[Senate Hearing 110-854]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-854


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2008

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                           FEBRUARY 28, 2008

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania        MEL MARTINEZ, Florida
JON TESTER, Montana                  BOB CORKER, Tennessee

                      Shawn Maher, Staff Director

        William D. Duhnke, Republican Staff Director and Counsel

               Roger Hollingsworth, Deputy Staff Director

                      Aaron Klein, Chief Economist

                   Dean V. Shahinian, Senior Counsel

               Julie Chon, International Economic Adviser

                Mark Oesterle, Republican Chief Counsel

           Peggy Kuhn, Republican Senior Financial Economist

           Mike Nielsen, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)










                            C O N T E N T S

                              ----------                              

                      THURSDAY, FEBRUARY 28, 2008

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Bunning
        Prepared statement.......................................    45
    Senator Dole
        Prepared statement.......................................    45

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     6
    Prepared statement...........................................    46
    Response to written questions of:
        Senator Shelby...........................................    50

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated February 27, 2008...    62

                                 (iii)

 
        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2008

                              ----------                              


                      THURSDAY, FEBRUARY 28, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:11 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order.
    I am pleased to call the Committee to order this morning. 
Today, the Committee will hear the testimony of Federal Reserve 
Chairman Ben Bernanke on the outlook of the Nation's economy, 
the Fed's conduct of monetary policy, and the status of 
important consumer protection regulations that are under the 
Fed's jurisdiction. This is Chairman Bernanke's second 
appearance before the Committee this year. Mr. Chairman, it is 
good to have you with us, and, again, it is 2 weeks ago and now 
again today here. You are becoming a regular here, and so we 
appreciate your appearance before the Committee.
    When Chairman Bernanke was first before the Committee 2 
weeks ago, I laid out the facts of what I consider to be our 
Nation's very serious, if not perilous, economic condition. 
Growth is slowing, inflation is rising, consumer confidence is 
plummeting, while indebtedness is deepening. And just as 
ominously, the credit markets have experienced significant 
disruptions. Consumers are unable or unwilling to borrow. 
Lenders are unable or unwilling to lend. There is a palpable 
sense of uncertainty and even fear in the markets with a crisis 
of confidence that has spread beyond the mortgage markets to 
markets in student loans. And I noted this morning--by the way, 
2 weeks ago I pointed out that Michigan was indicating some 
serious problems with student lending, and this morning I am 
reading where Pennsylvania today--you may have seen the 
article--may decide to also curtail student loans as a result 
of this growing economic situation. We have also seen the 
problem with credit cards, government bonds, and corporate 
finance.
    Unfortunately, the crisis of confidence does not just exist 
by American consumers and lenders. It increasingly appears that 
there is a crisis of confidence among the rest of the world in 
the United States economy. Yesterday, the dollar reached its 
lowest level since 1973, when the dollar was first allowed to 
float freely. And the Fed's own monetary report details an 
alarming fact. Foreign entities have not only stopped 
purchasing U.S. securities; they have actually been selling 
them because they have lost, it appears, confidence in their 
value. Now, I am going to be raising some questions, Mr. 
Chairman, about that, and I will be interested in your 
observations about these reports in the Monetary Policy Report.
    As I have said previously, the catalyst of the current 
economic crisis I believe very strongly is the housing crisis. 
Overall, 2007 was the first year since data has been kept that 
the United States had an annual decline in nationwide housing 
prices. A recent Moody's report forecast that home values will 
drop in 2008 by 10 percent to 15 percent, and others are 
predicting similar declines in 2009 as well. This would be the 
first time since the Great Depression that national home prices 
have dropped in consecutive years. We have all witnessed in the 
past where regionally there have been declines in home prices, 
but to have national numbers like this is almost unprecedented, 
certainly in recent history.
    If the catalyst of the current economic crisis is the 
housing crisis, then the catalyst of the housing crisis is the 
foreclosure crisis. This week, it was reported that 
foreclosures in January were up 57 percent compared to a year 
ago and continue to hit record levels. When all is said and 
done, over 2 million Americans could lose their homes as a 
result of what Secretary Paulson has properly and accurately 
described as ``bad lending practices.'' These are lending 
practices that no sensible banker, I think, would ever engage 
in. Reckless, careless, and sometimes unscrupulous actors in 
the mortgage lending industry essentially allowed banks--
rather, essentially allowed loans to be made that they knew 
hard-working, law-abiding borrowers would never be able to 
repay.
    Let me add here very quickly, because I think it is 
important to make the point here, that we are not talking about 
everyone here at all. We are talking about some who engaged in 
practices that I think were unscrupulous or bad lending 
practices. But many institutions acted very responsibly, and I 
would not want the world to suggest here that this Committee 
believed that this was an indictment on all lending 
institutions. And engaged--those who did act improperly engaged 
in practices that the Federal Reserve under its prior 
leadership, in my view, and this administration did absolutely 
nothing to effectively stop.
    The crisis affects more than families who lose their homes. 
Property values for each home within a one-eighth square mile 
of a foreclosed home could drop on an average as much as 
$5,000. This will affect somewhere between 44 to 50 million 
homes in our country. So the ripple effect beyond the 
foreclosed property goes far beyond that and has a contagion 
effect, in my view, in our communities all across this country 
beyond the very stark reality of those who actually lose their 
homes, the effect of others watching the value of their 
properties decline, not to mention what that means to local tax 
bases, supporting local police and fire, and a variety of other 
concerns raised by this issue.
    I certainly want to commend the Fed Chairman--I said so 
yesterday publicly, Mr. Chairman; I do so again this morning--
for candidly acknowledging the weakness in the economy and for 
actively addressing those weaknesses by injecting liquidity and 
cutting interest rates. I also am pleased that the 
administration and the Congress were able to reach agreement on 
a stimulus package, and our hope is--while some have argued 
this is not big enough or strong enough, our collective hope is 
this will work, will have some very positive impact on the 
economy. Certainly this will have some support, we hope, for 
working families who are bearing the brunt of these very 
difficult times.
    However, I think more needs to be done to address the root 
cause of our economic problems. Any serious effort to address 
our economic woes should include, I think, an effort to take on 
the foreclosure crisis. And, again, there are various ideas out 
there on how we might do this more effectively, and certainly 
the Chairman and others have offered some ideas and 
suggestions. Senator Shelby and I have been working and 
talking--and Mel Martinez and others who are involved in these 
issues--about ways in which we can in the coming days do 
constructive things in a positive way to indicate and show not 
only our concern about the issue but some very strong ideas on 
how we can right this and restore that confidence I talked 
about earlier.
    We on this Committee have already taken some steps to 
address these problems. We have passed the FHA modernization 
legislation through the Committee and the Senate and continue 
to work to make it law. We had a very good meeting yesterday, I 
would point out, Senator Shelby and I and the leadership of the 
House Financial Services Committee, I say to you, Mr. Chairman, 
in hopes that we can come to some very quick conclusion on that 
piece of legislation and move it along here.
    We appropriated close to $200 million to facilitate 
foreclosure prevention efforts by borrowers and lenders, and I 
want to commend Senator Schumer and others who have been 
involved in this idea of counseling and ideas to minimize the 
impact of this problem as well.
    In addition, the recently enacted stimulus package that I 
mentioned already includes a temporary increase in the 
conforming loan limits for GSEs to try to address the problems 
that have spread throughout the credit market and the jumbo 
mortgage market. And while this temporary increase is helpful, 
we still need to implement broad GSE reform. And as I have said 
previously, I am committed to doing that, and we will get that 
done.
    I have spoken about my belief in the need for additional 
steps to mitigate the foreclosure crisis in a reasonable and 
thoughtful manner. These steps include targeting some community 
development block grant assistance to communities in a targeted 
way to help them to counter the impact of foreclosed and 
abandoned properties in their communities. And they include 
establishing a temporary homeownership loan initiative, which I 
have raised and others have commented on, either using existing 
platforms or a new entity that can facilitate mortgage 
refinancing.
    But it is not just the Congress that needs to do more, and, 
again, the Fed needs, in my view, to be as vigilant a financial 
regulator as it has been a monetary policymaker. That includes 
breaking with its past and becoming more vigilant about 
policing indefensible lending practices. And, again, I commend 
the Chairman of the Federal Reserve--we have talked about this 
here--on the proposed regulations that you have articulated 
that would follow on the HOEPA legislation. And while I have 
expressed some disappointment about how far they go in certain 
areas here, the Chairman and I have talked about this a bit. We 
will be involved in the comment period here and are looking 
forward to finalizing those regulations, and hopefully at least 
shutting the door on this kind of a problem re-emerging in the 
coming months and years.
    So I want to thank you, Mr. Chairman, and your colleagues 
and urge them to consider some of the stronger measures, and we 
will offer some additional comments on them.
    Despite these unprecedented challenges, I think all of us 
here on this Committee, Republicans and Democrats, remain 
confident in the future of the American economy, and our 
concerns that will be raised here this morning should not 
reflect anything but that confidence in the future. We may need 
to change some of our policies, regulations, and priorities, 
but we strongly believe that the ingenuity, productivity, and 
capability of the American worker and the entrepreneur ought 
never to be underestimated in this country. And we remain firm 
and committed to doing everything we can to strengthen those 
very points.
    So I look forward to working with my good friend, Senator 
Shelby, and other Members of the Committee to do what we can 
here to play our role in all of this in a constructive way, to 
work with you, Mr. Chairman, and the Federal Reserve, the 
Secretary of the Treasury, and others of the financial 
institution regulators to see what we can do in the short term 
to get this moving in a better direction.
    So, with that, let me turn to Senator Shelby for his 
opening comments, and then we will try to get to some 
questions. And I will leave opening comments for the go-around 
and question period so we can get to a question-and-answer 
period here to make this as productive a session as possible. 
But we thank you again for being with us.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Chairman Dodd.
    Chairman Bernanke, we are pleased to have you again before 
the Committee to deliver the Federal Reserve's Semiannual 
Monetary Policy Report. I will keep my remarks brief this 
morning as we are all here to hear your views on the U.S. 
economy and other related issues. We also have the benefit of 
having read about your remarks before the House yesterday.
    Chairman Bernanke, the Federal Reserve has taken a number 
of steps over the past 6 months to address the tightening of 
credit markets and the slowdown in economic growth. In a bid to 
improve interbank liquidity, the Federal Reserve established 
the term auction facility in December of last year and has 
conducted, as I understand it, six auctions to date.
    Since last August, the Federal Open Market Committee has 
reduced the Federal funds target a total of 225 basis points, 
taking the target from 5.25 percent to 3 percent.
    Mr. Chairman, since monetary policy works with a lag, the 
full impact of this boost to the economy is not yet clear to 
you or to us. I know that we will spend time this morning 
discussing the length and the depth of the housing correction 
that Senator Dodd alluded to, and I think we should. I also 
want to make sure, however, that this Committee focuses on the 
risks associated with increasing inflation.
    The Labor Department, Mr. Chairman, reported this week, as 
you know, that wholesale price inflation hit a 26-year high in 
January. The January rise in the Consumer Price Index meant a 
12-month change in the overall CPI of 4.3 percent, twice the 
pace of a year ago. In addition, gold and oil are at all-time 
highs. These numbers certainly raise questions, Mr. Chairman, 
as to how much more room the Federal Reserve will have to 
provide further monetary accommodation without threatening 
long-term price stability, which is very important to all of 
us. While it is difficult to see our Nation's economy 
experience minimal growth, the consequences of failing to 
restrain inflation will be far more painful and more difficult 
to unwind.
    Chairman Bernanke, we are pleased to have you with us this 
morning, and we look forward to your thoughts on this and other 
issues.
    Chairman Dodd. Thank you very much.
    Let me correct myself. The tradition has been, Mr. 
Chairman, if Members do want to make some opening comments at a 
moment like this, and I do not want to break that tradition. So 
I am going to ask if any Members would like to make any opening 
comments at this point, I would be happy to entertain them. I 
realize that has been the tradition of the Committee, and I do 
not want to violate the traditions of the Committee. Does any 
Member want to be heard, some opening comments to make at this 
point? If they would like to, I would be happy to entertain----
    Senator Bunning. Let me ask a question. If we do not make 
them now and we make them during our timeframe, does that limit 
how many questions we can ask?
    Chairman Dodd. Well, that is the idea. I mean, I do not 
want to limit your time, but----
    [Laughter.]
    Chairman Dodd. So if you would like to----
    Senator Shelby. Make your opening statement.
    Senator Bayh. That would make Chairman Bernanke happy.
    Chairman Dodd. I understand that, and that is why you get 
the gavel after 27 years. But if you would like to make an 
opening comment----
    Senator Bunning. OK.
    Chairman Dodd. All right. Anyone else who would like to be 
heard?
    Senator Shelby. Why don't you add a minute and do both?
    Chairman Dodd. We will add a minute. Why don't I add a 
minute to the time here? Instead of having 5 or 6 minutes, we 
will make it 7 or 8 minutes. And I have never tried to be too 
rigid about that, and so we will do it that way if that is all 
right. That will move things along. Is that OK with everyone? 
Thank you very much.
    Mr. Chairman, we welcome you to the Committee.

            STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
        BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Bernanke. Thank you. Chairman Dodd, Ranking Member 
Shelby, and other Members of the Committee, I am pleased to 
present the Federal Reserve's Monetary Policy Report to the 
Congress. In my testimony this morning, I will briefly review 
the economic situation and outlook, beginning with developments 
in real activity and inflation, and then turn to monetary 
policy.
    Senator Bunning. Mr. Chairman, would you please move that 
microphone a little closer so we can all hear you?
    Mr. Bernanke. How is this?
    Senator Bunning. That is good.
    Mr. Bernanke. I will conclude with a quick update on the 
Federal Reserve's recent actions to help protect consumers in 
their financial dealings.
    The economic situation has become distinctly less favorable 
since the time of our July report. Strains in financial 
markets, which first became evident late last summer, have 
persisted; and pressures on bank capital and the continued poor 
functioning of markets for securitized credit have led to 
tighter credit conditions for many households and businesses. 
The growth of real gross domestic product held up well through 
the third quarter despite the financial turmoil, but it has 
since slowed sharply. Labor market conditions have similarly 
softened, as job creation has slowed and the unemployment 
rate--at 4.9 percent in January--has moved up somewhat.
    Many of the challenges now facing our economy stem from the 
continuing contraction of the U.S. housing market. In 2006, 
after a multiyear boom in residential construction and house 
prices, the housing market reversed course. Housing starts and 
sales of new homes are now less than half of their respective 
peaks, and house prices have flattened or declined in many 
areas. Changes in the availability of mortgage credit amplified 
the swings in the housing market.
    During the housing sector's expansion phase, increasingly 
lax lending standards, particularly in the subprime market, 
raised the effective demand for housing, pushing up prices and 
stimulating construction activity. As the housing market began 
to turn down, however, the slump in subprime mortgage 
originations, together with a more general tightening of credit 
conditions, has served to increase the severity of the 
downturn. Weaker house prices in turn have contributed to the 
deterioration in the performance of mortgage-related securities 
and reduced the availability of mortgage credit.
    The housing market is expected to continue to weigh on 
economic activity in coming quarters. Home builders, still 
faced with abnormally high inventories of unsold homes, are 
likely to cut the pace of their building activity further, 
which will subtract from overall growth and reduce employment 
in residential construction and closely related industries.
    Consumer spending continued to increase at a solid pace 
through much of the second half of 2007, despite the problems 
in the housing market, but it appears to have slowed 
significantly toward the end of the year. The jump in the price 
of imported energy, which eroded real incomes and wages, likely 
contributed to the slowdown in spending, as did the declines in 
household wealth associated with the weakness in house prices 
and equity prices.
    Slowing job creation is yet another potential drag on 
household spending, as gains in payroll employment averaged 
little more than 40,000 per month during the 3 months ending in 
January, compared with an average increase of almost 100,000 
per month over the previous 3 months. However, the recently 
enacted fiscal stimulus package should provide some support for 
household spending during the second half of this year and into 
next year.
    The business sector has also displayed signs of being 
affected by the difficulties in the housing and credit markets. 
Reflecting a downshift in the growth of final demand and 
tighter credit conditions for some firms, available indicators 
suggest that investment in equipment and software will be 
subdued during the first half of 2008. Likewise, after growing 
robustly through much of 2007, nonresidential construction is 
likely to decelerate sharply in coming quarters as business 
activity slows and funding becomes harder to obtain, especially 
for more speculative projects. On a more encouraging note, we 
see few signs of any serious imbalances in business inventories 
aside from the overhang of unsold homes. And, as a whole, the 
nonfinancial business sector remains in good financial 
condition, with strong profits, liquid balance sheets, and 
corporate leverage near historical lows.
    In addition, the vigor of the global economy has offset 
some of the weakening of domestic demand. U.S. real exports of 
goods and services increased at an annual rate of about 11 
percent in the second half of last year, boosted by continuing 
economic growth abroad and the lower foreign exchange value of 
the dollar. Strengthening exports, together with moderating 
imports, have in turn led to some improvement in the U.S. 
current account deficit, which likely narrowed in 2007--on an 
annual basis--for the first time since 2001. Although recent 
indicators point to some slowing of foreign economic growth, 
U.S. exports should continue to expand at a healthy pace in 
coming quarters, providing some impetus to domestic economic 
activity and employment.
    As I have mentioned, financial markets continue to be under 
considerable stress. Heightened investor concerns about the 
credit quality of mortgages, especially subprime mortgages with 
adjustable interest rates, triggered the financial turmoil. 
However, other factors, including a broader retrenchment in the 
willingness of investors to bear risk, difficulties in valuing 
complex or illiquid financial products, uncertainties about the 
exposures of major financial institutions to credit losses, and 
concerns about the weaker outlook for economic growth, have 
also roiled the financial markets in recent months. To help 
relieve the pressures in the market for interbank lending, the 
Federal Reserve--among other actions--recently introduced a 
term auction facility, through which prespecified amounts of 
discount window credit are auctioned to eligible borrowers, and 
we have been working with other central banks to address market 
strains that could hamper the achievement of our broader 
economic objectives. These efforts appear to have contributed 
to some improvement in short-term funding markets. We will 
continue to monitor financial developments closely.
    As part of its ongoing commitment to improving the 
accountability and public understanding of monetary 
policymaking, the Federal Open Market Committee--or FOMC--
recently increased the frequency and expanded the content of 
the economic projections made by Federal Reserve Board members 
and Reserve Bank presidents and released to the public. The 
latest economic projections, which were submitted in 
conjunction with the FOMC meeting at the end of January and 
which are based on each participant's assessment of appropriate 
monetary policy, show that real GDP was expected to grow only 
sluggishly in the next few quarters and that the unemployment 
rate was likely to increase somewhat. In particular, the 
central tendency of the projections was for real GDP to grow 
between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\ 
percent to 2\3/4\ percent projected in our report last July. 
FOMC participants' projections for the unemployment rate in the 
fourth quarter of 2008 have a central tendency of 5.2 percent 
to 5.3 percent, up from the level of about 4\3/4\ percent 
projected last July for the same period. The downgrade in our 
projections for economic activity in 2008 since our report last 
July reflects the effects of the financial turmoil on real 
activity and a housing contraction that has been more severe 
than previously expected. By 2010, our most recent projections 
show output growth picking up to rates close to or a little 
above its longer-term trend and the unemployment rate edging 
lower; the improvement reflects the effects of policy stimulus 
and an anticipated moderation of the contraction in housing and 
the strains in financial and credit markets. The incoming 
information since our January meeting continues to suggest 
sluggish economic activity in the near term.
    The risks to this outlook remain to the downside. The risks 
include the possibilities that the housing market or the labor 
market may deteriorate more than is currently anticipated and 
that credit conditions may tighten substantially further.
    Consumer price inflation has increased since our previous 
report, in substantial part because of the steep run-up in the 
price of oil. Last year, food prices also increased 
significantly, and the dollar depreciated. Reflecting these 
influences, the price index for personal consumption 
expenditures--or PCE--increased 3.4 percent over the four 
quarters of 2007, up from 1.9 percent in 2006. Core price 
inflation--that is, inflation excluding food and energy 
prices--also firmed toward the end of the year. The higher 
recent readings likely reflected some pass-through of energy 
costs to the prices of core consumer goods and services as well 
as the effect of the depreciation of the dollar on import 
prices. Moreover, core inflation in the first half of 2007 was 
damped by a number of transitory factors--notably, unusually 
soft prices for apparel and for financial services--which 
subsequently reversed. For the year as a whole, however, core 
PCE prices increased 2.1 percent, down slightly from 2006.
    The projections recently submitted by FOMC participants 
indicate that overall PCE inflation was expected to moderate 
significantly in 2008, to between 2.1 percent and 2.4 percent--
the central tendency of the projections. A key assumption 
underlying those projections was that energy and food prices 
would begin to flatten out, as implied by quotes on futures 
markets. In addition, diminishing pressure on resources is also 
consistent with the projected slowing in inflation. The central 
tendency of the projections for core PCE inflation in 2008, at 
2.0 percent to 2.2 percent, was a bit higher than in our July 
report, largely because of some higher-than-expected recent 
readings on prices. Beyond 2008, both overall and core 
inflation were projected to edge lower, as participants 
expected inflation expectations to remain reasonably well 
anchored and pressures on resource utilization to be muted. The 
inflation projections submitted by FOMC participants for 2010--
which ranged from 1.5 percent to 2.0 percent for overall PCE 
inflation--were importantly influenced by participants' 
judgments about the measured rates of inflation consistent with 
the Federal Reserve's dual mandate and about the timeframe over 
which policy should aim to achieve those rates.
    The rate of inflation that is actually realized will, of 
course, depend on a variety of factors. Inflation could be 
lower than we anticipate if slower-than-expected global growth 
moderates the pressure on the prices of energy and other 
commodities or if rates of domestic resource utilization fall 
more than we currently expect. Upside risks to the inflation 
projection are also present, however, including the 
possibilities that energy and food prices do not flatten out or 
that the pass-through to core prices from higher commodity 
prices and from the weaker dollar may be greater than we 
anticipate. Indeed, the further increases in the prices of 
energy and other commodities in recent weeks, together with the 
latest data on consumer prices, suggest slightly greater upside 
risks to the projections of both overall and core inflation 
than we saw last month. Should high rates of overall inflation 
persist, the possibility also exists that inflation 
expectations could become less well anchored. Any tendency of 
inflation expectations to become unmoored or for the Fed's 
inflation-fighting credibility to be eroded could greatly 
complicate the task of sustaining price stability and could 
reduce the flexibility of the FOMC to counter shortfalls in 
growth in the future. Accordingly, in the months ahead, the 
Federal Reserve will continue to monitor closely inflation and 
inflation expectations.
    Let me turn now to the implications of these developments 
for monetary policy. The FOMC has responded aggressively to the 
weaker outlook for economic activity, having reduced its target 
for the Federal funds rate by 225 basis points since last 
summer. As the Committee noted in its most recent post-meeting 
statement, the intent of those actions has been to help promote 
moderate growth over time and to mitigate the risks to economic 
activity.
    A critical task for the Federal Reserve over the course of 
this year will be to assess whether the stance of monetary 
policy is properly calibrated to foster our mandated objectives 
of maximum employment and price stability in an environment of 
downside risks to growth, stressed financial conditions, and 
inflation pressures. In particular, the FOMC will need to judge 
whether the policy actions taken thus far are having their 
intended effects. Monetary policy works with a lag. Therefore, 
our policy stance must be determined in light of the medium-
term forecast for real activity and inflation as well as by the 
risks to that forecast. Although the FOMC participants' 
economic projections envision an improving economic picture, it 
is important to recognize that downside risks to growth remain. 
The FOMC will be carefully evaluating incoming information 
bearing on the economic outlook and will act in a timely manner 
as needed to support growth and to provide adequate insurance 
against downside risks.
    Finally, I would like to say a few words about the Federal 
Reserve's recent actions to protect consumers in their 
financial transactions. In December, following up on a 
commitment I made at the time of our report last July, the 
Board issued for public comment a comprehensive set of new 
regulations to prohibit unfair or deceptive practices in the 
mortgage market, under the authority granted us by the Home 
Ownership and Equity Protection Act of 1994. The proposed rules 
would apply to all mortgage lenders and would establish lending 
standards to help ensure that consumers who seek mortgage 
credit receive loans whose terms are clearly disclosed and that 
can reasonably be expected to be repaid. Accordingly, the rules 
would prohibit lenders from engaging in a pattern or practice 
of making higher-priced mortgage loans without due regard to 
consumers' ability to make the scheduled payments. In each 
case, a lender making a higher-priced loan would have to use 
third-party documents to verify the income relied on to make 
the credit decision. For higher-priced loans, the proposed 
rules would require the lender to establish an escrow account 
for the payment of property taxes and homeowners' insurance and 
would prevent the use of prepayment penalties in circumstances 
where they might trap borrowers in unaffordable loans. In 
addition, for all mortgage loans, our proposal addresses 
misleading and deceptive advertising practices, requires 
borrowers and brokers to agree in advance on the maximum fee 
that the broker may receive, bans certain practices by 
servicers that harm borrowers, and prohibits coercion of 
appraisers by lenders. We expect substantial public comment on 
our proposal, and we will carefully consider all information 
and viewpoints while moving expeditiously to adopt final rules.
    The effectiveness of the new regulations, however, will 
depend critically on strong enforcement. To that end, in 
conjunction with other Federal and State agencies, we are 
conducting compliance reviews of a range of mortgage lenders, 
including nondepository lenders. The agencies will collaborate 
in determining the lessons learned and in seeking ways to 
better cooperate in ensuring effective and consistent 
examinations of, and improved enforcement for, all categories 
of mortgage lenders.
    The Federal Reserve continues to work with financial 
institutions, public officials, and community groups around the 
country to help homeowners avoid foreclosures. We have called 
on mortgage lenders and servicers to pursue prudent loan 
workouts and have supported the development of a streamlined, 
systematic approach to expedite the loan modification process. 
We also have been providing community groups, counseling 
agencies, regulators, and others with detailed analyses to help 
identify neighborhoods at high risk from foreclosures so that 
local outreach efforts to help troubled borrowers can be as 
focused and effective as possible. We are actively pursuing 
other ways to leverage the Federal Reserve's analytical 
resources, regional presence, and community connections to 
address this critical issue.
    In addition to our consumer protection efforts in the 
mortgage area, we are working toward finalizing rules under the 
Truth in Lending Act that will require new, more informative, 
and consumer-tested disclosures by credit card issuers. 
Separately, we are actively reviewing potentially unfair and 
deceptive practices by issuers of credit cards. Using the 
Board's authority under the Federal Trade Commission Act, we 
expect to issue proposed rules regarding these practices this 
spring.
    Thank you. I would be pleased to take your questions.
    Chairman Dodd. Thank you very much, Mr. Chairman.
    We will make these 7 to 8 minutes, and, again, I will not 
be rigid about the time constraints.
    Let me begin, Mr. Chairman, by going back to that old 
question that was asked more than, I guess, 30 years ago. I 
will sort of paraphrase on it, and that is, are we better off 
today to respond to this situation than we were--in this case I 
want to ask 7 years ago. The question that Ronald Reagan asked, 
I think, in 1980 in that campaign, Are we better off today than 
we were yesterday? And the reason I raise that is because I 
have been struck by the similarities between 2001 and that 
period going into, potentially falling into a recession, and 
here we are in 2008.
    The parallel seems striking to me in some ways, and I want 
you to comment on this, if you could. At both moments in this 
7-year period, we are on the brink of a recession--at least it 
seems so. The Fed was cutting interest rates very aggressively. 
A major asset bubble--in this case, it was the high-tech 
community rather than housing--was bursting. Yet despite those 
similarities, the differences in the basic economic information 
seems to be very, very different as well. Americans had just 
experienced the greatest economic boom in a generation. Real 
wages had gone up substantially. Income inequality had 
narrowed. The Federal Government was in a surplus. In fact, on 
this very Committee, your predecessor came to a hearing--I do 
not know who else was on the Committee in those days, but he 
came and talked about the things we ought to think about by 
retiring the national debt entirely. There were some downsides 
to that, and we actually had a very good hearing with Alan 
Greenspan about that very question in 2001. The dollar was at 
record highs as well, and, of course, today we are in the 
opposite position, with the dollar at its lowest level since we 
began floating currencies in 1973. Inflation is at a 17-year 
high. Real wages are falling, and we are faced with record 
Government debt and deficits. A very different fact situation 
than was the case in 2001.
    In 2001, as well, one might argue that there were 
deliberate actions taken by the Federal Reserve to deal with 
rising inflation. So the steps were in response to inflation 
here. Obviously, what is provoking, I think, the action--and 
you can certainly comment on this--is a different fact 
situation.
    So the question appears in a sense: Are we in a--what would 
be your analysis? Are we in a--comparing these two periods in 
time of history, relatively close to each other, faced with 
similar situations, it would appear to me that we are not in as 
strong a position to respond to this as we were in 2001. And so 
the question is, Are we better off? And if so, I would like you 
to explain why. And if not, what should we be doing and what 
different steps should we be taking if we cannot rely on these 
basic underlying strengths that occurred in 2001 that helped us 
at that time as opposed to where we are today?
    Mr. Bernanke. Mr. Chairman, there are certainly some 
similarities with the 2001 experience, most obviously the sharp 
change in asset price. In the previous case, it was the stock 
market, the tech stocks; in this case, it is home prices. But 
there are some important differences as well, as you point out. 
The decline in home prices is creating a much broader set of 
issues, both for borrowers and homeowners, but also for the 
credit markets. And so we have a sustained disruption in the 
credit process which has gone on now since last August and is 
not yet near completion. That is a continuing drag on the 
economy and a continuing problem for us as we try to restore 
stronger growth.
    The other problem is that we do have greater inflation 
pressure at this point than we did in 2001, and that is coming 
from oil. In 2001, the price of oil was somewhere around $20. 
Today it is $100.
    Chairman Dodd. Right.
    Mr. Bernanke. The increase in commodity prices around the 
world as the global economy expands and increases demand for 
those commodities is creating an inflationary stress which is 
complicating the Federal Reserve's attempts to respond.
    In some other ways, things are different. You pointed out 
the dollar was very strong in 2001. That was in part reflective 
of a large trade deficit at that time. It has since 
depreciated. But, on the other hand, part of the effect of that 
depreciation has been that we are at least seeing some 
improvement in that trade deficit, which is a positive factor.
    On the fiscal situation, I agree we are in a less 
advantageous situation than we were. The deficit is certainly 
higher, and perhaps even more seriously, we are now 7 years 
further on toward the retirement of the baby boomers and the 
entitlements, and those costs that are certainly bearing down 
on us as we speak.
    So it is a difficult situation, and there are multiple 
factors. I think there are some similarities, but as a Russian 
novelist once said, ``Unhappy families are all unhappy in their 
own way,'' and every period of financial and economic stress 
has unique characteristics.
    Chairman Dodd. Well, do you have any recommendations, then, 
differently here? If we are responding in a very similar way 
with different underlying economic fact situations, are there 
other things we ought to be doing here, taking any kind of a 
different approach? Or are we secure in feeling that the 
present course of action being taken by the Fed and by the 
administration is going to produce the desired results? That 
period of recession lasted about 8 months. There are fears that 
this one, if it takes hold, could be far more long-lasting for 
the very reasons we have outlined in the underlying problems 
economically that exist.
    Mr. Bernanke. Well, to some extent, the private sector is 
going to have to work through the problems in the financial 
markets. That is something that they will have to do with the 
help and guidance of the regulators and the supervisors, which 
we are certainly doing. We are reviewing our practices and our 
policies and trying to see how we can improve them.
    With respect to the broader economy, of course, we have 
both monetary and fiscal policy action now underway, which I 
hope will, and we project will, lead to stronger growth in the 
second half of this year. An important issue, as you have 
already alluded to, is the effects of the home price declines 
on consumers and, in particular, the delinquencies and 
foreclosures which we are now seeing.
    I have described briefly in my remarks some of the things 
that we have done in calling on private servicers and lenders 
to scale up their activities, to use more streamlined 
processes. I think it is important for us and for the servicers 
to move beyond temporary palliatives that they are using in 
many cases with delinquent borrowers and try to find more 
permanent, sustainable solutions in terms of restructuring 
mortgages or refinancing into the FHA or other mechanisms.
    Congress has already taken some steps, as you mentioned, 
and would urge you to continue to work on FHA modernization and 
GSE reform.
    Chairman Dodd. Right.
    Mr. Bernanke. Those are two areas that can help us meet 
these challenges.
    Additional steps may be necessary in the future, but at 
this point, I think we have taken a number of useful steps. We 
need to keep thinking about possible future options, but I do 
not have any additional recommendations right now.
    Chairman Dodd. I do not want to put words in your mouth, 
obviously, at all here, but I am looking at--obviously the 
housing burst or bubble, the burst of that bubble is, I think, 
far more dangerous than a high-tech problem, as you make those 
comparisons. Inflation and trade deficits are worse. Am I 
hearing you correctly that we are actually in a worse position 
today to respond to this than we were 8 years ago? Is that how 
I hear what you are saying?
    Mr. Bernanke. I think that is fair in that both fiscal and 
monetary policy face some additional constraints. Many people 
owned stocks, too, of course, and so that affected their wealth 
and their willingness to spend. But, in fact, the effects of 
the stock market declines in 2001 were primarily on investment 
firms than on consumers. In this case, the consumers are taking 
the brunt of the effects.
    Chairman Dodd. That is a good additional point. I did not 
make that.
    Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Bernanke, as I noted earlier, wholesale prices 
rose by 1 percent in January and 7.4 percent over the past 
year. This is the fastest increase in 26 years. In your opening 
statement, you noted greater upside risks to both overall and 
core inflation than we saw previously. Additionally, the most 
recent minutes of the Federal Open Market Committee gave 
anecdotal evidence that in some instances these price increases 
were passed on to consumers. The FOMC also noted a risk that 
inflation expectations could become less anchored.
    Do you have any concern at all that the 225 basis-point cut 
to the Federal funds rate has limited the options that can be 
used to combat the upside risk of inflation?
    Mr. Bernanke. Well, Senator, to answer that question, the 
PPI, the Producer Price Index, that you referred to mostly 
reflects the effects of large increases in prices of energy and 
other commodities. We live in a world where energy and metals 
and other commodities are globally traded, food as well, and 
demand of emerging market economies and a growing global 
economy has put pressure on the available supplies of those 
resources and has driven up those prices. And as I mentioned, 
the price of oil has quintupled or more.
    Senator Shelby. Do you see that abating?
    Mr. Bernanke. In 2007, the price of oil rose by about two-
thirds, and I suspect--and the futures markets agree--that it 
is much more likely that oil prices, while remaining high, will 
not increase by anything like that amount going forward. If oil 
prices and food prices do stabilize to some extent, even if 
they do not fall, that will be sufficient to bring inflation 
down as we have projected.
    Now, you are correct, though, that we do have to be very 
cautious. While we cannot do much about oil prices or food 
prices in the short run, we do have to be careful to make sure 
that those prices do not either feed substantially into other 
types of prices, other goods and services produced 
domestically, and that they do not dislodge inflation 
expectations or make the public less confident that the Federal 
Reserve will, in fact, control inflation, as we will.
    So we do have to watch those things very carefully, and 
will watch them very carefully.
    Senator Shelby. Is that what some of us would talk about, 
the psychology of inflation?
    Mr. Bernanke. Well, that is another way to put it. But, 
yes, inflation expectations essentially are measured many 
different ways, and I think the evidence is that they remain 
pretty stable. If you look at forecasters' long-term inflation 
expectations, consumer surveys, and even the financial markets, 
they show that inflation expectations remain reasonably well 
anchored. But it is certainly something we have to watch very 
carefully.
    Senator Shelby. Do you believe that setting a Fed funds 
rate target lower than the inflation rate--that is, a negative 
real rate of interest--can be an appropriate response to an 
economic slowdown? In other words, how long can the Fed run a 
negative real rate before inflationary pressures grow to 
dangerous levels?
    Mr. Bernanke. Well, Senator, there are different ways to 
measure the real interest rate. The one that is relevant is the 
one that is looking forward, and, again, if oil prices do not 
continue to rise at this pace they have, I think we would still 
be on the positive side of the real interest rate.
    Now, in the past, the Fed has for short periods lowered the 
rate to a negative level, but as you point out, that is not 
something you want to do for a sustained period.
    Senator Shelby. The Fed cannot ignore price stability, can 
it, when you are making these decisions to have more liquidity 
in the financial market?
    Mr. Bernanke. Senator, we are facing a situation where we 
have simultaneously a slowdown in the economy, stress in the 
financial markets, and inflation pressure coming from these 
commodity prices abroad. And each of those things represents a 
challenge. We have to make our policy in trying to balance 
those different risks in a way that will get the best possible 
outcome for the American economy.
    Senator Shelby. Would you be trying to avoid stagflation, 
as some people call it?
    Mr. Bernanke. I do not anticipate stagflation. I do not 
think we are anywhere near the situation that prevailed in the 
1970's. I do expect inflation to come down. If it does not, we 
will have to react to it, but I do expect that inflation will 
come down and that we will have both return to growth and price 
stability as we move forward.
    Senator Shelby. Do you still believe that the fundamentals 
of our economy is still robust, is strong, other than the 
housing market and some of the financial challenges that we 
have coming out of that?
    Mr. Bernanke. Senator, I realize my testimony was not the 
most cheerful thing you will hear today, and I was thinking 
very much about the short-term challenges that we face in terms 
of the financial markets and growth and inflation. But I do 
very much believe that the U.S. economy will return to a strong 
growth path with price stability. We have enormous resources, 
resilience, productivity, and I am quite confident in the 
American economy and the American people that we will have 
strong economic growth in the next few years.
    Senator Shelby. Mr. Chairman, a commonly watched measure of 
inflation, as you well know, is the core CPI. Housing 
constitutes, I understand, almost a third of the core CPI. To 
what extent has the recent decline in housing prices moderated 
recent increases in the core CPI? As housing prices go down, 
inflation, you know, should play here in a negative way, should 
it not?
    Mr. Bernanke. Well, Senator, not necessarily. You can get 
actually a perverse effect, which is that as house prices----
    Senator Shelby. And how would that work?
    Mr. Bernanke. As house prices fall, people will become more 
reluctant to buy a house because they are afraid that the house 
price will keep falling, so they rent instead. And that puts 
pressure on rents and actually could drive up the rent.
    Senator Shelby. Good for the landlords and bad for the 
sellers.
    Mr. Bernanke. It can be, and the way the Bureau of Labor 
Statistics calculates the cost of homeownership, it uses a lot 
of information from measured rents. So you can actually get--as 
we did last year--a period where the cost of homeownership as 
measured by the BLS actually went up, even though house prices 
were coming down, because of the fact that people were renting 
more and rental costs were going up. That effect has moderated 
somewhat recently, and that has helped to keep down----
    Senator Shelby. What would be the trend from your 
perspective in the core CPI if house prices were excluded?
    Mr. Bernanke. House prices are not included----
    Senator Shelby. I know they are not, but what if you did 
exclude them? What would be the trend in the core CPI?
    Mr. Bernanke. I am sorry. House prices are not included in 
the----
    Senator Shelby. OK, they are not.
    Mr. Bernanke. In the CPI. What is included----
    Senator Shelby. They are excluded.
    Mr. Bernanke. The measure of shelter costs is related to 
rents drawn from various sources.
    Senator Shelby. One more question, Mr. Chairman.
    What do you judge to be the threat of slow growth 
continuing with inflation remaining above the Federal Reserve's 
comfort level? What would you say to that? In other words, what 
do you judge to be the threat of the slow growth continuing 
with inflation remaining above your comfort level?
    Mr. Bernanke. Well, we are certainly aiming to achieve our 
mandate, which is maximum employment and price stability. We 
project that that will be happening. We are watching very 
carefully because there are risks to those projections. One of 
the risks, obviously, is the performance of the financial 
markets, and that again, as I mentioned before, complicates the 
situation.
    As events unfold--and certainly there are many things that 
we cannot control or cannot anticipate at this point--we are 
simply going to have to keep weighing the different risks and 
trying to find an appropriate balance for policy going forward.
    Senator Shelby. As a bank regulator, too--this will be my 
last question, Mr. Chairman--do you fear some bank failures in 
this country? I know there are big risks where they are heavily 
involved in real estate lending. Does that bother you as a bank 
regulator?
    Mr. Bernanke. Well, I believe the FDIC and the OCC have 
recently provided some information. There probably will be some 
bank failures. There are, for example, some small or in many 
cases de novo banks that are heavily invested in real estate in 
locales where prices have fallen, and, therefore, they would be 
under some pressure. So I expect there will be some failures.
    Among the largest banks, the capital ratios remain good, 
and I do not anticipate any serious problems of that sort among 
the large internationally active banks that make up a very 
substantial part of our banking system.
    Senator Shelby. Do you see some of those larger banks 
seeking additional capital to bolster themselves?
    Mr. Bernanke. They have already sought something on the 
order of $75 billion in capital in the last quarter.
    Senator Shelby. Is that enough?
    Mr. Bernanke. I would like to see them get more. They have 
enough now certainly to remain solvent and to remain above, 
well above their minimum capital levels. But I am concerned 
that banks will be pulling back and not making new loans and 
providing the credit, which is the lifeblood of the economy. In 
order to be able to do that, they need in many cases--not all 
cases, but in some cases at least--they need to get more 
capital.
    Senator Shelby. Thank you.
    Chairman Dodd. Thank you very much, Mr. Chairman.
    Let me just say to the Chairman, I said this to him 
privately, but I really appreciate your candor in all of this. 
Your job is not to be a cheerleader but to lay out for us 
exactly how you see things. And I for one, anyway--I do not 
know if other Members feel likewise, but I am very appreciative 
of the fact that you are very clear and very straightforward on 
your assessment of these matters, and that is important.
    Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman. And, 
Chairman Bernanke, welcome. I will say first that you bring to 
this very challenging job great intellect and great integrity, 
and I appreciate it very much. And it is a daunting moment in 
our economic history.
    You said in rather unemotional terms, characteristically 
talked about the squeeze that families are feeling. What I have 
heard in Rhode Island is exactly the same thing: increased 
costs for practically everything you need, flat wages, and then 
the housing problem taking away that sense of well reserve if 
something goes wrong.
    In fact, I was particularly struck by comments that were 
related to me about the bakers in Rhode Island, the family 
bakeries who have seen the price of wheat go up 200, 300, 400 
percent. It is unprecedented, frankly. And if that continues, 
we are going to have real serious, serious problems, as you 
alluded to.
    The Fed has two major responsibilities: monetary policy but 
regulation of large financial institutions. And in that latter 
category, I alluded to this in our last conversation in the 
Committee about your take on, frankly, how well you have 
activated your regulatory responsibilities in these last few 
years.
    We have seen major institutions write off billions of 
dollars, and mostly because of off-balance-sheet transactions. 
And it is quite clear that the Fed is there on a daily basis in 
all the institutions. I think the former Chairman of the CEA, 
Martin Feldstein, wrote, ``The Fed's banking examiners have 
complete access to all the financial transactions of the banks 
that they supervise and should have the technical expertise to 
evaluate the risks that those banks are taking.''
    Well, it seems quite clear now, with the restatement of 
balance sheets that these banks are taking lots of risks that 
they did not really see as risks.
    Are you satisfied that you have in place the regulatory 
procedures? And are you--I do not know what the right word is--
disappointed that your regulatory apparatus did not alert the 
banks or monitor the banks more closely over the last several 
months?
    Mr. Bernanke. Well, Senator, you raise some important 
questions. First of all, we and our fellow regulators, both in 
the United States and around the world, are engaged, as you 
might imagine, in a very serious review of what has happened 
and what we can do better in the future. The Federal Reserve 
itself is looking at our own practices and staffing and all 
those issues. The President's Working Group is working on a set 
of recommendations looking broadly at the financial markets and 
the problems that arose. And all of those discussions and 
information will be feeding into an international analysis--the 
Financial Stability Forum, the Basel Committee, international 
groups of financial regulators, central banks, Finance 
Ministers, and so on--which will try to determine, what the 
problems were, where we can do better, and what we have learned 
from this episode. So we are certainly doing a lot of stock 
taking and trying to determine where there were problems.
    In terms of the banks it should be emphasized that we do 
work very closely with the other regulators--the OCC, the FDIC, 
and others, depending on the type of bank. Our focus, I think 
of necessity, is for the most part on things such as the 
overall structure of risk management, the practices and 
procedures that the banks follow.
    It is very difficult for us to second-guess the specific 
asset price or asset purchase decisions that they make. I think 
going forward we do need to look in a much tougher way at the 
risk management and risk measurement procedures that the banks 
have. But, again, it is very difficult for us to tell a bank 
that--when they make a certain investment that they think it is 
a good investment, and they have done all the due diligence--
that it is a bad investment. That is not usually our role.
    Senator Reed. Let me follow up with two questions and ask 
for a brief response. First, when do you anticipate sharing 
with this Committee the results of this analysis you are doing 
of your regulatory position within the next several months in a 
detailed basis?
    Mr. Bernanke. Well, the President's Working Group and then 
the international bodies--the Financial Stability Forum, the 
Basel Committee--are anticipating sharing these reports within 
the next couple of months. The Financial Stability Forum has 
already issued a preliminary interim report trying to identify 
the areas of weakness and problems.
    Senator Reed. Another question, and this goes back to sort 
of the level of detail. Do your examiners look at what is 
happening on the trading desks of these large institutions in 
real time and then compare it to what is happening on the asset 
side? I mean, there has been a suggestion in some institutions 
that while they were being booked, some of these investments, 
at a reasonably high price, the traders were selling at a deep 
discount. Is that something that you did or propose to do in 
the future?
    Mr. Bernanke. Well, again, we cannot look over the shoulder 
of every trader on every trade, but what we can try to do is 
ensure that the systems exist so that the bank is ensuring that 
the appropriate markdowns are taking place so that they are 
consistent between the trade and the booking. So we do look at 
the systems and the risk management systems to try to determine 
if they are properly managed.
    Senator Reed. Well, you know, I think we have a problem 
here, frankly, maybe because--and, again, you can take a 
systematic procedure, see that the procedures are all in place, 
but if the procedures are missing a major point or the 
assumptions underlying the procedures are outdated--and I would 
hope that your review would be prompt and timely and allow us 
to see details of what you have been looking at.
    Let me ask a question. You brought up Basel II. One of the 
aspects of Basel II, to my understanding, is a reliance on 
ratings and rating agencies. In fact, it has been reported that 
Northern Rock, the British institution that failed that has now 
been nationalized by the British Government, was able to lower 
their risk-weighted assets by 44 percent under Basel II. The 
CEO at the time described it as the ``benefits of Basel.'' I 
suspect he is not describing it as that--certainly the Prime 
Minister is not describing it as the ``benefits of Basel'' now.
    Does that give you pause with respect to rushing forward 
with Basel II?
    Mr. Bernanke. Well, Basel II, I still believe, is the right 
direction. It is based on properly measuring risk and relating 
capital to the amount of risk that you are taking. I think in 
the case of Northern Rock, the real, most serious problems were 
not in the asset quality but, in fact, were due to a lack of 
liquidity planning because they did not have sources of 
liquidity when the run occurred, essentially. And we in our 
implementation of Basel II here in the United States do make 
liquidity planning an important part of our analysis.
    You mentioned credit ratings. It is true that credit 
ratings do play a role in some of the Basel II risk 
evaluations. They do not play a unique role. It is generally 
the case that banks are expected to make independent 
evaluations along with taking information from the credit 
ratings. However, this is certainly one of the areas where the 
Basel Committee, in reviewing the lessons of the recent events, 
is looking carefully on how or whether to use credit ratings in 
the risk measurement process.
    Senator Reed. Thank you, Mr. Chairman.
    Thank you, Chairman Dodd.
    Chairman Dodd. Yes, excellent questions. And, Mr. Chairman, 
just picking up on Jack Reed's questions here, it may be 
worth--I had not thought about the Basel implications. We have 
looked at this thing, obviously, in a more parochial way, but I 
might ask the Chairman of the Fed to give us--we had one 
hearing on this. Senator Shelby cares deeply about this issue, 
as I do as well, the rating agencies. It is a complicated 
issue. But I think all of us would be deeply appreciative of 
some ideas from the Fed to us. If there is any need here for 
legislative action at all in this area, we would be very 
interested in hearing your thoughts and ideas on that as well.
    Mr. Bernanke. Senator, the Basel Accord is implemented by 
regulation, and we have determined a joint action by the four 
bank regulators. We are working together through regulation to 
try to make improvements. We will certainly take a lot of 
advice from the Basel Committee and the changes and suggestions 
that they make.
    We have a very conservative process in place for 
introducing the Basel II system, which includes several years 
of transition floors that will not allow capital to decline 
very much, and a lookback study that will review the experience 
both here in the United States and elsewhere to try to 
understand and make sure that we are confident that the system 
is going to develop appropriately and provide enough capital 
for banks.
    So we will be taking the lessons of the recent experience 
very much to heart and incorporating them in the system. Basel 
II has the virtue of being flexible enough that it can adjust 
when you make changes like this. So I do not think at this 
point that legislation is necessary.
    Chairman Dodd. OK. Well, I am pleased to hear that, and as 
I said, it is an excellent question that Senator Reed has 
asked.
    Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman, and 
welcome, Chairman Bernanke. I trust you saw the piece in this 
morning's Wall Street Journal, the op-ed piece by Allan 
Meltzer.
    Mr. Bernanke. Yes.
    Senator Bennett. ``That 1970's Show.'' I will give you an 
opportunity to comment on that.
    Mr. Bernanke. Well, Mr. Meltzer, who is an excellent 
economist and indeed who is a historian of the Federal Reserve, 
is concerned that the current situation will begin to look like 
the 1970s, with very high inflation and high unemployment. I 
would dispute his analysis on the grounds that I do believe 
that monetary policy has to be forward looking, has to be based 
on where we think the economy and the inflation rate are 
heading. And as I said, the current inflation is due primarily 
to commodity prices--oil and energy and other prices--that are 
being set in global markets. I believe that those prices are 
likely to stabilize, or at least not to continue to rise at the 
pace that we have seen recently. If that is the case, then 
inflation should come down, and we should have, therefore, the 
ability to respond to what is both a slowdown in growth and a 
significant problem in the financial markets.
    He is correct, however, that there is some risk, and if the 
inflation expectations look to be coming unmoored, or if the 
prices of energy and commodities begin to feed into other costs 
of goods and services, we would have to take that very 
seriously. I mentioned that core inflation last year was 2.1 
percent, so it is food prices and energy prices, which are 
internationally traded commodities, which are the bulk of the 
inflation problem.
    Again, we do have to watch it very carefully, but I do not 
think we are anywhere near the 1970s type situation.
    Senator Bennett. Thank you. I wanted to get that on the 
record.
    As I look at the housing market and talk to some of my 
friends who are in the housing market, they tell me that the 
inventory is not monolithic, the inventory overhang--that is 
that the bulk of the overhang is in the higher-priced homes, 
because home builders wanted to build places where they would 
get the highest margin return, and if they built houses in the 
moderate housing area or affordable housing, their margins were 
not nearly as great and there were plenty of speculators 
willing to buy the bigger homes. And, indeed, they tell me that 
for affordable housing, there is, frankly, not a sufficient 
supply right now.
    They are urging me to do something on fiscal policy to 
stimulate people to build cheaper houses, that the housing 
construction would begin to catch up--not catch up. 
Construction levels would begin to pick up, whereas now they 
are dormant, waiting for the overhang to be worked off.
    Do you have any data that supports that anecdotal report?
    Mr. Bernanke. Well, we do have some data on investor-owned 
properties, and that has been increasing quite a bit. And my 
recollection is that among the mortgages that are having 
problems, something on the order of 20 percent of them are 
investor-owned; therefore, it is not a family that is being in 
risk of losing their home. So that is a significant 
