
use of one of these facilities as a possible indication of
ongoing financial problems, thereby undermining market
confidence in the institution or discouraging use of any future
facility that might become necessary to protect the U.S.
economy. An appropriate delay would also allow firms adequate
time to inform investors through annual reports and other
public documents of their use of Federal Reserve facilities.
Looking ahead, we will continue to work with the Congress
in identifying approaches for enhancing the Federal Reserve's
transparency that are consistent with our statutory objectives
of fostering maximum employment and price stability. In
particular, it is vital that the conduct of monetary policy
continue to be insulated from short-term political pressures so
that the FOMC can make policy decisions in the longer-term
economic interests of the American people. Moreover, the
confidentiality of discount window lending to individual
depository institutions must be maintained so that the Federal
Reserve continues to have effective ways to provide liquidity
to depository institutions under circumstances where other
sources of funding are not available. The Federal Reserve's
ability to inject liquidity into the financial system is
critical for preserving financial stability and for supporting
depositories' key role in meeting the ongoing credit needs of
firms and households.
Strengthening our financial regulatory system is essential
for the long-term economic stability of the Nation. Among the
lessons of the crisis are the crucial importance of
macroprudential regulation that is, regulation and supervision
aimed at addressing risks to the financial system as a whole--
and the need for effective consolidated supervision of every
financial institution that is so large or interconnected that
its failure could threaten the functioning of the entire
financial system.
The Federal Reserve strongly supports the Congress' ongoing
efforts to achieve comprehensive financial reform. In the
meantime, to strengthen the Federal Reserve's oversight of
banking organizations, we have been conducting an intensive
self-examination of our regulatory and supervisory
responsibilities and have been actively implementing
improvements. For example, the Federal Reserve has been playing
a key role in international efforts to toughen capital and
liquidity requirements for financial institutions, particularly
systemically critical firms, and we have been taking the lead
in ensuring that compensation structures at banking
organizations provide appropriate incentives without
encouraging excessive risk taking.
The Federal Reserve is also making fundamental changes in
its supervision of large, complex bank holding companies, both
to improve the effectiveness of consolidated supervision and to
incorporate a macroprudential perspective that goes beyond the
traditional focus on safety and soundness of individual
institutions. We are overhauling our supervisory framework and
procedures to improve coordination within our own supervisory
staff and with other supervisory agencies and to facilitate
more integrated assessments of risks within each holding
company and across groups of companies.
Last spring the Federal Reserve led the successful
Supervisory Capital Assessment Program, popularly known as the
bank stress tests. An important lesson of that program was that
combining onsite bank examinations with a suite of quantitative
and analytical tools can greatly improve comparability of the
results and better identify potential risks. In that spirit,
the Federal Reserve is also in the process of developing an
enhanced quantitative surveillance program for large bank
holding companies. Supervisory information will be combined
with firm-level, market-based indicators and aggregate economic
data to provide a more complete picture of the risks facing
these institutions and the broader financial system. Making use
of the Federal Reserve's unparalleled breadth of expertise,
this program will apply a multidisciplinary approach that
involves economists, specialists in particular financial
markets, payments systems experts, and other professionals, as
well as bank supervisors.
The recent crisis has also underscored the extent to which
direct involvement in the oversight of banks and bank holding
companies contributes to the Federal Reserve's effectiveness in
carrying out its responsibilities as a central bank, including
the making of monetary policy and the management of the
discount window. But most important, as the crisis has once
again demonstrated, the Federal Reserve's ability to identify
and address diverse and hard-to-predict threats to financial
stability depends critically on the information, expertise, and
powers that it has by virtue of being both a bank supervisor
and a central bank.
The Federal Reserve continues to demonstrate its commitment
to strengthening consumer protections in the financial services
arena. Since the time of the previous Monetary Policy Report in
July, the Federal Reserve has proposed a comprehensive overhaul
of the regulations governing consumer mortgage transactions,
and we are collaborating with the Department of Housing and
Urban Development to assess how we might further increase
transparency in the mortgage process. We have issued rules
implementing enhanced consumer protections for credit card
accounts and private student loans as well as new rules to
ensure that consumers have meaningful opportunities to avoid
overdraft fees. In addition, the Federal Reserve has
implemented an expanded consumer compliance supervision program
for nonbank subsidiaries of bank holding companies and foreign
banking organizations.
More generally, the Federal Reserve is committed to doing
all that can be done to ensure that our economy is never again
devastated by a financial collapse. We look forward to working
with the Congress to develop effective and comprehensive reform
of the financial regulatory framework.
Thank you.
Senator Johnson. [Presiding.] Thank you, Mr. Chairman.
Is there an agreement that 5 minutes should be enough on
the clock? I do not want to be overly rigid, but so be it.
Chairman Bernanke, the weather has been unusually harsh
across the country in the past month. This has disrupted
business and Government activity and is likely to have an
impact on employment. Do you think the effects will be strong
enough to show up in the next month's employment statistics?
Mr. Bernanke. Senator, first I would say that the harsh
weather will not have permanent effects on the----
Senator Bunning. Turn on your microphone.
Mr. Bernanke. Pardon me. Senator, I would like to say first
that the harsh weather is unlikely to have any permanent
effects on the economy, simply a temporary effect. But it does
seem likely that there will be some impact on the employment
statistics for January. It is very hard to know exactly how
much, but the snowstorms were during the week in which the
information is gathered about payrolls. It may also affect
unemployment insurance claims and some other kinds of
information. So we will have to be particularly careful about
not overinterpreting the data that we receive for January.
Senator Johnson. As Congress grapples with the need for job
creation and the need to reduce our mounting deficits and
national debt, can you talk about the impact unemployment and
the budget imbalance could have on inflation?
Mr. Bernanke. Well, currently Senator, inflation looks to
be subdued. We are not expecting inflation to rise
significantly in the near or medium term.
On the one hand, the unemployment and the low use,
utilization, the low rate of utilization of labor has been a
force keeping wage gains very lower, which, of course, from a
worker' perspective is a problem. From the perspective of
employers, they are seeing both very slow wage growth and
because of all the cuts and cost-cutting measures, they are
also seeing very strong increases in productivity, which are
quite remarkable. So the combination of slow wage growth and
high productivity gains means that the unit labor costs, the
costs of production are, if anything, falling for most firms.
So that, together with very weak demand in many industries,
means that firms have very little ability or incentive to raise
prices, which would, of course, tend to moderate inflation.
On the deficit, the impact on inflation in the near term I
think is limited. Of course, it is important that Congress, the
Administration, find solutions to our longer-term debt
problems. Otherwise, it is conceivable--and I am not
anticipating anything in the near term, but it is conceivable
that it could lead to a loss of confidence in aspects of the
U.S. economy. It could affect interest rates. It could affect
the value of the dollar. And those things could directly or
indirectly affect the state of the economy, the recovery, and,
of course, the rate of inflation.
Senator Johnson. As the Federal Reserve begins to wind down
purchases of mortgage-backed securities, what steps, if any,
are needed to ensure stability in the housing market during
this transition?
Mr. Bernanke. Well, as you know, Senator, we are at this
point planning to end our purchases at the end of this first
quarter. A question is to what extent will mortgage rates be
affected by the end of our purchases. Of course, even though we
have stopped purchases, we still retain on our balance sheet
$1.25 trillion of mortgage-backed securities, and we believe
that the holding of all those securities off the market in
itself will tend to keep mortgage rates down.
We do not know for sure how much mortgage rates will
respond to our leaving the market. So far, there is little
evidence of much change in mortgage rates, but obviously, we
have to keep monitoring that. If there is a response which
seems to threaten the broader economic recovery, we certainly
would be prepared to review that decision. But, again, at the
moment it does not seem to be that a large change in mortgage
rates or any effect on housing is evident.
Senator Johnson. Although the minutes of the January 26-27,
2010 Federal Open Market Committee meeting indicate that core
measures of inflation have been stable, they also indicate that
headline inflation with swings in energy prices and core
inflation may have been held down by unusually slow increases
in the price index for shelter due to the housing crisis. Do
you think that potentially higher future energy and housing
costs pose an inflationary threat in the medium run?
Mr. Bernanke. Well, we believe that the underlying trend of
inflation, given stable expectations, given a very weak
economy, looks to be subdued. Of course, we monitor energy and
commodity prices very closely and they can vary substantially
depending, for example, on the strength of the global recovery.
Recently, energy prices have been roughly stable and futures
prices don't indicate an expectation of sharp increases in the
near term. So, again, we will continue to monitor energy
prices, but currently, at least, they are not presenting a
major inflationary threat.
The very high vacancy rates in rental properties are
keeping rents down, as well as vacancies in homes, as well, and
our anticipation is that shelter costs are going to remain
quite subdued for some time.
Senator Johnson. Senator Shelby.
Senator Shelby. Thank you.
Chairman Bernanke, this Committee continues, as you well
know, to wrestle with financial reform and the role of the Fed
has been a significant part of that debate, as you are well
aware. Chairman Dodd has previously proposed stripping the Fed
of its regulatory authority, allowing you and your colleagues
to focus on your monetary policy, lender of last resort, and
payment systems functions and so forth. On the other hand, some
on the Committee have argued in favor of allowing the Fed to
retain some type of regulatory authority over the largest
institutions, perhaps some of the others.
What do you see--how do you see such an approach, as a net
positive or a net negative here, and what would you do as
Chairman of the Board of Governors of the Fed if the will of
the Congress was to give the Fed another opportunity to be a
regulator? What would you change, considering all the problems
that were had in the last 7 years in the regulatory process?
Mr. Bernanke. Thank you, Senator. As you know, I think that
stripping the Federal Reserve of its supervisory authorities in
the light of the recent crisis would be a grave mistake for
several reasons.
First, we have learned from the crisis that large, complex
financial firms that pose a threat to the stability of the
financial system need strong consolidated supervision. That
means they need to be seen and overseen as a complete company,
reflecting the developments not only in their banks, but also
in their securities dealers and all the various aspects of
their operations.
A bank supervisor which focuses on looking at credit files
is not prepared to look at the wide range of activities of a
complex international financial firm. The Federal Reserve, in
contrast, by virtue of its efforts in monetary policy, has
substantial knowledge of financial markets, payment systems,
economics, and a wide range of areas other than just bank
supervision, and in our stress test, we demonstrated that we
can use that whole range of multidisciplinary skills to do a
better job of consolidated oversight.
By the same token, we need to look at systemic risks.
Systemic risks themselves also involve risks that can span
across companies and into various markets. There again, you
need an institution that has a breadth of skills. It is hard
for me to understand why in the face of a crisis that was so
complex and covers so many markets and institutions you would
want to take out of the regulatory system the one institution
that has the full breadth and range of those skills to address
those issues.
Let me mention your second point, and I think your point is
very well taken. As I discussed in my testimony, we have taken
very, very seriously both changes in our performance, changes
in the way we go about doing supervision, but also changes in
the structure of supervision, and we have made very substantial
changes in order to increase the quality of our supervision, to
increase our ability to look for systemic risks, and to use a
multidisciplinary cross-expertise platform to look at these
different issues. So we are very committed, and I would be
happy to discuss with you through a letter or individually more
details.
I guess I would also like, if I might just have one more
second, the Federal Reserve, of course, made errors and made
mistakes in the supervisory function, but we were hardly alone
in that respect and there were----
Senator Shelby. But what have you learned? I guess that is
the question.
Mr. Bernanke. Well, my----
Senator Shelby. You and the Board of Governors. What have
you learned?
Mr. Bernanke. We have learned several things. We have
learned, first, that regulations need to be tougher, and we
have led the effort to strengthen capital requirements, to
strengthen liquidity requirements, to put more controls, risk
controls into these companies. We have learned that we need to
have a more risk and systemic-oriented approach and we have
changed our approach to do that. So we have gone at this very
extensively.
Senator Shelby. Mr. Chairman, I want to briefly get into
the Volcker Rule and size limits. The Administration recently
proposed, as you well know, that limitations be imposed on
banks and bank holding companies with respect to trading
activities, including proprietary trading, the so-called
Volcker Rule. The Administration also proposed placing
limitations on what was referred to as, quote, ``excessive
growth'' of the shares of liabilities at the largest financial
firms.
What are your views on the Volcker Rule proposal, and
separately, on the proposal to limit excessive growth in the
firms' liabilities? And do the regulators right now have the
power, as some people have suggested, to invoke the Volcker
Rule, or would you need legislation if the Congress so thought
it was necessary?
Mr. Bernanke. Senator, first, I think we would all agree
that we don't want companies taking excessive risks when they
are protected by the government safety net, so that is very
important. There are obviously multiple ways to address those
risks and they include capital requirements, and we have
increased capital requirements, as well as, for example,
restrictions on executive compensation, which affect
willingness to take risks.
If you go about imposing the Volcker Rule, I think it would
be difficult to do on a purely legislative basis because of the
potential for having unintended consequences. So while on the
one hand you may want to restrict purely proprietary trading,
you also want to distinguish that from, say, appropriate
hedging behavior----
Senator Shelby. You have to be careful, don't you?
Mr. Bernanke. You have to be careful of unintended
consequences. Hedging, market making, customer activities can
involve ownership of securities for a period of time. I do
think if you want to go in that direction, you should at least
allow some role for the supervisors to make determinations
about individual activities. I think it would not be
inappropriate if a supervisor determines that a company doesn't
have the managerial or risk capacity to appropriately manage a
particular activity, for the supervisor to be able to restrict
that activity.
I would argue that we have that authority to some extent
now, but if Congress wants to reinforce that, of course, it
couldn't hurt.
Senator Shelby. Thank you, Mr. Chairman.
Senator Johnson. Senator Reed?
Senator Reed. Thank you very much, Mr. Chairman, and
welcome, Chairman Bernanke.
A follow-up on the Volcker Rule. How would you implement it
if you were to do it through your regulatory process?
Mr. Bernanke. We would do it as part of our overall risk
management assessment. We would look at the range of activities
that the company engages in. There might be some activities
that would be explicitly prohibited by legislation, say perhaps
owning a hedge fund, for example. But if there are other
activities, such as purchasing of, say, credit default swaps, I
think it would be appropriate for the supervisor to, first of
all, ascertain that the use of credit default swaps is
primarily intended to hedge other positions and therefore is
overall a net reduction in risk for the company as opposed to
an increase or a speculative increase in risk.
Second, even if the purposes of the program are in some
sense legitimate, there is still the question of whether the
company has adequate managerial risk management resources to
properly manage those risks, and what we saw in the previous
crisis, and I think this is one of the things we really
learned, is that many large, complex companies didn't really
understand the full range of risks that they were facing and as
a result they found themselves exposed in ways they didn't
anticipate. So if a company didn't have strong risk management
controls and a strong culture of system--enterprise-wide risk
management, I think that would be also grounds for the
supervisor requesting either substantial strengthening in those
controls or eliminating those activities.
Senator Reed. Just an observation. Those controls are much
more rigorous today, but they tend to erode over time,
particularly as these unpleasant crises fade. And also, the
capacity of the regulators, the Federal Reserve and other
regulators, to make very nuanced judgments about management, et
cetera, there is really a question of regulatory capacity as
well as managerial capacity that at least the last several
months suggests that it won't be handled by simply sort of
letting you do what you inherently can do now.
Mr. Bernanke. Well, certainly Congress could provide
guidance about what they would like to see shut down or make
specific statutory recommendations or statutory laws. But
another--I am sorry. I lost my train of thought.
Oh, yes, sorry. I just recalled. I think another part of
the reform package that is very important is the resolution
authority and measures taken to address the too-big-to-fail
problem. If you can address the too-big-to-fail problem and get
market discipline affecting firms so that investors will have
an incentive to try to evaluate the risk taking of those firms,
that will be an additional--not a panacea, but it will be an
additional factor helping the regulators and the firm itself
make good decisions.
Senator Reed. Underlying this discussion of the Volcker
Rule is a more general principle, I think. That is, what risks
should taxpayers support? I think there is a consensus that
traditional commercial banking, which everything has a risk,
has historically been supported and should be supported. But
the ability to access your credit facilities and your authority
under 13(3) by large financial institutions whose primary
activity is not commercial banking but either proprietary
trading, which is inherently riskier, I mean, there is a real
question here of whether they should have that access and I
think that is at the heart of the Volcker Rule.
To your point about too big to fail, I mean, the size has
not been indicative of the sort of capacity to fail, so again,
I just--there are real questions that we have to wrestle with
with respect to, as a policy that you will implement, whether
we are going to, with taxpayers' money, support very profitable
risk-taking activities when they work and catastrophic
activities to taxpayers when they don't work.
Mr. Bernanke. Well, Senator, as an example, consider the
savings and loans, which basically were killed by interest rate
risk. Today, they would either be able to securitize the loans
that they made or they would be able to hedge that interest
rate risk.
So I am not disagreeing with you at all. I think we all
agree that we don't want excessive risk taking, particularly on
a ``tails, I win, heads, you lose'' basis, certainly. But there
are some legitimate purposes for using securities and we just
want to make sure not to increase the risk----
Senator Reed. No, I recognize the difficulty of sorting out
a proprietary trade. You don't have the staff, frankly, to do
that, to keep up with every trading platform and every trading
floor in the country. So that is why I think there has to be
perhaps a simpler approach, since these organizations are so
large in terms of their trading versus the commercial banks,
they might not qualify for the same type of support.
Thank you.
Senator Johnson. Senator Bunning?
Senator Bunning. Thank you, Mr. Chairman. Thank you for
being here.
On the discount rate increase, how much lending is
currently outstanding at the discount window? I don't want to
know the people, I just want to know the amounts.
Mr. Bernanke. I believe it is in the order of $17 to $20
billion.
Senator Bunning. OK. If that is the case, since there is so
little discount window borrowing going on, the increase in the
discount rate seems to be more for show than for substance. On
top of that, you and the Fed have gone out of your way to
downplay the importance of that move. Why should anyone take
that move as a sign that you are serious about taking away the
punch bowl at this time?
Mr. Bernanke. Well, Senator, what we have been trying to do
is to eliminate the extraordinary support that we have provided
financial markets, and we had a wide range of programs that try
to address the dysfunction in the commercial paper market,
money market mutual funds, interbank markets, repo markets, and
a variety of others. And as I mentioned in my testimony, on
February 1, we shut down most of those programs. By June, we
will have no more of these 13(3) programs----
Senator Bunning. Except--except what Senator Shelby brought
up. On Tuesday, the Treasury announced that they were starting
up a supplemental financing program again. It is $200 billion-
plus. Under that program, Treasury issues debts and deposits
the cash with the Fed. That is the effective same thing as the
Fed issuing its own debt, which you know is not legal.
Mr. Bernanke. What it does----
Senator Bunning. There are--well, let me finish with the
question and you can answer. What are the legal grounds that
the Fed and Treasury used to justify that program? And did
anyone in the Fed or Treasury object when the program was
created?
Mr. Bernanke. Well, legally, we are the fiscal agent of the
Treasury and we hold Treasury balances that they--for all kinds
of purposes, so there is no----
Senator Bunning. But they are not allowed to issue debt,
Treasury.
Mr. Bernanke. Treasury is allowed to issue debt.
Senator Bunning. On its own?
Mr. Bernanke. I don't--they issue bills and other kinds of
debt all the time.
Senator Bunning. Oh, yes, Treasury notes, Treasury bills,
Treasury 2-years, 5-years, 10-years. But you are buying--you
buying their debt.
Mr. Bernanke. We are just paying them interest on their
deposits on our balance sheet.
Senator Bunning. OK. That isn't the answer that I wanted.
Given what you learned during the AIG crisis and the
bailout, do you think Congress should be doing something to
address insurance regulation or the commercial paper markets?
Mr. Bernanke. Well, Senator, I think AIG is the poster
child for, first, consolidated supervision. It did not have a
strong consolidated supervisor that was paying attention to its
derivatives activities, for example. That is very important to
do. Second----
Senator Bunning. Were those the ones in England?
Mr. Bernanke. No, those were the ones, the CDS--the credit
default swaps that the Financial Products Division was
exposed----
Senator Bunning. Weren't they located in London?
Mr. Bernanke. Well, they were in any case accessible to
U.S. regulators.
Senator Bunning. I didn't ask that question. I said, but
didn't AIG have an office in London that did those things?
Mr. Bernanke. It had some foreign offices, but I believe
that the Financial Products Division is headquartered in
Connecticut.
Senator Bunning. OK. Go right ahead.
Mr. Bernanke. So again, to address AIG issues, you need a
strong consolidated supervisor that can identify those kinds of
risks to the company and you also need some methodology, and I
think you would agree that we don't want to have too-big-to-
fail firms. We don't want the Fed involved in these bailouts.
So you need an alternative legal structure. We have supported a
resolution regime. I know this Committee is considering
alternatives that would allow the government, excluding the
Fed, to wind down a firm like this in a crisis in a way that
would not bring down the overall financial system. I think that
is a very important direction.
Senator Bunning. Does any other Fed Governor have their own
staff?
Mr. Bernanke. The staff of the Federal Reserve works for
all the Governors. There is no----
Senator Bunning. That is not my question.
Mr. Bernanke. The staff--no, not dedicated, except for
clerical----
Senator Bunning. OK. Do you think they should?
Mr. Bernanke. No. I think we all work collectively and we
all get the support from the entire staff.
Senator Bunning. Do Fed Governors have access to the
Board's staff recommendations or do they only get to see the
recommendations you approve of?
Mr. Bernanke. They see the staff recommendations.
Senator Bunning. They do?
Mr. Bernanke. Yes.
