[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



     CHALLENGES FACING THE ECONOMY: THE VIEW OF THE FEDERAL RESERVE

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

              HEARING HELD IN WASHINGTON, DC, JUNE 3, 2009

                               __________

                           Serial No. 111-11

                               __________

           Printed for the use of the Committee on the Budget


                       Available on the Internet:
       http://www.gpoaccess.gov/congress/house/budget/index.html




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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ALLYSON Y. SCHWARTZ, Pennsylvania    PAUL RYAN, Wisconsin,
MARCY KAPTUR, Ohio                     Ranking Minority Member
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 SCOTT GARRETT, New Jersey
EARL BLUMENAUER, Oregon              MARIO DIAZ-BALART, Florida
MARION BERRY, Arkansas               MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida                  PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts     CONNIE MACK, Florida
NIKI TSONGAS, Massachusetts          JOHN CAMPBELL, California
BOB ETHERIDGE, North Carolina        JIM JORDAN, Ohio
BETTY McCOLLUM, Minnesota            CYNTHIA M. LUMMIS, Wyoming
CHARLIE MELANCON, Louisiana          STEVE AUSTRIA, Ohio
JOHN A. YARMUTH, Kentucky            ROBERT B. ADERHOLT, Alabama
ROBERT E. ANDREWS, New Jersey        DEVIN NUNES, California
ROSA L. DeLAURO, Connecticut,        GREGG HARPER, Mississippi
CHET EDWARDS, Texas                  ROBERT E. LATTA, Ohio
ROBERT C. ``BOBBY'' SCOTT, Virginia
JAMES R. LANGEVIN, Rhode Island
RICK LARSEN, Washington
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
GERALD E. CONNOLLY, Virginia
KURT SCHRADER, Oregon

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
                 Austin Smythe, Minority Staff Director













                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, June 3, 2009.....................     1

Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, ranking minority member, House Committee on 
      the Budget.................................................     2
    Hon. Gerald E. Connolly, a Representative in Congress from 
      the State of Virginia:
        Prepared statement of....................................     4
        Questions for the record.................................    60
    Hon. Ben S. Bernanke, Chairman, Board of Governors of the 
      Federal Reserve System.....................................     5
        Prepared statement of....................................     9
        Responses to questions submitted by:
            Ms. Kaptur, along with Mr. Bernanke's June 25, 2009 
              prepared statement before the House Committee on 
              Oversight and Government Reform....................    45
            Mr. Connolly.........................................    60
            Mr. Langevin.........................................    62
    Hon. Marcy Kaptur, a Representative in Congress from the 
      State of Ohio:
        Questions for the record.................................    43
        Article: ``BlackRock Is Go-To Firm to Divine Wall Street 
          Assets,'' June 2009, Bloomberg Markets Magazine........    64
        Article: ``Wall St. Firm Draws Scrutiny as U.S. 
          Adviser,'' May 18, 2009, New York Times................    71
    Hon. James R. Langevin, a Representative in Congress from the 
      State of Rhode Island, prepared statement and questions for 
      the record.................................................    62

 
                     CHALLENGES FACING THE ECONOMY:
                    THE VIEW OF THE FEDERAL RESERVE

                              ----------                              


                        WEDNESDAY, JUNE 3, 2009

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m., in room 
210, Cannon House Office Building, Hon. John Spratt [chairman 
of the committee] presiding.
    Present: Representatives Spratt, Schwartz, Doggett, 
McGovern, Tsongas, Etheridge, McCollum, Yarmuth, Andrews, 
Scott, Langevin, Larsen, Bishop, Moore, Connolly, Ryan, 
Hensarling, Garrett, Mack, Campbell, Jordan, Lummis, Aderholt, 
Nunes, and Latta.
    Chairman Spratt. The committee will come to order.
    We meet today to hear the distinguished Chairman of the 
Federal Reserve, Benjamin Bernanke, testify on the recession 
that is plaguing our economy and on the prospects of recovery.
    Chairman Bernanke testified before our committee on October 
20 of last year as we searched for ways to mitigate, if not 
avoid, a long recession. The Chairman acknowledged then that 
monetary policy has its limits. Without being specific, he 
welcomed a fiscal complement.
    Congress had just passed a bipartisan bill authorizing $700 
billion to dispose of troubled assets, so-called TARP. Backed 
by these funds, the Treasury, the Fed, and the FDIC have made 
extraordinary advances to banks and other financial 
institutions, recognizing what Chairman Bernanke told the Joint 
Economic Committee last month, that, quote, ``A sustained 
recovery in economic activity depends critically on restoring 
stability to the financial system.'' This is one question we 
hope you will address today, Mr. Chairman: Just how strong and 
how stable are our financial institutions?
    By February of this year, it was clear that TARP relief was 
a necessary but not sufficient solution. So Congress passed, on 
a partisan basis, an even bigger boost, the American Recovery 
and Reinvestment Act, which packed $787 billion of fiscal 
stimuli in the form of spending increases and tax decreases. We 
would like to know, Mr. Chairman, whether from the Fed's 
viewpoint this huge countercyclical thrust is working.
    Bold action was necessary to head off a collapse of the 
financial system, but the steps taken also swell the Nation's 
deficit and the national debt. It is all but impossible to 
balance the budget when the economy is bucking a headwind like 
this recession, because what we do to make the economy better 
is likely to make the deficit worse. Yet, at the same time, we 
cannot add infinitely to the national debt without facing 
consequences in global credit markets or on our future capacity 
to borrow.
    One purpose of this hearing is to explore both the 
advantages, and the potential downside risk of our bold and 
unprecedented response to financial turmoil. Should we be 
concerned that some of our swelling debt must be financed with 
foreign credit?
    We hope that most of our outlays are for nonrecurring needs 
and that much of what has been advanced in recent months will 
in time be recovered, repaid, and used to pay down the debt 
that we are incurring. We would like to have your assessment, 
Mr. Chairman, of that possibility.
    Despite bold, unprecedented action, the Director of the 
Congressional Budget Office told this committee on May 21st 
that our economy is still running at 7 percent or more below 
its capacity, or a trillion dollars per year below its 
potential. Recently there have been signs, however, of a 
turnaround. Business inventories are down; the stock market is 
up a bit; and so, too, to some extent, is the housing market. 
Our question to you, Mr. Chairman, is whether these are 
glimmers of hope or flashes in the pan.
    To keep this recession from growing worse, the Fed has 
pumped enormous liquidity into the money markets, so much so 
that some critics even worry of inflation, lurking, to be sure, 
just over the horizon, but a threat nevertheless. The spread 
between short- and long-term Treasuries has widened to more 
than 2.5 percentage points. We would like to know, Mr. 
Chairman, if these are salutary signs of a recovery or ominous 
signs of inflation.
    A month ago, Chairman Bernanke told the JEC that, quote, 
``We expect economic activity to bottom out and turn up later 
this year.'' But he went on to warn, ``Even after the recovery 
gets under way, the rate of real economic growth is likely to 
remain below potential for a while, only gradually gaining 
momentum.''
    The old locomotives that pulled the economy out of the rut 
in the past--real estate, consumer durables--are unavailing 
now. This causes us to ask, Mr. Chairman, what will empower a 
turnaround in this dismal economy, and when can we expect to 
return to normality?
    Mr. Chairman, as you can see, we have a lot of grist for 
our mill today. We thank you for being here, but, most of all, 
we thank you for your service to our Nation at this very 
crucial time.
    Before proceeding to your statement, let me turn to Mr. 
Ryan for his opening remarks.
    Mr. Ryan?
    Mr. Ryan. Thank you, Chairman Spratt, for arranging this 
important hearing.
    Chairman Bernanke, you come before this committee with the 
financial markets in a better position than in your previous 
appearance last fall. The economy is finally showing some signs 
of stabilizing, and that is encouraging. But despite these 
short-term glimmers of hope, I have become more concerned about 
the longer-term implications of our economic policies.
    On the fiscal side, the Treasury is issuing record amounts 
of debt, over $2 trillion this year alone, to support record 
government spending and record deficits. Meanwhile, the Federal 
Reserve has injected an enormous amount of monetary stimulus 
into the economy and has even started purchasing longer-term 
Treasury bonds in an attempt to lower borrowing costs and 
further ease financial conditions.
    This can be a dangerous policy mix. The Treasury is issuing 
debt, and the Central Bank is buying it. It gives the alarming 
impression that the U.S. one day might begin to meet its 
financial obligations by simply printing money. And we all know 
what happens to a country that chooses to monetize its debt. It 
gets runaway inflation and a gradual erosion of workers' 
paychecks and family savings.
    There is an increased discussion in the financial press 
about the potential negative consequences of our economic 
policies. Just this week, the yield on the 10-year Treasury 
bond rose to a 6-month high, over 3 percent--3.7 percent--a 
sign that global investors are becoming concerned about debt 
levels and the possibility of future inflation. This is the 
bond market telling us that there is no free lunch. When you 
issue record amounts of debt in your central bank, as the 
monetary policy levers at full throttle, red flags begin to get 
raised and our borrowing costs go up.
    There are some faint warning bells going off. The value of 
the dollar has slipped recently. The price of gold is back up 
to nearly $1,000 a troy ounce. And inflation compensation 
spreads in the Treasury bond market have risen to a 9-month 
high.
    Now, I realize that some of these signs in the financial 
markets are likely reassuring to the Fed, since the predominant 
risk over the short term has been deflation, and that this 
could be signs of a recovery. But I am generally concerned that 
the Fed will be unable to unwind its considerable monetary 
policy stimulus in a timely manner to prevent a sharp rise in 
inflation over the medium term.
    There are a number of technical challenges associated with 
shrinking your balance sheet and returning to a more normal 
monetary policy stance. But I am more concerned about the 
political challenges the Fed will face when you finally have to 
make this call. I imagine there will be substantial political 
pressure on the Fed to delay tightening its monetary policy 
while the unemployment rate is still rising, for instance. But 
the Fed's political independence is critical--it is critical 
and essential for safeguarding its commitment to price 
stability, which is the chief policy concern of every central 
bank. This clear commitment is all the more important at a time 
when the fine line between monetary policy and fiscal policy 
seems a bit blurry.
    Despite the recent signs of stabilization in the economy, 
we policymakers should recognize that our most challenging 
period is going to be ahead of us as we try to right the ship 
and get back on the path of sustainable growth and job 
creation. That will clearly take a renewed sense of fiscal 
discipline to rein in spending and budget deficits, but it will 
also take a clear exit strategy on the part of the Fed and a 
firm commitment to price stability. We, in Congress, are 
committed to working with the administration to accomplish the 
former, and we trust the Fed will work diligently to ensure the 
latter.
    Thank you, Chairman.
    Chairman Spratt. Thank you, Mr. Ryan.
    Now, before proceeding with Chairman Bernanke, let me, as a 
housekeeping detail, ask for unanimous consent that all members 
be allowed to submit an opening statement for the record at 
this point.
    So ordered.
    [The statement of Mr. Connolly follows:]

  Prepared Statement of Hon. Gerald E. Connolly, a Representative in 
                  Congress From the State of Virginia

    Mr. Chairman, thank you for holding this hearing and thank you, 
Chairman Bernanke, for your testimony on the state of our economy. I 
understand the complexity of issues affecting our economy and I respect 
the Federal Reserve's various efforts to stabilize the current crisis. 
There is, however, one critical area in which I believe the Fed has 
failed to act--the municipal bond market.
    Municipal bonds are the primary funding mechanism for state and 
local capital projects, including the repair or construction of our 
schools, fire and police stations, libraries, water treatment plants 
and critically needed transportation infrastructure. Traditionally, 
state and local governments have sold an average of $280 billion in 
bonds each year.
    The capital programs of our state and local governments, primarily 
funded by municipal bonds, have been one of the most effective engines 
for job creation throughout the country.
    Yet, despite the historically solid performance and low default 
rate of municipal bonds, investors fled from the muni market to U.S. 
Treasury notes following the economic meltdown last fall. As a result, 
the nation's 55,000 state and local governments are experiencing 
limited access to the capital markets. Further complicating the issue 
is the fact that the private insurance market virtually disappeared 
overnight, eliminating a viable means of credit enhancement for many 
issuers.
    If we do not address this serious problem, we could wind up in a 
situation where this squeezing of the municipal bond market has a 
counteractive effect on the benefits of our hard-fought economic 
recovery package. Municipal bonds are and have always been a tremendous 
source of economic stimulus that we cannot ignore.
    Chairman Bernanke, you stated in your March 31st letter to Members 
of Congress that although fixed-rate municipal debt is available to the 
larger municipalities, the costs to those localities are elevated, and 
thousands of smaller entities remain unable to access credit. You 
further noted the additional stress on the floating rate debt.
    According to Section 2a of the Federal Reserve Act, the Fed is 
required ``to promote effectively the goals of maximum employment, 
stable prices, and moderate long-term interest rates.'' To that effect, 
during the current recession, the Fed extended more than $2.1 trillion 
in credit through additional lending facilities to help spur the credit 
market.
    Earlier this year I introduced H.R. 1669, the Federal Municipal 
Bond Marketing Support and Securitization Act, as a way to begin to 
address the problem. At its core, my proposal directed the Secretary of 
the Treasury and Federal Reserve Board to work together to 
strategically intervene in the municipal bond market to restore 
liquidity and spark local job creation.
    The Congress now is considering several options, including 
authorizing a federal reinsurance program and a liquidity enhancement 
proposal to give the Federal Reserve the authority to fund a new 
liquidity facility for the purchase of variable rate demand notes.
    The Federal Reserve is empowered to conduct Open Market Operations. 
I understand the Fed's traditional reluctance to purchase municipal 
securities; however, the current recession is truly an extraordinary 
and historic situation, requiring new and innovative tools to address.
    Chairman Bernanke, you stated in your October 28, 2008 letter to 
Congressman Paul Kanjorski, ``the Federal Reserve Act provides the 
Federal Reserve with only limited ability to purchase directly the 
obligations of states and municipalities.''
    If we are serious about promoting economic stimulus and recovery, 
then we must address the credit crisis that is paralyzing our state and 
local governments' capital programs--programs which represent one of 
the most significant job creation engines in the nation.

    Chairman Spratt. Let me further say that the Chairman's 
testimony has been received and will be, without objection, 
entered in the record, so that you may summarize as you see 
fit. I think it is an important statement, full in detail, and 
we would encourage you to plow all the way through it, Mr. 
Chairman.
    One other very important detail. The Chairman has to leave 
at 12:30 today, so we will be riding the clock very closely on 
questions that members ask.
    Mr. Chairman, the floor is yours. And thank you, sir, again 
for coming.

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

    Mr. Bernanke. Thank you, Mr. Chairman.
    Chairman Spratt, Ranking Member Ryan, and other members of 
the committee, I am pleased to have this opportunity to offer 
my views on current economic and financial conditions and on 
issues pertaining to the Federal budget.
    The U.S. economy has contracted sharply since last fall, 
with real gross domestic product having dropped at an average 
annual rate of about 6 percent during the fourth quarter of 
2008 and the first quarter of this year.
    Among the enormous cost of the downturn is the loss of 
nearly 6 million jobs since the beginning of 2008. The most 
recent information on the labor market, the number of new and 
continuing claims for unemployment insurance through late May, 
suggests that sizeable job losses and further increases in 
unemployment are likely over the next few months.
    However, the recent data also suggests that the pace of 
economic contraction may be slowing. Notably, consumer 
spending, which dropped sharply in the second half of last 
year, has been roughly flat since the turn of the year, and 
consumer sentiment has improved. In coming months, household 
spending power will be boosted by the fiscal stimulus program.
    Nonetheless, a number of factors are likely to continue to 
weigh on consumer spending, among them the weak labor market, 
the declines in equity and housing wealth that households have 
experienced over the past 2 years, and the still-tight credit 
conditions.
    Activity in the housing market, after a long period of 
decline, has also shown some signs of bottoming. Sales of 
existing homes have been fairly stable since late last year, 
and sales of new homes seem to have flattened out in the past 
couple of monthly readings, though they remain at depressed 
levels. Meanwhile, construction of new homes has been 
sufficiently restrained to allow the backlog of unsold new 
homes to decline, a precondition for any recovery in 
homebuilding.
    Businesses remain very cautious and continue to reduce 
their workforces and their capital investments. On a more 
positive note, firms are making progress in shedding the 
unwanted inventories that they accumulated following last 
fall's sharp downturn in sales. The Commerce Department 
estimates that the pace of inventory liquidation quickened in 
the first quarter, accounting for a sizeable portion of the 
reported decline in real GDP during that period. As inventory 
stocks move into better alignment with sales, firms should 
become more willing to increase production.
    We continue to expect overall economic activity to bottom 
out and then to turn up later this year. Our assessments that 
consumer spending and housing demand will stabilize and that 
the pace of inventory liquidation will slow are key building 
blocks of that forecast. Final demand should also be supported 
by fiscal and monetary stimulus, and U.S. exports may benefit 
if recent signs of stabilization in foreign economic activity 
prove accurate.
    An important caveat is that our forecast also assumes 
continuing gradual repair of the financial system and an 
associated improvement in credit conditions. A relapse in the 
financial sector will be a significant drag on economic 
activity and could cause the incipient recovery to stall.
    I will provide a brief update on financial markets in a 
moment.
    Even after recovery gets under way, the rate of growth of 
real economic activity is likely to remain below its longer-run 
potential for a while, implying that the current slack in 
resource utilization will increase further. We expect that the 
recovery will only gradually gain momentum, and that economic 
slack will diminish slowly. In particular, businesses are 
likely to be cautious about hiring, and the unemployment rate 
is likely to rise for a time, even after economic growth 
resumes.
    In this environment, we anticipate that inflation will 
remain low. The slack in resource utilization remains sizeable. 
And notwithstanding recent increases in the prices of oil and 
other commodities, cost pressures generally remain subdued. As 
a consequence, inflation is likely to move down some over the 
next year relative to its pace in 2008. That said, improving 
economic conditions and stable inflation expectations should 
limit further declines in inflation.
    Conditions at a number of financial markets have improved 
since earlier this year, likely reflecting both policy actions 
taken by the Federal Reserve and other agencies, as well as a 
somewhat better economic outlook. Nevertheless, financial 
markets and financial institutions remain under stress, and low 
asset prices and tight credit conditions continue to restrain 
economic activity.
    Among the markets where functioning has improved recently 
are those for short-term funding, including the interbank 
lending markets and the commercial paper market. Risk spreads 
in those markets appear to have moderated, and more lending is 
taking place at longer maturities.
    The better performance of short-term funding markets in 
part reflects the support afforded by Federal Reserve lending 
programs. It is encouraging that the private sector's reliance 
on the Fed's programs has declined as market stresses have 
eased, an outcome that was one of our key objectives when we 
designed these interventions.
    The issuance of asset-backed securities, backed by credit 
card, auto, and student loans, has also picked up this spring, 
and ABS funding rates have declined--developments supported by 
the availability of the Federal Reserve's Term Asset-Backed 
Securities Loan Facility, or TALF, as a market backstop.
    In markets for longer-term credit, bond issuance by 
nonfinancial firms has been relatively strong recently. And 
spreads between Treasury yields and rates paid by corporate 
borrowers have narrowed some, though they remain wide. Mortgage 
rates and spreads have also been reduced by the Federal 
Reserve's program of purchasing agency debt and agency 
mortgage-backed securities.
    However, in recent weeks, yields on longer-term Treasury 
securities and fixed-rate mortgages have risen. These increases 
appear to reflect concerns about large Federal deficits but 
also other causes, including greater optimism about the 
economic outlook, a reversal of flight to quality flows, and 
technical factors relating to the hedging of mortgage holdings.
    As you know, last month, the Federal bank regulatory 
agencies released the results of the Supervisory Capital 
Assessment Program. The purpose of the exercise was to 
determine for each of the 19 U.S.-owned bank holding companies 
with assets exceeding $100 billion a capital buffer sufficient 
for them to remain strongly capitalized and able to lend to 
creditworthy borrowers, even if economic conditions over the 
next 2 years turn out to be worse than we currently expect.
    According to the findings of the SCAP exercise, under the 
more adverse economic outlook losses of the 19 bank holding 
companies would total an estimated $600 billion during 2009 and 
2010. After taking account of potential resources to absorb 
those losses, including expected revenues, reserves, and 
existing capital cushions, we determined that 10 of the 19 
institutions should raise, collectively, additional common 
equity of $75 billion. Each of the 10 bank holding companies 
requiring an additional buffer has committed to raise this 
capital by November 9th. We are in discussions with these firms 
on their capital plans, which are due by June 8th.
    Even in advance of those plans being approved, the 10 firms 
have among them already raised more than $36 billion of new 
common equity, with a number of their offerings of common 
shares being oversubscribed. In addition, these firms have 
announced actions that would generate up to an additional $12 
billion of common equity. We expect further announcements 
shortly, as their capital plans are finalized and submitted to 
supervisors. The substantial progress these firms have made in 
meeting their required capital buffers and their success in 
raising private capital suggests that investors are gaining 
greater confidence in the banking system.
    Let me turn now to fiscal matters. As you are well aware, 
in February of this year, Congress passed the American Recovery 
and Reinvestment Act, or ARRA, a major fiscal package aimed at 
strengthening near-term economic activity. The package included 
personal tax cuts, increases in transfer payments intended to 
stimulate household spending, incentives for business 
investment, increases in Federal purchases, and Federal grants 
for State and local governments.
    Predicting the effects of these fiscal actions on economic 
activity is difficult, especially in light of the unusual 
economic circumstances that we face. For example, households 
confronted with declining incomes and limited access to credit 
might be expected to spend most of their tax cuts. But then 
again, heightened economic uncertainties and a desire to 
increase precautionary saving or pay down debt might reduce 
households' propensity to spend.
    Likewise, it is difficult to judge how quickly funds 
dedicated to infrastructure needs and other longer-term 
projects will be spent and how large any follow-on effects will 
be. The CBO has constructed a range of estimates of the effects 
of the stimulus package on real GDP and employment that 
appropriately reflects these uncertainties. According to the 
CBO's estimates, by the end of 2010, the stimulus package could 
boost the level of real GDP between about 1 percent and a 
little more than 3 percent and the level of employment by 
between roughly 1 million and 3.5 million jobs.
    The increases in spending and reductions in taxes 
associated with the fiscal package and the financial 
stabilization program, along with the losses in revenues and 
increases in income support payments associated with the weak 
economy, will widen the Federal budget deficit substantially 
this year.
    The administration recently submitted a proposed budget 
that projects the Federal deficit to reach about $1.8 trillion 
this fiscal year before declining to $1.3 trillion in 2010 and 
roughly $900 billion in 2011. As a consequence of this elevated 
level of borrowing, the ratio of Federal debt held by the 
public, to nominal GDP is likely to move up from about 40 
percent before the onset of the financial crisis, to about 70 
percent in 2011. These developments would leave the debt-to-GDP 
ratio at its highest level since the early 1950s, the years 
following the massive debt buildup during World War II.
    Certainly our economy and financial markets face 
extraordinary near-term challenges, and strong and timely 
actions to respond to these challenges are necessary and 
appropriate. Nevertheless, even as we take steps to address the 
recession and threats to financial stability, maintaining the 
confidence of the financial markets require that we, as a 
Nation, begin planning now for the restoration of fiscal 
balance. Prompt attention to questions of fiscal sustainability 
is particularly critical because of the coming budgetary and 
economic challenges associated with the retirement of the baby 
boom generation and continued increases in medical costs.
    The recent projections from the Social Security and 
Medicare trustees show that, in the absence of programmatic 
changes, Social Security and Medicare outlays will together 
increase from about 8.5 percent of GDP today to 10 percent by 
2020 and 12.5 percent by 2030. With the ratio of debt to GDP 
already elevated, we will not be able to continue borrowing 
indefinitely to meet these demands.
    Addressing the country's fiscal problems will require a 
willingness to make difficult choices. In the end, the 
fundamental decision that the Congress, the administration, and 
the American people must confront is how large a share of the 
Nation's economic resources to devote to Federal Government 
programs, including entitlement programs.
    Crucially, whatever size of government is chosen, tax rates 
must ultimately be set at a level sufficient to achieve an 
appropriate balance of spending and revenues in the long run. 
In particular, over the longer term, achieving fiscal 
sustainability--defined, for example, as a situation to which 
the ratios of government debt and interest payments to GDP are 
stable or declining, and tax rates are not so high as to impede 
economic growth--requires that spending and budget deficits be 
well-controlled.
    Clearly, the Congress and the administration face 
formidable near-term challenges that must be addressed, but 
those near-term challenges must not be allowed to hinder timely 
consideration of the steps needed to address fiscal imbalances. 
Unless we demonstrate a strong commitment to fiscal 
sustainability in the longer term, we will have neither 
financial stability nor healthy economic growth.
    And let me close briefly with an update on the Federal 
Reserve's initiatives to enhance the transparency of our credit 
and liquidity programs. As I noted last month in my testimony 
before the JEC, I have asked Vice Chairman Kohn to lead a 
review of our disclosure policies, with the goal of increasing 
the range of information that we make available to the public.
    That group has made significant progress, and we expect to 
begin publishing soon a monthly report on the Fed's balance 
sheet and lending programs that will summarize and discuss 
recent developments and provide considerable new information 
concerning the number of borrowers at our various facilities, 
the concentration of borrowing, and the collateral pledged.
    In addition, the reports will provide quarterly updates of 
key elements of the Federal Reserve's annual financial 
statements, including information regarding the system open 
market account portfolio, our loan programs, and the special-
purpose vehicles that are consolidated on the balance sheet of 
the Federal Reserve Bank of New York.
    We hope that this information will be helpful to the 
Congress and others with an interest in the Federal Reserve's 
actions to address the financial crisis and the economic 
downturn. We will continue to look for opportunities to broaden 
the scope of the information and supporting analysis that we 
provide to the public.
    Thank you, Mr. Chairman.
    [The statement of Ben Bernanke follows:]

    Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of 
                Governors of the Federal Reserve System

    Chairman Spratt, Ranking Member Ryan, and other members of the 
Committee, I am pleased to have this opportunity to offer my views on 
current economic and financial conditions and on issues pertaining to 
the federal budget.
                   economic developments and outlook
    The U.S. economy has contracted sharply since last fall, with real 
gross domestic product (GDP) having dropped at an average annual rate 
of about 6 percent during the fourth quarter of 2008 and the first 
quarter of this year. Among the enormous costs of the downturn is the 
loss of nearly 6 million jobs since the beginning of 2008. The most 
recent information on the labor market--the number of new and 
continuing claims for unemployment insurance through late May--suggests 
that sizable job losses and further increases in unemployment are 
likely over the next few months.
    However, the recent data also suggest that the pace of economic 
contraction may be slowing. Notably, consumer spending, which dropped 
sharply in the second half of last year, has been roughly flat since 
the turn of the year, and consumer sentiment has improved. In coming 
months, households' spending power will be boosted by the fiscal 
stimulus program. Nonetheless, a number of factors are likely to 
continue to weigh on consumer spending, among them the weak labor 
market, the declines in equity and housing wealth that households have 
experienced over the past two years, and still-tight credit conditions.
    Activity in the housing market, after a long period of decline, has 
also shown some signs of bottoming. Sales of existing homes have been 
fairly stable since late last year, and sales of new homes seem to have 
flattened out in the past couple of monthly readings, though both 
remain at depressed levels. Meanwhile, construction of new homes has 
been sufficiently restrained to allow the backlog of unsold new homes 
to decline--a precondition for any recovery in homebuilding.
    Businesses remain very cautious and continue to reduce their 
workforces and capital investments. On a more positive note, firms are 
making progress in shedding the unwanted inventories that they 
accumulated following last fall's sharp downturn in sales. The Commerce 
Department estimates that the pace of inventory liquidation quickened 
in the first quarter, accounting for a sizable portion of the reported 
decline in real GDP in that period. As inventory stocks move into 
better alignment with sales, firms should become more willing to 
increase production.
    We continue to expect overall economic activity to bottom out, and 
then to turn up later this year. Our assessments that consumer spending 
and housing demand will stabilize and that the pace of inventory 
liquidation will slow are key building blocks of that forecast. Final 
demand should also be supported by fiscal and monetary stimulus, and 
U.S. exports may benefit if recent signs of stabilization in foreign 
economic activity prove accurate. An important caveat is that our 
forecast also assumes continuing gradual repair of the financial system 
and an associated improvement in credit conditions; a relapse in the 
financial sector would be a significant drag on economic activity and 
could cause the incipient recovery to stall. I will provide a brief 
update on financial markets in a moment.
    Even after a recovery gets under way, the rate of growth of real 
economic activity is likely to remain below its longer-run potential 
for a while, implying that the current slack in resource utilization 
will increase further. We expect that the recovery will only gradually 
gain momentum and that economic slack will diminish slowly. In 
particular, businesses are likely to be cautious about hiring, and the 
unemployment rate is likely to rise for a time, even after economic 
growth resumes.
    In this environment, we anticipate that inflation will remain low. 
The slack in resource utilization remains sizable, and, notwithstanding 
recent increases in the prices of oil and other commodities, cost 
pressures generally remain subdued. As a consequence, inflation is 
likely to move down some over the next year relative to its pace in 
2008. That said, improving economic conditions and stable inflation 
expectations should limit further declines in inflation.
                    conditions in financial markets
    Conditions in a number of financial markets have improved since 
earlier this year, likely reflecting both policy actions taken by the 
Federal Reserve and other agencies as well as the somewhat better 
economic outlook. Nevertheless, financial markets and financial 
institutions remain under stress, and low asset prices and tight credit 
conditions continue to restrain economic activity.
    Among the markets where functioning has improved recently are those 
for short-term funding, including the interbank lending markets and the 
commercial paper market. Risk spreads in those markets appear to have 
moderated, and more lending is taking place at longer maturities. The 
better performance of short-term funding markets in part reflects the 
support afforded by Federal Reserve lending programs. It is encouraging 
that the private sector's reliance on the Fed's programs has declined 
as market stresses have eased, an outcome that was one of our key 
objectives when we designed our interventions. The issuance of asset-
backed securities (ABS) backed by credit card, auto, and student loans 
has also picked up this spring, and ABS funding rates have declined, 
developments supported by the availability of the Federal Reserve's 
Term Asset-Backed Securities Loan Facility as a market backstop.
    In markets for longer-term credit, bond issuance by nonfinancial 
firms has been relatively strong recently, and spreads between Treasury 
yields and rates paid by corporate borrowers have narrowed some, though 
they remain wide. Mortgage rates and spreads have also been reduced by 
the Federal Reserve's program of purchasing agency debt and agency 
mortgage-backed securities. However, in recent weeks, yields on longer-
term Treasury securities and fixed-rate mortgages have risen. These 
increases appear to reflect concerns about large federal deficits but 
also other causes, including greater optimism about the economic 
outlook, a reversal of flight-toquality flows, and technical factors 
related to the hedging of mortgage holdings.
    As you know, last month, the federal bank regulatory agencies 
released the results of the Supervisory Capital Assessment Program 
(SCAP). The purpose of the exercise was to determine, for each of the 
19 U.S.-owned bank holding companies with assets exceeding $100 
billion, a capital buffer sufficient for them to remain strongly 
capitalized and able to lend to creditworthy borrowers even if economic 
conditions over the next two years turn out to be worse than we 
currently expect. According to the findings of the SCAP exercise, under 
the more adverse economic outlook, losses at the 19 bank holding 
companies would total an estimated $600 billion during 2009 and 2010. 
After taking account of potential resources to absorb those losses, 
including expected revenues, reserves, and existing capital cushions, 
we determined that 10 of the 19 institutions should raise, 
collectively, additional common equity of $75 billion.
    Each of the 10 bank holding companies requiring an additional 
buffer has committed to raise this capital by November 9. We are in 
discussions with these firms on their capital plans, which are due by 
June 8. Even in advance of those plans being approved, the 10 firms 
have among them already raised more than $36 billion of new common 
equity, with a number of their offerings of common shares being over-
subscribed. In addition, these firms have announced actions that would 
generate up to an additional $12 billon of common equity. We expect 
further announcements shortly as their capital plans are finalized and 
submitted to supervisors. The substantial progress these firms have 
made in meeting their required capital buffers, and their success in 
raising private capital, suggests that investors are gaining greater 
confidence in the banking system.
    fiscal policy in the current economic and financial environment
    Let me now turn to fiscal matters. As you are well aware, in 
February of this year, the Congress passed the American Recovery and 
Reinvestment Act, or ARRA, a major fiscal package aimed at 
strengthening near-term economic activity. The package included 
personal tax cuts and increases in transfer payments intended to 
stimulate household spending, incentives for business investment, 
increases in federal purchases, and federal grants for state and local 
governments.
    Predicting the effects of these fiscal actions on economic activity 
is difficult, especially in light of the unusual economic circumstances 
that we face. For example, households confronted with declining incomes 
and limited access to credit might be expected to spend most of their 
tax cuts; then again, heightened economic uncertainties and the desire 
to increase precautionary saving or pay down debt might reduce 
households' propensity to spend. Likewise, it is difficult to judge how 
quickly funds dedicated to infrastructure needs and other longer-term 
projects will be spent and how large any follow-on effects will be. The 
Congressional Budget Office (CBO) has constructed a range of estimates 
of the effects of the stimulus package on real GDP and employment that 
appropriately reflects these uncertainties. According to the CBO's 
estimates, by the end of 2010, the stimulus package could boost the 
level of real GDP between about 1 percent and a little more than 3 
percent and the level of employment by between roughly 1 million and 
3\1/2\ million jobs.
    The increases in spending and reductions in taxes associated with 
the fiscal package and the financial stabilization program, along with 
the losses in revenues and increases in income-support payments 
associated with the weak economy, will widen the federal budget deficit 
substantially this year. The Administration recently submitted a 
proposed budget that projects the federal deficit to reach about $1.8 
trillion this fiscal year before declining to $1.3 trillion in 2010 and 
roughly $900 billion in 2011. As a consequence of this elevated level 
of borrowing, the ratio of federal debt held by the public to nominal 
GDP is likely to move up from about 40 percent before the onset of the 
financial crisis to about 70 percent in 2011. These developments would 
leave the debt-to-GDP ratio at its highest level since the early 1950s, 
the years following the massive debt buildup during World War II.
    Certainly, our economy and financial markets face extraordinary 
near-term challenges, and strong and timely actions to respond to those 
challenges are necessary and appropriate. Nevertheless, even as we take 
steps to address the recession and threats to financial stability, 
maintaining the confidence of the financial markets requires that we, 
as a nation, begin planning now for the restoration of fiscal balance. 
Prompt attention to questions of fiscal sustainability is particularly 
critical because of the coming budgetary and economic challenges 
associated with the retirement of the baby-boom generation and 
continued increases in medical costs. The recent projections from the 
Social Security and Medicare trustees show that, in the absence of 
programmatic changes, Social Security and Medicare outlays will 
together increase from about 8\1/2\ percent of GDP today to 10 percent 
by 2020 and 12\1/2\ percent by 2030. With the ratio of debt to GDP 
already elevated, we will not be able to continue borrowing 
indefinitely to meet these demands.
    Addressing the country's fiscal problems will require a willingness 
to make difficult choices. In the end, the fundamental decision that 
the Congress, the Administration, and the American people must confront 
is how large a share of the nation's economic resources to devote to 
federal government programs, including entitlement programs. Crucially, 
whatever size of government is chosen, tax rates must ultimately be set 
at a level sufficient to achieve an appropriate balance of spending and 
revenues in the long run. In particular, over the longer term, 
achieving fiscal sustainability--defined, for example, as a situation 
in which the ratios of government debt and interest payments to GDP are 
stable or declining, and tax rates are not so high as to impede 
economic growth--requires that spending and budget deficits be well 
controlled.
    Clearly, the Congress and the Administration face formidable near-
term challenges that must be addressed. But those near-term challenges 
must not be allowed to hinder timely consideration of the steps needed 
to address fiscal imbalances. Unless we demonstrate a strong commitment 
to fiscal sustainability in the longer term, we will have neither 
financial stability nor healthy economic growth.
                      federal reserve transparency
    Let me close today with an update on the Federal Reserve's 
initiatives to enhance the transparency of our credit and liquidity 
programs. As I noted last month in my testimony before the Joint 
Economic Committee, I asked Vice Chairman Kohn to lead a review of our 
disclosure policies, with the goal of increasing the range of 
information that we make available to the public.\1\ That group has 
made significant progress, and we expect to begin publishing soon a 
monthly report on the Fed's balance sheet and lending programs that 
will summarize and discuss recent developments and provide considerable 
new information concerning the number of borrowers at our various 
facilities, the concentration of borrowing, and the collateral pledged. 
In addition, the reports will provide quarterly updates of key elements 
of the Federal Reserve's annual financial statements, including 
information regarding the System Open Market Account portfolio, our 
loan programs, and the special purpose vehicles that are consolidated 
on the balance sheet of the Federal Reserve Bank of New York. We hope 
that this information will be helpful to the Congress and others with 
an interest in the Federal Reserve's actions to address the financial 
crisis and the economic downturn. We will continue to look for 
opportunities to broaden the scope of the information and supporting 
analysis that we provide to the public.
---------------------------------------------------------------------------
    \1\ Ben S. Bernanke (2009), ``The Economic Outlook,'' statement 
before the Joint Economic Committee, U.S. Congress, May 5, 
www.federalreserve.gov/newsevents/testimony/bernanke20090505a.htm.