consideration, and I think that in those cases investors who 
make a bad investment should bear the consequences.
    Senator Bennett. That is my own attitude as well. But we 
are having conversations about stimulus packages around here, 
and it had not occurred to me, until I had this information 
from people in the housing market, that if we could stimulate 
people to buy the lower-priced houses, and those are the people 
who need the shelter, anyway, and there is not a surplus of 
inventory there, that that would have a very salutary effect 
both in terms of taking care of people's needs and on the 
economy, because home builders would start to build again, they 
just would not be building in that portion of the housing 
market where there is an oversupply. But you do not have any 
specific data as to where the price points are in the inventory 
overhang?
    Mr. Bernanke. I could probably obtain such data. I am not 
sure that directly trying to stimulate specific types of house 
construction is necessarily the most efficient way to go about 
it. Probably the better thing is to try to ensure strong 
employment so people have the income and they can purchase the 
home they want to have, or they can rent if they prefer. But I 
do not have the data with me.
    Senator Bennett. Well, I would appreciate it if we could 
get some because I find this an intriguing idea. I know in 
Utah, which has not been hurt as badly by the housing problem 
as some other States--because we generate something like 30,000 
new families every year that need houses. But in Utah, above a 
certain level, around $400,000, there is a glut of houses on 
the market and, therefore, nobody in that market or above can 
sell their house. But for houses in the $200,000 area, which we 
would now begin to think of as an affordable housing range, 
there does seem to be something of a shortage.
    So if you have any data on that that you could share with 
us, I would appreciate it. Because as we formulate the stimulus 
package, Mr. Chairman, this is something I think we ought to 
look at. It is a little more sophisticated and has drilled down 
through the data to a more granular level. But anything we can 
do to get the construction business started--you say, well, it 
is maybe too long term out, but there are a lot of jobs that 
people can get in the construction business if they are 
building the lower-priced houses that right now the 
construction workers do not have anything to do.
    Mr. Bernanke. Senator, one thing that is certainly true is 
that a lot of the big house price declines are taking place in 
high-priced areas like California and Florida, Nevada, Arizona, 
where prices went up a lot before, and now they are coming back 
down.
    Senator Bennett. That is the price range that it is hitting 
in Utah as well.
    Thank you, Mr. Chairman.
    Chairman Dodd. Not at all. And I might have missed this in 
your point here, but seemingly one of the issues we are 
grappling with here is the oversupply. And you are raising a 
different question. Where is that oversupply occurring? But one 
of the concerns I have is that allowing the market to take over 
here, if your supply increases and demand is not keeping pace, 
then obviously your ability for the market to really help 
stabilize this problem here is going to be de minimis, it seems 
to me.
    Senator Bennett. My point is that the market is not 
monolithic. There is an oversupply at the high range, but I am 
being told that in the lower range----
    Chairman Dodd. Well, that is a good question and one we 
ought to--if you have the ability to give us some information 
on that, I would be very interested in that as well, Mr. 
Chairman.
    Let me turn to Senator Menendez.
    Senator Menendez. Thank you.
    Thank you, Mr. Chairman, for your testimony and your 
service. It seems to me--and I am sure all of us--that the 
central bank is faced increasingly with the contradictory 
pressures of the slowing economy and rising consumer prices--
gas prices, food prices, energy prices as a whole, to name a 
few. Isn't revving up a slow economy far easier than slowing 
inflation once it has become entrenched?
    Mr. Bernanke. As you say, if it becomes entrenched, if 
inflation expectations were to rise and that were to lead to a 
wage-price spiral, for example, or, non-energy, non-food prices 
rising more quickly, that would be more of a concern. As I 
said, we are concerned. I do not wish to convey in any way that 
we are not concerned about it. We are trying to balance a 
number of different risks against each other.
    With respect to inflation, as I said, our anticipation is 
that inflation will come down this year and be close to price 
stability this year and next year. If it does not, then what we 
will be watching particularly carefully is whether or not 
inflation expectations or non-energy, non-food prices are 
beginning to show evidence of entrenchment, of higher 
inflation, as you point out. That would certainly be of 
significant concern to us and one that we are watching very 
carefully.
    Senator Menendez. Let me ask you, with consumers reluctant 
to spend and businesses reluctant to invest and lenders 
reluctant to lend and home prices going downwards, is the lower 
interest rates, do you believe, going to be enough to do the 
trick?
    Mr. Bernanke. Well, I think it is certainly helpful, and we 
also have a fiscal package, as you know. A lot is going to 
depend on the underlying resilience of the economy itself and 
of the financial system to work through these problems and to 
bring us back to a situation where we can grow in a normal way.
    Senator Menendez. How about something that you do not have 
control over, which is the foreign confidence in the American 
dollar? Isn't your ability to continue to cut rates to some 
degree restrained by the willingness of foreign countries to 
continue to finance the current account deficit?
    Mr. Bernanke. Well, it is a complex question. We----
    Senator Menendez. Can you give me a simple answer?
    Mr. Bernanke. I will try. It is important for the U.S. 
economy to be strong and an attractive place for investment. 
And I think we are better off in the medium term trying to 
ensure good, strong growth in the economy to attract foreign 
investment than we are falling behind and allowing the economy 
to drop into a severe decline.
    So there is a balance there. We have to think about the 
short-term return, which is partly related to our interest rate 
decisions, but we also need to think about the medium term, 
where we want to make sure the economy is growing in a stable 
and healthy way which will attract foreign investment.
    Foreign investment, I should emphasize, continues to be 
strong. We are not seeing any significant shifts of out of 
dollars among official holders, for example. And I anticipate 
that we will continue to have the capital inflows we need, in 
part, going back to my earlier comments, because I do think 
that the world recognizes that the U.S. economy has underlying 
strengths and resilience that will bring us back to a strong 
growth path within the next couple of years.
    Senator Menendez. If then the Fed's decision at this point 
in time--of course, it always depends upon the point in time--
is that dealing with the slowing economy is the present 
priority, and as the Chairman has said on more than one 
occasion, that if there is a great challenge in the economy, it 
stems from the mortgage meltdown, the housing market meltdown, 
are we--I have a real concern. You know, in March of last year, 
I and a few others said we are going to have a foreclosure 
tsunami, and everybody pooh-poohed that and said that is an 
overexaggeration. And, unfortunately, we are well on our way, 
and we have not even seen the totality of it.
    The question is, when I see the Center for Responsible 
Lending say that basically the present administration's plans 
will only deal with 3 percent of the properties, removing them 
from foreclosure, and I see Moody's saying that the experience 
of 2007 is largely around 3.5 percent of workout, at the end of 
the day is a 97-percent market correction something that we are 
willing to accept and something that we need to accept? Or is 
that a percentage that is far too high?
    Mr. Bernanke. Senator, there have been about four or five 
studies reviewing the experience of servicers and lenders and 
trying to work out mortgages, and, unfortunately, we are still 
getting a very mixed and fuzzy picture about exactly what is 
happening. One of the benefits, I think, of some of the recent 
actions associated with the Hope Now Alliance, for example, is 
that I hope we will be getting better, more up-to-date, and 
more consistent data on what is actually happening in the 
field.
    I do agree that while the servicers seem to have made some 
progress in scaling up their activities, they are not yet to 
the point where they can deal with what you called the 
``tsunami of foreclosures,'' which is already well underway. 
And for that reason, we continue to urge them to expand their 
efforts further, to work toward more permanent solutions.
    Senator Menendez. But if that were to be the figure, is 
that an acceptable market correction figure, 97 percent of the 
couple of million families in this country ready to lose their 
home? Is that what we are willing to accept, both in the 
context of public policy as well as in the context of our 
economy?
    Mr. Bernanke. Well, even under regular circumstances, 
unlike what we have today, the number of foreclosure starts 
that actually ends in an eviction or a sale is well less than 
97 percent. So I am not quite sure what to compare it to. 
Obviously, the more people who are able and desire to stay in 
their home, the more we can help, the better that is going to 
be. And I strongly support increased efforts by the servicers 
and lenders to address this issue.
    Senator Menendez. Well, my concern is we were behind the 
curve in trying to deal with the issue, and my concern is now 
we seem to be continuing behind the curve in stemming the 
hemorrhaging that is going on.
    One last question. The central bank has always seen its 
core mission as safety and soundness. Consumer protection I 
hope is going to increasingly be something that you will 
consider a core mission as well. And I heard your remarks at 
the very end of your testimony.
    Is it your intention--when you talk about issuing something 
on unfair and deceptive practices, is that in relation to 
credit cards, mortgages, to REITs? Is it cross-cutting?
    Mr. Bernanke. We have already issued the HOEPA rules, which 
address unfair, deceptive acts and practices relating to 
mortgages, for comment. We are currently receiving comments on 
those.
    The new rules, which I alluded to, for the spring are under 
the FTC unfair, deceptive acts and practices code, and they 
would apply to credit cards, and possibly other things, but 
primarily credit cards.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman, and thank you, 
Chairman Bernanke.
    Mr. Chairman, we have to, I think, remind ourselves exactly 
what is involved in a recession. I hear the reporters, I think 
erroneously, reporting a recession when actually we are having 
an economic slowdown. I would like to have you define for the 
Committee what would constitute a recession.
    Mr. Bernanke. Well, recessions are generally called, so to 
speak, by a committee called the Business Cycle Dating 
Committee, which is part of the National Bureau of Economic 
Research--a committee of which I was once a member, by the 
way--which looks at a wide variety of indicators to see 
essentially if the economy contracted over a period of time. It 
is a somewhat subjective decision, and it is often made well 
after the fact because of the revisions of data and so on.
    A more informal but widely used definition of recession is 
two consecutive quarters of negative growth. That would be an 
alternative that people use.
    Senator Allard. There was a newspaper article or report 
that came out, I think in the last day or two, suggesting that 
somehow or other the Federal--or you and the Fed may be running 
out of tools to control inflation. Do you have a comment on 
that comment?
    Mr. Bernanke. Well, as I said, we are trying to use our 
principal tool, which is the Federal funds rate, to balance the 
various risks that we see in inflation and growth and financial 
stability. We do not really have additional tools on inflation. 
We do have additional tools to deal with financial problems, 
such as, the term auction facility, which we are currently 
using, and other steps that we have taken or could take.
    With respect to inflation, I think our principal tool would 
be the interest rate.
    Senator Allard. Now, the Congress, through public policy, I 
think on a macro scale, may have some impact on the economy. 
And in general terms, if the Congress was to increase spending, 
what do you feel would--what kind of an impact would that have 
on the economy? And then look at the other side. Suppose 
Congress would increase taxes. What kind of an impact would 
that have perhaps on today's economy where we are standing?
    Mr. Bernanke. Well, from a short-term aggregate demand 
viewpoint, spending tends to add to demand, and if the economy 
is at a point where its resources are not being fully utilized, 
it could lead to more increased utilization of resources; 
whereas, higher taxes in a short period of time, if it reduces 
consumer spending, for example, could lead to less use of 
resources.
    The Congress has passed a fiscal stimulus package which 
tries to address the issues of aggregate demand and sufficient 
demand for utilization of resources. I would urge the Congress, 
in looking at additional spending and tax plans, to think about 
the underlying effects on the efficiency and effectiveness of 
the economy, that is, not to make decisions based on short-term 
demand considerations but to think about how these spending 
programs or tax programs affect how well the economy will grow 
over the long term.
    Senator Allard. So you are thinking about Social Security, 
Medicare, and Medicaid primarily on those costs, I would 
assume?
    Mr. Bernanke. Well, and from a fiscal perspective in the 
longer term--and by longer term, I means only a few years from 
now because we are coming very close to the point where the 
baby-boom generation is going to begin to retire in large 
number. By far, the biggest issue is entitlements, particularly 
the Medicare part, but Social Security as well.
    Senator Allard. Yes, I appreciate those comments.
    The other thing, you talk about, you know, inflation being 
pushed by energy and food costs. What is offsetting that? There 
must be some--to come out with an average of 2 percent, a 
little over 2 percent, there must be somewhere over here where 
we are getting a lesser amount that is offsetting those 
increases. Where do you see that happening?
    Mr. Bernanke. Well, what we saw in 2007 was about 2-percent 
inflation excluding energy and food. When you add on the energy 
and food, you get something more like 3.5 percent by our 
preferred indicator, which is obviously a high rate of 
inflation and we are not comfortable with.
    Senator Allard. So you do not see a sector of the economy 
that is being driven down in a way that it has an offsetting 
effect. You are just seeing this just averaging out as a part 
of the average. OK.
    We have on ethanol, for example, on energy, we have a 
really high tariff. It is 51, 52 percent. And energy builds 
into the whole economy. It is a fundamental driver.
    What do you think about us looking at reducing some of 
those high tariffs like that? What kind of an impact would that 
have on our economy?
    Mr. Bernanke. Well, Senator, as you know, I favor open 
trade, and I think that allowing Brazilian ethanol, for 
example, would reduce cost in the United States.
    Senator Allard. And is that--when you look at the food--the 
way I look at it is when you have an ethanol--you have your 
food products being diverted to ethanol production, it has an 
impact on both food as well as the cost of energy and whatnot. 
Is it a significant enough part of the economy that we need to 
look at that more seriously?
    Mr. Bernanke. I do not have an estimate of the overall 
effect. I think it would be hard to do. But it is the case that 
a significant portion of the corn crop is now being diverted to 
ethanol, which raises corn prices. And there are some knock-on 
effects; for example, some soybean acreage has been moved to 
corn production, which probably has some effects on soybean 
prices, too. So there is some price effect on foodstuffs coming 
through the conversion to energy use.
    Senator Allard. Well, you know, the wheat farmers in my 
State are saying that wheat is at a historic high for them, and 
so I wonder just, you know, how much of that--I suppose, again, 
that is a dryland crop, but there is some conversion to dryland 
corn. But, again, that seems to have some impact on the grains 
in general, and the poultry people and the livestock people--
well, all livestock people--swine, poultry, and beef in 
particular--all have concerns about that. So I was curious to 
see how you were evaluating that policy in respect to the total 
economy, and obviously you do not have too much to say on that 
because you do not think it is too big a part of the economy. 
Is that right?
    Mr. Bernanke. Well, again, I do not know quantitatively how 
big the effect is, but there is some inflationary pressure 
coming through foods, including corn and soybeans, and 
obviously other crops like wheat which have suffered various 
supply problems in the last year.
    Senator Allard. Yes, OK. Well, Mr. Chairman, I see my time 
has run out.
    Chairman Dodd. Great questions, too, and we will come back 
to those maybe in a little bit. Senator Reed was raising with 
me privately the issue as well, and I think it is worth 
exploring. The issue of the question of the value of the 
dollar, the rising price of oil, the dollar denomination oil 
pricing, whether or not that can shift in these commodities 
generally is an interesting issue.
    But let me turn to Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman.
    Mr. Bernanke, thank you for you--Chairman Bernanke, I 
should say. Thank you for your presence today, and thank you 
for your service to our country. I think you have your 
priorities right. You mentioned that the risks in the forecast 
are to the downside and that our principal concern at this 
moment--you have to strike a balance, but our principal concern 
should be avoiding an economic downturn of severity and 
duration while continuing to focus on inflation in the longer 
term.
    As you and some of my colleagues have pointed out, the 
genesis of much of this originated in the housing sector, 
particularly with some of the subprime type mortgages. And it 
seems to me that you, in setting monetary policy, erred on the 
side of--not erred, but you have been more aggressive than less 
and tried to minimize the downside risk to the economy. And 
that is as it should be.
    My question to you is: Should not Congress do the same in 
addressing the housing problem? The President has the voluntary 
Hope Now initiative you have outlined. I think it would be 
charitable to say that the results of that have been modest to 
date. You indicate there is not a lot of data, but it certainly 
does not seem as if it has had much of an impact.
    There are some proposals, fairly narrowly circumscribed 
ones before us, that would focus on this issue, allowing 
bankruptcy courts, only with regard to outstanding subprime 
mortgages, to revisit some of these issues, only when the 
borrowers have passed a strict means test. The interest rates 
would be set at prime plus a risk premium, and if the homes 
were ever resold, the lenders would participate in the upside, 
any potential upside, if the property would revalue.
    Now, the President has threatened to veto this initiative, 
and some have claimed that it would add as much as 2 percent to 
the cost of a mortgage. I find that to be not a credible 
analysis when it, by definition, does not apply to future 
mortgages. This is a one-off event, the greatest housing 
downturn in the last 50 years, fairly narrowly circumscribed.
    So my question to you is: Just as you have emphasized being 
more aggressive at this moment, should not we? And as an 
economist, is it credible to think that this would add 2 
percent to the cost of a mortgage moving forward in this 
narrowly circumscribed manner?
    Mr. Bernanke. I do not know how much it would add. I think 
it would probably add something because the collateral would be 
less secure.
    Senator Bayh. This only applies to past loans, by 
definition, not future ones.
    Mr. Bernanke. Well, then the question is raised: Will this 
happen again?
    Senator Bayh. Well, every 50 years when we have a calamity 
like this, maybe so.
    Mr. Bernanke. You know, I see concerns on both sides of 
this, and I understand the rationale for wanting to make those 
changes. I also see some concerns about the effects on the 
marketplace and, for example, on holders of current loans, how 
they would react.
    Senator Bayh. There are some implicit risks in the more 
aggressive monetary policy you have pursued.
    Mr. Bernanke. Monetary policy is my domain, and I----
    Senator Bayh. My point is and the question I am raising, 
just as you have been more aggressive--and appropriately so--
should not we?
    Mr. Bernanke. I think there is an argument for being 
aggressive in general, but I would just decline, if you would 
permit me, to endorse that particular action. I am really at 
this point focused on FHA and GSE reform as being two useful 
steps in the direction of helping the housing market. And we 
should continue to think about alternatives. But at this point 
I do not have, good additional measures to suggest to you.
    Senator Bayh. Well, I do not want to put you in the 
business of getting into the debate between the legislative and 
executive branches here, but I do think at this moment, as we 
have all recognized, this is a perilous moment for the economy. 
It seems to me that there are risks on either side, but the 
balance here, it seems to me, lies on being a little more 
aggressive than less. And that ought to apply to all aspects of 
our policy, not just one particular subset.
    We have had a big discussion here about inflation versus 
growth. Again, I think you have your priorities right in that 
regard. You have pointed out that the core rate, while modestly 
above target, has--the principal thing driving this in the near 
term has been food and energy costs, and that you do not see 
any persistent rise in the core over the longer term.
    My question, Mr. Chairman, is: What indicia of economic 
stability or greater growth would alleviate your concerns and 
would allow you to then perhaps pivot and focus on the 
inflation concern more than we currently are?
    Mr. Bernanke. Well, Senator, first, I do not want to leave 
the impression that we are looking only at one----
    Senator Bayh. No, no. You were very balanced.
    Mr. Bernanke. We are always trying to balance these risks 
and always trying to continually re-weight our thinking about 
the different risks to the economy.
    Senator Bayh. Maybe a better way to put my question would 
be: When will the risks be back in equilibrium as opposed to--
what indicia will you look at to reassure yourselves that the 
economy is stabilized and growth is resumed at an acceptable 
level?
    Mr. Bernanke. One of the concerns that I have is that there 
is some interaction between the credit market situation and the 
growth situation--that is, if the economy slows considerably, 
which reduces credit quality, that worsens potentially the 
condition of credit markets, which then may tighten credit 
further in a somewhat adverse feedback loop, if you will. I 
think that is an undesirable situation. I would feel much more 
comfortable if the credit markets were operating more nearly 
normally and if we saw forecasted growth--not necessarily 
current growth but forecasted growth--that looked like it was 
moving closer toward a more normal level.
    So what I would like to see essentially is a reduction in 
the downside risks which I have talked about, particularly the 
risk that a worsening economy will make the credit market 
situation worse.
    Senator Bayh. Well, let me ask you--but I have got only 1 
minute so I am going to need to hurry. I did have two 
questions. What aspect of the credit markets will you look to? 
And, in particular, I have been interested--you talked about 
the flight from risk. There have been some aspects of the 
credit market that seem to me to be almost without risk, and 
yet people are fleeing from those as well. These auction rate 
securities, very short term, the underlying assets, 
particularly in the municipal sector, virtually no risk of 
default, and yet that seems to have seized up as well.
    What do you think will lead people to begin to assume 
rational levels of risk again? And what indicia will you look 
to in the credit markets to reassure yourself that this 
situation is beginning to work itself through?
    Mr. Bernanke. Well, there is reluctance to take risk, and 
there are also concerns about understanding exactly what a 
particular financial asset consists of. And there are still 
some issues of transparency and so on that need to be worked 
out.
    I think that a stable situation would be one in which good 
quality credits like, major municipal borrowers would not have 
difficulty in getting credit, and the issue would be the same 
for good quality credits of firms and households as well.
    So when you see a pulling back, and seeing the problem 
spread through a variety of markets, which is interfering with 
the normal flow of credit, then obviously that is not a normal, 
healthy situation.
    Senator Bayh. Mr. Chairman, I have just one--my final 
question. Mr. Chairman, it has been visited by a couple of my 
colleagues; particularly Senator Reed I thought was excellent 
in his questioning. It has to do with the credit agencies. We 
had a couple of very capable individuals come before our caucus 
to focus on some of these economic concerns, and the issue of 
the rating agencies came up. And one of them, in response to my 
question about--markets can operate efficiently, but that 
presumes they have access to accurate information. In this 
case, you know, clearly that was not always so. And this is the 
problem with the credit markets in part you have pointed out 
here. So what can we do to avoid this again? You have mentioned 
that you and your people are looking at that.
    But when I asked the question, this individual said, 
``Well, I am not sure any additional action by the Government 
is necessary. The market will work this out. These rating 
agencies, their share prices will be punished and, therefore, 
they will have an incentive to not do this again.''
    But whether it is in regard to certain types of Latin 
American credit or other areas, it seems that the markets have 
a way of forgetting the lessons of history, focusing on short-
term decision making, every 7, 8, 10 years or so, and we kind 
of end up in some of these problems again. And the consequences 
to the broader economy here have been so profound and so great, 
it seems to me, that in addition to relying on the market, 
perhaps there should be some parameters to ensure that we do 
not end up in this situation again, which leads us to either 
regulatory or legislative action.
    So, just broadly speaking, do you think that some 
additional actions, either regulatory or legislative, may be in 
order to ensure that this situation does not repeat itself in 
the future and that we do not just simply rely upon the 
punishment of the market to prevent this in the future?
    Mr. Bernanke. Well, regulatory action is already being 
contemplated. The Securities and Exchange Commission, which has 
authority over the credit rating agencies, is reviewing the 
situation, and seeing whether additional steps need to be 
taken. Of course, the Congress already gave the SEC some 
powers, which they have begun to implement.
    The fault lies on both sides of the equation, if you will--
with the credit rates, but also with the investors, who over-
relied on those ratings and did not do sufficient due 
diligence. In that respect, as I mentioned before, the Basel 
Committee is looking at the use of ratings in risk measurement 
for banks, and I would encourage the regulators of pension 
funds and other investors, for example, to ensure that 
investors do due diligence over and above simply looking at the 
rating and assuming that is all you need to know.
    Senator Bayh. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very, very much. Again, 
some very, very good questions.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. My opening 
statement I will submit for the record.
    Chairman Dodd. By the way, I should have made that point. 
All opening statements and any supporting documents people want 
to have will all be included in the record, and I appreciate 
you raising that.
    Senator Bunning. Chairman Bernanke, can you explain what 
information or event caused the Fed to change its view on the 
conditions of the economy and the financial markets and led to 
the January 21 intermeeting rate cuts?
    Mr. Bernanke. Yes, Senator. First of all, as you know, we 
cut rates by about 100 basis points during the fall, reacting 
to the drag on the economy arising from the housing markets and 
from the credit market situation. Around the turn of the year 
and early in January, the data took a significant turn for the 
worse, and it seemed clear that the economy was slowing, and 
slowing more than anticipated, and that the credit market 
condition situation was continuing.
    On January 9, I called a meeting of the Federal Open Market 
Committee by video conference to discuss the situation. It was 
agreed by the committee that some substantial additional cuts 
in the Federal funds rate were likely to be necessary. The 
thought at the time of that meeting was that it might be worth 
waiting until the regular meeting at the end of the month where 
we could have a fuller discussion and see the revised forecast 
and so on, taking into account the possibility that we could 
also move intermeeting, if necessary.
    On January 10, I gave a speech where I informed the public 
that I thought that substantive additional action might well be 
necessary, thereby signaling that the conditions had changed 
and that further rate cuts were likely to happen.
    In the days that followed that speech, the tone of the data 
deteriorated considerably further, which made me think that the 
outlook was, in fact, much weaker and the risks were greater. 
That was showing up both in the data and in the financial 
markets. We were seeing sharp declines in equity prices. We 
were seeing widening of spreads. And we were also seeing, 
again, adverse data.
    On January 21, I became concerned that the continued 
deterioration of financial markets was signaling a loss of 
confidence in the economy, and I felt the Fed, instead of 
waiting until the meeting, really needed to get ahead of that 
and take action. So I called an FOMC conference call, and we 
agreed at that point to cut the Federal funds rate target by 75 
basis points.
    There was an understanding at that meeting that further 
additional action was very likely to be needed, but we felt 
that we could wait another 10 days until the regular meeting to 
determine exactly how much additional action. At the meeting at 
the end of January, we had a full review, discussion, forecast 
round and so on and determined that an additional 50 points was 
justified.
    Looking back, as the data have evolved, I think that the 
125 basis points was appropriate for the change in the tone of 
the economy, and I think it was the right thing to do.
    Senator Bunning. Are the days of constant and gradual Fed 
rate changes over? In other words, are large and intermeeting 
rate changes going to become a regular part of the Fed toolbox 
now?
    Mr. Bernanke. I cannot make any guarantees, Senator, but in 
general, we prefer to move at the regularly scheduled meetings. 
As I said, that is a chance to get together in Washington and 
to have a full briefing by the staff and to have all the 
information made available to us.
    Senator Bunning. How about which do you see as a greater 
threat to the economy, a credit crunch now or higher inflation 
in the future as a result of efforts to stop a credit crunch?
    Mr. Bernanke. Senator, we have to keep balancing those 
things. As I said, our current view is that inflation will 
moderate this year as oil and food prices do not rise as much 
this year as they did last year. We are also watching very 
carefully to make sure that higher oil and food prices do not 
feed into other costs and into other prices or that inflation 
expectations do not become unanchored. If those developments 
began to happen, that would certainly force us to pay very 
serious attention.
    At the moment, I think the greater risks are to the 
downside--that is, to growth and to the financial markets; but, 
again, we are always vigilant on all of our objectives and are 
always trying to balance those risks against each other.
    Senator Bunning. You read the Wall Street Journal. I am 
very sure of that. Today, in the Wall Street Journal, ``Report 
on profits a bright spot in the gloom. The Dow Jones Industrial 
Average has gained 6 percentage points since the first day of 
the year.'' In the Standard & Poor's index, 462 corporations 
have reported their earnings for the fourth quarter; 62 percent 
of those that have reported topped their earnings estimates--62 
percent. If you drop out financials, carve out financials, 
which were 12 percent lower, the gloom and doom that I have 
heard here today is not gloom and doom. Are you going to tell 
me that these same corporations that reported--and we had a 
really low growth rate in the fourth quarter--are going to be 
worse in the first quarter? Or are we also going to have the 
same kind of reporting in the first quarter of 2008 that this 
profit report on the Standard & Poor's and the Dow is not as 
accurate in the first quarter as it was in the fourth?
    Mr. Bernanke. Well, Senator, you are absolutely correct 
that profits at the nonfinancial firms have remained pretty 
good. I do not have with me an estimate of the profits for the 
first quarter. But firms seem to be indicating concerns about 
the future. For example, if you look at the ISM survey of non-
manufacturing industries, it dropped very significantly a few 
weeks ago, suggesting a good bit more pessimism on the part of 
firms.
    Senator Bunning. But isn't one of the real signals that we 
really have to watch the unemployment rate in the United States 
of America? And that moved from 4.9 to 5 percent in the fourth 
quarter. And where is it now? Where do you estimate it to go in 
the first quarter of 2008?
    Mr. Bernanke. It jumped in December from 4.7 to 5.0, which 
is a pretty significant jump, and it was certainly something 
that we looked at. And----
    Senator Bunning. Well, that was kind of indicated by the 
low growth rate and the reasonable expectation that the job 
rate would be higher, unemployment in the fourth quarter. I am 
asking about 2008.
    Mr. Bernanke. Well, I reported our projections for the 
fourth quarter, which were 5.2 to 5.3 percent in the fourth 
quarter. We are seeing unemployment insurance claims rising, 
which I think is consistent with the somewhat higher 
unemployment rate going forward.
    Senator Bunning. What are you telling me?
    Mr. Bernanke. That the unemployment rate is likely to go up 
from here.
    Senator Bunning. How bad? Are you saying 5.6, 5.7?
    Mr. Bernanke. The baseline projection we have made for the 
fourth quarter is 5.2 to 5.3, but there are downside risks. 
Things could get worse than that. We do not know. But it is not 
our main projection. It is just a risk that we see out there.
    Senator Bunning. Then does that bode well with the lowering 
of interest rates and the higher rate of unemployment? That 
indicates to me that someone in the Journal today that talked 
about stagflation might be talking more sense than we might 
anticipate.
    Mr. Bernanke. Well, again, Senator, we are just trying to 
balance the risk of growth, inflation, and financial stability. 
Monetary policy works with a lag, and, therefore, we have to--
--
    Senator Bunning. Well, I understand that very clearly. We 
should have lowered rates earlier, and all of a sudden we 
lowered them 2.25 points--225 basis points in less than--
what?--6 weeks, 8 weeks.
    Mr. Bernanke. It was 125.
    Senator Bunning. 125.
    Mr. Bernanke. Yes, Senator.
    Senator Bunning. Well, if you count the fourth quarter of 
last year, what was the total?
    Mr. Bernanke. We lowered 50 basis points in September, 25 
in October, 25 in December, and 125 in January.
    Senator Bunning. Then it was 225.
    Mr. Bernanke. Not in the fourth quarter.
    Senator Bunning. No, no. Total. Total since the last----
    Mr. Bernanke. That is right.
    Senator Bunning. That is considerable, and the market 
conditions indicated that that was absolutely necessary.
    Mr. Bernanke. I think so. The housing market decline and 
the weakness in the credit markets were suggestive of----
    Senator Bunning. Well, the weakness in the credit markets, 
Chairman Bernanke, were signaled last year, early in the year. 
I mean, it was not--it did not take a rocket scientist to 
figure that out. And I know with all the great economists that 
you have on the Federal Reserve and your members of the Federal 
Open Market Committee are a lot sharper than the people sitting 
up here at this table. And you had a big heads-up signal that 
the housing market was in the tank early last year.
    Mr. Bernanke. But the housing market was not affecting the 
broad economy. When we lowered interest rates on the last day 
of October, that morning we received a GDP report for the third 
quarter of 3.9 percent, which was subsequently revised to 4.9 
percent, and inflation was a problem. So, in fact, I think if 
we look back on this episode, we will see that the Fed lowered 
interest rates faster and more proactively in this episode 
probably than any other previous episode.
    As you point out, the unemployment rate is still below 5 
percent, and----
    Senator Bunning. I lived through the Greenspan years. I 
know exactly what you are talking about.
    Thank you.
    Chairman Dodd. Thanks very much.
    Senator Schumer.
    Senator Schumer. Mr. Chairman, with your and the 
Committee's permission, Senator Tester has to be somewhere at 
noon and so do I, so I volunteered to split my time with him 
and let him ask the first question and leave, and then I will--
if that is OK with you and the rest of the Committee.
    Chairman Dodd. Fine.
    Senator Tester. Thank you, Senator Schumer, and thank you, 
Mr. Chairman, and thank you, Chairman Bernanke. I appreciate 
your forthrightness today and always.
    I want to talk about commodities for a little bit. I am a 
farmer. I am happy when commodities go up. But as was earlier 
pointed out today, oftentimes this can end up potentially like 
it was in the 1970s when we saw a big commodity raise; we saw 
the inputs that went into agriculture go through the roof; we 
saw food prices on the shelf go up because commodity prices 
were higher; and then commodity prices fell back. Those inputs 
that went into production agriculture stayed up, and the food 
on the shelf stayed up, too, because they said there was not 
enough wheat in a loaf of bread to make a difference after they 
raised the prices because commodities went up.
    My question to you is: Do you see that playing out the same 
way? I mean, we are going to see food prices go up probably, it 
would be my guess. We already have. And we have already seen 
inputs go up on the farm for production agriculture. I 
anticipate this commodity price will not stay where it is at 
forever. They usually do adjust, and they usually adjust down. 
And food prices will stay up, inputs will stay up. Do you see 
that same thing happening again? And is there anything we can 
do if it is that way?
    Mr. Bernanke. If commodity prices come down, including 
energy prices and raw food prices, I would expect to see, 
perhaps with a lag, finished food prices come down as well. As 
we have been discussing, the commodity prices, both food and 
energy, have been the primary source of the recent inflation. 
If they stabilize, even if they remain high, then inflation 
will moderate. And I expect that would happen, at least over 
time, at the finished level as well as at the raw level.
    Senator Tester. OK. Thank you very much, and I want to 
thank Senator Schumer again. Thank you very much.
    Senator Schumer. My pleasure.
    Two questions, Mr. Chairman. The first involves these sort 
of combination, creating problems now, of marking to market and 
the credit crunch, freeze, call it what you will. You know, 
when I first got here on the Banking Committee, banks really 
did not mark to market, and we regarded it as great progress 
that they now have to mark to market, like securities firms and 
others always did. It is a proper valuation of their assets.
    The problem here is nobody knows how to mark to market 
because there is no market. In too many areas, no one is 
buying. And so you do not know what they do when they make a 
valuation. I have heard from many people that that valuation 
is--they make it artificially low, and that further 
exacerbates. It is a vicious cycle because then they do not 
have the capital, they cannot do any more lending, and 
everything is frozen up.
    Is there a way to deal with that problem now? Is there a 
way to say, yes, you have to mark to market, but in these 
unusual circumstances you can do it 6 months from now, or 
something to that effect, quarterly, yearly?
    I am not an expert here, but I do know it is a real 
problem. How do you mark to market when there is no market? And 
because there is no market, rare, almost never occurred in such 
large parts of the credit market before, is this an unusual 
circumstance where this does not work?
    And my second question--and I will ask you to answer both--
is this: The worry I think people have--and we have seen some 
questions on this--is that it is a lot easier to get the 
economy going than to shut inflation off. And the worry is that 
we go back to the situation in the late 1970s where the economy 
was stalling, rates were lowered, and then there was nothing 
that the Fed could do other than very late and drastic action 
to curb inflation. It was a difficult struggle. We went through 
it in the 1980s, and I remember paying 21 percent on my 
mortgage when I first signed my mortgage in 1982.
    Do we have better tools now that can control, you know, if 
inflation should start going beyond what you imagine for all 
the--we are global economy. You have less experience and less 
tests in this interconnected world than you did 20 years ago. 
Do we have better tools? Are you worried that if inflation 
really starts chugging along, that even a quick raise in 
interest rates will not be able really to head it off without 
really severe damage to the economy?
    So those are my two questions.
    Mr. Bernanke. Thank you, Senator. On the first one, you 
raise a very good point. The Federal Reserve has long had sort 
of a mixed view about fair-value accounting. We think that 
market-traded assets should be valued at the market price and 
that investors are entitled to know what that price is. But we 
have always recognized--and we had in mind things like bank 
loans, for example, that are relatively illiquid--that it might 
be difficult to value them on a fair-value basis and that there 
could be problems arising there.
    As you point out, we now have a situation where some assets 
which are normally tradable are perhaps not generally tradable. 
The accounting profession has created a system which, attempts 
to get around that problem. There are these three different 
levels where you have a market valuation or a model valuation 
or a judgment valuation.
    I think that is one of the major problems that we have in 
the current environment. I do not know how to fix it. I do not 
know what to do about it. I think the accountants need to make 
the best judgment they can.
    Senator Schumer. Some have suggested, you know, delaying a 
mark to market, even using this system until there is a market 
and letting the--because you really do not know the value of 
the asset. And if you undervalue it, you may be hurting things 
as much as if you overvalue it.
    Mr. Bernanke. I understand your concern, Senator, but the 
risk on the other side is that if you do too much forbearance 
or delay mark to market, that the suspicion will arise among 
investors that you are hiding something.
    Senator Schumer. Right. What about a rolling average that 
takes into account 6 months back?
    Mr. Bernanke. Senator, I have not worked through any 
proposals like that. This is really an Accounting Board 
responsibility. I agree there is a severe problem. It is 
difficult to change the rules in the middle of a crisis.
    Senator Schumer. I know.
    Mr. Bernanke. It is one of those things that we are going 
to have to put on the list of issues to evaluate as we try to 
learn the lessons from this experience.
    Senator Schumer. But you do admit it is a serious--it is 
one of the nubs of the problem now, even though it has not been 
talked about that much.
    Mr. Bernanke. And the direction of how to fix it is not at 
all clear.
    Senator Schumer. OK. Second question.
    Mr. Bernanke. On your second concern, I think we are better 
off now than we were in the 1970s in that there is a much 
broader recognition of the importance of price stability and 
greater confidence that central banks will deliver price 
stability. The indicia of inflation expectations, where some of 
them have moved a bit, are basically stable. We have not seen 
any major shift in views about inflation and where inflation is 
likely to go. The Federal Reserve has emphasized the importance 
of maintaining price stability and has indicated that we will 
watch very carefully and make sure that we do not see any 
deterioration in either broad measures of inflation 
expectations or increased pass-through of food and energy 
prices into other prices. We will watch those carefully and we 
will respond----
    Senator Schumer. But do you believe if you miscalculate and 
inflation starts coming out of the box more quickly than you 
think, do you have tools to deal with that or is that still a 
very difficult area, once inflation rears its head, it is very 
hard to put the genie back in the bottle? Or are we much better 
at it now than we were 20 years ago?
    Mr. Bernanke. Well, if higher inflation were to become well 
embedded in inflation expectations and wages and other parts of 
the economy, it would be difficult, and we do not really have 
new methods. It is a risk, and we take it very seriously, and 
we are monitoring it very closely. But as I have said several 
times, we are dealing with a number of different concerns here, 
and we are trying----
    Senator Schumer. I know. It is not easy.
    Mr. Bernanke. ----the risks as best we can.
    Senator Schumer. Thank you, Mr. Chairman, and I thank my 
colleagues.
    Chairman Dodd. Well, thank you very much, Senator, very 
much.
    Senator Dole.
    Senator Dole. Thank you.
    Mr. Chairman, I do not have to tell you that my State of 
North Carolina has lost a lot of manufacturing jobs over recent 
years, and you and I have had discussions about job retraining 
programs. I am very pleased that Congress has now begun to 
debate the best way to reform the Trade Adjustment Assistance, 
the TAA Program. And I would like to ask your opinion about 
what you feel the impact would be of congressional 
reauthorization and if there are any particular aspects of 
reform that you would want to suggest for the workforce of the 
21st century.
    Mr. Bernanke. Well, Senator, as I have argued in a number 
of speeches, for example, globalization and trade have a lot of 
benefits, but they also have some costs. They cause 
dislocation. They cause loss of jobs. And my view is that the 
best way to deal with that problem is not to shut down trade 
but, rather, to help those who are affected adjust to their 
circumstances.
    Senator Dole. Right.
    Mr. Bernanke. And so as a general matter, we should look 
for ways to help people through skill acquisition or other 
kinds of assistance that allow them to take advantage of the 
