[Senate Hearing 110-696]
[From the U.S. Government Publishing Office]
S. Hrg. 110-696
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2007
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE
FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
JULY 19, 2007
__________
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Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania ELIZABETH DOLE, North Carolina
JON TESTER, Montana MEL MARTINEZ, Florida
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Peggy R. Kuhn, Senior Financial Economist
Martin J. Gruenberg, Democratic Senior Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
?
C O N T E N T S
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THURSDAY, JULY 19, 2007
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 3
Prepared statement....................................... 51
Senator Brown................................................ 5
Senator Hagel................................................ 6
Senator Reed................................................. 6
Senator Menendez............................................. 7
Senator Schumer.............................................. 8
Senator Bunning.............................................. 25
Prepared statement....................................... 51
Senator Allard............................................... 30
Senator Bennett.............................................. 36
Senator Bayh................................................. 39
Senator Carper............................................... 42
Senator Akaka................................................ 45
Senator Dole................................................. 52
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 9
Prepared statement........................................... 53
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, July 18, 2007............ 57
(iii)
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2007
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THURSDAY, JULY 19, 2007
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:32 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 hearing will come to order.
The Committee is very pleased this morning to welcome the
Chairman of the Federal Reserve, Ben Bernanke. We thank you for
being with us to present your outlook for the Nation's economy,
the Fed's conduct of monetary policy, and the status of
important consumer protection regulations that are under the
Federal Reserve's jurisdiction.
Mr. Chairman, we once again welcome you to the Senate
Banking Committee.
Before I begin my opening statement, I wanted to recognize
several special guests we have with us here this morning, Dick,
the members of the European Parliament's Committee on Economic
and Monetary Affairs led by Chairwoman Pervenche Beres, and we
thank you very much, Madam Chairwoman, for being here, and your
colleagues as well. We are honored to have you here at the
Senate Banking Committee and to have you participate.
The Chairwoman mentioned to me that the last time you came
here and visited us was at the last testimony of Chairman
Greenspan. So this is kind of a beginning again, so we start
with the first testimony here of Mr. Bernanke. So welcome and
thank you for joining us here.
This hearing is being conducted pursuant to the statute and
according to practice. It is an occasion to consider not just
monetary policy in a narrow or limit sense but also the overall
health of our economy and what the Fed, as an agency, and we,
as policymakers, should do to increase prosperity and
opportunity in our country. The role of the Fed is critical not
just to setting monetary policy but it also serves as a
regulator for the safety and soundness of the largest lending
institutions, and very significantly, as a regulator and
enforcer of the laws passed by the Congress to protect
consumers and ensure that they have an opportunity to
participate and succeed in the American economy.
Mr. Chairman, I know I do not need to tell you that the Fed
stands at the center of some of the most critical economic and
public policy matters of our time. In the 17 months as Fed
Chairman, your steadiness at the helm of our Nation's monetary
policy seems to have earned you the confidence of the markets,
which is the initial step toward a successful tenure as Fed
Chairman. And I congratulate you on that.
The confidence has been reflected, in part, by some of the
positive economic news that we have experienced, including an
official unemployment rate that is low by historical standards,
by gains in the stock market, and the economy's overall
stability in the face of serious problems in both the housing
and automotive sectors of our economy.
Those positive factors aside, and notwithstanding the
positive impact of your leadership, there are some facts that
are cause for deep concern for many of us here about our
Nation's economic future, in particular the future of tens of
millions of hard-working Americans. Despite some increases in
income, working families are facing some unprecedented economic
burdens. Gas prices reached another record high of an average
of almost $3.25 a gallon across the country this past Memorial
Day weekend. Health care costs have increased by 25 percent
over the last 5 years. And the cost of sending a young person
to college has risen at more than double the rate of inflation
over the past 20 years. And default and foreclosure rates, as
you well know, for homeowners are an all-time high.
Mr. Chairman, there is a persistent if not growing sense
among many of our fellow countrymen that their future is less
secure and less hopeful today than it has been and should be.
It is in that respect that the Fed's role comes into play not
just as a monetary policymaker but also as a safety and
soundness regulator and as an agency charged with protecting
consumers. The Fed can and, in my view, should take additional
steps that can make a real difference in improving our overall
economic growth as well as an opportunity for all Americans to
contribute and to participate in the success and prosperity of
the economy.
In that regard, let me say that I am pleased that you, as
chairman, have accepted the Fed's duty to act under the Home
Ownership Equity Protection Act. I consider this a significant
statement by you and I trust and expect that it will result in
significant action by the Fed to ensure that every American who
seeks to buy a home will receive a fair, reasonable, and
responsible treatment by his or her lender.
Similarly, with respect to credit cards, I commend the Fed
for undertaking the effort to update Regulation Z which in my
view is long overdue. It is vital that consumers have the
clearest and most complete information possible about credit
cards so they can make the most informed decision about how to
use them.
However, improved disclosure is not, in and of itself,
sufficient to address abusive practices. I believe the Fed can
and should play a more active role not just in improving
disclosure for consumers but also in prohibiting policies and
practices that are harmful to consumers. In my view, credit
cards can and should be a tool for economic achievement and
advancement rather than an instrument of perpetual
indebtedness.
Last, Mr. Chairman, let me raise the issue of Basel II, of
the bank capital standards, with you. History has taught us
that well-capitalized banks are in the best interest of our
Nation when they are better positioned to weather unexpected
economic shocks, thereby protecting American taxpayers from
costly bank bailouts. And they enhance the competitiveness of
U.S. banks by instilling confidence in the strength of these
vital institutions.
As Senator Shelby and I have written to you and your fellow
banking regulators, the stakes are very high for our economy in
this debate. We believe that it is imperative that the four
regulatory agencies together agree upon the standards that will
strike the vital balance between the remarkable safety and
soundness of our federally insured lending institutions and
their competitiveness in the global economy.
Mr. Chairman, the challenges you face, of course, are
daunting. I think I speak for all of our Committee Members here
in saying that we are committed to seeing the Fed succeed at
each of these three vital missions: As a center of monetary
policy, a consumer protector, and a bank regulator.
What is at stake here is not just the success of your
agency, obviously, and your tenure as Fed Chairman, as
important as those are, but rather the success of our entire
economy and in particular for the tens of millions of Americans
whose hard work is the foundation of our economy's success and
who deserve every opportunity to maximize the fruits of their
labor.
With that, let me turn to my colleague from Alabama, the
Ranking Member of the Committee, Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Chairman Dodd.
Chairman Bernanke, we are pleased again to have you before
this Committee.
This hearing, as Senator Dodd has pointed out, provides the
Congress a very important opportunity to have an open and
detailed discussion about the Fed's monetary policy goals and
their implementation. I also expect that Members of the
Committee here, including myself, will take advantage of your
appearance, Mr. Chairman, to raise some other issues that fall
under the jurisdiction of the Federal Reserve.
I would also like to join Senator Dodd in welcoming our
colleagues from the European Union Parliament that are here
today. I had a nice meeting with them yesterday and we look
forward to these transatlantic visits. I think they are
healthy. I trust that your visit here today will be
enlightening and provide you with much to discuss with the
European Central Bank.
Chairman Bernanke, your testimony and report this morning
note the continued healthy performance of the economy in the
first half of 2000. Although real gross domestic product, GDP,
increased 0.7 percent in the first quarter the consensus view
among economists is that growth for the second quarter will
show a rebound in the neighborhood of 2.5 percent.
Along with continued GDP growth, we have seen positive news
on the job front. Gains in the payroll employment average
140,000 jobs per month in the first half of 2007. We continue
to enjoy low unemployment rate in this country, both
historically and relative to other industrialized nations in
the world.
The global economy also continues to be strong with Canada,
Europe, Japan, and the United Kingdom experiencing above trend
growth rates in the first quarter. This is good news, I
believe, for American businesses seeking to expand their
exports around the world.
In its statement following the June 28, 2007, meeting the
FOMC suggested that while core inflation readings had moderated
``sustained moderation in inflation pressures has yet to be
convincingly demonstrated.'' There is a lot in those words.
Inflation risks, not slow growth, remains the predominant
concern as we continue to see a rise in energy and food prices.
I also share, Mr. Chairman, your view on the importance of
low inflation in promoting growth, efficiency, and stability
which in turn equal maximum sustainable employment.
Chairman Bernanke, your statement also includes an
extensive discussion of the Federal Reserve's recent activities
relating to subprime mortgage lending, which is a concern to
all of us. The recent sharp increases in subprime mortgage loan
delinquencies are troubling. The rating agency's recent moves
are also very interesting too. The initiatives that you
highlight in your testimony are welcome.
However, I am concerned that the weaknesses, Mr. Chairman,
in the subprime market may have broader systemic consequences
than we are seeing yet. We have been told that the problem is
largely isolated and contained but I am concerned that that may
not be the case.
I will be particularly interested in hearing your views on
the scope and depth of the problem and how the Federal Reserve
will monitor and manage the situation hopefully going forward.
We are pleased to have you with us this morning, as I said, and
we look forward to the rest of the hearing and my colleagues
testimony.
Chairman Dodd. Thank you very much, Senator.
Let me inform my colleagues that as soon as a quorum
appears here, I am going to interrupt the hearing. I say that
to you, Mr. Chairman, as well, respectfully. We have several
nominees that are prepared to be confirmed by this body and I
would like to be able to move on that the moment a quorum
arrives here. So just to give you advance notice when that
happens here, realizing people have other obligations and may
be moving in and out here. So we will try to get that done.
If for whatever reason we do not, then I will be asking all
of you to join me after the first vote or during the first vote
sometime around noon off the floor of the Senate to try to get
these matters moved along so they can be considered by the full
Senate before our August adjournment.
With that, let me turn to Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman. And Chairman
Bernanke, thank you very much for joining us this morning. I am
particularly pleased that your testimony describes Congress as
prescient in the trend toward transparency. It is not often you
see the words Congress and prescient in the same sentence.
Thank you for that.
Of course, you are referring to an action 30 years ago, but
we will take what we can get.
As you know, we need to encourage transparency in both
central banking and in financial services and particularly in
the mortgage business. I appreciate your devoting much of your
testimony in the work of the Federal Reserve in promoting
better disclosure for mortgage borrowers and hope you and your
colleagues will approach this task with great urgency.
As you know, the loans of close to 2 million subprime
borrowers will reset in the next 2 years. Every day of inaction
means another 2,000 to 3,000 mortgages will reset without
sufficient protections. If they are lucky, many of these
families will be able to take out another lousy mortgage. If
they are unlucky, they may lose their life savings.
The Federal Reserve must act and must act quickly both to
mitigate the damage that has already been done and to prevent a
continuation of the abusive practices and products that have
characterized too much of the mortgage industry over the past
few years.
I understand why a lender needs to price for risk but I do
not understand why the structure of mortgage products is so
different in the prime and subprime markets. Most of the people
in this room do not have a prepayment penalty on their
mortgage. Most of us have our property taxes and our hazardous
insurance escrowed.
By contrast, the loans in the subprime sector, like the
228s, seem almost designed to deceive. They are sold to
borrowers with teaser rates and with dangerous features and
with the smooth pitch that there is no need to worry about the
reset because good things might happen in your life, a better
job, a better loan, even winning the lottery. But betting on
the outcome is not a sound banking practice.
It is possible that I will play like Grady Sizemore in next
year's Congressional baseball game but the Indians would be
well advised not to put him on waivers. Sadly, it is not very
likely I will climb the fence to rob somebody of a home run
next summer because Republicans just do not have that kind of
power.
You obviously need to take a broad view in your position.
But the very dispersion of risk that makes the subprime problem
less of a worry from an economic standpoint makes it a greater
problem for homeowners trying to work out an unaffordable loan.
We all know it makes economic sense for a lender to mitigate
losses but just try getting the right person on the phone in a
timely fashion, especially if the owner of the loan sits in
Shanghai.
One man's junk is another man's treasure. What may look
like BBB debt to an investor on Wall Street is really the hopes
and dreams of thousands of families in Slavic Village in
Cleveland and across the country. Those hopes and dreams
diminish with every day that we delay.
So, I would urge you to take action quickly and
comprehensively. You need to bring an end to the deceptive
practices in the subprime sector, not just for banks and their
affiliates but for all mortgage brokers and all types of
lenders.
Thank you. I look forward to your testimony.
Chairman Dodd. Thank you, Senator.
Senator Hagel.
COMMENTS OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Chairman, welcome. I will withhold my
comments until the question and answer period. I just want to
say that we are glad you are here with us today. Thank you.
Chairman Dodd. Thank you, Senator.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. I will not exercise such statesmanlike
restraint.
Thank you, Mr. Chairman. And thank you, Chairman Bernanke,
for joining us today to discuss the state of monetary policy
and its reflection on our economy.
At the past eight meetings of the FOMC, the Fed has held
the Federal Fund rates steady at 5.25 percent. However,
significant turmoil in the housing market particularly related
to subprime mortgages, a growing trade deficit, and a negative
household savings rate continue to pose tremendous challenges
to setting monetary policy.
I know, Mr. Chairman, you have personally expressed concern
about core inflation being higher than is desirable in the long
run. But the risk of raising interest rates too high is that a
weakening housing sector and rising oil prices may be taking
their toll on consumers and businesses alike and slowing down
the economy too much already.
I look forward to your insights about the kind of policies
that are likely to be effective in addressing the challenges we
face in this economy and offering real opportunities for growth
that provide widespread benefits to the American people.
On a systemic level, the weakening housing sector and
turmoil in the subprime mortgage market have placed pressure on
both investors and borrowers. Bear Stearns has recently
announced that two of its hedge funds are now worth nearly
nothing after some of its investments in subprime mortgages
went bad.
Last week both Moody's and Standard & Poor's significantly
downgraded ratings on hundreds of subprime related bonds. The
ABX Index, which tracks the performance of various classes of
subprime related bonds hit new lows yesterday. In the past few
months portions of the index that tracked especially risky
mortgage bonds with junk grade ratings have been falling. And
this is now spread into the portion of the index that track
bonds with ratings of AAA or AA.
According to Merrill Lynch's latest fund manager survey
which polled 186 fund managers controlling $618 billion in
assets, 72 percent of managers said that credit or default risk
was the biggest threat to financial market stability.
I would appreciate hearing your thoughts on some of these
events, particularly as they may pertain to the financial
accelerator effect you spoke of in Georgia last month and the
efforts of the Federal Reserve to monitor some of these risks.
Finally, the Federal Reserve has the authority and
responsibility to prohibit unfair and deception lending
practices. As such, Mr. Chairman, I was pleased to hear that
the Fed will likely propose additional rules under the Home
Ownership and Equity Protection Act, HOEPA, to provide
consumers with better protections through bans on some mortgage
purchases.
Additionally, I understand that the Fed will join other
regulators in a pilot project to monitor the practices of
nondepository subprime mortgage firms. I am interested in your
perspective on what additional actions the Federal Reserve will
be taking to meet the regulatory portion of its mandate.
I look forward to your testimony, Mr. Chairman. Thank you.
Chairman Dodd. Thank you very much, Senator Reed.
Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, it is always good to welcome a fellow
New Jerseyan back to the Committee. I am glad to have the
chance to have you before the Committee again this year. I
think your presence here is especially important, not just
because it gives Congress an opportunity to look critically at
the economy to see what is working and what is not, but because
it brings a discussion of the economy onto the front pages and
into the homes of Americans across the country.
I think Americans from all walks of life are clearly
affected when the market has a dip, by external pressure on
prices, by poor investment. For many, these factors are
invisible. I welcome these discussions with you because you
help make them much more tangible for average people across the
country.
And I assume you often ask yourself a question that I
certainly do, and I believe all of us should be asking, and
that is who is this economy working for? Who is this economy
working for?
Most middle-class Americans face rising food and energy
prices as well as health care costs while median incomes for
the last 5 years have remained stagnant. I think that there is
a good part of the American middle class who does not think
that this economy is working for them.
Unfortunately, most are aware of changes in the economy
when it affects them negatively. I would like to focus on a
specific group of Americans who have been keenly aware of how
the economy has not worked for them, those who dreamed of being
homeowners but in the wake of the subprime tsunami have seen
those dreams wash away in foreclosure and bankruptcy. More than
one million Americans lost their homes last year and few have
yet to recover. In fact, I would dare to argue that another
storm is on its way as adjustable rate mortgages explode in
coming months and force more homeowners into foreclosure.
And so in my mind this is not just simply a time for
suggestions, it is a time for solutions. The Federal Reserve
has, and has always had, the tools to protect Americans from
this storm. But as the warning signs were posted and as the
foreclosures began we saw little to no action.
Now I want to commend you for addressing this issue,
especially on low document loans and underwriting to the full
indexed rate. But I am still hoping for more substantive
solutions that will protect the borrower. We are talking also
about predatory lenders and we must take swift action. I do not
believe this is one that the market is going to handle simply
on its own. Congress and the Federal Reserve need to act and I
look forward to discussing this more with you today.
I welcome the focus you have recently had on discussing
certain inequalities in our economy and I will look forward to
your thoughts on these and other issues important to the
economic prosperity of our Nation.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman.