    Chairman Spratt. Thank you, Mr. Chairman.
    Can we conclude from what you have just said and from what 
you are seeing that the favorable factors in our economy today 
may be glimmers of hope, may be harbingers of an economy that 
is recovering? You have used the words, ``an incipient 
recovery.'' Do you see a recovery unfolding at this point in 
time?
    Mr. Bernanke. Yes, sir, our expectation is that we will 
begin to see growth in the economy, so the end of the technical 
recession, later this year.
    Underlying that prediction is some stabilization in final 
demand, including consumer spending, as well as the importance 
of unwinding the inventory dynamic. Firms have been cutting 
back their production and, therefore, have lowered their stocks 
of unwanted inventories. As that process goes forward, they 
will be able to increase production as they no longer have to 
get rid of those extra inventories.
    So we expect to see some growth, not robust growth but some 
positive growth, later this year. Unfortunately, since the 
growth rate, in the beginning of the process will be lower than 
potential, we expect unemployment to continue to rise into next 
year and to come down only slowly. So we will have a weak labor 
market for some time.
    Chairman Spratt. Without the extraordinary steps that we 
have taken, Fed has taken, the FDIC and the Treasury, without 
TARP and TALF and the Recovery Act, do you think we would be 
where we are, on the doorsteps of an incipient recovery?
    Mr. Bernanke. No, sir, I am quite sure we would not be.
    I recognize that many people have raised concerns about 
various aspects of policies, financial risks that have been 
incurred, for example. And those are real and serious concerns. 
But I do think we need to keep in front of us the fact that 
without the concerted effort of the Federal Reserve, the 
Treasury, and other agencies like the FDIC, supported by the 
Congress and the administration, that last fall we very likely 
would have had a serious and perhaps global financial meltdown, 
with extraordinarily adverse implications for the U.S. and 
global economies.
    I think having averted that and that we now seem to be on a 
process of slow and gradual repair, both of the financial 
system and of the economy, is a major accomplishment. And 
though, again, there are many issues that remain, we must keep 
in front us the fact that we averted, I think, a very, very 
serious calamity.
    Chairman Spratt. In undertaking these countercyclical 
steps, we have advanced large sums of money and taken back, in 
many cases, assets like preferred stock in the major banks 
which were recipients of TARP funds. In addition, the Fed has a 
TALF lending facility for asset-backed securities.
    Can you give us some idea of what you expect in the way of 
recovery or repayment on these assets so that we can, in turn, 
look towards the recovery of some of these moneys to be used to 
pay off the debt that was incurred in advancing these loans in 
the first place?
    Mr. Bernanke. I think that, with respect to the TARP, I 
think our recovery will be excellent. In particular, a number 
of banks are looking to repay TARP, the Federal Reserve will 
announce a list of banks next week that we believe are 
sufficiently sound and are able to lend, that they are eligible 
to repay the TARP, with, of course, interest. And if the 
Treasury accepts that recommendation, then we will see some 
repayment of the initial TARP outlay.
    With respect to the TALF, the Federal Reserve's program for 
asset-backed securities, we have extensive protections, which I 
would be happy to detail if you would give me a few minutes. 
But we are very comfortable that this program is, on the one 
hand, very effective in opening up the markets for consumer 
credit, including auto loans, student loans, small business 
loans, at the same time, I think, that the credit risks, 
especially to the Fed itself, are quite minimal.
    Chairman Spratt. Has the Fed done any work to determine 
what the likely pool of savings available for borrowing may 
be--foreign markets, world markets, global credit markets--and 
to what extent we will have to borrow substantially from those 
savings pools, capital pools, in order to meet our debt 
requirements in the foreseeable future?
    Mr. Bernanke. Yes, we have certainly looked at that. I 
think it is an interesting point. Even though as the Federal 
Government's borrowing has skyrocketed, that the U.S. current 
account deficit, which is essentially a measure of the amount 
of borrowing we do from abroad, is actually lower today than it 
has been in some years, which suggests that the increase in 
Federal borrowing has been substantially offset by a decline in 
private borrowing, as banks and households deleverage.
    So, in a sense of there being an availability, there is an 
availability of credit to meet the needs of the U.S. Government 
and other governments. That being said, as I mentioned in my 
testimony, in order to make lenders willing to continue to 
finance us at reasonable interest rates, we do have to persuade 
them that we are serious about returning to a more balanced 
fiscal situation going forward.
    Chairman Spratt. Mr. Chairman, thank you very much for your 
testimony.
    Mr. Ryan?
    Mr. Ryan. Thank you, Chairman.
    Good to see you again, Mr. Chairman.
    Let's talk about our deficit and debt. The CBO, their re-
estimate of the President's budget shows record deficits of 5.4 
percent of GDP in 2019 and debt rising to 82.4 percent of GDP. 
Meanwhile, Medicare and Social Security will have already begun 
their pathway of permanent deficits.
    Are you concerned about these levels of deficits and debt? 
And is this a sustainable and prudent fiscal policy course?
    Mr. Bernanke. Mr. Ryan, I certainly am concerned about 
that.
    I think we face a double challenge. One is that we have to 
restore ourselves to a more balanced fiscal path after 
addressing the financial and economic crises that we currently 
are facing. But, in addition, that is complicated by the fact 
that with the retirement of the baby boom and the increase in 
medical costs that we are facing rising entitlement costs, 
which--this is no longer a long-term consideration. This is 
something that has got to happen in the next 5 or 10 years. So 
that is extraordinarily challenging.
    My rough rule of thumb to the Congress would be, given that 
we have seen this increase in the debt-to-GDP ratio, that we 
should hope to try to at least stabilize it at the higher level 
and over time to try to reduce it. But certainly we cannot 
allow ourselves to be in a situation where the debt continues 
to rise, that means more and more interest payments, which then 
swell the deficit, which leads to an unsustainable situation. 
So it is very, very important that we----
    Mr. Ryan. So what matters is the trajectory. The path of 
the trajectory is really what kind of matters here in the long 
term; is that right?
    Mr. Bernanke. That is right. The CBO shows alternative 
simulations that involve the debt essentially exploding, which 
it would if it got so high that interest payments became 
unmanageable.
    Mr. Ryan. Let's turn to inflation. Your colleague at the 
Philadelphia Fed, Charles Plosser--and I have spoken to some 
other Fed bank presidents who seem to concur--he recently gave 
a speech in which he said that the economic forecasters rely 
too heavily on measures of the so-called ``output gap'' as a 
predictor of inflation. These forecasters argue that inflation 
will remain low for some time, given the large current output 
gap. He notes that other indicators, more forward-looking 
economic models, suggest a much higher risk of inflation over 
the medium term.
    Are we looking at the right indicators to gauge the risk of 
future inflation? Gold and inflation compensation spreads and 
the Treasury bonds markets are rising. So what indicators are 
you using to measure inflation, and why are they the right 
indicators?
    Mr. Bernanke. Well, Congressman, we look at a whole range 
of indicators, absolutely.
    I do think that when output gaps reach the level that we 
are currently seeing that it is no longer the case that we can 
really debate that the output gap exists. I think there is 
clearly an output gap.
    And the experience is that, in previous recessions, that 
inflation has tended to fall after the recession. That, I 
think, is a reliable empirical regularity. And the size of the 
current output gap will be a drag on inflation.
    Mr. Ryan. So you fall into the output gap camp.
    Mr. Bernanke. Mr. Plosser does, as well. He is simply 
saying we shouldn't put too much weight because it is very 
difficult to measure them. But what I am saying is that, 
currently, there is not much doubt that there is an output gap, 
and that, therefore, there would be a downward effect on 
inflation. That being said, there are other factors as well, 
including the currency, including commodity prices and so on, 
and we watch those very carefully.
    I think I would note that, if you look around for evidence 
of inflation, inflation expectations, you are not going to find 
very much. If you look, for example, at surveys of consumers, 
if you look at the forecast of professional forecasters, if you 
look at the spreads between indexed and nonindexed bonds, all 
of those things are quite consistent with inflation remaining 
stable and well within the bounds that the Federal Reserve 
believes is consistent with price stability.
    Mr. Ryan. Are you concerned that today's models, which 
reflect yesterday's models, are not fast enough to pick up on 
changing expectations? What I mean when I say that is, in the 
21st-century economy, information spreads much faster. Opinions 
are formed much more quickly because data is more available 
than it was, say, in the 20th century.
    Are you concerned that the models we use today do not fully 
reflect the fact that expectations can change a whole lot 
faster than they could in the past, and then we will be too 
late to catch it when it occurs?
    Mr. Bernanke. Well, of course, we always have to keep 
modifying our models and addressing new situations. But we have 
a lot of ways of checking on expectations, including monthly 
surveys of both businesses and households, the daily behavior 
of the TIPS market, the daily behavior of commodity prices, and 
other factors.
    And, in particular, you know, inflation expectations can 
only result in inflation if they actually affect wage and price 
setting. And what we are seeing in the markets is that prices 
of manufactured goods, for example, and wages in nominal terms 
are not showing any signs of a wage-price spiral. To the 
contrary, they are showing quite a slow rate of growth.
    So, first of all, I want to say that in the medium to 
longer term we are very focused on the price stability issue, 
and I understand your concerns about that. But, as best we as 
can tell within the uncertainties of the forecasting, we don't 
see any inflation risk in the near term.
    Mr. Ryan. So when the time comes where you do see that 
concern--my last question is basically this: one about your 
exit strategy and one about the independence of the Federal 
Reserve.
    You have four big policy tools that are being deployed at 
full tilt: targeting zero interest rates; a program of 
quantitative easing; you have a balance sheet around $2 
trillion, $2.1 trillion, some of which has longer-term paper on 
the balance sheet now than before; and you are buying Treasury 
bonds. That is a lot of policy that is out there that you would 
have to unwind very quickly in order to turn the corner.
    What is the exit strategy of the Fed? And what kind of 
confidence do you have that you will be able to wind all this 
down when the moment comes, question number one?
    Question number two is it was inevitable, I would argue, 
that your dealings with the Treasury were unprecedented. You 
had to do a lot in the last year to fight deflation, and I 
think everybody recognizes that. However, that has in some ways 
blurred the distinction of the independence between the 
administration, the executive branch, and the Federal Reserve 
and its unique independent role.
    What do you think of that concern? And what are you doing 
to reassert the independence of the Federal Reserve, not just 
in structure but in the impression of the marketplace?
    Mr. Bernanke. That is a very long question, but I would 
like to address it, if I might.
    First of all, on the technical aspects of unwinding, we are 
confident that we can unwind this process. What we need to be 
able to do is raise short-term interest rates to tighten policy 
in the normal way.
    In order to do that, we have a sequence of things that can 
happen. First, short-term lending, short-term programs can 
either decline because of lack of demand, which we are seeing--
we have seen a very substantial decline in the usage of our 
short-term programs over the last couple of months. Secondly, 
of course, as conditions return to normal we can simply shut 
down those short-term programs. That is step number one.
    Step number two and very important is the interest on 
Reserve's authority that the Congress gave us last year. By 
setting an interest rate on reserves close to our target for 
the short-term interest rate, we make it very unlikely that 
banks would want to lend out in the overnight Federal funds 
market at a rate below that interest rate.
    Mr. Ryan. Is that your biggest tool? Is that the most 
powerful tool you have?
    Mr. Bernanke. That is a very important tool, and many 
central banks around the world effectively use that tool. We 
have additional ones, though, including reverse repurchase 
agreements and, if necessary, sales. But there are a number of 
ways that we can address this problem. So I think, from a 
tactical point of view, we are able to address the current 
level of our balance sheet.
    Politically, there are several points here. First, as you 
point out, I think the American people would want the Federal 
Reserve and other agencies like the FDIC to work closely with 
the Treasury in trying to address these critical financial 
problems, which is what we have done. But we have done so on an 
equal basis, from a perspective of an independent agency. In 
particular, our supervisory decisions have been independent and 
have been made on our own information and our own decisions.
    So we have maintained our independence, even as we have 
collaborated closely with the Treasury, in trying to address 
the financial crisis. In that respect, that is consistent with 
previous financial crises when different agents of the 
government have worked together.
    On monetary policy, independence is, of course, crucial. We 
have not experienced any threats to our independence from 
Congress, the administration, or elsewhere. We have made all 
our decisions of monetary policy on a strictly independent 
basis, and we feel quite confident that we can continue to do 
that going forward.
    We face, as always, the same difficult decision about what 
is the right moment to begin to remove accommodation. You don't 
want to remove accommodation so soon as to prevent the recovery 
from taking hold. On the other hand, you don't want to wait so 
long as to lead to an inflation in the medium term. But that 
decision is the same difficult decision we always face when we 
come to a point to remove a monetary accommodation. And we are 
fully confident that, although that is a difficult decision in 
terms of balancing the risks on both sides, we are fully 
confident from a political independence point of view that we 
are able to make that decision as we need to make it.
    Mr. Ryan. It will clearly occur in an atmosphere of more 
pressure than I think you have seen in the past, given where we 
are right now.
    Thank you.
    Chairman Spratt. Mr. Doggett?
    Mr. Doggett. Thank you, Mr. Chairman.
    And thank you, Mr. Chairman.
    While the $700 billion bailout, which you urged Congress to 
adopt last September, has received continued scrutiny and 
debate, the Federal Reserve is apparently committing about 
three times that amount in public money, much of it through the 
emergency lending powers.
    Certainly, independence and secrecy may be important in the 
Fed's normal operations, but this use of expansive emergency 
powers relying on a vague statutory provision that has not been 
used in about seven decades is certainly not normal. The Fed, 
indeed, seems to have sprung into action through the backdoor 
as a way for some to avoid another request of the Congress for 
public funds through the front door.
    One of the few safeguards that we have in the taxpayer-
financed portion of the bailout is the congressional oversight 
panel. Yet the Fed has not responded to that panel's April 
request for specific information about your continued 
assistance to AIG, even though our oversight panel told you 
that the lack of information, quote, ``has substantially 
hampered oversight.''
    Meanwhile, we have learned that the AIG bailout was also a 
bailout of Goldman Sachs and some of the world's largest 
foreign banks, all of whom were not asked to accept a penny of 
losses.
    I have four questions or question areas for you that are 
all closely related. I will try to state them and then just ask 
you to respond at the end.
    The first one is just directly, when will you have a 
thorough and complete response to every query that the 
oversight panel asked you in April?
    The second is that that same congressional oversight panel 
concluded that a third of the taxpayer moneys that the Treasury 
gave away under TARP was wasted. You have not disclosed 
sufficient details to permit a similar independent analysis of 
what the Fed has been doing to determine what value the Fed is 
getting for its investment of our public money. What meaningful 
assurances can you provide the American people that we are not 
being fleeced again? Have you done a full review of what kind 
of deal the taxpayers are getting? And, if so, will you provide 
the complete documentation for the basis of that assessment?
    Third, while the Fed's secrecy regarding which banks are 
borrowing from its discount window is understandable, the 
situation is far different with your newly discovered emergency 
powers. There is little difference between those you are aiding 
in secret and those the Treasury is aiding in public. How can 
there be effective oversight, any protection, really, for the 
public, when you are not disclosing who the Fed is helping, how 
much they are getting, and on what terms? And I am not talking 
about just adding a table to your Web site or a summary report 
on a monthly basis. My question is, when will you be able to 
provide the identity of participants, transactions implemented, 
profits or losses posted from specific transactions to the 
oversight panel, the Fed inspector general, the GAO and this 
Congress?
    And, finally, relying upon the Federal Reserve instead of 
the Treasury for bailouts can also mask the true cost to the 
public in terms of our soaring national debt. Any losses on 
assets on loans through these riskier, abnormal emergency power 
activities could result in the Fed, of course, remitting less 
money to the Treasury. Have you undertaken a comprehensive 
analysis of the risk to the taxpayer from the assets that you 
are requiring in the loans that you are making? I am not 
referring to a conclusive statement that everything is fine, 
but if you have done such an analysis, can you provide it to us 
this month?
    Mr. Bernanke. Congressman, on the oversight panel request, 
I am sure we will respond to that. I am not aware of the status 
of that request.
    I would just note that the Senate--I think the Congress 
passed a rule recently that would allow the GAO to directly 
audit AIG and other individual banks or other interventions, 
and we are perfectly comfortable with that. We have provided 
extensive information to the Congress on AIG in those other 
rescues, including monthly reports required by Congress on all 
13(3) lending. So we have been quite open about it. If there 
are specific issues, I would be----
    Mr. Doggett. Well, how about the specific issues on the 
specifics? Who gets the money? What are the terms? What are 
the----
    Mr. Bernanke. On what program?
    Mr. Doggett. On any programs under your emergency powers, 
where you rely on emergency powers. Certainly on the 
approximately trillion dollars that you say you will be doing 
in mortgage-backed securities.
    Mr. Bernanke. Well, mortgage-backed securities, so if you 
look at our balance sheet, the bulk of it is in two things: 
short-term lending to financial institutions, which goes up to 
a trillion, is now down to about $600 billion, $700 billion 
because of payback, basically--the naming of those institutions 
relates to the concern that you mentioned earlier, which is 
that if you name the institutions they will not be willing to 
take the liquidity backstop, which is necessary for stabilizing 
financial markets.
    But I would like to point out that your concern was about 
credit risk. These are extremely safe, short-term loans, well-
collateralized, with recourse, and with supervisory oversight. 
To my knowledge, we have never lost a penny. We have actually 
made money on those loans. So that is a big part of it.
    The other big part of our balance sheet is securities, 
which are Treasuries, GSE, the debt and mortgage-backed 
securities. Those are standard securities that are guaranteed 
by the U.S. Government. There is no loss to the Fed from that. 
And there is nothing to be disclosed about that, other than the 
fact that they are just conventional securities.
    So those are the two biggest components of our balance 
sheet. Then, of course, there is about $100 billion, about 5 
percent of our balance sheet is dedicated to the Bear Stearns 
and AIG rescues. As I said, those things are now open to audit 
by the GAO, and we will cooperate in every way and provide 
whatever information is needed on that.
    So I would urge you to look at our new monthly report that 
we will issue very shortly. And we will respond to the 
congressional oversight panel, and I hope we can meet your----
    Mr. Doggett. But you have declined to provide any of the 
specific details?
    Mr. Bernanke. You will have to be more specific about what 
you need. I think, in the case of the short-term financial 
liquidity provision, I think there are good policy reasons not 
to provide that. But we have provided extensive information 
about the programs, about the collateral we accept, about the 
number of borrowers. And in cases where TARP money is 
concerned, we will provide all the information that SIGTARP 
would want or anyone else that needs to have an enforcement 
authority.
    Chairman Spratt. Mr. Hensarling?
    Mr. Hensarling. Thank you, Mr. Chairman.
    Welcome, Chairman Bernanke.
    If the staff could put up chart 10, please.
    Mr. Chairman, as you well know, we are looking at an 
explosion of debt over the next 10 years. Now, presently, our 
Federal debt is at 41 percent of GDP. I know this is well-known 
to you. CBO says that it will increase to 82 percent of GDP in 
10 years.
    In your testimony, you speak of the need to have prompt 
attention to questions of fiscal sustainability in order to 
maintain the confidence in our financial markets. So, 
certainly, the case has been made for short-term Federal 
intervention in our marketplace. I believe that in testimony by 
the head of CBO their estimate is that we will reach positive 
GDP growth in the third quarter of this year and that 
unemployment will level off, I believe, I think, the second 
quarter of next year. OMB had a rosier scenario. And today, in 
your testimony, you speak of an incipient recovery, and I 
believe you said economic activity should turn up later this 
year.
    So my question is, if OMB, CBO, and the Federal Reserve are 
predicting positive GDP growth, an upturn in economic activity 
somewhere in the next 6 to 18 months, we have concerns about 
the fiscal sustainability of these levels of debt. Having our 
debt go from 41 percent of GDP to 82 percent of GDP in 10 
years, tripling the national debt in 10 years, does this meet 
your definition of prompt attention to questions of fiscal 
sustainability?
    Mr. Bernanke. Well, Congressman, I am not sure whose CBO 
projection, I guess, that is. I would say that that picture is 
concerning not only because of the level but because of the 
fact that it continues to rise. Sustainability means--there are 
countries that have 80 percent or 100 percent debt-to-GDP 
ratios. I am not recommending that. But, clearly, you can't 
have a debt-to-GDP ratio which continues to rise indefinitely.
    So it is very important that we have now or very soon a 
plan to stabilize, at least, the debt-to-GDP ratio so that it 
doesn't go into a continued increase, which, because of 
interest payments, would make sort of a vicious circle going 
forward.
    Mr. Hensarling. I have seen one analysis that, clearly, to 
keep the debt at today's level, 41 percent of GDP, that either, 
number one, you are going to have to monetize the debt and 
essentially inflate the money supply 100 percent, or that tax 
increases across the board in the neighborhood of 60 percent 
would be necessary to balance the budget in 10 years.
    Has the Federal Reserve done its own calculations? Does 
this seem to be an accurate analysis?
    Mr. Bernanke. We haven't done that particular analysis. I 
don't think it is realistic to get back to 41 percent that 
quickly.
    Mr. Hensarling. Which means perhaps some level of tax 
increase, spending decrease, or inflating the money supply is 
going to be necessary?
    Mr. Bernanke. Relative to that CBO baseline, I mean, it is 
evident that either cuts in spending or increases in taxes will 
be necessary to stabilize the fiscal position.
    Mr. Hensarling. Will the Federal Reserve monetize this 
debt?
    Mr. Bernanke. The Federal Reserve will not monetize the 
debt. And I think it is important to point out that, 
notwithstanding our purchases of Treasuries as part of a 
program to strengthen private credit markets, even when we 
complete the $300 billion purchase that we have committed to, 
we will still hold less Treasuries, a smaller volume of 
Treasuries than we had before the crisis began.
    Mr. Hensarling. If the Fed will not monetize the debt and 
if the Congress refuses to deal with the spending curve, which 
will average about 23 percent of GDP for the next 10 years, 
that is either going to leave us with a massive tax increase or 
massive borrowing. But yet, apparently, as we send 
representatives to China to encourage them to continue to buy 
our debt, they are shifting to commodities; they are indicating 
concerns about the level of our debt. Recently, as I believe 
you know, S&P downgraded UK's debt on May 21st from stable to 
negative.
    So what is going to happen if the U.S. loses its AAA 
rating, or what happens if we have a 60 percent tax increase 
over the next 10 years to deal with this massive infusion of 
debt?
    Mr. Bernanke. At some point, you have to have a path of 
spending and taxes that will give you a stabilization of the 
debt-to-GDP ratio. If you don't, then fear that the debt will 
continue to rise will make it very difficult to finance it. 
And, at some point, you will hit a point where you will have to 
have both very Draconian cuts and very large tax increases, 
which is not something we want.
    So, in order to avoid that outcome down the road, we need 
to begin now to plan how we are going to get the fiscal 
situation into a better balance in the medium term.
    Mr. Hensarling. Thank you.
    Chairman Spratt. Mr. Scott of Virginia?
    Mr. Scott. Thank you, Mr. Chairman.
    The gentleman from Texas just showed a chart that showed 
how bad things have happened since 2000. What he didn't show is 
how we got there. This chart shows that when the Clinton 
administration came into office we made some tough choices and 
ran up a surplus that was to be surpluses, as far as the eye 
could see, kind of locked into the budget. In 2001, that is 
when the budget deficit exploded.
    The next chart shows the fact that, had nothing happened 
after 2001, we had a $5.6 trillion 10-year surplus. Because, as 
the gentleman from Texas has shown, that has gone into 
additional deficit. In fact, his chart, if you will think back 
to the chart that he showed, only showed less than a $4 
trillion debt held by the public. We had enough continuous 
surplus to pay off the entire national debt. In fact, it was 
projected to have been paid off by last year, all of the debt 
held by the public, if we hadn't messed up the budget.
    So I think the entire budget process should be shown, not 
just what happened starting in 2001. We had things under 
control; we were able to pay off the entire national debt. But 
the wrong choices were made in 2001, and we went directly into 
the ditch.
    One of the first things we have to do, of course, is to get 
the economy back in order. And I noticed, on page 6 of your 
testimony, you showed that the stimulus package may only create 
1 million to 3.5 million jobs. Is that correct?
    Mr. Bernanke. That is the CBO estimate.
    Mr. Scott. Now, what parts of the stimulus were more 
effective in creating jobs than others?
    Mr. Bernanke. I think, dollar for dollar, the 
infrastructure spending, the direct government spending is 
probably most effective--although it takes a longer period of 
time. The increased transfer payments and tax cuts work more 
quickly, but, because part of them are saved, the impact might 
be somewhat smaller.
    Mr. Scott. You mentioned the TARP funding. Can you tell me 
the effect--if the banks wanted to pay back the TARP funds, 
what effect would cashing in the warrants have on the cost of 
paying back?
    Mr. Bernanke. So, besides paying back the preferred shares, 
as you know, there are warrants also, which give the public 
some upside on the stock values of the companies.
    The Treasury is trying to determine, you know, how to price 
those warrants and how to go forward with that. There is a bit 
of a complication, as I understand it, because in the law the 
banks have the right of first refusal in terms of purchasing 
those warrants before the warrants can be auctioned in a public 
market. So that requires some analysis of the value of the 
warrants, which I understand Treasury is undertaking.
    So I assume that----
    Mr. Scott. Will we necessarily cash in? Because some have 
complained that the cost of the warrants would make the cost of 
the loan actually excessive.
    Mr. Bernanke. Well, the point of the warrants was that if 
things turned around and got better, that the public would 
share in some of that gain. I would say that TARP has been 
pretty successful in terms of stabilizing the banks and helping 
to get them back on their feet and get our banking system back 
on its feet. And stock prices, although they are still 
relatively low on an historical basis, have done a lot better 
lately, and some of that gain should go to the public.
    Mr. Scott. Some banks have also complained that the 
additional FDIC fees will reduce their lending capacity and, 
therefore, have an adverse effect on the economy.
    Do you have a comment on that?
    Mr. Bernanke. Do you mean the assets for the Deposit 
Insurance Fund?
    Mr. Scott. Yes.
    Mr. Bernanke. That is a concern because, given the losses 
to the banking system, if those losses were made up very 
quickly, it would be a fairly heavy tax on banks, including 
community banks. And for that reason, my understanding is the 
FDIC is trying to arrange to spread that assessment over a 
longer period of time, which would be, I think, desirable in 
the sense that this is not a time to be putting sort of a tax, 
essentially, on the banking system when we need them to be 
making loans.
    Mr. Scott. Because that would convert directly into reduced 
lending capacity?
    Mr. Bernanke. To the extent that it reduces capital, that 
is correct.
    Mr. Scott. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman. Thank you, Dr. 
Bernanke.
    If I look at the bills we have had here on the floor over 