new opportunities to replace the ones that they lost.
    I do not want to comment on specific elements. I know there 
are some competing TAA bills being considered, and I think that 
is really up to Congress to make those detailed decisions. But 
I do think that it is much better than shutting down trade to 
try to help people adjust to the effects of trade.
    I had the opportunity recently to speak in Charlotte, and 
one of my themes there was although North Carolina certainly 
has lost a lot of manufacturing jobs, if you look at the city 
of Charlotte and how it has reinvented itself to become a 
financial center, a services center and a center for the arts 
and many other things, there is a tremendous opportunity in a 
dynamic economy, as the one we have, to find new opportunities, 
to find new businesses and industries.
    And so rather than try to freeze the industrial structure 
the way it is, we are better off helping people move to the new 
opportunities, and TAA is one potential way of trying to assist 
that process.
    Senator Dole. Thank you. Mr. Chairman, let me ask you about 
Sarbanes-Oxley. Some smaller banks appear to be clearly 
overburdened by compliance with Sections 404 and 302. These 
financial institutions are already highly regulated, and it has 
become increasingly apparent that these regulations, while they 
were well intended, only increased the cost of doing business. 
I would really appreciate your comments on what needs to be 
done here.
    Mr. Bernanke. Well, it has been recognized that Section 
404, in particular, imposes a lot of costs. It does have some 
benefits and helps improve internal controls. The Securities 
and Exchange Commission and the PCAOB have recently issued an 
audit standard which tries to take a more balanced, risk-
focused approach to enforcement of 404. And I hope as a general 
matter that that will reduce the costs while preserving the 
benefits of Sarbanes-Oxley.
    In the case of banks in particular, there is a good bit of 
overlap, obviously, already with some of the rules that they 
have to follow under existing bank regulations. And I think it 
would be useful to consider where there are redundancies or 
overlaps that could be reduced in the future.
    Senator Dole. Thank you, Mr. Chairman. Over recent months, 
much has been written in the financial press regarding whether 
or not key worldwide central bankers--the Bank of England, Bank 
of Japan, European Central Bank, and the United States, et 
cetera--should become more coordinated in their monetary policy 
efforts. Proponents of such efforts point to the current spread 
between various key country lending rates.
    What is your reaction to this debate?
    Mr. Bernanke. Well, Senator, first of all, the major 
central banks do cooperate on many things. We meet quite often. 
I see my colleagues at international meetings here and in other 
countries very frequently. We are on the phone together, and we 
try to keep each other apprised of what is happening in our own 
economies and in the global economy, what we are planning, what 
we are thinking.
    We have worked together on some measures recently. In 
December, when we introduced the term auction facility, we did 
that in a coordinated way with the ECB, the Swiss National 
Bank, the Bank of England, and the Bank of Canada--who also 
undertook various liquidity options at that time. So there is a 
lot of coordination and cooperation in that respect.
    With respect to monetary policy per se, although we keep 
each other apprised, each economy is in a different place, in a 
different situation, and there is no necessity that each 
country has to have the same policy. I think the policy that is 
chosen depends on the particular circumstances of that country 
or that region. And so that is one of the benefits of having 
flexible exchange rates to provide some insulation, some 
ability for countries to run independent monetary policies.
    And so it has been our practice, as you know, for each 
major central bank to run an independent monetary policy, and 
while we keep each other apprised, I do not expect to see any 
extensive coordination in the near future.
    Senator Dole. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Senator Corker.
    Senator Corker. Mr. Chairman, thank you, and I thank you 
for your testimony. I listened carefully to what you had to say 
because I know you choose your words carefully. You need to 
because everybody in the world is listening to what you have to 
say. But I did notice that, you know, you mentioned that in 
every other sector of our economy, we are doing well except in 
the financial area. And I noticed that you have mentioned not 
to make--we shouldn't make decisions for the short term, that 
as it related to the housing issue itself, that you knew of no 
good additional measures, that you are focused on GSE reform 
and FHA reform. And I know the Senator from Indiana talked 
about on our side being aggressive. I would say that what we do 
ends up being a law that cannot be changed. What you do can be 
changed at the very next meeting, and so you have a great deal 
more flexibility to really look at indicators and make changes 
than we do. Our changes usually stay there for a long time.
    I was up at the New York Stock Exchange last week and 
noticed that they are trying to put in place the ability for 
people to know quickly what the value of their credit 
instruments are, that there is not the transparency there that 
we have in the equity markets. And my sense is because there is 
no transparency today, that even if we did not have the 
subprime issue, because people are making money packaging 
things and selling them off to the next person, that even if 
the subprime market had not tanked the way that it had, we 
still would have had writedowns because people were making so 
much money off of fees.
    Is that a fair assessment?
    Mr. Bernanke. Well, I think the subprime crisis sort of 
triggered these events. But it is true that investors have lost 
confidence in a lot of different assets at this point, 
including, it was mentioned, some student loans and other 
things as well. And part of the problem--not all of the 
problem, but part of the problem--is that in these complex 
structured credit products, it is very difficult for the 
investor to know exactly what is in there and what derivative 
support or credit liquidity support is involved.
    Senator Corker. So, in essence, the subprime issue that has 
occurred has caused us to look at those in a more healthy way, 
and hopefully the market will create some mechanisms for us to 
actually value those in real time and create a way for us to 
have some transparency there. Is that correct?
    Mr. Bernanke. I hope so. But, again, as Senator Schumer 
suggested, if the accounting industry or the regulators can be 
of help there, I think we ought to try to be of assistance.
    Senator Corker. You mentioned that leverage was at all-time 
lows in other sectors, and, you know, I still am shocked that 
when we had a credit problem, it was our wisdom to sprinkle 
money around America in an America that already had an 
incredibly low savings rate and ask them to spend it as quickly 
as possible. And I get concerned about actions that we might 
take here that, in essence--I know you mentioned at the last 
meeting several times the word ``correction.'' I know Chairman 
Dodd somewhat chastised me at the end because I was pressing 
for an answer. But do you still believe that--and he did so in 
a very amicable way. I appreciate that. But, in fact, do we 
have a crisis right now in housing, or do we have a correction?
    The reason I ask, I look at delinquencies over 30 days. 
Everything is over 30 days, all the way through foreclosure. 
And even though I know we are having some extreme issues in 
some of the higher-cost housing, it really is not very much 
different than it has been over the last 30 years, only about a 
percent and a half different as far as delinquencies go. Is 
this a correction or is this a crisis as it relates to housing 
itself?
    Mr. Bernanke. Senator, I do not know what terms to use. The 
housing market certainly has come down quite a bit, down to 
less than half the amount of construction that we had a couple 
years ago. Prices are falling. Foreclosures are up probably 
this year about 50 to 75 percent over last year. So, you know, 
there are certainly some major things going on in the housing 
market, and they have created some problems in the credit 
markets and the rest of the economy as well.
    Senator Corker. Is this the kind of thing, though, that the 
market can take care of itself? You know, you do not seem to 
have any other ideas legislatively that we might come forward 
with to deal with this problem. Is this something the market 
itself can deal with?
    Mr. Bernanke. Well, the first line of defense for dealing 
particularly with foreclosures is to have servicers and lenders 
work with the borrowers to try to restructure their mortgages 
or otherwise find a solution. And the Treasury, the Fed and 
other regulators and the Congress certainly have encouraged the 
private sector to ramp up their efforts as much as possible to 
try to deal with as many people as possible, because there 
certainly is a significant increase in the number of troubled 
borrowers.
    I have suggested other things--and things that this 
Congress has undertaken, like FHA modernization and GSE 
reform--that could be helpful in bringing the housing market 
back.
    Senator Corker. And, obviously, we have two instruments--
either monetary policy or fiscal policy. You are dealing with 
the monetary side. I guess on our side we deal with the fiscal.
    What I am taking away from what you are saying--a very 
intelligent person who certainly has a much broader view of 
what is happening not only here but also in the world--is that 
you know of nothing today, you have no additional ideas 
legislatively or fiscally for us to deal with other than GSE 
reform and FHA reform. You know of nothing else today other 
than the existing efforts by the marketplace itself to work out 
some issues between lenders and borrowers. You know of nothing 
else today that we might do constructively to solve this 
problem.
    Mr. Bernanke. Senator, I see no harm in trying to think 
about other alternatives, and there are things that have been 
suggested. But at this point, I am not prepared to support any 
additional----
    Senator Corker. I am all for us thinking. I am a little 
worried there is a package that is actually coming to the 
floor, and that moves something into law. But I just appreciate 
your testimony, and I want to say that just in general I do 
think that sometimes when issues occur here, our hair gets on 
fire to act in ways that I think can actually create other 
problems down the road. And my sense is that what you are 
saying is we are doing the things that we know to do today that 
make sense. And I hope that what you are also saying is that 
before we take any other action, we will think about those 
fully and look at the long-term implications of the market, not 
just trying to deal with something in the short term. I think 
that is what--thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator, and I 
appreciate that, and I appreciate the Chairman's response to 
your questions as well. And as he points out, and I pointed 
out, back a year ago we--in fact, I feel very strongly that the 
best line of defense is exactly what the Chairman has said, and 
that is, hopefully the servicers and others can work out things 
here so that you do not have to engage in extraordinary steps 
to try and minimize these problems. And that is the first line 
of defense, and we are very hopeful that will produce some 
results.
    I also just want to point out quickly to my good friend 
from Tennessee here, Residential Fixed Investment, the GDP 
component that includes spending on housing, plunged by 25.2 
percent in the fourth quarter, a bigger drop than the earlier 
23.9 percent; third quarter spending fell by 20.5 percent. To 
give you some sense of proportionality, that is the worst 
plunge since the fourth quarter of 1981. This is a larger issue 
than just a correction problem. I say that respectfully, but I 
think it is bigger than that is the case.
    Senator Corker. If I could respond to that, I would say, 
too, that is coming off of an extreme high. I mean, we have had 
an exuberance in the housing market, and I think we should 
measure those drops off of a mean, if you will, versus a high. 
I think that the housing industry has enjoyed extreme free 
credit for many, many years. We have had an exuberant market 
that we have known for some time--as a matter of fact, I would 
say that actually a few years ago we were concerned in 
California, for instance, that housing prices were going up so 
rapidly. And so I would say that that drop is off an extreme 
high, and I thank you for pointing that out to me.
    Chairman Dodd. Let me, if I can, Mr. Chairman, I want to 
raise a couple of questions, if I can for you, and some of them 
have been touched on. I do not want to take a long time here 
with you, but I am just intrigued by the correlation of some of 
these issues. Sometimes we cite a bunch of statistics and 
wonder what the correlations are between them.
    There are two factors that I want your thoughts on, if I 
can, that contribute to this huge run-up in commodity prices 
that we heard Senator Tester talk about and others. Oil is the 
first thing I think about, but obviously, if you are a farmer 
or a baker in Rhode Island, it can be the cost of wheat and 
others. The first is the increase in the demand for these 
goods. That is obviously one set of issues. The second is that 
these goods are priced in dollar terms. Sometimes we pass over 
that idea, but we talked about the price of oil a barrel, it is 
in dollar terms. And to what extent is the decline in the value 
of the dollar driving this? And beyond that concern, is that 
decline in the dollar--does that decline represent a decrease 
in confidence in the U.S. financial system?
    As the Fed report indicates--and I mentioned this at the 
outset--there was a net sale of U.S. securities by private 
foreign investors in the third quarter of 2007, the first 
quarterly net sale in more than 15 years. And I wonder how is 
that loss of confidence in the U.S. by foreign investors 
leading into a decline in the dollar, which leads to the rising 
commodity prices. I am trying to connect these questions, if at 
all.
    I was talking to a friend of mine in Europe this morning 
who is involved in the financial services sector--a totally 
different matter--and I told him I was going to be having the 
hearing this morning with you. And he was saying that one of 
the problems we have got is the fact that Europe is not cutting 
its interest rates at all, and so you are getting that 
comparison as well, which probably exacerbates this problem to 
some extent, at least in that market.
    And I was curious, because we have had a lot of questions 
of you--and I will come back to this in a minute--on the 
sovereign wealth funds, and I was trying to get some sense of 
proportionality about private investment versus sovereign 
wealth funds. And I do not minimize the importance of the 
sovereign wealth funds issues, but I asked staff to give me 
some sense of the proportionality of numbers. And out of the 
estimated $150 trillion in global capital stock, $2.2 trillion 
is held by sovereign wealth funds. And while sovereign wealth 
funds are about double the size of hedge fund assets, they 
represent less than 5 percent of global assets. And while 
China's sovereign wealth fund hold is about $200 billion in 
assets, the size of China's foreign exchange reserves is about 
$1.3 trillion.
    And so you have got--putting aside that for a second, the 
private investment sector here is an important one, and maybe 
I--am I making too much of this bar graph I saw in the Monetary 
Report Fund where you see for the first time that looks like a 
selling off here? And I noticed in your response to one of 
the--I forget who it was raised the question earlier. At least 
I thought I heard you say this was not as--that foreign 
investment is still coming in and that is a source of some 
confidence here.
    Anyway, could you try and connect those things for me? Is 
it a false connection? But I am curious how that relates to the 
decline in the dollar, the rise in commodity prices, and 
whether or not there is some connection here.
    Mr. Bernanke. Well, I do not think that foreign investors 
have lost confidence in the United States by any means. The 
data you are referring to shows some desire by foreign 
investors to shift out of corporate credits and other credit 
products and into treasuries. That is the same shift that 
American investors are making. They are getting away from what 
they view as risky credits toward the safety of U.S. Government 
debt. And, indeed, U.S. Government debt is still the safest, 
most liquid, desired asset in the world.
    There is some effect of the dollar on commodities. Oil and 
other commodities are traded globally. You can think of the 
price as being set by global supply and demand. If the dollar 
depreciates a bit, then you would expect to see commodity 
prices rise to offset that depreciation. But it is important to 
understand that, for example, oil has risen in euros as well as 
in dollars. I mean, it is not simply an issue of currencies. It 
also has to do with global supply and demand for the commodity. 
So the European Central Bank is concerned about food and energy 
inflation as well.
    With respect to the sovereign wealth funds, that is just 
another indication that foreigners have not lost confidence in 
the U.S. economy and that there has been a good bit of inflow. 
In particular, about something close to half of the capital 
that financial institutions have raised in the last few months 
has come from sovereign wealth funds, from other countries.
    I think that, in general, that is quite constructive. If we 
are confident, as I think we are in this case, that the 
investments are made for economic reasons and not for political 
reasons or other noneconomic reasons, and there is no issue of 
national defense, which the CFIUS process takes care of, then 
that inflow of investment is good for our economy and certainly 
is helping, in this case, the financial system. At the same 
time, allowing inflows of foreign capital through reciprocity 
gives us more opportunities to invest abroad.
    I know that Congress is very interested in sovereign wealth 
funds, and you should certainly take a close look at it. 
International agencies, like the International Monetary Fund 
and the OECD, are developing codes of conduct. The basic idea 
there is that sovereign wealth funds should be as transparent 
as possible. We should understand their governance and their 
motivations, and, in particular, we should be confident that 
they are investing, again, for economic rather than political 
or other purposes. If we are confident in that, then it is in 
our interest to keep our borders open and to allow that capital 
to flow in. And I think it will continue to flow in.
    Chairman Dodd. You raise a good point here and one I wanted 
to raise with you. This is a statement you made yesterday as 
well before the House Financial Services Committee, talking 
about it. And I do not disagree. It is quite constructive. And 
I think there has to be a sense of balance in how we look at 
sovereign wealth funds, and I think we run the danger of 
becoming a pejorative without understanding the value of it. So 
we have to be careful about it.
    And you pointed out, and you did again here just now, you 
mentioned CFIUS, which, of course, we developed good 
legislation, I think, out of the Committee on that, the IMF, 
the OECD, and looking at these investments from their various 
perspectives in terms of these issues, which are a very 
legitimate point.
    But what is the Fed's role in a sense? I mean, this is, it 
seems to me, while all these other institutions have an 
important role to play, I would make a case here that the Fed 
also has an important role. They are investing in bank holding 
companies. This is the jurisdiction of the Federal Reserve 
Board, and it seems to me you did not mention the Federal 
Reserve's obligation to be looking at these questions as well. 
And, obviously, we have had major investments here in bank 
holding companies. So tell me what you think is--what is the 
Fed doing about this, and what is the responsibility of the Fed 
in looking at this issue as well?
    Mr. Bernanke. You are quite correct, Senator. I should have 
mentioned that.
    Well, first, of course, we are very involved with the banks 
themselves, and we are very interested in their capital-raising 
efforts and making sure that they raise enough capital to meet 
the well-capitalized standards and to remain safe and sound. 
And so that whole process is something we pay very close 
attention to.
    We have statutory responsibilities. If the investment by 
any single person or group, whether it is a sovereign wealth 
fund or someone else, reaches certain levels that, imply a 
significant degree of control, then we have to look at that, 
make sure it is appropriate.
    Chairman Dodd. Is that a sort of objective test rather than 
a subjective test?
    Mr. Bernanke. I believe that 25 percent is the threshold.
    Chairman Dodd. But I was looking and thinking--I am just 
curious to get your reaction to this. And, again, I do not want 
to overdramatize this point, but I was curious in one of 
these--and you will know which one I am talking about. One of 
these major investment houses, when the decision was made as to 
who the new CEO was going to be, there was a flight I think 
occurred that went to a country that was making major 
investment to get the OK in a sense. Now, the amount invested 
would represent an amount far smaller than the 25-percent 
threshold. But clearly, at least, if you will, the visuals of 
going over and getting sort of a sign-off indicated that there 
was more of an influence than the dollar amount would indicate. 
I mean, does that trigger something? Or should it trigger 
something?
    Mr. Bernanke. Well, I think if the investor is making that 
big an investment, they need to understand what is going on. I 
am not sure whether it was a case of their deciding who was the 
CEO or just simply being informed of the plans of the company.
    In the cases that we have seen, the investments have been 
significant in absolute terms, but small in percentage of 
equity terms. And in most cases, the amount of control--rights, 
board of directors, membership and so on--has been quite 
limited. So there has not been any significant change in the 
control of these institutions. If there were, then the Federal 
Reserve would want to----
    Chairman Dodd. No, absolutely. I understand that. And, 
again, I am not trying to expand your portfolio here by 
suggesting an earlier intervention, but it would seem to me 
that there may be some signals here that may fall short of the 
25 percent. I would rather have you taking a look at those 
things where--and come to me and say, ``I think this is''--not 
to me necessarily, but to say we think we ought to take a look 
at this, it may fall short of that absolute trigger. That is 
why I say objective/subjective kind of analysis as to what this 
could mean, so look at that.
    Is there any chance, any worry you have at all--coming back 
to the first question I raised with you, the declining value of 
the dollar, the 24-percent decline, the lowest since 1973, 
compared to the six other major currencies. Is there any chance 
in your mind that we would watch something moving away from a 
dollar denomination in these areas, in these commodities, such 
as oil going to the euro, for instance? Do you see any danger 
in that? Or is it--do you worry about that at all?
    Mr. Bernanke. I know of no plans of that, but the 
denomination, as I said, is of second-order importance. There 
is some importance in the willingness of foreigners to hold 
dollar assets, which is a different matter entirely. And as I 
said, I know of no evidence that there is any reduction in 
interest.
    Chairman Dodd. Would that concern you if that happened? I 
mean, is there----
    Mr. Bernanke. If there was a change in denomination?
    Chairman Dodd. Yes, if they moved all of a sudden, went 
from the price of a barrel of oil measured not in dollars but 
in euros, what does that say about us and our economy? Does 
that have--I mean, it seems to me that would be rather a 
dramatic piece of news.
    Mr. Bernanke. Well, it might be symbolic. It might have 
symbolic value. But from an economic point of view, it is a 
global market, and foreign currencies are traded all the time. 
You know, if I want to buy a barrel of oil, I can do it in euro 
or yen or any other way I like. So from a fundamental sense 
point of view, it is not significant. There might be some 
symbolic value to it if that happened.
    Chairman Dodd. I was going to ask you a question to follow 
up on Senator Menendez who asked questions about the housing 
issue. But I think your answers in response to Senator Corker 
were good ones in thinking about this issue. And I sense in 
your comments here today that this housing issue is a serious 
one. And I am not going to try and put words in your mouth 
again, but I realize you put an adjective on this, and that 
becomes the headline. But it is serious and warrants serious 
thought as to what we can do to minimize this and to try and 
keep people in their homes, minimize this from happening again, 
and dealing with related issues. And I appreciate those 
comments. And we are going to continue talking with you about 
these various ideas that we have. And I certainly appreciate, 
having been here long enough to know, that sometimes actions, 
however well intended, can have unintended consequences, and so 
you need to think through things carefully. And so we are going 
to want to be in touch with you during that process.
    But we also want to make sure we are not looking back and 
wondering if we could have done some things here that would 
have minimized this from getting worse. So it is important.
    I will leave the record open for a couple of days here. 
Members who did not make it here may have some additional 
questions for you. You have been before this Committee a lot 
now in the last couple of weeks, and we are grateful to you for 
that, and we will continue working with you.
    The Committee will stand adjourned.
    [Whereupon, at 12:32 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    Thank you, Mr. Chairman.
    The health of our economy and financial markets is a concern to 
everyone here today. Growth has slowed and we have been through a rough 
patch in the credit markets. Everyone wants to see stability and growth 
return. Congress has acted to restore confidence in the economy. The 
Fed has taken steps to thaw the credit freeze. We hope that these 
policy actions will head off further damage, but no policy can reverse 
the busting of the housing bubble and we are not going to regulate away 
problems in the economy.
    While I have supported actions taken to respond to our economic 
problems, I fear they will have unintended consequences. I am most 
concerned about inflation and the fall of the dollar. We need to think 
beyond what we have already done and take steps to encourage long term 
growth. Congress can give taxpayers, businesses, and investors 
certainty that their taxes are not going to go up. Congress can knock 
down roadblocks to growth such as artificial limits on our energy 
supply. Congress can make it more appealing for corporations to stay in 
the United States by easing regulations and lowering the corporate tax 
rate. Only with long term permanent policies can we ensure a healthy 
economy for our grandchildren.
    I look forward to hearing from the Chairman.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
    Thank you, Chairman Dodd and Ranking Member Shelby for holding this 
very important hearing today. Chairman Bernanke, I join my colleagues 
in extending you a warm welcome.
    Since last August, our financial markets have experienced 
tremendous uncertainty. Credit and capital markets around the world 
have struggled to comprehend the ramifications of the U.S. subprime 
lending and housing crisis. Fortunately, the Federal Reserve has been 
quick to act, lowering the federal funds rate from 5.25 percent to 3 
percent. Congress also is working to help boost our economy.
    Several recent reports have highlighted ongoing economic 
challenges. Such as last week, the Wall Street Journal said that the 
``leading economic indicators'' fell for the fourth straight month. 
Since its July 2007 high, the index has fallen by 2 percent, which is 
the largest 6-month drop since 2001. Additionally, for the week ending 
on February 16, the 4-week average of initial unemployment claims rose 
by 10,750 to 360,500, pointing to a softening of the labor market.
    Furthermore, by the third quarter of 2007, household debt rose to 
$13.6 trillion from $7.2 trillion in 2001, a 10-percent annual 
increase. Over this same time period, mortgage borrowing more than 
doubled. As a result, one out of every seven dollars of disposable 
income earned by Americans goes towards paying down debt.
    Fears loom of higher inflation and more ``pain at the pump.'' The 
price of a barrel of oil has hovered around the $90 mark and recently 
closed above $100 per barrel. If these higher gas prices and 
inflationary pressures continue, coupled with the well-known weakness 
in across our housing sector, I--like many folks I hear from--am very 
concerned that future economic growth could be hindered.
    No question, the health of our economy is influenced by many 
complex issues and expected and unexpected events. That said, I would 
like to highlight a few areas where I am focused to help spur growth 
and job creation.
    I strongly support Trade Adjustment Assistance, which helps ensure 
that displaced workers have the ability to train for new careers. In 
recent years, my home state of North Carolina has undergone a difficult 
economic transition, as our state continues to evolve from a 
manufacturing and agriculture-based economy to a more services-oriented 
economy. In North Carolina and across the country, there is a need to 
address the growing gap between skilled and unskilled workers. Senator 
Cantwell and I have introduced legislation that would allow more 
workers to receive TAA benefits, including training, job search and 
relocation allowances, income support and other reemployment services.
    Additionally, with respect to current regulation of financial 
institutions, it has come to my attention that some smaller banks are 
overburdened by compliance with Sections 404 and 302 of the Sarbanes-
Oxley corporate accountability law. Mr. Chairman, these financial 
institutions are already highly-regulated, and it has become 
increasingly apparent that these regulations, while well-intended, only 
increase their costs of doing business. I hope this committee will soon 
consider legislation that would provide true regulatory relief for all 
financial institutions.
    Chairman Bernanke, thank you again for being here today. I look 
forward to hearing from you--and working with you--on these and other 
important issues.
                 PREPARED STATEMENT OF BEN S. BERNANKE
                               Chairman,
            Board of Governors of the Federal Reserve System
                           February 28, 2008
    Chairman Dodd, Ranking Member Shelby, and other Members of the 
Committee, I am pleased to present the Federal Reserve's Monetary 
Policy Report to the Congress. In my testimony this morning I will 
briefly review the economic situation and outlook, beginning with 
developments in real activity and inflation, then turn to monetary 
policy. I will conclude with a quick update on the Federal Reserve's 
recent actions to help protect consumers in their financial dealings.
    The economic situation has become distinctly less favorable since 
the time of our July report. Strains in financial markets, which first 
became evident late last summer, have persisted; and pressures on bank 
capital and the continued poor functioning of markets for securitized 
credit have led to tighter credit conditions for many households and 
businesses. The growth of real gross domestic product (GDP) held up 
well through the third quarter despite the financial turmoil, but it 
has since slowed sharply. Labor market conditions have similarly 
softened, as job creation has slowed and the unemployment rate--at 4.9 
percent in January--has moved up somewhat.
    Many of the challenges now facing our economy stem from the 
continuing contraction of the U.S. housing market. In 2006, after a 
multiyear boom in residential construction and house prices, the 
housing market reversed course. Housing starts and sales of new homes 
are now less than half of their respective peaks, and house prices have 
flattened or declined in most areas. Changes in the availability of 
mortgage credit amplified the swings in the housing market. During the 
housing sector's expansion phase, increasingly lax lending standards, 
particularly in the subprime market, raised the effective demand for 
housing, pushing up prices and stimulating construction activity. As 
the housing market began to turn down, however, the slump in subprime 
mortgage originations, together with a more general tightening of 
credit conditions, has served to increase the severity of the downturn. 
Weaker house prices in turn have contributed to the deterioration in 
the performance of mortgage-related securities and reduced the 
availability of mortgage credit.
    The housing market is expected to continue to weigh on economic 
activity in coming quarters. Homebuilders, still faced with abnormally 
high inventories of unsold homes, are likely to cut the pace of their 
building activity further, which will subtract from overall growth and 
reduce employment in residential construction and closely related 
industries.
    Consumer spending continued to increase at a solid pace through 
much of the second half of 2007, despite the problems in the housing 
market, but it appears to have slowed significantly toward the end of 
the year. The jump in the price of imported energy, which eroded real 
incomes and wages, likely contributed to the slowdown in spending, as 
did the declines in household wealth associated with the weakness in 
house prices and equity prices. Slowing job creation is yet another 
potential drag on household spending, as gains in payroll employment 
averaged little more than 40,000 per month during the 3 months ending 
in January, compared with an average increase of almost 100,000 per 
month over the previous 3 months. However, the recently enacted fiscal 
stimulus package should provide some support for household spending 
during the second half of this year and into next year.
    The business sector has also displayed signs of being affected by 
the difficulties in the housing and credit markets. Reflecting a 
downshift in the growth of final demand and tighter credit conditions 
for some firms, available indicators suggest that investment in 
equipment and software will be subdued during the first half of 2008. 
Likewise, after growing robustly through much of 2007, nonresidential 
construction is likely to decelerate sharply in coming quarters as 
business activity slows and funding becomes harder to obtain, 
especially for more speculative projects. On a more encouraging note, 
we see few signs of any serious imbalances in business inventories 
aside from the overhang of unsold homes. And, as a whole, the 
nonfinancial business sector remains in good financial condition, with 
strong profits, liquid balance sheets, and corporate leverage near 
historical lows.
    In addition, the vigor of the global economy has offset some of the 
weakening of domestic demand. U.S. real exports of goods and services 
increased at an annual rate of about 11 percent in the second half of 
last year, boosted by continuing economic growth abroad and the lower 
foreign exchange value of the dollar. Strengthening exports, together 
with moderating imports, have in turn led to some improvement in the 
U.S. current account deficit, which likely narrowed in 2007 (on an 
annual basis) for the first time since 2001. Although recent indicators 
point to some slowing of foreign economic growth, U.S. exports should 
continue to expand at a healthy pace in coming quarters, providing some 
impetus to domestic economic activity and employment.
    As I have mentioned, financial markets continue to be under 
considerable stress. Heightened investor concerns about the credit 
quality of mortgages, especially subprime mortgages with adjustable 
interest rates, triggered the financial turmoil. However, other 
factors, including a broader retrenchment in the willingness of 
investors to bear risk, difficulties in valuing complex or illiquid 
financial products, uncertainties about the exposures of major 
financial institutions to credit losses, and concerns about the weaker 
outlook for economic growth, have also roiled the financial markets in 
recent months. To help relieve the pressures in the market for 
interbank lending, the Federal Reserve--among other actions--recently 
introduced a term auction facility (TAF), through which prespecified 
amounts of discount window credit are auctioned to eligible borrowers, 
and we have been working with other central banks to address market 
strains that could hamper the achievement of our broader economic 
objectives. These efforts appear to have contributed to some 
improvement in short-term funding markets. We will continue to monitor 
financial developments closely.
    As part of its ongoing commitment to improving the accountability 
and public understanding of monetary policy making, the Federal Open 
Market Committee (FOMC) recently increased the frequency and expanded 
the content of the economic projections made by Federal Reserve Board 
members and Reserve Bank presidents and released to the public. The 
latest economic projections, which were submitted in conjunction with 
the FOMC meeting at the end of January and which are based on each 
participant's assessment of appropriate monetary policy, show that real 
GDP was expected to grow only sluggishly in the next few quarters and 
that the unemployment rate was seen as likely to increase somewhat. In 
particular, the central tendency of the projections was for real GDP to 
grow between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\ 
percent to 2\3/4\ percent projected in our report last July. FOMC 
participants' projections for the unemployment rate in the fourth 
quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, 
up from the level of about 4\3/4\ percent projected last July for the 
same period. The downgrade in our projections for economic activity in 
2008 since our report last July reflects the effects of the financial 
turmoil on real activity and a housing contraction that has been more 
severe than previously expected. By 2010, our most recent projections 
show output growth picking up to rates close to or a little above its 
longer-term trend and the unemployment rate edging lower; the 
improvement reflects the effects of policy stimulus and an anticipated 
moderation of the contraction in housing and the strains in financial 
and credit markets. The incoming information since our January meeting 
continues to suggest sluggish economic activity in the near term.
    The risks to this outlook remain to the downside. The risks include 
the possibilities that the housing market or labor market may 
deteriorate more than is currently anticipated and that credit 
conditions may tighten substantially further.
    Consumer price inflation has increased since our previous report, 
in substantial part because of the steep run-up in the price of oil. 
Last year, food prices also increased significantly, and the dollar 
depreciated. Reflecting these influences, the price index for personal 
consumption expenditures (PCE) increased 3.4 percent over the four 
quarters of 2007, up from 1.9 percent in 2006. Core price inflation--
that is, inflation excluding food and energy prices--also firmed toward 
the end of the year. The higher recent readings likely reflected some 
pass-through of energy costs to the prices of core consumer goods and 
services as well as the effect of the depreciation of the dollar on 
import prices. Moreover, core inflation in the first half of 2007 was 
damped by a number of transitory factors--notably, unusually soft 
prices for apparel and for financial services--which subsequently 
reversed. For the year as a whole, however, core PCE prices increased 
2.1 percent, down slightly from 2006.
    The projections recently submitted by FOMC participants indicate 
that overall PCE inflation was expected to moderate significantly in 
2008, to between 2.1 percent and 2.4 percent (the central tendency of 
the projections). A key assumption underlying those projections was 
that energy and food prices would begin to flatten out, as was implied 
by quotes on futures markets. In addition, diminishing pressure on 
resources is also consistent with the projected slowing in inflation. 
The central tendency of the projections for core PCE inflation in 2008, 
at 2.0 percent to 2.2 percent, was a bit higher than in our July 
report, largely because of some higher-than-expected recent readings on 
prices. Beyond 2008, both overall and core inflation were projected to 
edge lower, as participants expected inflation expectations to remain 
reasonably well-anchored and pressures on resource utilization to be 
muted. The inflation projections submitted by FOMC participants for 
2010--which ranged from 1.5 percent to 2.0 percent for overall PCE 
inflation--were importantly influenced by participants' judgments about 
the measured rates of inflation consistent with the Federal Reserve's 
dual mandate and about the time frame over which policy should aim to 
attain those rates.
    The rate of inflation that is actually realized will of course 
depend on a variety of factors. Inflation could be lower than we 
anticipate if slower-than-expected global growth moderates the pressure 
on the prices of energy and other commodities or if rates of domestic 
resource utilization fall more than we currently expect. Upside risks 
to the inflation projection are also present, however, including the 
possibilities that energy and food prices do not flatten out or that 
the pass-through to core prices from higher commodity prices and from 
the weaker dollar may be greater than we anticipate. Indeed, the 
further increases in the prices of energy and other commodities in 
recent weeks, together with the latest data on consumer prices, suggest 
slightly greater upside risks to the projections of both overall and 
core inflation than we saw last month. Should high rates of overall 
inflation persist, the possibility also exists that inflation 
expectations could become less well anchored. Any tendency of inflation 
expectations to become unmoored or for the Fed's inflation-fighting 
credibility to be eroded could greatly complicate the task of 
sustaining price stability and could reduce the flexibility of the FOMC 
to counter shortfalls in growth in the future. Accordingly, in the 
months ahead, the Federal Reserve will continue to monitor closely 
inflation and inflation expectations.
    Let me turn now to the implications of these developments for 
monetary policy. The FOMC has responded aggressively to the weaker 
outlook for economic activity, having reduced its target for the 
federal funds rate by 225 basis points since last summer. As the 
Committee noted in its most recent post-meeting statement, the intent 
of those actions has been to help promote moderate growth over time and 
to mitigate the risks to economic activity.
    A critical task for the Federal Reserve over the course of this 
year will be to assess whether the stance of monetary policy is 
properly calibrated to foster our mandated objectives of maximum 
employment and price stability in an environment of downside risks to 
growth, stressed financial conditions, and inflation pressures. In 
particular, the FOMC will need to judge whether the policy actions 
taken thus far are having their intended effects. Monetary policy works 
with a lag. Therefore, our policy stance must be determined in light of 
the medium-term forecast for real activity and inflation as well as the 
risks to that forecast. Although the FOMC participants' economic 
projections envision an improving economic picture, it is important to 
recognize that downside risks to growth remain. The FOMC will be 
carefully evaluating incoming information bearing on the economic 
outlook and will act in a timely manner as needed to support growth and 
to provide adequate insurance against downside risks.
    Finally, I would like to say a few words about the Federal 
Reserve's recent actions to protect consumers in their financial 
transactions. In December, following up on a commitment I made at the 
time of our report last July, the Board issued for public comment a 
comprehensive set of new regulations to prohibit unfair or deceptive 
practices in the mortgage market, under the authority granted us by the 
Home Ownership and Equity Protection Act of 1994. The proposed rules 
would apply to all mortgage lenders and would establish lending 
standards to help ensure that consumers who seek mortgage credit 
receive loans whose terms are clearly disclosed and that can reasonably 
be expected to be repaid. Accordingly, the rules would prohibit lenders 
from engaging in a pattern or practice of making higher-priced mortgage 
loans without due regard to consumers' ability to make the scheduled 
payments. In each case, a lender making a higher priced loan would have 
to use third-party documents to verify the income relied on to make the 
credit decision. For higher-priced loans, the proposed rules would 
require the lender to establish an escrow account for the payment of 
property taxes and homeowners' insurance and would prevent the use of 
prepayment penalties in circumstances where they might trap borrowers 
in unaffordable loans. In addition, for all mortgage loans, our 
proposal addresses misleading and deceptive advertising practices, 
requires borrowers and brokers to agree in advance on the maximum fee 
that the broker may receive, bans certain practices by servicers that 
harm borrowers, and prohibits coercion of appraisers by lenders. We 
expect substantial public comment on our proposal, and we will 
carefully consider all information and viewpoints while moving 
expeditiously to adopt final rules.
    The effectiveness of the new regulations, however, will depend 
critically on strong enforcement. To that end, in conjunction with 
other federal and state agencies, we are conducting compliance reviews 
of a range of mortgage lenders, including nondepository lenders. The 
agencies will collaborate in determining the lessons learned and in 
seeking ways to better cooperate in ensuring effective and consistent 
examinations of, and improved enforcement for, all categories of 
mortgage lenders.
    The Federal Reserve continues to work with financial institutions, 
public officials, and community groups around the country to help 
homeowners avoid foreclosures. We have called on mortgage lenders and 
servicers to pursue prudent loan workouts and have supported the 
development of streamlined, systematic approaches to expedite the loan 
modification process. We also have been providing community groups, 
counseling agencies, regulators, and others with detailed analyses to 
help identify neighborhoods at high risk from foreclosures so that 
local outreach efforts to help troubled borrowers can be as focused and 
effective as possible. We are actively pursuing other ways to leverage 
the Federal Reserve's analytical resources, regional presence, and 
community connections to address this critical issue.
    In addition to our consumer protection efforts in the mortgage 
area, we are working toward finalizing rules under the Truth in Lending 
Act that will require new, more informative, and consumer-tested 
disclosures by credit card issuers. Separately, we are actively 
reviewing potentially unfair and deceptive practices by issuers of 
credit cards. Using the Board's authority under the Federal Trade 
Commission Act, we expect to issue proposed rules regarding these 
practices this spring.
    Thank you. I would be pleased to take your questions.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM BEN S. BERNANKE

