[Senate Hearing 110-855]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-855
 
        FEDERAL RESERVE'S SECOND 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

                               __________

                             JULY 15, 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

                       Amy Friend, Chief Counsel

                   Dean V. Shahinian, Senior Counsel

                    Jennifer Fogel-Bublick, Counsel

                          Julie Chon, Counsel

                      Aaron Klein, Chief Economist

               Jonathan Miller, Professional Staff Member

               Colin McGinnis, Professional Staff Member

                Neal Orringer, Professional Staff Member

                  Drew Colbert, Legislative Assistant

                Brian Filipowich, Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

                    Jim Johnson, Republican Counsel

           Peggy Kuhn, Republican Senior Financial Economist

           Andrew Olmem, Republican Professional Staff Member

          Mark Calabria, Republican Professional Staff Member

           Brandon Barford, Republican Legislative Assistant

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)



























                            C O N T E N T S

                              ----------                              

                         TUESDAY, JULY 15, 2008

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     4
    Prepared statement...........................................    38
    Response to written questions of:
        Senator Shelby...........................................    42
        Senator Bunning..........................................    44

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated July 15, 2008.......    46

                                 (iii)


        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2008

                              ----------                              


                         TUESDAY, JULY 15, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:09 a.m., in room SR-325, Russell 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Well, good morning. Let me welcome my 
colleagues and others to this very important hearing this 
morning. I want to thank the Chairman of the Federal Reserve.
    Today we are meeting in the most unusual and extraordinary 
moments in many ways in the recent history of our country. Let 
me tell you how we are going to proceed this morning.
    This is, of course, a scheduled hearing with the Chairman 
of the Federal Reserve on Humphrey-Hawkins and dealing with 
monetary policy, and over the next hour or so, we are going to 
focus on that and give the Chairman an opportunity to give us 
his statement this morning on that statutorily mandated 
requirement to appear before the Committee and share his 
thoughts on this issue. And then, as I understand it, we are 
due to have a vote around 11 o'clock, and my hope would be that 
we would recess for a few minutes for that vote, and when we 
come back, the Secretary of the Treasury, Hank Paulson, and 
Christopher Cox, the Chairman of the Securities and Exchange 
Commission, will be with us to engage in a discussion of the 
financial services issues that are before us.
    I want to thank Senator Shelby and my colleagues here for 
waiving the normal requirements of having several days of 
notice before we actually have a hearing like this. But I think 
all of us recognize the significance of the issues that are 
going on in our country at this moment and the importance of 
having the Secretary of the Treasury and the Chairman of the 
SEC as well as the Chairman of the Federal Reserve to be with 
us this morning. So I am very grateful to you and to the 
Secretary of the Treasury and Chris Cox.
    So the first hearing will be to receive the Semiannual 
Monetary Policy Report from the Federal Reserve as previously 
scheduled, and after the conclusion of that hearing, we will 
convene a second hearing on Recent Developments in U.S. 
Financial Markets and Regulatory Responses to Them. The second 
hearing was noticed yesterday with the consent of Senator 
Shelby--and, again, I am grateful to him--due to the special 
and exigent circumstances in our Nation's financial markets.
    I want to thank Chairman Bernanke for testifying at both 
hearings. I also thank Secretary Paulson and Chairman Cox for 
agreeing to appear on very short notice at the second hearing. 
In deference to them and the importance of the matters at hand, 
I will provide a brief opening statement. I will ask Senator 
Shelby to do likewise. And then I would ask my fellow Members 
here if they would reserve their question period to make their 
opening statements. All statements will be included in the 
record as if read so that we can get to the statement by the 
Chairman of the Federal Reserve and then get to the questions 
as quickly as we can.
    In considering the state of our economy and, in particular, 
the turmoil in recent days, it is important to distinguish 
between fear and facts. In our markets today, far too many 
actions are being driven by fear and ignoring crucial facts. 
One such fact is that Fannie Mae and Freddie Mac have core 
strengths that are helping them weather the stormy seas of 
today's financial markets. They are adequately capitalized. 
They are able to access the debt markets. They have solid 
portfolios with relatively few risky subprime mortgages. They 
are well regulated, and they have played a vital role in 
maintaining the flow of affordable mortgage credit even during 
these volatile times.
    Another fact is that the subprime lending fiasco was 
preventable. In this Committee, 18 months of exhaustive 
hearings have documented what I have called a ``pattern of 
regulatory neglect.'' The previous leadership, along with other 
financial agency leaders appointed by this administration, in 
my view ignored the clear and present danger posed by predatory 
lending to homeowners, to financial institutions, and to the 
economy as a whole. The result of this neglect is that the 
American people are experiencing unprecedented hardships and 
uncertainties.
    Foreclosure rates continue at record levels. Each and every 
day in America, more than 8,000 families enter foreclosure. For 
those lucky enough to keep their homes, the value of their 
homes has dropped by the greatest amount in some cases since 
the Great Depression. Millions more are paying record-high 
prices for gasoline, for health care, for education, and even 
for the food that they put on their tables. They are watching 
the value of their pension funds and 401(k)s plummet. And they 
want to know when will things start to turn around, when will 
America get back on track.
    Chairman Bernanke, you are to be commended, in my view, for 
your efforts to bring greater stability to our financial system 
during an unprecedented period of volatility. You also deserve 
credit for your willingness to address some of the unsafe, 
unsound, and predatory practices that proliferated over the 
last several years in the subprime mortgage market, as well as 
in the credit card lending. And we look forward to hearing from 
you today about the outlook for the Nation's economy and what 
can be done to improve it.
    Certainly, this Committee has worked diligently in that 
regard. On Friday evening, the Senate passed, with an 
overwhelming bipartisan majority, a bill that we believe will 
assist homeowners at risk of foreclosure, establish a new, 
permanent affordable housing fund, modernize the FHA, 
strengthen the regulation of the GSEs, and help restore 
confidence to the mortgage markets as a whole. It is certainly 
my view that this legislation deserves to be enacted as soon as 
possible, and I hope that will occur.
    In addition, we are all by now aware that the Treasury and 
the SEC as well as the Fed made important policy announcements 
this past weekend, which we intend to examine carefully in the 
hearing later this morning with you, Mr. Chairman, Secretary 
Paulson, and Chairman Cox.
    I think I can speak for everyone, I hope, on this Committee 
in saying that we all share a common desire to promote the 
common good of our country, and I think we all certainly 
appreciate the spirit in which the Fed, the SEC, and the 
Treasury Department have acted. But we do them and the American 
people a disservice if we do not examine very carefully the 
proposals that are being put forward. That is particularly true 
of the Treasury proposals. It is in many respects 
unprecedented. Although limited in duration, these proposals 
would give the Treasury unlimited new authority to purchase GSE 
debt and equity, it would exempt those purchases from pay-as-
you-go budget rules, and it would grant to the Federal Reserve 
considerable new powers in relation to the regulation of the 
GSEs. These new powers could have the effect of crippling the 
efforts of virtually every Member of this Committee to create a 
true world-class regulator for the GSEs.
    These proposals raise serious questions--questions about 
the nature of the economic crisis facing our Nation, about the 
ability of these proposals to address this crisis effectively, 
and about the burden to the American taxpayer potentially being 
asked to carry. These questions deserve serious answers.
    Above all, this is a time to act on the basis of fact and 
not fear, as I said at the outset of these remarks. For too 
many years, leaders have shirked their duty, in my view, to 
protect the American taxpayer and to promote the American 
economy. At this critical moment, we must not flinch from our 
duty to do the same.
    With that, let me turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Mr. Chairman, I ask that my whole statement 
be made part of the record.
    Chairman Dodd. Without objection, it will be.
    Senator Shelby. Chairman Bernanke, we again welcome you to 
the Banking Committee. We know this is a stressful time for our 
country, for our banking system, and perhaps for the Federal 
Reserve. We welcome you to deliver the Federal Reserve's 
Semiannual Monetary Policy Report, as you are required by law 
to do.
    I will keep my remarks brief and wait for Secretary Paulson 
and also SEC Chairman Cox to join you. But we are all 
interested in your views on the economy, where the economy is 
going to go, more than the specter of inflation, but other 
issues, related issues, such as the GSE situation.
    A lot of us--and you have raised this issue, your Chairman 
raised this issue over 5 years ago in this Committee. A lot of 
us realized that the GSEs were not properly regulated and were 
thinly capitalized. We have seen this come home now. They were 
fears that we hoped would not come, but they are here today.
    I guess the situation is some said always that the GSEs, 
because of the implicit guarantee of the Government, with over 
$5 trillion of debt, exceeding that of France and the U.K. 
combined, that it was a ticking time bomb. Well, someone has 
started the fuse burning. I hope it is not too little or too 
late. But I believe this is an opportune time to rein in the 
GSEs.
    Senator Dodd has talked about this a lot: We realize they 
are important to our housing, they are important to our 
economy, but they have to be capitalized well. They have got to 
be managed well, and they have got to be regulated. And I hope 
later in the morning we will get into that. I think that is one 
of the topics of the day after your monetary policy report.
    Thank you, Senator Dodd.
    Chairman Dodd. With that, Mr. Chairman, we welcome your 
comments, and your statement in full will be included in the 
record.