the last couple of weeks we were in session and this week, 
virtually everything we are doing either authorizes or 
appropriates more money--spending--even, in many cases, than 
what is anticipated in the charts that we have talked about 
today.
    What are the economic consequences of continuing that sort 
of trend?
    Mr. Bernanke. Well, Congressman, as I have indicated, we, 
as a country, are going to have to make some hard choices. We 
can't expect to continue to borrow--certainly not 12 percent of 
GDP, but not even 4 or 5 percent of GDP--indefinitely, and so 
we need to make a plan, some decisions about how we are going 
to bring the budget closer to balance over the medium term. And 
that means that as you discuss various programs that include 
spending, you need to think about the revenue resources that 
would be related to that. If you don't do that, then again you 
will see interest rates rise, and you will see reluctance of 
lenders to provide credit to the U.S. Government. That would be 
a very bad outcome. And I believe there is a great deal of 
confidence in the markets that the U.S. Government will take 
the necessary steps to restore fiscal discipline, but it is 
essential that this body, and Congress in general, do that hard 
work and get that done.
    Mr. Campbell. Chancellor Merkel of Germany yesterday was 
very critical of central banks worldwide, but specifically of 
the Fed. Would you like to make any comment? I presume you have 
read what she said. Would you like to make any comments 
relative to her comments?
    Mr. Bernanke. Only that I respectfully disagree with her 
views. The U.S. and global economies, including Germany, have 
faced an extraordinary combination of a financial crisis unlike 
any seen since the Great Depression, plus a very serious 
downturn. And in that context, I think strong action on both 
the fiscal and monetary sides is justified to try to avoid an 
even more severe outcome.
    I am comfortable with the policy actions that the Federal 
Reserve is taking. And as I have described to Mr. Hensarling 
and Mr. Ryan, we are comfortable that we can exit from those 
policies at the appropriate time without inflationary 
consequences, and therefore we are comfortable with our policy 
position.
    Mr. Campbell. Are the current powers of the Fed, in your 
estimation, inadequate, excessive, or adequate?
    Mr. Bernanke. Well, I think there are some changes that are 
worth making. And I would mention specifically, I was asked a 
question a moment ago about AIG, for example. It was with 
great, great reluctance the Federal Reserve got involved in 
that kind of situation, there being no good alternative to 
avoid a collapse of a major financial firm and the consequences 
that would have for the financial system and for the economy.
    As I have said a number of times for at least a year, I 
think a very critical step that the Congress needs to take is 
to develop a resolution regime that would allow the 
government--not the Fed, but the government to step in when a 
major financial firm is near default and the financial system 
is in crisis. That would be parallel to what we already do now 
for banks through the fiduciary system.
    If we could have such a system in place, then the Fed would 
no longer be in the ``Hobson's choice'' of either standing 
aside and letting the system collapse or taking these actions 
using a 13(3) authority, which are very, very uncomfortable for 
us. So that would be an area where we would be happy to 
withdraw or pull back on our activity if the government would 
provide a good system for addressing that issue.
    Mr. Campbell. We discussed a little bit the Treasury bill 
rates, and specifically the 10-year Treasury, which according 
to my thing right now is 3.58 percent yield. Most adjustable-
rate mortgages reset on the 10-year Treasury number. If that 
10-year Treasury yield were to increase some more this year, 
what impacts might that have on potential second-wave and 
mortgage-backed security failures or ARM resets?
    Mr. Bernanke. I would like to check the data on that, but 
my impression is that most ARMs actually reset on shorter term 
interest rates, like the LIBOR rate, which is very, very low 
right now, or the Treasury bill rate.
    Since the Federal Reserve brought interest rates down to 
such a low level in the last year or so, concerns about resets 
in the mortgage market have considerably been reduced. There 
certainly are very serious concerns about affordability and 
about principal mortgages being underwater because of principal 
declines, but the interest rate reset problem on ARMs has been 
considerably moderated by the low level of short-term interest 
rates.
    Mr. Campbell. Last quick question. TARP money was 
originally intended to stabilize the markets, but also to give 
banks capital from which to do more lending. As they want to 
give it back in order to avoid the restrictions being placed on 
them, isn't that, in effect, going to reverse part of the 
original intent, which was to provide them more capital from 
which to lend, and therefore reduce potential lending in the 
marketplace?
    Thank you.
    Mr. Bernanke. Yes, that was part of the original intent. 
Unfortunately, because of the restrictions and other reasons, 
including just bad publicity, many banks want to repay the 
TARP. So it won't be able to serve that function. On the other 
hand, after the stress test and our supervisory reviews, many 
banks are raising private equity, which will I think be a more 
permanent form of capital, a higher quality form of capital in 
which they will be more willing to base their lending strategy.
    Chairman Spratt. Mr. Bishop.
    Mr. Bishop. Thank you, Mr. Chairman. And Mr. Chairman, 
thank you for your testimony.
    I have just two questions. Earlier--I think I am accurately 
paraphrasing your testimony--you indicated that in your opinion 
both the TARP funding and the stimulus legislation averted a 
tragedy. Is that essentially correct?
    Mr. Bernanke. That is right.
    Mr. Bishop. And in response to questions from Mr. Scott, 
you indicated that you thought direct government spending was 
the most effective means by which we would either stabilize 
jobs or create jobs?
    Mr. Bernanke. Well, I think it is important to have a mix, 
but in terms of immediate impact on the economy, government 
spending doesn't have the issue that tax cuts do, which is part 
of it may be saved. But that being said, I think a good mix is 
useful.
    Mr. Bishop. The stimulus package that was passed had round 
numbers, $500 billion worth of spending, $300 billion worth of 
tax cuts. Those are round numbers. When that legislation was on 
the floor, the Republican alternative offered was a package of 
essentially $500 billion worth of tax cuts.
    Can you estimate what the impact would have been had we 
passed simply a $500 billion package worth of tax cuts as 
opposed to some stimulative spending?
    Mr. Bernanke. No. I really am not able to do that on the 
fly. But in any case, I am sure that part of the motivation for 
the tax cuts was the incentive effects of tax cuts as well as 
the direct spending effects. So that would have to be factored 
into some comparison. But I would prefer not to get into that 
detailed level.
    Mr. Bishop. Understood.
    One of the policy issues before us over the next several 
months will be to deal with the President's recommendations 
with respect to higher education policy. One of his 
recommendations is to move away from what is referred to as 
FFEL lending to 100 percent direct lending, monies provided by 
the Treasury. There are arguments for doing that, and there are 
arguments that would suggest we should not do that. One of the 
arguments raised that suggest that we should not do it is that 
the increased borrowing would be detrimental to our both short 
and long-term fiscal stability.
    What is your assessment of that argument?
    Mr. Bernanke. I don't think that is a very strong argument 
because you are either directly making the loans or you are 
guaranteeing the loans. And as far as the potential loss to the 
Treasury is concerned, the guarantee is the same, essentially, 
as making the loan. So it is really an accounting difference, 
not a real economic difference.
    I think there are a lot of other issues that you point out. 
There are arguments on both sides for using a private lender 
who may be better at making the loans or may not be versus 
having the direct lending. I would just point out that if you 
were to continue using the private lenders, one of the problems 
that emerged last year was a mismatch between the interest rate 
they were allowed to charge and the interest rate in which 
their cost of funding was determined. So there were some 
technical issues that would have made that situation better. 
But again, that fundamental question of private versus public, 
a lot of issues there.
    Mr. Bishop. Thank you.
    Mr. Chairman, thank you. I yield back the balance of my 
time.
    Chairman Spratt. Mr. Latta.
    Mr. Latta. Chairman, thank you very much for being with us.
    Mr. Chairman, over Easter, I was in Latta, South Carolina. 
We were driving down that way. And I had to take a picture with 
my kids by the sign there of the corporation so they could say 
they were there.
    But thank you very much for being with us. And to give you 
a little background about where I am from, I am from the Fifth 
Congressional District. My district is the largest 
manufacturing district in Ohio. It is also the number one 
agriculture district in the State of Ohio. I butt up against 
Indiana on my west, Michigan on my north. So just kind of 
giving you a picture right there, we are in tough times.
    I have the highest unemployment rate of the counties in the 
State of Ohio, one over 16 percent now. And as we have been on 
our break, I have criss-crossed my district during that time, 
and also when I am at home every weekend, going through 
factories and talking to businesses across the region and also 
the people that work there. And I am finding folks who are out 
there in the business sector, especially in these factories, 
they can't shed any more jobs. If they shed any more jobs, they 
are not going to be operating. So a lot of them are just 
hanging on by their fingernails right now. And there have been 
pay cuts that people have taken. They have reduced the number 
of hours that they are working per week. So it is a very, very 
tough time.
    And when we have been doing this, going out and across the 
district, one of the things I would just like to ask is, in 
your testimony, on page one, you are saying that consumer 
spending has been relatively flat and consumer sentiment has 
improved, but you also say in the coming months household 
spending power will be boosted by the fiscal stimulus program. 
I was at another town hall last night, and folks were telling 
me what they are doing and were not buying. But what in the 
fiscal stimulus package out there is going to help the Fifth 
Congressional District in the next few months in our area?
    Mr. Bernanke. Well, in reference to my specific comment 
about boosting household income, the ``make work pay'' tax cuts 
and the UI insurance and other transfer payments, Social 
Security, veterans payment will of course go to your 
constituents like anyone else in the country. So they will get 
extra income. As I mentioned also in my testimony, how much of 
that they will spend and how much they will use to pay down 
debt or to squirrel away is an open question. But we saw 
already just this week, we have seen an increase in personal 
income, and a lot of that is coming from government support.
    Mr. Latta. I guess the next question, we were talking about 
income and things like that, and also jobs. You quoted a little 
bit earlier the CBO. By the end of 2010, CBO said there would 
be about a 1 to 3 percent increase, or 1 to 3.5 million jobs 
being created. Are we talking about private sector jobs, or are 
we talking about government jobs?
    Years back I was a county commissioner. Back in the 1991-
1992 recession we had other elected officials come before us 
and they said we can get this government money. And we always 
asked them the same question, how long is that job going to 
last? Because after that 1 year or 18 months is over, we are 
not going to fund it because we didn't have the money in the 
accounting budget.
    So when we are looking at that CBO, which you mentioned, 
are we talking private sector jobs being created or federally 
created jobs that might just last a short period of time?
    Mr. Bernanke. Well, it depends a bit on the baseline that 
you are comparing it against. But I think it is fair to say 
that the preponderance of the jobs will be private sector jobs. 
And they would be permanent if the economy has, by the end of 
this period, come closer to a better employment situation so 
that we are closer to a more normal labor market situation. So 
in that respect you are putting people to work 2 years earlier 
than they otherwise would have been put back to work. And that 
is the sense in which employment is being created.
    Mr. Latta. I guess real quickly, when you say more of a 
normal situation, the situation that we are in right now, would 
you consider that normal for the time? Or are we looking at a 
longer period of time that these jobs are going to have to be 
created over, especially getting back to work in the private 
sector?
    Mr. Bernanke. Well, the stimulus program, roughly speaking, 
only puts out a quarter of the money in 2009, half the money in 
2010, and a quarter of the money even beyond that. So if it 
takes several years for unemployment rates to come back down to 
sort of more normal levels, the fiscal program will be having 
some effect over that 2-to-3-year window.
    Mr. Latta. Thank you.
    Thank you, Mr. Chairman. I yield back.
    Chairman Spratt. Mr. Etheridge.
    Mr. Etheridge. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for being here this morning at this 
critical time.
    Along with Congress and the Treasury Department, the 
Federal Reserve is taking action to try and ensure the health 
of the credit markets, and you have talked about that a little 
bit already, and we thank you for that. As you have said, it is 
one of the toughest downturns we have seen in the financial 
sector since the Great Depression.
    Let me ask two questions. You have touched on this some. 
You touched a little bit on the sectors improving, but let me 
go back to that on the credit markets. Which ones are 
improving? What are the areas that are still lacking that need 
attention to improve? And specifically, I am thinking about how 
long will it take for additional credit to be available for 
consumers and small businesses.
    Because I was home this past week, and I talked to a lot of 
folks. They are still tight in the business sector. Car dealers 
are having a difficult time in a lot of places getting people 
qualified to buy the vehicle that actually is available, and 
they want to buy, and actually have pretty good credit. So I 
would be interested in your thoughts on that. Are there other 
things Treasury or the Federal Reserve needs to do or some 
things that we need to do here? Because there are people that 
are still hurting, and I think it is bleeding over into the 
farm sector as well in some areas. I would be interested in 
your thoughts on that.
    Mr. Bernanke. Certainly. There has been a pretty widespread 
improvement in financial markets; credit spreads are down 
through most types of credit markets, activity is up. This is 
true both in the short-term money markets, and it is also true 
in the longer-term corporate markets.
    As you point out, an area which is still quite tough is 
consumer lending and small business lending. And that is true 
for a couple of reasons. And the Fed is trying to address both 
of them. It is true, first of all, because consumers and small 
businesses rely very heavily on banks. And banks have not only 
had their capital reduced by losses, but they have become more 
reluctant to extend credit to these customers either because 
they are worried about losses or because they are worried about 
their own financial positions.
    In this respect, we have heard complaints that bank 
examiners from the Fed and other agencies are too prone to 
prevent banks from making loans in the interest of safety and 
soundness. We had a joint statement, the Federal Reserve and 
the other banking agencies, last fall making the point that 
making loans to creditworthy borrowers, maintaining credit 
relationships is profitable for banks and therefore good for 
banks. And that in addressing whether or not certain types of 
loans should be made, the examiner should balance the need for 
conservatism in a difficult situation and the need to allow 
creditworthy borrowers to receive credit.
    Mr. Etheridge. Mr. Chairman, I don't want to interrupt you, 
but it may be time to send that note back out again.
    Mr. Bernanke. Well, it is very, very difficult to get that 
message from the very top down to the examiners. We have been 
having workshops and so on. We will continue to try to get that 
message out.
    The second reason for the problems is that banks, after 
they make these loans, have traditionally wanted to securitize 
them in the secondary market; those markets have not been 
functioning. Our TALF program has brought those spreads down, 
has increased activity. For example, in auto loans, we have 
seen some better availability and lower rates. So as we 
continue in that area, we expect that will help.
    You asked me where there are still problems. One area I 
would mention besides small business and consumer lending is 
commercial mortgage-backed securities, commercial real estate. 
That is an area where we are also going to try to address that. 
But currently, getting refinancing for existing commercial 
projects is very, very difficult.
    Mr. Etheridge. Thank you. Let me just say, as a student 
of--not only a student, probably, but a world-renowned 
specialist in the Great Depression, what are your thoughts on 
avoiding these kinds of economic crises in the future? And are 
there lessons the Fed has learned from its role in the banking 
supervision that we have gone through so far that we, as a 
body, might pay attention to and help with?
    Mr. Bernanke. Sir, in dealing with a situation like this, 
there is the immediate emergency response and then there is the 
longer-term actions you want to take.
    On the emergency response, the two lessons I learned from 
studying the Great Depression are, first, that monetary policy 
has to respond aggressively. The Fed did not respond in the 
early thirties, and we, of course, have done that. The second 
is that maintaining financial stability is absolutely critical. 
And as you know, we have taken a number of measures--some of 
them quite extraordinary--working with the Treasury to prevent 
a meltdown in the financial system. And I believe that we have 
averted a much worse outcome by taking those steps.
    Going forward, we certainly want to avoid this kind of 
crisis happening in the future. We have learned a lot of 
lessons from the recent experience. I think we will have to 
have stronger oversight of the large firms, maybe higher 
capital. We need to have resolution regimes, as I mentioned 
earlier, to help resolve failing firms. And I believe we need 
to strengthen the financial infrastructure. But I would also 
say that I think we do need to take a more system-wide approach 
to regulation. Instead of looking only at individual firms 
where agency A is responsible for firm one and agency B is 
responsible for firm two, that there needs to be a more 
collaborative approach that looks at the whole system and make 
sure they aren't building risks in one area that are being 
ignored because they don't bear on a particular firm. So I 
think a more macro-prudential or system-wide approach would be 
helpful.
    Mr. Etheridge. Thank you, sir. Thank you, Mr. Chairman. I 
yield back.
    Chairman Spratt. Mr. Garrett.
    Mr. Garrett. Thank you, Mr. Chairman.
    Chairman Bernanke, the other hat I wear is in Financial 
Services. And when you come over there, the issue that is often 
discussed is the term ``the system risk,'' the systemic risk 
regulator. And as you know, of all the hearings that we have 
had, no one has really yet defined exactly what it is, what 
authority they will have, what they will regulate, so on and so 
forth.
    But one thing out of both of these committees that I serve 
on seems to be pretty emphatic--and I will be taking a page out 
of Paul Ryan's comments here--and that is that one thing that 
is a systemic risk is the unfunded debt that is out there, as 
Paul was alluding to before. For this country, it is up to 
$56.4 trillion, and the numbers vary on that.
    Interestingly enough, we have had expert after expert for 
the last 6 years come before the committee. They all say the 
same thing, and we hear it from both sides of the aisle. But in 
the budget that we got this year, unfortunately it really isn't 
addressed. Obviously, we spend more. The numbers you already 
said before. We are looking at the national debt would double 
in just 10 years, pushing the debt north of 100 percent of GDP. 
And interestingly, on those numbers--maybe somebody else 
referenced this--is what has happened over in the United 
Kingdom with S&P's downgrading them, going from stable to 
negative. And their situation, in some perspective, one 
economist is saying not quite as bad as where we are, and where 
our trajectory is, that we are going to be worse than them.
    So your comment already is, I think, that this is probably 
the looming largest issue that we need to address?
    Mr. Bernanke. I would say that is right.
    Mr. Garrett. And I wonder, everything else we do besides 
that is almost that, besides the point; is that a correct----
    Mr. Bernanke. I wouldn't go that far, but there are many 
other issues we face.
    And I want to say that you have had a lot of experts. And 
it is easy for us to sit at this table and tell you that you 
have to solve this problem, and it is a very hard problem to 
solve. But it is critical that we address that.
    Mr. Garrett. All right. So I over-strayed by saying it is 
besides the point, but the other aspect is trying to get our 
overall budget in order and trying to get those numbers down.
    Now, Secretary Geithner was over in China just this past 
week and he made a statement to their concerns about where we 
are on our spending. He said, well, don't worry, we are going 
to try to rein things in. And the reports I read was the 
response from the Chinese was just laughter to that. I guess 
they just don't believe it. About a month ago, I think it was, 
our President said that he was going to start tackling it. And 
the way he said he is going to start tackling it is he is going 
to save $100 million. Where would you put that $100 million 
savings in the whole scheme of things; significant, large, 
major, or just totally irrelevant to the entire picture that we 
are dealing with as far as our unfunded liabilities and our 
budget as well?
    Mr. Bernanke. Well, $100 million obviously by itself is not 
a very big amount of money relative to these problems. I think 
the important issue is the commitment that the administration 
and Congress have both talked about and need to put into play.
    Mr. Garrett. But do you see any commitment from the 
administration based upon the $100 million so far or from the 
budget that has been presented so far?
    Mr. Bernanke. A lot of the budget that was presented was 
placeholders and broad plans and themes. I think the proof will 
be in the pudding, as they say, how Congress and the 
administration actually begin to implement health care reform 
or climate change policy. Those details about how the spending 
and revenues will be matched will be the critical issue.
    Mr. Garrett. Well, regardless of how we spend them, let's 
assume for the moment that we spend them on all the best things 
in the world, the deficit numbers don't change and the debt 
numbers don't change. We are still going to spend that $634 
billion, whether it is on health care or something else, we are 
still going to spend this money on something, so the bottom-
line numbers don't change.
    Mr. Bernanke. Well, my understanding was that $634 billion 
placeholder came with some prospective revenue offsets from the 
carbon permits and from upper-class tax increases. Mr. Ryan 
says no.
    Mr. Garrett. I will yield to him.
    Mr. Ryan. Half from Medicare cuts and half from the upper 
tax increase.
    Mr. Bernanke. Well, prospectively, there was a match there. 
But as I say, this is all about execution, and that is the key 
issue.
    Mr. Garrett. When the CBO was here I guess about 2 weeks 
ago, one of the questions that I referenced to you as well, 
being a historian on this, was during the Great Depression--and 
I am not saying this is a depression--is that you actually say 
two depressions, one before Roosevelt and then one afterwards. 
With regard to the recession that we are in, is there the 
possibility that we will see what we are in right now, and that 
if the stimulus--and their description of the stimulus, my 
words, not theirs, was it started out small and will peter out 
altogether next year--if it doesn't have the impact that they 
suggest, that we will see that second bottom of a W then in 
next year's economy?
    Mr. Bernanke. It is very difficult to forecast that far in 
advance. If the fiscal program is not effective, then of course 
that would be a negative going forward.
    Mr. Garrett. They said that next year is going to have 
minimal impact, that basically you saw the impact now on the 
tax side of the question and basically it was of minimal impact 
as of next year. So if the stimulus is not having the impact, 
then what would?
    Mr. Bernanke. My understanding again is that about half of 
the effect will be in 2010, is my understanding of the timing 
of the stimulus package. But there are other factors at work as 
well. I mean, as confidence returns, private sector activity 
ought to increase, low-interest rates will stimulate demand. 
The rest of the world is strengthening. There are a lot of 
other factors that would provide support for growth outside the 
fiscal package.
    That being said, again, there are a lot of issues to be 
resolved, such as excessive leverage, for example, that are 
likely to be headwinds as the economy tries to get back to a 
sustainable growth path.
    Chairman Spratt. Ms. Schwartz.
    Ms. Schwartz. Thank you, Mr. Chairman.
    And Mr. Chairman, thank you for your testimony and for your 
comments, both about the reality of the situation fiscally and 
economically, but also going forward.
    I wanted to ask two questions, if I may, that really relate 
more to households and some of the things that we hear about in 
our districts. And I think Mr. Latta alluded to it on the issue 
of unemployment as one that is very significant more so in his 
district than maybe even mine in the Philadelphia area. 
Fortunately, while not great, it is still in the 10 percent, 9 
percent. It is not what we want it to be, but it is not as hard 
hit as other regions of the country.
    With that said, when I hear and when my constituents hear 
that we are seeing maybe some stabilization, maybe some signs 
of growth that are positive, we still do keep hearing that the 
unemployment rates are going to continue to be high and not 
recover--you said so yourself in the testimony. Could you 
elaborate in any way, both on the expectations about 
unemployment, but maybe more so what more we can do about it? 
Some of these are projections based on previous recessions, 
previous actions. We don't know that there won't be some 
changes because we are taking different actions and you are as 
well.
    Could you speak briefly just about whether there are 
additional actions or whether we can actually have more hope 
that we will see an increase in employment so that families in 
our district, businesses in our district are really starting to 
see that personal recovery?
    Mr. Bernanke. Well, the historical experience is that the 
labor market tends to lag the business cycle. So even as the 
economy begins to recover, unemployment can still remain high. 
In particular, if growth is relatively slow, it won't be fast 
enough to absorb workers coming into the labor force.
    Ms. Schwartz. So one of the last decisions businesses make 
is new employees and a commitment to new employees.
    Mr. Bernanke. That is right. So this is a very serious 
problem. Because besides the very important fact that people 
without jobs have difficulty meeting their house payments and 
other bills, people who are out of the labor force for a few 
years tend to lose their skills, tend to lose their connection 
to the labor force, and maybe when the economy recovers they 
may not even be employable. It is possible. So there are a lot 
of costs involved in this.
    And if I had an easy answer, I would give it to you. All I 
can say is that, as you know, the Federal Reserve has been very 
aggressive in trying to support the economy, and the Congress 
has been as well. We might look at trying to help people retain 
their skills through educational programs or other kinds of 
training programs.
    Ms. Schwartz. So maybe while people are on unemployment, we 
might want to actually get them into other kinds of job 
training or education?
    Mr. Bernanke. At least it is an opportunity, if you are 
unemployed, to fine-tune your skills and perhaps be prepared 
when jobs begin to open up.
    Ms. Schwartz. And maybe look at future jobs; jobs that 
might be opening up, what kind of industries are growing, 
looking at what is next.
    Mr. Bernanke. It is the strength of our country and our 
economy that we have, in our technical schools and junior 
colleges and all kinds of other formats, we have a lot of 
ability for people to retool even in mid-life.
    Ms. Schwartz. Maybe something we should do, I know we did 
under TAA, Trade Adjustment Assistance, I added some provision 
that said that you would be eligible for job training and 
education benefits if your industry was certified as one of 
those industries affected by international trade, even if your 
own company and your own facility hadn't closed yet, with the 
notion that why not get people new skills and the ability to 
move on. Maybe that is something we ought to look at as we are 
dealing with a great many people who are unemployed who are 
going to need some additional skills. It is a good point. Maybe 
that is something we can work on.
    Just very briefly, because I only have a minute, we have 
talked before about an interest of mine in helping to make sure 
that Americans learn to save. One of the interesting aspects of 
this recession is that people's fear about stagnant wages and 
unemployment is to actually hold the money and to actually 
begin to pay down debt and save.
    Could you speak very briefly about how, while we want 
people to be spending in the sense of encouraging use of 
consumer products and stimulating the economy that way, we 
don't want people to lose this notion that actually saving and 
preparing for a rainy day, being able to have some cushion 
personally is important. We have forgotten to do that in the 
last 10 years, at least, maybe 20 years. Could you speak 
briefly to what else we might want to do to hang on to this 
concept that Americans ought to be saving some part of their 
income if they could?
    Mr. Bernanke. You are absolutely right. Over the last 
couple of decades, in part because of rising house prices and 
stock prices, people have sort of felt not necessary to save. 
Now they are saving more for the reasons you have mentioned. 
And it is interesting to note that people who grew up during 
the thirties, even in prosperity 30 years later, are still 
saving much more than their children. So this experience is of 
course a very negative one, but one benefit might be it is 
going to have some impact on people's savings behavior.
    There are other things that can be done to try to increase 
saving, such as using only opt-outs from 401(k) participation, 
things of that sort. There is no magic bullet. And, indeed, 
