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




 
                  UNWINDING EMERGENCY FEDERAL RESERVE
                  LIQUIDITY PROGRAMS AND IMPLICATIONS
                         FOR ECONOMIC RECOVERY

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             MARCH 25, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-118


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 25, 2010...............................................     1
Appendix:
    March 25, 2010...............................................    57

                               WITNESSES
                        Thursday, March 25, 2010

Ball, Laurence, Professor of Economics, Johns Hopkins University.    47
Bernanke, Hon. Ben S., Chairman, Board of Governors of the 
  Federal Reserve System.........................................     6
Goodfriend, Marvin, Professor of Economics, and Chairman of the 
  Gailliot Center for Public Policy, Tepper School of Business, 
  Carnegie Mellon University.....................................    45
Meyer, Laurence H., Vice Chair, Macroeconomic Advisors...........    42
Taylor, John B., Mary and Robert Raymond Professor of Economics, 
  Stanford University............................................    44

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    58
    Watt, Hon. Melvin............................................    59
    Ball, Laurence...............................................    63
    Bernanke, Hon. Ben S.........................................    69
    Goodfriend, Marvin...........................................    76
    Meyer, Laurence H............................................    82
    Taylor, John B...............................................    90


                  UNWINDING EMERGENCY FEDERAL RESERVE
                  LIQUIDITY PROGRAMS AND IMPLICATIONS
                         FOR ECONOMIC RECOVERY

                              ----------                              


                        Thursday, March 25, 2010

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Waters, Velazquez, 
Watt, Sherman, Meeks, Moore of Kansas, Capuano, Baca, Lynch, 
Miller of North Carolina, Green, Cleaver, Bean, Perlmutter, 
Donnelly, Foster, Minnick, Adler, Grayson, Himes, Peters; 
Bachus, Royce, Paul, Hensarling, Garrett, McHenry, Marchant, 
McCotter, Posey, Jenkins, Lee, Paulsen, and Lance.
    The Chairman. The hearing will come to order, which means 
the photographers will get out of the way. This is an important 
hearing. We have had for some time now the Federal Reserve 
System under the leadership of Chairman Bernanke playing a very 
active role in dealing with the problems generated by the 
financial crisis of 2008 or that culminated in 2008. I believe 
the Federal Reserve has played a very constructive role in 
providing liquidity in ways that helped diminish the negative 
effects, and I believe the chairman and the system have also 
been responsible in making clear that they are aware of the 
need to undo this in a way that is protective of the taxpayers 
but also is not going to damage the economy and is not done 
prematurely.
    The chairman of the Subcommittee on Domestic Monetary 
Policy, the gentleman from North Carolina, Mr. Watt, has been 
closely monitoring this. I think he has been playing a very 
constructive role, and I will be turning over the job of 
presiding over this hearing to him, because he has taken the 
lead in this. And as we said, the Federal Reserve has a dual 
role, which is to make sure that it continues to be supportive 
of the economy, but that it also gets back to a more normal 
status in a way that does not cause damage.
    I will repeat publicly now what I have mentioned privately 
to Chairman Bernanke. Part of my job here as chairman is to 
hear from other members about what their current concerns are. 
Not surprisingly, in a bipartisan way, I have heard concerns 
from a number of members about commercial real estate and the 
impending problems with commercial real estate, with loans that 
have to be rolled over with problems of valuation, people 
concerned that loans that are fully performing in terms of the 
income may be jeopardized. One of the facilities that we are 
talking about here that's due to expire has a role in 
commercial real estate, so while I will not be able to stay for 
the whole hearing, Mr. Chairman, I hope you will be addressing 
what we can do about commercial real estate. I appreciate the 
fact that you, as well as other regulators, had sent some 
members of your staff here to talk to us about what could be 
done. Some of the members on this committee--Ms. Kosmas of 
Florida, Mr. Minnick of Idaho, Mr. Klein of Florida, and Mr. 
Gutierrez of Illinois--have various proposals both to the 
regulators and that could be legislated to deal with this. I 
think there's general agreement that dealing responsibly with 
the commercial real estate is very important.
    One of the things that occurs to me again to stress is some 
of this has to do with concerns over the accounting, and I 
would reiterate the position we have been taking. I don't think 
we should be telling the accounting board what to do or trying 
to, but we can, I think, urge the regulators to show some 
discretion and flexibility as they act on what the accounting 
rules require.
    So with that, I am now going to recognize the gentleman 
from Alabama for 2 minutes, according to the Minority's list, 
and the remainder of the hearing will be under the chairmanship 
of the gentleman from North Carolina.
    Mr. Bachus. Thank you, Mr. Chairman. Thank you for holding 
this hearing, and I thank you, Chairman Bernanke, for your 
testimony. The Federal Reserve, with a trillion-and-a-half 
dollars of additional liquidity in the system, is faced with a 
very difficult problem--how to vacuum that money out fast 
enough to avoid hyperinflation, but to do so without stalling a 
recovery.
    Chairman Frank, an exit strategy is made necessary in the 
first place due partially to a series of interventions by the 
Fed and the Treasury that were both unprecedented and highly 
controversial, the most questionable of which was the use of 
13(3) authorities to rescue individual firms and their 
creditors under the doctrine of ``too-big-to-fail.'' Of course, 
House Republicans have rejected the concept of ``too-big-to-
fail'' in the long term.