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

    Mr. Bernanke. Chairman Dodd, Senator Shelby, and Members of 
the Committee, I am pleased to present the Federal Reserve's 
Monetary Policy Report to the Congress.
    The U.S. economy and financial system has confronted some 
significant challenges thus far in 2008. The contraction in 
housing activity that began in 2006 and the associated 
deterioration in mortgage markets that became evident last year 
have led to sizable losses at financial institutions and a 
sharp tightening in overall credit conditions. The effects of 
the housing contraction and of the financial head winds on 
spending and economic activity have been compounded by rapid 
increases in the prices of energy and other commodities which 
have sapped household purchasing power even as they have 
boosted inflation.
    Against this backdrop, economic activity has advanced at a 
sluggish pace during the first half of this year while 
inflation has remained elevated. Following a significant 
reduction in its policy rate over the second half of 2007, the 
Federal Open Market Committee eased policy considerably further 
through the spring to counter actual and expected weakness in 
economic growth and to mitigate downside risk to economic 
activity. In addition, the Federal Reserve expanded some of the 
special liquidity programs that were established last year and 
implemented additional facilities to support the functioning of 
financial markets and foster financial stability.
    Although these policy actions have had positive effects, 
the economy continues to face numerous difficulties, including 
ongoing strains on financial markets, declining house prices, a 
softening labor market, and rising prices of oil, food, and 
some other commodities.
    Let me now turn to a more detailed discussion of some of 
these key issues.
    Developments in financial markets and their implications to 
the macroeconomic outlook have been a focus of monetary 
policymakers over the past year. In the second half of 2007, 
the deteriorating performance of subprime mortgages in the 
United States triggered turbulence in domestic and 
international financial markets as investors became markedly 
less willing to bear credit risks of any type.
    In the first quarter of 2008, reports of further losses and 
writedowns by financial institutions intensified investor 
concerns and resulted in further sharp reductions in market 
liquidity. By March, many dealers and other institutions, even 
those that had relied heavily on short-term secured financing, 
were facing much more stringent borrowing conditions.
    In mid-March, a major investment bank, the Bear Stearns 
Companies Incorporated, was pushed to the brink of failure 
after suddenly losing access to short-term financing markets. 
The Federal Reserve judged that a disorderly failure of Bear 
Stearns would pose a serious threat to overall financial 
stability and would most likely have significant adverse 
implications for the U.S. economy. After discussions with the 
Securities and Exchange Commission and in consultation with the 
Treasury, we invoked emergency authorities to provide special 
financing to facilitate the acquisition of Bear Stearns by 
JPMorgan Chase and Company.
    In addition, the Federal Reserve used emergency authorities 
to establish two new facilities to provide backstop liquidity 
to primary dealers, with the goals of stabilizing financial 
conditions and increasing the availability of credit to the 
broader economy.
    We have also taken additional steps to address liquidity 
pressures in the banking system, including a further easing of 
the terms for bank borrowing at the discount window and 
increases in the amount of credit made available to banks 
through the Term Auction Facility.
    The FOMC also authorized expansion of its currency swap 
arrangements with the European Central Bank and the Swiss 
National Bank to facilitate increased dollar lending by those 
institutions to banks in their jurisdictions.
    These steps to address liquidity pressures, coupled with 
monetary easing, seem to have been helpful in mitigating some 
market strains. During the second quarter, credit spreads 
generally narrowed, liquidity pressures ebbed, and a number of 
financial institutions raised new capital. However, as events 
in recent weeks have demonstrated, many financial markets and 
institutions remain under considerable stress, in part because 
the outlook for the economy and, thus, for credit quality 
remains uncertain.
    In recent days, investors became particularly concerned 
about the financial condition of the Government-sponsored 
enterprises Fannie Mae and Freddie Mac. In view of this 
development, and given the importance of these firms to the 
mortgage market, the Treasury announced the legislative 
proposal to bolster their capital, access to liquidity, and 
regulatory oversight.
    As a supplement to the Treasury's existing authority to 
lend to the GSEs, and as a bridge to the time when the Congress 
decides how to proceed on these matters, the Board of Governors 
authorized the Federal Reserve Bank of New York to lend to 
Fannie Mae and Freddie Mac should that become necessary. Any 
lending would be collateralized by U.S. Government and Federal 
agency securities. In general, healthy economic growth depends 
on well-functioning financial markets. Consequently, helping 
the financial markets to return to more normal functioning will 
continue to be a top priority of the Federal Reserve.
    I turn now to current economic developments and prospects. 
The economy has continued to expand, but at a subdued pace. In 
the labor market, private payroll employment has declined this 
year, falling at an average pace of 94,000 jobs per month 
through June. Employment in the construction and manufacturing 
sectors has been particularly hard hit, although employment 
declines in a number of other sectors are evident as well. The 
unemployment rate has risen and now stands at 5.5 percent.
    In the housing sector, activity continues to weaken. 
Although sales of existing homes have been unchanged this year, 
sales of new homes have continued to fall, and inventories of 
unsold new homes remain high. In response, home builders 
continue to scale back the pace of housing starts. Home prices 
are falling, particularly in regions that experienced the 
largest price increases earlier this decade. The declines in 
home prices have contributed to the rising tide of 
foreclosures. By adding to the stock of vacant homes for sale, 
these foreclosures have in turn intensified the downward 
pressure on home prices in some areas.
    Personal consumption expenditures have advanced at a modest 
pace so far this year, generally holding up somewhat better 
than might have been expected given the array of forces 
weighing on household finances and attitudes. In particular, 
with the labor market softening and consumer price inflation 
elevated, real earnings have been stagnant so far this year. 
Declining values and equities in house have taken their toll on 
household balance sheets, credit conditions have tightened, and 
indicators of consumer sentiment have fallen sharply. More 
positively, the fiscal stimulus package is providing some 
timely support to household incomes. Overall, consumption 
spending seems likely to be restrained over coming quarters.
    In the business sector, real outlays for equipment and 
software were about flat in the first quarter of the year, and 
construction of nonresidential structures slowed appreciably. 
In the second quarter, the available data suggests that 
business fixed investment appears to have expanded moderately. 
Nevertheless, surveys of capital spending plans indicate that 
firms remain concerned about the economic and financial 
environment, including sharply rising costs of inputs and 
indications of tightening credit, and they are likely to be 
cautious with spending in the second half of the year. However, 
strong export growth continues to be a significant boon to many 
U.S. companies.
    In conjunction with the June FOMC meeting, Board members 
and reserve bank presidents prepared economic projections 
covering the years 2008 through 2010. On balance, most FOMC 
participants expected that, over the remainder of this year, 
output would expand at a pace appreciably below its trend rate, 
primarily because of continued weakness in housing markets, 
elevated energy prices, and tight credit conditions. Growth is 
projected to pick up gradually over the next 2 years as 
residential construction bottoms out and begins a slow recovery 
and as credit conditions gradually improve. However, FOMC 
participants indicated that considerable uncertainty surrounded 
their outlook for economic growth, and they viewed the risks to 
their forecast as skewed to the downside.
    Inflation has remained high, running at nearly a 3.5-
percent annual rate over the first 5 months of this year, as 
measured by the price index of personal consumption 
expenditures. And with gasoline and other consumer energy 
prices rising in recent weeks, inflation seems likely to move 
temporarily higher in the near term. The elevated level of 
overall consumer inflation largely reflects a continued sharp 
run-up in the prices of many commodities, especially oil, but 
also certain crops and metals. The spot price of West Texas 
intermediate crude oil soared about 60 percent in 2007 and thus 
far this year has climbed an additional 50 percent or so.
    The price of oil currently stands at about 5 times its 
level toward the beginning of this decade. Our best judgment is 
that this surge in prices has been driven predominantly by 
strong growth in underlying demand and tight supply conditions 
in global oil markets.
    Over the past several years, the world economy has expanded 
at its fastest pace in decades, leading to substantial 
increases in demand for oil. Moreover, growth has been 
concentrated in developed and emerging market economies, where 
energy consumption has been further stimulated by rapid 
industrialization and by government subsidies that hold down 
the price of energy faced by ultimate users.
    On the supply side, despite sharp increases in prices, the 
production of oil has risen only slightly in the past few 
years. Much of the subdued supply response reflects inadequate 
investment and production shortfalls in politically volatile 
regions where large portions of the world's oil reserves are 
located. Additionally, many governments have been tightening 
their control over oil resources, impeding foreign investment 
and hindering efforts to boost capacity and production. 
Finally, sustainable rates of production in some of the more 
secure and accessible oil fields, such as those in the North 
Sea, have been declining.
    In view of these factors, estimates of long-term oil 
supplies have been marked down in recent months. Long-dated oil 
future prices have risen along with spot prices, suggesting 
that market participants also see oil supply conditions 
remaining tight for years to come.
    The decline in the foreign exchange value of the dollar has 
also contributed somewhat to the increase in oil prices. The 
precise size of this effect is difficult to ascertain as the 
causal relationships between oil prices and the dollar are 
complex and run in both directions. However, the price of oil 
has risen significantly in terms of all major currencies, 
suggesting that factors other than the dollar--notably, shifts 
in the underlying global demand for and supply of oil--have 
been the principal drivers of these increases in prices.
    Another concern that has been raised is that financial 
speculation has added markedly to upward pressure on oil 
prices. Certainly, investor interest in oil and other 
commodities has increased substantially of late. However, if 
financial speculation is pushing oil prices above the levels 
consistent with the fundamentals of supply and demand, we would 
expect inventories of crude oil and petroleum products to 
increase as supply rose and demand fell. But, in fact, 
available data on oil inventories show notable declines over 
the past year.
    This is not to say that useful steps could not be taken to 
improve the transparency and functioning of futures markets, 
only that such steps are unlikely to substantially affect the 
prices of oil or other commodities in the longer term.
    Although the inflationary effect of rising oil and 
agricultural commodity prices is evident in the retail prices 
of energy and food, the extent to which the high prices of oil 
and other raw materials have passed through to the prices of 
non-energy, non-food finished goods and services seems thus far 
to have been limited. But with businesses facing persistently 
higher input prices, they may attempt to pass through such 
costs into prices of final goods and services more aggressively 
than they have done so far.
    Moreover, as the foreign exchange value of the dollar has 
declined, rises in import prices have put greater upward 
pressure on business costs and consumer prices. In their 
economic projections for the June FOMC meeting, monetary 
policymakers marked up their forecasts for inflation during 
2008 as a whole. FOMC participants continue to expect inflation 
to moderate in 2009 and 2010 as slower global growth leads to a 
pooling of commodity markets, as pressures on resource 
utilization decline, and as longer-term inflation expectations 
remain reasonably well anchored. However, in light of 
persistent escalation of commodity prices in recent quarters, 
FOMC participants view the inflation outlook as unusually 
uncertain and cited the possibility that commodity prices will 
continue to rise as an important risk to the inflation 
forecast.
    Moreover, the currently high level of inflation, if 
sustained, might lead the public to revise up its expectations 
for longer-term inflation. If that were to occur and those 
revised expectations were to become embedded in the domestic 
wage- and price-setting process, we could see an unwelcome rise 
in actual inflation over the longer term. A critical 
responsibility of monetary policymakers is to prevent that 
process from taking hold.
    At present, accurately assessing and appropriately 
balancing the risks to the outlook for growth and inflation is 
a significant challenge for monetary policymakers. The 
possibility of higher energy prices, tighter credit conditions, 
and a still deeper contraction in housing markets all represent 
significant downside risks to the outlook for growth. At the 
same time, upside risks to the inflation outlook have 
intensified lately as the rising prices of energy and some 
other commodities have led to a sharp pick-up in inflation, and 
some measures of inflation expectations have moved higher.
    Given the high degree of uncertainty, monetary policymakers 
will need to carefully assess incoming information bearing on 
the outlook for both inflation and growth. In light of the 
increase in upside inflation risk, we must be particularly 
alert to any indications, such as erosion of longer-term 
inflation expectations, that the inflationary impulses from 
commodity prices are becoming embedded in the domestic wage- 
and price-setting process.
    I would like to conclude my remarks by providing a brief 
update on some of the Federal Reserve's actions in the area of 
consumer protection.
    At the time of our report last February, I described the 
Board's proposal to adopt comprehensive new regulations to 
prohibit unfair or deceptive practices in the mortgage market 
using our authority under the Home Ownership and Equity 
Protection Act of 1994. After reviewing more than 4,500 comment 
letters we received on these proposed rules, the Board approved 
the final rules yesterday. The new rules apply to all types of 
mortgage lenders and will establish lending standards aimed at 
curbing abuses while preserving responsible subprime lending 
and sustainable homeownership.
    The final rules prohibit lenders from making higher-priced 
loans without due regard for consumers' ability to make the 
scheduled payments and require lenders to verify the income and 
assets on which they rely when making the credit decision. 
Also, for higher-priced loans, lenders now will be required to 
establish escrow accounts so that property taxes and insurance 
costs will be included in consumers' regular monthly payments.
    The final rules also prohibit prepayment penalties for 
higher-priced loans in cases in which the consumer's payment 
could increase during the first few years and restrict 
prepayment penalties on other higher-priced loans. Other 
measures address the coercion of appraisers' service or 
practices and other issues. We believe the new rules will help 
to restore confidence in the mortgage market.
    In May, working jointly with the Office of Thrift 
Supervision and the National Credit Union Administration, the 
Board issued proposed rules under the Federal Trade Commission 
Act to address unfair or deceptive practices for credit card 
accounts and overdraft protection plans. Credit cards provide a 
convenient source of credit for many consumers, but as the 
terms of credit card loans have become more complex, 
transparency has been reduced.
    Our consumer testing has persuaded us that disclosures 
alone cannot solve this problem. Thus, the Board's proposed 
rules will require card issuers to alter their practices in 
ways that will allow consumers to better understand how their 
own decisions and actions will affect their costs. Card issuers 
would be prohibited from increasing interest rates 
retroactively to cover prior purchases, except under very 
limited circumstances. For accounts having multiple interest 
rates, when consumers seek to pay down their balance by paying 
more than the minimum, card issuers would be prohibited from 
maximizing interest charges by applying excess payments to the 
lowest-rate balance first.
    The proposed rules dealing with bank overdraft services 
seek to give consumers greater control by ensuring that they 
have ample opportunity to opt out of automatic payments of 
overdrafts. The Board has already received more than 20,000 
comment letters in response to these proposed rules.
    Thank you very much. I would be pleased to take your 
questions.
    Chairman Dodd. Well, thank you very much, Mr. Chairman. And 
let me just briefly say I appreciate the efforts of the Fed 
regarding both credit cards and the things dealing with 
predatory lending practices. We welcome those rules, and we 
welcome the suggestions in the credit card areas, and a future 
point here, we will maybe have more discussion about that. But 
I wanted to at least reflect my appreciation of what the Fed 
has done regarding those matters, and we appreciate it very 
much.
    I am going to put this clock on at 5 minutes so we can give 
everyone a chance to raise any questions they have on the 
monetary policy issues. Some of the questions may overlap, and 
at the conclusion of that, Secretary Paulson and Chairman Cox 
will be here to have a broader discussion about the proposals 
being made by Treasury over the weekend.
    Let me, if I can, jump to the economic projections for 
2009, the concerns about economic growth that you have raised 
in your statement here this morning. Given the fact that we 
have, as you point out, acknowledged the risk to your forecast 
for economic growth are skewed to the downside, to use your 
words, and given the fact that the stimulus package is about 
to--the effects of it are going to run out by the end of the 
year. The housing crisis continues, obviously, as we all know 
painfully. Gasoline prices, as you point out, are at record 
levels, costing consumers tremendously. The issues involving 
the weakness in the labor market are significant, 94,000 jobs 
lost every month for the last 6 months on a consistent basis. 
Inflation, as you point out, while it may abate in the coming 
years, it certainly is going to be with us for some time.
    What suggestions do you have for us in all of this? And I 
realize you may want to reserve some final judgment on the 
effects of the stimulus package and will not know the full 
effects of that until maybe toward the end of the year. But as 
we look down the road as policy setters here in the Congress 
looking at ideas, including a possibly a second stimulus 
package, one of the suggestions we made to increase 
productivity is to invest more heavily in infrastructure, the 
infrastructure needs of the country.
    I wonder if you might just share with us your views as to 
what ideas, as a menu of ideas, without necessarily embracing 
one or the other, but what you would be planning to do rather 
than just sort of waiting out the year and a new administration 
coming in, we will be leaving here, adjourning in late 
September, early October, maybe coming back, maybe not until 
after inauguration of the President late in January, it seems 
to me this would be an opportune time for us to be considering 
very seriously policy considerations that would provide for 
greater economic growth and opportunity than what we are 
presently looking at.
    Mr. Bernanke. Mr. Chairman, I think that the central issue 
in the economic situation right now is the housing market. It 
is the continued uncertainty about house prices and housing 
activity which is creating financial stress, is affecting 
consumer wealth and consumer expectations and causing the 
stress we are seeing in the economy. So my suggestion would be 
in the near term to focus on issues related to housing. I 
understand that you have already passed a bill that would 
address, for example, GSE reform. We need the GSEs to continue 
to be active in supporting the mortgage markets, as well as FHA 
modernization and other steps that Congress determines would 
strengthen and support mortgage finance in the housing sector. 
I think that is the most critical central issue we face.
    On a second stimulus package, my own sense is that we are 
still trying to assess the effects of the first round. It 
appears that it does seem to be helping. But it might be a bit 
more time before we fully understand the extent to which 
additional stimulus may or may not be needed.
    If additional stimulus is, in fact, invoked, it would be 
important to find programs that would be, as in the first 
round, timely, temporary, and targeted, in particular, that 
would take place quickly and would put money into the economy 
relatively quickly.
    In the case of infrastructure, it is often well justified 
on its merits, but one would have to ask whether the flow of 
funding would go into the economy in a relatively prompt way, 
or would there be long delays associated with the planning 
process?
    Chairman Dodd. But your objections or concerns, they are 
not about the effects of that in the longer term but more the 
near-term benefits of it.
    Mr. Bernanke. Addressing the infrastructure issue in the 
United States is very important since infrastructure is a 
critical part of the economic underpinnings. But except for 
those cases where the infrastructure spending would have 
immediate impact on total spending, I would suggest that those 
projects be evaluated on their own merits in terms of their 
ability to contribute to the overall strength of the economy in 
the longer term.
    Chairman Dodd. I have a last question for you dealing with 
gasoline prices, and, again, let me first of all commend you 
because you did something different than your predecessor. In 
the past, we have excluded in the consideration of inflation 
gasoline or energy pricing and food. And if you do not drive a 
car, heat your home, or put food on the table, I suppose that 
has some relevance here. And I understand the macroeconomic 
value of excluding energy and food. But for average Americans, 
excluding those two necessities hardly reflects real inflation. 
And so the fact that you are now adding those to real inflation 
is very welcome, and I thank you for it.
    I wonder if you might comment briefly on the notion, how is 
it--and I understand your points about demand in the country 
and around the world and supply issues. But it strikes many of 
us here in the speculation area, and you said the need to look 
at transparency issues and the like are warranted. But it seems 
to me in 1 year's time to go from $60 or $70 a barrel to this 
morning I think it is hovering around $150 a barrel has to be 
explained in terms other than just normal economic pressures 
that it created.
    Does it concern you at all about margin requirements, for 
instance, in the area of speculation where the margin 
requirements are somewhat different in the area of energy 
pricing than they are for other commodities that there should 
be some leveling of the playing field when it comes to margin 
requirements, as an example of what might come as a response?
    Mr. Bernanke. I would just like to comment briefly that the 