attitudes and psychology seem to be important, and this 
certainly is having an influence on that.
    Ms. Schwartz. Well, maybe it is something we can do 
together in the sense of really encouraging Americans to think 
about continuing to save.
    Mr. Bernanke. Yes.
    Ms. Schwartz. Thank you.
    Mr. Chairman, I yield back.
    Chairman Spratt. Mr. Nunes.
    Mr. Nunes. Welcome, Mr. Bernanke. I am going to switch over 
to the Fed's involvement in mortgage-backed securities. There 
has been a report out recently that says--I think Wall Street 
Journal ran a report that said you are about 10 percent 
underwater on these mortgage-backed securities. There is 
currently $480 billion worth, I think is the number that they 
use.
    As we look forward, I have a couple different questions 
related to this. Are you concerned that the risk of the Fed 
purchases will outweigh the benefits? That is the first 
question. The second question would be this; the Fed has said 
that they will buy up to a maximum of $1.25 trillion of 
mortgage-backed securities. Do you plan to go up to that limit? 
And if so, by when?
    Mr. Bernanke. On the first issue, I am not sure about the 
correctness of that calculation because we have a mix of 
securities, not just ones we purchased recently, but it is not 
our anticipation to be selling those off in the market in the 
near term. Right now we are financing those MBS, which pay 
coupons of 4 percent or so, using funds which cost us one-
fourth of 1 percent. And so there is a substantial flow of 
revenue that comes in that will offset losses that might occur 
down the road. So we are pretty comfortable. Obviously there 
are some issues there, but we are pretty comfortable that this 
will be providing revenue to the Treasury.
    That being said, I think the first question is trying to 
get this economy moving again. And since we took very 
aggressive actions in the March FOMC meeting to expand our 
mortgage-backed security purchases and initiate some Treasury 
purchases, I am not saying this was the only reason, but since 
then we have seen some significant improvement in financial 
markets and in the economic outlook. And of course that is the 
first order, that is the most important thing.
    What was your other question?
    Mr. Nunes. The $1.25 trillion; are you going to go up to 
that limit?
    Mr. Bernanke. Well, this is a decision of the Federal Open 
Market Committee. It is like a monetary policy decision. So we 
will meet and we will evaluate the state of the economy, the 
state of that market, the state of credit markets in general, 
and we will have to make a decision. But I can't preview that, 
we have to make that decision as a committee.
    Mr. Nunes. There is some concern out there and there are 
some numbers that float out there that basically the Federal 
Government, in some form or fashion, is involved in 75 percent 
of all mortgage-backed securities, of all mortgages out there. 
And I think there is a concern out there that this could create 
another bubble, a different type of bubble long term where 
essentially you have the Federal Government owning everyone's 
home or their mortgage. Do you see this trend continuing? Do 
you agree with the 75 percent number? Is it lower than that?
    Mr. Bernanke. Well, it is true that currently almost all 
mortgages--not all, but a very large proportion of mortgages 
being originated are passing through Fannie or Freddie or the 
FHA, which means that they are getting a government guarantee. 
Those are the only mortgages right now that can be sold into 
the private markets. So the Fed has nothing to do with that. We 
are buying Fannie and Freddie's mortgages, but they have 
already been guaranteed by those agencies, which are now, of 
course, in conservatorship in the government.
    Mr. Nunes. But we are on the hook for it long term.
    Mr. Bernanke. You are on the hook for it. And I believe 
that one of the things that this body will want to look at is 
reform of Fannie and Freddie and figure out how the 
government's intervention in the housing market ought to be 
conducted. I think many people are convinced that the way 
Fannie and Freddie were set up before was not entirely 
satisfactory, and we need to have some rethinking about what 
role the government should play in the housing market.
    Mr. Nunes. I want to switch topics just real quick here. I 
want to go to cap-and-trade and the global warming legislation 
that is supposedly going to move through this body. And I will 
be very up front with you, I am strongly opposed, I am strongly 
against this policy of adding any type of energy tax at all to 
the American public, especially at this time.
    I have a real concern about how we are going to compete 
with China and India and Brazil, who are putting billions of 
dollars into making energy and making energy cheaper and more 
available to their people, to their population. And you are an 
independent guy, you are supposed to operate outside of the 
Congress. And if someone of your stature would come out and say 
this is the wrong time to do an energy tax, I think it would 
send a message to this Congress to stop this energy tax. And so 
I would request that if you believe this is the wrong time to 
do an energy tax, that you would come out and say that. I think 
it would be a powerful statement.
    Mr. Bernanke. I think just from a short-term cyclical 
consideration, to the extent that there is an energy tax, it 
would make sense to rebate it somehow so that the net 
purchasing power is not diminished too much by such an action. 
But that would be the short-term consideration I would mention.
    Mr. Nunes. So you are not willing to go all the way and say 
we should not do an energy tax at all?
    Mr. Bernanke. In the long run, this clearly depends on the 
assessment of the Congress on the importance of reducing carbon 
greenhouse gas emissions. I am not a scientist, I can't judge 
that. If those costs are perceived to be large enough, then 
some intervention is justified.
    In addition, though, and I think a point that one should 
make, is that our doing this alone would probably not help the 
greenhouse gas situation that much. And so part of our 
strategy, if in fact we go this way, ought to be to negotiate 
or work with China and other countries to get them to do the 
same.
    Mr. Nunes. Well, thank you, Mr. Chairman.
    I think what we need to do, just to finish up, Mr. 
Chairman, is that nuclear power is where we should be putting 
our efforts to have clean energy in this country, not into an 
energy tax.
    Thank you, Mr. Bernanke.
    Chairman Spratt. Mr. Larsen.
    Mr. Larsen. Chairman Bernanke, there are some escape hoods 
right here in front if you need one to try and get away from 
that question.
    Mr. Bernanke. That is okay.
    Mr. Larsen. But I wanted to chat a little bit and ask a 
question, but I do want to clear something up. I was just in 
China as well this last week visiting with a lot of their 
leaders on the economy, asking some questions and trying to get 
some perspective. And the characterization that my colleague 
from New Jersey made about Mr. Geithner's reception was 
inaccurate. It may have been a little bit accurate when he 
spoke at Peking University, but I have never talked to a group 
of college students that didn't take me on either. So there is, 
perhaps, a disconnect there.
    But in our discussions with folks from the Central Bank and 
from the Ministry of Commerce, as well as Vice Premier Wang and 
some others, there is a real desire for cooperating on the 
economy with the Chinese. I want to give you a few assessments 
and ask a few questions, if I might, based on those meetings.
    The first headline is ``Concerned, Yet Confident.'' There 
was a general concern shared to us regarding the potential of 
inflation in the U.S., but not over the next 12 or 18 months, 
but kind of beyond that time frame. Even then, that concern was 
tempered by an expressed confidence in the dynamism of the U.S. 
economy and understanding that the steps we took were necessary 
and are necessary for our own economic health.
    ``A signal on the deficit'' would be another headline. The 
Chinese seem to be looking for a signal on the fiscal deficit, 
not that it disappears, but that it decreases over time. That 
is certainly consistent with what you said.
    The third, ``The Scare Is Gone''--to paraphrase B.B. King. 
There is an agreement on the assessment ``the worst has 
passed,'' but there is still not enough signs of improvement.
    And finally, exit strategy. And this gets to Mr. Ryan's 
question. I am hoping you can be a little bit more particular 
about it. Though there is this expectation of some inflation, 
the Chinese are looking for an exit strategy that gradually 
withdraws an appropriate amount of liquidity from the market 
and decreases the chance that you have to purchase our own debt 
issuance over time.
    And so the question I have is, what can you tell us about 
inflation expectations and the Fed's exit strategy with regards 
to this concern expressed by the Chinese?
    Mr. Bernanke. Certainly. And I think, not just for the 
benefit of the Chinese, but for the benefit of the United 
States and for our own people, we need to explain how we are 
going to restore fiscal sustainability and avoid inflation.
    On that latter issue, let me just begin by saying that the 
Federal Open Market Committee of the Federal Reserve is 
strongly committed to price stability. We will ensure price 
stability. Price stability means neither deflation nor 
inflation. And in the near term, our concern for a time at 
least was that the recession would be so severe that we would 
see deflation, and we have taken strong actions to try and 
avoid that. And I think the fear of deflation has receded 
somewhat, and that is a positive development.
    Now, for the time being, we still need to maintain a 
strong, supportive position in order to help this economy begin 
its recovery. But as that begins, at some point we are going to 
need to begin to withdraw the policy of accommodation so that 
we can avoid any inflation down the road.
    Basically, the exit strategy is that when the time comes, 
we need to begin to raise interest rates. That is the usual way 
that the Federal Reserve tightens policy as the economy begins 
to recover. And the question is, will we be able to raise 
interest rates given the size of our balance sheet? My answer 
is yes.
    First of all, as I mentioned earlier, many of our programs 
are short term and can be wound down. That will reduce the size 
of our balance sheet. Secondly, and very importantly, our 
ability to pay interest on reserves means that we can raise 
interest rates by raising the interest rate we pay on the 
reserves because banks will not be willing to lend in the 
Federal funds market at rates below what they can earn by just 
holding their cash at the Fed. We can raise interest rates and 
then we can tighten policy.
    Beyond that, we have additional tools. For example, we can 
do reverse repurchase agreements which will allow us to fund 
our balance sheet outside the banking system and therefore 
doesn't have the same effects on the money supply or interest 
rates. And if worse came to worse, we could sell some of our 
assets, but that is not a big part of the plan certainly in the 
near term.
    There are still other possibilities that we are looking at 
and that perhaps we can discuss with Congress at some point. 
But we are certainly, as we look forward and decide what 
further actions we want to take, we want to be sure that we 
will be able to remove accommodation at an appropriate time and 
an appropriate speed to be sure that we don't have an inflation 
risk down the road. It is not going to be an easy call, but we 
will have to balance the risk on both sides, not going too soon 
and stunting the recession, not going too late and having a bit 
of inflation, but we will get price stability after we get out 
of this recession.
    Chairman Spratt. Mrs. Lummis.
    Mrs. Lummis. Dr. Bernanke, thank you for being here today. 
I want to visit a bit about that balance between taxes and 
spending in the medium term.
    If Congress just increases taxes to eliminate the deficit 
in 10 years, let's say, without cutting spending, could that 
have an effect on our economic recovery, a negative effect?
    Mr. Bernanke. So as I was trying to make the distinction 
earlier that in an economy in recession, tax cuts or tax 
increases have two effects. One is the incentive effects, which 
are more long-term effects, but also withdrawing purchasing 
power, taking away income from consumers. And in a short-term 
recessionary situation, I think that latter effect is more 
important. So if you raise taxes during a recession, you 
probably want to offset it with a tax cut elsewhere, for 
example.
    Over a longer period of time, you have to weigh the 
implications of higher taxes on incentives and on potential 
growth against the benefits of what you are using the revenue 
for. So there is a cost-benefit tradeoff to be made there.
    So in particular, I believe the Congress will want to look 
at both sides, both the tax and the spending side, and try to 
find a reasonable balance between those two.
    Mrs. Lummis. Mr. Chairman, you mentioned just a few minutes 
ago that many of the programs at the Fed are temporary and 
could be wound down. Well, such is the case with the Congress 
also, and this stimulus bill comes to mind.
    If Congress were to freeze spending at 2009 fiscal year 
levels and freeze release of the TARP funds at the end of the 
this fiscal year, do you believe the economy will have 
recovered adequately that we could then begin to address the 
debt and deficit problem and focus on it? Because you mentioned 
that as a very important looming issue. So I am looking at the 
point at which we can actually, as a Congress, also enact an 
exit strategy from trying to stimulate economic growth because 
the economy is finally leveling out, and then begin to address 
that great looming issue that you mentioned as a concern--that 
I agree is a huge concern--that being both the deficit and the 
debt.
    Mr. Bernanke. I think it is very important, as I mentioned 
in my testimony, to begin the planning process as soon as 
possible so it will have a persuasive exit strategy that will 
not only give us a plan but will also help to reassure lenders 
in the bond markets that in fact the U.S. Government is going 
to find a fiscally sustainable path going forward.
    You asked about 2009. No one knows the future of course, 
but based on our best projections we think that the economy 
will be pretty weak albeit starting to grow at the end of 2009 
and the unemployment rate will probably still be rising. So 
would unlikely be a period of robust growth at that point.
    Mrs. Lummis. Mr. Chairman, suppose if we froze spending of 
the Federal Government's budgets at 2009 level and then let the 
stimulus package continue to work, would that be a way to begin 
to address the deficit and the debt as well as allow the 
stimulus monies to continue to flow into the economy?
    Mr. Bernanke. Congresswoman, I think that there are lots of 
ways that you could structure this, and I don't think I want to 
try to pick one, particularly on the fly here. So you really 
need to think about maybe not just the total amount of spending 
but the various programs and the various needs we have from 
health, and defense, and benefits payments, everything else, 
and think about those programs and try to think about how we 
are going to structure them in a way that over the next few 
years we are going to return to a more balanced situation. So I 
think a longer term perspective is probably necessary.
    Mrs. Lummis. Thank you, Mr. Chairman.
    A quick question about government intervention in our 
economy, given the degree and depth of the government 
intervention in the economy, which is the highest since World 
War II, can you estimate how long it might take for the 
government to unwind its immersion in the markets?
    Mr. Bernanke. It is going to depend on the market. For 
example, in some of the short-term markets, like the commercial 
paper market, we are already seeing an unwinding going on now 
as those markets stabilize. For other parts of the economy, 
like the TARP investment in banks or some of the longer term 
holdings of the Fed, it may take a few more years. But I would 
say that 4 or 5 years from now I hope that as a government we 
will be pretty much out of those financial markets and that 
things will be operating on a more normal basis.
    Mrs. Lummis. Thank you, Mr. Chairman.
    Chairman Spratt. Ms. Tsongas.
    Ms. Tsongas. Thank you, Mr. Chairman, and thank you, 
Chairman Bernanke, for being here with us.
    When we spoke last year, as we were considering our 
response to the downturn in the economy and we were trying to 
consider the parameters of a recovery package, I asked, and you 
stated, that helping the States prevent cutbacks in services 
could have a stimulative effect and indicated support for 
addressing weaknesses in the municipal bond market. The 
Recovery Act we passed did include money for state 
stabilization and created several flexible bond options to help 
our State and local governments. And this past week when I was 
in Massachusetts as part of the break and happened to meet with 
our Governor as well as our State senator who chairs the Ways 
and Means Committee, I can tell you how grateful they were for 
the fact that we included significant funds to help the States 
deal with the downturns in their revenues and the impacts on 
their budget. I think it is one of the most difficult places to 
be today, in State and local government. So I want to thank you 
for that, and also for your reiterating your support today for 
what we have done with the recovery package and the necessity 
for it.
    In your testimony you just stated that about one-quarter of 
the funds will come out either through tax cuts or direct 
benefits and direct spending this year, one-half next year, and 
possibly the last quarter in 2011. Are you concerned that we 
are meeting that timetable, and how important is the timetable 
as we go forward beyond the tax cuts that have showed up in 
people's paychecks today?
    Mr. Bernanke. Well, it is the very early days. At this 
point I think something on the order of 5 percent of the monies 
appropriated have entered the economic bloodstream, so to 
speak. It is important that there not be extensive delays in 
that process because it would possibly give you a fiscal 
stimulus exactly at the wrong time when the economy was already 
in a substantial recovery mode. But I don't have any 
information to the effect that the stimulus is not being 
disbursed at a reasonable pace. I think it is just too early to 
know how quickly the monies will get out.
    Ms. Tsongas. So you are confident that the administration 
is moving in a timely fashion, especially within the various 
departments where they have to put in place a regulatory 
framework, the process of people applying for the funds, that 
that is going along in a manner that should be helpful?
    Mr. Bernanke. As far as I know. But we all recognize that 
this is, from a bureaucratic point of view, a very challenging 
task. But so far, of course I think payments are underway and 
the planning process is underway.
    Ms. Tsongas. So the impact we see today, given the fact 
that only 5 percent is moved out, what do you attribute that 
to?
    Mr. Bernanke. The recent improvement in the economy?
    Ms. Tsongas. Yes.
    Mr. Bernanke. It is partly the fact that we had this very 
sharp decline in the latter part of last year related to the 
financial crisis that caused a big buildup of inventories. Very 
importantly, as I discussed earlier, we seem to have achieved a 
good deal of progress in stabilizing the financial system. That 
has helped restore confidence. Finally, demand is beginning to 
stabilize. We still had a very bad first quarter and we may yet 
have a negative second quarter because of the need to work down 
those inventories, but because the financial markets are doing 
better, because there is more confidence in the economy, in the 
financial system, as those inventories work down, we should 
begin to see a modest increase in growth.
    So I would put the internal dynamics of the economy in 
terms of inventories, and so on, as being part of it, but I 
also would like to give credit to actions taken by the 
Treasury, the Fed, the FDIC, and the Congress to help stabilize 
the financial system.
    Ms. Tsongas. Thank you, and I yield back.
    Chairman Spratt. Ms. Moore.
    Ms. Moore. Thank you very much, Mr. Chairman, and thank 
you, Mr. Chairman, for being patient.
    I have three questions, but I want to start out with your 
certainty that we won't be facing inflation and your certainty 
that we have gotten a handle on deflation. Just your last 
answer to Mrs. Tsongas about the buildup of inventory, and 
certainly there has been a loss of value in the housing market, 
given the unemployment rate that is going to continue to rise--
even recently from the GM and Chrysler restructuring--given the 
high unemployment and the buildup of inventory and the loss of 
value in housing, how can you say that deflation is not a risk 
and we are not having these fire sales to get rid of inventory 
or losses being taken in the housing market?
    I guess I don't understand how we have we are going to 
avoid deflation.
    Mr. Bernanke. Well, you correctly point out that we have a 
balancing act between on the one hand deflation risk and on the 
other hand potential medium-term inflation risk. We have to 
look at both sides of that equation. Recently, since the 
outlook seems to have improved some, since confidence is up 
somewhat, because inflation expectation is measured by a lot of 
different means seem to be pretty stable, I put a lower 
probability now on a deflation than I would have a few months 
ago. That is not to say it is completely----
    Ms. Moore. If people don't have jobs, how are they going to 
buy the built up inventory? What is going to happen when people 
just have to sell their houses and they have lost 30 percent 
value?
    Mr. Bernanke. Well, that has a very negative effect on the 
economy and we expect the employment to keep rising. I agree 
with you that the economy remains quite weak, but consumer 
spending, though at a lower level, it seems to be stabilizing, 
not growing great guns but it seems to be stabilizing, and 
those kinds of considerations, we think the deflation risk has 
receded. But we are certainly going to continue to follow that 
carefully.
    Ms. Moore. Let me go on before my time expires.
    There has been a lot of talk about the Fed being named as a 
super regulator or alternatively a systemic risk regulator. Mr. 
Ryan earlier asked about the independence of the Federal 
Reserve, and I just want your comment about whether or not you 
think you are the appropriate agency to be either a super 
regulator or a systemic risk regulator and whether or not that 
would be a little bit incestuous.
    Mr. Bernanke. Well, first of all let me say that I do think 
there is a benefit to going toward a more system-wide 
regulatory approach because so many things that caused problems 
in the recent crisis sort of slipped under the radar because 
there was nobody looking at it. So we do need to have a system 
whereby the large systemically critical firms are being 
appropriately overseen, where we have a way to address the 
potential failure of large financial firms, where we make sure 
that risks that build up in the system are----
    Ms. Moore. Should that be you? Before my time expires?
    Mr. Bernanke. The Federal Reserve needs to be part of that 
process. But given our expertise, given our historical role in 
financial crisis management, given the fact that we are the 
lender of last resort, we should have a substantial role in 
that. The exact structure of the arrangements I think remains 
to be discussed. The administration hasn't even come out with 
their proposal yet.
    Ms. Moore. I want to ask a question about what monetary 
policy should we be pursuing, given that the Chinese seem to be 
putting up a challenge to the dollar as the reserve currency. 
This would be a great loss to us were we seriously challenged. 
What should we be doing to maintain the dollar as our reserve 
currency?
    Mr. Bernanke. Well, first, I don't see any risk in the 
foreseeable future to the dollar status as reserve currency.
    Ms. Moore. You don't see the Chinese and the Brazilians 
that are now using their own currency for reserve currency, the 
Chinese concern about the strength of the dollar as being a 
challenge?
    Mr. Bernanke. Well, a share of reserves held by all 
countries in dollars, that share has actually gone up a bit 
recently. With that being said, we do have a responsibility to 
make sure our economy is appropriately run, and my view is that 
the best way to get a strong dollar is to get a strong economy 
and to get the economy back on a growth path with high 
productivity, good amount of savings. That is the best way to 
get the dollar strong, and that is why I think it is important 
to get us turned around, get the financial crisis fixed, and 
get the economy growing again, and that is what the Federal 
Reserve's policy is trying to achieve.
    Ms. Moore. Thank you, I yield back.
    Chairman Spratt. Ms. Kaptur.
    Ms. Kaptur. Thank you, Mr. Chairman. And Chairman Bernanke, 
thank you for your patience. Most of my questions will be yes 
and no, and but I want to begin by saying that very privileged 
and powerful bankers in our country have hurt our Nation 
deeply, yet it seems that they get special treatment by the 
Federal Reserve and other financial regulatory agencies that 
should be protecting the public interest. And these bankers 
have earned huge profits for themselves, but when their 
imprudent behavior causes vast economic dislocation, they throw 
the cost of that on the backs of the taxpayers, raising our 
national debt. Taxpayers who are hurt, homeowners lose their 
homes, people lose jobs, people lose their companies, 
bankruptcies go up, but they don't get the same treatment.
    So I am interested in the favoritism exhibited towards 
these bankers as well as the non-transparency of financial 
rescues being arranged by the Fed and other Federal regulatory 
agencies.
    The presidents of the regional reserve banks of the Fed 
extraordinarily have been expressing concern about what is 
going on and the power of the New York Fed, Kansas City Fed, 
Saint Louis Fed, the Richmond Fed, shockingly, signed an 
agreement with you, an unprecedented agreement where you agreed 
to absorb any losses that would be incurred by the Fed. The 
Treasury actually signed that agreement.
    And so my first question is, yes or no, do you support the 
concept of having the presidents of each of the Federal Reserve 
banks join the ranks of your Board of Governors and be 
nominated by the President and confirmed by the Senate to have 
a more representative Fed?
    Mr. Bernanke. No.
    Ms. Kaptur. Thank you.
    For the record, before this month is out, how much TARP 
money will AIG, can you provide for the record, before this 
month is out, how much TARP money AIG has disbursed since 
January 1 of this year and who were the recipients. Can you 
provide that for the record?
    Mr. Bernanke. I think so, but I can't do that here.
    Ms. Kaptur. Can you do it within the month?
    Mr. Bernanke. They have already produced the information on 
their counterparties. I think that information is in the public 
domain.
    Ms. Kaptur. How many of these disbursements and which 
derivative contracts were paid out at 100 percent on the dollar 
and which were not?
    Mr. Bernanke. All contracts, of which there was a legal 
contract binding, were paid out 100 percent because there was 
no bankruptcy allowed. We need a system where we can 
renegotiate those things, but we don't have a system like that.
    Ms. Kaptur. Well, we are going to want as much detail as 
you can provide for the record, because the Fed is really 
heavily involved in that, am I correct?
    Mr. Bernanke. The Fed is involved very unwillingly because 
there is no good system for addressing the failure of a major 
financial institution.
    Ms. Kaptur. How much more of our rising debt is being 
provided by foreign creditors now as our debt rises? Can you 
provide that for the record?
    Mr. Bernanke. Actually less, less than it has been, because 
we know the current account deficit has been declining. And 
that current account deficit measures the flow of new lending 
from foreign creditors to the United States.
    As the Federal deficit has gone up, the private borrowing 
has gone down.
    Ms. Kaptur. Thank you. We would like that for the record.
    How many no-bid contracts has the Fed now signed with the 
private money management firm BlackRock and any of its 
subsidiaries.
    Mr. Bernanke. We have signed several. Because of exigencies 
of time, all that information is going to be provided in this 
monthly report, which we are now releasing to the Congress.
    Ms. Kaptur. Will the contracts be released to the Congress?
    Mr. Bernanke. I believe so, yes.
    Ms. Kaptur. What is the value of assets being managed by 
BlackRock and any of these contracts in total?
    Mr. Bernanke. I don't have information.
    Ms. Kaptur. Will that be provided for the record?
    Mr. Bernanke. Oh, yes.
    Ms. Kaptur. What is the Fed providing for BlackRock in 
services. Will that be provided for the record?
    Mr. Bernanke. We have a committee, which has gone through 
and made a whole set of recommendations based on carefully 
considered analysis and consultation, and that will be 
providing a great deal of information. I don't remember every 
single decision that they made, but I would like to defer to 
their decisions.
    Ms. Kaptur. Do you know, Mr. Chairman, which foreign 
countries and companies are a part of BlackRock's transactions?
    Mr. Bernanke. I don't understand the question.
    Ms. Kaptur. What other business does BlackRock do besides 
service the Fed?
    Mr. Bernanke. They have a very large asset management 
business.
    Ms. Kaptur. But you wouldn't necessarily be aware of what 
those relationships are. Yes or no?
    Mr. Bernanke. Not necessarily.
    Ms. Kaptur. Are you aware that one of the contracts 
BlackRock manages for the Fed may be compromised, and that is 
the one, probably more than one is compromised, dealing with 
Freddie Mac and Fannie Mae? And I just wish to state this for 
the record.
    Laurence Fink, who is the head of BlackRock, which now is 
47 percent owned by Bank of America, in which the--Mr. Summers, 
who heads the National Economic Council, is a major investor, 
just got several no-bid contracts from the Fed, including one 
to manage Freddie Mac and Fannie Mae's troubled portfolios. I 
think that is one of the contracts you signed with BlackRock.
    Did the Fed know that Mr. Fink is the person who first 
created the collateralized mortgage obligation when he headed 
First Boston, and then he brought that instrument to Freddie 
Mac and initially sold it to them for over $1 billion of such 
obligations, making huge profits for himself and his firm. He 
is now the Fed's go-to man through his firm on Freddie Mac 
workouts.
    I have a question about the revolving door, and how do you 
protect the public, again, against his potential and that 
company's potential conflict of interest or possible self-
dealing that relate to his own and his firm's historic 
involvements with those mortgage portfolios?
    Mr. Bernanke. The Federal Reserve is a separate institution 
from Freddie Mac. We have nothing to do with Freddie Mac. I 
don't understand your question.
    Ms. Kaptur. You have signed a contract with BlackRock to 
manage the Freddie and Fannie portfolios, have you not, the 
troubled mortgages within those portfolios?
    Chairman Bernanke. Not to my knowledge.
    Ms. Kaptur. I understood it was one of the four or five 
contracts that you had signed with BlackRock.
    Mr. Bernanke. I will have to go back and check on that.
    Ms. Kaptur. We would appreciate that very much.
    [Questions for the record submitted by Ms. Kaptur follow:]