    Now is the time for the Federal Government and the Fed to 
get out of the bailout business. As I have said previously, the 
term ``intervention'' implies that the government is 
interfering with the economy and market forces. An intervention 
creates an artificial condition in which the system becomes 
increasingly dependent on government action. You see that with 
the GSEs. As with any addiction, an altered state is created 
where the only choices are permanent addiction or somewhat 
painful withdrawal.
    That is why a centerpiece of the Republican regulatory 
reform solution is not only to end ``too-big-to-fail'' but to 
rein in the Fed's 13(3) authorities consistent with that goal. 
To his credit, Chairman Frank has incorporated several of these 
ideas in the regulatory reform bill that passed the House in 
December. While there was much that we disagree with, the need 
for limitations on the Fed's authority to conduct large-scale 
bailouts of individual firms was one area in which there was 
bipartisan consent.
    In conclusion, withdrawing excess liquidity and returning 
the Fed to its more traditional monetary policy role will be 
difficult. If done incorrectly, it may negatively impact the 
economic recovery and result in higher borrowing costs for 
individuals, corporations and the U.S. Government. But this 
transition must take place.
    Thank you, Mr. Chairman.
    Mr. Watt. [presiding] The gentleman's time has expired, and 
I will yield myself--I think the balance of the time is 5 
minutes.
    In response to the global economic crisis, the Federal 
Reserve injected over $2 trillion into the economy through 
various liquidity initiatives, including the Term Asset-Backed 
Securities Loan Facility, the Commercial Paper Funding 
Facility, and the Fed's commitment to purchase about $1.25 
trillion of mortgage-backed securities.
    The immediate result of the Fed's action was to expand this 
balance sheet dramatically and to put an unprecedented volume 
of money into the banking system. These steps were designed to 
unfreeze the domestic credit markets, and many economists 
credit the decisive steps taken by the Fed with saving the U.S. 
economy from collapse and staving off an economic downturn that 
might have equalled or exceeded the Great Depression.
    The central issue of today's hearing is how the Fed will 
decide the proper timing and sequencing of unwinding these 
emergency liquidity programs. The Fed must withdraw this 
liquidity while keeping inflation in check and encouraging job 
growth, all without hurting the fragile economic recovery that 
is under way. Every analysis I have seen has suggested that 
this is a delicate balancing act that will have to be done just 
right to avoid significant damage to the economy. If recent 
history is any guide, any decisions the Fed makes to carry out 
this delicate balancing act, regardless of what these decisions 
are, will be second-guessed by the Congress and the public, and 
this could also lead to questions about the independence of the 
Fed.
    I'm hopeful that we can use this hearing to understand 
better the policy options available to the Fed to unwind these 
programs and the potential policy implications of these various 
options. At the same time, I think we should be careful not to 
infringe on the Fed's ability and willingness to exercise its 
independent judgment about which options will be the most 
desirable and effective.
    So I view this hearing as an effort to educate members of 
our committee, not as a forum for us to try to intimidate or 
browbeat the Fed into pursuing specific options. We have asked 
the witnesses to provide information about specific monetary 
policy tools and options that are available to the Fed, 
including paying interest on reserves, entering reverse 
repurchase agreements, utilizing the recently introduced Term 
Deposit Facility, conducting direct asset sales of the market-
backed securities it has purchased, and any other options that 
might be appropriate.
    We need to understand the projected advantages and 
disadvantages of each option so we'll understand better what 
the Fed is doing when it uses particular options, and perhaps 
even be in a position to explain to our constituents why 
particular steps are being taken.
    I look forward to Chairman Bernanke telling us how the Fed 
can effectively unwind its emergency liquidity programs while 
reducing inflationary fears, encouraging job growth, and 
managing the fragile economic recovery, knowing full well that 
we all expect him to be the master conductor who will wave the 
magic wand and lead our economy to play sweet music again.
    With that, I will submit the balance of my statement for 
the record, and I will recognize Mr. Paul of Texas, the ranking 
member of the Domestic Monetary Policy Subcommittee, for 3 
minutes.
    Dr. Paul. I thank you, Mr. Chairman, and welcome, Chairman 
Bernanke. On February 24th, we had our Humphrey-Hawkins meeting 
here, and I asked some questions about some of the things the 
Fed had done in the past, and the comments you made included 
the fact that you considered this rather bizarre, what I was 
saying. Chairman Frank followed up with sending a letter and 
asking to get some clarification for you to look into it, and 
even suggested that you and I get together so I can present 
exactly what my concerns are and see if we can resolve it. And 
I'm certainly open to that, so I hope that we can follow up on 
that and the suggestions of Chairman Frank.
    But I also wanted to make a comment about the March 19th 
ruling at the U.S. Court of Appeals in Manhattan, because once 
again, the Federal Reserve lost their case against the--I guess 
it was Bloomberg filing for a Freedom of Information Act for 
information dealing with the $2 trillion of loans during the 
crisis.
    Of course, that was ruled in a lower court, and the Court 
of Appeals has upheld this, and the main argument the Fed uses 
in the court as well as here in the hearings is that if we knew 
so much about these banks and where these loans are going, it 
would stigmatize these companies and banks and do harm to their 
reputation and make our problems worse. I sort of understand 
that argument, even though I don't agree with it, because in a 
way, that challenges the whole notion of what the SEC exists 
for. They want accounting procedures. They don't want to hide 
information. And if they do, if it's not out in front, it 
deceives the investors. So in a way, the SEC is fighting to get 
information to notify investors, and if they don't do it right, 
they get charged with fraud. But it seems to be perverse that 
the Federal Reserve takes a different position that if a 
company is in trouble or a bank is in trouble, what we don't 
want to do is let the customers know. So I find that rather 
challenging, because I think revelation of what's going on, and 
what's going on especially now with the financial crisis, is 
what the American people want.