Senator Bunning. Have you ever tried to change or influence
staff recommendations before they were presented to the Board?
Mr. Bernanke. Not final recommendations, no.
Senator Bunning. Your e-mails tell us differently.
Mr. Bernanke. You are referring to an e-mail where a
preliminary draft by a couple of economists----
Senator Bunning. It was the Fed staff. That is what the----
Mr. Bernanke. It was Fed staff, but it wasn't the Fed
staff's recommendation because it was a draft done by several
people in the division, not by the leadership of the staff. And
it was, in any case, a recommendation that was outdated because
of changes in circumstances.
Senator Bunning. That was in your opinion.
Mr. Bernanke. Yes, sir.
Senator Bunning. I have more, but I am past my time.
Senator Johnson. Senator Akaka?
Senator Akaka. Thank you very much, Mr. Chairman.
I want to welcome Chairman Bernanke back to the Committee
and also to congratulate and welcome him and wish him well in
his continued tenure as Chairman of the Board of Governors of
the Federal Reserve System. We both share a commitment to
improving the lives of working families by better educating,
protecting, and empowering consumers.
Chairman Bernanke, Chairman Dodd and other Members of this
Committee helped develop and enact meaningful card reform
legislation. I am proud that the law includes provisions from
my Credit Card Minimum Payment Warning Act which will provide
consumers with detailed personalized information on their
billing statements and access to reputable credit counseling
services. Consumers will learn the true costs of making the
minimum payments and how long it will take for them to pay off
their balance if they only make minimum payments. Consumers are
also provided with the amount that they need to pay to
eliminate their outstanding balance within 36 months, which is
the typical length of a debt management plan. This useful
information recently started appearing on statements, and I
looked at it and was happy to see it.
My question to you is, how will the personalized credit
card minimum payment information influence the behavior of
consumers, and also what additional personalized disclosures
pertaining to other financial service products would enable
consumers to make better informed choices?
Mr. Bernanke. Well, Senator, I congratulate you on those
contributions. As you know, the Federal Reserve developed
extensive disclosures for credit cards as well as some rules
which were very extensively incorporated in the Congressional
bill that passed and was signed by the President.
Obviously, as you point out, the more information you can
provide consumers, the better decisions they can make and the
kinds of information about minimum balances, time to pay off,
the cost of the card, the penalties they might face, those are
the kinds of things people need to shop. If they can shop, the
market becomes more competitive and you get a market that
better serves consumers.
We have been very focused on good disclosures, good
information. We have in our disclosure reform that we did
earlier, we--I don't see Senator Schumer here yet today, but
there is the so-called Schumer Box, which has----
Senator Bunning. He is at the White House.
Mr. Bernanke.----has a list of key features of the account.
We have done a lot of work on that to make it easier to read
and more understandable to consumers.
One of the innovations pioneered by the Federal Reserve has
been to use consumer testing. We have gone out and instead of
having some lawyers just sort of figure out what should be in
the disclosure, we have actually gone out to shopping malls and
had people look at the disclosures and then we have tested them
to see how much they understand and retain. And by doing that,
we think we are improving considerably the ability of folks to
understand what they are buying and encouraging them to shop
around to get a better deal.
So again, I congratulate you on your contributions to this
and on your longstanding support for financial literacy and for
clear disclosures.
Senator Akaka. Mr. Chairman, unfortunately, investment
banks, credit card issuers, and predatory lenders through their
excessive bonuses and unfair treatment of consumers are giving
the term ``bank'' an even greater negative connotation. I am
afraid that abused or angry consumers may continue to
underutilize mainstream financial institutions. After having
grown up in an unbanked home, I personally know the challenges
that confront the unbanked. Many community banks and credit
unions provide vital financial services to working families by
providing opportunities for savings, borrowing, and low-cost
remittances.
The question is, why is it essential that we attempt to
encourage the unbanked and the underbanked to utilize
mainstream financial institutions more?
Mr. Bernanke. Well, Senator, as you well know, for various
reasons, lack of information, cultural reasons, and so on, many
minority or immigrant communities don't make much use of the
regular banking system. The cost of that is they may find
themselves paying much more for check cashing or for short-term
borrowing or for other services that they need. In most cases,
they would be better off in a mainstream financial institution.
We have encouraged banks, credit unions, and other
financial institutions to reach out to minority neighborhoods
by, for example, having people on staff who speak the language,
through advertising and through other activities, through the
CRA, the Reinvestment Act. By doing that, you attract people
from these communities and give them access to the broader
financial network. It helps them not only to get better deals
on their financial services, to pay less for check cashing, for
example, but it also helps them begin to learn how to save or
learn how to borrow for a home and do other things that you
need to have access to the broad mainstream financial system in
order to achieve.
So I think it is very important that mainstream financial
institutions continue to reach out to people in their
communities, including minorities and immigrants, to attract
them to use of mainstream financial services.
Senator Akaka. Thank you. Thank you very much, Mr.
Chairman.
Senator Johnson. Senator Johanns?
Senator Johanns. Thank you, Mr. Chairman. Mr. Chairman,
good to see you again.
Mr. Chairman, let me start out and say that I think we have
done some good work as we have tried to move through regulatory
reform. I think everybody, quite honestly, has learned from the
mistakes of the last years, no doubt about that. But I must
admit, I have a concern about something that I think is shared
by probably everybody here. It may be a little sensitive, but I
want to ask about it, and that is Fannie and Freddie.
We have spent a lot of time talking about too big to fail
and looking at private companies and how gigantic they had
gotten and how that really put us in a box. In the end, the
taxpayers got put on the hook for that. Isn't Fannie and
Freddie the government version of that too big to fail? And how
do you get out of that box?
Mr. Bernanke. Well, Senator, first, as I am sure you know,
the Federal Reserve has a long record of warning about the
dangers of the structure of Fannie and Freddie. There are
numerous dangerous, including conflicts of private and public
interest, and most notably, insufficient capital to support the
very large portfolios that they held. And, in fact, it turned
out they didn't have enough capital and now the U.S.
Government, the taxpayer, is subject to substantial cost.
Right now, we are kind of in no man's land. Fannie and
Freddie are in conservatorship. They are part of the
government's efforts to maintain the housing market because
there really is no other source of mortgages at this point, or
mortgage securitization. But certainly, this is not a
sustainable situation and I think it is very important that we
move toward clarifying the longer-term status.
There are numerous ways to go. I have talked about some in
a speech. But to give two examples, one would be a
privatization approach, which might allow the privatized firms
that securitize mortgages to purchase insurance from the
government for the mortgages that they package and sell.
Another possibility would be just to acknowledge that these
are government utilities and incorporate them with Ginnie and
FHA and other government agencies. So those are two very
different approaches, but both of them have the advantage of
eliminating this platypus kind of, you know, neither fish nor
fowl status that those firms have now.
Senator Johanns. Neither approach will eliminate the
exposure that the taxpayer faces. Would you agree with me
there?
Mr. Bernanke. Well, for example, if you had a situation
where privatized firms were not allowed to hold large
portfolios, which is a major source of the risk, first; and,
second, that they paid actuarially fair premiums to the
Government as opposed to the implicit support they had before,
there would still be risks to the taxpayer, but at least there
would be some compensation, some premium is being collected.
Senator Johanns. In effect, it sounds to me like a
Government liquidation, and I do not know that I would want to
personally buy into that. But I guess as a taxpayer we would
all end up buying into that. But it is a huge number, isn't it?
It is probably $1 trillion plus of exposure.
Mr. Bernanke. Well, it depends how you count exposure. Of
course, the mortgage-backed securities outstanding are in the
trillions.
Senator Johanns. Yes.
Mr. Bernanke. The Government's commitment at this point is
a couple hundred billion to those institutions.
Senator Johanns. Let me also draw your attention to
something, and I am running out of time here, but I was just
catching up on some things, and I noticed today that first-time
unemployment filings have increased. That was not expected.
Durable goods orders have fallen the most since August. That is
not a good sign. And that excludes, I think, transportation.
The market has responded by dropping at least at this point
by 160, and I appreciate the market can have up days and down
days. I am starting to read more and more articles about the
national debt interfering with economic recovery. And yet I do
not see an effort to slow that down here.
In fact, if we were just to stand down and say, OK, we will
adopt the President's plan, there are trillion dollar deficits
over the next decade. I cannot imagine how that turns out for--
you know, I will be 70 years old the next decade. I am not
going to live long enough to pay that off. That means my
children and grandchildren are going to have to deal with that.
I am beginning to wonder, Mr. Chairman--and I do not want
this to sound overly pessimistic, but I am beginning to wonder
whether low interest rates really have any possibility of
spurring this economy. And I will tell you what I am thinking
about, and you may not even have enough time to respond. Unless
there is demand, unless we can get consumers back into it, it
just seems very unlikely to me that you are going to see much
growth.
I talked to people who handle the freight--the railroads,
the trucking companies. They are not seeing much improvement.
All these signs point to a situation where, quite honestly,
this economy is still enormously flat. And I am not sure that
offering somebody an interest rate at 2 percent versus 4
percent is going to get us on the other side of this, and I
would just like your thought on that.
Mr. Bernanke. Well, first, I agree that the economy is
still very weak and very disappointing in that respect. I think
low interest rates do tend to help, and I will give you a
couple of examples.
One, you mentioned the durable goods. Notwithstanding--I
have not had a chance to get into those numbers in detail this
morning, but investment, actually equipment investment,
equipment and software investment has been something of a
bright spot and has been growing. And part of the reason for
that is that larger firms at least have pretty good access to
credit at reasonable rates in the corporate bond market, for
example, and that has supported the investment rebound, which
is a big part of what we are seeing in the recovery.
Another example is that the Fed's actions, interest rate
actions and our purchases of mortgage-backed securities, have
helped bring down mortgage rates. That has helped to some
extent to stabilize demand for housing and helped--as you may
know, house prices seem to have flattened out and begun to rise
a bit, which is very important for consumers in terms of their
wealth, in terms of the risk of foreclosure, and in terms of,
you know, restarting activity in the residential construction
sector.
So those are two examples where we see growth. We did have
4-percent growth in the second half of 2009. I think the issue
we face is will the growth be fast enough to materially reduce
the unemployment rate at a pace that we would like to see, and
that is a big uncertainty right now. But we are getting some
output growth at this point.
Senator Johanns. Mr. Chairman, thank you.
Senator Johnson. Senator Brown.
Senator Brown. Thank you, Mr. Chairman. Mr. Chairman, nice
to see you.
We all know for most of our Nation's history--I am going to
go in a bit different direction. For most of our Nation's
history, manufacturing and agriculture and transportation drove
our economy, whether it is steel in Youngstown or agriculture
around places like Lexington, Ohio, or the Port of Cleveland
shipping raw materials and finished goods all over the Midwest.
As an expert on--as an economic historian, as you are, and
an expert on the Great Depression, you are aware, obviously, of
the role of manufacturing, especially a historic role, in
pulling our Nation out of recession.
As many Ohioans can tell you, can painfully tell you,
manufacturing steadily declined over the last three decades. At
the same time, we know that the financial industry has rapidly
expanded.
As recently as the 1980s, manufacturing made up 25 percent
of GDP; financial services made up less than half of that, in
the vicinity of 11 or 12 percent. Those numbers crossed in the
1990s. Now it is almost a direct flip. Manufacturing, 12
percent; financial services, 20 or 21 percent.
Wall Street's output, put another way, was equal to all the
Farm Belt States and the Industrial Belt States combined. In
2004, 44 percent of all corporate profits in the United States
came from the financial sector compared with 10 percent from
manufacturing. And I say that as a preface to my question for
this reason: Kevin Phillips, the writer, has noted sort of the
history of great nations in the last 400 years. Habsburg Spain,
the United Provinces of Netherlands, and Imperial England, all
three saw their economies go from manufacturing, shipping,
agriculture--depending on which of each of the three--and
energy into more and more emphasis on financial services. And
the financialization in that sense is what probably cost those
empires their empire. They were countries that never really
recovered in the wealth creation. It really is the fact that
banking is not an independent source of wealth. It does not
cause our prosperity. The success of banking is created by our
success and our ability to create wealth.
Then I hear people, when I talk about manufacturing policy,
I hear your predecessors say this, I hear advisers in the White
House, regardless of party, say we cannot have a manufacturing
policy, we cannot pick winners and losers. Well, it is pretty
clear in the 1980s that this country, this Government, your
predecessors, and the Treasury Department picked winners and
losers. They decided that financialization, the financial
services sector should be the winner as we got rid of usury
laws, as we changed rules and deregulated and all those things.
So we put ourselves in a position where, as Kevin Phillips
said, finance is the chosen sector of the U.S. economy.
So my question is this: As your role, your statutory role,
a mandated target of 4-percent unemployment, it is at least
twice, maybe three times that right now. When I look at a
building on the Oberlin College campus 20 miles from my house,
fully powered by solar energy, the largest solar-powered
building on any college campus in America, about 8 years it was
built. All the panels were built in Germany, a country that had
an industrial policy that stimulated demand and supply and have
built clean energy jobs way better than we have. You read the
articles in the paper about what China is about to way
outcompete us on alternative energy, solar and wind turbines.
We know all that. We still sit with no manufacturing policy.
So my question is this: As the economic historian that you
are, are you troubled by the fact that the financial sector is
now twice the size of the manufacturing sector? And I put
parentheses around the next part of that, that no country that
I can see in economic history has done well when that happened.
Are you troubled by that? And if you are troubled by that fact
that the financial industry is twice the size of manufacturing,
flipping what it was, what should we do about it and what are
you doing about it?
Mr. Bernanke. Well, financial services obviously has a
place to play in a modern economy, and it is a productive
industry in the sense that it helps allocate capital more
effectively and share risk and do important things like that. I
think we would all agree that over the past decade or so,
financial services, residential construction, and some other
sectors may have become too big relative to other sectors, and
we are now seeing the painful unwinding of that process.
I think the right way to address the size of financial
services is to make sure that it is being productive and
constructive, and that means having a good regulatory regime
that directs--that provides a context in which financial
services will do productive, constructive things for the
economy. So good financial regulatory reform should lead the
financial services industry to adjust to an appropriate size
that is right for the economy.
On manufacturing, it is really a mixed picture in the
United States. We still are probably the biggest or one of the
biggest manufacturers in the world. We are the most productive.
We have had extraordinary increases in productivity, in
manufacturing recently. That, in fact, is part of the reason
why the employment share of manufacturing keeps going down, is
that we need fewer workers to produce a car or an airplane than
we used to.
Senator Brown. That is true, Mr. Chairman, but look at the
profits of the financial services--the chasm between financial
services and manufacturing is--the chasm is big in terms of the
percentage of GDP. It is even larger in terms of profits in the
last 5 years. Keep that in mind.
Mr. Bernanke. So in terms of the financial industry, you
know, I think markets should be allowed to work, but they
should be allowed to work in an environment where regulation is
appropriate and where there is an appropriate level playing
field. So you would, I suppose, agree that financial services
were not appropriately regulated or appropriately supervised.
If we strengthen that regulation and allow appropriate changes
to take place, that ought to bring down the size of the
financial services industry to a size which is more appropriate
for our economy.
Manufacturing is another issue. I think there are lots of
things that mostly Congress--I do not think the Federal Reserve
has a lot of direct influence on any particular sector. But
there are a lot of things that Congress can do. There is tax
policy, there is immigration policy, trade policy.
There is the issue of picking winners and losers. I think
that is difficult to do. But you gave the example of solar
panels. Solar panels are a viable industry with Government
support if the Congress determines that, for example, for
global warming purposes that carbon-reducing technologies or
capital is socially desirable and, therefore, supports that
activity, then that will--the private sector will, therefore,
come out and produce that. So that is a determination of
Congress whether it needs a public subsidy. I do not think that
many of those alternative energy sources would survive by
themselves in a marketplace because whatever value they have in
reducing carbon, for example, is not captured in their price in
the market.
So I guess what I am saying is that we need, first of all,
better regulation in finance to bring finance down to an
appropriate size and an appropriate set of functions. And there
are a set of things that Congress can do to try to improve our
trade balance, for example, to improve the tax policy.
I think, frankly--and this is a topic that I never could
get much traction on. I think that our immigration policy which
restricts severely the number of highly trained, skilled
immigrants is a problem because bringing those sorts of folks
in helps our high-tech industries develop more competitive--
become more competitive. So there are things I think you can do
to strengthen manufacturing.
I would also just note that while it has been a very severe
recession in the manufacturing sector, manufacturing is, in
fact, leading this recovery, as you pointed out. Industrial
production has been very strong, and we are seeing, in fact,
growth in manufacturing employment. So it has been important in
that respect.
Senator Brown. One real quick closing statement. If
manufacturing were even close to the same percentage of GDP as
it was, think how much stronger--how much quicker we would come
out of this recession in terms of recovery, just as a point of
reference perhaps.
Thank you, Mr. Chairman.
Senator Johnson. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman. Thank you, Mr.
Chairman, for being here and for your work. Thank you for your
monetary report.
Mr. Chairman, when I go around my State and have town hall
meetings and other things, obviously folks are real concerned
about jobs and the recession. But I get just as many questions
and expressions of concern about what they consider the next
looming crisis caused by spending and debt.
Now, obviously, you gave us a monetary report focused on
things you can control. Federal spending and debt is not
something you can directly control.
What is your general projection and outlook, once we are
out of this current recession, for the impact on the current
levels of what are, in my view, unsustainable Federal spending
and debt and the impact on the economy?
Mr. Bernanke. Well, Senator as you point out, at the moment
we are in a deep recession. Revenues are down to 15 percent of
GDP. We have a lot of costs arising from the recession, and so
deficits are extremely high.
The really interesting question is: What is the structural
medium-term deficit? If you look at the range of estimates
provided by the OMB and the CBO over different scenarios and so
on, most of them suggest that the deficit after we come out of
recession, say 2013 or so and the rest of that decade, should
be somewhere between--will be somewhere between 4 and 7 percent
of GDP.
That is not a sustainable number. A rule of thumb is that
in order to keep the ratio of outstanding Government debt to
our GDP more or less constant--I mean, it would be better even
to reduce it, but just to keep it constant, you need to have
deficits more in the area of 2 \1/2\ to 3 percent.
So I think it is important--so 4 to 7 percent is not
sustainable. If it were actually to happen, what we would see
is increasing interest costs, and eventually the markets would
just entirely lose confidence in our fiscal policy, and
interest rates would spike.
So it is very important for Congress--even though we are
now still in a very deep recession or in a very weak economy,
it is important for Congress to try to clarify how we are going
to exit from our fiscal position and try to provide a credible
blueprint for how our Federal deficit will be controlled over
the next 10 years and 20 years.
Senator Vitter. And just to follow up on that, let us say
in the future we reach a point that we are truly out of this
recession in a meaningful way and those deficits are where they
are projected, 4 to 7 percent, versus 2 \1/2\. How quickly
would that become a major problem in terms of the economy?
Mr. Bernanke. Well, it could become a problem tomorrow if
bond markets are not persuaded that Congress is serious about
bringing down the deficit over time. But in any case, certainly
if you look at the CBO numbers, you know, by 2025, 2030, under
existing policies we are going to be seeing the curve very
sharply rising and----
Senator Vitter. But surely way before that it would be an
issue and a problem in terms of interest rates, et cetera.
Mr. Bernanke. Absolutely. Absolutely. And you would be
seeing debt-to-GDP ratios rising; you would be seeing crowding
out of investments and other problems. Yes, absolutely.
Senator Vitter. So is it fair to say, you know, we are
perhaps not seeing those immediate threats because we are in a
serious recession? Once we come out of that, those immediate
threats, the chances of their having a real negative impact
elevate enormously.
Mr. Bernanke. That is right. And we are not completely sure
we will not have negative effects even sooner than that.
Senator Vitter. Before that.
Mr. Bernanke. Depending on how interest rates respond.
Senator Vitter. Right. Mr. Chairman, I want to Fannie Mae
and Freddie Mac. On June 18, the Treasury Secretary said before
us, ``Fannie and Freddie were a core part of what went wrong in
our system.'' I assume you agree with that.
Mr. Bernanke. Yes, sir.
Senator Vitter. We are discussing regulatory reform. In
terms of the draft bills we are discussing, there is no title
on Fannie and Freddie. When should we be addressing that?
Sooner rather than later, or when?
Mr. Bernanke. Well, I think for no other reason than just
trying to reduce uncertainty in the markets, the sooner that
you can come to some clarity on the future of Fannie and
Freddie, the better. Of course, I understand that you are
dealing with a lot of complex issues in financial reform and
health care and in other areas right now. But it would be,
obviously, helpful to try to get some clarity on that.
That does not mean necessarily that you can get to that new
situation quickly. It is going to take some time to move from
the current situation to a more stable long-run situation. But
certainly I hope Congress is looking at this issue now and
thinking about where you want to go.
Senator Vitter. OK. We are really not looking at the issue
now, at least in a meaningful way. And the schedule, as I
understand it, particularly from Treasury, is not until 2011.
Is there any good reason, in your opinion, to essentially put
that off to 2011?
Mr. Bernanke. Well, I think their concern is just that the
agenda is so full and is there time, you know, for everyone to
focus on that. And that is not my judgment to make, but I think
that is their concern. I think they would agree that an earlier
resolution would be better, certainly.
Senator Vitter. OK. Mr. Chairman, I want to go to
resolution authority and 13(3) type authority, and we have
talked about this before, but it is really important so I want
to have the discussion quickly again.