Q.1. Increases in the GSE/FHA Conforming Loan Limits: The 
stimulus bill recently passed by Congress includes an increase 
in the conforming loan limit amount for mortgages that the 
Government Sponsored Entities (GSEs) and the Federal Housing 
Administration can guarantee.
    Do you believe that increasing these loan amounts adds to 
the systemic risks associated with the GSEs' operations?
    While these increases are only temporary, some have raised 
the idea of permanently increasing the amounts. Are there 
additional risks associated with a permanent increase?

A.1. Temporarily raising the conforming loan limit allows the 
GSEs to securitize an expanded range of mortgage loans and 
likely would increase liquidity in the secondary market for 
loans covered by the expansion. The GSEs should be strongly 
encouraged to rapidly use this authority, even if it requires 
that they raise substantial amounts of capital.
    Over a longer horizon, it is important to realize that 
raising the conforming loan limits extends the implicit 
government-backing of the GSEs into a larger portion of the 
mortgage market. While the jumbo mortgage market has 
experienced substantial liquidity problems during the past 
year, this market historically has operated efficiently and 
functioned well without GSE involvement. Moreover, prime 
quality homeowners who use jumbo mortgages are, in general, the 
highest income and wealthiest members of our society. Extending 
the reach of the GSEs to these borrowers would do little to 
expand homeownership or to extend mortgage credit to those that 
cannot obtain mortgages otherwise.
    Thus, raising the conforming loan limit involves the larger 
question of how far to extend government guarantees, either 
explicit or implicit, to resolve short-term liquidity problems 
in secondary asset markets. Temporary expansions of the safety 
net, such as those undertaken by the Federal Reserve, can boost 
short-term liquidity without distorting private market credit 
analysis. In contrast, permanent expansions of the safety net, 
such as raising the conforming loan limit permanently, may well 
cause greater problems in the long-run. There are many reasons 
for the recent breakdown in private market credit analysis, but 
it is not clear to me that the best approach to rectify the 
current situation is simply to substitute implicit government 
guarantees for much needed private market discipline. If 
private markets are unable to provide a secondary market for 
some assets, we should first endeavor to understand why this is 
the case rather than immediately turn to a broader expansion of 
GSE guarantees.
    Any permanent expansion of GSE guarantees must, be 
accompanied by comprehensive GSE reform to mitigate further 
systemic risks. In particular, capital standards for the GSEs 
must be significantly toughened and clear and credible 
receivership procedures for the GSEs should be established. 
Moreover, the role and function of the GSE portfolios should be 
clearly articulated by Congress. As has been evident in recent 
months, this portfolio is managed mainly to meet needs of GSE 
shareholders and not to fulfill public policy objectives.