    I'm also interested in finding out someday whether or not 
you will appeal this case that was ruled on March 19th, and I 
think the taxpayers would like to know how much does the 
Federal Reserve really spend on their legal counsels? I'm sure 
there are a lot of lawyers, and I know you don't have to come 
to the Congress to get an appropriation for this. So I would 
like to know how you pay these bills and how much you pay.
    So these are the things that we need to talk about, but 
also in the question-and-answer session, I do want to bring up 
some specifics about the challenges that you have for someday 
maybe shrinking the balance sheet, but I will pursue that in 
the question-and-answer period. Thank you.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Texas, Mr. Hensarling, is recognized for 1\1/2\ minutes.
    Mr. Hensarling. Thank you, Mr. Chairman. On Sunday night, 
the Nation's fiscal future went from grim to grimmer. If one 
takes out the Bernie Madoff accounting gimmicks like the timing 
shift, the unpaid-for doc fix, the raid on Social Security, and 
the double accounting for the half a trillion dollars of 
Medicare cuts, the true cost of the government health care 
takeover bill is $2.3 trillion, or another $20,000 per American 
family.
    This is on top of the fact that our deficit has increased 
tenfold in the last 2 years. The President has submitted a 
budget that will triple the national debt over the next 10 
years, a budget that even his own OMB Director says is 
unsustainable. Spending as a percentage of the economy is 24.7 
percent of GDP, the highest since World War II. This has caused 
CBO Director Doug Elmendorf to say, ``The outlook for the 
Federal budget is bleak. U.S. fiscal policy is on an 
unsustainable path.''
    Economist Robert Samuelson has said about our spending 
patterns, ``It could trigger an economic and political death 
spiral.'' Unless the Congress and the President have a sudden 
epiphany of fiscal sanity, this story does not have a happy 
ending. It ends in either job-crushing, family-budget-crushing 
tax increases, or skyrocketing interest rates as we beg the 
Chinese to buy more of our debt. Our level of inflation will 
make us look longingly and nostalgically upon the Carter era. 
Clearly, the actions of the President, the Congress, and the 
blurring of the lines with the Federal Reserve between fiscal 
and monetary policy will have much to do with the future, and I 
look forward to the chairman's testimony.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from New Jersey, Mr. Garrett, is recognized for 1\1/2\ minutes.
    Mr. Garrett. Thanks, Mr. Chairman. Today, obviously we're 
going to be discussing the Fed's exit strategy from the 
unprecedented propping up of the economy due to the financial 
crisis.
    Back on February 10th, you were here, and you talked about 
one of the tools that you now have, and that's paying interest 
on reserves held at the Fed. I would think, and experts seem to 
tell me that trying to use this and other tools is going to be 
a real challenge for the Fed in order just to get it all right. 
And that's not just me saying that. Renowned Fed historian Alan 
Meltzer said, for instance, that he believes that the Fed's 
anti-inflationary exit strategy will fail. He asserts that the 
efforts to reduce inflation back during the 1970's failed 
because, as the chairman points out, if you do it prematurely, 
if it ends prematurely. And if it ends prematurely, it's 
because of public pressure, pressure from the public, pressure 
from Congress, from the Administration, and they complain 
loudly because, well, these things affect the employment rate 
or the unemployment rate.
    We're sort of in the same situation today with high current 
and prospective unemployment, and so you may be facing, as you 
realize, a similar dilemma. So, here you have these political 
obstacles, and I'm wondering if the Chairman and others at the 
Fed have concerns about the political ramifications if the Fed 
were to, say, hold reserves on the balance sheet of around a 
trillion dollars, interest rates go up to say around 5 percent 
that you're paying out on those, and in effect, the Fed will be 
paying out, at that rate, $50 billion every year with that 
balance sheet and the interest rates stayed at that level. Some 
might say, then, well, the Fed would be paying $50 billion to 
banks not to lend. So I'll be curious to see how the Fed will 
be able to deal with that political ramifications.
    Mr. Watt. The gentleman's time has expired. We are pleased 
today to have again the Chairman of the Federal Reserve, 
Chairman Bernanke, and we will now recognize the Chairman for 
his statement.

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

    Mr. Bernanke. Thank you, Chairmen Frank and Watt, Ranking 
Members Bachus and Paul, and other members of the committee and 
subcommittee. I appreciate the opportunity to discuss the 
Federal Reserve's exit strategy from the extraordinary lending 
and monetary policies that it implemented to combat the 
financial crisis and support economic activity.
    As you know, I previously submitted prepared testimony for 
a hearing on this topic that was canceled because of weather 
conditions. I requested that testimony be included in the 
record of this hearing. This morning, in lieu of repeating my 
previous prepared statement, I would like to summarize some key 
points from the earlier testimony and update the committee on 
recent developments.
    Broadly speaking, the Federal Reserve's response to the 
crisis and the recession can be divided into two parts. First, 
our financial system during the past 2\1/2\ years experienced 
periods of intense panic and dysfunction during which private 
short-term funding became difficult or impossible to obtain 
from any borrowers. The pulling back of private liquidity at 
times threatened the stability of financial institutions and 
markets and severely disrupted normal channels of credit.
    In its role as the liquidity provider of last resort, the 
Federal Reserve developed a number of programs to provide well-
secured, mostly short-term credit to the financial system. 