If in our regulatory reform package we come up with a
reasonable, workable wind-down mechanism to resolve large
failed institutions in an orderly way, to take them down, to
break them up in an orderly way, if we do that, would you
support our also ending, taking away 13(3) and other similar
authority from the Fed and others to put taxpayer dollars in
large quantities into individual firms?
Mr. Bernanke. In short, yes, I would support that--13(3)
has been used two ways. It has been used in what you would call
bailouts, and it has been used in developing these broad-based
lending facilities to help individual markets, like the ones we
just closed down on February 1st. I think the latter is a
valuable thing to have in case of a future crisis, but we would
be happy to give up any involvement in the wind-down of
failing, systemically critical firms.
Senator Vitter. And just to make clear, I am talking about
the former not the latter, so I think we are on the same page.
Mr. Bernanke. We are on the same page.
Senator Vitter. As I understand the Treasury's position,
they say they support a resolution authority, but they
essentially also want to keep that other authority as ``foam on
the runway,'' as sort of a backup plan, however you want to
term it. Do you think that is necessary or a good idea?
Mr. Bernanke. It depends on exactly how the resolution
authority is structured. It might be that you want the Fed to
be available to provide liquidity as part of the resolution
process, for example. But, generally speaking, I prefer that
you develop a process that leaves the Fed to do only its
standard discount window lending against collateral as it
always has done, without use of the emergency authority.
Senator Vitter. So if we get the resolution authority
right, you do not see any need for that other authority with
regard to individual firms continuing to exist?
Mr. Bernanke. We would be very happy if you could find a
solution that allows us to give up that authority.
Senator Vitter. OK.
Senator Johnson. Could you gentlemen wrap it up?
Senator Vitter. OK. I have one more question, which is
about audits and transparency of the Fed. I welcomed your
recent written comments about that as certainly movement in the
right direction from my point of view. One thing you
underscored was some delay in terms of disclosing certain
action so as not to disrupt the markets in terms of an
immediate disclosure of certain activity.
What is your reaction to the idea of having the same
disclosure with a lag for all loans and collateral used to
secure loans made by the Fed--in other words, the normal
discount window activity?
Mr. Bernanke. Including the names of the borrowers?
Senator Vitter. Correct.
Mr. Bernanke. That is a concern that we have, and the
problem is that if banks think they are going to be--that their
names are going to be publicized, then they will not come even
if they are under attack by the market, even if there is a
panic or a run on the firm. So it is a very delicate issue. I
think we will have further discussions, I am sure, but we are
quite nervous about essentially shutting down the viability of
this critical tool, which proved to be very valuable during the
crisis. So that is something that we are concerned about, even,
you know, with a delay.
Senator Vitter. So even with a delay.
Mr. Bernanke. You know, I am sure we will have further
discussions about this, but, you know, again, if a company is
under attack by people who do not believe that it is stable and
they know that if they go to the window, their name is going to
be published even with some delay, they may feel that they have
no option, that they will just have to fail, because if they go
to the window and that is revealed, then the market will then
believe that they, in fact, are not stable, and the whole
purpose of the discount window loan will not be served.
So that is a particularly sensitive one for us, even though
that is a relatively small part of our lending.
Senator Vitter. OK. Thank you.
Senator Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman. I appreciate
getting my time.
Thank you, Chairman Bernanke, for being here. I do share
one concern that Senator Vitter mentioned about the deficit,
and, gosh, I wish we would have supported Senator Gregg's
proposal when we had a chance. I think it was still the best,
perhaps last best proposal to actually force this Congress to
take an up-or-down vote on a plan that would put us back into
fiscal sanity.
I want to come back on the question of financial
regulation. Mr. Chairman, you make, I think, a strong case
about the need to have sophisticated, strong supervision for
bank holding companies and that this supervision has to take a
look at not just individual supervision but systemic risk in a
macro level. I still think we are weighing where that role
should be, and I am not sure, at least from my standpoint,
while you make a strong case that you have fully made the case
that it absolutely has to be deposited within the Federal
Reserve, that it could perhaps be deposited elsewhere.
You know, one of the comments you have made--and we are now
18 months after the crisis, and you have said that you have
looked at the Fed within supervision of the bank holding
companies, stronger capital, stronger risk supervision. You
know, we have had a lot of discussion over the last 18 months
about size. We have talked a little bit earlier--Senator Reed
raised questions about the Volcker Rule, and I share some of
your concerns about how you draw those lines. Chairman Dodd
raised the question about use of some of the instruments out
there in terms of derivatives.
Could you tell us a little bit in this last 18 months, with
this increased focus on the large sophisticated bank holding
companies that you currently supervise, you know, what steps
that has taken to strengthen that supervision in a little more
specific way than you did in your----
Mr. Bernanke. Well, it would take me quite a long time.
Senator Warner. Perhaps you could give that for the record.
I would like to see----
Mr. Bernanke. OK. So just very briefly, there has been a
lot on the regulatory side. We are working with our colleagues
in Basel and elsewhere to substantially strengthen and
modernize the capital requirements, liquidity requirements,
executive compensation requirements, risk management
requirements, and a whole raft of things just to give a
tougher, stronger regime. So that is an important part.
In terms of supervision, we are restructuring our internal
organization, and we think a landmark event, a watershed event
was the stress tests last spring, which were incredibly
successful, which the Federal Reserve led. And I think the
Federal Reserve's input to that was to supplement the standard
bank examiner going in looking at the credit file with a lot of
analytical statistical information which helped improve
comparability across banks, which helped to determine the
factors underlying possible risks to banks, which integrated
the macroscenarios so we could do stress tests and those sorts
of things.
So in our internal structure, we are, first of all,
creating a new group which will bring together not just the
bank supervisors but people from other dividends--and I
mentioned the economists, the payment system people, the
financial people, and so on--to manage the supervisory effort
for the system as a whole, and they will be looking at a
portfolio of firms, and so it will not be a firm-by-firm
operation where this teams looks at Citigroup and this team
looks at JP Morgan. Instead, they will be looking collectively
at groups of firms doing horizontal comparisons and taking a
more systemic type approach.
On top of that, we will also have a quantitative evaluation
team which increases something we have already done, which is
currently for small banks, we do not go in every year or every
6 months. What we tend to do is we look at a bunch of data, a
bunch of call report information, for example, and use
statistical models to try and evaluate whether there are
problems that we should go back and look.
Well, expanding that idea in a much more sophisticated way,
we can give these quantitative folks the license to look at a
range of activities in the firms and look at them across firms
and try to use their offsite type analysis to supplement and
support the on-side analysis.
Senator Warner. Because I want to be absolutely sensitive
to my colleagues' times who have been waiting here for a long
time, I want to just get one more point out.
Mr. Bernanke. Sure.
Senator Warner. I have got a lot of other questions, but I
will take them at another time.
Specifically in terms of, I believe, within safety and
soundness you can look at proprietary trading, hedge fund
activities, and private equity, whether you have ramped up on
that, and one of the issues that one of the panels raised with
us a little bit earlier that I thought was quite good was the
whole question of interconnectedness, and I will close with
that. But I would love to get your quick comments on that,
recognizing other folks have been waiting a long time.
Mr. Bernanke. So we have not tried to apply the Volcker
rules. We have not forbidden some activities. But we have----
Senator Warner. Heightened.
Mr. Bernanke. Yes, we have heightened our activities,
particularly with respect to risk management. We find that was
the big Achilles heel in the whole situation, that firms did
not really have a sufficient understanding of the broad-based
exposure across all their business lines to certain kinds of
risks. And we have been working very hard on that part.
Senator Warner. Interconnectedness.
Mr. Bernanke. On interconnectedness, this is a place, I
think, where the Federal Reserve really has a comparative
advantage. We have, for example, been working very hard on
strengthening the operations of the credit default swap market,
the tri-party repo market, et cetera. And in doing that, we are
looking at how the--it is critical to us--you know, JP Morgan
plays a critical role in the tri-party repo market. DTCC plays
a critical role in the securities clearing markets and so on.
So we are integrating those with our analysis of the firms,
and that is extremely important. We are paying a lot of
attention to that.
Senator Warner. Thank you, Mr. Chairman.
Senator Johnson. Senator Gregg?
Senator Gregg. Were you here earlier than I was, Jim?
Senator Johnson. Senator DeMint?
Senator Gregg. I think Senator DeMint was here. He left. I
do believe he is--go ahead.
Senator DeMint. Thank you, Mr. Chairman.
Thank you, Mr. Bernanke, for enduring us again here. I
really appreciate you being here. I apologize for missing some
of the questions, but I did hear your testimony.
I would just like to get a broad perspective. I know we are
talking about a lot of the details of financial monetary
systems, but just maybe a larger concern. As I look at what we
are doing here in Washington overall and a lot of the debate
about specifics, it does seem that the underlying debate is
more about are we going to have a free market economy or more
of a centrally planned, government-directed economy. And there
are very different views on monetary policy depending really on
what our paradigm is, I believe.
My concern is as I look at where we are even versus 5 years
ago, that the Federal Government owns two of our largest auto
companies, our largest insurance company, our largest mortgage
company. We are heavy in debate about expanding government
control of health care. We pretty much control the energy
sector, where we drill, all of those kinds of things. We are
considering now a new financial reform package that would
supercede State control, go all the way down to payday lenders
and pawn shops. And in the process of moving in this direction,
we have created huge debts, unsustainable, and 10-year
projections are more than a trillion dollars a year additional
debt.
My concern is that in your testimony, that you didn't
mention any of this. Not until we questioned the debt was it a
concern. I mean, I know it is a concern. I am not suggesting it
is not. But I would think that given the fact that the
uniqueness of the American economic system has a lot to do with
more of the Adam Smith invisible hand, bottom up, that the
Chairman of our Federal Reserve would express some concern
about the expansion of government ownership and controls of
large sections of the private sector economy, knowing that
there is a tipping point at some point where we no longer
function as a free market economy.
I am not sure if we have gone past that or not, but my
concern and alarm is that you had not expressed any concern or
alarm of the need for Congress to look at ways to devolve and
divest of these things, to try to move things back in that
direction. Is that not a concern, or is your focus just not--
your focus is what you have to do with what you have got to
work with and that is just not your area?
Mr. Bernanke. Well, Senator, first, I have, obviously, a
lot of things to talk about, so I can't cover everything of
concern.
Senator DeMint. Sure.
Mr. Bernanke. Let me talk about the financial sector, and I
think there, that returning to a more market-oriented financial
sector is a top priority and we are, in fact, doing that. For
example, all the big banks have now paid back their TARP money
and we are trying as quickly as we can to get those banks
financed by private capital, which they have raised a great
deal of private capital and it is very important.
AIG, of course, is very problematic, but they are selling
off assets in order to pay us back and they are making progress
on that, and our objective there, of course, is to put them
back in the private sector.
We talked earlier about Fannie and Freddie, and I do think
that we have to get away from this neither fish nor fowl
situation where they are part public, part private. I think one
solution would be to privatize those firms, and I think that is
an interesting direction to go.
If I might, I think perhaps the most important thing, as a
number of people have discussed, this Committee is looking at
too big to fail, looking at resolution authorities and so on.
If you were able to get a strong resolution authority, you
would do more to bring back a level competitive playing field,
market discipline into the financial sector than anything else
that you can do, because with a true resolution authority where
creditors know they will lose money, shareholders know they
will lose money if the firm fails, then they have the incentive
after that to evaluate the firm's credit, quality, and their
risk taking and so on, and that would, again, bring back
competition, bring back market discipline.
So I am very much in favor of bringing back the market in
all these areas, recognizing that the financial sector does
need appropriate regulation, but market forces and competition
ought to play a substantial role, and I am all in favor of
doing that and will work with you on that.
Senator DeMint. Well, I appreciate that and I suspect we
have very much the same philosophies about economies. But I
think the country and the world needs to know that and I just
would appreciate as you look at where we are that there is a
need to back away from where we are. A lot has happened in a
short period of time that has expanded the government scope in
a lot of areas, and there is a big difference in central
planning concepts, as you know more than I do, than free market
accountabilities, and I think you are talking about and believe
in. So I appreciate that and I thank the Chairman for allowing
me to ask a question. I yield back.
Senator Johanns. Senator Bayh?
Senator Bayh. Thank you, Mr. Chairman. It is good to see
you again.
First, just a comment. I count myself as one who believes
the Fed should retain a robust role in the supervisory area.
The reason for that is that any new entity would have to get up
to speed. There would be a learning curve there that I think
would present some difficulties.
Second, my strong impression is that you and your team have
learned from the recent past about what can go wrong and that
can inform your decisionmaking going forward.
And third, my impression is that you gain some important
insights by the oversight at the micro level informing your
judgment about setting monetary policy and making macro
decisions. So that is kind of my take on how we ought to view
this going forward.
Just a couple of questions. First, as you mentioned, the
last quarter GDP figures were pretty good, but a big chunk of
that was inventory rebuilding and that sort of thing. So we are
all worried about the sustainability of the recovery, the risk
of a double-dip, that sort of thing.
You mentioned the key to this, to have it become self-
sustaining, is final private demand. I don't want you to wade
into the political thickets, but there is a debate in Congress
about what measures we might take to augment final private
demand. Do you have any sense about what steps would be prudent
to take at this time to put some wind at the back of the
recovery and ensure that it is sustainable?
Mr. Bernanke. Well, as you know, Senator, I don't like to
inject myself in debates on fiscal policies----
Senator Bayh. But as an economist, do you care to offer
any?
Mr. Bernanke. Well, no. I don't think I can separate my
role that easily. My sense is, I mean, just as an observer, it
seems that the Congress is debating a number of potential
fiscal actions, but none of them are--I think no one is
proposing anything of the scale we saw last year, as far as I
know----
Senator Bayh. Well, let me put it another way. The Senate
voted the other day on a $15 billion package. I voted for it.
There are some good things in there. Some of my colleagues
disagreed, took a different approach. Just in terms of scale, I
mean, most people would say, even myself, some good things, I
voted for it, but that is unlikely to be of a magnitude that is
going to materially add to final private demand, to use your
words. Do you have any sense about the scale that would be
needed to have a material impact on final private demand?
Mr. Bernanke. Well, if these smaller programs are well
designed, they can be very beneficial, and so we don't want to
denigrate those at all. But----
Senator Bayh. I didn't mean to, and I wasn't asking you
to----
Mr. Bernanke. But my sense is----
Senator Bayh. I am just trying to get a sense of, what can
we do to try and ensure the economy gets the legs under it that
it needs?
Mr. Bernanke. You know, this is going to sound like a
dodge, but I think that if you are going to do more fiscal
policy in the near term, it would be very constructive to
combine that with more attention to the exit strategy 5 years
down the line, because I think there is a risk that financial
markets may begin to become concerned about the sustainability
of U.S. Fiscal policy, and the more you can assure them of
ultimate----
Senator Bayh. It is actually not a dodge. It leads to my
second question. You were asked by Senator Dodd about the use
of derivatives and the problems they are having in Greece.
Senator Vitter touched upon the deficit. I would like to raise
the question of Greece again. At what level--you know, our
debt-to-GDP ratio is now going to be going up. Some of that is
unavoidable because of the recession we are experiencing. But
you are asking us to focus on the intermediate term, which I
think is exactly right, and that is why I was a strong
supporter of the Gregg-Conrad Commission and other steps.
Do you have a sense, at what ratio of debt-to-GDP do we
begin to approach the tipping point and really run into a risk
of currency problems, interest rate spikes, the kinds of things
that Greece is now experiencing? Do you have any judgment about
that?
Mr. Bernanke. It is, of course, very hard to know, and we
are very different from Greece in terms of the type of our
economy, the size of our economy, the fact that we have our own
currency and all those sorts of issues.
Just to give you one number, Ken Rogoff and Carmen
Reinhart's book about financial crisis has been discussed in
many quarters, mentioned a 90 percent debt-to-GDP ratio as a
level at which growth becomes impacted after that. Now, saying
that, we have got a wide variety of experience among industrial
countries, ranging up to very high levels in Japan and in other
countries. But our historic levels, we were down to the 30s in
terms of debt-to-GDP and I think heading toward a 100 percent
debt-to-GDP ratio would be very undesirable, particularly given
the aging of our society and those obligations we are facing
longer term.
Senator Bayh. And we are estimated to get up close to,
what, 65, 70 percent here over the next five to 10 years,
something like that?
Mr. Bernanke. Yes.
Senator Bayh. My last question. My time is about to expire.
And we also finance our debt. Japan is mostly internal, isn't
it? We have a lot of external, which makes it a little bit
different.
Are you at all concerned about Japan's recent steps to
constrain demand there? What impact might--their economy is
obviously growing very robustly. Does that present any risks to
the global economy, the fact that they are moving in that
direction?
Mr. Bernanke. Do you mean China?
Senator Bayh. I am sorry. I misspoke. China. Yes, I did
mean China.
Mr. Bernanke. No, I am not concerned about it. I think they
have to make appropriate decisions about not overheating their
economy. They are obviously growing very quickly. From our
perspective, we would like to see more flexibility in their
exchange rate as being part of the process for reducing
overheating risks. But I think it is important that they
achieve an appropriate balance between very rapid growth and
the risks of overheating, the risks that their extensive credit
extension becomes troubled. So, no, I am not particularly
concerned about that right now.
Senator Bayh. Thank you for your service, Mr. Chairman.
Thank you.
Senator Johnson. Senator Gregg.
Senator Gregg. Thank you, Mr. Chairman.
I want to associate myself with Senator Bayh's comments
relative to your regulatory authority and the range of
regulatory authority that you should retain. I do think it is
important that you be a major player in the regulatory
atmosphere, and I do believe that although there are obviously
errors that have occurred across the regulatory regimes, that
yours are no more grievous than anybody else's, and in fact, I
think in many ways, less grievous.
To get into this issue, however, which Senator Bayh has
touched on, Senator Vitter has touched on, which is when is the
tipping point, you have basically alluded to the fact that it
may be sooner rather than later if the markets lose confidence
in us, the international markets especially. And we have had a
budget presented to us which puts us on a path, as you
described, of unsustainability because deficits will run at
five to 7 percent, debt will triple, and the public debt-to-GDP
will hit 80 percent by 2015, 2016, and we will hit 60 percent
this year, actually.
So the question becomes, what do we need as a government to
do to give the markets confidence that we are actually taking
some action, real action in trying to control the out-year
event, not the immediate issue of getting out of this
recession, but the fact that in the out years, we have an
unsustainable situation which could lead to a significant
financial issue for us as a nation and the reduction in our
lifestyle and the quality of life and the standard of living of
our children?
Mr. Bernanke. Well, the earlier question was about the
debt-to-GDP ratio, which was the tipping point. Another way to
look at this is what does the trajectory look like? If the
trajectory is such that you have an unstable dynamic where
interest payments get larger and larger, that in turn increases
the deficit, that in turn leads to higher interest payments and
it explodes, essentially, then that is a situation where
markets will become very concerned.
So I think this is as much a political question as an
economic question. The question is, can the Congress--and I
recognize these are very, very hard problems. I don't want to
in any way downplay the difficulty that it is for Congress to
address these hard problems. But it would be extraordinarily
helpful if there was persuasive evidence that Congress had the
political will to achieve over a number of years a
stabilization of the debt-to-GDP ratio or of the fiscal
trajectory, and that could be done either through whatever
mechanisms you choose to undertake or it may be through
specific plans, or maybe even through actions that you could
take now that would affect expenditures and deficits in the out
years.
Senator Gregg. But something should be done.
Mr. Bernanke. It would be very--again, the point I would
like to make is that there really is some--it is not just a
question of paying today for a benefit tomorrow. There is
benefit today if, in fact, you can increase the confidence of
the markets that we will, in fact, address this issue. It gives
you more scope and probably lower interest rates today.
Senator Gregg. And arguably, the markets aren't going to
have that confidence unless there is an event which gives them
confidence, which means the Congress has to address the gap
between spending and revenues with the fact that that gap is
primarily driven by spending, in my view. That is a rhetorical
question.
So where are we in the perception of the world relative to
this country? Does the world have confidence that we can get
our house back in order, in your opinion?
Mr. Bernanke. Well, the markets seem to have confidence. I
mean, we can sell 20- and 30-year debt at relatively low
interest rates and I think that is a vote of endorsement for
the long-term ability of this country to respond to these
challenges. But we have to make good that trust. We have to
follow through.
Senator Gregg. And if we look at the issue of how you get
the money out of the market, you have put $2 trillion,
basically, into the economy. Is that about right?
Mr. Bernanke. The Federal Reserve?
Senator Gregg. Right.
Mr. Bernanke. Our balance sheet is $2.3 trillion. It was
$900 billion before we started, so we have expanded our balance
sheet by about $1.4 trillion.
Senator Gregg. So you have got to get that money back out
at some point, right?
Mr. Bernanke. That is right.
Senator Gregg. And I notice you listed a few things here
that you have got as mechanisms. There is one, however, that I
wasn't that familiar with. I am not familiar with it at all, to
be honest with you. You said, the Federal Reserve is currently
refining plans for a term deposit facility that can convert a
portion of depository institution holdings of reserves balances
into deposits that are less liquid. Does that mean you are
basically going to require bigger reserves?
Mr. Bernanke. No. It means that instead of having reserves
held at the Federal Reserve only on an overnight basis, we are
going to offer a slightly higher interest rate so that banks
will be willing to hold reserves with us for an extended
period, and that would take those reserves out of the overnight
money markets and give us more control over the Federal funds
rate.
Senator Gregg. So you are not raising the reserves. You are
just going to say----
Mr. Bernanke. No----
Senator Gregg.----you are going to encourage people to put
more money in because you are going to pay them interest on it.