Federal Reserve and the CFTC are part of a task force which is 
gathering data analyzing these issues and hope to bring some 
more explicit recommendations to you later this summer or early 
fall.
    Margin requirements serve two purposes. They can affect the 
cost of credit, but they also are a very important part of the 
counterparty risk management process for exchanges. And so we 
need to be careful in changing margin requirements that we do 
not interfere with these other important functions or that we 
do not unnecessarily reduce the liquidity in those markets. But 
we are certainly looking at these issues, and we hoped that 
they would bring to you some ideas.
    Chairman Dodd. You will be looking at that one 
specifically, the margin requirement issue. Is that----
    Mr. Bernanke. We will be looking specifically at the whole 
range of issues about transparency, practices, positions, and 
so on.
    Chairman Dodd. Thank you very much.
    Senator Shelby.
    Senator Shelby. Mr. Chairman, I have a number of questions 
that I would like to submit for the record dealing with 
monetary policy.
    Chairman Dodd. That will all be done, by the way. Any 
questions people have and they do not feel they have enough 
time on monetary policy, we will make sure the Chairman gets 
them.
    Senator Shelby. Chairman Bernanke, you are also a bank 
regulator, the Federal Reserve, and I know that you are not the 
primary regulator of IndyMac, which was the largest bank 
failure since 1984, Continental Illinois. Why did that bank 
fail? And could it have been prevented? What is your take on 
it? And is that just the beginning of a number of bank failures 
that you should be concerned with and we should be concerned 
with in this country?
    Mr. Bernanke. Well, Senator, as you point out, we are not 
the primary regulator of that institution, but we were involved 
in it----
    Senator Shelby. Absolutely.
    Mr. Bernanke. ----because the Federal Reserve Bank of San 
Francisco was attempting to assist in the wind down, and we 
certainly had extensive communication with the FDIC and the OTS 
about that bank.
    My assessment of IndyMac is that it was particularly 
weighted down with low-quality mortgages, subprime and other 
exotic mortgages, and those losses created a capital hole that 
it was unable to fill. So in that respect, I think its failure, 
barring acquisition by another firm, which did not occur, was 
inevitable. So, again, I think it was basically the asset 
quality of the bank that had that effect.
    Of course, all banks are being challenged by credit 
conditions now. The good news is that the banking system did 
come into this episode extremely well capitalized, extremely 
profitable. I do not have any forecast to make. I think 
Chairman Bair gave a good discussion yesterday about the 
pressures that banks are facing, and she discussed her list of 
problem banks.
    I suppose it is a bit of good news that most of the problem 
banks that she had is a far smaller list than we have seen in 
some episodes in the past, in the 1990s, for example.
    Senator Shelby. Overall, looking at our banking system, 
could you say today here in the Senate that you believe as 
Chairman of the Federal Reserve that our banking system is 
stable and capitally strong?
    Mr. Bernanke. Our banking system is well capitalized. They 
came in with strong capital. We are watching the situation very 
carefully. My concerns have turned less on the solvency of 
these institutions and more on their ability to extend the 
credit that our economy needs to keep growing, because in many 
cases banks are deleveraging or shrinking or are reluctant to 
raise the extra capital needed to take advantage of business 
opportunities. So that is more my concern than solvency 
concerns.
    Senator Shelby. Let's briefly, because I have just got a 
couple of minutes, focus on the GSEs, and we will get into it 
more when the Treasury Secretary gets here and the Chairman of 
the SEC. Is this just a stopgap measure or is this a real 
approach to fundamentally reform the GSEs? A lot of us, you 
included, have been advocating that right here on this 
Committee for a long time. We did not have a lot of help from 
certain people, some of our friends, and Fannie Mae and Freddie 
Mac have some of the most powerful lobbyists, believe me, in 
Washington. And I do not believe that they are going to like 
some of the things that I believe we have to come forth with 
now. But is this just a piecemeal deal? Because we have got 
systemic risk here. Where do we go? Will this do it, in other 
words, or will this just be postponing the inevitable?
    Mr. Bernanke. Well, Senator, our goals at this point should 
be to protect the financial system, to protect the taxpayer, 
and to strengthen and support the housing market. There are a 
number of steps that we need, but I think a critical step would 
be----
    Senator Shelby. What are the three most important steps?
    Mr. Bernanke. The most important step will be to get a 
strong, bank-like, world-class regulator that will be able to 
provide assurance to the public, to the taxpayer, and to the 
investors that these firms will be well capitalized and able to 
maintain and support their core mission, which is to support 
mortgage financing in the United States. So I would say that is 
job one.
    Then we need to think about what else is needed to make 
sure that they are, in fact, strong enough financially and 
there is enough confidence that they can, in fact, carry out 
their mission. And, again, the taxpayers' interest must be 
protected.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you, 
Chairman Bernanke, for your testimony and your successful.
    I want to visit with you on the housing issue. In March of 
2007, you said that, ``The impact on the broader economy and 
financial markets of the subprime market seems likely to be 
contained.'' And I assume you would want to change that 
statement today somewhat, amend it, with the ability of 20/20 
hindsight.
    What do you think in the housing crisis, do you see it 
hitting rock bottom this year? A year from now? Because this is 
one of the significant challenges within the economy. What do 
you see on the horizon?
    Mr. Bernanke. Well, first, of course, I would like to 
revise and extend my remarks from March of 2007. The issue was 
that the subprime crisis triggered a much broader retreat from 
credit and risk taking, which has affected not just subprime 
lending but a wide variety of credit instruments. And that is 
why it has become a much bigger element in the situation than, 
frankly, I anticipated at that time.
    The housing market is still under considerable stress and 
construction is still declining. I do believe that we will 
start to see stabilization in the construction of new homes 
sometime later this year or the beginning of next year, and 
that will be a benefit because the slowing construction pattern 
has been subtracting about 1 percentage point from the growth 
of the GDP going back now for some time. So that will be a 
benefit.
    House prices may continue to fall longer than that because 
of the large inventories of unsold homes that we still face. 
And then I would have to say that there is uncertainty about 
exactly what the equilibrium level that house prices will reach 
is. Unfortunately, it is that uncertainty, which is generating 
a lot of the stress and risk aversion we are seeing in 
financial markets.
    It is for that reason--the need to find a footing, to find 
stability in the housing market--that I do think that action by 
this Congress to support the housing market through 
strengthening the GSEs and FHA and so on is of vital 
importance.
    Senator Menendez. Let me talk about the other major driver, 
then, of what is happening to our economy, and that is the 
whole question of energy prices and oil. You know, I appreciate 
in your answer to the Chairman and in your testimony, because 
we have had testimony before the Congress by all executives who 
say that the difference between supply and demand over the last 
2 years would largely lead us to a concern that, in fact, 
speculation may have driven the price of oil up an additional 
$50 a barrel. You have the view that that may not be the most 
significant thing in prices, but you do take the view that 
useful steps can be taken to improve the transparency and 
functioning of future markets.
    Are you ready to say to the Committee today what some of 
those useful steps are? Or are you still depending upon that 
Committee that you are meeting with to look at that? Because we 
do not have a lot of time here.
    Mr. Bernanke. Senator, this is really the CFTC's function 
and responsibility. We are trying to assist them, and we are 
trying to work as quickly as possible to gather information and 
try to make some useful recommendations.
    Senator Menendez. Well, many of us believe we need to 
pursue market speculation now as a critical element of helping 
to drive down particularly gas prices. Let me ask you this: 
There is one thing squarely within your realm, and that is the 
question of a weaker dollar.
    In 2000, we ran a budget surplus. Ever since then, the 
Federal Government has been running up larger budget deficits. 
We added to that a $1.6 trillion tax cut and a $700 billion war 
that would generally contribute to a larger budget deficit. And 
if you look at that and you look at the twin deficits of both 
trade and the budget in combination, you have a low--with a low 
domestic savings rate, you have all of the makings of a 
weakening dollar.
    In 2002, the barrel of oil cost $23 and 23 euros. Now it 
costs--well, the Chairman had even a higher figure than I had. 
I had $145 and 90 euros. I am sure it just changed overnight.
    Do you agree with the Commodity Futures Trading Commission 
and others that the weakening dollar has contributed to the 
higher price of oil as an elemental part of our challenge?
    Mr. Bernanke. I do agree, and I said so in my testimony. It 
should be noted that the decline in the dollar from 2002 
reversed an appreciation of the dollar that had taken place 
from the early 1990s until that point. And it is related to the 
dynamics of our trade deficit, as you alluded to.
    In the late 1990s and early 2000s, strong capital inflows 
drove the dollar up, but that made up less competitive and 
created a trade deficit. Some of that has to be unwound to 
bring us back toward a better balance of trade, and, in fact, 
we had been seeing considerable improvement in our balance of 
trade as the dollar reversed that increase. But we also import 
a lot of oil, and because we import it, when oil prices rise, 
that also works in the other direction. It tends to hurt the 
dollar. So there is really causality going in both directions.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Welcome, Chairman Bernanke. I have the same kinds of 
questions everybody has with respect to the deal made over the 
weekend for Fannie and Freddie, but I will save those for the 
next panel.
    Let's talk about your forecast. The GDP for the first 
quarter was originally forecast at six-tenths of 1 percent and 
then nine-tenths of 1 percent and then at 1-percent growth. It 
has always been raised as the data come in. We have had a bear 
signal on the Dow theory. I don't know whether you follow that 
or not, but there has been a lot of that in the newspapers, 
which I know you do follow that. Whether you believe the Dow 
theory or not, you follow it. I don't know whether you believe 
it or not. That is a separate issue. But, nonetheless, we have 
got a bear signal that says we are now in a bear market, which 
historically lasts for anywhere from 18 to 24, 30 months, 
something of that kind.
    The blue chip forecast for the second half has always been 
for growth--slow to be sure, relatively low to be sure, but for 
growth. And in your previous appearances before the Committee 
in this kind of a context, you have pretty much been in that 
same territory. Are you still there?
    Mr. Bernanke. Well, as your point about the first quarter 
makes clear, even after the fact, it is sometimes hard to know 
exactly how much growth there was. Yes, our forecast calls for 
growth in the second half, but relatively weak. Part of what 
seems to have happened is that perhaps the fiscal stimulus or 
other factors--some of the growth that we anticipated--has been 
pulled forward into the second quarter, which looks to be doing 
somewhat better, frankly, than we anticipated. So our 
forecast----
    Senator Bennett. You mean pulled forward into the first 
quarter?
    Mr. Bernanke. No. To the second quarter, the current--the 
quarter that just ended.
    Senator Bennett. Oh, yes. All right. I am second half so 
that is--OK. Right.
    Mr. Bernanke. So the second quarter appears to be actually 
better than expected, and, therefore, our forecast for the 
entire year might actually be stronger than it was earlier. But 
with that strength having been brought forward to some extent 
into the second quarter, we are looking at the remainder of the 
year as being probably positive growth, but certainly not 
robust growth.
    Senator Bennett. The one thing the markets hate more than 
anything else is uncertainty, and I have the feeling that that 
is part of the problem with respect to oil prices and part of 
the problem with respect to the housing market.
    Now, you have suggested that the housing market might 
stabilize over the next 6 to 12 months so that people will 
begin to say, OK, we have now reached bottom and we are 
starting to build back up again. Do you feel that the deal that 
was made over the weekend with Fannie and Freddie can help 
eliminate some of the uncertainty and cause people to have a 
greater degree of confidence that the timeframe that we have 
been talking about will indeed come to pass?
    Mr. Bernanke. Well, Senator, no deal was made. All that was 
done was a proposal was made to bring to Congress----
    Senator Bennett. I am using newspaper talk. I realize that 
is always a mistake.
    Mr. Bernanke. But as I said earlier, I think the housing 
sector, together to some extent with oil, is at the heart of 
the current uncertainty, the current situation. I think were it 
to happen that there would become a general view that the 
housing situation had stabilized, you would see actually a very 
strong bounce-back in the economy and the financial markets, 
and it is the uncertainty about when that happens that remains 
a problem.
    Again, it is the Congress' prerogative to decide what to do 
about the GSEs and other housing-related legislation. But as I 
tried to indicate before, I think the best thing that we can do 
to remove this uncertainty and to speed the recovery is to make 
sure that the housing market and the mortgage finance markets 
are functioning as well as possible.
    Senator Bennett. Yes, but very specifically, taking away 
the word ``deal''--and I agree with you that even though that 
is the word we have seen in the press, that is probably not the 
right word. But the structure that you have agreed to in terms 
of some kind of a back-up for the GSEs, should they get in 
trouble, do you have the feeling that the announcement of the 
terms of that structure should remove some of the uncertainty 
with respect to their future?
    Mr. Bernanke. Yes. I think right now that, in fact, part of 
the reaction in markets has to do with the uncertainty about 
exactly what the deal, as you call it, might look like. So if 
there is clarity which provides assurances that the GSEs will 
have the financial strength they need to support the mortgage 
market, and, second, as Senator Shelby emphasized, there is 
also a very strong regulator that will protect the system and 
protect the taxpayer, the combination of those two things would 
be very constructive.
    Senator Bennett. I think we know about the regulator. It is 
the other thing that people are waiting to find out about.
    Mr. Bernanke. I think so, Senator, because right now the 
GSEs are a very big part of the U.S. mortgage market.
    Senator Bennett. Thank you very much.
    Chairman Dodd. Senator Casey.
    Senator Casey. Mr. Chairman, thank you very much, and, 
Chairman Bernanke, I want to thank you for your presence here 
today and for your testimony.
    We have had the opportunity to question you on a number of 
occasions, I probably more than most because not only am I 
Member of this Committee but I am also a Member of the Joint 
Economic Committee, and we are grateful, again, for your 
testimony today.
    I wanted to review just some of the basic data, some of 
which you were kind enough to put in your statement today in 
terms of where we are economically in this country. It is, to 
use an old expression from the 1970s, a ``misery index,'' a 
``tale of woe,'' but I think it is important to remind all of 
us kind of where we are.
    You cited on page 3, I guess, of your testimony the average 
pace of 94,000 jobs per month lost through June. If you look at 
it another way, just in terms of real GDP, the growth rate over 
the last couple of years--I had not seen these numbers until 
recently--2005, 3.1-percent growth, ``only'' I should say; 
2006, 2.9; 2007, 2.2; and then the first quarter of 2008, as 
was cited earlier, 1 percent. The total job loss the last 6 
months, 438,000. You look at the trade deficit just with China 
alone, that went up even though the overall trade deficit went 
down. Foreclosures, 8,400 to 8,500 families per day, if you 
look at just weekdays, entering foreclosure. The projection by 
Treasury for foreclosures for 2008 is at some 2.5 million. The 
prices report--there is a story today, a brief story in the New 
York Times, I guess online, sales of retail goods and food grew 
just 0.1 percent in June. Consumers spent a large amount of 
money on one product. Of course, gasoline we know, have heard 
an awful lot about that. But outside of fuel, sales actually 
dropped last month by 0.5 percent.
    All of that is background, of course, to two basic 
questions I wanted to ask you, one of which I have asked and 
you have answered over the course of many months in your 
appearances here.
    The first question pertains to the difference between the 
real world of the impact of this economic crisis on families 
versus the economist's definition of ``recession.'' And I 
think, frankly, the old definition or the textbook definition 
of ``recession'' does not apply when it comes to what families 
are up against.
    And I think it was probably said best, not by a set of the 
data points I just read and not by any economist, recently in a 
story in the Centre Daily Times in Pennsylvania, in Centre 
County, Pennsylvania, ``Tammy May, a single mother of two in 
Pleasant Gap, Pennsylvania, probably said it best in just one 
line''--and I am quoting her. She is a single mother of two. 
``Pretty much we have reprioritized. The house payment is 
first, then day care, then we worry about gas, then food.'' 
Food is number four.
    So I would ask you, in light of that economic misery that I 
have just highlighted, and in light of your own testimony, your 
own work, and I think your own sensitivity to these issues, how 
do we deal with this question of what is a recession and what 
it isn't, and do we need some new definitions and some new 
terminology to better define what is happening to real families 
and real people?
    Mr. Bernanke. Well, there is a technical definition of 
recession which has to do with behavior of employment and 
investor production and other things, and that is a 
determination that is made by some economists after the fact. I 
don't know whether they will determine we have been in a 
recession or not according to these technical definitions, but 
I agree with you entirely that whether it is a technical 
recession or not, the combination of declining wealth, weak job 
market, rising food and energy prices, foreclosures, tight 
credit--all those things are putting tremendous pressure on 
families and explain why consumer sentiment is very low. People 
are very worried.
    So I certainly would never make the claim that even if we 
were not in a technical recession that it was not a serious 
situation. And I just want to assure you that everything the 
Federal Reserve does is intended to try to promote the welfare 
of the average American, and that is our objective.
    Senator Casey. Thank you. I think I am out of time. I will 
go to the next question on the second round.
    Thank you.
    Chairman Dodd. I think Senator Bunning, I believe--no, 
excuse me. Senator Allard. I apologize.
    Senator Allard. Thank you, Mr. Chairman.
    Welcome to the Committee. I always look forward to hearing 
your comments, Chairman Bernanke. Business lending has--I want 
to talk about that a little bit, and a big aspect of business 
lending historically, I am told, has been that business plans 
and their ability to execute those business plans has been a 
big factor in assessing credit and whether they get a loan or 
not. I am told that in recent history that has been minimized 
considerably.
    First of all, I would like to know if that is true. And the 
other question, if it is true, do you think we could help 
confidence if we had provisions that somehow or the other 
brought more accountability to the business plan aspect when 
you apply for a loan?
    Mr. Bernanke. Well, there is a general tightening in credit 
and tightening in underwriting standards, you know, related to 
this pullback from credit risk in general. It has affected 
different groups differentially. For example, prime corporate 
borrowers are still able to access the bond market and the loan 
market pretty effectively. Riskier firms, smaller firms, are 
having more difficulty accessing credit.
    I think that I would encourage banks to continue to make 
sound loans, and we at the Federal Reserve will not penalize 
banks that are making sound loans. We want them to extend 
credit. In assessing how to make a good loan to a business, 
certainly there are many factors, including financials and 
personal relationships and many other things, but the business 
plan is certainly an important part and one that a good bank 
lender would look at.
    Senator Allard. You have assumed, meaning the Fed has 
assumed, a great regulatory oversight authority recently here. 
Are you comfortable with that? And do you anticipate that you 
may even take on a greater regulatory role?
    Mr. Bernanke. We have begun to work with, as you know, the 
Securities and Exchange Commission, who are the primary 
regulator. We have been working with them to help evaluate and 
oversee the four large investment banks and the other primary 
dealers. That is because of the lending facility that we opened 
up after Bear Stearns. We have a responsibility to protect our 
loans, and I believe that the SEC views our participation as 
helpful in trying to make sure that these firms are 
sufficiently strong.
    It remains to be seen how the Congress would like to think 
through regulation going forward. I do think that the 
investment banks need a consolidated supervisor, but have not 
proposed a particular agency to do that. The key issue is that 
they have strong consolidated supervision. The only area in 
which I have raised the possibility of additional powers for 
the Federal Reserve--in my testimony and in speeches--is in 
payment systems, which are systemically important and where in 
most countries central banks have considerable oversight 
responsibility.
    I think it would be useful for the Congress to review how 
payment and settlement systems are overseen and to ask whether, 
from a systemic point of view, they are adequately regulated 
and whether the Fed should have some additional role in that 
area. Otherwise, we are going to have to do a lot of thinking, 
all of us, and certainly the Congress, about how, if at all, 
the regulatory structure should change based on what we have 
learned in the last year.
    Senator Allard. Some of the discussions I have been 
involved in have said that if the Fed assumes a greater 
regulatory role, it could affect your independence. And I would 
like to hear you comment on that as acting in your current 
role.
    Mr. Bernanke. Well, the way Congress wants to organize the 
regulatory structure is an important question that needs to be 
worked out, and I am not asking for any change at this moment. 
However, the Federal Reserve has a wide range of 
responsibilities, including not only regulatory oversight but 
also consumer protection, payment systems, and other things. 
The independence, which is critical, is the independence vis-a-
vis monetary policy. And I think we have been able to keep a 
good separation between monetary policy and these other areas. 
In these other areas, we are an independent agency, but we have 
no stronger claimed independence than, say, the OCC would. It 
is only in monetary policy where we need to maintain a strict 
independence, you know, in order to make the right decisions.