These programs, which imposed no cost on taxpayers, were a 
critical part of the government's efforts to stabilize the 
financial system and restart the flow of credit to American 
families and businesses. Besides ensuring that a range of 
financial institutions, including depository institutions, 
primary dealers, and money market mutual funds had access to 
adequate liquidity in an extremely stressed environment, the 
Federal Reserve's lending helped to restore normal functioning 
and support credit extension in a number of key financial 
markets, including the interbank lending market, the commercial 
paper market, and the market for asset-backed securities.
    As financial conditions have improved, the Federal Reserve 
has substantially phased out these lending programs. Some 
facilities were closed over the course of 2009, and most others 
expired on February 1st. The Term Auction Facility under which 
fixed amounts of discount window credit were auctioned to 
depository institutions, was discontinued in the past few 
weeks. As of today, the only facility still in operation that 
offers credit to multiple institutions, other than the regular 
discount window, is the Term Asset-Backed Securities Loan 
Facility or TALF, which has supported the market for asset-
backed securities, such as those backed by auto loans, credit 
card loans, small business loans, and student loans.
    Reflecting notably better conditions in many markets for 
asset-backed securities, the TALF is scheduled to close on 
March 31st for loans backed by all types of collateral except 
newly issued commercial mortgage-backed securities or CMBS, and 
on June 30th for loans backed by newly issued CMBS.
    In addition, the Federal Reserve has been normalizing the 
terms of regular discount window loans. We have reduced the 
maximum maturity of discount window loans from 90 days to 
overnight for nearly all loans, restoring the pre-crisis 
practice. In mid-February, the Federal Reserve also increased 
the spread between the discount rate and the upper limit of our 
target range for the Federal funds rate from 25 basis points to 
50 basis points.
    We have emphasized that both the closure of our emergency 
lending facilities and the adjustments to the terms of discount 
window loans are responses to the improving conditions in 
financial markets. They are not expected to lead to tighter 
financial conditions for households and businesses, and hence 
do not constitute a tightening of monetary policy, nor should 
they be interpreted as signaling any change in the outlook for 
monetary policy.
    The second part of the Federal Reserve's response to the 
crisis and recession, besides the provision of liquidity to the 
financial system, involves both standard and less conventional 
forms of monetary policy. After reducing short-term interest 
rates nearly to zero, the Federal Open Market Committee 
provided additional monetary policy stimulus through large-
scale purchases of Treasury securities, agency mortgage-backed 
securities, and agency debt. All told, the Federal Reserve 
purchased $300 billion of Treasury securities and will conclude 
purchases of $1.25 trillion of agency MBS and about $175 
billion of agency debt at the end of this month.
    The Federal Reserve's purchases have had the effect of 
leaving the banking system highly liquid, with U.S. banks now 
holding more than $1.1 trillion of reserves with Federal 
Reserve banks. A range of evidence suggests that these 
purchases and the associated creation of bank reserves have 
helped improve conditions in mortgage markets and other private 
credit markets and put downward pressure on longer-term, 
private borrowing rates and spreads.
    At its meeting last week, the FOMC maintained its target 
range for the Federal Funds Rate at zero to one-fourth percent, 
and indicated that it continues to anticipate that economic 
conditions, including low rates of resource utilization, 
subdued inflation trends, and stable inflation expectations are 
likely to warrant exceptionally low levels of the Federal Funds 
Rate for an extended period.
    In due course, however, as the expansion matures, the 
Federal Reserve will need to begin to tighten monetary 
conditions to prevent the development of inflationary 
pressures. The Federal Reserve has a number of tools that will 
enable it to firm the stance of policy at the appropriate time.
    Most importantly, in October 2008, the Congress gave the 
Federal Reserve statutory authority to pay interest on balances 
that banks hold at the Federal Reserve banks. By increasing the 
interest rate on banks' reserves, the Federal Reserve will be 
able to put significant upward pressure on all short-term 
interest rates, as banks will not supply short-term funds to 
the money markets at rates significantly below what they can 
earn by holding reserves at the Federal Reserve banks. Actual 
and prospective increases in short-term interest rates will be 
reflected in turn in higher long-term interest rates and in 
tighter financial conditions more generally.
    The Federal Reserve has also been developing a number of 
additional tools it will be able to use to reduce the large 
quantity of reserves currently held by the banking system. 
Reducing the quantity of reserves will lower the net supply of 
funds to the money markets, which will improve the Federal 
Reserve's control of financial conditions by leading to a 
tighter relationship between the interest rate paid on reserves 
and other short-term interest rates.
    Notably, to build the capability to drain large quantities 
of reserves, the Federal Reserve has been working to expand its 
range of counterparties for reverse repurchase operations 
beyond the primary dealers and to develop the infrastructure 
necessary to use agency MBS as collateral in such transactions. 
In this regard, the Federal Reserve recently announced the 
criteria that it will be applying in determining the 
eligibility of money market mutual funds to serve as 
counterparties in reverse repurchase agreements.
    As an additional means of draining reserves, the Federal 
Reserve is also developing plans to offer to depository 
institutions term deposits which are roughly analogous to 
certificates of deposit that the institutions offer to their 
own customers. A proposal describing a Term Deposit Facility 
was recently published in the Federal Register, and the Federal 
Reserve is finalizing a revised proposal in light of the public 
comments that have been received. After a revised proposal is 
reviewed by the Board, we expect to be able to conduct test 
transactions this spring and to have the facility available if 
necessary thereafter.