I want to thank you for holding this hearing and I want to
thank Chairman Bernanke. As Chairman of the Joint Economic
Committee, I am always interested in hearing your thoughts on
the current state of economy and appreciate your availability
on so many issues when we reach out to you.
As I have said in the past, we live in interesting economic
times. And you face a number of important challenges in setting
a course for monetary policy that will achieve the multiple
goals of high employment, balanced economic growth, and low
inflation. Right now, there are certain reasons to be concerned
about where we find ourselves.
In the short-term, even with the likely improvements in the
second quarter, overall economic growth in the first half of
the year has been disappointing to say the least. Most
forecasters have revised downward their expectations for
economic growth through the rest of the year. The
Administration continues to run high budget deficit that
threaten our future stability to compete with the rest of the
world. And our trade gap, particularly with China, remains
immense and growing at a rapid rate.
Energy prices are hovering at record highs, feeding our
trade gap and fueling anxiety among middle-class families. The
collapse of parts of the housing market which you call a
correction has become a serious drag on our economic growth and
a threat to economic security of too many American families.
And while I welcome the Fed's new pilot program to monitor
independent subprime brokers, I do not think consumers will
truly be safe from irresponsible and deceptive lending
practices until we enact tougher Federal laws to protect the
subprime mess from happening again. As indication of the
weakness in the housing market continue to mount, there is an
urgent need for better protections for existing and aspiring
homeowners, although I do want to thank--the Appropriations
Committee did a $100 million in for the workouts. So nonprofits
can do workouts that Senators Casey, Brown, and I had asked
them to do.
Most importantly, a view is recognized. We have an economy
whose rewards seems to be more and more going to fewer and
fewer privileged Americans. We are facing the greatest
concentration of income since 1928 right before the crash and
the beginning of the Depression when 24 percent of all income
went to the richest 1 percent. It is now close to 22 percent
and will pass the 24 percent, if present trends continue, all
too soon.
At a time when the wealthiest in this country have been
doing extremely well, the American middle class, the engine of
our economy, has not been as fortunate. Most Americans have not
seen the benefits of working harder in their paychecks.
Between 2000 and 2006 the typical worker's earnings grew
less than 1 percent after accounting for inflation while
productivity increased a whopping 18 percent. And now that
economic growth seems to be slowing, its fair to ask whether
most middle-class Americans will slip even further behind. The
dramatic increase in productivity and its failure to raise wage
rates is a great conundrum for our economy that needs all of
our attention.
I do not pretend that there are easy solutions to the
troubling challenges facing our economy but we need to remember
that our collective focus must be on achieving strong
sustainable long-term economic growth that can be shared by all
families in this country, not just those in the top 1 or 5
percent.
Unless economic fortunes in this country grew together
rather than apart, we cannot be confident about our children's
economic futures.
I look forward to your testimony, and thank you, Mr.
Chairman, for the time.
Chairman Dodd. Thank you, Senator, very much.
Mr. Chairman, we welcome you here to the Committee once
again and we are prepared to receive your statement.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Chairman Bernanke. Thank you. Chairman Dodd, Ranking Member
Shelby, and Members of the Committee, I am pleased to present
the Federal Reserve's Monetary Policy Report to the Congress.
As you know, this occasion marks the 30th year of
semiannual testimony on the economy and monetary policy by the
Federal Reserve. And in establishing these hearings, the
Congress proved prescient in anticipating the worldwide trend
toward greater transparency and accountability of central banks
in the making of monetary policy.
Over the years, these testimonies and the associated
reports have proved an invaluable vehicle for the Federal
Reserve's communication with the public about monetary policy
even as they have served to enhance the Federal Reserve's
accountability for achieving that dual objectives of maximum
employment and price stability set forth by the Congress.
I take this opportunity to reiterate the Federal Reserve's
strong support of the dual mandate. In pursuing maximum
employment and price stability, monetary policy makes its
greatest possible contribution to the general economic welfare.
Let me now review the current economic situation and the
outlook beginning with developments in the real economy and the
situation regarding inflation before turning to monetary
policy. I will conclude with comments on issues related to
lending to households and to consumer protection, topics not
normally addressed in monetary policy testimony but, in light
of recent developments, deserving of our attention today.
After having run at an above trend rate earlier in the
current economic recovery, U.S. economic growth has proceeded
during the past year at a pace more consistent with sustainable
expansion. Despite the downshift in growth, the demand for
labor has remained solid, with more than 850,000 jobs having
been added to payrolls thus far in 2007 and the unemployment
rate having remained at 4.5 percent. The combination of
moderate gains in output and solid advances in employment
implies that recent increases in labor productivity have been
modest by the standards of the past decade. The cooling of
productivity growth in recent quarters is likely the result of
cyclical or other temporary factors but the underlying pace of
productivity gains may also have slowed somewhat.
To a considerable degree, the slower pace of economic
growth in recent quarters reflects the ongoing adjustment in
the housing sector. Over the past year, home sales and
construction have slowed substantially and house prices have
decelerated. Although a leveling off of home sales in the
second half of 2006 suggested some tentative stabilization of
housing demand, sales have softened further this year, leading
the number of unsold new homes in builders' inventories to rise
further relative to the pace of new home sales.
Accordingly, construction of new homes has sunk further,
with starts of new single-family houses thus far this year
running 10 percent below the pace of the second half of last
year.
The pace of home sales seems likely to remain sluggish for
a time partly as a result of some tightening in lending
standards and the recent increase in mortgage interest rates.
Sales should ultimately be supported by growth in income and
employment as well as by mortgage rates that--despite the
recent increase--remain fairly low relative to historical
norms. However, even if demand stabilizes as we expect, the
pace of construction will probably fall somewhat further as
builders work down stocks of unsold new homes. Thus, declines
in residential construction will likely continue to weigh on
economic growth over coming quarters, although the magnitude of
the drag on growth should diminish over time.
Real consumption expenditures appear to have slowed last
quarter, following two quarters of rapid expansion. Consumption
outlays are likely to continue growing at a moderate pace aided
by a strong labor market. Employment should continue to expand,
though possibly at a somewhat slower pace than in recent years,
as a result of the recent moderation in the growth of output
and ongoing demographic shifts that are expected to lead to a
gradual decline in labor force participation. Real compensation
appears to have risen over the past year and, barring further
sharp increases in consumer energy costs, it should rise
further as labor demand remains strong and productivity
increases.
In the business sector, investment in equipment and
software showed a modest gain in the first quarter. A similar
outcome is likely for the second quarter as weakness in the
volatile transportation equipment category appears to have been
offset by solid gains in other categories. Investment in
nonresidential structures, after slowing sharply late last
year, seems to have grown fairly vigorously in the first half
of 2007.
Like consumption spending, business fixed investment
overall seems poised to rise at a moderate pace bolstered by
gains in sales and generally favorable financial conditions.
Late last year and early this year motor vehicle manufacturers
and firms in several other industries found themselves with
elevated inventories, which led them to reduce production to
better align inventories with sales. Excess inventories now
appear to have been substantially eliminated and should not
prove a further restraint on growth.
The global economy continues to be strong. Supported by
solid economic growth abroad U.S. exports should expand further
in coming quarters. Nonetheless our trade deficit, which was
about 5.25 percent of nominal gross domestic product in the
first quarter is likely to remain high.
For the most part, financial markets have remained
supportive of economic growth. However, conditions in the
subprime mortgage sector have deteriorated significantly,
reflecting mounting delinquency rates on adjustable-rate loans.
In recent weeks, we have also seen increased concerns among
investors about credit risk on some other types of financial
instruments. Credit spreads on lower quality corporate debt
have widened somewhat, and terms for some leveraged business
loans have tightened. Even after their recent rise, however,
credit spreads remain near the low end of their historical
ranges and financing activity in the bond and business loan
markets has remained fairly brisk.
Overall, the U.S. economy appears likely to expand at a
moderate pace over the second half of 2007, with growth then
strengthening a bit in 2008 to a rate close to the economy's
underlying trend. Such an assessment was made around the time
of the June meeting of the Federal Open Market Committee by the
members of the Board of Governors and the Presidents of the
Reserve Banks, all of whom participate in deliberations on
monetary policy.
The central tendency of the growth forecasts, which are
conditioned on the assumption of appropriate monetary policy,
is for real GDP to expand roughly 2.25 to 2.5 percent this year
and 2.5 to 2.75 percent in 2008.
The forecasted performance for this year is about one-
quarter percentage point below that projected in February, the
difference being largely the result of weaker than expected
residential construction activity this year. The unemployment
rate is anticipated to edge up to between 4.5 and 4.75 percent
over the balance of this year and about 4.75 percent in 2008, a
trajectory about the same as the one expected in February.
I turn now to the inflation situation. Sizable increases in
food and energy prices have boosted overall inflation and
eroded real incomes in recent months, both unwelcome
developments. As measured by changes in the price index for
personal consumption expenditures, PCE inflation, inflation ran
at an annual rate of 4.4 percent over the first 5 months of
this year, a rate that if maintained would clearly be
inconsistent with the objective of price stability.
Because monetary policy works with a lag, however,
policymakers must focus on the economic outlook. Food and
energy prices tend be quite volatile so that, looking forward,
core inflation, which excludes food and energy prices, may be a
better gauge than overall inflation of underlying inflation
trends. Core inflation has moderated slightly over the past few
months with core PCE inflation coming in at an annual rate of
about 2 percent so far this year.
Although the most recent readings on core inflation have
been favorable, month-to-month movements in inflation are
subject to considerable noise and some of the recent
improvement could also be the result of transitory influences.
However, with long-term inflation expectations contained,
futures prices suggesting that investors expect energy and
other commodity prices to flatten out, and pressures in both
labor and product markets likely to ease modestly, core
inflation should edge a bit lower on net over the remainder of
this year and next year.
The central tendency of FOMC participants forecast for core
PCE inflation--2 to 2.25 percent for all of 2007 and 1.75 to 2
percent in 2008--is unchanged from February. If energy prices
level off as currently anticipated, overall inflation should
slow to a pace close to that of core inflation in coming
quarters.
At each of its four meeting so far this year, the FOMC
maintained its target for the Federal funds rate at 5.25
percent, judging that the existing stance of policy was likely
to be consistent with growth running near trend and inflation
staying on a moderating path. As always, in determining the
appropriate stance of policy, we will be alert to the
possibility that the economy is not evolving in the way we
currently judge to be the most likely.
One risk to the outlook is that the ongoing housing
correction might prove larger than anticipated, with possible
spillovers onto consumer spending.
Alternatively consumer spending, which has advanced
relatively vigorously on balance in recent quarters, might
expand more quickly than expected. In that case, economic
growth could rebound to a pace above its trend. With the level
of resource utilization already elevated, the resulting
pressures in labor and product markets could lead to increased
inflation over time.
Yet another risk is that energy and commodity prices could
continue to rise sharply, leading to further increases in
headline inflation and, if those costs pass through to the
prices of nonenergy goods and services, to higher core
inflation as well.
Moreover, if inflation were to move higher for an extended
period and increase became embedded in longer-term inflation
expectations, the reestablishment of price stability would
become more difficult and costly to achieve. With the level of
resource utilization relatively high and with a sustained
moderation in inflation pressures yet to be convincingly
demonstrated, the FOMC has consistently stated that upside
risks to inflation are its predominant policy concern.
In addition to its dual mandate to promote maximum
employment and price stability, the Federal Reserve has an
important responsibility to help protect consumers in financial
services transactions. For nearly 40 years, the Federal Reserve
has been active in implementing, interpreting, and enforcing
consumer protection laws. I would like to discuss with you this
morning some of our recent initiatives and actions,
particularly those related to subprime mortgage lending.
Promoting access to credit and to homeownership are
important objectives and responsible subprime mortgage can help
to advance both goals. In designing regulations, policymakers
should seek to preserve those benefits.
That said, the recent rapid expansion of the subprime
market was clearly accompanied by deterioration in underwriting
standards, and in some cases by abusive lending practices and
outright fraud. In addition, some households took on mortgage
obligations they could not meet, perhaps in some cases because
they did not fully understand the terms.
Financial losses have subsequently induced lenders to
tighten their underwriting standards. Nevertheless, rising
delinquencies and foreclosures are creating personal, economic,
and social distress for many homeowners and communities,
problems that will likely get worse before they get better.
The Federal Reserve is responding to these difficulties at
both the national and the local levels. In coordination with
the other Federal supervisory agencies we are encouraging the
financial industry to work with borrowers to arrange prudent
loan modifications to avoid unnecessary foreclosures. Federal
Reserve Banks around the country are cooperating with community
and industry groups that work directly with borrowers having
trouble meeting their mortgage obligations. We continue to work
with organizations that provide counseling about mortgage
product to current and potential homeowners. We are also
meeting with market participants--including lenders, investors,
servicers, and community groups--to discuss their concerns and
to gain information about market development.
We are conducting a top to bottom review of possible
actions we might take to help prevent recurrence of these
problems. First, we are committed to providing more effective
disclosures to help consumers defend against improper lending.
Three years ago, the Board began a comprehensive review of
Regulation Z, which implements the Truth in Lending Act, or
TILA. The initial focus of our review was on disclosures
related to credit cards and other revolving credit accounts.
After conducting extensive consumer testing, we issued a
proposal in May that would require credit card issuers to
provide clearer and easier to understand disclosures to
consumers. In particular, the new disclosures would highlight
applicable rates and fees, particularly penalties that might be
imposed. The proposed rules would also require card issuers to
provide 45 days advance notice of a rate increase or any other
change in account terms so that consumers will not be surprised
by unexpected charges and will have time to explore
alternatives.
We are now engaged in a similar review of the TILA rules
for mortgage loans. We began this review last year by holding
four public hearings across the country, during which we
gathered information on the adequacy of disclosures for
mortgages, particularly for nontraditional, traditional, and
adjustable rate products.
As we did with credit card lending, we will conduct
extensive consumer testing of proposed disclosures. Because the
process of designing and testing disclosures involves many
trial runs, especially given today's diverse and sometimes
complex credit products, it may take some time to complete our
review and propose new disclosures.
However, some other actions can be implemented more
quickly. By the end of the year, we will propose changes to
TILA rules to address concerns about mortgage loan
advertisements and solicitations they may be incomplete or
misleading and to require lenders to provide mortgage
disclosures more quickly so that consumers can get the
information they need when it is most useful to them. We
already have improved a disclosure that creditors must provide
to every applicant for an adjustable rate mortgage product to
explain that better the features and risks of these products
such as ``payment shock'' and rising loan balances.
We are certainly aware, however, that disclosure alone may
not be sufficient to protect consumers. Accordingly, we plan to
exercise our authority under the Home Ownership and Equity
Protection Act, HOEPA, to address specific practices that are
unfair or deceptive. We held a public hearing on June 14 to
discuss industry practices including those pertaining to
prepayment penalties, the use of escrow accounts for taxes and
insurance, stated income and low documentation lending, and the
evaluation of a borrower's ability to repay. The discussion and
ideas we heard were extremely useful and we look forward to
receiving additional public comments in coming weeks. Based on
the information we are gathering, I expect the Board will
propose additional rules under HOEPA later this year.
In coordination with the other Federal supervisory
agencies, last year we issued principles-based guidance for
nontraditional mortgages, and in June of this year we issued
supervisory guidance on subprime lending. These statements
emphasized the fundamental consumer protection principles of
sound underwriting and effective disclosures. In addition, we
reviewed our policies related to the examination of nonbank
subsidiaries of bank and financial holding companies for
compliance with consumer protection laws and guidance.
As a result of that review and following discussions of the
Office of Thrift Supervision, the Federal Trade Commission, and
State regulators as represented by the Conference of State Bank
Supervisors and the American Association of Residential
Mortgage Regulators, we are launching a cooperative pilot aimed
at expanding consumer protection compliance reviews at selected
nondepository lenders with significant subprime mortgage
operations.
The reviews will begin in the fourth quarter of this year
and will include independent state-licensed mortgage lenders,
nondepository mortgage lending subsidies of bank and thrift
holding companies, and mortgage brokers doing business with or
serving as agents of these entities. The agencies will
collaborate in determining the lessons learned and in seeking
ways to better cooperate in ensuring effective and consistent
examination of and improved enforcement for nondepository
mortgage lenders. Working together to address jurisdictional
issues and to improve information sharing among agencies, we
will seek to prevent abusive and fraudulent lending while
ensuring that consumers retain access to beneficial credit.
I believe that the actions I have described today will help
address the current problems. The Federal Reserve looks forward
to working with Congress on these important issues.
Thank you.
Chairman Dodd. Thank you very much, Mr. Chairman.
I am sure my colleagues will have some additional questions
for you on dealing with HOEPA, but I want to express my
appreciation for the Fed in deciding to aggressively pursue
these issues beyond just the guidance and looking at
regulations.
I will try to keep this about 7 minutes a round here so can
get through to everybody, at least one around anyway. And then
the record will stay open, as well, for those who are not here
to submit some questions. And we will try to move along.
Let me, if I can, begin with the Basel II issue here.