Q.2. International Liquidity Coordination: Chairman Bernanke, 
as of the minutes of the last Federal Open Market Committee 
meeting, the Federal Reserve reaffirmed their commitment to 
working with foreign central banks to coordinate international 
monetary policy.
    Please describe for us the details of the Federal Reserve's 
agreements with foreign central banks, such as the European 
Central Bank and the Bank of England for exchanging assets into 
dollars.
    Why have these agreements been made and are financial 
institutions using these tools?

A.2. The Federal Open Market Committee (FOMC) established swap 
lines with the European Central Bank (ECB)and Swiss National 
Bank (SNB) in conjunction with the establishment of the Term 
Auction Facility (TAF) on December 12, 2007. These swap 
agreements were requested by the ECB and SNB and allowed them 
to draw a maximum of $20 billion and $4 billion respectively, 
for a period of up to 6 months. Under the agreements, both 
central banks are allowed to purchase U.S. dollars with their 
foreign currencies based on the prevailing spot exchange rate, 
and they pay interest on the foreign currency received by the 
Federal Reserve. Given the strong financial position of the ECB 
and SNB, the swap lies involve virtually no credit risk to the 
Federal Reserve. The Federal Reserve has also maintained 
longstanding swap facilities with the Bank of Mexico and the 
Bank of Canada as part of the North American Framework 
Agreement. Those facilities amount to $2 billion with the Bank 
of Canada and $3 billion with the Bank of Mexico.
    The agreements with the ECB and SNB were established to 
allow dollar funding problems faced by European and Swiss banks 
to be addressed directly by their respective home central 
banks. In the absence of such agreements, European and Swiss 
banks were believed to be more likely to seek dollar funding in 
U.S. markets, potentially increasing volatility and adding to 
term funding pressures in U.S. markets. By providing dollars to 
the ECB and SNB to use in their efforts to address term dollar 
funding problems abroad, the FOMC believed that it would assist 
U.S. credit markets.
    Both the ECB and SNB have used their swap agreements. The 
first use of these swap lines was on Monday, December 17, when 
the ECB drew upon $10 billion and the SNB drew upon $4 billion 
for a 28-day period. The two central banks used the funds to 
auction dollar funding to their eligible depository 
institutions; the ECB offered funds to its eligible depository 
institutions at the 4.65 percent rate set in the Federal 
Reserve's TAF auction, and the SNB auctioned $4 billion at a 
weighted average rate of 4.79 percent. The ECB drew upon a 
further $10 billion on Thursday, December 20, in conjunction 
with the second TAF auction held by the Federal Reserve. At the 
expiration of its first use of its swap line, the ECB renewed 
its draws in conjunction with the January 14 and January 28 TAF 
auctions, offering $10 billion in 28-day dollar funds both 
times at a rate equal to the rate set in the TAF auction. The 
SNB also renewed its draw of $4 billion on its swap line to 
participate in the January 14 auction of dollar funds. On March 
11, the FOMC announced that it would increase its temporary 
swap line to the ECB from $20 billion to $30 billion and its 
line to the SNB from $4 billion to $6 billion, extending the 
swap lines through September 30, 2008. Both central banks have 
signaled that they would draw upon the lines to offer 28-day 
dollar funding in auctions to be held on March 25.