       Questions for the Record Submitted by Congresswoman Kaptur

    How much TARP money AIG has disbursed since January 1 of this year 
and who were recipients?
    How much more of our rising debt is being provided by foreign 
creditors now as our debt rises?
         copies of the contracts between the fed and blackrock
    What is the value of assets being managed by BlackRock and any of 
these contracts in total?
    What is Blackrock being paid for each contract?
    Do you know which foreign countries and companies are part of Black 
Rock's transactions?
                  additional questions for the record
     What actions are taken by the Fed to examine and prevent 
conflicts of interest of any kind when awarding no bid contracts? What 
processes are in place? Please include copies of the documents of the 
evaluation of conflict of interest in regard to all BlackRock 
contracts, both those that BlackRock might have bid on and those that 
were no-bid contracts.
     Can you explain to me why the Federal Reserve Bank of New 
York is expected to regulate Wall Street, and yet on its board are Wall 
Street Executives? Isn't this a conflict on interest from perspective? 
Please elaborate here. Do we really trust Wall Street to regulate 
itself?
     Why does the Federal Reserve buy Treasury notes? Isn't 
this just money shuffling, especially since the Treasury has $200 
billion deposited in the Fed right now through the Treasury 
Supplemental Financing Program?
     The Federal Reserve Bank of New York is the only bank of 
the 12 with an established vote on interest rates; the seven governors 
have a vote, the Federal Reserve Bank of New York has a vote, and the 
other 11 banks rotate through the other 4 votes. Why is the NY Fed so 
special?
     How much was now Secretary Geithner involved in the 
drafting of the trust agreement between the Federal Reserve Bank of New 
York and AIG--at the time Mr. Geithner was service as President of the 
Federal Reserve Bank of New York.
     Do you think it is appropriate for the President of the 
Federal Reserve Bank of New York to have close ties with the CEO's and 
other key management of the very banks one is regulating?
     Given that the taxpayers are at this time currently losing 
money through the obligations accrued through the purchases of 
securities from AIG and Bear Sterns, is there any real hope that the 
taxpayers will paid back in full?
     Can you give me your thoughts on why AIG was saved, and 
Chrysler and GM allowed to enter bankruptcy? Sure you were involved in 
each discussion to some degree.
     Why do you think that Chrysler and GM were given far less 
money than the banks through TARP with restrictions and conditions on 
what was to happen at each before there was any more infusion of 
capital from the TARP into the companies, and the banks can keep coming 
back and are barely asked to do even reporting in return?
     Were you present in any meeting in which the Bank of 
America acquisition of Merrill Lynch was discussed? Please state when 
each meeting took place, where each meeting was held, the other 
attendees of the meeting, and go into detail on what was discussed. In 
addition to the aforementioned, how involved were people such as Larry 
Summers and other Members of the President's Economic Advisory Council 
or the President's Working Group on Financial Markets? Other bank 
CEO's? Do you feel it was appropriate for the federal government to 
play a role in the activities of private banks, and in particular, the 
matter of Bank of America and Merrill Lynch?
     Would you welcome a full audit of the PIPP program now and 
regularly? Why or why not?
     Do you resolution authority and a financial product safety 
commission? Why or why not on each item?
     You have been quoted as stating that in looking back, it 
was probably a mistake to let Lehman fail. Please elaborate on this 
matter.

    [Mr. Bernanke's responses to Ms. Kaptur's questions 
follow:]




    [Prepared statement of Mr. Bernanke before the House 
Committee on Oversight and Government Reform follows:]

  Before the Committee on Oversight and Government 
                                            Reform,
                             U.S. House of Representatives,
                                     Washington, DC, June 25, 2009.

              Statement of Hon. Ben S. Bernanke, Chairman,
               Board of Governors, Federal Reserve System

    Chairman Towns, Ranking Member Issa, and other members of the 
Committee, I appreciate the opportunity to discuss the Federal 
Reserve's role in the acquisition by the Bank of America Corporation of 
Merrill Lynch & Co., Inc. I believe that the Federal Reserve acted with 
the highest integrity throughout its discussions with Bank of America 
regarding that company's acquisition of Merrill Lynch. I will attempt 
in this testimony to respond to some of the questions that have been 
raised.
                               background
    On September 15, 2008, Bank of America announced an agreement to 
acquire Merrill Lynch. I did not play a role in arranging this 
transaction and no Federal Reserve assistance was promised or provided 
in connection with that agreement. As with similar transactions, the 
transaction was reviewed and approved by the Federal Reserve under the 
Bank Holding Company Act in November 2008. It was subsequently approved 
by the shareholders of Bank of America and Merrill Lynch on December 5, 
2008. The acquisition was scheduled to be closed on January 1, 2009.
    As you know, the period encompassing Bank of America's decision to 
acquire Merrill Lynch through the consummation of the merger was one of 
extreme stress in financial markets. The government-sponsored 
enterprises, Fannie Mae and Freddie Mac, were taken into 
conservatorship a week before the Bank of America deal was announced. 
That same week, Lehman Brothers failed, and American International 
Group was prevented from failing only by extraordinary government 
action. Later that month, Wachovia faced intense liquidity pressures 
which threatened its viability and resulted in its acquisition by Wells 
Fargo. In mid-October, an aggressive international response was 
required to avert a global banking meltdown. In November, the possible 
destabilization of Citigroup was prevented by government action. In 
short, the period was one of extraordinary risk for the financial 
system and the global economy, as well as for Bank of America and 
Merrill Lynch.
discussions regarding the possible termination of agreement to acquire 
                             merrill lynch
    On December 17, 2008, senior management of Bank of America informed 
the Federal Reserve for the first time that, because of significant 
losses at Merrill Lynch for the fourth quarter of 2008, Bank of America 
was considering not closing the Merrill Lynch acquisition. This 
information led to a series of meetings and discussions among Bank of 
America, the regulatory agencies, and Treasury. During these 
discussions, Bank of America's CEO, Ken Lewis, told us that the company 
was considering invoking the Material Adverse Event clause in the 
acquisition contract, known as the MAC, in an attempt to rescind its 
agreement to acquire Merrill Lynch.
    In responding to Bank of America in these discussions, I expressed 
concern that invoking the MAC would entail significant risks, not only 
for the financial system as a whole but also for Bank of America 
itself, for three reasons. First, in light of the extreme fragility of 
the financial system at the time, the uncertainties created by an 
invocation of the MAC might have triggered a broader systemic crisis 
that could well have destabilized Bank of America as well as Merrill 
Lynch. Second, an attempt to invoke the MAC after three months of 
review, preparation, and public remarks by the management of Bank of 
America about the benefits of the acquisition would cast doubt in the 
minds of financial market participants--including the investors, 
creditors, and customers of Bank of America--about the due diligence 
and analysis done by the company, its capability to consummate 
significant acquisitions, its overall risk-management processes, and 
the judgment of its management. Third, based on our staff analysis of 
the legal issues, we believed that it was highly unlikely that Bank of 
America would be successful in terminating the contract by invoking the 
MAC. Rather, an attempt to invoke the MAC would likely involve extended 
and costly litigation with Merrill Lynch that, with significant 
probability, would result in Bank of America being required either to 
pay substantial damages or to acquire a firm whose value would have 
been greatly reduced or destroyed by a strong negative market reaction 
to the announcement. For these reasons, I believed that, rather than 
invoking the MAC, Bank of America's best option, and the best option 
for the system, was to work with the Federal Reserve and the Treasury 
to develop a contingency plan to ensure that the company would remain 
stable should the completion of the acquisition and the announcement of 
losses lead to financial stress, particularly a sudden pullback of 
funding of the type that had been experienced by Wachovia, Lehman, and 
other firms.
    Ultimately, on December 30, the Bank of America board determined to 
go forward with the acquisition. The staff of the Federal Reserve 
worked diligently with Treasury, other regulators, and Bank of America 
to put in place a package that would help to shore up the combined 
company's financial position and reduce the risk of market disruption. 
The plan was completed in time to be announced simultaneously with Bank 
of America's public earnings announcement, which had been moved forward 
to January 16, 2009, from January 20, 2009. The package included an 
additional $20 billion equity investment from the Troubled Asset Relief 
Program and a loss-protection arrangement, or ring fence, for a pool of 
assets valued at about $118 billion. The ring-fence arrangement has not 
been consummated, and Bank of America now believes that, in light of 
the general improvement in the markets, this protection is no longer 
needed.
    Importantly, the decision to go forward with the merger rightly 
remained in the hands of Bank of America's board and management, and 
they were obligated to make the choice they believed was in the best 
interest of their shareholders and company. I did not tell Bank of 
America's management that the Federal Reserve would take action against 
the board or management if they decided to proceed with the MAC. 
Moreover, I did not instruct anyone to indicate to Bank of America that 
the Federal Reserve would take any particular action under those 
circumstances. I agreed with the view of others that the invocation of 
the MAC clause in this case involved significant risk for Bank of 
America, as well as for Merrill Lynch and the financial system as a 
whole, and it was this concern that I communicated to Mr. Lewis and his 
colleagues.
                              disclosures
    The Federal Reserve also acted appropriately regarding issues of 
public disclosure. As I wrote in a letter to this Committee, neither I 
nor any member of the Federal Reserve ever directed, instructed, or 
advised Bank of America to withhold from public disclosure any 
information relating to Merrill Lynch, including its losses, 
compensation packages or bonuses, or any other related matter. These 
disclosure obligations belong squarely with the company, and the 
Federal Reserve did not interfere in the company's disclosure 
decisions.
    The Federal Reserve had a legitimate interest in knowing when Bank 
of America or Merrill Lynch intended to disclose the losses at Merrill 
Lynch. Given the fragility of the financial markets at that time, we 
were concerned about the potential for a strong, adverse market 
reaction to the reports of significant losses at Merrill Lynch. If 
federal assistance to stabilize these companies were to be effective, 
the necessary facilities would have to be in place as of the disclosure 
date. Thus, our planning was importantly influenced by the companies' 
planned disclosure schedule. But the decisions and responsibilities 
regarding public disclosure always remained, as it should, with the 
companies themselves.
    A related question is whether there should have been earlier 
disclosure of the aid provided by the U.S. government to Bank of 
America. Importantly, there was no commitment on the part of the 
government regarding the size or structure of the transaction until 
very late in the process. Although we had indicated to Bank of America 
in December that the government would provide assistance if necessary 
to keep the company from being destabilized, as it had done in other 
cases during this time of extraordinary stress in the financial 
markets, those December discussions were followed in January by 
significant and intense negotiations involving Bank of America, the 
Federal Reserve, the Treasury, the Federal Deposit Insurance 
Corporation, and the Office of the Comptroller of the Currency 
regarding many key aspects of the assistance transaction, including the 
type of assistance to be provided, the size of the protection, the 
assets to be covered, the terms for payments, the fees, and the length 
of the facility. The agreement in principle on these items was 
reflected in a term sheet that was not finalized until just before its 
public release on January 16, 2009. The Federal Reserve Board and the 
Treasury completely and appropriately disclosed the information as 
required by the Congress in the Emergency Economic Stabilization Act of 
2008.
    In retrospect, I believe that our actions in this episode, 
including the development of an assistance package that facilitated the 
consummation of Bank of America's acquisition of Merrill Lynch, were 
not only done with the highest integrity, but have strengthened both 
companies while enhancing the stability of the financial markets and 
protecting the taxpayers. These actions were taken under highly unusual 
circumstances in the face of grave threats to our financial system and 
our economy. To avoid such situations in the future, it is critical 
that the Administration, the Congress, and the regulatory agencies work 
together to develop a new framework that strengthens and expands 
supervisory oversight and includes a broader range of tools to promote 
financial stability.
    I would be pleased to take your questions.

    Chairman Spratt. Mr. Ryan has one final question.
    Mr. Ryan. Since we are before you have to leave, Mr. 
Chairman, I figured I would ask you a second.
    We are going to make two big fiscal policy decisions just 
this summer, talked about cap-and-trade briefly and then health 
care legislation. And those are the two big fiscal dockets. And 
that is going to impact our borrowing and our deficits, no two 
ways about it.
    The bill that is moving to the floor that is already out of 
the Commerce Committee on cap-and-trade auctions off 88 percent 
of the permits, which therefore dramatically reduces the 
ability to do the rebates such as you discussed as needed to be 
offsetting to blunt the negative fiscal impact on the economy--
gives away, yes, did I say auctions off--gives away 88 percent 
of the permits.
    Given that the legislation that we are looking at gives 
away 88 percent of the permits, drying up the money to do 
rebates, do you think that that has a negative effect on the 
economy?
    Mr. Bernanke. My understanding is that they will be given 
away and then passed through to consumers; is that correct?
    Mr. Ryan. No, they are given away to various industries.
    Mr. Bernanke. If you give it away to the industries but 
prices still reflect the cost of the permit, then it is 
basically money being given to the industries.
    Mr. Ryan. But the targets will be the same. So the emission 
targets will be as aggressive. But the point I am trying to 
make is the revenue from auctions which are needed to do 
rebates will not be there because the permits will be given 
away to the firms.
    Mr. Bernanke. It is certainly true. If the permits are 
given away, then you don't get the revenue from the auctions, 
absolutely.
    Mr. Ryan. And, therefore, if there is not an offsetting 
rebate anywhere close to one for one, do you think that that 
therefore has negative effects on the economy?
    Mr. Bernanke. It could, yes. But, again, my understanding 
is that some of these auctions, some of these permits that are 
being given away that are being required to be passed through 
to consumers, which has a different effect in terms of spending 
but to some extent goes against the premise of the policy, 
which is to try to reduce energy consumption, since if 
consumers don't see higher prices you won't reduce their 
consumption.
    Mr. Ryan. Yes. I think a lot of us would question the 
efficacy or logic of it being passed through to the consumers, 
because it counts against the whole notion of the program.
    Mr. Bernanke. That is right.
    Mr. Ryan. Let me ask you one final question. Do you think 
it makes sense that we need to spend more on entitlements in 
order to save money on entitlements? What I mean when I get at 
that is we are in the middle this health care debate, the 
discussion revolves around raising about 1.3, 1.2 trillion in 
new revenues to spend on a new entitlement program that will be 
created for health care for the under 65 population. We already 
spend more than 2.5 times per person on health care compared to 
any other country in the world.
    Is it a good idea from a fiscal standpoint to increase that 
by another 1.2, 1.3 trillion over the next 10 years? And is 
that the best way to save more money in the long run with these 
entitlement programs? So we have two health care entitlement 
programs already, Medicare and Medicaid. We are going to create 
a third one now with a huge expenditure requirement, with a 
revenue stream that may or may not meet that expenditure 
requirement.
    Nevertheless, it is a larger tax and spend program than 
what we have right now. Is that the right way to go down toward 
containing our fiscal problems, in your opinion?
    Mr. Bernanke. From a fiscal perspective, the reforms to 
health care need to address the cost issue. Now, the question 
is about how to change the structure of the health care system 
or whether to do it or not or how the government's role should 
change, if at all.
    But if you don't get control of the cost of health care, 
then the fiscal issues are very serious. And, in particular, 
for example, Medicare trustees assumed that health care costs 
were going to grow at only 1 percent faster than per capita 
income. In fact they have been growing at 2.5 percent faster 
than per capita income. So we need some substantial cost 
controls just to get down to the Medicare trustees' prediction.
    Mr. Ryan. Do you think that creating a new entitlement and 
more spending and taxing is the way to contain those costs?
    Mr. Bernanke. Part of the reform effort has got to be 
addressing the cost somehow, the cost of per capita health care 
and the growth in that rate. So that has got to be a big part 
of that program. If you don't do that, then just adding 
programs would be a big problem, yes.
    Mr. Ryan. Thank you.
    Chairman Spratt. I ask unanimous consent that before 
concluding that members who did not have an opportunity to ask 
questions of our witness be given 7 days to submit questions 
for the record.
    Mr. Chairman, thank you very much for your testimony and, 
in particular, for your forthright, clear, and very insightful 
answers.
    We appreciate your being here again today, and we look 
forward to working with you in the future. Thank you very much 
indeed.
    The committee is now adjourned.
    [Questions for the record submitted by Mr. Connolly 
follow:]

           Questions for the Record Submitted by Mr. Connolly

    Chairman Bernanke, would you agree that the municipal credit market 
is still in distress?
    Chairman Bernanke, while a federal reinsurance program may be a 
worthwhile action, do you believe it is the only necessary action in 
returning the municipal bond market to its pre-recession condition?
    Chairman Bernanke, would the high interest rates currently facing 
state and local governments and the lost employment potential as needed 
municipal capital projects remain idle be actionable concerns under the 
Fed's purview?
    Chairman Bernanke, if the Federal Reserve has the authority to 
purchase municipal debt, given the extraordinary economic situation 
facing the nation, the extreme hardships facing our states and 
localities, and the immediate benefits that their capital programs will 
provide to our economic recovery, shouldn't the Fed consider this 
option as a tool?

    [Mr. Bernanke's responses to Mr. Connolly's questions 
follow:]

          Board of Governors of the Federal Reserve System,
                                     Washington, DC, June 30, 2009.
Hon. Gerald E. Connolly,
U.S. House of Representatives, Washington, DC.
    Dear Congressman: Enclosed are my responses to the questions you 
submitted following the June 3, 2009, hearing before the House 
Committee on the Budget entitled ``Challenges Facing the Economy: The 
View of the Federal Reserve.'' I have also forwarded a copy to the 
Committee for inclusion in the hearing record.
    Please let me know if I can be of further assistance.
            Sincerely,
                                           Ben S. Bernanke,
                                                          Chairman.

    Chairman Bernanke subsequently submitted the following in response 
to written questions received from Congressman Gerald Connolly in 
connection with the June 3, 2009, hearing before the House Committee on 
the Budget:

    Chairman Bernanke, would you agree that the municipal credit market 
is still in distress?

    The functioning of the primary market for municipal debt market has 
improved significantly since late last year. For example, the spread 
between the interest rate paid on long term fixed-rate municipal debt 
and that on comparable-maturity Treasury bonds has fallen significantly 
since November, and average yields on fixed-rate municipal bonds are 
currently quite low by historical standards. The seven-day SIFMA swap 
index, a measure of yields for high-grade variable rate demand 
obligations (VRDOs), has also declined sharply since November, which 
suggests that this part of the market is functioning quite well for 
higher-rated Issuers. Moreover, gross issuance of municipal bonds has 
been fairly well maintained so far this year.
    To be sure, some segments of the municipal debt market remain 
stressed. One symptom of this stress is that the spread between 
municipal bonds rated AA versus those rated A remains high by 
historical standards despite its recent narrowing. In the market for 
floating-rate municipal debt, some market participants report that the 
cost of liquidity support and credit enhancement for VRDOs remains 
sharply higher than it was a year ago, and auctions of most remaining 
auction rate securities continue to fail. (The value of municipal 
auction rate securities outstanding has diminished by at least half 
since 2007.) In addition, some VRDOs have reportedly been put to their 
liquidity providers, turning them into ``bank bonds,'' which typically 
carry penalty interest rates and can eventually be subject to 
accelerated amortization. The combination of a higher interest rate and 
accelerated amortization can cause a sudden and substantial increase in 
the debt service payments required of the issuing municipality.