As you know, Mr. Chairman, Senator Shelby and I earlier
this week sent a letter to the four banking regulators, calling
on each one of them to make sure a consensus on the final
regulation on Basel II, the bank capital accords, could be
reached. And while I believe that no one regulator should have
a veto power certainly over these important regulations, it is
critically important that the final rule be in agreement among
all the regulators. Proper capital accounting is obviously
critically important to competitiveness and to the safety and
soundness of our financial institutions. Capital should be
based on risk not who the regulator is, in my view.
One, I would ask if you would agree that there would be
tremendous value to have a rule that all four regulators agree
to? And conversely, obviously would it be a failure if there
was a failure to reach consensus? I know you are working at
this, but I want to raise that issue with you. I know how
important you think it is but it is extremely important there
be this consensus. I realize that you are working toward that
but why don't you share with us how that is moving?
Chairman Bernanke. Thank you, Mr. Chairman.
I think we agree that the existing Basel I capital system
is no longer adequate for the largest international banks and
that we need to move expeditiously forward to provide a new
capital standard that will appropriately link capital to risk
taking. I think that the Basel II approach, with perhaps some
modifications but in essence what was agreed upon with the
international banking authorities, is the right approach for
providing that kind of capital base protection.
We are already rather late in this process. We have delayed
the process for a year. Therefore, it is very essential that we
do move expeditiously. I can assure you that the four agencies
are currently working very hard on a range of issues. Again, we
all appreciate the importance of making progress.
With respect to your question, I too would strongly prefer
that all four agencies would come together and agree on a
single proposal. And I am relatively optimistic that we will be
able to achieve that in the near future.
Chairman Dodd. Thank you for that. I suspect Senator Shelby
may raise a question about that as well, since we both have a
strong interest in that conclusion. And we urge you to do
everything you can in these coming days to reach that
consensus, because of the importance of it, as you have stated
here.
Let me move, if I can, to the currency manipulation issue.
I know because of your previous testimony before the Committee,
the issue was raised here about a speech that you gave during
that trip to China along with Secretary Paulson and others in
which you said that China's exchange rate practices amounted to
an effective subsidy. I know there was longer remarks than that
alone, but nonetheless that comment was one that certainly
attracted some attention.
As you are aware, there is great concern to me and to many
of our colleagues here on this issue. Senator Shelby and I have
introduced some legislation that has the support of many of our
colleagues here, Senator Bayh, Senator Carper, Senator Brown,
Senator Casey, Senator Bunning, Senator Dole, on this
Committee.
I should point out that Senator Baucus in the Finance
Committee has also introduced some legislation. He and I have
talked about this. The issue of currency is appropriately a
matter of jurisdiction of this Committee but nonetheless there
is a strong interest reflected by Senator Baucus, and Senator
Schumer as well has a strong interest in this subject matter.
And so there is, without a doubt here, as you gather, among
Democrats and Republicans, while there may be disagreements on
a lot of other issues on this one there seems to be a growing
consensus here of our concern about the currency manipulation.
In fact, it is our attention here to try before the August
recess to possibly markup some legislation which we have
introduced and I discussed with you here.
I wonder if you could still share with us your opinion
about this matter here, what it means, and some reflection on
where you think this is heading. Because it is a deep, deep
concern regarding our manufacturing base in this country that
struggles every day to stay open and competitive in global
markets. Share with us, if you will, your thoughts on this
matter today.
Chairman Bernanke. Thank you, Mr. Chairman.
I share your concern, I share your frustration about the
slow pace of the appreciation of Chinese currency.
I have argued, as I did in that speech you referred to in
China, that further appreciation of the currency would, in
fact, be in China's interest for a number of reasons. First, it
would give them an independent monetary policy. And they are,
at this point, dealing with some issues of inflation and asset
price increases that would be better dealt with if they had an
independent monetary policy.
And second, again in reference to my comments about
distortions, their economy is too oriented toward exports, not
enough toward the home market. And I believe that appreciation
would better help orient the economy toward serving domestic
needs and domestic consumers rather than relying entirely on
the global market.
So, I agree with your premise that it is important that the
Chinese begin to appreciate further.
Let me just raise a couple of issues which I guess I would
call tactical issues without addressing any specific
legislative proposal. The first is that the currency, while an
important issue, is probably in itself not going to solve the
trade imbalance problem. There are fundamental saving
investment imbalances, both in the United States and abroad,
which need to be changed in order to make real progress on the
trade balance. In particular, we have emphasized with the
Chinese the importance of structural changes in their economy
such as increased safety net and improved financial system that
would increase the share of their output going to consumers and
being consumed at home. The combination of currency
appreciation and this other set of measures is really what is
needed to begin to move things in the right direction.
So, I would urge you to broaden focus just a bit beyond the
currency to talk about the savings and investment balances that
need to be adjusted in both the United States and in China.
The other point I would just make from I guess essentially
a tactical point of view is that, again as I understand the
frustration and concern about this particular issue and I
advocate and I urge the Chinese to move their currency up more
quickly, the United States and China have a wide range of
issues on which we need to collaborate, coordinate, and
cooperate including energy and the environment and financial
services and trade and many other issues. I hope that as we
look toward these sorts of measures that we try to keep in mind
the importance of engaging China on a wide range of questions
and not simply restricting our attention to this one important
issue. But it is only one of many issues.
Thank you.
Chairman Dodd. I appreciate that and I do not disagree that
there are these other critical questions.
In fact, Title II of our legislation deals with some of the
trade issues here that you have raised, and I think--I will let
Senator Shelby speak for himself here obviously--but we
understand the importance of that as well.
I cannot begin to tell you however, Mr. Chairman, of the
difficulty there is for those of us who go back to our
constituencies and talk about these issues here with, day after
day, Chinese firms that export to the United States enjoying
what you called an effective export subsidy, as a result of
their undervaluation.
So it makes it very difficult for those of us to try to
make the case that there are a variety of issues that we need
to be working with the Chinese on. I think all of us would
agree with you on that. But this issue lurks as this huge
obstacle to those issues, particularly when American jobs are
being so adversely affected by this.
Is it still your opinion that this is an effective subsidy
on that issue?
Chairman Bernanke. It is not a subsidy in the legal sense,
that a subsidy is a payment by the government directly to
producers to support their production. Nothing like that is
going on. That is not what I was referring to.
I was talking about the economic implication which is that
the undervalued exchange rate creates a distortion in the
economy which artificially sends resources into the export
sector as opposed to in the domestic sector. So it is a
distortion in the economy. From a legal perspective it is not
the same thing as a subsidy.
Chairman Dodd. No, I know. I notice you said effective
subsidy.
Chairman Bernanke. Or implicit.
Chairman Dodd. Implicit subsidy.
Thank you very much. Let me turn to my colleague, Senator
Shelby.
Senator Shelby. Thank you, Chairman Dodd.
I want to pick up on what Senator Dodd was talking about,
the Chinese. We have been dealing with this a long time. And
whether it is a direct subsidy, Mr. Chairman, or a backyard
subsidy they have an advantage there obviously because of the
currency situation, to their advantage and to our detriment. A
lot of us represent States that have substantial manufacturing
industries there and we have seen ourselves the erosion of a
lot of these jobs, not just in Alabama but Ohio, Connecticut,
New Jersey, you name it. We have to answer to our constituents.
And the American people, they know something is wrong. They
know something is wrong and they look to us to do something
about it and I know it is very complicated myself.
But on the other hand, do we just continue to sit back and
say well, everything is fine, when we know it is not fine. We
know there is an advantage there. They are manipulating it to
their advantage, in my judgment.
The other thing I wanted to pick up on, what Senator Dodd
has already raised, and that is Basel. I do hope, Mr. Chairman,
I know you are one of the regulators, too, here. But we have
talked to the FDIC Chairperson and others.
Senator Dodd and I have been on this Committee quite a
while. We were here during the savings and loan debacle when
the Government, the taxpayers, spent billions and billions of
dollars. And that is not fun. And we want to avoid that.
I agree with Senator Dodd that I do not know of any bank,
financial institution, that has gone bankrupt or has become
insolvent that is well-capitalized and well-managed, you know,
in combination. And if we are going through this international
accord to lower our capital standards, that is probably to us.
Everybody on this Committee--I cannot speak for everybody but
just about, Democrats and Republicans, because we have that
oversight responsibility here. And ultimately we do not want
this to land in our lap. Is that right, Senator Dodd?
Chairman Dodd. That is right.
Senator Shelby. So, I will move on to some other things.
Subprime problems. The subprime problems are real, not just
in New Jersey and Ohio but in Alabama and everywhere else.
There has been a huge expansion, Mr. Chairman, as you know, of
structured financial products. We call what, collateralized
debt obligations backed by subprime debt. In concept these
projects involve converting highly risky loans, as I understand
it, into a collection of securities that have a range of risk
from AAA to junk.
The rating agencies provide the AAA ratings based on the
idea that the structure of the products satisfactorily
dissipates or spreads the risks associated with the underlying
prime loan. That is the basis of that. But it appears that is
not always working.
It appears that many of the assumptions here regarding
these structured products, collateralized, have significantly
underestimated the true risk. We have seen what the rating
agencies, it has been talked about, at least Senator Menendez
and also Senator Brown brought it up. We have seen S&P--and I
believe Senator Reed. We have seen S&P and Moody's already
downgrading the debt that they invited as AAA. How did they get
to the point to rate a lot of these collateralized obligations
AAA grade with so much underlying junk you might say? You
cannot make gold out of lead. We know that. That has been
tried.
Does all of this deeply concern you, how this came about to
begin with? Because I think the subprime not only has deep
repercussions when a lot of people, our constituents that have
been victimized I think to some extent by this. But a lot of it
has been brought about by very ingenious financial people. And
then looks like the rating agencies fell right in line with
them, knowing that this is not really AAA stuff. This is
questionable stuff. Now it is coming home to roost. And, as
someone else said earlier here, a lot of those loans are going
to be reset not downward but upward.
Senator Dodd is very much out front on this, and should be
as the Chairman of this Committee. And we are deeply concerned
that the subprime problem is not going to just be contained so
easily but could deeply spread and have some repercussions out
there. What do you think?
Chairman Bernanke. Senator, let me address the financial
side. We have talked about this effect on homeowners. On the
financial side, I am not sure there is anything essentially
wrong with structured credit products, per se. But what we have
learned since early this year is that a lot of the subprime
mortgage paper is not as good as was thought originally. And
there clearly are going to be significant financial losses
associated with defaults and delinquencies on these mortgages.
As a result, the credit quality of many of the structured
projects that include in them substantial amounts of subprime
mortgage paper is being downgraded. The one issue is that the
structured credit products are quite complex. They include many
different kinds of assets. Then the risks are divided up in
different so-called ``tranches.'' So it takes quite a complex
model or analysis to determine what the real value of these
things is.
Senator Shelby. But the value seems to be going down
instead of up.
Chairman Bernanke. Well, it is going down because the
credit losses associated with subprime have come to light and
they are fairly significant. Some estimates are on the order of
between $50 billion and $100 billion of losses associated with
subprime credit products.
The credit rating agencies have begun to try to make sure
they account for those losses and they have downgraded some of
these products.
I should say that the investors, many of them, recognize
even before the downgrades occurred that there were risks
associated with these products including not only credit risks
but also liquidity and interest rate and other types of risks.
And so the spreads they were charging on these products were
not necessarily the same as would be implied by the credit
rating agency.
Senator, if I could just say one word about Basel, I would
be very grateful. It is simply not the case that Basel II is
about lowering credit standards. It is about making the banking
system safer, not less safe.
Senator Shelby. I did not say credit standards. We are
about capital.
Chairman Bernanke. Capital standards, I am sorry. Capital
standards, thank you.
The system we have now, Basel I, was designed 20 years ago
for a very different kind of banking world. Banks are far more
obligated. They use much more off balance sheets types of
operations. The existing Basel I Accord, as the GAO study that
just came agrees, and as the international banking community
strongly agrees, is not safe for the largest and most
sophisticated international banking organizations.
And so it is not a question of going to lower capital
standards. It is a question of finding a new system that will
provide capital on a risk-adjusted basis that will match the
capital against the risk, and therefore make these banks safer
not less safe.
So we take a backseat to nobody in the importance of making
sure that these banks are safe and sound. That is our primary
objective. And we believe that making this change to Basel II
will increase, not decrease, the safety of these banks.
In addition, of course, in any change from one system to
another there is going to be a period of uncertainty as we work
through the new methods and so on. And so we have been very
careful to include a wide variety of protections including, as
you know, the leverage ratio, prompt corrective action, the
transition floors, Pillar II, a wide variety of things that
will make sure that we have the control that we need to begin
to see any unsafe drops in capital, we can make the changes to
ensure that the banks are operating safely and soundly.
So, I would just very strongly urge you to consider that
Basel II is not about lowering capital, it is about making
banks safer.
Senator Shelby. But some banks believe it is about lowering
capital. There has been a lot of stuff written about it. At the
end of the day they said it would free up their capital, in
other words lower the capital. That is some of our concerns.
Chairman Bernanke. What they are referring to is
situations, there are situations where banks under the old
system are forced to hold a lot of capital against which is
essentially very safe assets. That part of the capital is
excess capital. One of the problems they face is that foreign
banks that do not have as much capital against these very safe
assets will be able to just come and take that business away
because they do not cost as much.
So against a safe asset and one whose risk is appropriately
calibrated, it seems to me appropriate to reduce capital. But
against risky assets, we need to have enough capital to ensure
safety.
Senator Shelby. We want to make sure our banking system is
strong. We have a great banking system. And we do not need to
weaken the pillars in any way.
Mr. Chairman, thank you.
Chairman Dodd. Thank you, Senator Shelby. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Chairman Bernanke, your response to Chairman Dodd about
China, I appreciate your talking in terms of broadening the
discussion beyond currency, Chinese savings, their domestic
economy. You have talked in the past about intellectual
property as you should. I would also implore you in the future,
if you would, to also bring in labor issues in terms of slave
labor, in terms of child labor, in terms of fair labor
practices. We discussed that back several months ago when you
were here, on international labor organization standards.
I hope that your broadening the discussion of the issues
with China trade and our trade in our bilateral trade deficit
which, in my first year in Congress in 1992 when I ran, was in
the low double digits with China. And today is way in excess of
$200 billion. As you know that, without prodding, would include
labor issues in this discussion.
I would like to switch with a couple questions on the whole
issue of the subprime loans. I appreciate your willingness to
act under the HOEPA authority this year. I think the progress
you have made is generally good. We would obviously like, if
possible, for you to move a little more quickly but
understanding how things go sometimes.
But a couple of questions. With the closing fees that
people pay, it seems that the prepayment penalties, it seems to
me do not seem that necessary from the investors standpoint.
They seem more designed to lock people into bad loans. Wouldn't
the better protection for lenders be to offer a fair loan in
the first place rather than the prepayment penalties?
Chairman Bernanke. Senator, we are looking at that very
carefully. Our subprime mortgage guidance, which has already
been issued with the other banking agencies, takes the position
that prepayment penalties should not extend into the period
where the interest rates reset. So they should not prevent
people from refinancing when their industries are about to go
up. We are looking at that specifically as part of our HOEPA
rules, as well.
I agree with you, there are situations where prepayment
penalties are not in the interest of the borrowers and we are
looking at those.
Senator Brown. Are those just guidelines or are those
actually requirements?
Chairman Bernanke. They are requirements. That is, they are
enforced by examination and supervision of the banks. But the
subprime guidance, which is a collaboration of the four banking
agencies, applies only to banks and thrifts and not to lenders
outside of the banking system, which is what the HOEPA was
about, would apply to everything.
Senator Brown. If this is about investors protecting their
interests, as it should be in part, doesn't failure to escrow
create the very risk that prepayment penalties allegedly guard
against?
Chairman Bernanke. That is another issue that we heard a
lot about in our hearings in June. It also is covered in the
subprime guidance and is also one of the things we are looking
at very carefully for our rulemaking.
Senator Brown. How are you approaching the determining of
borrowers ability to repay a loan? You emphasize the
importance. Are we setting standards on that level, also?
Chairman Bernanke. Once again, there is some reference to
that in the subprime guidance, the idea being there that the
loan should be underwritten at the fully indexed rate, that is
that the rate once the adjustable resets have taken place.
I should say though, particularly from the perspective of
writing a rule, we are going to do our very best. But it is
hard to put into a rule exactly what criteria one would use in
order to decide whether a loan is affordable or not. But we are
going to do our best.
In particular, we are going to look at the question of
underwriting to the fully indexed rate. And also, ask ourselves
whether or not there can be guidelines in terms of demonstrated
payment ability or demonstrated income that we related to the
payments under the mortgage.
Senator Brown. But there are some things, understanding the
difficulty of writing a rule to conclude everything, but there
are certainly some things, no doc loans, better disclosures, so
people understand in readable large print, if you will, on the
first page what this loan is going to cost, what their
adjustable rate could be in worse case scenario. All of those
absolutely could be included; right?
Chairman Bernanke. These are all on our agenda. The top
page of the mortgage documents that you are alluding to is part
of our Regulation Z review which will cover all home mortgage
advertising solicitation and disclosures.