Q.3. Sovereign Wealth Funds and Systemic Risk: Chairman 
Bernanke, recently we have seen an influx of capital into our 
domestic financial institutions from foreign governments, 
specifically sovereign wealth funds. Previous foreign direct 
investments have usually been in smaller quantities and from 
private investors, rather than governments. These investments 
may be under the threshold of control for each sale, but 
collectively could represent a large proportion of U.S. 
financial services firms.
    Is there a danger of systemic risk from one or more 
Sovereign Wealth Funds holding noncontrolling stakes many 
financial firms?

A.3. The recent prominent equity investments by sovereign 
wealth funds in large U.S. financial institutions permanently 
increased the capital of these firms, enhancing their soundness 
and the soundness of the U.S. financial system. These 
investments also support the ability of the financial 
institutions to provide credit to businesses and consumers. It 
is difficult to envision circumstances under which non-
controlling equity stakes in financial institutions, could 
increase systemic risk in a financial system.
    Sovereign wealth funds have been relatively stable 
investors. The funds generally are neither highly leveraged nor 
exposed to liquidity risk arising from investor withdrawals or 
redemptions. Sovereign wealth funds often use professional 
private fund managers who are tasked with seeking higher 
returns and greater diversification--relative to official 
reserves--for a portion of a country's foreign exchange assets.
    Because sovereign wealth funds are government owned, there 
has been concern, however, that these funds have the potential 
to be motivated by political reasons To the extent these funds 
make only smaller, noncontrolling investments, the ability of a 
sovereign wealth fund to have an effect on the operation, 
strategic direction or policies of a banking organization are 
minimal.
    If two or more companies with noncontrolling investments in 
a U.S. bank or bank holding company were to agree to act 
together in an attempt to influence the operations of a U.S. 
bank or bank holding company, the Federal Reserve has the 
authority to combine the companies' shareholdings and treat the 
group as one company (an ``association'') for purposes of the 
Bank Holding Company Act (BHC Act). If the combined 
shareholding were significant enough, the association could be 
treated as a bank holding company subject to the requirements 
of the BHC Act. To date, the Board has not found that sovereign 
wealth funds from different countries have in fact acted 
together to control a U.S. financial institution.
    Another important safeguard applies to the U.S. banking 
organization itself. U.S. banking organizations themselves are 
subject to the supervisory and regulatory requirements of U.S. 
banking law. For example, federal banking agencies are required 
under the Federal Deposit Insurance Act to establish certain 
safety and soundness standards by regulation or guideline for 
all U.S. insured depository institutions. These standards are 
designed to identify potential safety and soundness concerns 
and ensure that action is taken to address those concerns 
before they pose a risk to the Deposit Insurance Fund. Thus, 
the Federal banking agencies may monitor and require action by 
the U.S. banking organization to maintain its financial health 
regardless of the owner of the banking organization.

Q.4. Is there a Bernanke ``Put''? Chairman Bernanke, some 
economists speculate that market participants became willing to 
take greater risks because monetary policy under Chairman 
Greenspan protected investments by cutting interest rates in 
response to economic shocks. This phenomenon came to be called 
the Greenspan ``put''--referring to the financial instrument 
that guarantees its owner a certain return if prices fall below 
a specified level. Now critics are wondering if there is also a 
Bernanke put, given the recent significant drop in rates.
    How do you respond to these observations? How do you 
balance responding to slower economic growth while at the same 
time allowing the market to follow a normal business cycle?
    Do you have any concerns that the 225 basis point drop in 
interest rates since last August creates moral hazard for 
market participants?