    The use of reverse repos and the deposit facility would 
together allow the Federal Reserve to drain hundreds of 
billions of dollars of reserves from the banking system quite 
quickly should it choose to do so.
    When these tools are used to drain reserves from the 
banking system, they do so by replacing bank reserves with 
other liabilities. The asset side and the overall size of the 
Federal Reserve's balance sheet remain unchanged. If necessary, 
as a means of applying monetary restraint, the Federal Reserve 
also has the option of redeeming or selling securities. The 
redemption or sale of securities would have the effect of 
reducing the size of the Federal Reserve's balance sheet as 
well as further reducing the quantity of reserves in the 
banking system. Restoring the size and composition of the 
balance sheet to a more normal configuration is a longer-term 
objective of our policies.
    In any case, the sequencing of steps and the combination of 
tools that the Federal Reserve uses as it exits from its 
currently very accommodative policy stance will depend on 
economic and financial developments and our best judgments 
about how to meet the Federal Reserve's dual mandate of maximum 
employment and price stability.
    In sum, in response to severe threats to our economy, the 
Federal Reserve created a series of special lending facilities 
to stabilize the financial system and encourage the resumption 
of private credit flows to American families and businesses. As 
market conditions and the economic outlook have improved, these 
programs have been terminated or are being phased out.
    The Federal Reserve also promoted economic recovery through 
sharp reductions in its target for the Federal Funds Rate and 
through large-scale purchases of securities. The economy 
continues to require the support of accommodative monetary 
policies. However, we have been working to ensure that we have 
the tools to reverse at the appropriate time the currently very 
high degree of monetary stimulus. We have full confidence that 
when the time comes, we will be ready to do so.
    Thank you, Mr. Chairman.
    [The prepared statement of Chairman Bernanke can be found 
on page 69 of the appendix.]
    Mr. Watt. I thank the Chairman for his statement, and we 
will now recognize members for 5 minutes each. I will recognize 
myself initially for 5 minutes.
    Chairman Bernanke, I guess one thing I usually am pretty 
aggressive about is the balance between unemployment and 
inflation or an emphasis on unemployment, and again there seems 
to be more emphasis in your statement about making sure we 
counter inflation than on the employment side. So I guess my 
first question would be, how should the high unemployment rate 
factor into the Fed's timing and sequencing decisions? And if 
you could elaborate on that a little bit more.
    Mr. Bernanke. Certainly. Of course, as you know, we have a 
dual mandate from the Congress to pursue both maximum 
employment and price stability, and we intend to do that. The 
two are mutually reinforcing, in particular maintaining stable 
inflation over the longer term increases economic growth and 
improves employment potential in that respect. So it's very 
important that we pay attention to both sides of the dual 
mandate, and we will do so.
    Currently, the employment situation is very weak, as you 
know. The unemployment rate is close to 10 percent, and about 
40 percent of the unemployed have been unemployed for a long 
term. In response to that, the Federal Reserve has been 
maintaining extremely accommodative policies. We have lowered 
the interest rate almost to zero. We have increased the size of 
our balance sheet, as I described, to $2.3 trillion, 2\1/2\ 
times what it was before the crisis. So, we are producing some 
very substantial support for the economy. And as we have 
indicated in our statements, we believe that the overall 
configuration of resource utilization and inflation will be 
such that accommodative policy will be justified for an 
extended period. And so we are certainly not ignoring that side 
of our mandate.
    Mr. Watt. I'm sure my ranking member may think that I'm 
throwing you a softball when I ask this question, but I seem to 
detect in your statement a greater emphasis on transparency at 
the Fed, particularly on page 4 where you say that the Federal 
Reserve recently announced the criteria that it will apply to 
determine the eligibility of money market mutual funds to serve 
as counterparties. That's something that you are announcing 
pretty far in advance. And then a proposal describing a Term 
Deposit Facility was recently published in the Federal 
Register, and the Federal Reserve is finalizing a revised 
proposal. Am I misreading that you all seem to be putting a 
greater emphasis on providing more transparency to the public 
and to the people that you deal with about how the Fed is going 
to play this out?
    Mr. Bernanke. We have been very much committed to 
maintaining high transparency. We will continue to explain and 
communicate as clearly as possible our criteria and how we're 
going to forward with withdrawing stimulus. And we'll be 
providing information, as we already are, for example, on the 
specifics of our asset purchases and what we hold.
    As I mentioned in my testimony, we have just recently 
phased out, and with the TALF in June we will have phased out 
all of our 13(3) facilities that we created to support troubled 
financial markets. And as I mentioned in my Humphrey-Hawkins 
testimony before this committee, we are quite open to a very 
full auditing of those facilities by the GAO, including with an 
appropriate delay the names of all the firms to which we made 
loans. So we understand the importance of transparency, and I 
promise you that we will continue to do that.
    Mr. Watt. And you have announced closing dates for a 
couple--at least one of the facilities--March 31st and June 
30th. Are there potential specific impacts that we could see 
from closing those facilities? Could you elaborate on whether 
there may be specific impacts in doing that?
    Mr. Bernanke. Mr. Chairman, these facilities were created 
under the 13(3) emergency authority because conditions were 
unusual and exigent. The markets were highly disrupted, and 
highly dysfunctional. In substantial part because of our 
interventions, those markets are now working quite normally. So 
there's no longer a justification for holding those facilities 
open. And as I mentioned, we had closed most of them as of 
February 1st, and so far we have seen no adverse circumstances.