    Senator Allard. I noticed on some of the projections into 
2009 that they seem pretty positive--that they are better than 
what we are looking at this year, generally. What part of the 
economic sector do you see will continue to struggle? And where 
do you see that growth to improve our economy as we move into 
2009?
    Mr. Bernanke. Well, first of all, there are some factors 
which have been positive and continue to be positive. Foreign 
trade exports have been a very positive factor and have 
contributed significantly to our growth, and as that continues, 
that will be a basis to build on.
    I mentioned already the home-building sector. That has 
already declined quite substantially. It is very likely going 
to begin to level out somewhere around the end of the year. 
That leveling out will also provide additional strengths, at 
least in the sense of not subtracting from the GDP growth.
    As the situation begins to stabilize and credit markets 
begin to stabilize, then I think confidence will return to 
consumers, and we will see the beginnings of a recovery. But as 
I noted and as everyone has made allusion to, the uncertainties 
of the exact timing of this are still great.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you.
    Senator Tester.
    Senator Tester. Thank you, Mr. Chairman. Thank you, 
Chairman Bernanke.
    In your statement, you said the world economy was growing 
at the fastest pace in decades. I believe that is what you 
said. Do you anticipate that to continue or to decline?
    Mr. Bernanke. I think that this year and going into next 
year, we probably will see some moderation but still healthy 
growth.
    Senator Tester. So do you think that those impacts, if it 
backs off some, will have positive or negative or no effect on 
our financial situation?
    Mr. Bernanke. Well, it cuts two ways. On the one hand, it 
might weaken to some extent the contribution of exports and 
trade to our growth. But, on the other hand, if these other 
economies cool down, it might reduce commodity prices or 
flatten out commodity prices, which would be very beneficial.
    Senator Tester. Do you anticipate overall negative, 
positive, or pretty static in its effect?
    Mr. Bernanke. Sorry?
    Senator Tester. I know it is a two-edged sword, but do you 
anticipate it will be positive, negative, or negligible?
    Mr. Bernanke. I think it will be probably positive if it 
contributes to a slowing in commodity prices.
    Senator Tester. You talked about the long-term oil supplies 
are down. I believe that is what you said.
    Mr. Bernanke. Well, not rising.
    Senator Tester. Is that domestically, worldwide, or both?
    Mr. Bernanke. Well, certainly oil supplies are declining in 
the United States. Worldwide, they have been relatively flat.
    Senator Tester. OK. Senator Menendez talked about the 
dollar and the value it has on oil. Does the budget deficit 
have any effect on the value of the dollar?
    Mr. Bernanke. Perhaps a weak effect, but I don't think it 
is a first-order effect. The linkage between the budget deficit 
and the trade deficit is there because the trade deficit does 
reflect our national savings and investment imbalance. But, 
empirically, the effect is relatively weak under most 
circumstances.
    Senator Tester. And the value of the dollar has devaluated 
by about 40 percent--is that correct?--over the last 4 or 5 
years.
    Mr. Bernanke. No. I think it is more like 25 percent. And, 
again, it has reversed a considerable appreciation prior to 
that peak in 2002.
    Senator Tester. Are you comfortable with where the dollar's 
value is now?
    Mr. Bernanke. I am looking for the economy to strengthen 
next year, and as it does, I think that will support a strong 
dollar going forward.
    Senator Tester. Do you anticipate it--OK. That is fine.
    Is there anything that you see on the horizon that could 
impact the credit rating for the Treasury?
    Mr. Bernanke. No, I don't. In the very long term, or even 
the medium term, we need to address these large issues of 
entitlements and the aging population, and there are tremendous 
challenges involved there. I don't think anything in the next 
short period of time, including issues related to the GSEs, for 
example, would affect the credit rating. That is my 
understanding, for example, based on statements that some 
credit raters have made.
    Senator Tester. And we will get into this in the next 
panel, but what you are saying is that even if we don't do 
anything with the bill that is being proposed on the GSEs, you 
don't think that could have any negative impact on the credit 
rating?
    Mr. Bernanke. If we don't do anything?
    Senator Tester. If we don't do anything, if we just let it 
play out.
    Mr. Bernanke. No, I don't think so. I don't think it would, 
no.
    Senator Tester. OK. You stated earlier in your testimony 
that the housing is really kind of the root of what we are 
seeing, the housing contraction. From my perspective, we have 
kind of gone into a credit economy. Do you see that as being 
another part of this equation that is kind of a boat anchor on 
our economy, that we are making adjustments out of this? Or do 
you anticipate we are going to be in this, what I would say is 
a credit economy, from now on?
    Mr. Bernanke. Well, a part of what has been happening--and 
this goes back to Senator Menendez's question about the role of 
the subprime crisis and so on--is that there was, if you will, 
a credit boom or a credit bubble where there was an 
overextension of credit in a lot of areas. There has been a big 
reversal of attitudes. Banks and other financial institutions 
are scaling back on their credit risk. They are deleveraging. 
They are raising capital. And that adjustment process is part 
of what is happening now that is creating the drag on economic 
growth. So it is harder to get a mortgage, it is harder to get 
a business loan. And until we come to a more stable situation 
where banks are comfortable with their credit standards and 
their balance sheets, the leveraging process is going to 
continue and is part of what we are seeing here.
    Senator Tester. And very quickly, because my time is over, 
do you--I mean, we have heard figures of 150 banks potentially 
going down because, I assume, of this adjustment that you just 
talked about. Do you guys have any projections on what kind of 
impact banking institutions going down, how many there 
potentially could be in the next year or do you not want to 
comment on that?
    Mr. Bernanke. I think I would just refer you to Chairman 
Bair's list and discussion from the last couple of days. We 
don't have a projection.
    Senator Tester. How many are on that list?
    Mr. Bernanke. About 95, as I recall. As I said, I think the 
banking system came into this episode with good capital basis 
and with strong earnings.
    Senator Tester. OK. Thank you, Mr. Chairman. I appreciate 
that. Thank you.
    Chairman Dodd. Thank you very much.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. Since I did not 
give an opening statement, I want to give an opening statement 
in all deference to Chairman Bernanke. I know we have a lot of 
ground to cover today, but I want to say a few things on the 
topic of this hearing and the next.
    First, on monetary policy, I am deeply concerned about what 
the Fed has done in the last year and in the last decade: 
Chairman Greenspan's easy money in the late 1990s and then 
followed the tech bust, inflated the housing bubble, and 
created the mess we are in today. Chairman Bernanke's easy 
money in the last year has undermined the dollar and sent oil 
prices to a new high every day, and an almost doubling since 
the rate cuts started. Inflation is here and hurting us and the 
average American, and it was brought out very clearly by the 
Senator from Pennsylvania.
    Second, the Fed is asking for more power, but the Fed has 
proven they cannot be trusted with the power they have. They 
get it wrong, do not use it, or stretch it farther than it was 
ever supposed to go in the first place. As I said a moment ago, 
their monetary policy is the leading cause of the mess we are 
in. As regulators, it took until yesterday to use the power we 
gave them in 1994 to regulate all mortgage lenders. Then they 
stretched their authority by buying $29 billion worth of Bear 
Stearns assets so JPMorgan could buy Bear Stearns at a deep 
discount.
    Now the Fed wants to be a systemic risk regulator, but the 
Fed is a systemic risk. Giving the Fed more power is like 
giving a neighborhood kid who broke a window playing baseball 
in the street a bigger bat and thinking that will fix the 
problem.
    I am not going to go along with that, and I will use every 
power in my arsenal as a Senator to stop any new powers going 
to the Fed. Instead, we should give them less to do so they can 
get it right, either by taking their monetary responsibility 
away or by requiring them to focus only on inflation.
    Third, and finally, since I expect we will try to get it 
right to question the next hearing, let me say a few words 
about the GSE bailout plan. When I picked up my newspaper 
yesterday, I thought I woke up in France. But, no, it turned 
out it was socialism here in the United States of America, and 
very well, going well. The Treasury Secretary is now asking for 
a blank check to buy as much Fannie and Freddie debt or equity 
as he wants. The Fed purchase of Bear Stearns assets was 
amateur socialism compared to this. And for this unprecedented 
intervention in our free markets, what assurance do we get that 
it will not happen again? Absolutely none.
    We are in the process of passing a strong regulator for the 
GSEs, and that is important. But it allows them to continue in 
the current form. If they really do fail, we should let them go 
back to what they were doing before? I doubt it.
    I close with this question, Mr. Chairman. Given what the 
Fed and Treasury did with Bear Stearns, and given what we are 
talking about here today, I have to wonder what the next 
Government intervention into the private enterprise will be. 
More importantly, where does it all stop?
    Thank you.
    Chairman Dodd. Do you want to respond to that, Mr. 
Chairman?
    [Laughter.]
    Chairman Dodd. Senator Bunning just does not have any 
strong views on these matters. I wish he would be more clear in 
the future when he speaks.
    Mr. Bernanke. Well, I think some of the problems with the 
GSEs that you allude to were pre-existing. I mean, the moral 
hazard issue, the Government implicit guarantee, those----
    Senator Bunning. We tried to pass a bill. We could not get 
it----
    Mr. Bernanke. And I agreed with----
    Senator Bunning. We passed it here.
    Mr. Bernanke. And I agree with you.
    Senator Bunning. And it got stuck between here and the 
floor of the Senate.
    Mr. Bernanke. And I agree with you on that. As far as 
powers are concerned, as I mentioned earlier, I think we ought 
to review the payment system issue which is something that 
other central banks have. But I have not asked for any other 
powers.
    Thank you.
    Chairman Dodd. Very good.
    Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    You indicated in your opening statement that in this 
economic turmoil the banking system is approaching it with good 
capital levels. Your estimate is based upon not just their 
balance sheet, but their off-balance-sheet arrangements. I 
understand there are new anything rules that will shortly be 
enacted that will require much more recognition of off-balance-
sheet activities. Have you looked at the fully diluted value of 
the balance sheets? And can you still make that assessment?
    Mr. Bernanke. I don't think we have done a full assessment. 
Those rules are yet to be clarified, and I think it may well be 
some time before they are enacted. At such time we will 
obviously think hard about how it affects those ratios.
    Senator Reed. But you are beginning to consider much more, 
I hope, focus on some of these off-balance-sheet----
    Mr. Bernanke. Oh, certainly. For a long time we have been 
aware of those off-balance-sheet vehicles. There were some 
things we did not appreciate. I think one of the issues we did 
not fully appreciate was what is referred to sometimes as the 
moral recourse issue, which is that off-balance-sheet vehicles, 
which are not technically owned by the bank, nevertheless the 
bank feels for reputational reasons it needs to assume them in 
a difficult period. We have been thinking about the capital 
requirements in those kinds of contexts. But we have certainly 
been quite attentive to off-balance-sheet vehicles, very 
attentive in particular since this crisis began in August.
    Senator Reed. Let me refer to another issue in your 
statement. You indicated that one of the contributing factors 
to the present increase in oil prices is the lack of investment 
over the last several years. Now with oil at extraordinarily 
high prices, one would think in a simple market model that 
investment would be accelerating rapidly.
    Is investment in new drilling and new production and new 
refining, is that taking place?
    Mr. Bernanke. In some places, but not to the extent you 
might think. Part of it is bottlenecks in the materials and 
manpower and expertise that goes into drilling and development. 
Part of it is the fact that a large share of the world's oil is 
controlled by national governments who may not have the same 
immediate profit motives as a private driller might have. In 
particular, some countries prohibit foreign technology or 
foreign investment in their oil production. So there are these 
political constraints as well that have been affecting the 
supply as well as economic bottlenecks and other problems.
    Senator Reed. Is there a lack of adequate fields to exploit 
worldwide? Is that one of the significant factors?
    Mr. Bernanke. Well, experts have some disagreement over 
this, but in terms of proved reserves, there seems to be 
adequate oil in the ground. It is really a question of 
exploiting it.
    Senator Reed. You indicated that in terms of speculation, 
that was not a significant factor, but you are, with the CFTC, 
looking into the issue of possible speculation. And I am 
getting into dangerous ground. You are an economist and I am 
not. But it would seem to me this is a market that would be 
ripe for speculation. Demand is highly inelastic. Price signals 
are blunted in many countries because of subsidies. Is that 
your understanding of the market, that there is an opportunity 
at least for speculation in this particular market for oil?
    Mr. Bernanke. Well, there is speculation, but speculation 
under most circumstances is a positive thing. It provides 
liquidity and allows people to hedge their risks. It provides 
price discovery. It can help allocate oil availability over 
time, depending on the pattern of futures prices and so on.
    What is really a concern--what the CFTC, for example, is 
concerned with would be manipulation as opposed to speculation.
    Senator Reed. Well, I will use the term ``manipulation'' in 
the same situation.
    Mr. Bernanke. And as I said, you know, transparency and 
data collection are important aspects of assuring there is no 
manipulation. But given the enormous size of this market, it is 
quite a difficult market--would be quite a difficult market, I 
would think, to corner.
    Senator Reed. Thank you. My time is about to expire.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Dole.
    Senator Dole. Chairman Bernanke, in December of last year--
--
    Chairman Dodd. Senator, would you just postpone for 1 
second? What I am going to do here with Members, by the way, is 
several Members who have already asked questions have gone to 
vote, and they will come right back. And this way we will try 
and keep going. If there is going to be a minute or two before 
you get to question, I suggest you go vote and come back. We 
are not going to interrupt. I want to give everyone a chance to 
get one round in on this before we move to our larger panel.
    Senator Dole, please.
    Senator Dole. In December of last year, Attorney General 
Cuomo of New York entered into an agreement with Fannie Mae, 
Freddie Mac and OFHEO to create a mortgage appraiser code of 
conduct. While everyone appreciates the goals of this 
agreement, the code leans heavily toward inconsistent and 
potentially counterproductive regulation of the lending 
industry and, if implemented poorly, could actually increase 
costs of obtaining appraisals and slow down the process of 
obtaining appraisals.
    Recognizing that the current settlement recommendations are 
inconsistent with current appraisal regulations and guidelines 
issued by the FFIEC Subcommittee on Appraisals, what are you 
doing to ensure that implementation of the code of conduct does 
not further disrupt the current housing and mortgage crises on 
federally regulated banking institutions? What can you do?
    Mr. Bernanke. Senator, as I understand, the agreement 
requires acceptance by the FFIEC, by the bank regulators, and 
so we are currently looking at it, and we do want to make sure 
that it does not prevent banks, for example, from using their 
own appraisers in situations where they need that information 
to make a good appraisal. And we want to make sure it does not 
impose excessive costs--there are already guidances by the 
regulators about how to do appraisals which already exist for 
banks. And we think those are pretty good, and we want to make 
sure there is no inconsistency. So we are looking at that, but 
we want to be particularly careful about some of the issues 
that you have just raised.
    Senator Dole. As you are aware, the FDIC gathers and 
monitors various bank performance data for its member 
institutions as part of its regulatory oversight, and this is 
on a quarterly basis, of course. Ending with this most recent 
data collection period, the end of the first quarter of 2008, 
the FDIC's data indicates that banks in North Carolina are on 
fairly good footing relative to its peer group nationally. But 
the report did show the number of unprofitable financial 
institutions with a market cap under $1 billion in my home 
State increased from the previous quarter, while the national 
numbers actually improved.
    My question for you is whether the Fed currently reviews 
the performance of smaller financial institutions such as 
community banks as a proxy for the health of the local economy 
in which they served. And if so, how does this information 
factor into Fed policy?
    Mr. Bernanke. Senator, we absolutely do look at community 
banks. We have a regulatory responsibility for State member 
banks, which include many, many small banks that we oversee in 
conjunction with the State regulator or with the FDIC. There 
are many benefits of our regulation of those banks in terms of 
what we learn, but, in particular, as you point out, small 
banks have their fingers on the pulse of the local economy, and 
they can provide us a lot of useful information about what is 
happening. And for the same reason, we are required to have 
bankers on the boards of the reserve banks around the country 
so that we can gather information from them and benefit from 
their insights.
    Senator Dole. Thank you very much, Mr. Chairman.
    Thank you.
    Chairman Dodd. Thank you, Senator Dole.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman. Chairman Bernanke, 
thank you. Nice to see you again, and thank you for your public 
service.
    I appreciate the Fed has finalized its regulation for some 
prime mortgage lending. In my view, as you know, this comes, 
especially in a place like Ohio, several years too late. 
Hindsight, of course, is near perfect, but there were lots of 
voices and warning signals trying to get the Fed to act both 
here in Washington, also at places like the Cleveland Fed and 
elsewhere.
    First of all, I appreciate the refreshingly different 
approach you have to this job and to this issue than that of 
your predecessor. I think that is very good for our country. 
But there is a certain cynicism in the public at large how, 
when Bear Stearns gets in trouble, when Fannie and Freddie get 
in trouble, that you act, that Congress acts, the Treasury 
Department acts, but we do not act so quickly, neither the 
regulatory system, the Fed, the Congress act so quickly in 
protecting the public and the issues that Senator Casey, the 
story Senator Casey brought up.
    Tell me what steps we need to take, and you need to take 
especially, to get the same rapid response for consumers, for 
consumer protection, that we have achieved, if you will, with 
Bear Stearns and with Fannie and Freddie.
    Mr. Bernanke. Well, Senator, first, although I know it is 
not always easy to explain, our actions, as I said earlier, 
with respect to Bear Stearns, with respect to Fannie and 
Freddie, with respect to the financial system in general are 
based on our view that financial stability is critical to 
economic stability. I think the benefit is more obvious to the 
average person from Fannie and Freddie because they, after all, 
are providing liquidity for mortgages, and people want to be 
able to have access to mortgages. So I just do not accept the 
distinction between helping Wall Street and helping Main 
Street. The actions we have taken are aimed at supporting the 
overall economy and helping the average American.
    With respect to your question, I agree that there was a 
delay in recognition of this issue. Once we undertook it, 
though, we had to go through a regulatory process that involves 
developing regulations, putting them out for comment, re-
evaluating them and so on. There is a natural period of time. I 
think that is probably a good thing in the sense that we want 
regulations to be well thought out and so on. But to the extent 
that Congress wants to act more quickly or is concerned about 
the constraints on the agency's powers given to them by their 
enabling legislation, Congress, of course, can act very quickly 
if they need to.
    Senator Brown. While I do not oppose your actions on what 
we are going to try to do with Fannie and Freddie, and I think 
we did what we had to do with Bear Stearns, I think there is a 
perception, and probably a reasonable perception, a deserved 
perception, that our Government, whether it is regulatory 
process or the Congress, is much more apt to move quickly on 
Wall Street when we do not move so quickly on Main Street. 
Granted, you had to go through a process, and as I say, I think 
you are refreshingly different from your predecessor. But what 
can you do to speed that up so the public really can be assured 
that while it does make sense for the economy as a whole, which 
helps everyone on Main Street, too, doing the right thing with 
Wall Street, but it is pretty clear that when--and the Bush 
administration really did not seem to think there was a 
subprime crisis until it spread to Wall Street. When it was 
just Main Street, Mansfield, and Main Street, Zanesville, it 
did not seem to be much of a problem.
    Mr. Bernanke. Well, we just have to do a better job, first 
of all, monitoring what is going on. The Treasury Secretary had 
an interesting idea. The mortgage origination commission, I 
think it was called, would be evaluating the quality of the 
State regulators to make sure that State-regulated institutions 
were being adequately supervised. So that is one possible 
suggestion. But in a way of keeping better tabs on what is 
going on, we need to be more vigilant, and we need to be as 
effective and rapid as possible in promulgating good 
regulations. But, again, the legal process and our 
responsibility to do a good job means that we cannot produce 
the regulations in a month. It really does take some time for 
us to do all the work, including one thing we have done at the 
Fed, which is a lot of consumer testing, to make sure that 
people understand disclosures, for example. We think we get 
more effective regulation that way.
    Senator Brown. Does the Fed have a mechanism to listen 
better to the regional--when the Cleveland Fed feeds you 
information about a problem that may come to Cleveland before 
it comes to New York or before it comes to Chicago or Los 
Angeles, do you feel like the Fed here is listening to places 
like Cleveland the way that you should?
    Mr. Bernanke. Absolutely. The 12 reserve banks around the 
country were created to make sure that the Fed always had a 
national constituency, that it always listened to the concerns 
of the whole country and not just the financial sector, and 
that works very effectively. We do have a lot of input from 
reserve banks and their boards, their advisory councils, their 
contacts. And related to my reply to Senator Dole, those kinds 
of contacts are useful in a macroeconomic monetary sense, but 
also in a regulatory sense as well.
    Senator Carper [presiding]. The Senator's time has expired. 