A.4. In conducting monetary policy, the Federal Reserve is 
guided by its statutory mandate to promote maximum employment 
and stable prices over time. I do not believe that monetary 
policy actions aimed at these goals are a significant source of 
moral hazard. To be sure, in carrying out its mandate, the 
Federal Reserve takes account of a broad range of factors that 
influence the outlook for economic growth and inflation, 
importantly including financial asset prices, such as the 
prices of equity shares and houses. Financial asset prices are 
important for the economic outlook partly because they affect 
household wealth and thus consumer spending on goods and 
services and therefore ultimately influence output, employment, 
and inflationary pressures. Depending on overall circumstances, 
declines in asset prices may adversely affect the outlook for 
aggregate demand, and consequently the stance of monetary 
policy may need to be eased in order to cushion the effect on 
aggregate demand. It is important to recognize that such a 
response of monetary policy is not designed to support 
financial asset prices themselves but to foster overall 
economic growth and to mitigate the risks of particularly 
adverse economic outcomes. It is also worth noting that past 
Federal Reserve efforts to buoy economic growth in the face of 
declining asset prices have not insulated from substantial 
losses investors who made poor investment choices. This point 
is evidenced by the very large losses suffered by investors in 
the tech sector early this decade despite considerable monetary 
policy easing, and by the losses experienced by investors in 
many subprime-related mortgage products more recently even as 
the stance of monetary policy was eased.

Q.5. Term Auction Facility: Chairman Bernanke, the Federal 
Reserve created a new Term Auction Facility to help ensure that 
American banks have adequate liquidity.
    What has been the response to the auctions thus far and for 
how long will they continue?
    What type of collateral are banks posting in these 
auctions? What happens if that collateral, particularly AAA-
rated mortgage backed securities, is downgraded?

A.5. The demand for TAF credit from depository institutions has 
been ample. All eight auctions conducted to date have been 
oversubscribed, with resulting interest rates in each case 
above the minimum bid rate. The Federal Reserve will continue 
to conduct TAF auctions for at least the next 6 months unless 
evolving market conditions clearly indicate that such auctions 
are no longer necessary.
    TAF borrowing is collateralized by the same pool of assets 
as pledged against other types of discount window loans. For 
all types of discount window loans, Federal Reserve Banks will 
consider accepting as collateral any assets that meet 
regulatory standards for sound asset quality. Commonly pledged 
assets include residential and commercial real estate loans, 
consumer loans, business loans, and a variety of securities. 
The standards applied to each type of collateral are available 
on the Federal Reserve discount window Web site at 
www.frbdiscountwindow.erg. Collateral that is downgraded below 
Federal Reserve eligibility standards is given no value and 
must be withdrawn. The likelihood that the downgrade of a 
portion of a depository institution's collateral will affect a 
TAF loan is reduced by the requirement that, at the time of 
bidding, the sum of the aggregate bid amount submitted by a 
depository institution and the principal amount of TAF advances 
that the same depository institution may have outstanding 
cannot exceed 50 percent of the collateral value of the assets 
pledged by the depository institution.

Q.6. Value of the Dollar: As you know, the U.S. dollar declined 
against most major currencies over the past year. The dollar 
has lost 10.4 percent again the Euro and 5.7 percent versus the 
yen in 2007.
    What does it mean for our economy if foreign countries turn 
away from holding the dollar as their reserve currency or even 
if they diversify, which has already begun?
    Are there dangers that we will be more constrained in the 
actions we are able to take domestically, including selling 
Treasury securities, to finance our deficit?

A.6. The dollar's status as a reserve currency reflects 
investor confidence in the sophistication and liquidity of U.S. 
financial markets and the relative stability of our 
macroeconomic environment. To date, there is little evidence of 
a shift in foreign official holdings away from dollar 
denominated assets. U.S. data show further growth in foreign 
official holdings of U.S. assets. Data reported to the IMF also 
show continued growth in dollar assets in foreign official 
reserves. While the IMF data show a decline in the dollar share 
of reported reserves, this decline is entirely attributable to 
the depreciation of the dollar, which has raised the dollar 
value of the other currencies held in the reserve portfolios. 
In response to a private survey conducted by the Royal Bank of 
Scotland, several reserve managers indicated they planned to 
increase the weight of non-dollar assets in future investments, 
but there was again no evidence of a general shift out of the 
dollar on the part of these respondents.
    In principle, a shift in foreign appetite away from U.S. 
securities toward foreign securities might be expected to lower 
the value of the dollar and to raise U.S. interest rates; 
however, these effects are difficult to measure and appear to 
be modest. Furthermore, while it is true that foreign official 
institutions hold a significant fraction of U.S. Treasury 
securities outstanding, it is important to note that these 
holdings represent less than 5 percent of the total debt 
outstanding in U.S. credit markets. As such, U.S. credit 
markets could likely absorb a shift in foreign official 
allocations away from dollar assets without undue difficulty. 
In the event that such a shift were to occur and put undesired 
upward pressure on U.S. interest rates, the Federal Reserve has 
the capacity to increase available credit to maintain a level 
of short-term interest rates consistent with our domestic 
economic goals. Any effect of reduced foreign demand on the 
term premium between short-term and long-term interest rates 
could affect the cost of long-term borrowing by the Federal 
Government; however, this impact is likely to be relatively 
small and is unlikely to materially constrain the U.S. 
government's ability to finance its deficit.

Q.7. Slow Growth and Rising Inflation: Mr. Chairman, there is 
some evidence of contradictory forces at play in the economy 
right now. In the middle of the present economic downturn, 
commodity and food prices have increased.
    What do you judge to be the threat of slow growth 
continuing, with inflation remaining above the Federal 
Reserve's comfort level?

A.7. The FOMC, in the statement released at the conclusion of 
its most recent meeting on March 18, noted that the outlook for 
economic activity has weakened further in recent weeks and that 
downside risks to growth remain. At the same time, inflation 
has been elevated, uncertainty about the inflation outlook has 
increased The actions taken by the Federal Reserve since last 
August, including measures to foster market liquidity, should 
help to promote moderate growth over time and to mitigate the 
risks to economic activity. However, the Federal Reserve 
remains attentive to the risks to the outlook for activity and 
inflation, and it will act in a timely manner as needed to 
promote sustainable economic growth and price stability.

Q.8. Capital: The ongoing turmoil in our financial markets 
vividly demonstrates the wisdom of prudent capital requirements 
for our financial institutions. If our financial institutions 
hold sufficient capital, they are much more likely to weather 
the inevitable economic storms that occur as part of the 
business cycle. Because a healthy banking system is one of the 
best defenses against a severe economic downturn, one of the 
most important responsibilities of our financial regulators is 
ensuring that financial institutions are adequately 
capitalized.
    Chairman Bernanke, what is your assessment of the current 
capital levels in our banking system? As part of your answer, 
would you explain the steps your agency has taken over the past 
year to make sure that our banks are adequately capitalized?
A.8. As you how a bank is deemed to be well capitalized under 
Prompt Corrective Action rules if it has a tier 1 risk-based 
capital ratio of 6 percent or greater, a total risk-based 
capital ratio of 10 percent or greater, a leverage ratio of 5 
percent or greater and is not subject to any written directive 
issued by the Federal Reserve Board. As can be seen in the 
summary table below, the majority of U.S. commercial banks have 
substantial buffers over the well capitalized requirements (as 
of year-end 2007), which should prove helpful during these 
difficult times. However, capital ratios in banking 
organizations can erode rapidly during downturns, depending on 
the rate of increase and amounts of write-downs and additions 
to the allowance for losses and the extent to which these 
cannot be offset by the retention of earnings or raising of new 
capital.

            Summary Average Data for Insured Commercial Banks
------------------------------------------------------------------------
               Ratios                   Avg. 1997-2007     2006    2007
------------------------------------------------------------------------
Equity Capital/Assets...............                9.2    10.2    10.2
Leverage............................                7.8     8.1     7.9
Tier 1 Ratio (Risk-Based)...........                9.7     9.8     9.4
Total Ratio (Risk-Based)............               12.4    12.4    12.2
% Deemed Well Capitalized...........               98.3    99.3    98.9
------------------------------------------------------------------------
Source: Summary Profile Report, Dec. 2007, BS&R, Federal Reserve Board
  of Governors.


    The Federal Reserve Board, together with the other banking 
agencies, is currently reviewing several elements of its 
regulatory capital requirements to ensure that banking 
organizations have sufficient capital levels to weather losses 
during difficult times and to ensure a high standard in the 
quality of capital (i.e., its ability to absorb losses 
effectively) being issued by these organizations. In addition, 
our ongoing supervisory activities include monitoring banking 
organizations' asset quality, market exposures, quality of 
earnings, capital management plans, effectiveness and adequacy 
of provisioning, and valuation policies, all of which directly 
impact the banking organizations' capital standing.
    In December 2007, the Federal Reserve Board, together with 
the other banking agencies, approved final rules implementing 
the Basel II advanced risk-based capital rules--for large, 
internationally active banking organizations--that more closely 
align regulatory capital requirements with actual risks and 
should further strengthen banking organizations' risk-
management practices. The improvements in risk management under 
Basel II will be valuable in promoting the resiliency of the 
banking and financial systems.
    Under the Basel II rules, banking organizations must have 
rigorous processes for assessing their overall capital adequacy 
in relation to their total risk profile and publicly disclose 
information about their risk profile and capital adequacy. We 
will continue to assess the Federal Reserve Board's capital 
rules to ensure that banking organizations' capital 
requirements remain prudent.

Q.9. Role of Credit Rating Agencies for Capital Requirements: 
Many financial institutions and pension funds are only 
permitted to hold assets with an ``investment grade'' rating.
    Chairman Bernanke, what steps is the Fed taking to ensure 
that banks monitor the quality of assets on their balance 
sheets and that financial institutions are not outsourcing 
their due diligence requirements to credit rating agencies?

A.9. Many investors and financial firms relied too heavily on 
ratings assigned by credit rating agencies in their risk 
management activities, particularly with regard to structured 
credit instruments. The Federal Reserve has long stressed to 
bankers the importance of proper due diligence and independent 
analysis in making credit risk assessments. A recent analysis 
of several global financial institutions by supervisors from 
the United Kingdom, Germany, France, and the United States--
including staff from the Federal Reserve--demonstrated that 
principle in the current environment. Those institutions that 
had developed robust internal processes for assessing risks of 
complex subprime-related instruments were able to more quickly 
identify declines in value and the heightened risks of these 
instruments. Accordingly, these institutions were less 
vulnerable to the underestimates of risk made by the credit 
rating agencies on these instruments, less likely to 
underestimate the volatility of these instruments, and better 
able to analyze the effects of changing market conditions on 
their credit and liquidity risk profiles. \1\
---------------------------------------------------------------------------
     \1\ Senior Supervisors' Group, ``Observations on Risk Management 
Practices During the Recent Market Turbulence,'' March 6, 2008.
---------------------------------------------------------------------------
    We are reminding institutions that they should conduct 
independent, thorough, and timely credit risk assessments for 
all exposures, not just those in the loan book. Their processes 
for producing credit risk assessments should be subject to 
periodic internal reviews--through financial analysis, 
benchmarking and other means--to ensure that these assessments 
are objective, accurate and timely. Supervisors are also 
redoubling efforts to ensure that institutions do not rely 
inappropriately on external ratings. We continue to emphasize 
that for any cases in which U.S. banks rely on third-party 
assessments of credit risk, these institutions should conduct 
their own assessments to ensure that they are sound and timely 
and that the level and nature of the due diligence should be 
commensurate to the complexity of the risk.
    In addition, the Federal Reserve and the other members of 
the President's Working Group on Financial Markets (PWG) have 
recommended a review of existing regulations and supervisory 
policies that establish minimum external ratings requirements 
to ensure they appropriately take account of the 
characteristics of securitized and other structured finance 
instruments. The PWG also has endorsed plans by the Basel 
Committee on Banking Supervision and the International 
Organization of Securities Commissions to reconsider capital 
requirements for complex structured securities and off-balance-
sheet instruments that are keyed to ratings provided by credit 
rating agencies. The PWG further has recommended changes in the 
oversight of credit rating agencies and their required 
disclosures to improve the comparability and reliability of 
their ratings, and expressed support for recent initiatives by 
the credit rating agencies to improve their internal controls 
and ratings for structured finance instruments. \2\
---------------------------------------------------------------------------
     \2\ The President's Working group on Financial Markets, ``Policy 
Statement on Financial Market Developments,'' March 12, 2008.

Q.10. HOEPA Rulemaking: During this period of correction in the 
housing market, I believe it is incredibly important that we do 
not overreact and restrict access to credit to individuals who 
need it the most. In December of last year, the Federal Reserve 
produced a proposed rule under its Homeownership Equity 
Protection Act (HOEPA) authority. That rule is currently out 
for notice and comment.
    Mr. Bernanke, can you comment for the record on some of the 
steps that the Fed took to ensure that an appropriate balance 
was struck between eliminating many of the mortgage market 
excesses that created many of the problems we face today while 
ensuring that borrowers have adequate access to credit?

A.10. Our goal in proposing new regulations under the authority 
of the Home Ownership and Equity Protection Act (HOEPA) was to 
produce clear and comprehensive rules to protect consumers from 
unfair practices while maintaining the viability of a market 
for responsible mortgage lending. To help us achieve this goal, 
we gathered substantial input from the public, including though 
five public hearings we held on the home mortgage market in 
2006 and 2007. We also focused the proposed protections where 
the risks are greatest by applying stricter regulations to 
higher-priced mortgage loans, which we have defined broadly so 
as to cover substantially all of the subprime market.
    As an example of the Board's approach, the rules would 
prohibit a lender from engaging in a pattern or practice of 
making higher-priced loans that the borrower cannot reasonably 
be expected to repay from income or from assets other than the 
house. The proposal is broadly worded to capture different ways 
that risk can be layered even as the practices that increase 
risk may change. It would not set numerical underwriting 
requirements, such as a specific ratio of debt to income, but 
would provide some specific guidance for lenders to follow when 
assessing a consumer's repayment ability. For instance, 
creditors who exhibited a pattern or practice of not 
considering consumers' ability to repay a loan at the fully-
indexed rate would be presumed to have violated the rule.
    Another proposed rule would require lenders to verify the 
income or assets they rely on to make credit decisions for 
higher-priced loans. Creditors would be able to rely on 
standard documents to verify income and assets, such as W-2 
forms and tax returns. However, to ensure access to credit for 
consumers, such as the self-employed, who may not easily be 
able to provide traditional documentation, the rule would allow 
creditors to rely on any third-party documents that provide 
reasonably reliable evidence of income and assets. For example, 
creditors could rely on a series of check cashing receipts to 
verify a consumer's income.
    We believe these proposed rules will help protect mortgage 
borrowers from unfair and deceptive practices. At the same 
time, we did not want to create rules that were so open-ended 
or costly to administer that responsible lenders would exit the 
subprime market. So, our proposal is designed to protect 
consumers without shutting off access to responsible credit.

Q.11. Housing Market: Chairman Bernanke, the current downturn 
in the housing market is not the first that we've seen, and is 
unlikely to be the last.
    What has been the average length of time from peak to 
trough in previous housing market downturns?
    How does the current downturn compare to previous ones?

A.11. Although there are considerable differences across 
episodes and measures of housing market activity, the trough 
usually occurs between 2 and 3 years after the peak. Thus far, 
the current downturn in residential investment has lasted eight 
quarters, similar to the average of previous downturns. As 
measured by single-family housing starts, the decline in 
activity so far in this cycle has been greater than average, 
although not quite as large as the contraction that occurred in 
the late 1970s and early 1980s.

Q.12. Home Prices and Inflation: Chairman Bernanke, a commonly 
watched measure of inflation is the core-CPI. Housing 
constitutes almost a third of core-CPI.
    To what extent has the recent decline in housing prices 
moderated recent increases in the core-CPI?
    What would be the trend in core-CPI if house prices were 
excluded?

A.12. The CPI for owner-occupied housing is not directly 
affected by changes in housing prices. The Bureau of Labor 
Statistics (BLS) uses a rental equivalence approach to measure 
changes in the price of housing services from owner-occupied 
units. This approach defies the implicit rent of an owner-
occupied unit as the money that would be received were it to be 
rented out (that is, the opportunity cost of owning, as opposed 
to renting, the unit). As a result, the BLS uses observations 
on tenants' rents (after making adjustments for landlord-
provided utilities) to construct the CPI for owner-occupied 
housing. It is reasonable to expect that tenants' rents should 
be related over time to the affordability of owner-occupied 
housing, which would depend in part on home prices. The BLS 
does not publish an index for the core CPI excluding owners' 
equivalent rent. However, one can gain some insight with regard 
to its limited contribution to core CPI inflation of late from 
the fact that the CPI index for all items less food and energy 
rose 2.3 percent over the 12 months ending in February 2008, 
while the index for owners' equivalent rent of primary 
residence increased 2.6 percent.

Q.13. Housing Wealth: Chairman Bernanke, the recent decline in 
home prices in many parts of the country followed several years 
of extraordinary home price appreciation.
    What has been the overall impact of the housing bubble, and 
its burst, on household wealth? Is a family that purchased a 
home in 2002 or 2003 still better off?
    Of those families who purchased homes earlier this decade, 
and have seen substantial overall appreciation, how have their 
spending patterns been affected by the declining market?

A.13. Nationwide, according to the Office of Federal Housing 
Enterprise Oversight (OFHEO) purchase-only house price index, 
house prices peaked in mid-2007 and have since fallen about 3 
percent; according to the more volatile S&P/Case-Shiller house 
price index, house prices peaked in mid-2006 and have since 
fallen about 10 percent. Both indexes show major regional 
disparities, with house prices peaking earlier, and falling 
more, in California, Nevada, some New England states, and 
Michigan and Ohio. Indeed, according to OFHEO's measure, home 
prices in Michigan have fallen, on net, since 2001. In all 
other states, families that purchased their homes in 2003 or 
earlier continue to have seen a net appreciation in their 
home's value.
    According to the Federal Reserve's flow of funds accounts, 
housing wealth peaked at $20.3 trillion in 2007:Q3 before 
falling about $170 billion in 2007:Q4. Estimates by academic 
economists of the direct effect of housing wealth on 
consumption vary widely, from as little as 2 cents on the 
dollar to as high as 7 cents on the dollar. These effects tend 
to be spread out over roughly a 3-year period, so that current 
spending is still being supported to some extent by earlier 
house price gains, and the effects of the current declines will 
only be fully felt over the next couple of years.
    In addition to directly affecting spending by reducing 
family wealth, falling house prices may affect a family's 
spending indirectly through credit market channels. Borrowing 
against home equity is often the lowest-cost form of finance 
available to a household; falling house prices can decrease the 
collateral value of a home, forcing borrowers to turn to 
costlier forms of finance, such as credit cards. These indirect 
effects, which are extremely difficult to quantify, probably 
are a factor that has increased the size of some of the larger 
published estimates of the effect of falling house prices on 
consumer spending.

Q.14. Covered Bonds: Chairman Bernanke, recently FDIC Chairman 
Bair indicated that covered bonds were a ``front burner issue'' 
at the FDIC as they continued to look for ways to improve 
liquidity in the mortgage market. I understand that Europe has 
a mature, $2 trillion covered bond market.
    Do you think there could be a benefit to fostering such a 
market in the United States?
    What distinctions do you see between the European market 
and the status of the U.S. market?

A.14. As long as banks and their counterparties are safe and 
sound, efforts to provide more financing opportunities to banks 
and bank holding companies, particularly under current market 
conditions, should be taken seriously. Such actions may make it 
more likely that the financial markets will be able to provide 
the necessary credit to sustain and enhance economic activity. 
In general, the European markets appear to be useful additions 
to their financial markets, successfully providing liquidity 
and credit for some assets under most market conditions.
    Covered bonds have been available in Europe for many years, 
and such programs differ greatly across countries. Much could 
be learned by studying the merits of each country's program and 
applying these lessons to creating a unique program in the 
United States. Creating a covered bond market in the United 
States, however, may be difficult without Congressional 
discussion and legislation. Covered bonds raise many issues 
related to the safety net provided to banks in the United 
States, including issues related to the bank deposit insurance 
fund. The legal structure provided for covered bonds in 
European countries resolves many of these issues. With regard 
to creating a covered bond market in the United States, all 
parties should seek to distill the best practices from the 
European markets and work towards the establishment of a robust 
and well-designed covered bond market that includes safeguards 
to ensure that the safety net provided banks would not be 
measurably extended further.





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