That is part of your new authority?
Mr. Bernanke. That is part of the authority Congress gave
us, to pay interest on reserves.
Senator Gregg. OK. Thank you.
Senator Johanns. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman.
I was going to go in a different direction, but just
because the last part of this was so useful, I wanted to say we
just heard the Fed Chairman talk about the political will in
Congress to be able to address this issue, and I just--it is
breathtaking to me as somebody new here that 2 weeks ago, we
had the chance, because of Senator Gregg's leadership and
Senator Conrad's leadership, to vote for a bipartisan
commission--that is all it was--to take a look over a period of
time and give us recommendations for an up or down vote, and we
didn't have the political will as an institution even to
support that.
So I want to thank Senator Gregg for his leadership and I
hope we will try again, because we need to demonstrate the
political will that you are talking about if we are not going
to leave our kids a completely diminished set of opportunities.
But I will come back to that.
I wanted to ask you a question a little bit along the lines
of what Senator Brown was asking, but different. In Colorado,
if you look at the last period of economic growth in the
country before we went into this terrible recession, that
period of economic growth resulted in an $800 decrease in
median family income in our State. So the economy grew, but
middle-class family income fell, as it did across the country.
For our middle-class families, I would argue, we have got two
recessions that we are trying to recover from, this one and the
last period of economic growth that didn't drive their income.
And at the same time, in our State, the cost of health
insurance over that period went up by 97 percent. The cost of
higher education went up by 50 percent. So you have got an
economy that is driving costs of things that are important to
move families ahead, but income is going down. And my
understanding is it is the first time our economy has grown in
our history and median family income went down.
I just wonder if you have some thoughts about that, because
it just feels to me like there are some structural things going
on in our economy that we need to be worried about, we need to
concern ourselves with.
Mr. Bernanke. You are correct that median family income
hasn't kept up with average GDP or productivity, and there are
a couple of arithmetic----
Senator Bennet. Let me just say, because you made that
point earlier, as well, and at the same time, because of the
increases in productivity you were talking about, it is not
apparent where the jobs are going to come from to be able to
help ameliorate the issues that I was just talking about. I
will stop there. Sorry.
Mr. Bernanke. So just in terms of the median income, you
mentioned one factor, which is the higher costs of benefits and
medical care, those things which have lowered wage growth as
opposed to total compensation growth. But more importantly is
the increased inequality. So you can have a growing economy,
but if there is more going to the top, then the median guy
could still be coming down and that is an issue, and I have
given some speeches on this and tried to address this to some
extent. I mean, it is a very vexed issue.
The one thing I think everybody agrees about is that income
inequality is to some extent tied to educational skills and
equality. We live in a society where technology is advancing,
where we are competing with other countries that have very
large pools of unskilled labor, and therefore, as Senator Brown
was saying, union jobs in manufacturing are no longer a
normal--or a predominate form of employment. So for all those
reasons, in order to get more people to enjoy the benefits of
productivity and higher economic growth, the training, skills,
education is a critical part of that.
One of the advantages of the United States in general is
that we do have a very flexible system. You know a lot about
education. But besides K to 12, we have community colleges,
junior colleges, on-the-job training, and all kinds of other
ways for people to get skills.
One of the things I would just say to this Committee as you
think about our unemployment problem, one of the lasting scars
of this recession is very likely to be a generation of people
who have been unemployed for a year or 2 years and will find it
difficult to come back and get a decent job because their loss
of skills, because they will have to explain why they were out
of work for 2 years. So that retraining, those aspects are very
important.
Senator Bennet. I think I am already out of time, but let
me just observe that I agree on the importance of education,
and it is one of the sad facts of the legacy of the last decade
that in addition to the economic issues we were just talking
about, we started the decade, as I understand it, roughly first
in college degrees, and 10 years later, we are roughly 15th in
the world. So I wouldn't say that our track record there over
the last 10 years has been particularly good, either, and it
just is a reminder of the urgency that we face.
This is working itself out in the daily lives of Americans.
I think there is enormous anxiety that we are at risk of being
the first generation of Americans to leave less opportunity to
our kids and our grandkids. It goes to the deficit and the debt
issue we were talking about earlier and also these fundamental
economic issues.
I appreciate your being here today. Thank you.
Mr. Bernanke. Thank you.
Senator Johanns. Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman, and
Chairman Bernanke, I appreciate your being here.
Picking up on what Senator Gregg was talking about, simply
an observation so that everybody understands exactly what we
are talking about. When we say political will, cut spending,
two-thirds of the Federal budget is in mandatory spending, and
that is a combination of the entitlements, Social Security,
Medicare, Medicaid, farm subsidies, interest on the national
debt. I am an appropriator. None of those items come before the
Appropriations Committee. All of them are on autopilot to be
spent by virtue of commitments that have been made.
I once had a very wealthy man say to me, ``Explain to me
why the Federal Government sends me a check every month for,''
I have forgotten the number, $250 or whatever it is. He says,
``I don't need it.'' And I said, but Sam, you are entitled to
it, and by law, we are going to give it to you whether we have
got it or not.
And let us make it very clear that when we are talking
about spending, we are talking about fiscal policy, these are
terms we hide behind when we talk to our constituents and give
speeches about Congress has got to get tough on spending. The
real fact is that we have got to have the courage to attack the
most popular programs in American history. We have got to level
with our constituents and tell them we are talking about the
programs you value the most and you insist are off limits. If
the entitlements are off limits for any kind of discussion here
on fiscal policy, we are going to hit 10 percent of GDP within
24 months unless we have the courage to deal with. It is 65 to
67 percent of the budget now. We are on autopilot to see 75
percent of the budget within 10 years and the other 25 percent
includes defense. So if you take defense out of the remaining
25 percent, you have got about 10 percent of the budget that
you have to get tough on in order to solve this problem.
All right. I have finished my soapbox, but I think anybody
who is paying attention to these hearings ought to hear that
and understand that because that is the reality.
Let me get to a question relating to the debt. We had our
experiences, you and I and all the rest of us, a little over a
year ago with respect to TARP. One of the things you said to us
at the time, and we banked on as we voted for TARP, was that
this was not a bailout. This was money that would come back to
the Treasury, would come back to the Federal Reserve, wherever
it came from. And, in fact, you were right. The money is coming
back, has come back. A lot of the major players of TARP have
paid it back.
Now, the Treasury is recycling that money. Senator Gregg
and I have been very firm about we were in the room when the
conversation was made as to what would happen to that money
when it came back, and we thought, naively, that we wrote into
the law the requirement that when it came back, it would be
used to pay down the national debt. But we have been informed
by the Treasury lawyers that that is not what we did.
I would like your reaction. My opinion is, TARP solved its
problems. TARP did, indeed, avoid a worldwide depression--a
worldwide collapse. We maybe are in a worldwide depression, but
TARP did, indeed, avoid a worldwide collapse in that very
difficult weekend in September when you came here and said, ``I
have run out of tools,'' a very chilling kind of comment. One
of my colleagues said, ``I feel like I am in a James Bond
movie,'' listening to the Chairman of the Federal Reserve say
we have run out of tools.
I think TARP worked. My position, and I would like your
reaction, is that having worked, it is now time to end it so
that the Treasury does not recycle it and that when the money
does come back from those people who benefited from TARP, it
goes to pay down the national debt. I would like your reaction
to that.
Mr. Bernanke. Well, first let me just say on the first part
of your comments that this is why I think it is so very
difficult to address these deficit problems, because those are
very popular programs.
I agree with you that the TARP, unpopular as it is,
achieved its basic objective of stabilizing the banking system.
It did not do as much as we would have liked to create more
credit. It is now coming back. The financial firms--I would put
aside the autos and the mortgages.
Senator Bennett. Right.
Mr. Bernanke. Just talking about the financial firms,
including AIG, putting them all together it looks like a pretty
good chance we are going to break even on that, which would be
a remarkable--in the long run, which would be a remarkable
achievement.
You have put me in a very difficult position. I do not know
how to adjudicate the legal debate. I think basically
Congress----
Senator Bennett. Forget the law. Just give me your opinion
of whether or not you think TARP should be terminated.
Mr. Bernanke. It boils down--well, I do not think--I think
Treasury was right not to terminate it unconditionally at this
point because there is still some risk out there that we may
have further financial problems. I think it is small. But to
have some flexibility in case some new crisis were to arise, I
think at least for a short period, is not unreasonable.
I am afraid I am going to have to defer to Congress on
whether or not you think the other programs that are being
proposed, like support for small business lending and those
things, are within the spirit of the TARP or good programs in
themselves. I do not know how to help you on that one.
Senator Bennett. All right. Well, this Member of Congress
thinks they are not.
Thank you, Mr. Chairman.
Senator Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair. And thank
you, Chair Bernanke, for your testimony.
I first wanted to note that when Senator Vitter asked the
question on whether there is a need to limit the Fed's ability
to use Section 13(3) Federal Reserve Act emergency lending
power funds to support individual firms, I just wanted to note
that in Chair Dodd's draft that action--that is, emergency
lending to individual firms--is prohibited. And so a point I
was asked to put forward and clarify.
I wanted to turn to the issue of recapitalizing our
community banks. This is something I hear about back home all
the time, the challenge of these banks to be able to put out
new loans given their leverage limitations and their capital
challenges. And I had supported an effort to recapitalize
community banks, and the Administration has now put forward a
very similar plan. I was just wondering if you could give us
any insights on your perceptions on how the role of community
banks in supporting lending to small business might be a factor
in the recovery of our economy.
Mr. Bernanke. Well, I think it is very important, and I
guess on the subject of regulation, I guess I would like to
remind the Committee that the Federal Reserve, although we have
been very focused on large institutions over the last couple
years because of the crisis, we also supervise a large number
of community banks, State member banks, and they provide us
very important information about the economy. We can learn from
them what is happening at the grass-roots level, what is
happening to lending. And, you know, to get to your question,
that kind of information is very valuable for us as we try to
understand what is going on in the economy.
As you point out, the community banks have in many cases,
when they are able, when they are strong enough, have been able
to step up and provide lending. They are very important lenders
to small businesses, for example. And as you say--and this was
the issue that Senator Bennett was raising--one of the
proposals that the Treasury has made is to create a fund that
would capitalize small banks that demonstrate that they can
increase their lending to small businesses.
So in the spirit of my previous conversation with Senator
Bennett, I am not going to endorse or not endorse that
approach. There are other approaches also for addressing small
businesses. But I would say that if you go do that, one
suggestion the Treasury makes, which is to separate it from the
TARP, maybe to pass it--this would address Senator Bennett's
question--to pass it separately so that it is not stigmatized
or otherwise associated with the restrictions with the TARP,
which increase the chance that that would be a successful
program. But we certainly do value the small banks for what
they are able to do, and if we are going to get this economy
going again and get employment growing again, then small banks,
small businesses are going to be critical for that.
Senator Merkley. Thank you very much, and I want to turn to
another issue, which is that I was meeting with a group of
Members of Parliament from Canada two nights ago, and when I
asked them about the economic meltdown and the impact on
Canada, they smiled and said:
Well, you know, we kept the risk out of our banking system, and
now there is a huge economic movement in which we are going
down, Canadians are going down and buying up the foreclosed
real estate in the United States.
And certainly in your role, there is the chance to look at and
learn how different models interacted around the world. And
would you just take a second to comment on the Canada
structure, how they managed risk, whether there are any
insights for us here in our efforts to provide regulatory
reform?
Mr. Bernanke. I will start with one point, which is that
Canada's monetary policy was very similar to that of the United
States, and they had very different outcomes. So those who
blame this on monetary policy should address that issue. I
think the differences between Canada and the United States had
to do with their regulatory structure, and there were two
primary advantages that they had.
First, they simply had a much more conservative bank
supervisory structure in terms of what they allowed banks to
do, in terms of the amount of capital that banks had. You know,
in the go-go days, they would be considered staid and
unexciting. But, of course, that turned out to be the right way
to go, and they are looked at as models around the world as we
look at banks supervision.
The other thing that they did, which we did not avoid, was
they avoided the deterioration in underwriting standards in
mortgages and the proliferation of very low downpayments and
bad underwriting and other problems that came back to bite us
in the crisis.
So they took a very conservative approach, and it really
paid off for them, although given that they are the biggest
trading partner of the United States, they still have had a
significant recession, of course.
Senator Merkley. Well, if I can follow up on your point
about the underwriting standards, some have argued that the
reason that Canada proceeded to maintain solid underwriting
standards was that they had an independent consumer financial
protection agency and that that vision of defending consumers
from tricks and traps in lending was never subverted, if you
will, to other goals, be they safety and soundness, monetary
policy, and so forth. Any insights on the role that institution
plays in Canada?
Mr. Bernanke. I do not know the facts on that, but I would
agree with you that it is very important to have strong
consumer protection laws.
Senator Merkley. I think I am over my time now, so I will
stop there. But thank you very much.
Senator Reed. [Presiding.] Senator Shelby, a second round.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Bernanke, the Chinese have made a number of
comments about their massive U.S. Treasury holdings. Last year,
they publicly ``worried'' about whether their investments were
safe. Recently, they have expressed the belief that they should
respond to some of the Obama Administration decisions by
selling billions of Treasury holdings.
While China does not have a financial interest in rapidly--
I do not believe they do--dumping its U.S. dollar assets, it
may have other competing political interests.
Do you believe that there is a risk to stability of the
financial system associated with risk to the value of the
dollar stemming or coming from international relations between
China and the United States?
Second, do you believe that China's large dollar reserve
holdings pose a threat to the stability of the global financial
system given the leverage those holdings provide to China to
enable it to pursue a policy of pegging its currency at an
artificially low value?
I know that is a mouthful, but I think these are important
questions.
Mr. Bernanke. Well, let me try to address that. First is
just the factual question. I do not think there has been any
significant change in China's holding of dollar reserves.
Senator Shelby. OK.
Mr. Bernanke. They have continued to acquire reserves. They
have done that when the dollar was falling. They did that when
the dollar was rising.
Senator Shelby. Do you think that is a good thing, a bad
thing, or are you indifferent about it?
Mr. Bernanke. I think it arises from a couple of problems.
Senator Shelby. OK.
Mr. Bernanke. One problem is their foreign exchange policy
to keep the currency pegged, and in order to do that, they have
no alternative but to buy treasuries. The other reason is the
global imbalances, the fact that they run this very large--
which is related, of course, to foreign exchange policy, which
is that they run a very large current account surplus while we
run a current account deficit. And it was one of the objectives
discussed by the G-20 leaders in the recent financial summits
that we should all work to try to get a more balanced trade and
capital flow situation. So I think it would be a healthier
situation if China saved less and we saved more and as a result
they were not accumulating dollar assets so quickly and we had
a more balanced financial picture.
I do think that those large capital flows and the potential
instability of those flows can be a risk to our financial
system, and, you know, I think we need to try to get those
imbalances rectified.
Senator Shelby. Picking up--and it has already been
mentioned a couple of times by Senator Vitter and others--about
the GSEs, at this point, as has been said here, there is no
indication that any GSE reform will take place in the near
term. In fact, just yesterday Secretary Geithner indicated and
I think you alluded to this--that the Administration is
unlikely to provide a plan for reforming these institutions
prior to 2011 at the earliest.
I know it is difficult and I know it is costly, but while
implementing reform will take time, could you describe to the
Committee here some of the risks that we face should we not
start the process of reform as soon as possible? In other
words, if we kick the can down the road, we could cause
difficult problems, could we not?
Mr. Bernanke. Yes, sir. First of all, I think you and I
have a lot in common on this particular issue.
Senator Shelby. We have worked together on it.
Mr. Bernanke. We have worked together on it. The Federal
Reserve has had concerns for a long time, and you were a
supporter of very good, strong regulatory oversight of Fannie
and Freddie. And unfortunately, you know, we know how it turned
out, that they did not have enough capital.
You know, I think the current situation is worrisome. It
obviously is a costly situation. And it also generates a
certain amount of uncertainty in markets as people try to
anticipate, you know, what the U.S. housing financial situation
is going to be in the future. Housing policy is a very big part
of our financial policy in this country, and the lack of
clarity about that is an issue.
Now, again, let me just say I sympathize with Secretary
Geithner in that there is an awful lot going on and financial
reform is complex. But I do hope we will be thinking about
where we want to take Fannie and Freddie soon so that we can at
least provide some clarity to the markets and to the public
about, you know, where we think this ought to be.
Senator Shelby. Thank you, Mr. Chairman.
Senator Reed. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, welcome and congratulations on your
confirmation.
Mr. Bernanke. Thank you.
Senator Menendez. I was pleased to support you.
Let me ask you, over the next few years, there is going to
be more than $1 trillion in short-term commercial real estate
loans that will reach maturity, and the ongoing credit crunch
will make it very difficult for owners of viable commercial
real estate to secure long-term financing.
In 2007, at this Committee hearing with others, I said we
were going to have a tsunami of foreclosures in the housing
market. I was told that was an exaggeration. I wish they had
been right and I had been wrong. And I see this as the next
looming crisis.
You know, it seems to me that the Federal Government failed
to act on the warning signs about the home foreclosure crisis,
and I am very concerned that we are not acting on increasingly
clear warning signs about this commercial mortgage market.
So I am wondering, first, do you believe that this is a
very serious issue facing us down the road and might this
emerge as our next economic crisis? And regardless of how you
might characterize it, which I will wait to hear what you have
to say, what do you think we can do?
For example, I have been told that this is one in which
community banks will face a fair challenge across the spectrum.
Is, for example, allowing those banks to amortize losses over
10 years an option so that we do not completely dry up lending
and at the same time maybe have a lot of these institutions
close as a result of it?
I am looking to get ahead of the curve, but that curve is
coming--that tidal wave is coming really soon, and so I would
like to hear your views on it.
Mr. Bernanke. Senator, I share your concerns about this.
This is yet another place where the Federal Reserve's oversight
of small and regional banks has been very informative for us.
We have been able to follow the situation closely and to look
at its implications for the broader economy and for the
financial system.
It seems likely that small and regional banks will be
facing a lot of challenges from losses on commercial real
estate, and the bank regulators are watching this very
carefully because it is going to put a lot of pressure on some
banks. Chairman Bair, I think the other day, put out a list of
problem banks, which has been obviously increased, and one of
the key reasons for that is the commercial real estate issues
that a lot of small banks are facing. It has the implication
not only of putting pressure on the banks, but if a small bank
has lost capital because of its losses in commercial real
estate, then it does not have the funds to make loans to small
businesses, for example, so it can permeate, it can affect the
broader economy as well.
Just a few comments. As I said, we are very alert to this.
We are concerned about it. We and the other bank regulators
have tried to address it. We have put out commercial real
estate guidance to the banks which attempts to address the
question you raised about how to deal with debts that are
coming due. And that guidance, one of the main purposes is,
first of all, to avoid unnecessary writedowns. So one of the
guidances we give is that a commercial real state project that
is able to make the payments but whose collateral value has
declined should not necessarily be written down for that
purpose, for example.
Our guidance also gives specific examples and helps banks
see how they can restructure loans, just like we restructure
residential mortgages, in ways that will keep the loan current
without having a major writedown for the bank. So we have been
doing that; as bank regulators, we have been trying to find
solution.
I also want to mention the TALF again, which is still open
for commercial mortgage-backed securities. We have had a bit of
success in bringing down commercial mortgage-backed security
spreads and in starting up some activity, including activity
outside of the Fed in creating new CMBS securities. So we are
very focused on those issues, and we have addressed it in a
number of different ways.
I want to end with just a little bit of--I would not say
good news, but lately the evidence on commercial real estate is
that there seems to be some improvement in some places, that
the fundamentals are a little better than we had feared in some
cases as the economy has done a bit better. And as we said, we
have seen some more progress in the CMBS market and in banks'
ability to restructure loans.
I do not disagree with your initial characterization that
this is a very, very serious problem that we have to continue
to monitor, but I would put forward just a sliver of optimism
recently in terms of some improvement in the outlook for that
category.
Senator Menendez. If I may briefly follow up, Mr. Chairman?
Chairman, I appreciate your answer, and I appreciate the
guidance that the regulators have given. That is somewhat
helpful. I am just concerned--and I am happy to hear that there
is a sliver of a silver lining here about some improvement in
certain sectors.
But my sense is that that is not going to meet the
challenge before us, and I hope that we are thinking
prospectively about what else we need to do or be ready to do,
because it seems to me that if the worst-case scenario
happens--and I have to be honest with you. I have heard from a
wide sector of community banks, and I have heard from a wide
sector of those who are in the commercial real estate market,
who tell me that there is not a market out there for the
renewal of these mortgages. And as such, it could be a body
blow to this economy at a time that we are seeing recovery take
place. And that would be hugely unfortunate as well as
consequential in a very real way to our overall economy.
So I would love to continue to engage with you on figuring
out how we are going to continue from all different levels--not
just the Federal Reserve, but we have also talked to the
Treasury about this. We need to figure out how do we best meet
this challenge, because it is a challenge that is coming. And
while, you know, those who maybe were irresponsible beyond a
certain degree will have to face the possibility of closure,
the breadth and scope of this is something that I am afraid of
the consequences of what it means to our overall economy.
Mr. Bernanke. Thank you. We are very focused on it and we
would like to work with you on it.
Senator Menendez. All right. Thank you, Mr. Chairman.
Senator Reed. Senator Bennett?
Senator Bennett. Thank you, Mr. Chairman.