    In the case of the asset-backed securities market, which is 
the one remaining area where we are providing support, while 
that market has not completely returned to normal, we have seen 
considerable improvement. For example, the spreads between the 
ABS yields and the Treasury yields have come in considerably. 
Those markets are now exhibiting issuances without any kind of 
Fed support. And so, you know, we believe that it's appropriate 
as those markets are returning to a more normal condition that 
we withdraw that support.
    Mr. Watt. Thank you. My time has expired and I'll recognize 
the gentleman from Alabama, Mr. Bachus.
    Mr. Bachus. Thank you. Chairman Bernanke, I want to 
acknowledge that you have been talking about transparency for 
several years, and you have been an advocate on the Board, and 
I appreciate that. I think there are distinctions we draw 
between transparency when it comes to the 13(3) actions and 
monetary policy, and I think there's a consensus on the 13(3) 
programs, and some of the extraordinary things, and I think 
that we can get there on the monetary policy.
    As part of your quantitative easing strategy, you're going 
to stop purchasing mortgage-backed securities at the end of 
this month. Does that indicate that you believe that maybe 
housing has reached a sustainable level?
    Mr. Bernanke. Well, the housing market, Congressman, as we 
all know, is still quite weak, and we have just seen some very 
weak sales numbers in the last few days. But we do believe that 
the mortgage markets are performing better and mortgage rates 
are quite low from a historical perspective, and moreover, our 
purchases of mortgage-backed securities were also intended to 
create better conditions in private credit markets more 
broadly. And we're seeing, for example, record issuance in the 
corporate bond market. So we think that our program has been 
effective.
    We announced quite a while ago that we were going to stop 
those purchases, taper off those purchases at the end of this 
quarter. When we did that, we of course were concerned that 
when we stopped that, mortgage rates might pop back up or we 
might see some fallback in financial conditions. We'll of 
course continue to watch that situation, but so far, there 
seems to be very little negative reaction, which is 
encouraging, and that would allow us to stop our purchases 
without concerns about the implications for the economy.
    Mr. Bachus. I guess that is some indication that you 
believe we may have reached sustainable prices in housing or at 
least the short-term prospects for housing are more stable?
    Mr. Bernanke. As I have said in the past, knowing the 
correct value for any asset is a difficult challenge, but many 
economists have pointed out that the ratio of house prices to 
rents, for example, is very much in a normal range, and between 
low mortgage rates and the decline in house prices, 
affordability of housing for people who want to buy homes is 
now at a very good level.
    Mr. Bachus. All right. Thank you. I appreciate that some of 
the actions that were taken in the financial markets by the Fed 
were a result of an economy that was under extreme stress. I'm 
not sure the American people realize the challenges, and they 
were somewhat unprecedented. And so I think some of the actions 
that were taken were, because of financial markets, in what I 
have said was a heart attack or a stroke condition almost.
    Having said that, we want to avoid that in the future. And 
my concern as we're talking about regulation, we're talking 
about tools to deal with this, but--and I would like your 
thoughts on this. I don't believe that even with all the tools 
and all the regulations, if we don't get our fiscal house in 
order, the Congress, you're not going to be successful. I think 
reining in the growth of debt is simply going to be impossible 
for you to do your job if we don't do ours. And I have listed 
budget reform, entitlement reform, tax reform.
    I think--do you agree that those--it's critical for 
Congress to take action and do that now to avoid another 
catastrophic event, whether it's 2 years, 5 years or 10 years 
from now?
    Mr. Bernanke. Congressman, we have very high deficits this 
year and next year, and given the severity of the recession, 
it's unlikely we could get a balanced budget in the next year 
or two. And I think we all understand that.
    But my concern is that our projections, whether they come 
from the Administration or from Congress or from outside 
analysts, still show deficits between say 2013 and 2020 of 
between 4, 5, 6, and 7 percent of GDP, which, if that happens, 
would cause the ratio of debt outstanding to our GDP to rise to 
very high levels. I think while that's still sometime in the 
future, the risk exists that even today investors, creditors 
might become concerned about our ability to maintain a 
sustainable fiscal position.
    So I think it is very important that the Congress try to 
develop a plan, a program, an exit that will be a credible plan 
for returning to a sustainable fiscal situation over the next 
few years.
    Mr. Bachus. Thank you.
    Mr. Watt. The gentleman's time has expired. The gentlelady 
from California, Ms. Waters, is recognized for 5 minutes.
    Ms. Waters. Thank you very much, Mr. Chairman. I would like 
to thank Mr. Bernanke for being here today. The last time he 
was here, we had a limited discussion about the Federal funds 
rate. There's going to be some testimony here today by Dr. Ball 
of Johns Hopkins, where he says the Fed should not raise the 
Federal funds rate in the near term. His exact quote is, 
``Someday the economy will recover and the Fed should raise the 
Federal funds rate, not soon but someday.'' Would you agree 
with this assessment? How long would unemployment have to go in 
order for you to think it was appropriate to raise the Federal 
funds rate? Do you agree with Dr. Ball's assessment that the 
Fed should give greater weight than usual to unemployment when 
deciding how to set rates?