One concern we have about that is just that in the past
these disclosures have been written by lawyers sitting in an
agency. And when we put them out, the public does not
understand what it really means. And so if you are going to
have effective disclosures, they have to be done in a way that
ordinary people can understand what the implications are.
And for that reason we have, for the Government at least,
been very innovative in making sure that all of our disclosures
are being consumer tested and focus group tested. And we are
making sure that people really do understand what the
disclosure is telling them. I think that is critical if this is
really going to be effective and not just a cosmetic step.
Senator Brown. And you can write that prescriptively in
your rule?
Chairman Bernanke. We can prescribe the form, yes.
Senator Brown. In several of the answers, and I appreciate
your answers, you spoke in terms of it is on your agenda. A
skeptical look would say that implies some inertia. Are you
pleased, personally, with the speed at which you are doing
this? Chairman Dodd has talked about and Senator Shelby has
talked about with a number of resets in the next couple of
years and the number of people who are going to lose their life
savings every week, every day, every week, every month. Are you
satisfied you are moving as fast as you can?
Chairman Bernanke. I believe that we are moving as fast as
we responsibly can. We have to do it right. We have to make
sure the disclosures, for example, are actually of value. And
we have to follow, of course, the rules and regulations
associated with how an agency makes rules. Congress has told us
what steps we have to take and we have to follow those steps.
I would say to you, Senator, if you feel that the
regulatory process is too slow the only remedy I can think of
is for Congress to act directly.
Senator Brown. We always move fast enough, too, Mr.
Chairman.
Chairman Bernanke. I understand.
Senator Brown. Thank you.
Chairman Dodd. Let me just say in that regard, Mr.
Chairman, before I turn to Senator Reed here, my hope would be
that you--and I am sure you will--keep us posted on the
progress of this. I had a chance to speak with the Chairman a
day or so ago about the very matter that Senator Brown has
raised here. My hope is that you would give us a commitment to
come back to the Committee once the regulation comes out to
discuss it with the Committee, we would have a strong interest.
I see your head nodding affirmatively.
Chairman Bernanke. Yes.
Chairman Dodd. I appreciate that response, as well. It will
give us a chance to move on this.
Senator Reed.
Senator Reed. Thank you, Mr. Chairman. And thank you,
Chairman Bernanke. I want to return to the topic that I
broached in my opening statement and Senator Shelby addressed.
And that is the issue of the valuation of CDOs. What you have
is an illiquid market, basically. There is a thinly traded,
very complex instruments, asset valuation is difficult to
determine. As a result, what we have is something described as
mark to ratings. Senator Shelby alluded to that.
How comfortable are you with this approach? What are you
doing specifically to engage the rating agencies to ensure that
they are, and the originators of these products are, valuing
their assets accurately?
As I pointed out in my opening statement, there seems to be
a growing wave and realization that these assets are
overvalued. Some people have suggested billions and billions of
dollars. What appears to be the motivating factor in the
workout of the Bear Stearns funds was the extreme reluctance to
try to have the market evaluate these assets and that would
cause a value of mark to market for everything else they held
and probably through the whole system. This is potentially a
very serious problem.
So specifically what are you doing with the rating agencies
and the originators of these products to make sure they are
valued effectively?
Chairman Bernanke. The Federal Reserve does not have any
specific powers or responsibilities regarding the rating
agencies themselves. What we are doing is working with our
banks that we supervise to ensure that they are safe and sound
and that they are doing due diligence in the types of assets
that they purchase or the types of assets they themselves
securitize and resell. So our perspective is protecting the
safety of the banking system. We do not have broader authority
to dictate how these assets are created.
Senator Reed. Should someone have the broader authority to
do that? I mean if we assume, as I think you perhaps might,
that the market will not evaluate these assets accurately
because they are so thinly traded, difficult to understand, it
falls upon a rating agency. And if the rating agency, if there
is no supervision, is there a gap?
Chairman Bernanke. No, I think the market will find
solutions. They already are finding some. For example, even if
the individual instruments are not particularly liquid, there
are indices that are based on the payments from CDOs or CLOs
which are traded and therefore give some sense of the market
valuation of these underlying assets.
So this is a market innovation. Sometimes there are bumps
associated with a market innovation. I think we just have to
sit and see how it works out. There are very strong incentives
in the market to change the structure of these instruments as
needed to make them attractive to investors.
Senator Reed. Let me change gears just slightly. You
alluded to it, not the CDOs but the CLOs, the collateralized
loan obligations, essentially derivatives of corporate debt.
There has been a lot of discussion that it is very easy now to
go out in this market and to prop up companies that do not have
the ability to borrow directly. And that the underwriting
standards have slipped a bit because the banks who typically do
the underwriting do not hold the product. They move them out
very quickly in these complex secondary markets.
First, can you comment on the underwriting standards for
the corporate borrowing? Are they loosening to a degree that
could--
Chairman Bernanke. Recently, I think they perhaps tightened
a bit, actually, because of some concerns that were initially
prompted by the subprime mortgage lending issues.
Again from the Federal Reserve's perspectives, our
principal concern is the safety and soundness of the banking
system. What we have done recently is work with other
regulators such as the SEC and the OCC and, in some cases also
with foreign regulators, the FSA in the United Kingdom for
example and German and Swiss regulators, to do what we call
horizontal reviews which is that collectively we look at the
practices of a large set of institutions, both commercial banks
and investment banks, to see how they are managing certain
types of activities. For example, the financing of leveraged
buyouts, abridged equity and the like. And trying to make an
evaluation of what are best practices, trying to give back
information back to the companies and trying to use those
reviews to inform our own supervision.
And so we are very aware of these issues from the
perspective of the risk-taking by large financial institutions
and we are studying them, trying to provide information to the
institutions themselves, and using them in our own supervisory
guidance.
Senator Reed. Are you confident that you can identify and
monitor these risks posed by CLOs? And in a related point, do
you anticipate seeing the same phenomena in the CLO market that
we have seen in the CDO market, a bump?
Chairman Bernanke. It is not our expertise to directly say
that this deal is a good deal and that deal is a bad deal. What
we try to do is make sure that the banks and the investment
banks themselves have good controls, have good models, have
good approaches, have good risk management so that they can
make what we believe to be, in general, appropriate decisions
about these instruments.
Senator Reed. Let me shift gears again, Mr. Chairman, to
try to cover a lot of ground. We have witnessed all a booming
housing market until very recently. As your predecessor,
Chairman Greenspan, opined in many homes their increasing
equity valuation was an ATM that they could go to without
leaving the house.
Current estimates are that equity withdrawals are down
precipitously, 70 percent from 2005. What is your view of the
macroeconomic effect as people can no longer essentially use
their equity as a quick source of cash?
Chairman Bernanke. Taking equity out of a home is one very
convenient and sometimes tax favored way of getting at your
assets essentially. That explains the tremendous increase in
that type of cash out refinancing and home equity loans.
Our sense though, and so far this seems to be borne out by
the data, is that consumers respond to changes in the value of
their home essentially because there is a change in their
wealth not because there is a change in their access to liquid
assets. So there is probably something on the order of between
four cents and nine cents on the dollar of an effect on
consumer spending when home values decline. So that is one of
the things we are looking at.
It should be pointed out that by, I think, the most
reliable indices that house prices nationally speaking have not
declined. They have only risen more slowly. So we have not yet
seen anything, except in a few local areas, akin to a decline
in house prices. So again, we have not seen a significant
effect on consumption. We are watching it carefully. Once
again, I think the so-called ``wealth effect,'' the effect that
the value of the home has on the consumer's overall wealth is
probably the principal relationship between house values and
consumer spending.
Senator Reed. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Reed.
As colleagues are coming in here, so my colleagues are
aware, Senator Bunning has arrived. We will then turn to
Senator Menendez, then Senator Allard. Senator Schumer has come
back and then Senator Carper and Senator Bayh have joined us,
as well. I thank you for being here.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
First of all, I would like to enter my opening statement
into the record.
Chairman Dodd. All statements, by the way, will be included
in the record and we will leave the record open for a day or so
for other questions.
Senator Bunning. I figured that.
I do not want to go over old business but I have to because
everybody looked at the past Fed Chairman and the past Fed's
oversight of the banking industry and what happened in the
subprime area. The banks all looked very good when you looked
at their bank statements. But what happened is that those
mortgages, ARMs, interest-only loans were sold off. And
therefore the bank statements all look clean.
But where we found we had a problem was that they were
overextended, a lot of people were overextended. Instead of
buying a $400,000 home it should have been a $200,000 home.
Instead of an interest-only loan, it should have been a 30-year
mortgage and on down on the line. That did not show up on the
Fed's record but I do not think the Fed went far enough.
Do you have the capability of going far enough now to see
what happens to the loan after the bank sells it off ?
Chairman Bernanke. Again, our interest in this particular
case is in bank safety and soundness. And the question: Is
there any recourse question? Does the bank have any
responsibility for that loan?
Senator Bunning. All of them had responsibility when they
were originally taken out.
Chairman Bernanke. There are two issues, Senator. One is
the consumer protection issue and one is the safety and
soundness issue. On safety and soundness, the question is does
the bank have financial responsibilities in case the loan goes
bad? In which case they should have capital against that. This
is an example of why Basel I does not adequately capture the
necessary----
Senator Bunning. That is why we did Basel II.
Chairman Bernanke. That is exactly right.
On the consumer side, the issue is where was the loan made?
In some cases, the bank simply bought up packaged loans that
were made somewhere else. And there part of the problem is that
it used to be that you could only get a loan at the bank or a
thrift. Now of course, there is a great diversity of lending
institutions and it is not entirely a level playing field in
terms of the oversight of their consumer protection.
Senator Bunning. Please get to my question.
Chairman Bernanke. I am sorry, what is the question?
Senator Bunning. The question is does the Fed now have the
ability to go beyond the original bank and find out what
happened to that loan when it went sour? In other words, if
they sold that loan off to a third party and now the people are
incapable of making the payments or it was an interest-only
loan or there was an ARM that popped up after 5 years.
Chairman Bernanke. We can follow where the bank initially
disposes of the loan. But if it goes through several steps,
then we can only make general estimates.
Senator Bunning. You do not figure that you have a
responsibility in that respect?
Chairman Bernanke. I do not think we have the authority.
Senator Bunning. You do not have the authority but how
about the responsibility?
Chairman Bernanke. Without authority, I cannot be
responsible, Senator.
Senator Bunning. Let me go back to inflation and interest
rates. In your statement you repeated a line from the June Fed
statement that says ``A sustained moderation in inflationary
pressure has yet to be convincingly demonstrated.'' Those are
quotes. What will it take for moderation to be convincingly
demonstrated?
Chairman Bernanke. Our objective is to achieve enduring
price stability and in particular we want to be sure that
inflation remains under good control in the medium run. There
are several elements of that. One is that I think it is
important to recognize that the month-to-month inflation
numbers are very noisy. And so a couple of good numbers does
not, by itself, mean that the problem is solved and gone away.
So part of it is just simply seeing more data and getting a
greater sense of assurance that the trend is really in the
direction we would like to see it.
The other is that as long as there are some very important
risks out there to inflation, there is the possibility of
inflation--even if it has come down some--there is the
possibility that it will go back up in the future. The risks
that I talked about in my testimony include high resource
utilization, the fact that the economy is working at a very
tight use of resources.
And second, the fact that energy and food prices have
raised headline inflation. Those prices might feed through into
core inflation, they might raise inflation expectations.
So what we need to see is enough confidence that the risks
have subsided so that we can feel confident that in the medium
term inflation will be well-controlled.
Senator Bunning. Last week, you gave a speech and spoke at
length about inflation expectations. You also said that
expectations are ``imperfectly anchored.'' What in the world
does ``imperfectly anchored'' mean?
Chairman Bernanke. Senator, it means that expectations as
measured through various means are not at a fixed number. That
is, if a piece of news comes in, about, say, employment that
long-term inflation expectations move. And what that means is
that although the confidence in the Federal Reserve to maintain
price stability----
Senator Bunning. Isn't that in your model when you are
looking at inflation, all the different things that you put in?
Chairman Bernanke. I am thinking now about the very long-
term. So if there was complete confidence--let me not
overstate. I think there is a great confidence in the Federal
Reserve that we will maintain low inflation in the long-term.
But if that confidence were complete then people would say oh,
this is a temporary movement in the economy but we know that in
the long-term inflation is going to go back to whatever is the
normal level. And there would not be much movement in these
longer-term inflation expectations when there was a short-term
development in the economy.
Senator Bunning. But that is exactly what you are trying to
do every time you meet, is to anticipate----
Chairman Bernanke. We are trying to anticipate it. But in
order to make sure that inflation in the long-term is very
stable. If people are saying oil prices have gone up, that not
only affects what we think inflation is going to do over the
next year but it affects what we think inflation is going to be
5 years from now. Then that leads to the possibility that they
do not have complete confidence that the Fed to bring inflation
back down to a stable level.
Again, let me not overstate this. I think that we have made
tremendous progress over the last 20 years or so in increasing
the confidence the public has in the Fed's ability to keep
inflation low and stable. I am only saying that there is still
some imperfect degree in terms of which those expectations are
completely tied down.
Senator Bunning. Mr. Chairman, we know we are not all
perfect and we know that the Fed does the best they can. We
appreciate your service and thank you for being here.
Chairman Bernanke. Thank you.
Chairman Dodd. Thank you, Senator.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, I appreciate the testimony you have
given on the subprime issue and the actions. But I am wondering
if the actions reflect the crisis at hand. I find it hard to
believe that months of hearings and reviews, a pilot project
that will not commence until the end of the year, and guidance
after guidance that seems to take only small steps, is a swift
enough response for a crisis that has led to over one million
foreclosures last year and ruined the American Dream of owning
a home for too many people in this country.
With all due respect, when, as part of that challenge, we
are talking about predatory lending, I am not convinced that
the proposals the Fed has put forward will be enough to stop
predatory lenders dead in their tracks.
I also hope that we have at least prospectively a better
monitoring system because it is my personal opinion that, in
many respects, the Fed was somewhat asleep at the switch, that
we could have been more proactive in this process. It seems to
me we are coming to the table with a plan after a tornado has
already ripped through a community.
So, I hope that the one message I think many of our
colleagues have for you and the Reserve is that you will be as
swift and use the powers that were given to you under the Home
Ownership and Equity Protection Act as vigorously as we would
like to see you use them. I hope that that is both your intent,
your mission, and in terms of timing within the context of
being judicious but not be judicious to the point that we err
on the side of being able to protect more people in this
country.
I would like to hear your response to that in a moment. Let
me get my second line of question and give you the balance of
the time to answer.
In my mind, I always ask who is this economy working for?
Is inflation tame or is it still a significant problem? I guess
that depends upon where you sit. Consumer prices rose at a
moderate rate in June with a key factor keeping things under
control is collapsing clothing costs. They have dropped for the
past 4 months. But after energy, clothing is probably about the
next most volatile component in the Consumer Price Index. So, I
would not be surprised if sometime soon we see a major increase
in prices in that regard.
In addition, we already know that the pullback in gasoline
prices in June has been unwound so energy will be adding
greatly to consumer woes in July. And then there is food. As
you mentioned yourself, prices jumped again and since June 2006
food and beverage costs have risen by 4 percent.
With that, with the ethanol issues that are spiraling
through food costs, I do not know that we can be looking for
relief anytime soon, at least if you are looking at it from the
context of the consumer. It seems to me that pain for the
consumer is still there.
When I look at household debt in America that has risen to
record levels over the past 5 years. In the first quarter of
2007, household debt relative to disposable income stood at
130.7 percent. That is the third highest ratio on record. That
means the average family in America is in debt for over $130
for every $100 it has to spend. Compounding this, the average
household savings rate has actually been negative for the past
seven quarters, averaging a negative 1 percent for 2006.
One last measurement, one measure of this economic
insecurity that I hear New Jerseyans talk to me about, that I
hear other Americans talk about, is the percentage of middle-
class families who have at least 3 months of their salary in
savings. That percentage of middle-class families who had three
or more months salary in savings rose over 72 percent from 16.7
percent in 1992 to 28 percent in 2001. But unfortunately, in
the span of less than 4 years that percentage has dropped to
18.3 percent in 2004.
So, I am looking at this and I am saying to myself so you
have rising food costs, you have rising energy costs, rising
health costs. You have stagnant median income for the last 5
years for families in this country. You have more debt, the
third-highest ratio on record, and you have less families in
quite some time that have 3 months and savings or more. Who is
this economy working for? And is inflation tame or is it still
a significant problem?
Chairman Bernanke. Senator, you asked a lot of questions.
Senator Menendez. I have given you a lot of time. I have
not even used all my time. You can take that and plus the rest
of what is necessary to answer.
Chairman Bernanke. First, on the subprime rules, as I said,
I asked for a top to bottom review. We looked at every possible
power that we have. We have examined each one. We have had a
lot of input, a lot of hearings, and we are moving forward. We
will move as expeditiously as the process allows, making sure,
of course, that we do a good job. But we will move forward as
expeditiously as possible to try to address these issues.