The one thing that I hear most often and I think my
colleagues hear most often as they talk about where we are
right now, a constant, constant complaint that banks aren't
lending. And when I talk to the banks, they say, well, we are
better than we were. Year over year, we are better in 2010 than
we were in 2009, so the volume has gone up and we are doing our
best, but we can't find creditworthy borrowers. We are ready to
loan, but we can't find creditworthy borrowers.
And then when I drill down a little more, I find the real
challenge comes from regulators who come in with a definition
of creditworthy borrowers that say to the bank, OK, you used to
make auto loans at this number on your credit report and now,
if that isn't this higher number, you can't make the auto
loans. I have had business people with whom I have been
involved personally, now divested myself, say we go to our bank
with whom we have had a 30-year relationship, say we want to
make this acquisition, and can we get a loan to fund it, and
instead of saying yes, as the bank has always said before, we
like your business plan, we like your track record, you are
solid people, you know exactly what you are doing, they say, we
will give you this loan if you can demonstrate that you can pay
out of your current cash stream. Well, if I could pay out of my
current cash stream, I wouldn't be coming for the loan to try
to make the acquisition. And so additional jobs or additional
productivity that would come from what we would normally think
of as very ordinary kind of transactions is simply not there.
And inevitably, it always comes back to the regulators
won't let us do this. The regulators have tightened their
requirements of what is considered creditworthy.
You are the primary regulator. You see this, I am sure,
every day, or at least your staff does. I would like your
reaction to that because that is what I hear after the rhetoric
is all over and the screaming is all over in a political way.
That is what I hear from the business people. The banks are not
supporting true entrepreneurial activity in this country, and
until they do, we won't get the jobs back, we won't get the
economic recovery going, and they are saying it is primarily
because of tightened standards on the part of the regulators.
Mr. Bernanke. Well, it is a difficult problem and one we
are very focused on, as well. First of all, there is a
tradeoff. Probably credit terms were too easy before the
crisis. They have tightened up some. Lately, banks seem to have
leveled out. They are not tightening any further, at least. But
there is a tradeoff between making sure that you are really
making good loans versus making sure that creditworthy
borrowers are not denied.
Now, our focus at the Federal Reserve has been to achieve
an appropriate balance. We want to make sure that creditworthy
borrowers who are creditworthy can obtain credit, and we have
been very aggressive in trying to do that. We started with,
again, these guidances, but these are instructions to our
examiners as well as to the banks which say, first of all, that
we strongly encourage banks to make creditworthy loans because
it is good for the bank, it is good for the borrower, it is
good for the economy. We have trained our examiners to take
that approach.
We have most recently put out yet another guidance on small
business which actually says, you know, you should not be
denying credit based on what business you are in, whether you
are restaurant or whatever, or what geographic location you are
in. Again, this issue about your collateral value. If that has
declined, that should not be a reason not to make the loan. We
are encouraging so-called Second Look Committees who look,
again, at loans that have been turned down just to make sure
that there is not a way to make that loan.
So our guidances, our regulatory philosophy, our training
of our examiners has been very focused on getting that
appropriate balance.
Now, I have said this in previous testimonies. People say,
well, I am not convinced. What is your evidence? So since then,
we have been really trying to do outreach and try to get
information directly back from banks, small businesses. We
have, for example, put questions in the NFIB's Survey of Small
Businesses to get more information about their credit
experience. We are requiring banks to provide us more
information on small business loans. We have a series of
meetings and programs at the Reserve Banks which bring together
small banks, small businesses, community development
organizations, and so on.
We are doing our best to go out there and find out what is
really happening, because in some cases, I mean, I think you
would agree, in some cases, the regulator is a good scapegoat
and----
Senator Bennett. Yes. I understand that.
Mr. Bernanke.----and gets the credit for the problem. But
the Federal Reserve, because we have interest, of course, in
safety and soundness, but we also have interest in a healthy
economy, and that insight that we get and that balance is very
important. I realize it doesn't filter down to every bank and
every situation, but we are making enormous efforts to get that
balance.
When you do talk to your business acquaintances, first, ask
them who the regulator is who is causing the problem, because
it is not always the Federal Reserve----
Senator Bennett. I think that is fair.
Mr. Bernanke. But if you are hearing stories related to the
Federal Reserve, I would be more than happy to talk to you
about it and hear more details.
Senator Bennett. Well, if I could just quickly, Mr.
Chairman, one other aspect of this that I have discovered as I
have talked to the people in the venture capital community,
they say, we are not in the venture capital business anymore.
To the degree we are investing any money, we are doubling down
on previous bets, because the pattern used to be the venture
capital would come in, fund the startup. Once the startup
proved its viability, it would then go to a bank and get the
money that it needed to get to the point where it could then
make an IPO and go public.
And, they said, we are now discovering that the start-ups
that we funded in that first wave can't get the bank funding,
so to keep the organization alive and protect our first
investment, we double-down on our bet and we are now in a
position we have never, ever been in before. We are providing
what the banks used to provide, and as a consequence, there is
no VC money available for new start-ups and new activities.
So I am delighted to hear your focus on this. I think you
are exactly right with the kinds of things you need to do and I
simply encourage you to keep doing it.
Mr. Bernanke. We are hearing the same things on venture
capital that you are hearing.
Senator Bennett. Thank you, Mr. Chairman.
Senator Reed. Thank you, Senator Bennett.
Mr. Chairman, again, thank you for your testimony and for
your leadership. You, in response to several questions, pointed
out how central the housing sector is to our economy, and one
of the areas of great concern to all of us is the mortgage
foreclosure situation. Frankly, we have not effectively
responded to that yet. It is a growing phenomenon. In my State,
one out of ten homes are either in foreclosure or 90-days
delinquent, and that saps not only the energy from the economy,
but with the uncertainty in the employment market, with the
fear of losing your home, particularly for people at mid-life,
their sense of the American dream is evaporating. Part of what
we have to do is not only get the economy right, we have to get
the confidence of the American people restored, and their
trust.
So specifically, I am wondering what you can do as the
Federal Reserve to compel institutions to do more to modify
mortgages. I get complaints constantly, I am sure my colleagues
do, that there is a help line number. You call it and, oh, yes,
sure, and then we don't get back to it. I know there are a lot
of press releases about everything that is being done, but
until I think you make it clear that this is an important
objective, we will get a lot of motion and not a lot of
results.
And I would assume, for example, I would hope that as
within your powers of supervising the management could insist
that at least there is a calculation done for each mortgage,
whether a refinancing would be better than a foreclosure, or
something like that which would be an open process, a quick
process, and encourage institutions that you regulate--if you
can't order them, then encourage them, and you have many tools
to encourage them--to do more.
Mr. Bernanke. We are doing so. I guess I would first
mention that our mortgage-backed security purchases----
Senator Reed. Yes.
Mr. Bernanke.----lowered the mortgage rate and allowed for
some millions of refinances, which I am sure has been helpful.
As you know, the leadership in terms of actual programs is the
Treasury's program, the HAMP program, and there are a few
others, the Help for Homeowners and those, and we felt that our
best way of contributing is to be supportive of those things
and to strongly encourage both banks and, in our case, as
consolidated supervisors, we also have supervisory
responsibilities for non-bank subsidiaries, whether it is some
servicers or mortgage companies or whatever, to participate and
to be effective in those programs.
And we have for some time now been both looking for
solutions to barriers, legal or accounting barriers, and we
have been doing research to try to support these programs. For
example, we have long felt that the problem of being
underwater, the principal issue, is a serious one, and so that
was why we were supportive of some of these efforts, like the
Hope for Homeowners, that involves a principal reduction.
Unfortunately, that program apparently has not been successful
in bringing in a lot of participation, but we continue to look
at different approaches to get restructuring.
I think it is encouraging. The Treasury, I know, is not
only trying to do their best to ramp up the HAMP program, and I
think we will see more permanent modifications coming in since
they have a pretty big pipeline at this point, but they are
also doing some pilot programs that involve alternative
approaches.
For example, one problem that their approach doesn't deal
with is the problem of somebody who is unemployed, can't even
make a reduced payment. So what is needed there is not a
permanent modification but some temporary assistance. Another
issue has to do with principal reduction. So in some of their
pilot programs, I think they are looking to try to take some of
these different approaches.
We have worked with them, our economists worked with their
economists, and we have been very engaged in trying to figure
out what is the best approach. It is a very hard problem.
Unfortunately, many foreclosures are just hard to avoid for a
wide variety of reasons. But where there is a preventable
foreclosure, it is not only in the interest of the borrower,
but in the interest of the bank and of the whole economy to try
to avoid it.
Senator Reed. I will concede, it is a difficult problem,
but sometimes you have got to send a very strong message. For
example, you know, could you set a goal, maybe institution by
institution of modifications as a condition to access your
credit facilities? These institutions are borrowing money at
virtually zero percent and then they are turning around saying,
we can't modify a loan because of the interest, or we will do,
from 8 percent, we will cut it 50 basis points, when
essentially many of these people, when they pay their taxes,
they are giving them zero percent loans.
Mr. Bernanke. Well, I don't think we have to use that
threat. I think we could use our supervisory authority, and we
went back--in November of 2008, we made very clear in our
guidance that we expected full compliance and full cooperation
on this issue and we have had many conversations with the banks
and----
Senator Reed. Expecting it and getting it are two different
things, and I think we have reached the point we have got to
get it, Mr. Chairman. I know you agree conceptually, but we
have just got to move on this issue. Senator Menendez sort of
previewed another potential problem with commercial, but we are
in the midst of this great residential and it goes right to the
core of economic confidence and ultimately consumer demand and
everything else that we have to do.
Let me switch quickly, and you have been very kind to take
these questions, but at this juncture and going forward, are
you using multiple tests for the adequate capital of
institutions and the adequate sort of resources, i.e.,
leverage, indexes, liquidity measures, tangible capital as well
as risk-based capital, or are you still essentially and
formally simply relying upon the Basel capital requirements?
Mr. Bernanke. No, we have gone beyond that. We have a
general principle that there are regulatory minima and then
above that, you know, we reserve the right to push banks to do
more, depending on the risks they take and so on. So to give
two examples, one, we have actually worked with international
colleagues to develop new liquidity principles. That was one of
the, I think, real big shortcomings that was made evident in
the crisis, that they didn't have enough liquidity, and we have
pushed banks to expand their liquidity and we have been pretty
successful in doing that.
The other example I would give is that another thing that
was illustrated by the crisis was that a lot of the capital,
quote-unquote, was not really very high quality. It wasn't of
much use when the crisis came. And so, for example, as we have
worked with banks in the stress tests or as we work with banks
who want to repay TARP, we have put very heavy emphasis on
raising new common equity as the highest quality form of
capital.
So yes, and every bank is required to do an internal
capital assessment that we work with them on to make sure that
not only are they meeting all the regulatory minima, but they
are prepared for serious stresses that might come down the
road.
Senator Reed. Can I presume that you would not object to
statutory language requiring multiple tests that are readily
made and disclosed?
Mr. Bernanke. Well, I would like to talk to you about
exactly what those tests would be. We already have capital and
leverage requirements----
Senator Reed. No, I would presume they would be the
measures which you would agree and your colleagues would agree
were appropriate, but they would not be simply one standard.
Again, I think some of the problems with the Basel II,
particularly, were the ability to rely exclusively on credit
ratings for securitized products, many of which the banks were
sort of structuring and then buying because they couldn't sell
them, but they were AAA-rated, so that was a very low charge on
their risk-based capital but inherently very, very risky, as we
found out, so----
Mr. Bernanke. We have been working on the charges and they
have been substantially increased. We are currently testing out
the implications of that.
On the particular issue of these off-balance sheet
vehicles, as you know, the new accounting standards will force
banks to consolidate most of those onto their own balance sheet
and so they will have to have a full capital charge against
them.
Senator Reed. And one final question, Mr. Chairman, and
that is we have talked a lot about derivatives. We all do
recognize there is a long-term value to derivatives. My
recollection is the Chicago Board in 1848 started trading
agricultural futures. In fact, I think I recall a story where
General Grant and General Sherman showed up to congratulate one
of the architects for helping them win the Civil War because of
being able to guarantee supply. So that is the question of the
utility in that sense, and other senses, is not at stake here.
But there also is the growing perception, and I am coming
to a conviction, that many times these devices are used to
avoid regulatory constraints. In the case of Greece, it might
have been strictly legal, but clearly the intent was to avoid
the budget limitations and the budget restrictions of joining
the European Community.
With respect to many other derivatives, for example, even
commercial derivatives, because they are not typically recorded
as lending, or in some cases not even on the books, it is
borrowing that is not in violation of covenance with other
lenders. It is borrowing that allows additional leverage. And
one of the problems we are trying to recognize now is over-
leverage.
So to the extent that we have to deal with these
derivatives, any thoughts our guidance about how we prevent
them from being used not for economic hedging but for clearly
and very deliberately--maybe legally, maybe not--avoiding your
capital requirements, the lending covenants of a bank, and many
other examples.
Mr. Bernanke. Yes. There are two related issues here. One
has to do with circumventing accounting rules, which maybe is
what Greece is about. After Enron, that turned out to be--a lot
of financial arrangements essentially were structured to avoid
accounting requirements and we, at that time, the Federal
Reserve--not me personally, but the Federal Reserve--came down
pretty hard, providing sets of rules and guidances to banks to
assure that they were not creating special structures or in
order to----
Senator Reed. And yet they did.
Mr. Bernanke.----in order to avoid accounting rules. The
Greek thing is from before that period, as far as we know.
Senator Reed. Yes.
Mr. Bernanke. We are looking into that, but as far as we
know, that was about 10 years ago that those were done. So that
is one set of issues.
The other set of issues has to do with whether hedging,
which is in principle a good thing, is actually true hedging or
not, and the poster child for that would be the capital hedges
that banks took out with AIG which allowed them to reduce their
capital standards because they were, quote, protected by the
credit default swaps with AIG. And there, the challenge is to
make sure that when the hedge takes place, that it is a true
hedge and that it doesn't induce other risks, like counterparty
risks, for example, or liquidity risks.
So it is a difficult technical problem, but you are
absolutely right that derivatives have a legitimate role for
hedging risks, but if they are used to distort accounting
results or regulatory ratios, then that needs to be addressed.
We are working on that as part of the broad reforms that Basel
is undertaking.
Senator Reed. Thank you very much, Mr. Chairman.
Mr. Bernanke. Thank you.
Senator Reed. Seeing no other members, the hearing is
adjourned.
Mr. Bernanke. Thank you.
[Whereupon, at 11:49 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
February 25, 2010
Chairman Dodd, Ranking Member Shelby, and other members of the
Committee, I am pleased to present the Federal Reserve's semiannual
Monetary Policy Report to the Congress. I will begin today with some
comments on the outlook for the economy and for monetary policy, then
touch briefly on several other important issues.
The Economic Outlook
Although the recession officially began more than 2 years ago, U.S.
economic activity contracted particularly sharply following the
intensification of the global financial crisis in the fall of 2008.
Concerted efforts by the Federal Reserve, the Treasury Department, and
other U.S. authorities to stabilize the financial system, together with
highly stimulative monetary and fiscal policies, helped arrest the
decline and are supporting a nascent economic recovery. Indeed, the
U.S. economy expanded at about a 4 percent annual rate during the
second half of last year. A significant portion of that growth,
however, can be attributed to the progress firms made in working down
unwanted inventories of unsold goods, which left them more willing to
increase production. As the impetus provided by the inventory cycle is
temporary, and as the fiscal support for economic growth likely will
diminish later this year, a sustained recovery will depend on continued
growth in private-sector final demand for goods and services.
Private final demand does seem to be growing at a moderate pace,
buoyed in part by a general improvement in financial conditions. In
particular, consumer spending has recently picked up, reflecting gains
in real disposable income and household wealth and tentative signs of
stabilization in the labor market. Business investment in equipment and
software has risen significantly. And international trade--supported by
a recovery in the economies of many of our trading partners--is
rebounding from its deep contraction of a year ago. However, starts of
single-family homes, which rose noticeably this past spring, have
recently been roughly flat, and commercial construction is declining
sharply, reflecting poor fundamentals and continued difficulty in
obtaining financing.
The job market has been hit especially hard by the recession, as
employers reacted to sharp sales declines and concerns about credit
availability by deeply cutting their workforces in late 2008 and in
2009. Some recent indicators suggest the deterioration in the labor
market is abating: Job losses have slowed considerably, and the number
of full-time jobs in manufacturing rose modestly in January. Initial
claims for unemployment insurance have continued to trend lower, and
the temporary services industry, often considered a bellwether for the
employment outlook, has been expanding steadily since October.
Notwithstanding these positive signs, the job market remains quite
weak, with the unemployment rate near 10 percent and job openings
scarce. Of particular concern, because of its long-term implications
for workers' skills and wages, is the increasing incidence of long-term
unemployment; indeed, more than 40 percent of the unemployed have been
out of work 6 months or more, nearly double the share of a year ago.
Increases in energy prices resulted in a pickup in consumer price
inflation in the second half of last year, but oil prices have
flattened out over recent months, and most indicators suggest that
inflation likely will be subdued for some time. Slack in labor and
product markets has reduced wage and price pressures in most markets,
and sharp increases in productivity have further reduced producers'
unit labor costs. The cost of shelter, which receives a heavy weight in
consumer price indexes, is rising very slowly, reflecting high vacancy
rates. In addition, according to most measures, longer-term inflation
expectations have remained relatively stable.
The improvement in financial markets that began last spring
continues. Conditions in short-term funding markets have returned to
near pre-crisis levels. Many (mostly larger) firms have been able to
issue corporate bonds or new equity and do not seem to be hampered by a
lack of credit. In contrast, bank lending continues to contract,
reflecting both tightened lending standards and weak demand for credit
amid uncertain economic prospects.
In conjunction with the January meeting of the Federal Open Market
Committee (FOMC), Board members and Reserve Bank presidents prepared
projections for economic growth, unemployment, and inflation for the
years 2010 through 2012 and over the longer run. The contours of these
forecasts are broadly similar to those I reported to the Congress last
July. FOMC participants continue to anticipate a moderate pace of
economic recovery, with economic growth of roughly 3 to 3 \1/2\ percent
in 2010 and 3 \1/2\ to 4 \1/2\ percent in 2011. Consistent with
moderate economic growth, participants expect the unemployment rate to
decline only slowly, to a range of roughly 6 \1/2\ to 7 \1/2\ percent
by the end of 2012, still well above their estimate of the long-run
sustainable rate of about 5 percent. Inflation is expected to remain
subdued, with consumer prices rising at rates between 1 and 2 percent
in 2010 through 2012. In the longer term, inflation is expected to be
between 1 \3/4\ and 2 percent, the range that most FOMC participants
judge to be consistent with the Federal Reserve's dual mandate of price
stability and maximum employment.
Monetary Policy
Over the past year, the Federal Reserve has employed a wide array
of tools to promote economic recovery and preserve price stability. The
target for the Federal funds rate has been maintained at a historically
low range of 0 to \1/4\ percent since December 2008. The FOMC 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.
To provide support to mortgage lending and housing markets and to
improve overall conditions in private credit markets, the Federal
Reserve is in the process of purchasing $1.25 trillion of agency
mortgage-backed securities and about $175 billion of agency debt. We
have been gradually slowing the pace of these purchases in order to
promote a smooth transition in markets and anticipate that these
transactions will be completed by the end of March. The FOMC will
continue to evaluate its purchases of securities in light of the
evolving economic outlook and conditions in financial markets.
In response to the substantial improvements in the functioning of
most financial markets, the Federal Reserve is winding down the special
liquidity facilities it created during the crisis. On February 1, a
number of these facilities, including credit facilities for primary
dealers, lending programs intended to help stabilize money market
mutual funds and the commercial paper market, and temporary liquidity
swap lines with foreign central banks, were allowed to expire.\1\ The
only remaining lending program for multiple borrowers created under the
Federal Reserve's emergency authorities, the Term Asset-Backed
Securities Loan Facility, is scheduled to close on March 31 for loans
backed by all types of collateral except newly issued commercial
mortgage-backed securities (CMBS) and on June 30 for loans backed by
newly issued CMBS.
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\1\ Primary dealers are broker-dealers that act as counterparties
to the Federal Reserve Bank of New York in its conduct of open market
operations.
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In addition to closing its special facilities, the Federal Reserve
is normalizing its lending to commercial banks through the discount
window. The final auction of discount-window funds to depositories
through the Term Auction Facility, which was created in the early
stages of the crisis to improve the liquidity of the banking system,
will occur on March 8. Last week we announced that the maximum term of
discount window loans, which was increased to as much as 90 days during
the crisis, would be returned to overnight for most banks, as it was
before the crisis erupted in August 2007. To discourage banks from
relying on the discount window rather than private funding markets for
short-term credit, last week we also increased the discount rate by 25
basis points, raising the spread between the discount rate and the top
of the target range for the Federal funds rate to 50 basis points.
These changes, like the closure of most of the special lending
facilities earlier this month, are in response to the improved
functioning of financial markets, which has reduced the need for
extraordinary assistance from the Federal Reserve. These adjustments
are not expected to lead to tighter financial conditions for households
and businesses and should not be interpreted as signaling any change in
the outlook for monetary policy, which remains about the same as it was
at the time of the January meeting of the FOMC.