    I raise this question because, as you know, the National 
Urban League released its State of Black America report for 
2009 yesterday. We know that last month, Blacks were unemployed 
at nearly twice the rate of Whites, 15.9 percent to 8.8 
percent. The gap since 1974 is just barely closing. In 
considering the question on the Federal funds rate, do you 
consider this wealth and employment gap to be a serious 
problem? Do you think that a rising tide for the overall 
economy will actually reduce the gap? Based on your experience 
as an economist, should we be targeting stimulus to the 
communities with the greatest needs? On and on and on. I guess 
I have been talking to you and others about the unemployment 
rate among African Americans, Latinos, and the rural poor for a 
long time. I hear nothing about what we can do in terms of 
targeting. I hear no plan coming forth about how we can involve 
these communities in opportunities that would reduce the 
unemployment. Can you help me out with this in some way today, 
in talking about the Federal funds rate or any other aspect of 
your responsibility to help us understand what we can do?
    Mr. Bernanke. Certainly. First, we are in complete 
agreement that the high unemployment rate is a tremendous 
social and economic problem in the United States today, and 
just a quick look at the figures verifies that minority 
immigrant populations suffer from much higher unemployment 
rates than the average.
    And that's bad for social integration, it's bad for 
progress in the communities, so I absolutely agree with you 
that's a very severe problem, particularly when you have as you 
have today a lot of long-term unemployment. Because it's one 
thing to be out of work for a month or two, but if you're out 
of work for 6 months or a year, then you begin to lose your 
skills, you begin to become very unattractive to employers, and 
it's clearly a long-term negative and not just a short-term 
negative.
    As I have said to Chairman Watt, the Federal Reserve takes 
very seriously its responsibility to try to induce maximum 
employment, and that's precisely why we have done these 
extraordinary things to go beyond zero interest policy to 
expanding our balance sheet and providing as much stimulus as 
we can to get the economy moving again, and we consider that to 
be very important.
    As we exit at some point, of course, we'll try to pay 
attention--we will pay attention to employment and how that's 
evolving. We will not be able to wait until things are 
completely back to normal, because monetary policy takes some 
time to operate, and given those lags, we're going to have to 
anticipate to some extent the return of the economy back to 
normal conditions. But we certainly want to be sure that the 
economy is on a sustainable growth path and that jobs are being 
created as we begin to withdraw some of the--
    Ms. Waters. Excuse me, Mr. Chairman, I don't want to 
interrupt you. Do you have any ideas about what we could do 
about the extreme unemployment in these communities, rural 
poor, African Americans, Latinos?
    Mr. Bernanke. Sure.
    Ms. Waters. I understand what you're saying, and you 
correctly described the problem, reiterating what we all know, 
but what plans, what ideas do you have about how we can target 
these communities to get rid of this unemployment?
    Mr. Bernanke. Well, I was talking about the Federal 
Reserve's role, but there are certainly a number of things that 
Congress can consider.
    Ms. Waters. Well, now I really do want to know the Federal 
Reserve's role. Is there anything that you can recommend?
    Mr. Bernanke. I can recommend things. For example, I met 
yesterday with Community Development Financial Institutions, 
CDFIs--I'm sure you're familiar with those--who are taking 
funding and bringing it to underserved communities to try to 
create economic opportunities. I think that's a very valuable 
direction.
    I know Congress is looking at education and training 
issues, and I think given the long-term unemployment issues, 
trying to make sure people can either retain their skills or 
get new skills is going to be very, very important. There are a 
number of proposals out there for job creation through fiscal 
measures. I think it's really up to Congress to decide what 
combination of actions to take, but certainly there are things 
that you can do through the States, for example, to try to 
increase employment. But many of those programs are fiscal, and 
therefore are the appropriate province of the Congress.
    We at the Federal Reserve have a lot of economic analytical 
capability, and as you know, we are always willing and 
interested to provide technical assistance to any 
Congressperson working on a program. We have worked with 
Treasury on their employment programs, and we stand ready to 
provide any kind of help we can, and if you have some specific 
things you would like us to work with you on.
    Mr. Watt. That might be one of those issues that we want to 
pursue outside the context of this hearing. The gentlelady's 
time has expired, and the gentleman from Texas, Mr. Paul, is 
recognized.
    Dr. Paul. I thank the gentleman for yielding. I imagine 
everybody agrees that the increase in the monetary base in this 
last year-and-a-half is probably historic. I don't think we 
have much in our history to look back at as a precedent. So I 
would assume that we can't look back too easily and look at 
trying to solve a problem like this and what we have to do and 
how much the monetary base has to shrink.
    As we talk about this, I think most people assume that 
they're waiting for a signal from you when the balance sheet 
might shrink. But even in the Depression, when it shrunk 16 
percent, it wasn't done purposely; it was the way the system 
was working back then. Can you give me a rather quick answer on 
this? Do you have any idea what percentage the base should 
shrink or might shrink, or is that something that you don't 
even want to address?
    Mr. Bernanke. No. I think we would like to bring the 
balance sheet back to something consistent with where it was 
before the crisis, which means enough to accommodate Americans' 
demand for currency plus a modest amount of reserves in the 
banking system, and that would suggest something under a 
trillion dollars I think would be--
    Dr. Paul. A trillion dollars?
    Mr. Bernanke. Or less, yes.
    Dr. Paul. Okay. Of course, that would be very 
unprecedented. During the crisis that Paul Volcker had to deal 
with from 1979 to 1982, it was considered a major problem. The 
inflation got out of hand at 15 percent and he had to come in 
and do something. And I guess the question is, how much did he 
have to shrink the balance sheet during those 3 years?
    Mr. Bernanke. Well, not very much. He was focused on money 
growth in particular. So he wasn't clearly in a situation where 
we are now where there are these large, unused balances. I 
would point out that he was focused on M1 and M2 growth. M1 and 
M2 are not doing anything now. They're very flat. It's just the 
base, as you point out.