With respect to inflation, I agree in the sense that
certainly over 2007 food and energy prices have risen
significantly so that the overall inflation rate is higher than
we would like it to be. Our concern is that high food and
energy prices might somehow infect the underlying trend of
inflation, for example causing people's expectations--this is
Senator Bunning's question--to rise and become less persuaded
that inflation will be stable in the long-run. Therefore, that
is part of the reason why we continue to treat inflation as our
predominant policy concern.
With respect to the household financial situation, it is a
complicated story. Part of the reason that official saving
rates for households are negative as that those saving rates do
not include any capital gains in assets that households may
own. So in some cases, people have had their homes appreciated,
as happened over the last 5 years until recently and they took
money out, the money they took out would count as spending but
the appreciation in their home would not count the saving.
So that has been part of the reason that saving has been so
low, that people have seen increases until recently in their
home equity. As that situation flattens out----
Senator Menendez. But if they took their savings on their
appreciation, the only way to do that would be to sell and/or
accrue debt?
Chairman Bernanke. No, they can make use of some of their
capital gains by home equity loans or refinancing.
Senator Menendez. But that would be accruing debt.
Chairman Bernanke. I am sorry?
Senator Menendez. If you take a loan out in order to get to
your accrued appreciation, now you are going into debt to do
that.
Chairman Bernanke. But if I have $1,000 appreciation and I
take out $500 in debt, I have increased my debt by $500 but I
am still, on net, $500 better off than when I started.
Now having said all that, let me just say that I agree with
you on the issue of consumers needing to build wealth and
assets. The Federal Reserve manages the Survey of Consumer
Finances, which is the best available source for family asset
building, information about family asset holdings. The fact is
that the bottom third of our population has almost no savings,
maybe less than $500. And I think that is a very serious
problem. We need to find ways to make people more cognizant of
the need to save, to help them to save, so that they can build
wealth and that they will have more security in case they have,
for example, an illness or an unemployment spell.
So your general point that there are many families that do
not have adequate wealth reserve, I think is entirely correct.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Correct me if I am wrong, Mr. Chairman, but the numbers I
have used, what I am told is that the average household has
revolving debt in excess of $9,000, most of that being credit
card debt. Just to make the point that Senator Menendez is
talking about, and a negative savings rate. These are very
disturbing statistics, if in fact those numbers increase like
that. That is just unacceptable, I think.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman.
I have an opening statement I would like to have put in the
record, if you would, please.
Chairman Dodd. All opening statements will be put in the
record.
Senator Allard. Thank you very much.
I want to talk about a little bit about stock market and
some of the things that are going on there and how you view
those. You have been getting a lot of articles written about
hedge funds and private refunds and the like. Are they of much
concern as far as the Fed is concerned?
Chairman Bernanke. Hedge funds and private equity funds and
other private pools of capital provide some very important
beneficial services to the U.S. economy. They represent a way
to share risks more broadly. Instead of all the risk sitting in
the banking system, it can be spread through a whole different
set of institutions. They provide a lot of liquidity in
financial markets. It is easier to buy and sell when the hedge
funds are taking part in market activity.
And one other particular area where private equity is
valuable, it is important for our economy to have an active
market for corporate control. That is we need to have some way
of putting pressure on poorly managed companies or poor
management that will create some discipline and improve our
economic performance.
We had LBOs in the 1980s. Private equity is the current
manifestation of that. Not all private equity deals are
beneficial and not all of them work out well, but we do need to
have a mechanism that strengthens the efficiency of our
corporate sector.
Now are there concerns? There are some concerns. Hedge
funds in private equity are relatively opaque in terms of
seeing what their assets are. And they vary considerably in the
types of investments that they make.
Recently, the President's Working Group issued a set of
principles which argue that the best way to control the risk of
hedge funds and other private pools of capital is through
market discipline, by which we mean that the first line of
defense should be the investors, the counterparties, the
creditors, those people in the market who have the most to lose
if a hedge fund goes bust, for example.
The role of the supervisors is to make sure that banks and
other counterparties are, in fact, getting the information they
need, managing the risk in the way they need to so that should
there be any problems in a hedge fund that it does not spread
more broadly probably in the financial system.
So, I think that is the best way to manage the risks in
those pools of capital.
Senator Allard. Now has Sarbanes-Oxley contributed to the
growth of the hedge funds, in your view?
Chairman Bernanke. If you are referring to the private
equity in particular, taking firms private, there is some
disagreement about that. I think I would point out that private
equity is also a very big thing in the UK, as well, where
Sarbanes-Oxley is obviously not relevant. So, I do not think it
is the principal explanation.
I think that what is happening is that financing is
available and there are these firms that feel that they can
essentially do a better job of running certain corporations
than the existing management is.
Senator Allard. If taxes were applied to these equity funds
and these hedge funds, would that have an adverse impact on our
economy?
Chairman Bernanke. I do not want to take a position on
particular tax rules. I think I would just point out that hedge
funds have a lot of international flexibility. They can move
around. And even if they are based in another place they can
still operate with U.S. corporations. And so I think there is a
lot of international mobility, so to speak, in these
institutions.
Senator Allard. This leads me to the next question. We have
these sovereign wealth funds, apparently.
Chairman Bernanke. Yes.
Senator Allard. They are Government Sponsored Entities and
apparently they are pretty flush with cash right now. How do
you view them as impacting our economy and our risk in the
securities?
Chairman Bernanke. I have talked about in the past what I
called the global saving glut, which is basically the idea that
outside the United States there is a huge amount of funds
looking for returns. That includes reserves of China and other
countries that have accumulated lots of reserves. But it also
includes the profits from oil and commodity sales. And that is
a lot of where the sovereign wealth funds are based on revenues
from, say, oil sales. So a lot of that capital is looking for
return, is looking for a home, and a lot of it is flowing into
the United States.
On net, I think that is beneficial because it provides
capital for our economy. It does drive real interest rates
probably lower than they might otherwise be.
In terms of risk taking, the sovereign wealth funds, for
the most part, are pretty passive investors. They are not
active in switching between types of assets. They may sometimes
have components which are more return-seeking, such as the
Chinese, for example, have a component of their reserves fund
that is more return-seeking. But for the most part they are
pretty passive suppliers of capital.
Senator Allard. They are going after security more than
anything; is that right?
Chairman Bernanke. They are looking for return and, in
particular, some of them--the purpose of sovereign wealth
funds, in many cases, is to take the current windfall and to
make sure it is available for future generations. So for
example, Norway is taking its oil profits, putting them into
this fund in order to help fund the retirement pensions of its
citizens. For that purpose, it needs to have long-term safe
assets. And that is the kind of investment that they tend to
make.
Senator Allard. Do you feel the free trade agreement
between the United States and South Korea is having a positive
or negative impact on our economy?
Chairman Bernanke. I am not conversant with any specific
elements of that particular agreement, but in general, as most
economists do, I think that opening the economy to trade is
beneficial. It creates new opportunities for trade in both good
and services as well as opportunities for investment. So as a
general matter, I think that we should continue to keep our
economy open both to trade and to investment, keeping in mind
that trade and investment--international trade and investment
sometimes do create dislocations in the economy and we should
be prepared to address those, as well.
But overall, I believe that open economies are more
prosperous and would therefore support, in general, free trade
type agreements.
Senator Allard. Mr. Chairman, I see my time has expired.
Chairman Dodd. Thank you. Senator Schumer.
Senator Schumer. Thank you. Thank you always, Mr. Chairman.
I would like to return to the issue of carried interest and
partnerships, as well. I know you will not take a public
position on any of these but I have two questions.
First is the breadth of what we do. In other words, some
have said we should look at them for hedge funds and for
private equity funds. But there is carried interest and
publicly PTP's in other areas, oil and gas, venture capital,
real estate. Does it make any economic sense to treat one of
these industries differently than the other when the broad
concept of either carried interest or taxing corporate
partnerships who go corporate basically extends through all of
them? Some have talked about singling out financial services
and obviously I am very concerned about that.
Chairman Bernanke. Senator, as you point out, there are two
different issues.
Senator Schumer. Yes, they are separate issues.
Chairman Bernanke. All else equal, I think consistent
treatment under the tax code is a good approach.
The carried interest turns, as you know, on how to divide
the returns to hedge fund managers between compensation for
services and capital gains. And there are a lot of technical
issues there. I think the Treasury or the IRS might be better
at figuring out the details of that.
With respect to partnerships, the issue is whether or not
the income can flow through directly to the partners. And the
rule is that as long as more than 90 percent of the income is
``passive'' that it should. And so I think I see the argument
for making the treatment uniform among partnerships. I think
the question is defining what is passive and making sure we are
comfortable with that definition.
Senator Schumer. That would apply to any industry, whether
it is oil and gas, venture capital, real estate, or financial
services.
Chairman Bernanke. Yes.
Senator Schumer. So all things being equal, you should
treat them all the same.
Chairman Bernanke. If the underlying economic principles
are the same and economic sources of income are comparable,
then that is what is called horizontal equity, treating likes
in the same way.
Senator Schumer. Exactly.
The second question I had is the proposals to treat carried
interest differently in terms of tax treatment, the same with
publicly traded partnerships. You know they are out there. And
there are arguments on both sides. Obviously someone from New
York, but someone who believes our Government has to raise
revenues and the highest income people are the appropriate
place to raise those revenues--those are my beliefs, I know
they are not necessarily yours. It is the very tough issue.
One of the things that greatly concerns me is if we were to
raise taxes in both of these ways, would there be a danger that
America would decline on a percentage basis, on a general
basis, as a financial center? Obviously, that would affect New
York dramatically and would be of great concern to me.
Now is that a worry on either of these two issues?
Chairman Bernanke. On the case of carried interest, it
might not affect their activities. But it might affect the
location of their activities.
Senator Schumer. Yes. That is what I am worried about. If
they all move to London or the Cayman Islands, I do care about
that, for some strange reason.
Chairman Bernanke. If they are looking for the lowest tax
regime, that might be an effect. As I mentioned to Senator
Allard, if the company moves to London they still could
potentially be involved in U.S. investments.
Senator Schumer. No question. But that jobs would be in
London.
Chairman Bernanke. But the individuals might choose to move
elsewhere.
Senator Schumer. So it is something to keep an eye on and
worry about, in your opinion.
Chairman Bernanke. It is a consideration. As you pointed
out initially, I am not taking a position on this.
Senator Schumer. I understand. I am just asking your
economic views of these things and I appreciate it.
Next, I would like to go to subprimes. Basically, you
mentioned today that direct Federal legislation would help
speed up the Fed's efforts to fix the problems in the subprime
industry. As you know, Senators Brown, Casey, and I have
introduced proposed legislation that would specifically
regulate the mortgage broker industry. Our bill would establish
a fiduciary duty and good faith stands for mortgage brokers and
other nonbank originators and require originators to underwrite
loans at the fully indexed rate, prohibit steering, among other
things.
First, could you give us your thoughts--I am not asking you
to endorse the specific bill--but on those concepts and whether
it makes sense? And are these types of proposals some that
would help the Fed's efforts to regulate the subprime mortgage
broker industry?
Chairman Bernanke. There is a whole set of diverse
initiatives that you are referring to.
Senator Schumer. Can you comment on each of them or any of
them?
Chairman Bernanke. I will try. One issue, as you know, as
we discussed earlier, is trying to make sure there is an even
playing field in terms of enforcement and oversight. One
suggestion that has been made is for more cooperation between
Federal and State authorities, for example, through to a
Federal registry or some Federal licensing.
The Federal Reserve, as I mentioned, is also trying to
increase our cooperation with the State authorities. And so
there are different ways to approach that issue. That is
certainly one thing that I think is very important to increase
that coordination and cooperation if possible.
Senator Schumer. But if the State resists you, there is not
too much you can do.
Chairman Bernanke. We have backup Federal authority in FTC,
which is another possible vehicle.
Senator Schumer. They have not been a tiger on----
Chairman Bernanke. As well as the U.S. Attorneys General
would also have some authority in those----
Senator Schumer. What do you think of legislation that
would require this at a Federal level?
Chairman Bernanke. Require which?
Senator Schumer. Require, say, regulation of mortgage
brokers in certain ways so that there is a suitability rule.
Chairman Bernanke. In terms of the uniform authority, I
think one very important question to answer is if you are not
going to let the States be the primary regulators, what would
be the substitute? How would you propose to do that?
Again, I think at this point my preferred approach would be
to work with the States because many of the States are, in
fact, very effective.
Senator Schumer. I am a little confused here. I thought
earlier, in reference to Senator Brown's questions, you said
that Federal legislation would help speed up the Fed's efforts
to fix those problems?
Chairman Bernanke. I was referring there to the HOEPA rules
that we are considering and the other things that we are doing
under our regulatory authority. We have certain procedures we
have to follow in terms of putting out proposed rules and
taking comments and the like. And I was only commenting that
while we would move as expeditiously as possible, if Congress
wanted to move more quickly, of course, legislation can
override those procedural steps.
Senator Schumer. But much of your authority here is not--
you cannot force it to happen basically if you have reluctant
parties that you are trying to exert pressure on; is that
correct?
Chairman Bernanke. Our HOEPA authority applies to all
lenders. We can set rules for all lenders but we do not have
the enforcement authority outside of the banks. So finding ways
to have better cooperation between the Federal and State
authorities, I think, is a useful direction.
Another thing you have mentioned I know, and we have
discussed this before, is counseling. I think that the Federal
Reserve itself, the Reserve Banks around the country, are
partnering with nonprofit agencies that do counseling. I,
myself, have visited with some nonprofits that do counseling.
It is not a panacea, in part because not all counselors are
effective and so on. But it can be helpful and it is something
to be kept in mind.
With respect to suitability, this is, I think, a very tough
issue. It has to be done in a way that will not essentially
drive away interest in this market. One way of thinking about
suitability--let me take a step back.
If you think of suitability as requiring the lender to pick
the very best of the dozens of products available for the
borrower, that may be setting a standard which is not actually
viable. Perhaps another way of thinking about it is equating
suitability with affordability.
Senator Schumer. That is what we do.
Chairman Bernanke. And essentially saying that there is
some presumption that the lender will appropriately take into
account ability to pay in making the loan. And that itself
turns to some of the things that we are trying to think about
under our HOEPA authority, which is whether or how to require
underwriting to the fully indexed rate and how or whether to
require more documentation than is currently required about
ability to pay, for example, and what standards one might set
in terms of linking ability to pay to the monthly payment. So
those are some of the issues.
Senator Schumer. So we are somewhat on the same page on
some of these things.
Thank you, Chairman Bernanke.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Schumer.
Let me thank Senator Schumer for his comments on the issue
of these matters affecting the carried interest and other
issues. As Chairman of the Committee, I share some of his
concerns about that, in terms of there being an equitable
application of these issues here, and that we understand the
full implications of what may be occurring here. You have
raised them very, very well. And I think it is something the
entire Committee would want to express an interest in.
So as we look at these issues here we may, at some point,
Mr. Chairman, want to ask you to participate and ask you--I
realize it is a bit--and you point out that the IRS and
Treasury may be a more appropriate place to look but obviously
your expertise and thoughts on this could be helpful as well,
as we consider the implications of all of this.
But I thank Senator Schumer for his points.
Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman.
Chairman Bernanke, welcome.
I have two issues I want to pursue with you and get your
thoughts on, but I want to make just an observation prior.
I have been on this Committee now for over a dozen years.
And we see the pressure going one way and then the other.
First, the requirement on or the desire on the part of Members
of this Committee to make capital available to the people that
are poor. We have to do everything we can to make capital
available to them and push in the direction. No, you are
holding capital just for the rich. You have to make it
available to the poor.
Then when we get into the subprime problem, I understand,
at least on the House side, there is legislation to hold the
lender responsible for the fact that they pushed money at
people who could not afford to pay it. And now that the homes
are being foreclosed on it is the lender's fault and we have to
punish the lender for making the capital available in the first
place.
It is an interesting pendulum to watch it swing back and
forth in this debate. I hope we do not end up saying to the
counselor, the counselor is liable if the counselor said you
should make this deal rather than that deal and then the
counselor has to pay the damages if, in fact, there is a
problem and the people cannot pay their mortgage.
The two issues I want to talk to you about are labor and
housing. In my home State of Utah, the unemployment rate is
two-point-something percent and the something does not really
matter. When you get down that low it is a very, very serious
problem. We have a labor shortage.
Nationwide the unemployment rate is at levels approaching
historic lows. I would like your reaction to that problem and
what it might do with respect to inflation. Your predecessor,
Chairman Greenspan, talked about tight labor markets and the
impact of that on inflation.
Productivity is going up so we have to have a different
historic benchmark on unemployment figures. I was taught in
college that 6 percent was full employment, that you got below
6 percent and you were facing serious inflationary pressures.
Interestingly enough, at the height of the last recession the
unemployment was in the 6 percent range. And now we are at 4
percent or something. So, I would like your comment on that.