Although the Federal funds rate is likely to remain exceptionally
low for an extended period, as the expansion matures, the Federal
Reserve will at some point need to begin to tighten monetary conditions
to prevent the development of inflationary pressures. Notwithstanding
the substantial increase in the size of its balance sheet associated
with its purchases of Treasury and agency securities, we are confident
that we have the tools we need to firm the stance of monetary policy at
the appropriate time.\2\
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\2\ For further details on these tools and the Federal Reserve's
exit strategy, see Ben S. Bernanke (2010), ``Federal Reserve's Exit
Strategy,'' statement before the Committee on Financial Services, U.S.
House of Representatives, February 10, www.federalreserve.gov/
newsevents/testimony/bernanke20100210a.htm.
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Most importantly, in October 2008 the Congress gave statutory
authority to the Federal Reserve to pay interest on banks' holdings of
reserve balances at Federal Reserve Banks. By increasing the interest
rate on reserves, the Federal Reserve will be able to put significant
upward pressure on all short-term interest rates. Actual and
prospective increases in short-term interest rates will be reflected in
turn in longer-term interest rates and in financial conditions more
generally.
The Federal Reserve has also been developing a number of additional
tools to reduce the large quantity of reserves held by the banking
system, 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, our
operational capacity for conducting reverse repurchase agreements, a
tool that the Federal Reserve has historically used to absorb reserves
from the banking system, is being expanded so that such transactions
can be used to absorb large quantities of reserves.\3\ The Federal
Reserve is also currently refining plans for a term deposit facility
that could convert a portion of depository institutions' holdings of
reserve balances into deposits that are less liquid and could not be
used to meet reserve requirements.\4\ In addition, the FOMC has the
option of redeeming or selling securities as a means of reducing
outstanding bank reserves and applying monetary restraint. Of course,
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. I provided
more discussion of these options and possible sequencing in a recent
testimony.\5\
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\3\ The Federal Reserve has recently developed the ability to
engage in reverse repurchase agreements in the triparty market for
repurchase agreements, with primary dealers as counterparties and using
Treasury and agency debt securities as collateral, and it is developing
the capacity to carry out these transactions with a wider set of
counterparties (such as money market mutual funds and the mortgage-
related government-sponsored enterprises) and using agency mortgage-
backed securities as collateral.
\4\ In December the Federal Reserve published a proposal describing
a term deposit facility in the Federal Register (see Board of Governors
of the Federal Reserve System (2009), ``Federal Reserve Board Proposes
Amendments to Regulation D That Would Enable the Establishment of a
Term Deposit Facility,'' press release, December 28,
www.federalreserve.gov/newsevents/press/monetary/20091228a.htm) We are
now in the process of analyzing the public comments that have been
received. A revised proposal will be reviewed by the Federal Reserve
Board, and test transactions could commence during the second quarter.
\5\ See Bernanke, ``Federal Reserve's Exit Strategy,'' in note 2.
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Federal Reserve Transparency
The Federal Reserve is committed to ensuring that the Congress and
the public have all the information needed to understand our decisions
and to be assured of the integrity of our operations. Indeed, on
matters related to the conduct of monetary policy, the Federal Reserve
is already one of the most transparent central banks in the world,
providing detailed records and explanations of its decisions. Over the
past year, the Federal Reserve also took a number of steps to enhance
the transparency of its special credit and liquidity facilities,
including the provision of regular, extensive reports to the Congress
and the public; and we have worked closely with the Government
Accountability Office (GAO), the Office of the Special Inspector
General for the Troubled Asset Relief Program, the Congress, and
private-sector auditors on a range of matters relating to these
facilities.
While the emergency credit and liquidity facilities were important
tools for implementing monetary policy during the crisis, we understand
that the unusual nature of those facilities creates a special
obligation to assure the Congress and the public of the integrity of
their operation. Accordingly, we would welcome a review by the GAO of
the Federal Reserve's management of all facilities created under
emergency authorities.\6\ In particular, we would support legislation
authorizing the GAO to audit the operational integrity, collateral
policies, use of third-party contractors, accounting, financial
reporting, and internal controls of these special credit and liquidity
facilities. The Federal Reserve will, of course, cooperate fully and
actively in all reviews. We are also prepared to support legislation
that would require the release of the identities of the firms that
participated in each special facility after an appropriate delay. It is
important that the release occur after a lag that is sufficiently long
that investors will not view an institution's use of one of the
facilities as a possible indication of ongoing financial problems,
thereby undermining market confidence in the institution or
discouraging use of any future facility that might become necessary to
protect the U.S. economy. An appropriate delay would also allow firms
adequate time to inform investors through annual reports and other
public documents of their use of Federal Reserve facilities.
---------------------------------------------------------------------------
\6\ Last month the Federal Reserve said that it would welcome a
full review by the GAO of all aspects of the Federal Reserve's
involvement in the extension of credit to the American International
Group, Inc. (see Ben S. Bernanke (2010), letter to Gene L. Dodaro,
January 19, www.federalreserve.gov/monetarypolicy/files/
letter_aig_20100119.pdf). The Federal Reserve would support legislation
authorizing a review by the GAO of the Federal Reserve's operations of
its facilities created under emergency authorities: the Asset-Backed
Commercial Paper Money Market Mutual Fund Liquidity Facility, the
Commercial Paper Funding Facility, the Money Market Investor Funding
Facility, the Primary Dealer Credit Facility, the Term Asset-Backed
Securities Loan Facility, and the Term Securities Lending Facility.
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Looking ahead, we will continue to work with the Congress in
identifying approaches for enhancing the Federal Reserve's transparency
that are consistent with our statutory objectives of fostering maximum
employment and price stability. In particular, it is vital that the
conduct of monetary policy continue to be insulated from short-term
political pressures so that the FOMC can make policy decisions in the
longer-term economic interests of the American people. Moreover, the
confidentiality of discount window lending to individual depository
institutions must be maintained so that the Federal Reserve continues
to have effective ways to provide liquidity to depository institutions
under circumstances where other sources of funding are not available.
The Federal Reserve's ability to inject liquidity into the financial
system is critical for preserving financial stability and for
supporting depositories' key role in meeting the ongoing credit needs
of firms and households.
Regulatory Reform
Strengthening our financial regulatory system is essential for the
long-term economic stability of the nation. Among the lessons of the
crisis are the crucial importance of macroprudential regulation--that
is, regulation and supervision aimed at addressing risks to the
financial system as a whole--and the need for effective consolidated
supervision of every financial institution that is so large or
interconnected that its failure could threaten the functioning of the
entire financial system.
The Federal Reserve strongly supports the Congress's ongoing
efforts to achieve comprehensive financial reform. In the meantime, to
strengthen the Federal Reserve's oversight of banking organizations, we
have been conducting an intensive self-examination of our regulatory
and supervisory responsibilities and have been actively implementing
improvements. For example, the Federal Reserve has been playing a key
role in international efforts to toughen capital and liquidity
requirements for financial institutions, particularly systemically
critical firms, and we have been taking the lead in ensuring that
compensation structures at banking organizations provide appropriate
incentives without encouraging excessive risk-taking.\7\
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\7\ For further information, see Board of Governors of the Federal
Reserve System (2009), ``Federal Reserve Issues Proposed Guidance on
Incentive Compensation,'' press release, October 22,
www.federalreserve.gov/newsevents/press/bcreg/20091022a.htm.
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The Federal Reserve is also making fundamental changes in its
supervision of large, complex bank holding companies, both to improve
the effectiveness of consolidated supervision and to incorporate a
macroprudential perspective that goes beyond the traditional focus on
safety and soundness of individual institutions. We are overhauling our
supervisory framework and procedures to improve coordination within our
own supervisory staff and with other supervisory agencies and to
facilitate more-integrated assessments of risks within each holding
company and across groups of companies.
Last spring the Federal Reserve led the successful Supervisory
Capital Assessment Program, popularly known as the bank stress tests.
An important lesson of that program was that combining onsite bank
examinations with a suite of quantitative and analytical tools can
greatly improve comparability of the results and better identify
potential risks. In that spirit, the Federal Reserve is also in the
process of developing an enhanced quantitative surveillance program for
large bank holding companies. Supervisory information will be combined
with firm-level, market-based indicators and aggregate economic data to
provide a more complete picture of the risks facing these institutions
and the broader financial system. Making use of the Federal Reserve's
unparalleled breadth of expertise, this program will apply a
multidisciplinary approach that involves economists, specialists in
particular financial markets, payments systems experts, and other
professionals, as well as bank supervisors.
The recent crisis has also underscored the extent to which direct
involvement in the oversight of banks and bank holding companies
contributes to the Federal Reserve's effectiveness in carrying out its
responsibilities as a central bank, including the making of monetary
policy and the management of the discount window. Most important, as
the crisis has once again demonstrated, the Federal Reserve's ability
to identify and address diverse and hard-to-predict threats to
financial stability depends critically on the information, expertise,
and powers that it has by virtue of being both a bank supervisor and a
central bank.
The Federal Reserve continues to demonstrate its commitment to
strengthening consumer protections in the financial services arena.
Since the time of the previous Monetary Policy Report in July, the
Federal Reserve has proposed a comprehensive overhaul of the
regulations governing consumer mortgage transactions, and we are
collaborating with the Department of Housing and Urban Development to
assess how we might further increase transparency in the mortgage
process.\8\ We have issued rules implementing enhanced consumer
protections for credit card accounts and private student loans as well
as new rules to ensure that consumers have meaningful opportunities to
avoid overdraft fees.\9\ In addition, the Federal Reserve has
implemented an expanded consumer compliance supervision program for
nonbank subsidiaries of bank holding companies and foreign banking
organizations.\10\
---------------------------------------------------------------------------
\8\ For further information, see Board of Governors of the Federal
Reserve System (2009), ``Federal Reserve Proposes Significant Changes
to Regulation Z (Truth in Lending) Intended to Improve the Disclosures
Consumers Receive in Connection with Closed-End Mortgages and Home-
Equity Lines of Credit,'' press release, July 23,
www.federalreserve.gov/newsevents/press/bcreg/20090723a.htm.
\9\ For more information, see Board of Governors of the Federal
Reserve System (2009), ``Federal Reserve Approves Final Amendments to
Regulation Z That Revise Disclosure Requirements for Private Education
Loans,'' press release, July 30, www.federalreserve.gov/newsevents/
press/bcreg/20090730a.htm; Board of Governors of the Federal Reserve
System (2009), ``Federal Reserve Announces Final Rules Prohibiting
Institutions from Charging Fees for Overdrafts on ATM and One-Time
Debit Card Transactions,'' press release, November 12,
www.federalreserve.gov/newsevents/press/bcreg/20091112a.htm; and Board
of Governors of the Federal Reserve System (2010), ``Federal Reserve
Approves Final Rules to Protect Credit Card Users from a Number of
Costly Practices,'' press release, January 12, www.federalreserve.gov/
newsevents/press/bcreg/20100112a.htm.
\10\ For further information, see Board of Governors of the Federal
Reserve System (2009), ``Federal Reserve to Implement Consumer
Compliance Supervision Program of Nonbank Subsidiaries of Bank Holding
Companies and Foreign Banking Organizations,'' press release, September
15, www.federalreserve.gov/newsevents/press/bcreg/20090915a.htm.
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More generally, the Federal Reserve is committed to doing all that
can be done to ensure that our economy is never again devastated by a
financial collapse. We look forward to working with the Congress to
develop effective and comprehensive reform of the financial regulatory
framework.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM BEN S.
BERNANKE
Emergency Lending Under Section 13(3)
Q.1.a. Charles Plosser, President of the Federal Reserve Bank
of Philadelphia, stated in a recent speech his belief that the
Fed's emergency 13(3) lending authority should be either
eliminated or severely curtailed (``The Federal Reserve System:
Balancing Independence and Accountability,'' presented February
17, 2010 by President Plosser to the World Affairs Council of
Philadelphia). He stated:
I believe that the Fed's 13(3) lending authority should be
either eliminated or severely curtailed. Such lending should be
done by the fiscal authorities only in emergencies and, if the
Fed is involved, only upon the written request of the Treasury.
Any non-Treasury securities or collateral acquired by the Fed
under such lending should be promptly swapped for Treasury
securities so that it is clear that the responsibility and
accountability for such lending rests explicitly with the
fiscal authorities, not the Federal Reserve. To codify this
arrangement, I believe we should establish a new Fed-Treasury
Accord. This would eliminate the ability of the Fed to engage
in `bailouts' of individual firms or sectors and place such
responsibility with the Treasury and Congress, squarely where
it belongs.
Do you agree with President Plosser?
A.1.a Since the fall of 2008, I have advocated that Congress
establish a statutory resolution regime that provides a
workable alternative to Government bailouts and disorderly
bankruptcies. With enactment of a workable resolution regime
for systemically important firms, I have also called for
removal of the Federal Reserve's authority under section 13(3)
to extend credit to troubled nonbanking entities.
However, I believe that it would be appropriate for the
Federal Reserve to retain the authority to lend to establish
broad market-based credit facilities in unusual and exigent
circumstances. In exceptional circumstances the preservation of
financial stability may require that the Federal Reserve have
the authority to provide liquidity to restart or encourage
markets to operate, thereby providing liquidity needed to allow
households, small businesses, depositors and others access to
working liquid markets. The need for such authority was fully
evident during the financial crisis, when preventing a
financial catastrophe required that the Federal Reserve provide
liquidity to money market mutual funds, primary dealers, the
commercial paper market, and the market for student loans,
credit card loans, small business loans and the commercial real
estate market.
Q.1.b. Do you believe that modifications to Section 13(3) of
the Federal Reserve Act would be useful in clarifying emergency
responses of various branches of government to financial
crises? If so, what modifications do you believe would be most
useful?
A.1.b. Apart from a possible elimination of the authority to
lend to single firms (as discussed above), I do not believe
that significant modifications to section 13(3) are necessary
or appropriate. The Federal Reserve has historically been
extremely cautious in using the section 13(3) authority.
Prior to the recent financial crisis, the Federal Reserve
had authorized the extension of credit under section 13(3) in
only one circumstance since the Great Depression and had not in
fact extended credit under this section since the 1930s.
During this financial crisis, the Federal Reserve worked
closely with the Department of the Treasury before exercising
authority under section 13(3). We believe this consultation is
important and appropriate and would not object to a statutory
provision requiring consultation with or approval by the
Secretary of the Treasury prior to authorizing an extension of
credit under section 13(3).
Q.1.c. Do you favor the establishment of a new Fed-Treasury
Accord to provide greater distinction between fiscal policy
actions and lender-of-last resort actions taken by the Federal
Reserve in an emergency?
A.1.c. The Federal Reserve and the Treasury have an accord that
sets forth the principles applied by each in addressing the
current crisis. We would favor a legislative provision allowing
the Federal Reserve to transfer to the Treasury obligations
that, while acquired in the course of Federal Reserve action as
the lender of last resort, become fiscal obligations more
appropriately managed by the Treasury Department. We would be
happy to work with you on developing this type of approach.
Interest on Reserves
Q.2. Congress provided the authority to pay interest on
reserves to the Board of Governors of the Federal Reserve, and
not the Federal Open Market Committee (FOMC). Similarly, the
Board of Governors, and not the FOMC, has authority over
setting the discount rate and reserve requirements. According
to minutes of the January 26-27, 2010, FOMC meeting, the
interest rate paid on excess reserve balances (the IOER rate)
is one of the tools available to support a gradual return to a
more normal monetary policy stance. Quoting from the minutes:
Participants expressed a range of views about the tools and
strategy for removing policy accommodation when that step
becomes appropriate. All agreed that raising the IOER rate and
the target for the Federal funds rate would be a key element of
a move to less accommodative monetary policy.
LAre there any possible future conflicts or
difficulties that you could imagine might arise from
having the Federal Reserve's target for the Federal
funds rate determined by the FOMC while the IOER and
discount rate are determined by the Board of Governors?
LAs it moves toward a more normal monetary policy
stance, the Federal Reserve may use the IOER rate to
help manage reserve balances. If the IOER rate, rather
than a target for a market rate, becomes an indicator
of the stance of monetary policy for a time, will the
balance of power over monetary policy between the FOMC
and the Federal Reserve Board change?
A.2. As you know, the Congress has assigned to the Board the
responsibility for determining the rate paid on reserves.
Although the Federal Open Market Committee (FOMC) by law is
responsible for directing open market operations, the Congress
has also assigned to the Board the responsibility for
determining certain other important terms that are relevant for
the conduct of monetary policy--for example, the Board
``reviews and determines'' the discount rates that are
established by the Federal Reserve Banks; the Federal Open
Market Committee has no statutory role in setting the discount
rate. Similarly, the Board sets reserve requirements subject to
the constraints established by the Congress; the Federal Open
Market Committee has no statutory role in setting reserve
requirements.
For many years, the Board and the FOMC have worked
collegially and cooperatively in setting the discount rate, the
Federal funds target rate, and other instruments of monetary
policy. I am convinced that the Board and the FOMC will
continue to work cooperatively in the future in adjusting all
of the instruments of monetary policy.
Monetary Policy and Fiscal Policy Distinction
Q.3.a. Several regional Federal Reserve bank presidents have
expressed concern that actions taken by the Fed, many under
Section 13(3) authority, were actions to channel credit to
specific firms or specific segments of financial markets and
the economy. The concern is that some actions amounted to
fiscal, and not lender of last resort, policies. Moreover, in a
March 23, 2009 joint press release, the Fed and the Treasury
stated the following:
The Federal Reserve to avoid credit risk and credit allocation
The Federal Reserve's lender-of-last-resort responsibilities
involve lending against collateral, secured to the satisfaction
of the responsible Federal Reserve Bank. Actions taken by the
Federal Reserve should also aim to improve financial or credit
conditions broadly, not to allocate credit to narrowly defined
sectors or classes of borrowers. Government decisions to
influence the allocation of credit are the province of the
fiscal authorities.
In accord with the joint statement, should the Fed's stock
of agency debt and mortgage-backed securities along with its
Maiden Lane holdings be swapped for Treasury securities,
thereby transparently placing the channeling of credit support
to the housing sector firmly in the hands of fiscal
authorities?
A.3.a. The Federal Reserve's purchases of agency debt and
mortgage-backed securities, and the credit it has extended to
the Maiden Lane entities, arose for different reasons and
deserve different treatment.
The primary purpose of the Federal Reserve's purchases of
securities issued or guaranteed by Federal agencies was a
monetary policy response intended to support the overall
economy by providing support to the mortgage and housing
sectors. The Federal Reserve believes that in routine
circumstances the modes of government support for the housing
sector should be determined by the Congress and carried out
through agencies other than the Federal Reserve.
For that reason, the Federal Reserve in recent decades
minimized its participation in the agency securities markets.
However, the highly strained financial market conditions of the
past few years prevented the Federal Reserve's monetary policy
actions to lower interest rates from being fully transmitted to
housing markets, as would have happened in more normal times,
and the Federal Reserve's ability to lower short-term interest
rates further was constrained after short-term rates were
lowered to essentially zero. In the circumstances, the Federal
Reserve initiated a program to purchase agency debt and
mortgage-backed securities.
The credit extensions to AIG and the Maiden Lane entities
represent exercise of the Federal Reserve's authority as lender
of last resort. The Treasury Department is better suited to
make the policy and management decisions that attend the longer
term relationship with a nonbanking firm that requires
government assistance. Accordingly, the Federal Reserve would
support a transfer to the Treasury of its AIG and Maiden Lane
credits. The issues regarding a possible swap of agency debt
and MBS securities for Treasury securities are somewhat more
complex and would require careful study.
Q.3.b. The Fed has purchased over $1 trillion of agency
mortgage-backed-securities and intends to complete purchases of
$1.25 trillion of those securities by the end of March. To help
finance those purchases, the Fed uses supplemental borrowing
from the Treasury and issues interest-bearing reserve balances.
In effect, the Fed is borrowing from the public, including
banks, with promises to repay the borrowed sums plus interest.
The Fed will continue that borrowing in order to hold on to its
mortgage-backed securities until those assets gradually decline
as they mature or are prepaid or sold. When the Fed effectively
finances an enormous portfolio holding of a specific class of
assets using interest bearing debt issued to the public, how is
that not a fiscal policy exercise?
A.3.b. Monetary policy and fiscal policy are different tools
that both can be used to stimulate the economy. The purpose of
the Federal Reserve's large-scale asset purchases was primarily
to apply macroeconomic stimulus by lowering longer-term
interest rates and by improving financial market functioning;
fiscal policy applies stimulus by adjusting overall government
spending or revenues. Because the Federal Reserve's large-scale
asset purchases involved changes in the central bank's balance
sheet--and, in particular, the creation of a large volume of
reserves, it is clear that the purchases were a monetary policy
action. Moreover, the Federal Reserve's decision to purchase a
large volume of longer-term assets in the crisis was consistent
with its statutory mandate to promote maximum employment and
price stability, and it was clearly supported by its statutory
authorities. These transactions can and will be unwound in a
manner consistent with these same mandates.
Systemic Risk Regulation
Q.4.a. Your February 25, 2010, testimony identifies that the
Fed is making fundamental changes in its supervision of bank
holding companies to, in your words, ``incorporate a
macroprudential perspective that goes beyond the traditional
focus on safety and soundness of individual institutions.''
Could you precisely define what you mean by a
``macroprudential perspective,'' and what metrics guide that
perspective?
A.4.a. Our supervisory approach should better reflect our
mission, as a central bank, to promote financial stability. As
was evident in the financial crisis, complex, global financial
firms can be profoundly interconnected in ways that can
threaten the viability of individual firms, the functioning of
key financial markets, and the stability of the broader
economy. A macroprudential perspective requires a more system-
wide approach to the supervision of systemically critical firms
that considers the interdependencies among firms and markets
that have the potential to undermine the stability of the
financial system. To that end, we have supported the creation
of a council of regulators that would gather information from
across the financial system, identify and assess potential
risks to the financial system, and work with member agencies to
address those risks.