    Chairman Bernanke, while a federal reinsurance program may be a 
worthwhile action, do you believe it is the only necessary action in 
returning the municipal bond market to its pre-recession condition?

    The stress in municipal debt markets reflects several different 
factors. One important factor is the underlying fiscal weakness of the 
issuing municipalities. Investors are responding to this weakness by 
drawing distinctions among different jurisdictions, and they are 
charging higher rates to states and localities with weaker fiscal 
conditions. But there are other contributing factors as well, including 
the diminished financial strength and capacity of the financial 
guaranty industry and the pressures on banks and other providers of 
liquidity backstops and credit enhancement, in response to which those 
entities have reduced the availability and increased the cost of their 
support for municipal debt. The Congress could choose to provide 
assistance to states and localities by addressing anyone of these 
factors, or all of them. Indeed, as you are. well aware, some policy 
actions have already been taken, including the fiscal stimulus package 
now in the process of being implemented as well as the many steps taken 
by the Federal Reserve to improve the functioning of financial markets. 
These policy actions have already had some positive effect and should 
continue doing so in the future. Whether to undertake further action in 
support of state and local governments is an issue that must be weighed 
by the Congress in light of the overall federal fiscal situation and 
the competing potential uses of the resources that might be devoted to 
this purpose.
    Regardless of the policy actions the Congress may decide to 
implement, it may also wish to consider ways to minimize the potential 
for distortions in the market for municipal bonds. One effect of the 
current financial crisis has been to expose some important 
vulnerabilities of the municipal debt market. For example, because 
contracts for letters of credit and standby bond purchase agreements 
are typically of short duration, municipalities face significant 
``rollover'' risks for their VRDOs that raise serious questions about 
whether these securities should remain a significant vehicle for 
municipal finance in the long term. Congress may wish to tailor any 
government intervention in the municipal bond market relatively 
narrowly to avoid perpetuating such vulnerabilities, to encourage 
market participants to seek private-sector solutions, and to facilitate 
the government's exit from the market.

    Chairman Bernanke, would the high interest rates currently facing 
state and local governments and the lost employment potential as needed 
municipal capital projects remain idle be actionable concerns under the 
Fed's purview?

    As I mentioned in response to the first question, average yields on 
municipal bonds are currently quite low by historical standards. Of 
course, some municipalities are facing difficult financing conditions 
at a time when the recession is causing tax revenues to fall and 
required spending to rise.
    The Federal Reserve seeks to promote the objectives of maximum 
employment and price stability as mandated by Congress. In striving to 
attain these objectives, the Federal Reserve takes account of the full 
range of factors impinging on the current economic situation and the 
outlook for economic conditions in the future. One of those factors is 
the demand for goods and services that states and localities are likely 
to generate. To the extent that conditions in municipal debt markets 
impede that demand, we will certainly modulate our policy stance in an 
offsetting manner, all other factors being equal.

    Chairman Bernanke, if the Federal Reserve has the authority to 
purchase municipal debt, given the extraordinary economic situation 
facing the nation, the extreme hardships facing our states and 
localities, and the immediate benefits that their capital programs will 
provide to our economic recovery, shouldn't the Fed consider this 
option as a tool?

    While Federal Reserve policies have helped and should continue to 
help promote better conditions in municipal securities markets, we have 
important misgivings about assuming a more direct role in those 
markets. In particular, given the extensive fiscal relationships 
between the federal government and state and local governments, it 
seems more appropriate for the Congress to lead the way in addressing 
issues in municipal debt markets. lndeed, this is one reason why the 
Federal Reserve Act imposes limits on the ability of the Federal 
Reserve to purchase municipal debt, including a six-month maturity 
limit. Our misgivings also reflect our determination that we should be 
mindful of the need to protect both the Federal Reserve and federal 
taxpayers from credit losses; and that we should design all our 
interventions in the current financial crisis with a careful eye to 
allowing a clear exit strategy, thereby helping to ensure our ability 
to raise the federal funds rate from its current level once the Federal 
Open Market Committee determines that such a move is necessary to 
promote the mandate given to us by the Congress to foster maximum 
sustainable employment and price stability. For all these reasons, we 
believe that direct policy action, if deemed necessary, is better 
suited to fiscal authorities than to the central bank.

    [Prepared statement and questions for the record submitted 
by Mr. Langevin follow:]

Prepared Statement and Questions Submitted by Hon. James R. Langevin, a 
       Representative in Congress From the State of Rhode Island

    Chairman Bernanke, thank you for your testimony today. One of the 
central challenges facing American businesses and families has been a 
lack of access to adequate credit. The inability to obtain consumer and 
business loans has been a paralyzing force to the economic and fiscal 
well being of the nation.
    I am encouraged by recent indications that the recession may be 
slowing, but ensuring the proper liquidity of our credit markets 
continues to be a top priority. I am particularly interested in your 
efforts to stimulate lending for small businesses, as they are the 
economic backbone of Rhode Island and the Country.
    1. Can you please discuss the progress that has been made under the 
Term-Asset-Backed Securities Loan Program (TALF), which was instituted 
in March to ease credit and help stabilize the financial system?
    2. One of the goals of TALF is to free up lending for small 
businesses and consumers; however, many small businesses in my home 
state of Rhode Island are still unable to access and maintain adequate 
lines of credit. When do you expect small businesses and consumers to 
have access to the lending they need?
    3. Various new outlets (Reuters and AP) reported yesterday that 
demand for Fed loans rose to about $11.5 billion, up 8 percent from May 
and up 145 percent from the first round in March. Do these numbers meet 
with your expectations for growth under TALF?
    4. As credit markets begin to thaw and the recession slows, the 
infusion of more than $1 trillion dollars into our economy could 
present another significant challenge--ensuring the strong value of the 
dollar by guarding against inflation. Are there currently any economic 
indications that inflation might be a risk? What actions does the Fed 
plan to take to avert the potential concerns of inflation?

    [Mr. Bernanke's responses to Mr. Langevin's questions 
follow:]

          Board of Governors of the Federal Reserve System,
                                      Washington, DC, July 7, 2009.
Hon. James R. Langevin,
U.S. House of Representatives, Washington, DC.
    Dear Congressman: Enclosed are my responses to the questions you 
posed following the June 3, 2009, hearing before the House Budget 
Committee on ``Challenges Facing the Economy.'' Your questions dealt 
with the Federal Reserve's Term Asset-Backed Securities Loan Facility 
and with monetary policy and inflation. A copy of my response has also 
been forwarded to the Committee for inclusion in the hearing record.
    I hope this information is helpful. Please let me know if I can 
provide any further assistance.
            Sincerely,
                                           Ben S. Bernanke,
                                                          Chairman.

    Chairman Bernanke subsequently submitted the following in response 
to written questions submitted by Congressman James Langevin in 
connection with the June 3, 2009, hearing before the Committee on the 
Budget:

    1. Can you please discuss the progress that has been made under the 
Term Asset? Backed Securities Loan Program (TALF), which was instituted 
in March to ease credit and help stabilize the financial system?

    Under the TALF, the Federal Reserve Bank of New York (FRBNY) 
extends loans to finance purchases of certain newly issued highly rated 
asset-backed securities (ABS) that are in turn backed by loans to small 
businesses and households. The Board established the TALF after a near-
shutdown in the ABS market last fall contributed to a reduction in 
credit availability. By supporting new issuance of ABS, the program is 
designed to encourage new lending to small businesses and households.
    As initially announced, the ABS eligible to collateralize TALF 
loans include ABS backed by auto loans, credit card loans, student 
loans, and small business loans guaranteed by the Small Business 
Association. The Board subsequently added ABS backed by several 
different types of business loans and leases, and also new and existing 
commercial mortgage-backed securities.
    In March and April, about $3 billion in TALF loans were extended 
each month, a bit below our expectations, in part because it took time 
for investors to work out the necessary legal arrangements associated 
with TALF financing, and reportedly also because investors were 
concerned about participating in a government program. In May and June, 
however, as investor comfort with the program increased, lending picked 
up to about $11 billion a month.
    In May and June, ABS issuance increased to levels approaching those 
recorded prior to the slowdown in the ABS market last fall. Investors 
have purchased and pledged as collateral for TALF loans ABS of nearly 
all the eligible types, including ABS backed by auto loans, consumer 
loans, student loans, small business loans, loans to small businesses 
to purchase property and casualty insurance, and loans to finance 
purchases of business equipment. The strengthening of investor demand 
for ABS has contributed to a narrowing in ABS spreads. Importantly. 
some ABS is now being issued without TALF financing at yields that are 
below the TALF lending rate, an indication that markets are 
normalizing.
    In addition, the expansion in May to new and existing commercial 
mortgage-backed securities (CMBS) should help revive the CMBS market, 
in which there has been no new issuance since the spring of 2008, 
facilitating the extension of new commercial mortgage credit and the 
refinancing of existing credit when it matures. No TALF loans 
collateralized by CMBS have yet been made, in part because CMBS take 
some time to arrange.

    2. One of the goals of TALF is to free up lending for small 
businesses and consumers; however, many small businesses in my home 
state of Rhode Island are still unable to access and maintain adequate 
lines of credit. When do you expect small businesses and consumers to 
have access to the lending they need?

    We recently surveyed lenders that have issued ABS with support from 
the TALF. The issuers reported that the availability of TALF financing 
enabled them to increase lending to small businesses and consumers. 
Several noted that they would have substantially reduced lending 
without the TALF.
    While the TALF and other government programs have helped prevent an 
even more severe contraction in credit availability, credit still 
remains difficult for many small businesses and households to obtain. 
The Federal Reserve's quarterly Senior Loan Officer Opinion Survey on 
Bank Lending Practices has recorded a net tightening in standards on 
loans to small business for eight consecutive quarters. In the survey, 
banks point to a weak economic outlook as the principal reason for 
tightening standards. Credit to small businesses and households will 
likely become more readily available as the economic outlook improves 
and a sustained economic recovery gets under way.

    3. Various news outlets (Reuters and AP) reported yesterday that 
demand for Fed loans rose to about $11.5 billion, up 8 percent from May 
and up 145 percent from the first round in March. Do these numbers meet 
with your expectations for growth under TALF?

    As indicated above, although TALF lending in March and April was 
below our expectations, activity picked up in May and June. Our 
objective in establishing the TALF was to support the extension of 
credit to households and businesses rather than to achieve prespecified 
volume targets for the TALF. The narrowing of spreads in the ABS market 
and the increase in ABS issuance suggests that the TALF is being 
successful in promoting that objective.

    4. As credit markets begin to thaw and the recession slows, the 
infusion of more than $1 trillion into our economy could present 
another significant challenge--ensuring the strong value of the dollar 
by guarding against inflation. Are there currently any economic 
indications that inflation might be a risk? What actions does the Fed 
plan to take to avert the potential concerns of inflation?

    I do not currently see any economic indications that an increase in 
consumer price inflation is a major risk to the economy. The total 
price index for personal consumption expenditures edged up just 0.1 
percent over the 12 months ending in May, while the core PCE price 
index, which excludes the direct effects of movements in food and 
energy prices, rose 1.8 percent over the same period, about 112 
percentage point less than in the previous 12-month period. In 
addition, although the prices for crude oil and other commodities have 
risen recently, we have not seen the sort of run up in labor costs and 
inflation expectations that could lead to a deterioration in the longer 
term outlook for inflation. In particular, wages appear to have 
decelerated noticeably in recent quarters, and although some indicators 
of inflation expectations have increased a little recently, long-term 
inflation expectations still appear to be reasonably well anchored.
    Thus, as was noted in the Federal Open Market Committee (FOMC) 
statement released on June 24, with the substantial amount of resource 
slack that has opened up both here and abroad likely to dampen cost 
pressures going forward, members of the FOMC expect that inflation will 
remain subdued for some time. Some observers have argued that the 
expansion of the Federal Reserve balance sheet associated with our 
policy actions during the financial crisis poses inflationary risks to 
the economy. However, we at the Federal Reserve have judged these 
actions as appropriate in light of the economic weakness and 
significant strains in financial markets, and indeed we anticipate that 
our policy actions will contribute to a gradual resumption of 
sustainable economic growth in a context of price stability. In this 
regard, I would also emphasize that we have the necessary tools to 
remove monetary stimulus in time to head off inflationary pressures if 
they were to emerge. More generally, I can assure you that the Federal 
Reserve remains committed to its dual mandate of fostering full 
employment and price stability, and we will continue to adjust our 
policies in response to the evolving economic outlook and conditions in 
financial markets in order to promote these objectives.

    [Articles for the record submitted by Ms. Kaptur follow:]

    [Published in the June 2009 issue of Bloomberg Markets Magazine]