And then on housing, the housing bubble has the potential,
in my view, of triggering an economic downturn just as the dot-
com bubble that we were all excited about and thrilled about in
the late 1990s triggered the recession that began in 2000 as
that bubble started to burst. Everyone was delighted to see his
house value go up, particularly if he did not have to buy a new
one. And you referred to the number of people who took home
equity loans and went out and went on a spending binge. Now the
housing prices have flattened, if not fallen, in many areas.
There has to be a shakeout just as there was a shakeout from
the dot-com bubble there has to be a shakeout from the housing
bubble.
Look into your crystal ball and see if it is, in fact,
going to create an economic downturn? If so, any ideas as to
how severe or when?
I know you do not make those specific prophecies and I am
not asking you to. But just in a general term what you might
see as the housing shakeout works its way through the economy.
If you could address those two, I would appreciate it.
Chairman Bernanke. Certainly Senator.
Just one word on your initial comment. I agree with you
that legitimate subprime lending is beneficial. It gives people
access to homeownership and access to credit.
So the real trick for us is to write rules, to write
regulations that will screen out the abusive practices and the
improper practices while preserving this market. I think that
is a very challenging task.
Senator Bennett. If I just might, a witness in a previous
hearing said not all predatory lending is subprime.
Chairman Bernanke. That is correct.
Senator Bennett. And not all subprime lending is predatory.
Chairman Bernanke. I agree entirely.
On labor shortages, there is, I think, a very strong demand
in this country for skilled workers. In particular, we hear
from our contacts around the country how difficult it is to
find people, not just Ph.D.'s, but people who are familiar with
plumbing and welding and other kinds of what we used to think
of and still think of as blue-collar type occupations. And so I
think there is an enormous opportunity here, if we can help
people acquire those skills, to help them obviously but also to
lower the unemployment rate that the economy can sustain
because we will change unskilled workers into people who can
fill these spots. I think that is very important.
With respect to the effect on inflation, the way I think
about this is that the economy at a given time has a certain
amount of normal potential output. If the Fed is too easy or
other factors lead to increased aggregate demand, and that
demand is exceeding the supply essentially, then you can get
inflation pressures. And so the challenge for the Fed is always
to balance supply and demand, to think about whether or not the
level of demand that we are generating with our interest rate
policies and with other policies, Government policies for
example, is consistent with the underlying supply.
It is not so much that a given level of employment is per
se inflationary. But if the economy is overheating, one might
see a temporary dip in unemployment reflecting the extra
resource utilization associated with it.
So we do not have a magic unemployment rate that we look
at, say, that is too low or too high. What we try to do is look
at the whole economy, look for sources of price pressure. Are
firms finding it easy to raise prices? Are there indications
that markets are very tight, both at the labor level and the
product level? And we try to make a judgment about the balances
of supply and demand and that helps to govern our thinking
about this.
The labor market, you mentioned 6 percent. The labor market
changes a lot over time in terms of demographics, in terms of
skills and education, in terms of job finding through the
Internet and so on. And so that number is not a fixed number.
We always have to think about how it might be changing over
time.
With respect to housing, I talked about that quite a little
bit in my testimony. There is, at this point, a pretty
substantial overhang of unsold new homes. So even if demand
stabilizes, as we think it will soon, there is going to be a
period of weakness as builders work down those inventories and
reduce their construction.
Housing has been subtracting from GDP growth over the last
year about a percentage point. If demand stabilizes and
builders begin to work down those inventories, we think that
the drag, while still negative, will begin to diminish over
time. And so that effect will begin to moderate.
In the testimony we do mention housing as a downside risk.
It is, of course, possible that declining housing values will
cause consumers to spend less. It is possible that it might
lead to fewer construction jobs. That might also have effects
on the economy.
But to this point we have not seen significant spillovers
from the housing sector into other parts of the economy. Most
of the rest of the economy is functioning at a pretty strong
level. But that is obviously something we are very alert to,
the possibility that the housing slowdown might have
implications for other parts of the economy.
Chairman Dodd. Thank you very much.
Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Chairman Dodd. And thank you,
Chairman Bernanke, for your presence here today and for your
service.
I, too, have a keen interest in some of the issues that
have been raised today, particularly the currency valuation
issue in China, which tends to have an impact on our
manufacturing sector, which is concentrated in the Midwest. And
also in the housing issue, which is having a tremendous impact
on my home State right now. But I think that territory has been
pretty thoroughly covered here today, so I will perhaps focus
on some other things but I did not want anyone to think that my
lack of questioning in those areas evinced any disinterest.
This is, of course, the beginning or we are well into a
political season and I do expect you to answer any political
questions. But they are going to be a number of issues debated
over the next year that are going have a pretty profound impact
on the course of the American economic and financial policy.
So, in general terms, I would like to raise a couple of those
and get your take on them if that is OK.
Our economy has done pretty well over the last decade or
two, in terms of the macro level of growth. But there is a
growing belief that the benefits of that growth have been
disproportionately concentrated in the hands of the top 1
percent or so of the American people. There is at least one
candidate who points out that about 50 percent of the wealth
generated over the last couple of decades has gone to the top 1
percent in our country.
So my question to you is are there things that can be done
to try and more equitably distribute the fruits of the growth
that our economy has been generating into the hands of the
middle class in this country?
Chairman Bernanke. Senator, this is a very hard problem
because it touches on almost all the other problems that we
address as a country. I think you could break down the lack of
progress of the middle class, if you like, into several
different factors. One is this very long-term movement toward
inequality and wages which has arisen partly because of
technological change which favors higher skilled workers, to a
lesser extent because of globalization. That is a long-term
trend that has been going on for 30 years. That is one factor.
A second factor which I think is probably temporary and I
am not sure what can be done about it in any case, is that over
the last few years profits have been very high and so there has
been somewhat of a shift between capital and labor income. In
the past, those things have corrected themselves. I am not sure
that is a policy issue at this point.
A third factor is the cost of energy and the cost of health
care which----
Senator Bayh. Can I interrupt you for just a minute, Mr.
Chairman.
Chairman Bernanke. Sure.
Senator Bayh. So you say in the past that the rewards to
capital versus labor has tended to correct itself. If we are
living in an era of more rapid rates of innovation, might that
not lead it to correct perhaps not quite as quickly as in the
past?
Chairman Bernanke. We, of course, had many areas of rapid
innovation in the past and it is just one of the long-standing
economic irregularities that the share of capital and labor
tends to stabilize over time. We saw in the 1990s, for example,
that capital went ahead of labor for a while during the
productivity boom and then labor began to catch up again.
So, I do think that we will see a more normal----
Senator Bayh. I do not want to use all my time on this
question and I apologize for interrupting. We are not for
redistributing wealth overtly. But to judge at least by the
first part of your answer, if the economy is rewarding more
highly skilled parts of the labor force better, then perhaps a
focus on education, access to college, and those kind of things
might empower the middle class to enjoy a larger share of the
wealth.
Chairman Bernanke. I agree entirely. The way I was trying
to answer your question was here are some of the major things
that are explaining and they all tie into these major issues,
particularly this inequality. I do believe that education, in a
very broad sense--not just K-12 and college--but on-the-job
training, vocational schools, technical schools, junior
colleges, community college, a whole variety of mechanisms can
be used to give people higher skills to meet the kind of demand
for workers that Senator Bennett was asking me about.
I think that is a very important part of trying to reverse
this increasing inequality in wages. But there are some things
like energy policy and health care policy that the cost of
those things have subtracted from the gains that families
otherwise would have enjoyed. Those, themselves, are very
important issues.
The other thing I would mention is that there is a
perception of greater economic insecurity, not just the level
of income but that your tenure is not as long in a particular
job, for example. There is some evidence of that. I would have
to say it is not overwhelming evidence but there is some
evidence that people spend a somewhat shorter period of time at
a given job. Some have argued there is a little bit more
volatility of income year-to-year than there was in the past.
Part of the response of the political system to the public
to try and reassure them about these huge forces of
globalization and technology which are taking place is steps to
try to increase or reduce the feeling of insecurity. Ways to do
that include, for example, trying to make health care and
pension more portable between jobs so people do not feel that
if they lose their job they lose everything. There might also
be more creative ways to structure unemployment insurance to
help people move from one job to another, to acquire necessary
training, and so on.
So there are a lot of creative policies out there that
could be considered. But I guess my bottom line is that this
issue of income stagnation is really a multifaceted thing. It
ties into almost all of these other big issues. And so a single
magic bullet is probably not there. You have to address the
different components of it.
Senator Bayh. Let me ask you about another component. As
you are aware, we continue to face some deficits with the aging
of the population, particularly on the health care side, that
is going to exacerbate it. We will have to deal with that from
the spending point of view. Perhaps there are revenue issues
that come into that, as well.
One of the issues that will be debated over the course of
the next year and several months is going to be tax policy. So
in my remaining 37 seconds, I will try to pose two questions to
you and I hope you will address them both.
How would you explain to an audience of middle-class
Americans that is experiencing the economic anxiety that you
just mentioned, that we tax income up to a marginal rate of 35
percent but capital gains and dividends at a 15 percent rate?
How would you explain to them that that is an equitable tax
policy? That is number one.
Number two, there are some proposals out there to focus on
the top 1 percent or so as a way to reduce the deficit, or to
fund education initiatives that you just pointed out are
important, or health care initiatives, that thing. Some people
argue that that will have a drag effect on the economy.
I think that argument was made back in 1993, the last time
rates were raised in the top brackets. In fact, the economy did
very well.
So if you could address how do you explain to middle
Americans the disparity between how we tax income versus
capital gains and dividends on the one hand? And second, what
would the likely effect on the economy be of looking at the top
1 percent, given the history in 1993 and the effect or lack
thereof that that had at that point in time?
Chairman Bernanke. Senator Bayh, I hope you can appreciate
my position as the head of the nonpartisan central bank that I
do not want to take----
Senator Bayh. I am asking in a purely theoretical context,
Mr. Chairman.
Chairman Bernanke. A theoretical question. I will make a
couple responses.
One, the tax code overall, the general progressivity of the
tax code has not changed radically. On the one hand, you
mentioned 35 percent. At one point, of course, the top marginal
rate was 28 percent 20 years ago. We have also seen a lot of
credits for--so forth and so on.
Senator Bayh. Here is what we have going on. Forgive me for
interrupting your thoughts.
That is all true. We now tax capital gains and dividends at
15. As you pointed out, given the trend in the economy, it
skewed the returns toward capital a little more than labor. And
yet there is the difference in the tax rates, even though on
labor it was much higher in the past at the top marginal rate.
Chairman Bernanke. To answer your question, what a defender
would say is that there are both equity and efficiency
arguments for differential taxation. The equity argument is
much capital income is also taxed, for example, at the level of
the corporation. The efficiency argument is that in order to
promote saving and risk-taking and investment it is better to
put a lower tax on capital income.
And then your concern about the differential between labor
income and capital income is an argument that would be made on
the other side. So it is a very long-standing debate in
economics.
Senator Bayh. And about the likely grow effect of changing
the marginal rate on the top 1 percent, given the experience
after 1993, the last time that was done?
Chairman Bernanke. After 1993 there was a lot of things
happening besides changes in fiscal policy.
Senator Bayh. There always are.
Chairman Bernanke. Let me say something which I think is
objective or at least as objective as can be, is that the
studies that have been done of the revenue benefits of the very
top rate suggest the revenues are pretty small from doing that.
So if you want to have a substantial revenue impact, you
would probably have to go down somewhat further than 1 percent.
So there really is a question of trading off the revenue versus
whatever efficiency benefits might be involved.
I cannot give you a precise estimate of what----
Senator Bayh. On the marginal effect on growth.
Chairman Bernanke. --the marginal impact. I do believe as a
general matter that there is some trade-off. As you raise
marginal tax rates, you do tend to get a less efficient
economy. But the exact trade-off, economists have not really
pinpointed it precisely.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
I do not know if I heard you, in response to Senator Bayh's
excellent questions, mention the statistics you cited that have
been highly quoted now and frequently quoted in your Omaha,
Nebraska, speech back earlier this year, something that I have
repeated over and over again to people, and that is the
declining number of union households in the country as also
being a major factor in what has happened in income disparity.
I thought it was very interesting statistics, just looking
at the data at what had happened. And of course, knowing that a
lot of those gains that the middle-class acquired were not
necessarily given out freely but negotiated rather extensively
and intensively to produce the incomes, the working conditions,
the hours, and so forth that raised those levels so that people
moved into that income category that allowed them to purchase
and to do the other things that middle-income people have
historically done.
You may have mentioned that and, if you did, I may have
missed it. But I thought it was a very worthwhile observation
you made, among others, as to what had happened over this gap
that has grown now 82 years. Great questions.
Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thanks, Mr. Chairman.
Chairman Bernanke, welcome. It is good to see you again.
Thank your coming and joining us today, and for your service.
Others have asked about the subprime mortgage market. I
want to just touch briefly on that as we start out here.
Yesterday, we tried to have a hearing in this same room on
FHA reauthorization. In my opening statement yesterday, I
mentioned that if you look at the increase in the subprime
mortgage market it really mirrors the decrease of FHA's market
presence for subprime lending.
The Administration has come to us with the recommendation,
a series of recommendations, on how to change things in the FHA
program. I just wanted to ask if you have any thoughts on what
might be an appropriate course for us?
Chairman Bernanke. The FHA's market share is declining
quite radically, as I am sure you know, down to about 3
percent.
Senator Carper. Actually, I think they reported it about 6,
down from about 14 to 6 just in the last couple of years or
something like that.
Chairman Bernanke. So there is clearly less reliance on the
FHA than in the past. My sense is that part of the problem is
lack of flexibility, costs of dealing with the FHA, lack of
diversity of products and so on. So, I think that modernizing
the FHA and trying to make it more responsive, easier for
ultimate lenders to work with and so on, might reverse this
trend and might give the FHA a larger share in the market which
could be a positive thing.
I guess I would point out that the FHA, if I remember
correctly, still has a fairly high delinquency and default rate
and it has not solved the problem of delinquencies and so on.
And so as those changes get made, I would suggest moving
with some caution to make sure that we do not create yet
another source of problems in terms of inappropriate loans for
specific borrowers.
So, I do see a case for trying to make the FHA more modern
and to expand its role. But I would urge some caution and go
slow on that.
Senator Carper. Thank you.
When you were before us, I believe a year or so ago, I
raised the issue of concern expressed by domestic auto
manufacturers with regards to alleged manipulation of currency
by not China but by the Japanese. I think you indicated in your
response that as far as we can tell, at least since the earlier
part of this decade, the Japanese have not been manipulating
their currency.
Since that time we have had a huge debate here in the U.S.
Senate about whether or not we should raise fuel efficiency
requirements for cars, trucks, and vans built in this country,
to do that over the next 13 years or so. The domestic auto
industry has come back to us and said please do not raise CAFE
standards dramatically. If you do, you will push us closer to
being out of business.
They said do something about the Japanese currency
manipulation. They said do something about our legacy costs,
particularly health costs for employees and for pensioners. And
they call on us to provide some Federal investments in plants,
in their plans to enable them to move toward flexible
manufacturing where they would make more than just one or two
products in a plant.
I am not going to ask you to comment on all of those but I
would be interested in your thoughts again on alleged
manipulation by the Japanese of their currency. A year ago you
suggested that it had not been done for several years, and I
just wanted to ask your views on that today.
Chairman Bernanke. There has not been any changes to my
knowledge. The last time that the Japanese intervened was in--
as far as we know, was in March 2004 and there has not been a
subsequent intervention since then. The yen has been quite weak
reflecting in large part the fact that interest rates in Japan
are quite low, which in turn reflects the policies of the Bank
of Japan in the face of still very low, near deflation,
inflation rates.
I view the end as being essentially a market determined
exchange rate and I think that market determined rates are the
way to go. And so I would not advocate any particular policy
changes with respect to Japan.
Senator Carper. Thank you.
Are you alarmed at all by our growing reliance on foreign
oil?
Chairman Bernanke. It is certainly an issue. We now import
about two-thirds of our oil. We are very heavily reliant on
oil. It would be very desirable for us to have a more
diversified energy portfolio. I think there are ways to do
that.
As a very basic approach, I could suggest three things. One
is that the Government has a very substantial role and has been
very effective in the past in promoting or doing basic
research, developing alternative technologies either in terms
of conservation or new energy sources.
A second issue is what I guess I would call regulatory
certainty. We do not get new refineries, we do not get nuclear
plants, not so much because the regulations per se are so
onerous but because between the uncertainty of how they will be
applied and legal suits and so on nobody wants to undertake a
new investment.
So it is fine to have strong regulations to protect the
environment and achieve other social goals but it would be
productive to have a system whereby people who want to make
investments in alternative energy forms or refineries, et
cetera, would know in advance what they have to do in order to
meet the regulatory requirements.
The third thing I would say is that although the high
energy prices and high oil prices we are seeing right now, of
course are very painful, and I do not want to downplay that in
any way, they do have at least the benefit that they make a lot
of other alternatives potentially economically viable. With
regulatory certainty and basic research, among other things,
that market I think can begin to deliver some alternatives.