When Senator Martinez returns, it will be his time to ask 
questions, but until he does, I am going to ask a few of my 
own. Welcome, Mr. Chairman.
    I was reflecting. How long have you been Federal Reserve 
Chairman now?
    Mr. Bernanke. Two-and-a-half years.
    Senator Carper. Does it seem that long?
    [Laughter.]
    Mr. Bernanke. About that long.
    Senator Carper. Did you ever imagine in your wildest dreams 
that the Federal Reserve would end up being called upon to do 
the kinds of things you have done in recent months? I remember 
when you were going through your confirmation hearing, we 
focused, as I recall, on just what should be the right rate of 
inflation, kind of, if you will, the window or the limits for 
the rate of inflation. I do not think we ever asked you whether 
or not the discount window should be made available to 
investment banks. I do not think we ever asked you if the 
discount window should be made available to Fannie or to 
Freddie. I do not think we ever asked you about trying to 
arrange the marriage, if you will, of JPMorgan Chase with Bear 
Stearns.
    All that stuff has just come along, and I want to commend 
you and those with whom you serve, those who you lead, for the 
way you have responded, and quickly, thinking outside the Box, 
and trying to help us through all of this. I thought you said a 
great truth in terms of where we want to position ourselves as 
we come out of this fall. We have seen this drop in housing 
values, and I think part of what is going on here in our 
economy today is the loss of confidence you have alluded to. We 
have seen a loss of home equity, and a lot of us in this 
country have treated the equity in our home as a piggy bank, 
and the wealth effect that we derive from that, and couple that 
with going up to the gas pump and spending $80 or $90 to fill 
up the tank of our vehicles--I think the two of those together 
has a dramatic negative effect on our confidence in this 
country and has sort of led to it.
    One of the questions you were asked earlier--and I want to 
follow up on it--was: Where do we want to be when we bottom 
out? Eventually, we will bottom out. There are a lot of people 
who are renting today that are not buying, but eventually they 
are going to want to get in. They are going to want to be 
homeowners. What are the things that we need to be doing to 
make sure that when they are ready to move, when they think 
that we have come to the bottom and prices are starting to go 
back up? Just say again, how do we want to plow the field, how 
do we want to prepare the field in terms of a mortgage market 
and in terms of housing markets? And you have said some of this 
already. I just want you to re-emphasize it, please?
    Mr. Bernanke. Well, of course, fundamentally the market 
will do it. The free market will do it. But there are things 
that we can do. The Federal Reserve has already tried to 
address, some of the regulatory aspects of high-cost mortgage 
lending. We and our fellow regulators are also looking at the 
treatment of mortgages by banks and other lenders in terms of 
their capital and how they manage that. I think the banks and 
the private sector themselves are rethinking the standards, the 
underwriting standards, the loan-to-value ratios, those sorts 
of things as they go forward.
    So, I anticipate that we will have a healthy recovery in 
the housing market once we have gone through this necessary 
process. But it will probably be less exuberant than we saw 
earlier with somewhat tougher underwriting standards, more 
investment due diligence, probably less use of securitization 
or complex securitized products. But I am confident that, with 
the appropriate background--I probably include here the GSEs 
and FHA--the housing market will recover, and it will help be 
part of the economy's return to growth.
    Senator Carper. One of my colleagues asked you earlier 
about the drop in the value of the dollar and asked you 
quantify that. I will not ask you to do that again. But we have 
seen the dollar drop, whether it is 20 percent or 30 percent or 
some other number. We have seen exports, conversely, rise, but 
yet we have seen a continued loss in manufacturing jobs in this 
country. I think the last month I noticed maybe 30,000 or 
40,000 additional manufacturing jobs had been lost.
    When do we see that turn around? And what do we need to do 
to turn it around, the loss of manufacturing jobs, that is?
    Mr. Bernanke. Well, there has been an ongoing loss of 
manufacturing jobs even during periods of growth in production 
because the U.S. manufacturing sector is enormously productive 
and its productivity has been growing more quickly than the 
rest of the economy. And so even when output is growing--and we 
have some of the best growth and the highest productivity 
growth in manufacturing of any industrialized country--because 
of the high productivity growth, you need fewer workers to make 
the same amount of output.
    Now, one thing that has certainly been clear, and we have 
seen in the U.S. manufacturing over the last few years, is an 
increasing emphasis on sophisticated high-tech exports, 
including capital goods and so on. And what I hear from 
manufacturers is that they have plenty of low-skilled workers, 
but what they need are workers with high skills--not 
necessarily a college degree, but with skills, like welding and 
machine work and so on. And, in fact, the number of skilled 
manufacturing workers has actually been rising, not falling.
    So I think the future for us is to continue to go to more 
and more sophisticated manufacturing products, but to support 
that and to make sure there are good jobs associated with it, 
we need to have the training and education that will provide 
the workforce that is consistent with that.
    Senator Carper. The last question that I have deals with 
just to follow up on the drop in the value of the dollar. The 
hearings that we have had in this Committee and other 
committees that I have participated in suggest there are three 
major factors driving up the cost of oil. One of those is the 
laws of supply and demand. Nations are pretty much holding 
their output level. Demand is rising. There has been--we 
discussed the drop in the value of the dollar and the effect 
that that has had. The third factor that we keep coming back to 
is the role that speculation is playing. We touched on this at 
least indirectly here today. Just give us some advice. I think 
we are going to debate, seriously debate, probably before the 
beginning of next month, legislation dealing with speculation 
to try to curb the excesses that may be occurring there. If you 
could give us some advice, it would be timely and much 
appreciated.
    Mr. Bernanke. Well, as I said, based on the evidence that 
is available, I would not estimate that speculation or 
particularly manipulation is a significant part of the rise in 
oil prices.
    That said, the CFTC and others are looking at the data and 
trying to evaluate that. These are very difficult matters. We 
do not want to do anything that will stop the futures markets 
from legitimate functions like providing liquidity and hedging. 
So, my advice would be to go slow and carefully and to take the 
insights that you get from the CFTC and others who are 
associated directly overseeing these activities.
    Despite the concerns--and I fully understand the concerns 
about high gas prices--I don't think it is likely that you can 
have a big effect on gas prices with short-term moves in the 
futures markets. And I would urge careful and deliberate action 
in this area.
    Senator Carper. All right. Thank you, Mr. Chairman.
    Senator Martinez is next, and then followed by Senator 
Akaka.
    Senator Martinez. Thank you, Mr. Chairman.
    Mr. Chairman, thank you very much for being with us today. 
I wanted to focus on a couple of areas. One was your remarks 
during your testimony regarding the fundamental issue in the 
energy situation which you identify one of supply and demand, 
which makes sense to me. I wonder if you might dwell just for a 
moment on the speculation side as to why you do not see that as 
a fundamental part of the problem, but then also what we could 
do to be more helpful in the area of transparency and 
oversight.
    Mr. Bernanke. Well, there are a number of pieces of 
evidence against the view that speculation is a primary force. 
I mentioned in my testimony the absence of hoarding or 
inventories that you would expect to see if speculation was 
driving prices above the supply demand equilibrium. There are a 
number of studies which show that there is little or no 
connection between the open interest taken by non-commercial 
traders in futures markets and the subsequent movements in 
prices.
    It is also interesting to note that there are many 
commodities--or at least some commodities--that are not even 
traded on futures markets, like iron ore, for example, which 
have had very large increases in prices. So I think the 
evidence is fairly weak.
    That said, I think that transparency in futures markets, 
information available to the overseer, the CFTC, is a positive 
thing. And I expect that the CFTC will come forward with some 
suggestions in that regard. But I just do not think it is going 
to be a magic bullet to address this very difficult problem of 
high oil and commodity prices.
    Senator Martinez. In other words, well, it might be helpful 
and useful to have more transparency ultimately. The supply and 
demand equilibrium is only going to be impacted by more supply 
or less demand.
    Mr. Bernanke. I believe that to be true, yes.
    Senator Martinez. I want to commend you for the work you 
have done in consumer protection. I noted in your testimony in 
a couple of areas that I think are particularly important. I 
think that it is terrific to prohibit lenders from making 
higher-priced loans without due regard for a consumer's ability 
to make the scheduled payments. And I also think it is great to 
also include the escrowing of property taxes and insurance as 
an integral part of what we need to do in order to keep 
homeowners in their home.
    And, last, the area of credit cards as well, I think all 
those are very, very good things for consumers, and 
particularly at stressful times like this, it is good to have a 
reckoning of where we are and where we are going and include 
that in that help to consumers.
    I know in the next panel we will talk more about the GSE 
situation. I want to talk about regulatory reform, if I could. 
Your predecessor and I had an opportunity to discuss this when 
I was Secretary of HUD, and I recall also coming before this 
Committee and testifying with Secretary Snow at that time, 
proposing a new regulatory framework for the GSEs. That was in 
2003. I wish we might have done that. But at the same time, we 
are where we are today.
    We do have a piece of legislation moving its way through 
the Congress, which includes the creation of a new affordable 
housing trust fund. This affordable housing trust fund is 
funded by a fee on the GSEs' new business purchases. So, in 
other words, as they increase their book of business, this fund 
would grow at a percentage of that.
    I wondered if you have a concern, which I certainly have, 
about this provision. particularly at a time when the GSEs are 
suffering such substantial losses and when we are, in fact, 
taking other Government action in order to ensure their 
sustainability.
    Mr. Bernanke. Senator, I think that is really a 
congressional prerogative. I really have not gotten into that 
particular issue. I think the really critical issue, as you 
alluded to, is that we have a strong and robust regulator that 
will restore confidence in the markets and will allow Fannie 
and Freddie to support the mortgage market in the way they are 
intended to do. That would be my emphasis.
    Senator Martinez. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman. Let me 
add my welcome to Chairman Bernanke for being here, and my 
concerns in our country is to educate the people of America as 
well as to protect them and empower them in our financial 
system.
    Given the recent failures, I am concerned by the increasing 
lack of trust that individuals have in the banking system. When 
large numbers of depositors lose trust in their financial 
institution and demand their money back, the bank can fail as a 
result, and we know that.
    In addition, distrust of the banking system causes many 
immigrants to miss out on savings, borrowing, and low-cost 
remittance opportunities found at banks and credit unions.
    My question to you is: What must be done to increase trust 
in the banking system among depositors as well as among the 
unbanked?
    Mr. Bernanke. Well, Senator, you point to a legitimate 
question, which is that there are still many people, 
disproportionately immigrants, who do not have a checking 
account, do not have a savings account, and these are the 
``unbanked,'' as the term goes. In not all but in many cases, 
those people would be better off with a banking relationship. 
They might be able to avoid high fees for remittances, for 
example, or high fees for check cashing if they were associated 
with a bank. To some extent, it is a cultural element. We 
encourage banks to reach out to communities, to have people who 
speak the appropriate language.
    On the other side, as you know--and this is one of your 
important issues that you have been a leader on--is to promote 
financial literacy and to get folks to understand, how to 
manage their finances and how important having the right 
relationships with financial institutions can be.
    So I think it is really on both sides. We have to get the 
banks to reach out. We have to get the public to understand and 
reach out. Where necessary, as in the case of home mortgages, 
disclosures and regulation may be necessary to keep the 
contracts, clear enough that the public can make use of them. 
And in that respect, I hope that, for example, our actions on 
mortgage lending will restore some confidence where there are 
people who feel that they got burned taking out a subprime 
mortgage. Perhaps in the future, they will see more clearly 
what the contract entails, and they will be more confident in 
taking out a mortgage.
    So it is a very important issue, and we can address it, I 
think, from a number of different directions.
    Senator Akaka. Thank you. Working families, as you know, 
are having trouble paying for increases today in gasoline, 
groceries, and other daily living expenses while wages are not 
increasing fast enough and affordable credit is becoming harder 
to obtain. I am deeply concerned that too many working families 
are being exploited by the unscrupulous lenders who give payday 
loans, and this is where protection, I think, is needed.
    I have been impressed by the work of the National Credit 
Union Administration, NCUA, due to a NCUA grant on the windward 
side of the island of Oahu in Hawaii at the Community Federal 
Credit Union at Kailua, and it has developed an affordable 
alternative to payday loans to help U.S. Marines and other 
members they serve. We must further encourage the development 
of these alternatives so that working families have access to 
affordable small loans.
    My question to you is: What must be done to protect 
consumers from high-cost payday loans and encourage the 
development of affordable payday loan alternatives?
    Mr. Bernanke. Well, again, I think that competition is the 
best solution, and I give particular credit to credit unions. 
They have done some especially good work in terms of providing 
remittance services to allow people to get money back to their 
families without exorbitant cost. But I think we should 
continue to urge banks and other financial institutions to 
reach out into underserved neighborhoods. That is, in fact, 
part of the Community Reinvestment Act to try to do that to 
give people the alternative rather than the storefront in their 
neighborhood.
    So I think that is a desirable goal, and through financial 
literacy education and working with banks and community 
development experts, I think we can make progress in that 
direction, and I would very much like to support that.
    Senator Akaka. Thank you very much for your responses.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Senator Crapo, you are next, then Senator Bayh, and then I 
believe we are prepared to move to the additional panel members 
here. So Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    I want to return for just a moment--I know you have gone 
over this a lot already--to the question of speculation and the 
issue of prohibiting or aggressively regulating the over-the-
counter derivatives. And, you know, I understand that measures 
to enhance the transparency in our energy markets are a very 
appropriate response to today's global markets. I am concerned, 
however, that overly restrictive limitations on the number of 
speculative positions that can be held by individuals or other 
entities could have significant impacts on liquidity in those 
markets and naturally have the opposite impact that we would 
intend by those actions, namely, to reduce liquidity and 
actually drive the price of fuel up or petroleum up.
    Could you comment on that?
    Mr. Bernanke. Certainly. First of all, OTC derivatives are 
not really unregulated in that the dealers and the banks who 
make these transactions are, of course, regulated in one way or 
another, and one of the things that the oversight regulators do 
is make sure that they are taking adequate precautions of a 
counterparty risk, that they are managing their positions in a 
safe way.
    In general, I think there is some reason to look for more 
standardization where possible so that we could begin to use 
particular exchanges as ways of improving liquidity and 
management of counterparty risk. But I think there is always 
going to be some scope for over-the-counter products because 
they are the ones that customize to the particular needs of the 
other party.
    So I think it is important for us to maintain our oversight 
of the dealers and the banks. We need to continue to work to 
make sure that the clearing and settlement process works 
efficiently so there is no confusion or delay. There is some 
scope for working toward standardization in order to move 
toward essential counterparties or exchanges. But I think we 
are always going to have over-the-counter derivatives. They 
serve a useful function. They help with risk sharing. They 
provide liquidity to hedgers. And so, I am not advocating any 
major change in the way we look at those particular instruments 
other than making sure we clear them and settle them properly.
    Senator Crapo. If you take, say, futures trading in 
petroleum as an example, isn't it correct that for every 
transaction, there is a counterparty? In other words, every 
time there is a buyer, there is also a seller.
    Mr. Bernanke. Yes, of course. With almost no exceptions, 
speculators in commodities never take delivery. They have to 
sell their position when it comes due, and so they are not in 
any way using up the physical resource that underlies the 
contract. So there has always to be two sides to every 
transaction.
    Senator Crapo. And the liquidity that we are talking about, 
am I correct, is primarily being provided for those who are not 
actual users of petroleum. This liquidity is primarily coming 
from pension funds. Is that not correct?
    Mr. Bernanke. Well, it depends which side of the 
transaction you are on. You have people on both sides who are 
trying to make a bet essentially on whether oil prices will go 
up or down. But, clearly, one of the major economic functions 
of futures markets is to allow those who want to lay off their 
risk, like an airline, the opportunity to sell or to buy 
forward the fuel so that they will not be subject to the risk 
of price fluctuations. And it is the activities of speculators 
in those markets that provides the other side of that 
transaction and makes those markets liquid and allows them to 
serve that function.
    Senator Crapo. The airlines are a good example. As you 
know, a number of the CEOs of a number of airlines have 
maintained that the price of their jet fuel is being forced 
unnaturally high because of market speculation in the futures 
market. Do you believe that they are correct in that?
    Mr. Bernanke. Well, as I have indicated, I think that it is 
worthwhile making sure that, there is some transparency, that 
we are doing all we can to make sure these markets are as 
liquid and as efficient as possible. CFTC has the primary 
responsibility for that. We are happy to work with them and try 
to support that.
    So I am not saying there cannot be improvements made in 
these markets, but my best guess, as I have indicated a few 
times now, is that I do not think that speculative activity per 
se, or particularly manipulation, is the principal cause of the 
increases in energy and other commodity prices that we have 
been seeing.
    Senator Crapo. Thank you.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman, and given the nature 
of our having to leave to vote and then come back, I hope that 
my questions are not redundant. It is an occupational hazard.
    You mentioned that the housing turmoil is sort of the crux 
of many of the challenges that we are currently facing. Have 
there been any analogous episodes in other countries previously 
or in our own that might give some guidance as to--or further 
guidance as to when this might bottom out?
    Mr. Bernanke. There have been similar episodes in the U.K. 
and Australia, for example. But it is hard to draw strict 
analogies. One reason is that the financing systems are 
different in the different countries. Clearly, in this case, 
the high loan-to-value subprime adjustable rate mortgages, 
those sorts of instruments were particularly sensitive to the 
decline in house prices that we saw, and the effects, 
therefore, on credit quality and on bank balance sheets were 
stronger. So there are other examples, and we have looked at 
those. Most of them suggest, which is something which I am sure 
we are all happy to hear, that eventually the new equilibriums 
is established, the housing market comes back into balance, and 
the negative effects of that are ended, and you begin to see 
more stable growth again. I am sure that will happen here, but 
there is not an exact analogy.
    Senator Bayh. Well, along those lines--and I know you are 
reluctant to offer advice to the legislative branch of 
Government, but I am sure you have followed the bill that 
passed out of the Senate last week. Going over to the House, 
there may be some marginal adjustments, but probably not more 
than that. Is there anything else we should be looking at doing 
here in a timely fashion to address the housing challenge that 
has not been included in this legislation?
    Mr. Bernanke. No, I do not think so. Not that I can think 
of. Again, as this next hearing will reveal, of course, you now 
have a set of issues and questions to answer relating to the 
GSEs, and, of course, that fits directly with the elements of 
the bill that already include a stronger regulator. So I think 
that is going to be a very, very important issue in the next 
weeks and months for the----
    Senator Bayh. And that is going to raise the topic of 
borrowing from the discount window, which I would like to ask 
you about. What currently is the amount that has been let from 
the window as we gather here today?
    Mr. Bernanke. Well, the loans are short-term loans, and 
they are rolled over. So I could not give you----
    Senator Bayh. We do not know the----
    Mr. Bernanke. Several hundred billion dollars outstanding 
at any given time. But I----
    Senator Bayh. Several hundred billion at a time?
    Mr. Bernanke. At a given time, yes.
    Senator Bayh. Is there any limit to the amount that can be 
utilized through that mechanism, any practical limit? We have 
the investment banks partaking. If we get the GSEs partaking, I 
am just wondering how much more there is to be had from that 
mechanism.
    Mr. Bernanke. I think the Federal Reserve's balance sheet 
is about $900 billion, and even if we reached that level, which 
I have no expectation we would, there are other things we could 
do to address that.
    Senator Bayh. I read here recently--I think it was the 
Economist. I cannot recall the source of the data, but it 
caught my eye, and I would like your reaction to it. The 
assertion was by some analysts that of the stimulus checks that 
had been sent, 90 percent of the amount had been saved. Do you 
have a reaction to that?
    Mr. Bernanke. I do not know how they would know that. The 
historical experience, based, for example, on the checks that 
were sent in 2001, suggests that people spent something on the 
order of 40 to 50 percent of their check within a few quarters. 
The relatively strong consumer spending number, as we saw 