In our own supervisory efforts, we are reorienting our
approach to some of the largest holding companies to better
anticipate and mitigate systemic risks. For example, we expect
to increase the use of horizontal reviews, which focus on
particular risks or activities across a group of banking
organizations. In doing so, we have drawn on our experience
with the Supervisory Capital Assessment Program (SCAP), in
which the Federal Reserve led a coordinated effort by the bank
supervisors to evaluate on a consistent basis the capital needs
of the largest banking institutions in an adverse economic
scenario. Because the SCAP involved the simultaneous evaluation
of potential credit exposures across all of the included firms,
we were better able to consider the systemic implications of
financial stress under an adverse economic scenario, in
addition to the impact of an adverse scenario on individual
firms.
The SCAP also showed the benefits of drawing on the work of
a wide range of staff--including supervisors, economists, and
market and payments system experts--to comprehensively evaluate
the risks facing financial firms. Going forward, the Federal
Reserve is instituting a data-driven, quantitative surveillance
mechanism that will draw on a similar range of staff expertise
to provide an independent view of the risks facing large
banking firms. As part of that effort, we are developing
quantitative tools to help identify vulnerabilities at both the
firm level and for the aggregate financial sector. We
anticipate that these tools will incorporate macroeconomic
forecasts, including spillover and feedback effects. We also
expect to develop indicators of interconnectedness, which could
encompass common credit, market, and funding exposures. The
development of specific metrics will also depend, in part, on
the availability of timely and comparable data from
systemically important firms.
Q.4.b. Does the Fed intend to redefine what regulators should
regard as ``safety and soundness?''
A.4.b. Ensuring the safety and soundness of institutions has
been a cornerstone of the Federal Reserve's supervision
program. The recent crisis has shown that large, interconnected
firms can be buffeted by a market-driven crisis, magnifying
weaknesses in risk management practices, and revealing capital
and liquidity buffers calibrated to withstand institution-
specific stress events to be insufficient. For this reason,
leading supervisors in the United States and abroad are
reviewing the prudential standards needed to ensure safety and
soundness for individual firms and the financial system as a
whole. The Federal Reserve is participating in a range of joint
efforts to ensure that large, systemically critical financial
institutions hold more and higher quality capital, improve
their risk-management practices, have more robust liquidity
management, employ compensation structures that provide
appropriate performance and risk-taking incentives, and deal
fairly with consumers.
We are working with our domestic and international
counterparts to develop capital and prudential requirements
that take account of the systemic importance of large, complex
firms whose failure would pose a significant threat to overall
financial stability. Options under consideration include
assessing a capital surcharge on these institutions or
requiring that a greater share of their capital be in the form
of common equity. For additional protection, systemically
important institutions could be required to issue contingent
capital, such as debt-like securities that convert to common
equity in times of macroeconomic stress or when losses erode
the institution's capital base. U.S. supervisory agencies have
already increased capital requirements for trading activities
and securitization exposures, two of the areas in which losses
were especially high.
Liquidity requirements should also be strengthened for
systemically critical firms, as even solvent financial
institutions can be brought down by liquidity problems. The
bank regulatory agencies are implementing strengthened guidance
on liquidity risk management and weighing proposals for
quantitatively based requirements. In addition to insufficient
capital and inadequate liquidity risk management, flawed
compensation practices at financial institutions also
contributed to the crisis. Compensation should appropriately
link pay to performance and provide sound incentives. The
Federal Reserve has issued proposed guidance that would require
banking organizations to review their compensation practices to
ensure they do not encourage excessive risk-taking, are subject
to effective controls and risk management, and are supported by
strong corporate governance including board-level oversight.
Federal Reserve's Asset Holdings
Q.5. Charles Plosser, President of the Federal Reserve Bank of
Philadelphia, stated in a recent speech that
. . . the Fed could help preserve its independence by limiting
the scope of its ability to engage in activities that blur the
boundary lines between monetary and fiscal policy. Thus, as the
economic recovery gains strength and monetary policy begins to
normalize, I would favor our beginning to sell some of the
agency mortgage-backed securities from our portfolio rather
than relying only on redemptions of these assets. Doing so
would help extricate the Fed from the realm of fiscal policy
and housing finance.
Do you agree with President Plosser?
A.5. I provided my views on asset sales in my March 25, 2010,
testimony before the House Committee on Financial Services. The
relevant passage is reproduced below.
When these tools [reverse repurchase agreements and term
deposits] 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 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 on our best judgments about how to
meet the Federal Reserve's dual mandate of maximum employment
and price stability.
Treasury Financing Account at the Fed
Q.6. On February 23, 2010, the Treasury announced, rather
suddenly and surprisingly, and without much explanation, that
it anticipates increasing its Supplementary Financing Account
at the Fed by around $200 billion over the next 2 months. This
means, essentially, that the Treasury will borrow on behalf of
the Fed and simply hold the funds in the Treasury's account at
the Fed. I understand that the Treasury's Supplementary
Financing Program helps the Fed absorb reserves from the
banking system and manage its balance sheet. I wonder, however,
about the lack of information concerning why the Treasury
suddenly decided to increase its balance at the Fed.
LWas the Treasury's February 23 announcement planned
in advance and coordinated with the Fed, or was it a
surprise to the Fed?
LWhat are the future plans for the size of the
Treasury's Supplemental Financing Account?
LWho will decide what will be the future balances in
the Supplemental Financing Account?
A.6. The Treasury and the Federal Reserve consulted closely on
the Treasury's February 23 announcement regarding the
Supplementary Financing Program. However, the Treasury makes
all decisions on balances to be held in the Supplementary
Financing Account.
Efforts to Toughen Capital and Liquidity Requirements
Q.7.a. Your testimony on February 25, 2010 identifies that
. . . the Federal Reserve has been playing a key international
role in international efforts to toughen capital and liquidity
requirements for financial institutions, particularly
systemically critical firms . . .
Could you describe what those efforts have been?
A.7.a. The Federal Reserve has an active leadership role within
the Finance Stability Board, the Basel Committee for Banking
Supervision, and various other international supervisory fora.
Through these fora, especially the Basel Committee, the Federal
Reserve has worked diligently with supervisors from around the
world to develop a comprehensive series of reforms to address
the lessons that we have learned from the recent global
financial crisis. The goal of the Basel Committee's reform
package is to improve the international banking sector's
ability to deal with future economic and financial stress, thus
reducing the contagion risk from the financial sector to the
real economy.
The Federal Reserve co-chairs three Basel Committee working
groups that are focusing on reforms especially pertinent to
systemically important institutions. These groups are
developing: a) revisions to the capital regulations for trading
book activities, designed to enhance risk measurement and to
significantly increase the capital requirement associated with
various financial instruments that contributed to losses at
systemically important institutions during the crisis; b)
enhanced and higher capital charges for counterparty credit
risk, including a new charge for credit valuation allowances
(CVA), which were a significant source of loss during the
crisis; and c) new liquidity standards, which directly address
a major challenge during the global turmoil. With regard to the
latter, the proposed standards draw heavily from conceptual
design work contributed by Federal Reserve staff. In addition,
Federal Reserve staff made significant contributions to the
Basel Committee's Principles for Sound Liquidity Risk
Management and supervision issued in September 2008. In many
cases, the international principles articulated drew heavily
from established Federal Reserve guidance. Moreover, Federal
Reserve economists and supervisors have been heavily involved
in work conducted by the Basel Committee and by the Committee
of Global Financial Stability to develop forward-looking
measures of systemic liquidity risks and in assessing the
current state of funding and liquidity risk management at
internationally active financial institutions.
Federal Reserve staff also are key players in the Basel
Committee's working groups developing a new international
leverage ratio standard, which is largely inspired by the U.S.
leverage standard, and a new definition of regulatory capital
for banking organizations, which is an area where the Federal
Reserve provides insightful experience since almost all banking
capital issuance in the U.S. is executed at the bank holding
company level.\1\ Moreover, the Federal Reserve has also played
an active role in the Basel Committee's working group that
recently issued recommendations to strengthen the resolution of
systemically significant cross-border banks.\2\
---------------------------------------------------------------------------
\1\ See ``Strengthening the resilience of the banking sector-
consultative document'' (December 2009), available at www.bis.org/publ/
bcbs164.htm.
\2\ See ``Report and recommendations of the Cross-border Bank
Resolution Group-final paper'' (March 2009), available at www.bis.org/
publ/bcbs169.htm.
---------------------------------------------------------------------------
Q.7.b. Could you define a ``systemically critical'' firm and
identify how many such firms currently operate in the United
States?
A.7.b. A ``systemically critical'' firm is one whose failure
would have significant adverse effects on financial markets or
the economy. At any point in time, the systemic importance of
an individual firm depends on a wide range of factors including
whether the firm has extensive on- and off-balance sheet
activities, whether the firm is interconnected--either
receiving funding from, or providing funding to other
systemically important firms--whether the firm plays a major
role in key financial markets, and/or whether the firm provides
crucial services to its customers that cannot easily or quickly
be provided by other financial institutions. That said, the
identification of systemic importance requires considerable
judgment because each stress event is different, because market
structure, business practices, financial products,
technologies, supervisory practices and regulatory environments
evolve over time. This evolution, of course, changes the
interconnections between firms, their relative sizes, their
functions and services, and the extent to which services can be
obtained from other firms or in financial markets. As a
practical matter, it is likely that the number of firms that
are considered systemically critical will be less than 50. For
example, only about 35 U.S. financial firms, with publicly
traded stock outstanding, have total assets over $100 billion
as of 2008:Q4.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BROWN FROM BEN S.
BERNANKE
Bank Lending
Q.1. I have heard from Ohio banks that banking regulators are
preventing them from expanding commercial lending by requiring
them to maintain greater capital reserves. I agree that we need
to ensure that our banks are well capitalized, but at some
point we've got to get lending going again, particularly to
businesses that will use their money to hire workers.
How can banks strike a balance between being well
capitalized and still lending like they are supposed to?
A.1. The loss absorbing characteristics of capital provide the
economic bedrock that supports prudent bank lending and, as
such, it is not inconsistent for banks to remain well
capitalized and concomitantly engage in healthy lending
practices. However, during the financial crisis, many banks
recorded significant financial losses that eroded their capital
base and as a result, some banks may be operating with reduced
capital bases to support lending activities. In other
instances, well capitalized banks may be reluctant to lend if
their outlook on economic conditions lead them to believe that
additional losses are likely in the near term, which would
further erode their current capital position. The Federal
Reserve believes that, in cases where banks are concerned about
potential additional losses, a prudent response would be for
those banks to increase their capital position in order to
address this concern and to take advantage of any demand in
commercial lending. Likewise, we believe that an improving
economic outlook should help banks to bolster their capital
levels and contribute to increased willingness of banks to
lend.
Q.2. Have you considered taking any specific steps, like
lowering the Fed's interest payments on excess bank reserves,
or perhaps even imposing a penalty on hoarding money, to
promote greater lending?
A.2. The Federal Reserve's payment of interest on excess
reserves is unlikely to be a significant factor in banks'
current reluctance to lend. The Federal Reserve is currently
paying interest at a rate of only one quarter of 1 percent on
banks' reserve balances. By contrast, the prime rate is
currently at 3 \1/4\ percent, and many bank lending rates are
considerably higher than the prime rate. Given the large
difference between the interest rate paid on excess reserves
and the interest rates on banks, the ability to earn interest
on excess reserves is unlikely to be an important reason for
the tightening of banks' lending standards and terms over the
past few years. Indeed, survey results suggest that the major
reason that banks have tightened lending terms and standards
over the past 2 years or so was their concern about the
economic outlook. As you know, the Federal Reserve has acted
aggressively from the outset of the financial crisis to
stabilize financial market conditions and promote sustainable
economic growth. An improving economic outlook should
contribute to increased willingness of banks to lend.
Bank Concentration
Q.3. Banks are borrowing at record low interest rates--
particularly those banks that are viewed as ``too big to
fail.'' According to the Center for Economic and Policy
Research, the 18 biggest banks are getting what amounts to a
$34.1 billion a year subsidy because of their implicit
government guarantee. More recent data from the FDIC shows that
big banks are turning a profit, but small banks are not. Data
from 1999 shows that large banks' fees for overdrafts are 41
percent higher than at small banks and bounced check fees are
43 percent higher. Now borrowers are having their lines of
credit slashed and their bank fees are still increasing.
So it appears that consumers and small banks are suffering,
while the big banks thrive. And the market is only getting more
concentrated: 319 banks were forced to merge or fail in 2009.
What steps are the Fed taking to ensure that there is not
excessive concentration in the banking industry, and that
consumers are being well served through meaningful competition?
A.3. The Riegle-Neal Interstate Banking and Branching
Efficiency Act (IBBEA) of 1994 provides prudential protection
against excessive concentration in the banking industry by
prohibiting the Federal Reserve from approving a bank
acquisition that would result in a bank holding company
exceeding a nationwide deposit concentration limitation of more
than 10 percent of the total amount of deposits of insured
depository institutions in the United States.
Notwithstanding that protection, there are many other
potential methods to address the subsidies that may arise
because of perceptions that large financial firms are ``too-
big-to-fail.'' For example, firms that might reasonably be
considered ``too-big-to-fail'' may be subject to higher capital
(and liquidity) requirements, more highly tailored resolution
mechanisms, tighter deposit share caps, required issuance of
contingent capital instruments and/or subordinated debt
instruments, limitations on, or a ban of, certain activities
(e.g., hedge funds or private equity funds), and taxes on non-
deposit balance-sheet liabilities. As the financial crisis
winds down, many of these types of proposals to reduce the
subsidies that arise from implicit guarantees are under
consideration in the United States and abroad. In fact, Federal
Reserve staff are participating on many international working
groups that are considering the potential effects, including
unintended consequences, that may arise from implementing such
proposals either singularly, or in combination. A key factor in
such analyses is the impact on competition here in the United
States and internationally across borders.
Research on whether consumers benefit from ``too-big-to-
fail'' subsidies is scant. It is plausible that large financial
institutions might pass along some of their subsidies to
consumers to fuel their own growth at the expense of smaller
peers. Some evidence, however, suggests otherwise. For example,
Passmore, Burgess, Hancock, Lehnert, and Sherlund (in a
presentation at the Federal Reserve Bank of Chicago Bank
Structure Conference, May 18, 2006) estimate that just 5
percent of the Fannie Mae and Freddie Mac's borrowing advantage
flowed through to mortgage rates, resulting in just a few basis
points reduction in conforming mortgage loan rates. Even if
financial firms do not pass along their ``too-big-to-fail''
subsidies to consumers, it does not necessarily imply that they
cannot pass along the higher costs that would result from the
reduction of such subsidies. Indeed, larger firms may set the
market prices for some financial products because of other cost
advantages associated with their size. In such circumstances,
consumers may end up paying higher prices when ``too-big-to-
fail'' subsidies are reduced (or eliminated) even though they
did not previously much benefit from such subsidies. That said,
all consumers benefit from a more stable financial system with
less systemic risk and this is the goal of reducing or
eliminating ``too-big-to-fail'' subsidies.
Resolution of Failed Banks
Q.4. You have previously said that you favor ``establishing a
process that would allow a failing, systemically important non-
bank financial institution to be wound down in any orderly
fashion, without jeopardizing financial stability.'' There's
been a lot of talk about whether this job should be done by
banking regulators or a bankruptcy court.
Do you have an opinion about this, particularly whether the
FDIC is doing a good job with its resolution authority?
A.4. In most cases, the Federal bankruptcy laws provide an
appropriate framework for the resolution of nonbank financial
institutions. However, the bankruptcy code does not
sufficiently protect the public's strong interest in ensuring
the orderly resolution of a nonbank financial firm whose
failure would pose substantial risks to the financial system
and to the economy.
A new resolution regime for systemically important nonbank
financial firms, analogous to the regime currently used by the
Federal Deposit Insurance Corporation for banks, would provide
the government the tools to restructure or wind down such a
firm in a way that mitigates the risks to financial stability
and the economy and thus protects the public interest. It also
would provide the government a mechanism for imposing losses on
the shareholders and creditors of the firm. Establishing
credible processes for imposing such losses is essential to
restoring a meaningful degree of market discipline and
addressing the ``too-big-to-fail'' problem.
It would be appropriate to establish a high standard for
invocation of this new resolution regime and to create checks
and balances on its potential use, similar to the provisions
governing use of the systemic risk exception to least-cost
resolution in the Federal Deposit Insurance Act (FDI Act). The
Federal Reserve's participation in this decisionmaking process
would be an extension of our long-standing role in protecting
financial stability, involvement in the current process for
invoking the systemic risk exception under the FDI Act, and
status as consolidated supervisor for large banking
organizations. The Federal Reserve, however, is not well
suited, nor do we seek, to serve as the resolution agency for
systemically important institutions under a new framework.
Because the suitability of an entity to serve as the resolution
agency for any particular firm may depend on the firm's
structure and activities, the Treasury Department should be
given flexibility to appoint a receiver that has the requisite
expertise to address the issues presented by a wind down of
that firm.
Banks Trading Commodities Futures Derivatives
Q.5. You gave an address at Harvard in 2008 in which you talked
about out-of-control crude oil prices. You said that ``demand
growth and constrained supplies'' were responsible for
``intense pressure on [gas] prices.'' Senator Carl Levin
investigated the crude oil market and found that speculation
``appears to have altered the historical relationship between
[crude oil] price and inventory.'' In 2003, at the request of
Citigroup and UBS, the Fed authorized bank holding companies to
trade energy futures, both on exchanges and over-the-counter.
Given that commodity prices affect the Consumer Price
Index, which affects inflation, have you investigated what
effect the rule change, and the resulting investments in
commodities futures and other commodities-related derivatives,
have had on oil prices?
Q.6. If not, how can you conclude that rises in gasoline prices
are due solely to simple changes in supply and demand?
Q.7. If presented with evidence that energy speculation was
driving up prices or affecting inflation, would you consider
revoking the banks' authority to trade energy futures?
A5.-7. The broad movements in oil and other commodity prices
have been in line with developments in the global economy. They
rose when global growth was strong and supply was constrained.
and they collapsed with the onset of the global recession. As
the global economy began to recover and financial conditions
began to normalize, commodity prices rebounded.
Nonetheless, the extreme price swings, particularly in the
case of oil, have been surprising. Some have argued that
speculative activities on the part of financial investors have
been responsible for these outsized price movements.
Notwithstanding considerable study, however, conclusive
evidence of the role of speculators and financial investors
remains elusive. The fundamentals of supply and demand, along
with expectations for how these fundamentals will evolve in the
future, remain the best explanation for the movements in
commodity prices. That said, we must remain open to other
possibilities, and if conclusive evidence emerged that
commodity markets were not performing their price discovery and
allocative role effectively, then changes in regulatory
policies may be appropriate.
Fed Purchases of Foreign Currency Derivatives
Q.8. In the wake of the Greek debt crisis, I'm concerned about
governments' use of foreign currency exchanges--that other
governments might be using foreign currency swaps to mask their
debt, or for other purposes. We know that the Federal Reserve
entered into swaps with Foreign Central Banks and then those
Foreign Central Banks bailed out their own banking systems. For
example, the Federal Reserve worked with the Swiss central bank
on the rescue effort for UBS, securing dollars through a swap
agreement for francs. As of December 31, 2008, the United
States had entered into $550 billion in liquidity swaps with
foreign central banks.
How are these arrangements between the Federal Reserve and
the other central banks structured?
A.8. The dollar liquidity swap arrangements that the Federal
Reserve entered into with foreign central banks were
fundamentally different from the currency swaps that have been
discussed in the Greek context. According to reports, the Greek
cross-currency swaps were highly structured arrangements
initiated 8 or 9 years ago between the government of Greece and
a private sector financial institution. These swaps apparently
entailed payment obligations over a period of 15 to 20 years
with large balloon payments at maturity, and they allowed the
Greek government to exchange into euros the proceeds of
borrowing it had done in Japanese yen and U.S. dollars at off-
market rates of exchange.
The dollar liquidity swaps, the volume of which is now zero
following the termination of the arrangements in February, were
more straightforward, shorter-term arrangements with foreign
central banks of the highest credit standing. In each dollar
liquidity swap transaction, the Federal Reserve provided U.S.
dollars to a foreign central bank in exchange for an equivalent
amount of funds in the currency of the foreign central bank,
based on the market exchange rate at the time of the
transaction. The parties agreed to swap back these quantities
of their two currencies at a specified date in the future,
which was at most 3 months ahead, using the same exchange rate
as in the initial exchange. The Federal Reserve also received
interest corresponding to the maturity of the swap drawing.
Because the terms of each swap transaction were set in
advance, fluctuations in exchange rates following the initial
exchange did not alter the eventual payments. Accordingly,
these swap operations carried no exchange rate or other market
risks. In addition, we judged our swap line exposures to be of
the highest quality and safety. The foreign currency held by
the Federal Reserve during the term of the swap provided an
important safeguard. Furthermore, our exposures were not to the
institutions ultimately receiving the dollar liquidity in the
foreign countries but to the foreign central banks. We have had
long and close relationships with these central banks, many of
which hold substantial quantities of U.S. dollar reserves in
accounts at the Federal Reserve Bank ofNew York, and these
dealings provided a track record that justified a high degree
of trust and cooperation. The short tenor of the swaps, which
ranged from overnight to 3 months at most, also offered some
protection, in that positions could be wound down relatively
quickly were it judged appropriate to do so.