We do have to address issues related to the environment and
global warming and the like. But I think there are really a
large number of possible alternatives and we should let the
economy explore those.
Senator Carper. Thank you. Those are excellent points.
The last question. In the past you have been vocal in your
support for reforming our Government Sponsored Enterprises, at
least the regulation of those. I think you actually gave a
speech back in March that dwelled on that.
I guess my question is we seem to be hung up. The House has
passed a bill, we are expecting to take up legislation later
this year that addresses GSE reform and regulation of our
Fannie Mae, Freddie Mac, and Federal Home Loan Banks.
The hang up appears to be really in two areas: What kind of
support should we provide for low-income housing through some
kind of creation of a low-income housing fund? And the
questions about the mortgage portfolio and what kind of
constraints should be on the mortgage portfolio?
Any advice that you would have for us as we approach that?
Chairman Bernanke. The Federal Reserve's concern is about
financial stability. And so we have not taken a position on the
housing fund type things.
But for financial stability purposes, I think there are
three elements: Strong bank-like capital powers. Second, well-
defined receivership positions so that if a GSE goes out of
business we know under what circumstances that would happen and
what the resolution of that would be. And third, anchoring the
portfolio in a public purpose. Right now, it can expand almost
at will and it is not tied directly to public purpose.
In my speech that you referred to, I advocated tying the
portfolio to affordable housing or to housing goals in some
explicit way.
So those are the recommendations that I would suggest in
order to assure us, in terms of our concern which is about the
implications for financial stability if these large portfolios
were to come under financial stress.
Senator Carper. Thank you very much.
Chairman Dodd. Senator Carper, thank you.
Senator Akaka.
STATEMENT OF SENATOR DANIEL K. AKAKA
Senator Akaka. Thank you very much, Mr. Chairman.
Mr. Bernanke, it is good to see you in person here. And I
want to tell you my role here on the Banking Committee has come
down to being very concerned about the consumers of America.
Here I have looked upon this as trying to improve the quality
of life for consumers, as well as to help them improve
themselves. Consumer protection is important, and also
equipping them with the skills and knowledge that will help
them with their understandings and also to empower them with
economic empowerment.
So this area has been important to me. Our modern complex
economy depends on the ability of consumers to make informed
financial decisions. Without a sufficient understanding of
economics and personal finance, individuals will not be able to
appropriately manage their finances, evaluate credit
opportunities, and successfully invest for long-term financial
goals in an increasingly complex marketplace.
Mr. Chairman, I really appreciate your personal involvement
on the important issues of financial literacy. I also wanted to
take the time to thank all of the Federal Reserve employees,
and I want to include Sandy Bronstein in that, and all of those
who have taken such an active role in helping improve the
financial knowledge of consumers and evaluating the
effectiveness of education programs.
As you know, approximately 10 million households in the
United States do not have accounts at mainstream financial
institutions. Unfortunately, too many of these households
depend on high cost fringe financial services. They miss out on
opportunities for saving, borrowing, and lower cost remittances
found at credit unions and banks. And so the unbanked has
become one of my concerns.
My question to you is what must be done to bring these
households into mainstream financial institutions?
Chairman Bernanke. Senator, first let me say that I agree
wholeheartedly with your views on financial literacy. As I
discussed earlier, the Federal Reserve works very hard on all
these disclosures for these sometimes complex financial
products. But if people do not have the basic literacy to
understand them and evaluate them, it is really of no use.
Without financial literacy they are not going to be able to
participate fully in our economy.
In terms of bringing more people into the banking system, I
think it would be a positive development. The main way the
Federal Reserve can help that process is what we do, which is
to encourage the banks and bank holding companies that we
supervise to reach out into underserved communities, partly
through the Community Reinvestment Act but more generally to
provide services and to try to attract unbanked people into the
banking system.
I have given not only testimony before the Senate on
financial literacy, but I have also given some testimony in the
past on remittances which is one mechanism. Many of the
remittances that immigrants send back home, they lose a
significant portion of the money they are sending because of
the high cost of the types of services they use and other
problems. One of the ways in which credit unions and banks have
made inroads into the minority communities, in particular, has
been by offering better and cheaper remittance services. I
think that is one particular way to get in.
But we are seeing banks more and more employing Spanish
speaking, for example, tellers and understanding that there
really is a good market in these low and moderate income
neighborhoods. And we encourage banks to provide services in
those neighborhoods.
Senator Akaka. Mr. Chairman, FDIC has found that their
Money Smart financial literacy program has resulted in positive
behavioral change among consumers. I know that measuring the
effectiveness of financial literacy programs is an issue that
the Federal Reserve has been interested in for several years.
What has the Federal Reserve learned thus far about the
effectiveness of financial education?
Chairman Bernanke. First, a lot of what we do is partner
with various groups. The Chicago Federal Reserve Bank partners
with the Money Smart group that you just referred to. So a lot
of what we do is try to develop best practice and to try and
spread that to schools and to nonprofit organizations and so
on.
In terms of what we learned, we are still, I think--and
here I am referring to the entire education community--groping
with how best to teach financial literacy at the school level.
There is an organization called JumpStart which does testing of
kids in high school. Unfortunately, the progress on financial
literacy there has not been all that we would like.
One place, however, where we do see more progress, and I
referred to this in my discussion with Senator Schumer, is that
when potential homebuyers receive counseling nearer to the time
when they are going to be making their decisions that they do
learn and they do understand and it does affect their
decisions, as you might expect, because they are very highly
motivated at that point to understand the terms of the contract
that they are about to enter into.
So it is still a very open issue. We have a website which
includes lots and lots of materials which have been tested in
various contexts. But I cannot say that there is, at this
point, a definitive approach. I think you have to take a little
bit of this, a little bit of that, and mix it all together and
recognize that financial literacy is not just a school subject.
It really has to be used throughout life because it is really,
as you get older and you have to worry about buying a house and
sending your kids to college and retirement, that you really
begin to think hard about these financial issues. Kids in the
10th grade may not be as motivated to think about them.
Senator Akaka. I thank you so much for your responses. My
time has expired, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Akaka. These
are very important questions and I thank you for raising them.
Your point about the 10 million households without access to
mainstream financial institutions is a very legitimate concern
and something I have talked a lot about myself.
The Chairman points out that the cost of this to these
people, because they are using financial services, and it will
cost an average person thousands of dollars more than they
would otherwise pay if they were dealing with mainstream
financial institutions. So the cost differentials are huge, not
to mention, of course, the ability for people in those
circumstances to improve their economic lot. So, I thank you
for raising it.
I, too, find it remarkable, from the time a young person
enters a traditional schooling system in this country through
the 12th grade there is not a single requirement that I know of
anywhere that there is some period of time in which just basic
financial services literacy would be required. We have talked a
lot about this and schools are inundated with requests and
demands on them. They do not want to hear about another one.
But one of the major problems is people's inability to
understand basic financial obligations. So, I thank you for
raising and thank you, Mr. Chairman, for your comments.
Chairman Bernanke. A few States, Senator, have actually
made these requirements but it is not universal.
Chairman Dodd. Have they done that? That is good to hear.
Let me turn to Senator Shelby for one question. I have one
additional one after his and then we will complete the hearing.
Senator Shelby. Thank you.
Chairman Bernanke, GSE reform. We have talked about this
before. This Committee has been interested in strengthening the
regulatory system for the housing related Government Sponsored
Enterprises for a number of years. The House recently, as you
are probably aware, considered language giving the new proposed
regulator the ability to regulate the size and the growth of
the enterprise portfolios and charged the regulator to consider
risk of the portfolios. However the language, which was amended
on the House floor, I understand, which passed in the House,
limited the risk consideration to only risk to the enterprises.
Would you view this language, as it was passed by the House
as amended on the floor, with what bank regulators have over
financial institutions? That is do you consider, as a
regulator, only the risk to a particular financial institution?
Or do you look at the portfolio? Do you look at other things?
The portfolio your predecessor, Chairman Greenspan, says
right here in this Committee and I believe you have reiterated
that there is risk there in that portfolio, possibly to the
taxpayer. Would you comment on this?
Chairman Bernanke. Senator, I am aware of this legislation
and the amendment. The amendment in the House does concern me
greatly because I think it eliminates the ability of the
regulator to take the financial system's stability overall into
account. So in particular, one might imagine a situation where
greatly increasing the size of the GSE portfolio is in the
interest of the company but raises the risk to the overall
system.
As I said a moment ago, in my role my principal concern is
about the stability of the overall system. And I fear that
without some consideration of the overall financial stability
implications, that this new regulation would be incomplete.
Senator Shelby. I think there are some good things in the
House-passed bill but that was not one of them, in my judgment.
I appreciate your comment.
Thank you, Chairman Dodd.
Chairman Dodd. Thank you, Senator Shelby. And just on that
point alone, obviously we are going to looking at that and
trying to get a bill done fairly soon. Again, the realization
here, I just have to add two cents on this. And that is, of
course, the presence of the GSEs in this area, I think many
would agree, have created a possibility. One of the unique
opportunities we offer in our economy is that 30-year more
fixed rate mortgage which provides great stability and great
wealth creation for an awful lot of people, in the absence of
which it would be very difficult to achieve. So striking the
balance here, the points you have raised here, and seeing to it
we do not move away from the opportunity that those vehicles
provide is something very important to all of us.
Let me raise a quick question if I can, as well, with you
here. The hedge fund industry is obviously an important wealth
creator in the country. It has done an awful lot of worthwhile
things in terms of a valuable role in capital markets.
The President's Working Group, which you are a part of,
back in February released a set of principles and guidelines. I
would just quote, it says ``To guide U.S. financial regulators
as they address public policy issues associated with the rapid
growth of the private pools of capital, including hedge funds.
The agreement concentrates on investor protection and systemic
risk concerns.'' The President's Working Group, at that point,
determined that additional regulation was not needed.
Let me raise the issue that has been raised by others. You
had a piece in the Chicago Tribune recently talking about the
Amaranth situation, which many people pointed out, given the
size of it, it did not create that much of a bubble unless you
were in San Diego and had a pension fund and then $100 million
was lost.
So from your perspective, from stepping back from a macro
standpoint, it had seemingly very little effect. And yet if you
were dealing with the pensions in San Diego, it was a rather
significant effect.
There was then a story in, I think it was Business Week,
that I was not aware of. A lot of smaller colleges are now
moving aggressively into hedge funds, according to this
article. It identified colleges that had invested between 60
and 82 percent of their endowments in hedge funds. They said
they may be putting their endowments in jeopardy. That was the
conclusion of this Business Week article.
Again, they are just two newspaper stories here. I just
wonder, in light of all of this, do you have any additional
recommendations about this? What did the President's Working
Group want market participants to do differently after the
release of the principles than they were doing before? How were
the Working Group agencies overseeing the impact of this new
guidance that they put out? And last, do you feel that
additional regulation of hedge funds is needed to avoid
concerns about systemic risk?
Chairman Bernanke. Mr. Chairman, the essence of making the
market discipline approach work is that the counterparties,
investors, and creditors be sophisticated and able to evaluate
the investments that they are undertaking. In the case of a
pension fund, the pension fund manager has a fiduciary duty to
make investments which are appropriate for the risk/return
needs of that fund.
So if that fiduciary manager has sufficient sophistication
to use some of these things, that perhaps is OK. But in most
cases I think that pension funds should probably not go heavily
into these types of instruments.
In fact, on average, ERISA funds have relatively small
shares of their assets in these funds. But again, in those
cases and in the cases of endowments as well, it is really the
responsibility of the sophisticated managers to make sure that
they are making the right risk/return trade-offs. The whole
system depends on those people knowing what they are doing.
Chairman Dodd. Given the exposures you were talking about,
and I agree with that totally. I do not disagree with what you
said. Do we, you, and these other appropriate agencies bear an
additional responsibility here to be more mindful of what is
going on, including possibly some regulatory role here?
Chairman Bernanke. With respect to the pension funds, for
example, they already are regulated by ERISA and the Department
of Labor. And they have fiduciary responsibilities and that
should be enforced, obviously.
In terms of the broader issue of market discipline for
private pools of capital, I would like to emphasize that this
is not a laissez-faire approach. In particular the supervisors,
including the Federal Reserve, have the responsibility to make
sure that the institutions who are the prime brokers, the
counterparties, the creditors of these private pools of
capital, that they have in place adequate risk measurement
techniques, risk management techniques, they have enough
information so they can make adequate assessments of the risks
that they are facing.
So we, in fact, do put a lot of effort into ensuring that
these institutions--and I say we, this is in collaboration with
the SEC and other regulators--that they are doing sufficient
due diligence to protect themselves and their own investors and
depositors from excessive risk.
So that is what makes the system work, a combination of
self-interested counterparty market discipline but overseen and
overlaid by effective supervisory attention.
Chairman Dodd. I interpret that that you do not see any
additional regulation needed at this point?
Chairman Bernanke. I do not, at this point, see any need
for additional regulation, no.
Chairman Dodd. Mr. Chairman, I thank you and we have a vote
on here. Obviously, there will be a lot more questions for you
but you have been very generous with your time. We appreciate
that very much.
I am going to leave the record open for a day or two here
for additional questions. We had very good participation by the
Committee Members here but there may be some additional
questions that they would like to raise with you. We will
submit them to you in a timely fashion.
Once again we thank you immensely for your participation.
Chairman Bernanke. Thank you.
Chairman Dodd. This hearing will stand adjourned.
[Whereupon, at 12:10 p.m. the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
Chairman Bernanke, we are very pleased to have you before the
Committee this morning to deliver the Federal Reserve's Semi-Annual
Monetary Policy Report. This hearing provides the Congress a very
important opportunity to have an open and detailed discussion about the
Fed's monetary policy goals and their implementation. I also expect
that Members of the Committee, including myself, will take advantage of
your appearance to raise some other issues that fall under the
jurisdiction of the Federal Reserve.
I also would like to welcome our colleagues from the European Union
Parliament.
I trust that their visit today will be enlightening and provide
them with much to discuss with the European Central Bank.
Chairman Bernanke, your testimony and report this morning note the
continued healthy performance of the economy in the first half of 2007.
Although real gross domestic product (GDP) increased 0.7 percent in the
first quarter of 2007, the consensus view among economists is that
growth for the second quarter will show a rebound in the neighborhood
of 2.5 percent. Along with continued GDP growth, we have seen positive
news on the job front. Gains in payroll employment averaged 145,000
jobs per month in the first half of 2007. We continue to enjoy a low
unemployment rate, both historically and relative to other
industrialized nations.
The global economy also continues to be strong, with Canada,
Europe, Japan, and the United Kingdom experiencing above-trend growth
rates in the first quarter. This is good news for American businesses
seeking to expand their exports around the world.
In its statement following the June 28, 2007, meeting, the FOMC
suggested that while core inflation readings had moderated, ``sustained
moderation in inflation pressures has yet to be convincingly
demonstrated.'' Inflation risk, not slow growth, remains the
predominant concern as we continue to see a rise in energy and food
prices. I also share your view on the importance of low inflation in
promoting growth, efficiency, and stability which in turn equal maximum
sustainable employment.
Chairman Bernanke, your statement also includes an extended
discussion of the Federal Reserve's recent activities relating to
subprime mortgage lending. The recent sharp increases in subprime
mortgage loan delinquencies are troubling. The initiatives that you
highlight in your testimony are welcome.
However, I am concerned that the weaknesses in the subprime market
may have broader systemic consequences. We have been told that the
problem is largely isolated and contained, but I am concerned that it
may not be. I will be particularly interested in hearing your views on
the scope of the problem and how the Federal Reserve will monitor and
manage the situation going forward.
Chairman Bernanke, we are pleased to have you with us this morning.
We look forward to discussing in greater detail the Federal Reserve's
performance and its views on the future direction of our Nation's
economy.
Thank you, Mr. Chairman.
______
PREPARED STATEMENT OF SENATOR JIM BUNNING
Chairman Bernanke, I watched your testimony yesterday with
interest. Apparently the markets did too, but I am not sure if they did
or did not like what they heard.
You covered a lot of ground yesterday, but there is some new ground
I will cover in the questions and some things that are worth repeating.
First, it has been interesting to watch market reactions and
expectations to Fed policy statements over the last few months. For a
while, the markets did not believe your clear statements that the
biggest concern was that inflation would not moderate as expected.
Market indicators have moved more in line with your view in the last
month or two, and I hope both the markets and you have learned about
communication and the way each other think.
While this is a monetary policy hearing, I think it is worth
repeating that many of us believe the Fed and other regulators share
some responsibility for the current state of the housing market. Low
interest rates fueled the housing boom, and loose supervision of
mortgage writing allowed it to proceed. The market is certainly
punishing bad behavior by lenders, but some of the damage could have
been prevented by more careful scrutiny of some of the most
undisciplined lending. The Fed should have been especially careful
because of the credit bubble it created with cheap money.
I am glad you and your fellow regulators have taken action, and
that you did not overreact and cause further damage. It is important
for you to remain vigilant, but not to give in to pressure to over
regulate. I would also say to Chairman Dodd that I hope we can quickly
confirm the new nominees so that the Fed board will have more industry
experience when tackling these issues.