recently, could be due to even a higher propensity to spend out 
of those checks. So to my way of thinking, so far it seems that 
they are having an effect, but we will not really know for sure 
until we see how things play out over the next two quarters.
    Senator Bayh. Just two final questions, Mr. Chairman. 
Chairman Dodd asked you about the prospects of a second 
stimulus package moving through. My question is: If we are 
really looking at trying to buttress the consumer at this 
fragile time, doesn't income and wealth level, don't those 
affect the marginal propensity to consume? Is that an accurate 
statement?
    Mr. Bernanke. That is generally thought to be the case.
    Senator Bayh. And should that not lead us to focus on those 
who are more likely to consumer, you know, the more middle-
class, lower-middle-class level, if propping up the consumer is 
our aim?
    Mr. Bernanke. As I said when we were discussing the first 
stimulus package, one of the criteria was to be targeted, which 
means to go to people who would be more likely to spend in the 
short term, and, generally speaking though it is not uniform, 
there tends to be a higher spending propensity from people of 
lower income and lower wealth
    Senator Bayh. My final question here as my time expires: 
There has been a recent increase in the price of credit default 
swaps on U.S. Treasurys. What do you think accounts for that? 
And should that be a matter of some concern in the message the 
market seems to be sending about their confidence?
    Mr. Bernanke. There has been a lot of movement in a variety 
of spreads, for example, the spreads between newly issued and 
previously issued bonds and so on. I would not read too much 
into that. It is a very small change. I think it has more to do 
with liquidity in markets and other risk aversion--other types 
of behavior rather than any sense that there is a default risk. 
That would be my guess.
    Senator Bayh. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    We have one additional question from Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you for 
being here. I had two.
    One is not about the Fannie and Freddie rescue per se, but 
just about the criteria. There is tremendous focus on the stock 
price, which we all know has sunk a great deal. But it seems to 
me that of much greater importance to the economy and to the 
markets and even to the stability of Fannie and Freddie is the 
differential that Fannie and Freddie have to pay for their 
bonds and, say, the U.S. Government has to pay for Treasury's. 
Do you agree with that, and could you give us some indication 
of how the bond spread is going? And how does it measures in 
terms of Fannie and Freddie's stability?
    Mr. Bernanke. Well, that bond spread opened up last week. 
It has generally come in since Paulson announced these actions. 
I think that is very important, both because Fannie and Freddie 
obligations, both MBS and corporate debt, are held all over the 
world, including large amounts by banks, so that is very 
important. And, second, that determines their marginal cost of 
finance for mortgages, which ultimately we want to make sure 
that mortgages are available at a reasonable price.
    So the announcements have been generally good for the debt 
because of the sense that the Government is going to become 
involved in these agencies. The stock prices are also important 
because they affect the ability of Fannie and Freddie to raise 
capital. And I think at this point, there is probably a lot of 
uncertainty for shareholders as to exactly what is going to 
happen and to what extent that will affect the value of their 
shares.
    Senator Schumer. One final question. There has been a lot 
of talk now about somehow limiting short selling, particularly 
in financial companies, because of all the problems. Now, a 
while ago we had something called the uptick rule, which 
provided some measure of restraint on short sellers. When we 
changed from selling stocks from eighths to hundredths, an 
uptick of one one-hundredth does not mean much. But I have 
heard some ideas recently--I have been toying with it--of 
recommending that we go back to the uptick rule and say you 
don't need a one one-hundredth uptick, but you need 12 upticks, 
and you get back to the one-eighth.
    Do you have any thoughts, preliminary thoughts, on whether 
that would be a good idea and, in general, your view on short 
selling as it affects the markets here?
    Mr. Bernanke. Well, I think you do not want to rule out 
short selling as a general matter. That is a way for markets to 
be efficient and for people to take a view on where a stock 
price ought to be. There are already limits on so-called naked 
shorts without owning the stock, and certainly we want to be 
very careful about situations in which a potential short seller 
spreads unverified rumors and so on.
    I think I am in an excellent position here to answer your 
question because Chairman Cox is going to be sitting next to me 
in a few minutes, and I think he could give you a much better 
sense of where they are at the SEC on this issue. But my short 
answer is that some limits on short selling are probably 
appropriate, but we want to make sure that legitimate short 
selling remains part of the market.
    Senator Schumer. I agree with both.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator, and with that, 
we are going to take a couple minutes' break, give the Chairman 
an opportunity to take a few minutes, and we will invite 
Secretary Paulson and Chairman Cox to come into the room, and 
we will begin the second phase of this hearing. So we will take 
about 5 minutes here.
    [Whereupon, at 12:09 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
                 PREPARED STATEMENT OF BEN S. BERNANKE
                               Chairman,
            Board of Governors of the Federal Reserve System
                             July 15, 2008
    Chairman Dodd, Senator Shelby, and Members of the Committee, I am 
pleased to present the Federal Reserve's Monetary Policy Report to the 
Congress.
    The U.S. economy and financial system have confronted some 
significant challenges thus far in 2008. The contraction in housing 
activity that began in 2006 and the associated deterioration in 
mortgage markets that became evident last year have led to sizable 
losses at financial institutions and a sharp tightening in overall 
credit conditions. The effects of the housing contraction and of the 
financial headwinds on spending and economic activity have been 
compounded by rapid increases in the prices of energy and other 
commodities, which have sapped household purchasing power even as they 
have boosted inflation. Against this backdrop, economic activity has 
advanced at a sluggish pace during the first half of this year, while 
inflation has remained elevated.
    Following a significant reduction in its policy rate over the 
second half of 2007, the Federal Open Market Committee (FOMC) eased 
policy considerably further through the spring to counter actual and 
expected weakness in economic growth and to mitigate downside risks to 
economic activity. In addition, the Federal Reserve expanded some of 
the special liquidity programs that were established last year and 
implemented additional facilities to support the functioning of 
financial markets and foster financial stability. Although these policy 
actions have had positive effects, the economy continues to face 
numerous difficulties, including ongoing strains in financial markets, 
declining house prices, a softening labor market, and rising prices of 
oil, food, and some other commodities. Let me now turn to a more 
detailed discussion of some of these key issues.
    Developments in financial markets and their implications for the 
macroeconomic outlook have been a focus of monetary policymakers over 
the past year. In the second half of 2007, the deteriorating 
performance of subprime mortgages in the United States triggered 
turbulence in domestic and international financial markets as investors 
became markedly less willing to bear credit risks of any type. In the 
first quarter of 2008, reports of further losses and write-downs at 
financial institutions intensified investor concerns and resulted in 
further sharp reductions in market liquidity. By March, many dealers 
and other institutions, even those that had relied heavily on short-
term secured financing, were facing much more stringent borrowing 
conditions.
    In mid-March, a major investment bank, The Bear Stearns Companies, 
Inc., was pushed to the brink of failure after suddenly losing access 
to short-term financing markets. The Federal Reserve judged that a 
disorderly failure of Bear Stearns would pose a serious threat to 
overall financial stability and would most likely have significant 
adverse implications for the U.S. economy. After discussions with the 
Securities and Exchange Commission and in consultation with the 
Treasury, we invoked emergency authorities to provide special financing 
to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Co. 
In addition, the Federal Reserve used emergency authorities to 
establish two new facilities to provide backstop liquidity to primary 
dealers, with the goals of stabilizing financial conditions and 
increasing the availability of credit to the broader economy. \1\ We 
have also taken additional steps to address liquidity pressures in the 
banking system, including a further easing of the terms for bank 
borrowing at the discount window and increases in the amount of credit 
made available to banks through the Term Auction Facility. The FOMC 
also authorized expansions of its currency swap arrangements with the 
European Central Bank and the Swiss National Bank to facilitate 
increased dollar lending by those institutions to banks in their 
jurisdictions.
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     \1\ Primary dealers are financial institutions that trade in U.S. 
government securities with the Federal Reserve Bank of New York. On 
behalf of the Federal Reserve System, the New York Fed's Open Market 
Desk engages in the trades to implement monetary policy.
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    These steps to address liquidity pressures coupled with monetary 
easing seem to have been helpful in mitigating some market strains. 
During the second quarter, credit spreads generally narrowed, liquidity 
pressures ebbed, and a number of financial institutions raised new 
capital. However, as events in recent weeks have demonstrated, many 
financial markets and institutions remain under considerable stress, in 
part because the outlook for the economy, and thus for credit quality, 
remains uncertain. In recent days, investors became particularly 
concerned about the financial condition of the government-sponsored 
enterprises (GSEs), Fannie Mae and Freddie Mac. In view of this 
development, and given the importance of these firms to the mortgage 
market, the Treasury announced a legislative proposal to bolster their 
capital, access to liquidity, and regulatory oversight. As a supplement 
to the Treasury's existing authority to lend to the GSEs and as a 
bridge to the time when the Congress decides how to proceed on these 
matters, the Board of Governors authorized the Federal Reserve Bank of 
New York to lend to Fannie Mae and Freddie Mac, should that become 
necessary. Any lending would be collateralized by U.S. government and 
Federal agency securities. In general, healthy economic growth depends 
on well-functioning financial markets. Consequently, helping the 
financial markets to return to more normal functioning will continue to 
be a top priority of the Federal Reserve.
    I turn now to current economic developments and prospects. The 
economy has continued to expand, but at a subdued pace. In the labor 
market, private payroll employment has declined this year, falling at 
an average pace of 94,000 jobs per month through June. Employment in 
the construction and manufacturing sectors has been particularly hard 
hit, although employment declines in a number of other sectors are 
evident as well. The unemployment rate has risen and now stands at 5\1/
2\ percent.
    In the housing sector, activity continues to weaken. Although sales 
of existing homes have been about unchanged this year, sales of new 
homes have continued to fall, and inventories of unsold new homes 
remain high. In response, homebuilders continue to scale back the pace 
of housing starts. Home prices are falling, particularly in regions 
that experienced the largest price increases earlier this decade. The 
declines in home prices have contributed to the rising tide of 
foreclosures; by adding to the stock of vacant homes for sale, these 
foreclosures have, in turn, intensified the downward pressure on home 
prices in some areas.
    Personal consumption expenditures have advanced at a modest pace so 
far this year, generally holding up somewhat better than might have 
been expected given the array of forces weighing on household finances 
and attitudes. In particular, with the labor market softening and 
consumer price inflation elevated, real earnings have been stagnant so 
far this year; declining values of equities and houses have taken their 
toll on household balance sheets; credit conditions have tightened; and 
indicators of consumer sentiment have fallen sharply. More positively, 
the fiscal stimulus package is providing some timely support to 
household incomes. Overall, consumption spending seems likely to be 
restrained over coming quarters.
    In the business sector, real outlays for equipment and software 
were about flat in the first quarter of the year, and construction of 
nonresidential structures slowed appreciably. In the second quarter, 
the available data suggest that business fixed investment appears to 
have expanded moderately. Nevertheless, surveys of capital spending 
plans indicate that firms remain concerned about the economic and 
financial environment, including sharply rising costs of inputs and 
indications of tightening credit, and they are likely to be cautious 
with spending in the second half of the year. However, strong export 
growth continues to be a significant boon to many U.S. companies.
    In conjunction with the June FOMC meeting, Board members and 
Reserve Bank presidents prepared economic projections covering the 
years 2008 through 2010. On balance, most FOMC participants expected 
that, over the remainder of this year, output would expand at a pace 
appreciably below its trend rate, primarily because of continued 
weakness in housing markets, elevated energy prices, and tight credit 
conditions. Growth is projected to pick up gradually over the next 2 
years as residential construction bottoms out and begins a slow 
recovery and as credit conditions gradually improve. However, FOMC 
participants indicated that considerable uncertainty surrounded their 
outlook for economic growth and viewed the risks to their forecasts as 
skewed to the downside.
    Inflation has remained high, running at nearly a 3\1/2\ percent 
annual rate over the first 5 months of this year as measured by the 
price index for personal consumption expenditures. And, with gasoline 
and other consumer energy prices rising in recent weeks, inflation 
seems likely to move temporarily higher in the near term.
    The elevated level of overall consumer inflation largely reflects a 
continued sharp run-up in the prices of many commodities, especially 
oil but also certain crops and metals. \2\ The spot price of West Texas 
intermediate crude oil soared about 60 percent in 2007 and, thus far 
this year, has climbed an additional 50 percent or so. The price of oil 
currently stands at about five times its level toward the beginning of 
this decade. Our best judgment is that this surge in prices has been 
driven predominantly by strong growth in underlying demand and tight 
supply conditions in global oil markets. Over the past several years, 
the world economy has expanded at its fastest pace in decades, leading 
to substantial increases in the demand for oil. Moreover, growth has 
been concentrated in developing and emerging market economies, where 
energy consumption has been further stimulated by rapid 
industrialization and by government subsidies that hold down the price 
of energy faced by ultimate users.
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     \2\ The dominant role of commodity prices in driving the recent 
increase in inflation can be seen by contrasting the overall inflation 
rate with the so-called core measure of inflation, which excludes food 
and energy prices. Core inflation has been fairly steady this year at 
an annual rate of about 2 percent.
---------------------------------------------------------------------------
    On the supply side, despite sharp increases in prices, the 
production of oil has risen only slightly in the past few years. Much 
of the subdued supply response reflects inadequate investment and 
production shortfalls in politically volatile regions where large 
portions of the world's oil reserves are located. Additionally, many 
governments have been tightening their control over oil resources, 
impeding foreign investment and hindering efforts to boost capacity and 
production. Finally, sustainable rates of production in some of the 
more secure and accessible oil fields, such as those in the North Sea, 
have been declining. In view of these factors, estimates of long-term 
oil supplies have been marked down in recent months. Longdated oil 
futures prices have risen along with spot prices, suggesting that 
market participants also see oil supply conditions remaining tight for 
years to come.
    The decline in the foreign exchange value of the dollar has also 
contributed somewhat to the increase in oil prices. The precise size of 
this effect is difficult to ascertain, as the causal relationships 
between oil prices and the dollar are complex and run in both 
directions. However, the price of oil has risen significantly in terms 
of all major currencies, suggesting that factors other than the dollar, 
notably shifts in the underlying global demand for and supply of oil, 
have been the principal drivers of the increase in prices.
    Another concern that has been raised is that financial speculation 
has added markedly to upward pressures on oil prices. Certainly, 
investor interest in oil and other commodities has increased 
substantially of late. However, if financial speculation were pushing 
oil prices above the levels consistent with the fundamentals of supply 
and demand, we would expect inventories of crude oil and petroleum 
products to increase as supply rose and demand fell. But in fact, 
available data on oil inventories show notable declines over the past 
year. This is not to say that useful steps could not be taken to 
improve the transparency and functioning of futures markets, only that 
such steps are unlikely to substantially affect the prices of oil or 
other commodities in the longer term.
    Although the inflationary effect of rising oil and agricultural 
commodity prices is evident in the retail prices of energy and food, 
the extent to which the high prices of oil and other raw materials have 
been passed through to the prices of non-energy, non-food finished 
goods and services seems thus far to have been limited. But with 
businesses facing persistently higher input prices, they may attempt to 
pass through such costs into prices of final goods and services more 
aggressively than they have so far. Moreover, as the foreign exchange 
value of the dollar has declined, rises in import prices have put 
greater upward pressure on business costs and consumer prices. In their 
economic projections for the June FOMC meeting, monetary policymakers 
marked up their forecasts for inflation during 2008 as a whole. FOMC 
participants continue to expect inflation to moderate in 2009 and 2010, 
as slower global growth leads to a cooling of commodity markets, as 
pressures on resource utilization decline, and as longer-term inflation 
expectations remain reasonably well anchored. However, in light of the 
persistent escalation of commodity prices in recent quarters, FOMC 
participants viewed the inflation outlook as unusually uncertain and 
cited the possibility that commodity prices will continue to rise as an 
important risk to the inflation forecast. Moreover, the currently high 
level of inflation, if sustained, might lead the public to revise up 
its expectations for longer-term inflation. If that were to occur, and 
those revised expectations were to become embedded in the domestic 
wage- and price-setting process, we could see an unwelcome rise in 
actual inflation over the longer term. A critical responsibility of 
monetary policymakers is to prevent that process from taking hold.
    At present, accurately assessing and appropriately balancing the 
risks to the outlook for growth and inflation is a significant 
challenge for monetary policymakers. The possibility of higher energy 
prices, tighter credit conditions, and a still-deeper contraction in 
housing markets all represent significant downside risks to the outlook 
for growth. At the same time, upside risks to the inflation outlook 
have intensified lately, as the rising prices of energy and some other 
commodities have led to a sharp pickup in inflation and some measures 
of inflation expectations have moved higher. Given the high degree of 
uncertainty, monetary policymakers will need to carefully assess 
incoming information bearing on the outlook for both inflation and 
growth. In light of the increase in upside inflation risk, we must be 
particularly alert to any indications, such as an erosion of longer-
term inflation expectations, that the inflationary impulses from 
commodity prices are becoming embedded in the domestic wage- and price-
setting process.
    I would like to conclude my remarks by providing a brief update on 
some of the Federal Reserve's actions in the area of consumer 
protection. At the time of our report last February, I described the 
Board's proposal to adopt comprehensive new regulations to prohibit 
unfair or deceptive practices in the mortgage market, using our 
authority under the Home Ownership and Equity Protection Act of 1994. 
After reviewing the more than 4,500 comment letters we received on the 
proposed rules, the Board approved the final rules yesterday.
    The new rules apply to all types of mortgage lenders and will 
establish lending standards aimed at curbing abuses while preserving 
responsible subprime lending and sustainable homeownership. The final 
rules prohibit lenders from making higher-priced loans without due 
regard for consumers' ability to make the scheduled payments and 
require lenders to verify the income and assets on which they rely when 
making the credit decision. Also, for higher-priced loans, lenders now 
will be required to establish escrow accounts so that property taxes 
and insurance costs will be included in consumers' regular monthly 
payments. The final rules also prohibit prepayment penalties for 
higher-priced loans in cases in which the consumer's payment can 
increase during the first few years and restrict prepayment penalties 
on other higher-priced loans Other measures address the coercion of 
appraisers, servicer practices, and other issues. We believe the new 
rules will help to restore confidence in the mortgage market.
    In May, working jointly with the Office of Thrift Supervision and 
the National Credit Union Administration, the Board issued proposed 
rules under the Federal Trade Commission Act to address unfair or 
deceptive practices for credit card accounts and overdraft protection 
plans. Credit cards provide a convenient source of credit for many 
consumers, but the terms of credit card loans have become more complex, 
which has reduced transparency. Our consumer testing has persuaded us 
that disclosures alone cannot solve this problem. Thus, the Board's 
proposed rules would require card issuers to alter their practices in 
ways that will allow consumers to better understand how their own 
decisions and actions will affect their costs. Card issuers would be 
prohibited from increasing interest rates retroactively to cover prior 
purchases except under very limited circumstances. For accounts having 
multiple interest rates, when consumers seek to pay down their balance 
by paying more than the minimum, card issuers would be prohibited from 
maximizing interest charges by applying excess payments to the lowest 
rate balance first. The proposed rules dealing with bank overdraft 
services seek to give consumers greater control by ensuring that they 
have ample opportunity to opt out of automatic payments of overdrafts. 
The Board has already received more than 20,000 comment letters in 
response to the proposed rules.
    Thank you. I would be pleased to take your questions.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM BEN S. BERNANKE