Q.9. Are these swaps being used in any way to mask U.S.
Government debt?
A.9. No. These swaps were limited to the exchange of U.S.
dollar liquidity for foreign-currency liquidity and were not
used in any way to mask U.S. Government debt.
Q.10. Does the Federal Reserve keep track of which foreign
banks ultimately receive U.S. money from foreign central banks?
If so, what banks have gotten U.S. money, and how much has each
gotten?
A.10. The Federal Reserve's contractual relationships were with
the foreign central banks and not with the financial
institutions ultimately obtaining the dollar funding provided
by these operations. Accordingly, the Federal Reserve did not
track the names of the institutions receiving the dollar
liquidity from the foreign central banks but instead left to
the foreign central banks the responsibility for managing the
distribution of the dollar funding. This responsibility
included determining the eligibility of institutions that could
participate in the dollar lending operations, assessing the
acceptability of the collateral offered, and bearing any
residual credit risk that might have arisen as a result of the
lending operations.
Q.11. Is the U.S. Treasury issuing Treasury bonds which the Fed
is then buying through the U.K. or other foreign governments?
A.11. No.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MERKLEY FROM BEN S.
BERNANKE
Q.1. The homeownership rate in Canada is almost identical to
that of the United States. Yet the percentage of U.S. mortgages
in arrears is fast approaching 10 percent while the percentage
of Canadian mortgages in arrears has been relatively stable for
the past two decades at less than 1 percent. What
characteristics of the mortgage market in Canada do you believe
have helped that country avoid a similar foreclosure crisis?
A.1. A number of characteristics of the Canadian mortgage
market helped Canada avoid a foreclosure crisis. Canadian
homeowners typically maintain greater equity in their homes, in
part because mortgage insurance, which is required when loan-
to-value ratios exceed 80 percent, is more costly than in the
United States. Moreover, Canadian mortgages are subject to
substantial pre-payment penalties, reducing the incentives of
households to regularly refinance their mortgages. While in
general this limits households' ability to take advantage of
falling interest rates, it also reduces the number of ``cash
out'' refinancings, increasing the average equity held by
households.
In addition, a greater fraction of Canadian mortgages are
prime mortgages, which default at lower rates than sub-prime
mortgages. One reason the sub-prime market was slower to grow
in Canada is because of the incentives, noted above, for
borrowers to make higher down payments. Another reason is that
a smaller fraction of mortgages in Canada are securitized,
because even mortgages that have been securitized and resold
carry a capital charge, giving Canadian banks less incentive to
securitize mortgages. A mortgage lender that plans to hold a
mortgage to maturity likely employs higher underwriting
standards than a mortgage lender that plans to securitize the
loan.
Finally, Canada has experienced a comparatively milder
labor-market downturn than the United States and only a modest
decline in house prices. These factors, too, have helped reduce
the incidence of default.
Q.2. All of the six major banks in Canada own investment
banking and insurance subsidiaries. All five of the major banks
in Canada would probably be considered ``too-big-to-fail.''
However, the Canadian banking regulators have prudently
enforced more stringent capital requirements including a 7
percent minimum of Tier 1 capital and 10 percent minimum of
total capital. Additionally, there is an Assets-to-Capital
Multiple maximum of 20 (or leverage ratio).
What lessons have you learned from observing the actions
that Canadian regulators have taken regarding the use of more
stringent capital requirements than those required under Basel
II?
A.2. At present, the U.S. regulatory capital rules result in a
requirement for banking organizations to hold capital at levels
that are equal to, or exceed, Canadian peers; notwithstanding
that the stated required minimum Tier 1 risk-based capital
ratio is 6 percent for ``well capitalized'' banks under PCA.\1\
Because of statutorily required responses to the breeching of a
PCA capital threshold, market forces generally necessitate
banks and bank holding companies to hold substantially more
capital than the ``well capitalized'' ratio requirements to
ensure that significant losses can be absorbed before a ``well
capitalized'' ratio is breached. The following table outlines
the Tier I, Total and Leverage ratios of the top six U.S. bank
holding companies and provides our estimate of their respective
Assets-to-Capital Multiple as computed under the Canadian
regulatory capital regime. As shown below, each of the top six
U.S. bank holding companies would easily exceed the Canadian
standards outlined above.
---------------------------------------------------------------------------
\1\ To be considered ``well capitalized'' under the U.S. Prompt
Corrective Action (PCA) requirements, a bank must have a Tier 1
Leverage ratio of no less than 5 percent, a Tier I risk-based capital
ratio of no less than 6 percent, a Total risk-based capital ratio of no
less than 10 percent.
Selected Capital Ratios
Six Largest U.S. Bank Holding Companies
(as of December 31, 2009)
----------------------------------------------------------------------------------------------------------------
Assets-to-
Tier 1
Capital Assets-to-
Tier 1 Risk- Total Risk- Tier 1 Multiple Capital
Based Based Leverage (Inverse of Multiple
Capital Capital Ratio U.S. (Canadian
Leverage Definition)
Ratio)
----------------------------------------------------------------------------------------------------------------
Bank of America................................ 10.41% 14.67% 6.91% 14.5 11.6
JP Morgan Chase................................ 11.10% 14.78% 6.88% 14.5 13.7
Citigroup...................................... 11.67% 15.25% 6.89% 14.5 12.7
Wells Fargo.................................... 9.25% 13.26% 7.87% 12.7 9.6
Goldman Sachs.................................. 14.97% 18.17% 7.55% 13.2 12.3
Morgan Stanley................................. 15.30% 16.38% 5.80% 17.2 17.1
----------------------------------------------------------------------------------------------------------------
The Federal Reserve believes that, going forward, capital
requirements will need to be recalibrated to directly address
the inappropriate incentives that were the underlying causes of
the financial crisis. We are engaged in a significant effort
both here in the United States and abroad to achieve this
objective.
Q.3. Canada has an independent consumer protection agency,
called the Consumer Financial Agency of Canada. Do you believe
that this agency's mission and independence has helped the
Canadian financial markets remain stable and well capitalized,
even under the current economic conditions?
A.3. Consumer protection laws are very important for
maintaining a well-functioning financial system. The Financial
Consumer Agency of Canada (FCAC) is responsible for ensuring
compliance with consumer protection laws and regulations;
monitoring financial institutions' compliance with voluntary
codes of conduct; and informing consumers of their rights and
responsibilities as well as providing general information on
financial products.
Ensuring compliance with consumer protection laws is an
important defense against future financial problems, and
informed consumers are undoubtedly less likely to enter
unfavorable mortgage agreements. It is difficult to gauge,
however, the extent to which the quality of consumer
information and extent of consumer protection help explain why
Canada had relatively few of the exotic, hard-to-understand
sub-prime mortgages that have had such high default rates in
the United States. As noted in the answer to the preceding
question, other factors--the structure of the mortgage market
and bank capital regulation in Canada--appear to represent more
tangible reasons why the sub-prime market was slow to develop
in Canada.
Q.4. Throughout the past year, many witnesses before the Senate
Banking Committee have argued that the widespread practice of
securitizing mortgages helped propagate bad underwriting
practices and contributed to the toxic nature of many, if not
all, investments in subprime mortgages. The Canadian mortgage
market only has approximately 5 percent of outstanding
mortgages categorized as ``subprime.'' Additionally, according
to the Bank of Canada, 68 percent of mortgages remain on the
balance sheet of the lender and most residential mortgage
financing is funded through deposits. Do you think that banks
who keep major portions of their residential real estate
lending ``on the books'' are less likely to engage in the
financing of, ``subprime'' mortgage lending?
A.4. It is unlikely that a requirement to keep mortgage
exposures on balance sheet would make banking organizations
less likely to underwrite ``subprime'' exposures. For instance,
prior to the financial crisis, many banking organizations
entered into ``subprime'' mortgage securitizations and retained
the ``first loss'' positions ``on the books,'' reflecting a
high risk tolerance for exposure to the ``subprime'' mortgage
market. Additionally, many other banking organizations provided
recourse on ``subprime'' mortgage exposures that they sold to
securitization structures; again, a reflections of a high risk
tolerance ``subprime'' mortgage exposures. If banking
organizations were no longer allowed to place ``subprime''
mortgages into securitization vehicles, it could be reasonably
posited that banking organizations would continue to underwrite
``subprime'' mortgages given the higher yield earned from these
exposures and the fact that the current risk-based capital
framework levies an identical capital requirement for a
``subprime'' exposure as it does for a ``prime'' exposure.
There are several distinct differences between the U.S. and
Canadian mortgage markets that raise difficulty in using the
Canadian experience as a comparator. For example, the Canada
Mortgage and Housing Corporation (CMHC), which serves a similar
function as Freddie and Fannie, is guaranteed by the full faith
and credit of Canada, in the same manner as GNMA is guaranteed
by the United States. As a result, banking organizations that
invest in securitization structures through the CMHC are
required to hold no regulatory capital against their investment
(0 percent risk-weight exposure), versus in the United States
where banking organizations must risk-weight exposures to
Freddie or Fannie at 20 percent. In addition, Canadian banking
organizations are required to obtain private mortgage insurance
(PMI) for all mortgages with a loan-to-value ratio over 80
percent and they must maintain the PMI for the life of the
loan, regardless of any subsequent reduction in a mortgage's
LTV that may result from loan repayment or house appreciation.
However, banks that rely on private mortgage insurers receive a
government guarantee against losses that exceed 10 percent of
the original mortgage in the event of an insurer failure. As a
result, Canadian banking organizations are required to hold
relatively little capital against mortgage exposures that are
held on balance sheet--either through on-balance sheet mortgage
portfolios or through investments in CMHC securitizations.
The market for ``subprime'' mortgages was all but ended for
Canadian banking organizations in 2008 when the CMHC decided to
no longer insure ``subprime'' mortgages. This provided a
significant regulatory capital disincentive for Canadian
banking organizations to underwrite ``subprime'' mortgages.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM BEN S.
BERNANKE
Q.1. Treasury recently announced they were starting up the
Supplemental Financing Program again. Under that Program,
Treasury issues debt and deposits the cash with the Fed. That
is effectively the same thing as the Fed issuing its own debt,
which is not allowed. What are the legal grounds the Fed and
Treasury use to justify that program? And did anyone in the Fed
or Treasury raise objections when the program was created?
A.1. Section 15 of the Federal Reserve Act requires the Federal
Reserve to act as fiscal agent for the United States and
authorizes the Treasury to deposit money held in the general
fund of the Treasury in the Federal Reserve Banks. Balances
held by the Reserve Banks in the Treasury's Supplementary
Financing Account (SFA) are deposited and held under this
authority. Although the Treasury and the Federal Reserve have
consulted closely on matters regarding the Supplemental
Financing Program (SFP), the Treasury makes all decisions on
balances to be held in the SFA.
I am not aware of any staff member or policymaker raising
legal objections to the creation of the SFP. However, at least
one Federal Reserve policymaker has publicly expressed policy
concerns with the SFP. See Real Time Economics, WSJ Blogs,
``Q&A: Philly Fed's Plosser Takes on `Extended Period'
Language,'' March 1, 2010.
Q.2. Given what you learned during the AIG crisis and bailout,
do you think Congress should be doing something to address
insurance regulation or the commercial paper market?
A.2. The financial crisis has made clear that all financial
institutions that are so large and interconnected their failure
could threaten the stability of the financial system and the
economy must be subject to consolidated supervision. Lack of
strong consolidated supervision of systemically critical firms
not organized as bank holding companies, such as AIG, proved to
be a serious regulatory gap. The Federal Reserve strongly
supports ongoing efforts in the Congress to reform financial
regulation and close existing gaps in the regulatory framework.
An effective framework for financial supervision and
regulation also must address macroprudential risks--that is,
risks to the financial system as a whole. The disruptions in
the commercial paper market following the failure of Lehman
Brothers on September 15, 2008 and the breaking of the buck by
a large money fund the following day are examples of such
macroprudential risks.
Legislative proposals in both the House and Senate would
also improve the exchange of information and the cross-
fertilization of ideas by creating an oversight council
composed of representatives of the agencies and departments
involved in the oversight of the financial sector that would be
responsible for monitoring and identifying emerging systemic
risks across the full range of financial institutions and
markets. The council would have the ability to coordinate
responses by member agencies to mitigate identified threats to
financial stability and, importantly, would have the authority
to recommend that its member agencies, either individually or
collectively, adopt heightened prudential standards for the
firms under the agencies' supervision in order to mitigate
potential systemic risks.
Q.3.a. When did you know that AIG's swaps partners were going
to be paid off at effectively par value in the Maiden Lane 3
transaction?
Q.3.b. Did you or the Board approve the payments?
A.3.a.-b. I was not directly involved in the negotiations with
the counterparties that sold multi-sector collateralized debt
obligations (``CDOs'') to Maiden Lane III LLC (``ML III'') in
return for termination of credit default swaps AIG had written
on those CDOs. These negotiations were handled by the staff of
the Federal Reserve Bank of New York (``FRBNY''). I
participated in and support the final action of the Board to
authorize lending by the FRBNY to ML III for the purpose of
purchasing the CDOs in order to remove an enormous obstacle to
AIG's financial stability and thereby help prevent a disorderly
failure of AIG during troubled economic times.
As explained in the testimony of Thomas Baxter, Executive
Vice President and General Counsel, FRBNY, before the Committee
on Oversight and Government Reform on January 27, 2010, the
Federal Reserve loan to ML III was used by ML III to purchase
the multi-sector CDOs underlying AIG's CDS at their current
market value (approximately $29 billion), which represented a
significant discount to their par value ($62 billion).
Collateral already posted by AIG (not ML III) under the terms
of the CDS contracts was also relinquished by AIG in return for
tearing-up the contracts and freeing AIG of further obligations
under the CDS contracts. Before agreeing to the transaction,
the Federal Reserve consulted independent financial advisors to
assess the value of the underlying CDOs and the expectation
that the value of the CDOs would be recovered. The advisors
believed that the cash flow and returns on the CDOs would be
sufficient, even under highly stressed conditions, to fully
repay the Federal Reserve's loan to ML III. Under the terms of
the agreement negotiated with AIG, the Federal Reserve will
also receive two-thirds of any profits received on the CDOs
after the Federal Reserve's loan and AIG's subordinated equity
position are repaid in full.
Q.3.c. When did you find out about the cover-up of the amount
of the payments?
Q.3.d. Did you approve of the efforts to cover up the amount of
the payments?
Q.3.e. If you did not approve of the cover-up at the time, do
you believe that it was the right decision?
A.3.c.-e. The amount of the payments to the CDS counterparties
was fully disclosed by AIG. Moreover, the Federal Reserve fully
disclosed the amount of its loan to ML III and the fair value
of the assets that serve as collateral for that loan in both
the weekly balance sheet of the Federal Reserve (available on
the Board's website) and in the Board's reports to Congress as
required by law.
AIG was at all times responsible for complying with the
disclosure requirements of the various securities laws. I was
not involved in the discussions between the Federal Reserve and
AIG related to AIG's securities law filings. I fully supported
AIG's decision to release publicly in March 2009 the identities
of these counterparties.
Q.4. The Fed has been out in the press talking about how they
are going to make money on their AIG loans, making it sound
like a good deal for the taxpayers. However, that is not the
whole story because Treasury has committed some $70 billion to
the AIG bailout. So the taxpayers are still exposed to AIG, and
in fact are likely to take losses. Do you agree that the Fed's
exposure to AIG is not the whole story and the taxpayers are
likely to face losses from the AIG bailout?
A.4. As you know, the Federal Reserve provided liquidity to AIG
through direct line of credit and through loans provided to two
Maiden Lane facilities that funded certain assets of AIG.
Extensive information about each of these credits is available
on the Board's website and in reports and testimony provided by
the Federal Reserve to Congress. Based on analysis of the
collateral supporting these loans by experienced third-party
advisors and the FRBNY, the Federal Reserve expects to be fully
repaid on each of these credits, with no loss to the taxpayers.
The Treasury Department has provided equity to AIG. Like
the liquidity provided by the Federal Reserve, this equity was
provided in order to prevent the disorderly collapse of AIG
during a period of extreme financial stress that could have
caused significant economic distress for policy holders,
municipalities, and small and large businesses, and led to even
greater financial chaos and a far deeper economic slump than
the very severe one we have experienced.
Q.5. Did you or the Board approve of then New York, Fed
President Geithner staying on at the New York Fed while working
for the Obama transition team? If yes, why did you think that
was a good idea?
A.5. Timothy Geithner was appointed President of the Federal
Reserve Bank of New York for a 5-year term that extended until
February 28, 2011. When President Geithner was asked by the
President-elect of the United States to serve as Secretary of
the Treasury, President Geithner withdrew from the Bank's day-
to-day management pending his confirmation by the Senate. He
also relinquished his Federal Open Market Committee (FOMC)
responsibilities which were assumed by Christine Cumming, the
Reserve Bank's alternate representative elected in accordance
with the Federal Reserve Act. President Geithner did not attend
the December 2008 FOMC meeting. Ms. Cumming served as a voting
member of the FOMC until President Geithner's successor took
office. It was expected that President Geithner would continue
to serve as President of the Reserve Bank at least through the
end of his term if he did not become Secretary of the Treasury.
Q.6. Is the Fed now, or has the Fed in recent years, purchased
Greek Government or bank debt?
A.6. The Federal Reserve has not purchased debt of the
government of Greece nor has the Federal Reserve purchased the
debt of any Greek financial institution. Detailed information
on the Federal Reserve's foreign exchange holdings, both
currency and investments, is available in the quarterly
Treasury and Federal Reserve Foreign Exchange Operations report
published by the Federal Reserve Bank of New York. See http://
www.newyorkfed.org/markets/quar_reports.html.
Q.7. Unemployment numbers continue to bounce up and down every
week. As this year goes on, the Census is going to be hiring
700,000 to 800,000 workers on a temporary basis. Are you
worried those numbers will distort the true jobs picture, and
that economic forecasts that use those jobs numbers will be
wrong?
A.7. As you suggest, hiring of temporary workers by the U.S.
Bureau of the Census in support of the decennial census will
elevate the total payroll employment counts reported by the
Bureau of Labor Statistics (BLS) each month because these
temporary workers are included in Federal Government employment
in the Current Employment Statistics (CES) survey. However, I
do not think that Census hiring will make it much more
difficult than usual to interpret the monthly employment
reports. The BLS is publishing information each month on the
number of temporary census workers in the CES data, and thus it
will be straightforward to adjust the data to calculate the
monthly changes in payroll employment excluding the effects of
Census hiring; moreover, Census hiring will not distort the BLS
estimates of employment change in the private sector. In
addition, the Bureau of the Census has made available its
hiring plans for coming months, which economic forecasters can
use in making their projections of employment changes for the
remainder of this year. Although these plans are subject to
change, based on this information, the Department of Commerce
expects the effect on the level of payroll employment reported
by the BLS to peak at about 635,000 jobs in May 2010 and to
fall back to roughly 25,000 jobs by September. The extent to
which Census hiring reduces the measured unemployment rate is
more difficult to estimate because that effect depends on the
prior labor force status of the temporary Census workers.
However, based on the employment estimates, the peak effect on
the unemployment rate in May would probably be between \1/4\
and \1/2\ percentage point.
Q.8. Please explain how term deposits and reverse repo
transactions are not the economic equivalent of the Fed issuing
debt.
A.8. There are a number of similarities and differences between
term deposits, reverse repurchase agreements and agency debt
obligations. In principle, each could be used to drain reserves
from the financial system in order to reduce the potential for
inflation and thereby maintain price stability. Indeed, various
central banks use instruments similar to these to help manage
interest rates and maintain price stability.
In the United States, Congress has specifically authorized
the Federal Reserve to accept deposits from depository
institutions. (See 12 USC 342). Congress has also specifically
authorized the Federal Open Market Committee to direct Reserve
Banks to purchase and sell in the open market obligations of,
or obligations guaranteed as to principal and interest by, the
United States or its agencies. (See 12 USC 263 and 355).
Reverse repurchase agreements represent the sale and purchase
of obligations of, or obligations guaranteed as to principal
and interest by, the United States or its agencies. Congress
has not specifically authorized the Federal Reserve to issue
its own agency debt obligations.
Unlike deposits and reverse repurchase agreements, agency
obligations are freely transferable. Term deposits may only be
accepted from depository institutions and are not transferable.
Reverse repurchase agreements also are not transferable and
occur only with counterparties that are interested in
purchasing qualifying government or agency securities.
Q.9. Given that you have signaled that the Fed will be using
the interest on reserves rate as a policy tool in the near
future, do you believe that rate should be set by the Federal
Open Market Committee rather than the Board of Governors?
A.9. As you know, the Congress has assigned to the Board the
responsibility for determining the rate paid on reserves.
Although the Federal Open Market Committee (FOMC) by law is
responsible for directing open market operations, the Congress
has also assigned to the Board the responsibility for
determining certain other important terms that are relevant for
the conduct of monetary policy--for example, the Board
``reviews and determines'' the discount rates that are
established by the Federal Reserve Banks; the FOMC has no
statutory role in setting the discount rate. Similarly, the
Board sets reserve requirements subject to the constraints
established by the Congress; the FOMC has no statutory role in
setting reserve requirements.
For many years, the Board and the FOMC have worked
collegially and cooperatively in setting the discount rate, the
Federal funds target rate, and other instruments of monetary
policy. I am convinced that the Board and the FOMC will
continue to work cooperatively in the future in adjusting all
of the instruments of monetary policy.