          BlackRock Is Go-To Firm to Divine Wall Street Assets

            By Kambiz Foroohar and Sree Vidya Bhaktavatsalam

    May 8 (Bloomberg)--Got assets you can't value? Call Larry Fink.
    That's what Federal Reserve Chairman Ben S. Bernanke and Treasury 
Secretary Timothy Geithner have done, as have many heads of banks and 
insurance companies, including Robert Willumstad, former chief 
executive officer of American International Group Inc., and current AIG 
CEO Edward Liddy.
    Fink, 56, is CEO of BlackRock Inc., the U.S.'s biggest publicly 
traded asset management firm, with $1.3 trillion under management for 
clients that include Ford Motor Co. and Microsoft Corp. BlackRock, like 
many other money managers, has taken some hits in the credit crisis. It 
also loaded up on Lehman Brothers Holdings Inc. stock, for example, 
buying shares last June at $28 only three months before Lehman declared 
bankruptcy. One BlackRock fund that rushed in to buy distressed debt in 
September 2007 saw its value plunge 25 percent during the following 12 
months.
    More recently, mirroring results at rival firms, BlackRock's first 
quarter profits fell 65 percent to $84 million after stock and bond 
market declines hurt its fees.
                                dominant
    Fink has a way of making good money in bad times. A decade ago, he 
created a subsidiary called BlackRock Solutions, looking to capitalize 
on ever-more-sophisticated risk-management analytics that the firm was 
running for clients, including mortgage giant Freddie Mac, that needed 
help in assessing stressed portfolios or in deciding whether an 
investment made sense.
    In the unfolding credit crisis, BlackRock Solutions has become the 
dominant player in evaluating and pricing distressed assets such as 
mortgage-backed securities by winning more contracts from the 
government, investment banks and insurance companies than other firms.
    ``It's our fastest-growing unit,'' says Robert Kapito, BlackRock's 
president, citing revenue that doubled to $400 million last year. In 
the latest quarter, the unit's revenue more than doubled to $140 
million from $60 million a year earlier.
    ``BlackRock has established itself as the go-to firm when you have 
problems,'' says Terrence Keeley, a managing director at UBS AG, which 
sold a $22 billion portfolio of subprime mortgages to a fund managed by 
BlackRock.
                          desperate customers
    The terms--in which UBS offered a $7 billion discount and provided 
$11.25 billion in financing--demonstrate how desperate banks are to get 
distressed assets off their books. ``It's hard to replicate the 
BlackRock approach because they built their systems, tools and 
analytics a long time ago,'' Keeley says.
    The Federal Reserve and U.S. Treasury Department have awarded 
contracts to BlackRock Solutions to manage $130 billion in distressed 
debt formerly on the books of investment bank Bear Stearns Cos. and 
crippled financial giant AIG. The Fed called on the company in 
September to analyze the assets of Fannie Mae and Freddie Mac after the 
government took an 80 percent stake in the two mortgage giants. 
BlackRock is also one of four co-managers of a $500 billion Fed 
program, announced in November and expanded to $1.25 trillion in March, 
to buy residential mortgage-backed securities.
    Fink began his career as a bond trader who three decades ago helped 
pioneer collateralized-mortgage obligations, the forerunners of the 
complicated derivatives at the heart of the present crisis.
                             lucrative work
    Over time, Fink and BlackRock Solutions stand to earn tens of 
millions or even hundreds of millions of dollars in fees, primarily 
from lucrative private-sector toxic-asset work, according to Fink and 
people familiar with the contracts.
    ``We're managing hundreds of billions for governments,'' Fink says. 
Asked for details about whom else BlackRock is working for and how it 
actually goes about its tasks, he demurs. ``I have to be opaque,'' he 
says. ``It's hundreds of billions and not necessarily for the U.S. 
government.''
    The Fed and Treasury, beyond confirming Fink's contracts, also have 
little to say about the exact nature of the work--a stance that worries 
some. Janet Tavakoli, president of Chicago-based Tavakoli Structured 
Finance Inc. and the author of three books on derivatives, says the 
government should be more forthcoming.
                         need for transparency
    ``The Federal Reserve and the Treasury would do the world a favor 
by giving us more transparency on AIG and Bear Stearns assets,'' she 
says. ``The regulators have just given up and are just throwing the 
assets with BlackRock and saying `Manage this.' '' (Bloomberg News 
filed a Freedom of Information Act lawsuit in November asking a federal 
judge to require the government to disclose data about the Bear Stearns 
assets.)
    Not content to be a manager of toxic assets with no transparent 
value, Fink is also planning to buy them. He says BlackRock Inc. wants 
to raise $5 billion to $7 billion from investors to participate in a 
government plan, announced March 23 by Geithner, to finance up to $1 
trillion of such purchases. BlackRock intends to apply to become one of 
the five managers under the plan, known as the Treasury Department's 
Public-Private Investment Program. Fink says he sees no conflict of 
interest in being one of the Treasury's managers and participating in 
the plan.
    ``I don't get any inside information, and it's a competitive 
auction pool,'' he says.
                              rescue plans
    In theory, BlackRock Solutions has competition. Goldman Sachs Group 
Inc., for example, has its own risk management teams. Pacific 
Investment Management Co., the world's largest bond manager, has a risk 
management component, as does Legg Mason Inc., a Baltimore-based asset 
management company.
    As Bear Stearns collapsed during a frantic weekend in mid-March 
2008, JPMorgan Chase & Co. called on a BlackRock team of 50 analysts 
and number crunchers who worked around the clock to assess Bear 
Stearns's most illiquid assets.
    At the end of the weekend, Geithner, then chairman of the Federal 
Reserve Bank of New York, called Fink personally to ask him to oversee 
$30 billion in soured mortgage debt that had been cleaved from Bear 
Stearns's books before its viable assets were sold to JPMorgan.
    Likewise, the Fed considered no other company for managing an 
additional $100 billion in AIG assets that the government steered 
Fink's way last November, according to comments from an investigator 
for U.S. Senator Charles Grassley.
    BlackRock had also undertaken a crash mission at the behest of 
AIG's Willumstad during his four-month run as CEO, in a last-ditch 
effort in the summer of 2008 to avoid a government takeover of the 
firm.
                           advanced analytics
    He had them run analytics on his company's portfolio of 
collateralized-debt obligations and credit-default swaps. The 
government intervened before Willumstad could put together a rescue 
plan. That drama unfolded shortly before the government began injecting 
huge amounts of taxpayer capital--$182.5 billion as of April of this 
year--to keep AIG afloat.
    ``We had the expertise; we had already evaluated the assets,'' Fink 
says. ``It's not that we're being opportunistic. We've been in this 
advisory business since 1994.''
    During hearings in Congress in January, Grassley, an Iowa 
Republican and ranking member of the Senate Finance Committee, 
questioned the no-bid government contracts awarded to BlackRock. ``Why 
is it that BlackRock is the only firm qualified to manage the assets of 
special-purpose vehicles?'' he asked.
    Geithner supplied the answer. ``They come with a world-class 
reputation,'' he said. ``We thought the interest of the American 
taxpayer would be best served by having them there on our side as we 
made those consequential judgments.''
                         distressed debt losses
    BlackRock's asset management unit, which accounted for 87 percent 
of the company's revenue last year, has stumbled by investing in assets 
similar to those the government is now calling on BlackRock Solutions 
to manage.
    In April 2008, after the collapse of Bear Stearns, Fink said U.S. 
Treasuries had become too expensive and investors should put money into 
riskier debt such as MBSs. Merrill Lynch & Co.'s U.S. High Yield Master 
II index, which tracks corporate bonds, fell 30 percent between March 
31 and year-end.
    On June 13, 2008, as Lehman Brothers' troubles began to unfold, 
Kapito, BlackRock's president, said, ``We have confidence in the firm, 
in the leadership.'' On Sept. 15, Lehman filed for bankruptcy.
    The $3 billion BlackRock Credit Investors LP fund, created in 
September 2007, sank hundreds of millions of dollars into distressed 
bank loans that continued to plummet as the credit crisis deepened. 
Investors, including pension funds, saw the value of their holdings 
shrink by 25 percent during the next 12 months, according to the New 
Jersey State Investment Council.
                         `good money after bad'
    BlackRock remained bullish and urged investors to increase their 
holdings, and many did. In October 2008, the NJSIC added about $144 
million to the $400 million it had originally put in. The Oregon 
Investment Council added $72 million to its $200 million investment in 
the same fund.
    ``We were throwing good money after bad,'' says Jim Marketti, 
retired president of the Communications Workers of America Local 1032, 
who sits on the board of New Jersey's Division of Investment. ``They 
say these investments will perform well in the long run. Well, in the 
long run, we're all dead.''
    BlackRock was hardly alone in racking up losses. One fund set up by 
rival Pimco to buy troubled mortgages lost 38 percent last year, 
according to investors in the fund who declined to be named. (Pimco 
declined to comment.) ``Even with the best and brightest, BlackRock 
missed what has been a glaring risk,'' says Michael Herbst, an analyst 
at Chicago-based investment research firm Morningstar Inc.
                           long-term optimism
    Fink, while contrite, maintains his long-term optimism. ``Clearly, 
I've been early in calling for clients to take more risks, as our 
balance sheet losses show,'' Fink says. ``In the long term, they'll be 
good investments.''
    For BlackRock's fans, there's no mystery as to why the government 
picked BlackRock Solutions to analyze--without competitive bids--
distressed portfolios. The company's more than a decade of experience 
coupled with its advanced analytics give it an edge over rivals, says 
Peter Federico, Freddie Mac's treasurer.
    You won't get an argument from Morgan Stanley.
    After Lehman's bankruptcy, Morgan Stanley shares went into free 
fall, declining 74 percent in four weeks. The investment bank founded 
by Henry Morgan--the grandson of J. Pierpont Morgan--and Harold Stanley 
needed a lifeline. Mitsubishi UFJ Financial Group Inc. was chewing over 
a possible $9 billion investment.
                           `proctology exam'
    Lazard Ltd., Mitsubishi's adviser, called BlackRock to analyze 
Morgan Stanley's most illiquid commercial-backed securities, since 
Mitsubishi, Japan's largest bank, wouldn't act without reliable data on 
these assets' values.
    One Morgan Stanley executive described the experience as a 
``proctology exam,'' yet after BlackRock delivered its results, 
Mitsubishi went ahead with the $9 billion investment.
    Cleaning up a tainted balance sheet is complicated. Bad assets have 
to be identified and isolated from viable ones, removed from a 
financial institution's books, somehow valued and eventually sold off 
into a secondary market. While that process unfolds, the assets also 
have to be managed. Some are securities that still throw off cash in 
the form of dividends. ``The computations are complex and time-
consuming,'' Federico says. ``BlackRock has the most sophisticated and 
widest range of expertise across all fixed income.''
                          lack of ostentation
    In a photo gallery of archetypes, Laurence Douglas Fink would stand 
out as the middle-aged banker that he is: the tailored suits spiced up 
with the occasional flashy tie, the receding hairline and a demeanor 
rendered slightly professorial by his glasses. At a lectern, he tends 
to gesture a lot with his hands.
    Save for the oblong A. Lange & Sohne watch he wears--an artsy 
German brand whose intricate models can cost $40,000--and a fondness 
for San Pietro, a pricey Manhattan power eatery, Fink shuns most of the 
trappings of Wall Street.
    It's not like he can't afford them. He earned $21 million in 2008, 
down 26 percent from $26.4 million in 2007, according to company 
filings.
    There have been no John Thain-style million-dollar office 
renovations for Fink. He holds forth in a modest, light-filled, fifth-
floor office sporting a couch, a heavy rosewood-colored desk and a 
mundane view of 52nd Street in midtown Manhattan. A green china vase 
filled with striking purple orchids graces a filing cabinet.
                         shoe-store experience
    His prized adornment is a framed platinum CD by Maroon 5, a Grammy-
winning Los Angeles band signed to the record company that Fink helped 
to fund. It leans against a wall. Acquaintances trace Fink's lack of 
ostentation to his roots in Van Nuys, a working-class town in 
California's San Fernando Valley, where he grew up counting laces and 
stacking polish in his father's shoe store.
    His brother Steven B. Fink, now a Los Angeles venture capitalist, 
helped out in the store, too. He recalls Larry as a trenchant observer 
of customers and what they wanted. ``That's a skill that Larry learned: 
being cognizant of other people's needs and desires,'' he says.
    After attending public school in Van Nuys, Fink majored in 
political science at the University of California, Los Angeles. He 
stayed on at UCLA to earn a Master of Business Administration in 1976 
from what's now known as the Anderson School of Management.
                            `brilliant mind'
    Fred Weston, a professor who taught Fink at the management school, 
was so impressed with him that he put a note in his file predicting 
future business triumphs. ``He had an unusually brilliant mind,'' 
Weston says. ``I predicted that he'd be a great success.''
    After getting his MBA, Fink took a job selling bonds at New York-
based investment bank First Boston Corp. (now a part of Zurich-based 
Credit Suisse Group AG), rising to managing director by the age of 28. 
Bond trading, say colleagues who knew him then, made Fink rich but 
didn't affect his West Coast affability.
    Fink's diplomatic skills were on display in 2003, when as a 
director at the New York Stock Exchange, he worked out a deal to 
persuade then Chairman Richard Grasso to step down during a controversy 
over Grasso's $140 million pay package.
    ``He's very sensitive to the fairness of what he does,'' says 
Kenneth Langone, a founder of Home Depot Inc. who served with Fink on 
the NYSE board and was a vocal supporter of Grasso. ``Fink is a voice 
for reason.''
                           scolding congress
    That doesn't mean he can't get riled up. On Sept. 29, 2008, as the 
Dow Jones Industrial Average was falling more than 700 points, Fink 
lashed out at the rhetoric coming out of Congress as it debated the 
need for the government to rescue the banks.
    ``It's abhorrent that Congress is trying to say that this is a 
bailout of Wall Street,'' Fink said during an interview on CNBC. ``This 
package is a bailout of Main Street, and if we don't solve this, Main 
Street is going to feel some very ill effects.'' He went on to suggest 
that the Congressional naysayers--almost all of them at that point 
Republicans--ought to be fired in the next elections.
    Fink has remained married for 34 years to his high-school 
sweetheart, Lori Weider. They have three grown children, including one 
who runs a hedge fund. Fink lives in a co-op on Manhattan's Upper East 
Side in the same neighborhood as other Wall Street leaders such as 
private equity tycoon Henry Kravis.
                             maroon 5 gold
    And while hedge fund managers and stock traders who play in garage 
bands are a dime a dozen, Fink in 2000 took his baby boomer affection 
for rock-and-roll and along with eight colleagues provided $5 million 
in startup capital for an independent record label called Octone 
Records. The company, now known as A&M/Octone, scored big when it 
signed a pop band known as Maroon 5.
    The group has recorded four CDs and sold 15 million albums 
worldwide. Maroon 5 played at BlackRock's 2006 holiday party for 4,000 
people at the Jacob K. Javits Convention Center in Manhattan.
    Fink's rocketlike rise at First Boston was largely a result of his 
creative work with MBSs: the then novel idea of slicing and pooling 
mortgages and selling them as bonds. Fink took his concept to Freddie 
Mac, where he sold the mortgage company's board on a $1 billion package 
of what became known as collateralized-mortgage obligations, or CMOs. 
The $1 billion was three times what he was expecting to sell, he says. 
``What Fink did was a tremendous success and created a huge market,'' 
says Richard Roll, a professor of finance at the Anderson School.
                           swings in fortune
    By 1986, a decade into his First Boston stint, Fink was among the 
firm's rainmakers, along with mergers and acquisitions specialists 
Bruce Wasserstein and Joseph Perella. In the first quarter alone, 
Fink's team made $130 million by amassing a huge position in securities 
known as Z-tranche CMOs: zero-coupon bonds whose value is driven down 
if interest rates fall and prepayments on the bonds climb.
    Fink's hero status was short-lived. The next quarter, interest 
rates fell, and he was hammered. His group posted a loss of $100 
million.
    ``Fink vowed never to be in that situation again,'' says Gregory 
Fleming, a former president of Merrill Lynch who first met Fink in the 
mid-1990s and who helped BlackRock go public in 1999. ``Larry has an 
appropriate sense of paranoia. He thinks bad things can happen and 
often do.''
                         a form of `communism'
    In 1988, Fink joined forces with Ralph Schlosstein, a friend and 
managing director at Lehman Brothers, to start the firm that would 
become BlackRock. It began life as Financial Management Group within 
private equity firm Blackstone Group LP. Blackstone provided an office, 
a telephone line and a $5 million line of credit in return for a 40 
percent stake in the company. In its early days, the firm was an 
egalitarian place. For the first two years, the six original partners 
drew the same salary.
    ``We could focus on building the company without worrying about 
individual incentives,'' says Susan Wagner, one of those partners and 
now BlackRock's chief operating officer. ``Larry and Ralph thought it 
was communism but agreed.''
    In 1994, BlackRock parted company with Blackstone. Fink and 
Blackstone co-founder Stephen Schwarzman had a falling-out over how 
much equity should be awarded to new BlackRock hires. (Schwarzman 
didn't return calls seeking comment.) PNC Bank Corp. of Pittsburgh 
bought Fink's group for $240 million.
                             turning point
    A turning point in BlackRock's fortunes came the next year, when it 
helped General Electric Co. dispose of $10 billion in distressed MBSs 
left over after the Fairfield, Connecticut, company's sale of its 
Kidder, Peabody & Co. brokerage unit to PaineWebber Group Inc. GE's 
financial unit, GE Capital, had tried to sell the assets, only to get 
low-ball bids from investment banks.
    BlackRock was convinced that it could run its sophisticated 
computer models to more accurately assess the value of GE's distressed 
assets.
    ``We said, `We'll analyze the risks and auction the assets,' '' 
Fink recalls. ``'That way, you are not dependent on one price.' ''
    It was BlackRock's analytics that allowed the company to accomplish 
this, says Charles Morris, a New York banker, lawyer and financial 
writer who wrote a book on the global credit crisis called The 
Trillion-Dollar Meltdown (Public Affairs, 2008). ``They had every 
security on a real-time system so they could see what each portfolio 
was doing every minute,'' Morris says.
                             biggest payday
    Within six months, BlackRock had disposed of the portfolio for far 
more than GE expected--saving GE $1 billion. Fink, says Dennis 
Dammerman, who was then CEO of GE Capital, had no idea how to price the 
service he had just rendered. ``If you think we did a good job, pay us 
what you think,'' Dammerman remembers Fink saying.
    The result was a $7 million payday--the biggest fee BlackRock had 
ever received, Fink recalls.
    By 1998, as the use of derivatives and other arcane instruments 
spread throughout finance, Fink saw an opportunity to turn BlackRock's 
risk management services into a separate business.
    Today, BlackRock Solutions occupies three floors of its own 
Manhattan high-rise, directly across the street from the asset 
managers. There, amid arrays of open offices and banks of computers, 
Charles Hallac, head of BlackRock Solutions' day-to-day operations, 
oversees an army of 950 analysts, programmers, economists and other 
number crunchers.
                           parsing complexity
    The group includes 18 Ph.D.'s in such areas as mathematics, nuclear 
physics and aerospace and electrical engineering. BlackRock Solutions' 
client list includes companies and pension funds, such as the 
California State Teachers' Retirement System, that collectively control 
about $7 trillion of assets. The Solutions team is in the business of 
parsing complexity.
    In 1983, when Fink sold the first CMO to Freddie Mac, it had only 
three tranches, or portions, that paid a different interest payment. It 
took a First Boston mainframe a whole weekend to model the payment 
scenario.
    By the 1990s, some of the CMOs contained 125 tranches that were 
almost impossible to understand, Morris says. Those instruments seem 
simple compared with the collateralized debt obligations, or CDOs, that 
are at the heart of the global meltdown. CDOs are pools that bundle 
high-yield subprime mortgages with high-yield loans. The hitch: higher-
than-anticipated default rates among the subprime mortgages in the CDOs 
prompted rating firms to downgrade CDOs to sub-investment-grade debt, 
causing their values to plunge.
                             daunting task
    Analyzing pools of CDOs to determine which are toxic and which 
aren't is a daunting task requiring computing power that simply wasn't 
available 10 years ago. Each CDO may consist of 1,000 loans. BlackRock 
technicians say they have to run 500,000 computer models, in many cases 
tracing a mortgage or a loan back to the homeowner or to the property's 
zip code.
    ``We can model every single item on a balance sheet and project 
cash flows,'' says Mark Wiedman, managing director of BlackRock 
Solutions' advisory group. After running the numbers, BlackRock assigns 
a ``fair value'' to each CDO, a value that's supposed to represent the 
up-to-date value of the loans.
    That doesn't mean people will be willing to buy the assets at that 
price. ``There is a big difference between the fair value of toxic 
assets and their market value,'' says Gregg Berman, co-head of New 
York-based RiskMetrics Group Inc.'s Risk Management unit.
                             hard to value
    To determine a fair-value price, analysts look at the underlying 
collateral and the various tranches and their interest rates. They 
prepare mathematical models to determine default rates, percentages of 
prepayments and interest-rate changes. Different models produce 
different valuations, Berman says.
    The value of a toxic asset largely hinges on the default rates of 
the underlying loans, a figure that can't be precisely predicted, even 
with the most sophisticated of models, he says.
    ``It's almost impossible to figure out the prices of these 
things,'' says Marshall Blume, a professor of finance at the University 
of Pennsylvania's Wharton School.
    Investors who bought into Fink's vision for BlackRock early have 
been rewarded. Fink took the firm public on Oct. 1, 1999, at $14 a 
share. BlackRock's shares climbed an average of 38 percent a year to a 
high of $230.75 on Aug. 11, 2008, before tumbling to $90.57 on March 3, 
hit by the drubbing financial stocks have received in the credit 
crisis. The stock has since staged a rally of 60 percent, closing at 
$144.48 on May 7.
    Fink now finds himself with a new major shareholder: Bank of 
America Corp. It wasn't an alliance he'd planned.
                           looking to expand
    Fink, seeking to expand his firm, began hunting for a partner in 
2005. In January 2006, after weeks of merger talks with Morgan Stanley 
deadlocked when the two firms couldn't come to terms, Stanley O'Neal, 
then Merrill Lynch's CEO, came calling on Fink to talk about a deal.
    By February, Fink had snapped up Merrill Lynch Investment Managers, 
Merrill's asset management business, for $9.5 billion--the largest 
asset management deal ever. In return, Merrill ended up with 49.8 
percent of BlackRock. (PNC reduced its stake to 34 percent.) The deal 
doubled BlackRock's assets under management to $1 trillion, Fink says.
    In October 2007, Merrill's mounting subprime troubles forced it to 
take an unprecedented $8 billion write-off and prompted the board to 
push out O'Neal.
                           merrill contender
    Fink emerged as one of a handful of front-runners for the job. Fink 
wanted a look at Merrill's books before deciding but never got a 
chance; the board appointed John Thain. In September 2008, having 
reported a $19.2 billion loss, Merrill was sold for about $50 billion 
in stock to Bank of America. Thain, O'Neal's replacement, would himself 
soon be fired by Bank of America CEO Kenneth Lewis. That leaves Bank of 
America holding Merrill's 47 percent stake in BlackRock, a position the 
company says it plans to keep. BlackRock on May 6 emerged as one of the 
bidders to make a preliminary offer to buy Bank of America's mutual-
fund unit, according to people familiar with the situation.
    Fink hasn't been bashful about using his BlackRock platform to 
offer advice on fixing the financial crisis. Toward the end of U.S. 
President George W. Bush's administration, Fink counseled then Treasury 
Secretary Henry Paulson on the original rollout of the $700 billion 
Troubled Asset Relief Program, suggesting Paulson use TARP funds to buy 
banks' toxic assets, Fink says.
    Paulson opted instead to acquire equity stakes in banks, and Fink, 
on Dec. 11, publicly called the decision a ``mistake,'' a position he 
says is unchanged.
                            `major mistake'
    ``The major mistake was not putting money in assets,'' Fink says. 
``You can not stabilize equity until you stabilize balance sheets.''
    Fink has since made the same appeal to the administration of Barack 
Obama, talking up the purchase option to both Geithner and Bernanke 
before Geithner made his March announcement. Fink says he's known both 
men for several years, though only through the professional circles 
they all travel in. Politically, Fink is a registered Democrat and says 
he voted for Obama and raised $30,800 at a fundraiser for the 
Democratic Party.
    BlackRock Solutions looks like a terrific investment for Fink. 
Besides its government contracts, the company says that in the last 
four months of 2008 it ran analytics on $1.5 trillion of new assets for 
its private clients. ``The phone was kinda ringing off the hook,'' 
Wiedman says. ``Great for business. Not so good for weekends.''

                [From the New York Times, May 18, 2009]

              Wall St. Firm Draws Scrutiny as U.S. Adviser

               By Eric Lipton and Michael J. de la Merced

    The financial crisis has ravaged many a Wall Street giant, but it 
has also produced a handful of winners. BlackRock, a money manager that 
is much admired but little known outside financial circles, is fast 
emerging as one of the nation's financial powerhouses.
    BlackRock, which started in a one-room office 21 years ago, now 
manages $1.3 trillion in assets for big private clients, including 
hedge funds and foreign governments.
    But it is the company's highly prized role as a government adviser 
and contractor that is now drawing attention.
    By dint of its expertise and track record, it has won contracts to 
help the government manage the complex rescues of Bear Stearns, the 
American International Group and Citigroup.
    It also won a bid to carry out a Federal Reserve program to 
stimulate the moribund housing market, and it has been hired to help 
evaluate Fannie Mae and Freddie Mac, the government-created mortgage 
finance giants.
    Other firms have been hired by the government to assist with the 
bailout, illustrating the increasingly symbiotic relationship between 
Washington and Wall Street.
    It makes sense for the government to turn to financial experts for 
help, but BlackRock has become so ubiquitous that some lawmakers, 
federal auditors and watchdog groups are now asking if the firm does 
too much, and if its roles as government adviser, giant federal 
contractor and private money manager will inevitably collide.
    Can a company that is being paid to price and sell troubled assets 
for the government buy the same kinds of assets for private clients 
without showing preference? And should the government seek counsel from 
a company whose clients stand to make or lose billions if those 
policies are enacted?
    ``They have access to information when the Federal Reserve will try 
to sell securities, and what price they will accept. And they have 
intricate financial relations with people across the globe,'' Senator 
Charles E. Grassley, Republican of Iowa, said. ``The potential for a 
conflict of interest is great and it is just very difficult to 
police.''
    Without naming BlackRock, federal auditors have warned that any 
private parties that purchase distressed assets on the government's 
behalf could use generous federal subsidies to overpay, artificially 
pushing up the price of similar assets that they manage for their own 
portfolios.
    ``In other words, the conflict results in an enormous profit for 
the fund manager at the expense of the taxpayer,'' Neil M. Barofsky, 
the special inspector general for the Troubled Asset Relief Program, 
wrote in a report last month.
    Some of BlackRock's advice to the government has in fact helped the 
company. For example, in its role as an informal adviser, it urged the 
Fed to intervene in the markets in a way that made investors feel it 
was safe to put money back into money market funds, including 
BlackRock's.
    The Federal Reserve will not reveal what it is paying BlackRock, 
disclosing only that on one of its five contracts, it will pay at least 
$71 million over three years to BlackRock and other firms to manage a 
portfolio of mortgage assets once owned by Bear Stearns. BlackRock says 
that rate is discounted and that the fees it collects on bailout-
related work are only a tiny portion of its overall revenue.
    BlackRock has many admirers for the range and the quality of 
services it has provided to the federal government. James R. Wilkinson, 
who served until January as the chief of staff to the former Treasury 
secretary, Henry M. Paulson Jr., described BlackRock's co-founder and 
chief executive, Laurence D. Fink, as a ``patriot.''
    He added, ``He is willing to help our country when we need it 
most.''
    Mr. Fink said he was proud that his company was helping pull the 
economy back from the brink, and he bristled at the suggestion of 
impropriety.
    Treasury and Fed officials have begun to take precautions. 
BlackRock's dominance has prompted the Fed to seek an alternative 
partner as it prepares to expand its rescue efforts, a government 
official close to the situation said, requesting anonymity because the 
actions could affect the market.
    And Treasury is holding off announcing the winning bidders for 
perhaps the most anticipated of all the bailout programs--the $1 
trillion federally subsidized plan to purchase troubled assets from 
banks--in part to make sure the bidders cannot game the system. 
BlackRock is widely expected to win one of the contracts, in which the 
government would be a partner with private firms.
    Andrew Williams, a Treasury Department spokesman, said that 
BlackRock had no special status and was among a large group of industry 
players consulted about bailout programs.
    ``We take this very seriously,'' Mr. Williams said. ``We talk to a 
lot of people--as we should.''
    Now 47 percent owned by Bank of America, BlackRock offers 
traditional services like managing other people's money. But the unit 
that has grabbed most of the attention lately is BlackRock Solutions, 
whose sophisticated software, fine-tuned over many years, can take 
apart the thousands of loans in a mortgage-backed security to estimate 
what it is now worth and what it will most likely be worth in the 
future, helping investors decide whether to hold or sell the asset.
    During one frantic weekend in March 2008, when Bear Stearns was 
collapsing, BlackRock's omnipresence became evident.
    On a Saturday, the firm was hired by JPMorgan Chase--which was 
considering buying Bear Stearns--to value one type of Bear Stearns 
security.
    The next day the Federal Reserve hired BlackRock, through a no-bid 
contract, to analyze and eventually sell off a $30 billion pool of 
risky mortgage securities that JPMorgan did not want.
    Those multiple roles created the potential for conflict, 
BlackRock's own executives acknowledge. The company would be trying to 
sell assets on behalf of the government that were similar to assets it 
buys and sells for thousands of other private investors.
    For example, if BlackRock Solutions signaled to BlackRock's asset 
managers the timing of a planned sale, that could benefit BlackRock's 
investors, but harm taxpayers and the Federal Reserve.
    ``We were very sensitive to it,'' said Mark Wiedman, a managing 
director at BlackRock Solutions.
    To avoid this, BlackRock Solutions and BlackRock asset management 
employees are housed in separate buildings, working on separate 
computer networks. The firm also sells the Bear Stearns securities only 
through an independent broker, meaning BlackRock does not know who the 
buyers are. The Fed, in addition, has prohibited BlackRock from 
knowingly buying any of the Fed-controlled assets.
    But some remain skeptical that such firewalls really protect 
taxpayers.
    ``How can one company have so much control over the process?'' said 
Scott Amey, general counsel at the Project on Government Oversight, a 
Washington-based non-profit group. ``Isn't there somebody else they can 
turn to?''
    The concerns about BlackRock also extend to its role as an informal 
adviser. Mr. Fink has been known to call Treasury officials several 
times a day, Bush and Obama administration officials said, between 
occasional visits.
    Last fall Mr. Fink urged the Fed to take action to unlock the 
frozen market for short-term lending to companies--a business that 
BlackRock's money market mutual funds played a major role in. Investors 
had withdrawn $48 billion from those BlackRock funds, but once the Fed 
adopted the policy Mr. Fink was advocating, the money came pouring 
back.
    Mr. Fink said his advice was for the good of the economy, and that 
his was one of many industry voices calling for such a move.
    Still, Mr. Fink has not been shy in boasting about his access. ``I 
mean it is a great seal of approval,'' Mr. Fink told Wall Street 
analysts in December, as he simultaneously coached the Bush 
administration and the incoming Obama team. ``We are asked to help 
navigate new policy. I'm running out of here to go meet with Treasury 
to talk about plans later this afternoon.''
    But it is clear that the income from fees is a lesser benefit than 
the buffing of its global reputation, a point Mr. Fink has made. ``It 
gives comfort to our clients that we are being involved in some of the 
solutions of our economy, and it allows us to show our clients that we 
are being asked in these difficult situations to provide advice,'' he 
said at the same event.
    BlackRock has not been immune to market turmoil, but its stock over 
the last year has held up better than its peers'. While BlackRock's 
share price tumbled 33 percent, Federated Investors shares have lost 34 
percent and Legg Mason, 65 percent. BlackRock ended 2008, a disastrous 
year for Wall Street, with $786 million in profit on $5 billion in 
revenue.
    Some lawmakers remain wary, even though they cannot cite any 
specific impropriety. ``The very nature of what we are asking them to 
do almost guarantees that it is going to be to the benefit of 
BlackRock,'' said Representative Darrell Issa of California, the 
ranking Republican on the House Committee on Oversight and Government 
Reform. ``You can have separate pews, but if you go to the same church, 
it will cross over.''

    Edmund L. Andrews contributed reporting, and Kitty Bennett 
contributed research.

    [Whereupon, at 12:06 p.m., the committee was adjourned.]

                                  
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