I continue to be impressed by the current economy, which seems to
have passed through the worst of the slowdown caused largely by Fed
tightening. My biggest concerns are rising food and energy prices, and
the negative effects on the economy of the massive tax increases the
new majority in Congress seems determined to allow. The current
economic expansion is driven by the 2001 and 2003 tax cuts, and
allowing a tax increase in 2010 will reverse years of gains in the
economy and the stock markets.
I look forward to hearing your responses.
______
PREARED STATEMENT OF SENATOR ELIZABETH DOLE
Thank you, Chairman Dodd. Chairman Bernanke, I join my colleagues
in extending you a very warm welcome. Thank you for your strong
leadership as Chairman of the Federal Reserve and for joining us here
today.
As you know, we have seen very strong growth in our economy over
the last few years--even as our Nation has faced some extremely
challenging times. Over the past year, the Dow Jones Industrial Average
has risen by approximately 26 percent, and in 2006 GDP expanded by
approximately 3 percent. The market continues to shatter records with
both the Dow and the S&P 500 reaching all-time highs.
No question, we have hard work ahead to ensure that all levels and
sectors of the economy continue to prosper. For example, the housing
sector has been showing some signs of weakness . . . and high gas
prices continue to be a burden, as Americans must allocate more and
more of their income to fund this necessity of everyday life. According
to AAA, the current average price of gas in my home State North
Carolina is $2.93. The price of a barrel of oil has hovered around the
$70 mark and has recently hit $75. If high gas prices and housing
sector weaknesses persist, and if we face other challenges, future
economic growth could be hindered.
With regard to job creation, over the past 10 months, the national
unemployment rate has hovered around 4.5 percent, and the economy has
continued to add jobs, bringing us to an impressive total of 8.2
million new jobs created since August 2003. While the overall national
economy trends positively, too many areas of North Carolina continue to
face obstacles. The forces of the global marketplace have triggered an
economic transformation in our State, and many thousands of our
manufacturing jobs have been lost.
New opportunities and jobs for North Carolinians, however, are
being created in this transition. As our economy moves forward, in
North Carolina and across America, we must educate our workforce so
that all individuals can take advantage of the new jobs being created.
To this end, as I have discussed with you in the past, I believe our
community colleges are a tremendous resource. This certainly is the
case in North Carolina--where our university system and 58-member-
strong community college network have been a beacon of hope--providing
retraining and remedial education to those who have lost their jobs,
and developing curriculum to suit the evolving needs of employers.
Before I conclude, let me mention what I believe to be a vital
resource that North Carolina workers have been able to utilize to
update and improve their skill set--Trade Adjustment Assistance (TAA).
The TAA program is critical to ensuring that displaced workers can
train for new careers and that they do not slip through the cracks. I
recently introduced legislation with my colleague Senator Cantwell to
strengthen this program. Our bill would help workers whose jobs
relocate to countries without preferential trade agreements with the
United States to receive TAA benefits. Eligible workers can receive
training, job search and relocation allowances, income support, and
other reemployment services.
Mr. Chairman, we must continue backing programs such as TAA, and
supporting an agenda that will create jobs and grow our economy--by
reducing regulatory burdens, educating and training a highly skilled
workforce, building and updating infrastructure, and ensuring
affordable, accessible energy and health care.
Chairman Bernanke, thank you again for being here today. I look
forward to hearing from you--and working with you--on these and other
important issues.
______
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
July 19, 2007
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
I am pleased to present the Federal Reserve's Monetary Policy Report to
the Congress. As you know, this occasion marks the 30th year of
semiannual testimony on the economy and monetary policy by the Federal
Reserve. In establishing these hearings, the Congress proved prescient
in anticipating the worldwide trend toward greater transparency and
accountability of central banks in the making of monetary policy. Over
the years, these testimonies and the associated reports have proved an
invaluable vehicle for the Federal Reserve's communication with the
public about monetary policy, even as they have served to enhance the
Federal Reserve's accountability for achieving the dual objectives of
maximum employment and price stability set for it by the Congress. I
take this opportunity to reiterate the Federal Reserve's strong support
of the dual mandate; in pursuing maximum employment and price
stability, monetary policy makes its greatest possible contribution to
the general economic welfare.
Let me now review the current economic situation and the outlook,
beginning with developments in the real economy and the situation
regarding inflation before turning to monetary policy. I will conclude
with comments on issues related to lending to households and consumer
protection--topics not normally addressed in monetary policy testimony
but, in light of recent developments, deserving of our attention today.
After having run at an above-trend rate earlier in the current
economic recovery, U.S. economic growth has proceeded during the past
year at a pace more consistent with sustainable expansion. Despite the
downshift in growth, the demand for labor has remained solid, with more
than 850,000 jobs having been added to payrolls thus far in 2007 and
the unemployment rate having remained at 4\1/2\ percent. The
combination of moderate gains in output and solid advances in
employment implies that recent increases in labor productivity have
been modest by the standards of the past decade. The cooling of
productivity growth in recent quarters is likely the result of cyclical
or other temporary factors, but the underlying pace of productivity
gains may also have slowed somewhat.
To a considerable degree, the slower pace of economic growth in
recent quarters reflects the ongoing adjustment in the housing sector.
Over the past year, home sales and construction have slowed
substantially and house prices have decelerated. Although a leveling-
off of home sales in the second half of 2006 suggested some tentative
stabilization of housing demand, sales have softened further this year,
leading the number of unsold new homes in builders' inventories to rise
further relative to the pace of new home sales. Accordingly,
construction of new homes has sunk further, with starts of new single-
family houses thus far this year running 10 percent below the pace in
the second half of last year.
The pace of home sales seems likely to remain sluggish for a time,
partly as a result of some tightening in lending standards and the
recent increase in mortgage interest rates. Sales should ultimately be
supported by growth in income and employment as well as by mortgage
rates that--despite the recent increase--remain fairly low relative to
historical norms. However, even if demand stabilizes as we expect, the
pace of construction will probably fall somewhat further as builders
work down stocks of unsold new homes. Thus, declines in residential
construction will likely continue to weigh on economic growth over
coming quarters, although the magnitude of the drag on growth should
diminish over time.
Real consumption expenditures appear to have slowed last quarter,
following two quarters of rapid expansion. Consumption outlays are
likely to continue growing at a moderate pace, aided by a strong labor
market. Employment should continue to expand, though possibly at a
somewhat slower pace than in recent years as a result of the recent
moderation in the growth of output and ongoing demographic shifts that
are expected to lead to a gradual decline in labor force participation.
Real compensation appears to have risen over the past year, and barring
further sharp increases in consumer energy costs, it should rise
further as labor demand remains strong and productivity increases.
In the business sector, investment in equipment and software showed
a modest gain in the first quarter. A similar outcome is likely for the
second quarter, as weakness in the volatile transportation equipment
category appears to have been offset by solid gains in other
categories. Investment in nonresidential structures, after slowing
sharply late last year, seems to have grown fairly vigorously in the
first half of 2007. Like consumption spending, business fixed
investment overall seems poised to rise at a moderate pace, bolstered
by gains in sales and generally favorable financial conditions. Late
last year and early this year, motor vehicle manufacturers and firms in
several other industries found themselves with elevated inventories,
which led them to reduce production to better align inventories with
sales. Excess inventories now appear to have been substantially
eliminated and should not prove a further restraint on growth.
The global economy continues to be strong. Supported by solid
economic growth abroad, U.S. exports should expand further in coming
quarters. Nonetheless, our trade deficit--which was about 5\1/4\
percent of nominal gross domestic product (GDP) in the first quarter--
is likely to remain high.
For the most part, financial markets have remained supportive of
economic growth. However, conditions in the subprime mortgage sector
have deteriorated significantly, reflecting mounting delinquency rates
on adjustable-rate loans. In recent weeks, we have also seen increased
concerns among investors about credit risk on some other types of
financial instruments. Credit spreads on lower-quality corporate debt
have widened somewhat, and terms for some leveraged business loans have
tightened. Even after their recent rise, however, credit spreads remain
near the low end of their historical ranges, and financing activity in
the bond and business loan markets has remained fairly brisk.
Overall, the U.S. economy appears likely to expand at a moderate
pace over the second half of 2007, with growth then strengthening a bit
in 2008 to a rate close to the economy's underlying trend. Such an
assessment was made around the time of the June meeting of the Federal
Open Market Committee (FOMC) by the members of the Board of Governors
and the presidents of the Reserve Banks, all of whom participate in
deliberations on monetary policy. The central tendency of the growth
forecasts, which are conditioned on the assumption of appropriate
monetary policy, is for real GDP to expand roughly 2\1/4\ to 2\1/2\
percent this year and 2\1/2\ to 2\3/4\ percent in 2008. The forecasted
performance for this year is about \1/4\ percentage point below that
projected in February, the difference being largely the result of
weaker-than-expected residential construction activity this year. The
unemployment rate is anticipated to edge up to between 4\1/2\ and 4\3/
4\ percent over the balance of this year and about 4\3/4\ percent in
2008, a trajectory about the same as the one expected in February.
I turn now to the inflation situation. Sizable increases in food
and energy prices have boosted overall inflation and eroded real
incomes in recent months--both unwelcome developments. As measured by
changes in the price index for personal consumption expenditures (PCE
inflation), inflation ran at an annual rate of 4.4 percent over the
first 5 months of this year, a rate that, if maintained, would clearly
be inconsistent with the objective of price stability.\1\ Because
monetary policy works with a lag, however, policymakers must focus on
the economic outlook. Food and energy prices tend to be quite volatile,
so that, looking forward, core inflation (which excludes food and
energy prices) may be a better gauge than overall inflation of
underlying inflation trends. Core inflation has moderated slightly over
the past few months, with core PCE inflation coming in at an annual
rate of about 2 percent so far this year.
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\1\ Despite the recent surge, total PCE inflation is 2.3 percent
over the past 12 months.
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Although the most recent readings on core inflation have been
favorable, month-to-month movements in inflation are subject to
considerable noise, and some of the recent improvement could also be
the result of transitory influences. However, with long-term inflation
expectations contained, futures prices suggesting that investors expect
energy and other commodity prices to flatten out, and pressures in both
labor and product markets likely to ease modestly, core inflation
should edge a bit lower, on net, over the remainder of this year and
next year. The central tendency of FOMC participants' forecasts for
core PCE inflation--2 to 2\1/4\ percent for 2007 and 1\3/4\ to 2
percent in 2008--is unchanged from February. If energy prices level off
as currently anticipated, overall inflation should slow to a pace close
to that of core inflation in coming quarters.
At each of its four meetings so far this year, the FOMC maintained
its target for the Federal funds rate at 5\1/4\ percent, judging that
the existing stance of policy was likely to be consistent with growth
running near trend and inflation staying on a moderating path. As
always, in determining the appropriate stance of policy, we will be
alert to the possibility that the economy is not evolving in the way we
currently judge to be the most likely. One risk to the outlook is that
the ongoing housing correction might prove larger than anticipated,
with possible spillovers onto consumer spending. Alternatively,
consumer spending, which has advanced relatively vigorously, on
balance, in recent quarters, might expand more quickly than expected;
in that case, economic growth could rebound to a pace above its trend.
With the level of resource utilization already elevated, the resulting
pressures in labor and product markets could lead to increased
inflation over time. Yet another risk is that energy and commodity
prices could continue to rise sharply, leading to further increases in
headline inflation and, if those costs passed through to the prices of
nonenergy goods and services, to higher core inflation as well.
Moreover, if inflation were to move higher for an extended period and
that increase became embedded in longer-term inflation expectations,
the reestablishment of price stability would become more difficult and
costly to achieve. With the level of resource utilization relatively
high and with a sustained moderation in inflation pressures yet to be
convincingly demonstrated, the FOMC has consistently stated that upside
risks to inflation are its predominant policy concern.
In addition to its dual mandate to promote maximum employment and
price stability, the Federal Reserve has an important responsibility to
help protect consumers in financial services transactions. For nearly
40 years, the Federal Reserve has been active in implementing,
interpreting, and enforcing consumer protection laws. I would like to
discuss with you this morning some of our recent initiatives and
actions, particularly those related to subprime mortgage lending.
Promoting access to credit and to homeownership are important
objectives, and responsible subprime mortgage lending can help advance
both goals. In designing regulations, policymakers should seek to
preserve those benefits. That said, the recent rapid expansion of the
subprime market was clearly accompanied by deterioration in
underwriting standards and, in some cases, by abusive lending practices
and outright fraud. In addition, some households took on mortgage
obligations they could not meet, perhaps in some cases because they did
not fully understand the terms. Financial losses have subsequently
induced lenders to tighten their underwriting standards. Nevertheless,
rising delinquencies and foreclosures are creating personal, economic,
and social distress for many homeowners and communities--problems that
likely will get worse before they get better.
The Federal Reserve is responding to these difficulties at both the
national and the local levels. In coordination with the other Federal
supervisory agencies, we are encouraging the financial industry to work
with borrowers to arrange prudent loan modifications to avoid
unnecessary foreclosures. Federal Reserve Banks around the country are
cooperating with community and industry groups that work directly with
borrowers having trouble meeting their mortgage obligations. We
continue to work with organizations that provide counseling about
mortgage products to current and potential homeowners. We are also
meeting with market participants--including lenders, investors,
servicers, and community groups--to discuss their concerns and to gain
information about market developments.
We are conducting a top-to-bottom review of possible actions we
might take to help prevent recurrence of these problems. First, we are
committed to providing more-effective disclosures to help consumers
defend against improper lending. Three years ago, the Board began a
comprehensive review of Regulation Z, which implements the Truth in
Lending Act (TILA). The initial focus of our review was on disclosures
related to credit cards and other revolving credit accounts. After
conducting extensive consumer testing, we issued a proposal in May that
would require credit card issuers to provide clearer and easier-to-
understand disclosures to customers. In particular, the new disclosures
would highlight applicable rates and fees, particularly penalties that
might be imposed. The proposed rules would also require card issuers to
provide 45 days' advance notice of a rate increase or any other change
in account terms so that consumers will not be surprised by unexpected
charges and will have time to explore alternatives.
We are now engaged in a similar review of the TILA rules for
mortgage loans. We began this review last year by holding four public
hearings across the country, during which we gathered information on
the adequacy of disclosures for mortgages, particularly for
nontraditional and adjustable-rate products. As we did with credit card
lending, we will conduct extensive consumer testing of proposed
disclosures. Because the process of designing and testing disclosures
involves many trial runs, especially given today's diverse and
sometimes complex credit products, it may take some time to complete
our review and propose new disclosures.
However, some other actions can be implemented more quickly. By the
end of the year, we will propose changes to TILA rules to address
concerns about mortgage loan advertisements and solicitations that may
be incomplete or misleading and to require lenders to provide mortgage
disclosures more quickly so that consumers can get the information they
need when it is most useful to them. We already have improved a
disclosure that creditors must provide to every applicant for an
adjustable-rate mortgage product to explain better the features and
risks of these products, such as ``payment shock'' and rising loan
balances.
We are certainly aware, however, that disclosure alone may not be
sufficient to protect consumers. Accordingly, we plan to exercise our
authority under the Home Ownership and Equity Protection Act (HOEPA) to
address specific practices that are unfair or deceptive. We held a
public hearing on June 14 to discuss industry practices, including
those pertaining to prepayment penalties, the use of escrow accounts
for taxes and insurance, stated-income and low-documentation lending,
and the evaluation of a borrower's ability to repay. The discussion and
ideas we heard were extremely useful, and we look forward to receiving
additional public comments in coming weeks. Based on the information we
are gathering, I expect that the Board will propose additional rules
under HOEPA later this year.
In coordination with the other Federal supervisory agencies, last
year we issued principles-based guidance on nontraditional mortgages,
and in June of this year we issued supervisory guidance on subprime
lending. These statements emphasize the fundamental consumer protection
principles of sound underwriting and effective disclosures. In
addition, we reviewed our policies related to the examination of
nonbank subsidiaries of bank and financial holding companies for
compliance with consumer protection laws and guidance.
As a result of that review and following discussions with the
Office of Thrift Supervision, the Federal Trade Commission, and State
regulators, as represented by the Conference of State Bank Supervisors
and the American Association of Residential Mortgage Regulators, we are
launching a cooperative pilot project aimed at expanding consumer
protection compliance reviews at selected nondepository lenders with
significant subprime mortgage operations. The reviews will begin in the
fourth quarter of this year and will include independent State-licensed
mortgage lenders, nondepository mortgage lending subsidiaries of bank
and thrift holding companies, and mortgage brokers doing business with
or serving as agents of these entities. The agencies will collaborate
in determining the lessons learned and in seeking ways to better
cooperate in ensuring effective and consistent examinations of and
improved enforcement for nondepository mortgage lenders. Working
together to address jurisdictional issues and to improve information-
sharing among agencies, we will seek to prevent abusive and fraudulent
lending while ensuring that consumers retain access to beneficial
credit.
I believe that the actions I have described today will help address
the current problems. The Federal Reserve looks forward to working with
the Congress on these important issues.