Q.1. Inflation: Mr. Chairman, I have great concerns about 
inflation. Inflation degrades consumer's purchasing power and 
reduces the value of many investments, including people's 
homes. Additionally, continued food and energy price increases 
can have negative effects on consumer confidence and 
potentially unhinge inflation expectations.
    How large of a shift in expectations would the FOMC have to 
see before it began to tighten the target for the Federal Funds 
rate?
    Please comment on whether you have observed a pass-through 
of higher input prices for commodities and energy in the form 
of higher prices for finished goods?

A.1. The inflationary effects of the sharp increases in oil and 
agricultural commodity prices earlier this year are clearly 
evident in the retail prices of energy and food. In particular, 
the PCE price index for food and beverages increased almost 6 
percent over the 12 months ending in August 2008, while the PCE 
price index for energy moved up 28 percent over that same 
period. The acceleration in the price indexes for these two 
components of spending accounted for much of the pickup in the 
12-month change in the overall PCE price index to 4.5 percent 
in August 2008 from 2 percent over the 12 months ending in 
August 2007.
    It appears that, to some extent, the earlier increases in 
the prices of oil and other raw materials have been passed 
through to the prices of non-energy, non-food finished goods 
and services. Prices for consumer items that have a high energy 
content--such as airfares and other transportation services, 
housekeeping supplies, and household operations--have moved up 
noticeably this year; moreover, energy and other basic input 
costs could well have pushed up prices for a range of other 
items for which the direct effect of commodity prices is more 
difficult to identify. In the aggregate, the PCE price index 
excluding food and energy rose at an annual rate of 2.6 percent 
over the 12 months ending in August 2008, about one-half 
percentage point faster than over the 12 months ending in 
August 2007.
    Thus far, however, we have not seen the sort of run up in 
labor compensation and inflation expectations that could lead 
to a deterioration in the longer term outlook for inflation. In 
particular, although some indicators of inflation expectations 
have increased, long-term inflation expectations still appear 
to be reasonably well anchored. Indeed, given the recent sharp 
declines in the prices for crude oil and other commodities and 
the weakening in economic conditions, the FOMC believes that 
inflation is likely to moderate later this year and in 2009. Of 
course, the Committee will continue to monitor the incoming 
information on inflation and inflation expectations carefully.

Q.2. Update on Bear Stearns: Chairman Bernanke, the Federal 
Reserve created a limited liability corporation (Maiden Lane 
LLC) to acquire and manage certain assets from Bear Stearns, 
with the goal of maximizing repayment of the original loan back 
to the Federal Reserve Bank of New York. We all hope that this 
loan will be repaid in its entirety through the sale of these 
assets over time.
    How has the value of the Bear Stearns portfolio changed 
over time?
    In the few months since this transaction occurred, has 
anything changed that would lead to a reassessment of potential 
losses?

A.2. As indicated in the Federal Reserve's weekly H.4.1 
statistical releases, the fair value of the net portfolio 
holdings of Maiden Lane LLC was $29.816 billion as of March 14, 
2008, $28.893 billion as of June 26, 2008, and $29.018 billion 
as of June 30, 2008. The Federal Reserve will publish in the 
H.4.1 statistical release an updated fair value of the net 
portfolio holdings of Maiden Lane LLC as of the end of each 
calendar quarter. The fair value of the net portfolio holdings 
of Maiden Lane LLC was $26.979 billion as of November 26, 2008, 
which reflects valuations as of September 30, 2008.
    As more fully explained in my testimony before the 
Committee on April 3, 2008, the Federal Reserve decided to 
finance a portion of Bear Stearns' assets to facilitate the 
acquisition of the firm by JPMorgan Chase to address the severe 
consequences that likely would have resulted from a disorderly 
liquidation of the firm in the unusually fragile circumstances 
that then prevailed. In taking this action, the Federal Reserve 
consulted closely with the Treasury Department.
    In order to maximize the returns to the Federal Reserve and 
the taxpayer, the Federal Reserve has engaged an independent 
portfolio management firm to professionally manage the assets 
held by Maiden Lane LLC. The assets will be managed with a 
long-term time horizon of at least 10 years. Although the value 
of the portfolio declined between March 14, 2008, and June 30, 
2008, given the long-term time horizon for the portfolio it is 
too early to estimate what, if any, net losses might result 
from the eventual liquidation of the portfolio. Importantly, as 
previously announced, JPMorgan Chase will bear the first $1 
billion of any losses on the collateral pool.

Q.3. Negative Real Interest Rates: Chairman Bernanke, real 
interest rates appear to be negative at present, since the 
nominal short-term rate is lower than inflation.
    Does having a negative real rate of interest during a 
period of increased inflation harm the Fed's ability to work 
towards maintaining price stability?
    For how long can the Fed run a negative real interest rate 
before inflation pressures grow to dangerous levels?

A.3. The FOMC has judged the current level of short-term 
interest rates as appropriate in light of its statutory 
objectives of maximum employment and price stability. 
Relatively low real short-term interest rates are currently 
necessary to counter the adverse effects of the broad range of 
factors restraining aggregate spending and output. Such factors 
include severe strains on financial markets and institutions, 
tight credit conditions, the ongoing housing correction, and 
elevated energy prices, which reduce households' discretionary 
income. As such, we do not believe that the current low level 
of real short-term interest rates is likely to have an adverse 
effect on the economy. Clearly, the highly accommodative stance 
of monetary policy cannot be maintained indefinitely. But, in 
view of the expectation for inflation to decline, such a stance 
is appropriate for a time to help foster moderate economic 
growth in the face of the range of factors that is restraining 
growth. The Committee believes that inflation is likely to 
moderate later this year and during 2009 as the effect of 
recent sharp drops in the prices of energy and other commodity 
prices shows through to broad price indexes and as slack in the 
economy resulting from slower economic growth reduces pressure 
on resources.

Q.4. FOMC Statement Bias: Mr. Chairman, in the FOMC's most 
recent statement, the Committee seemed to shift its bias away 
from concerns over slower growth, towards concern about 
inflation and inflation expectations.
    Would you elaborate on what this shift means for future 
policy decisions?
    Additionally, how long would inflation rates have to stay 
elevated for the Committee to display unambiguous bias towards 
alleviating inflation concerns?

A.4. In conducting monetary policy, the Committee carefully 
monitors ongoing developments in the economy and financial 
markets that influence the outlook for the economy and 
inflation. From time to time, the Federal Reserve adjusts its 
policy stance in view of the evolving economic outlook and 
risks to the outlook. After each meeting, the Committee issues 
a statement that explains any adjustment to its policy stance 
and characterizes the outlook for economic growth and 
inflation. In the period before the June meeting, incoming 
economic data had indicated that economic growth in the second 
quarter was stronger than had been expected. Also, financial 
market conditions appeared to have improved somewhat, although 
markets clearly remained under stress. Meanwhile, oil prices 
had increased further. In these circumstances, the Committee 
judged at its June meeting that the downside risks to growth 
diminished and the upside risks to inflation had increased.
    An important uncertainty in the outlook for inflation is 
whether the current elevated level of total inflation may lead 
to upward pressure on longer-term inflation expectations. At 
present, although some indicators of inflation expectations 
have increased, long-term inflation expectations still appear 
to be reasonably well anchored. However, the Committee is 
monitoring inflation and inflation expectations very carefully.
                                ------                                


        RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
                      FROM BEN S. BERNANKE

Q.1. The number and severity of credit rating downgrades from 
credit rating agencies in the last year casts doubt on the 
reliability of such ratings. What is the Fed doing to verify 
the credit rating of the collateral you are accepting at the 
various Fed facilities?

A.1. The Federal Reserve regularly updates the credit ratings 
of assets pledged as collateral and uses multiple ratings 
rather than just one. Assets are regularly marked to market and 
haircuts are applied to provide adequate protection against 
market, liquidity, and credit risks. In cases where ratings are 
less reliable, we require a higher rating than we would 
otherwise. It should be noted that the entire pool of 
collateral pledged by a depository institution secures any 
loans to that institution; moreover, the Federal Reserve has 
recourse to the borrower under all of its lending facilities 
beyond the specific collateral pledged.
    Although credit ratings are one determinant of the 
eligibility of collateral pledged to Federal Reserve liquidity 
facilities, Reserve Banks also perform independent credit 
analysis when receiving collateral and especially when 
extending a loan to a depository institution. That analysis is 
based on publicly available information as well as on 
supervisory information on both the quality of the collateral 
and on the financial condition of the pledging institution.

Q.2. In 2006, Congress passed the Credit Rating Agency Reform 
Act, which created a formal process for recognizing and 
examining credit rating agencies with a goal of increasing 
competition and rating quality. Under that law, the SEC has now 
recognized 10 National Recognized Statistical Rating 
Organizations. However, the Fed only accepts credit ratings 
from the three largest rating agencies for collateral taken at 
the various Fed facilities. Why does the Fed not accept ratings 
from the other approved agencies? Are there any plans to 
revisit that prohibition?

A.2. The Federal Reserve accepts a very large volume of 
collateral, and it is critically important to be able to access 
credit ratings and other information on a timely basis in a 
fully automated fashion. The Federal Reserve is open to 
utilizing credit ratings of all NRSROs consistent with this 
basic requirement.

Q.3. Given the concerns about the government-sponsored entities 
that led the Fed to grant them access to a lending facility and 
the Treasury Department to ask for rescue legislation, has the 
Fed changed its practices on accepting GSE-backed securities as 
collateral at the Fed facilities? Have you increased the 
collateral required when GSE-backed collateral is posted?

A.3. Securities issued or guaranteed by the GSEs remain 
eligible collateral at the Federal Reserve's various liquidity 
support facilities. The market prices of GSE securities pledged 
as collateral are regularly updated and the haircuts are 
determined to provide the Federal Reserve with adequate 
protection against market, liquidity, and credit risk. The 
haircuts applied to collateral pledged by depository 
institutions to the discount window are regularly recalibrated 
by the Federal Reserve, and it has not been necessary to change 
those applied to GSE-related securities. Haircuts applied to 
securities pledged by primary dealers for repurchase 
agreements, the primary dealer credit facility, and the term 
securities lending facility are chosen to be consistent with, 
but slightly more conservative than, market practice.

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