    Dr. Paul. Excuse me, but the truth is, is during that time, 
which was considered very tight money, the monetary base was 
still growing, during those 3 years, the monetary base grew 31 
percent. So my suggestion is, it might not be so easy to cut 
back, because even in the midst of an inflationary crisis like 
that, because maybe in 6 months or a year from now when you 
decide to do something, maybe there will be an increase in M1 
and M2, and then it will be a different ball game when you're 
dealing with this.
    But I have another question dealing with something you said 
on page 4 when you talked about one tool that you will have. 
Because quite frankly, I think if we get into a situation where 
this housing crisis reemerges, which I believe it is, it is 
going to be difficult for you to do what you say, because 
that's why you have been obviously hesitant to do anything.
    But you said one of your tools will be to pay interest on 
the balances, and that will cause banks to do different things 
and borrowers to do different things. And of course, I see that 
as a method of price fixing. In the early part of the last 
century, the free market economists said that socialism 
couldn't work. It wouldn't work. It would fail. And socialism 
and communism would fail because of pricing. And I assume that 
you would endorse this principle that wage and price controls 
aren't necessarily the best way to handle rising prices. Is 
that a safe assumption?
    Mr. Bernanke. Absolutely.
    Dr. Paul. Okay. My question and concern in economic policy 
is, isn't fixing interest rates in order to get the economy to 
do something a form of price fixing? The importance of prices 
in a free market is to tell the businessman and the consumer 
what to do. If the price is too high, they don't buy, and the 
businessman responds to supply and demand. Why is that not true 
in money? Money is one-half of every transaction. So if we're 
working on this false assumption that you're exempt from the 
market forces and you have some type of unique ability to say, 
ah, interest rates are different. I know what is best. I know 
what they should be. They should be zero percent for 15 months 
instead of 16 months. Why does that logic not apply to fixing 
interest rates?
    Mr. Bernanke. Because if you believe that wages and prices 
are not perfectly flexible, and there are many that are not, 
then the economy can get pushed away from full employment, as 
it obviously is today. And economists of all stripes, including 
Milton Friedman and others, agree that using monetary policy, 
monetary policy can be a useful tool to try to create growth 
and stability. In this particular case, low interest rates 
create more demand and can help bring the economy back to full 
employment.
    Now obviously there are limits to that, and we recognize 
those limits, but changing the interest rate is really just the 
other side of changing the quantity. Quantity and price are two 
sides of the same equation, as you know. So we can either 
change the quantity or we can change the price. By changing the 
price, we affect economic activity and try and achieve the 
objectives that the Congress has given us.
    Dr. Paul. Well, my fear is--
    Mr. Watt. The gentleman's time has--
    Dr. Paul. --that your results will be the same as wage and 
price controls.
    Mr. Watt. The gentleman's time has expired. The gentlelady 
from New York, Ms. Velazquez.
    Ms. Velazquez. Thank you, Mr. Chairman. Good morning, 
Chairman Bernanke.
    Mr. Bernanke. Good morning.
    Ms. Velazquez. The Central Bank is currently in the process 
of winding down the TALF facility which provided vital 
liquidity for commercial real estate and small business 
lending. Many experts have expressed concern that these lending 
sectors remain vulnerable to further losses. Without the TALF, 
what will the Fed do in the event that instability returns in 
the CRE or small business lending markets?
    Mr. Bernanke. Let me put aside just for a moment the CRE. 
In the other categories, credit cards and auto loans and 
student loans and small business loans, we have seen the 
secondary market, asset-backed securities market, coming back 
pretty well, and we have been seeing spreads that are normal. 
We have been seeing issuance outside the Fed's facility. So 
it's not 100 percent normal, but we have seen considerable 
improvement in those asset-backed securities markets.
    Now CRE is a difficult problem, as you know, and the basic 
reason at this point is that the prices of commercial real 
estate across the country have dropped, in many areas 40 
percent or more, which obviously makes the creditworthiness or 
their credit risks much greater, and has made it much more 
difficult to obtain credit.
    We have been attacking that issue from a number of fronts 
at the Federal Reserve. The TALF is just one dimension. The 
commercial mortgage-backed securities market is not completely 
normalized, but it has improved, and those spreads have come 
in. And we believe that it's getting more and more difficult 
for us to justify our unusual and exigent emergency powers in 
the context of a market that is improving.
    But we recognize there are a lot of issues still, and 
that's why we have, for example, issued guidance to the banks 
about how to manage their CRE portfolios, and in particular how 
to make sure that they provide credit where the borrowers are 
creditworthy, and try to help them work out loans that are 
troubled and find ways to solve that problem.
    So we're working more through the banks now at this point 
than through the MBS market or CMBS market. But that is a 
troubled, certainly one of the most difficult areas right now.
    Ms. Velazquez. Mr. Chairman, we continue to hear that small 
businesses are facing a problem of accessing credit. In your 
view, is the lack of liquidity the root cause of credit for 
small businesses? What is it?
    Mr. Bernanke. Well, there are a lot of reasons. There has 
certainly been a big drop in the demand for credit from small 
businesses because of weakness of the economy. And in some 
cases, small businesses have had financial reverses, which make 
it much more difficult to lend to them. But all that being 
said, there certainly are creditworthy small businesses that 
cannot obtain credit, and again, that has been an important 
priority of the Federal Reserve, and we have worked with the 
Congress and the Treasury as well to try to support small 
business lending.
    Once again, we have issued guidance to the banks about 
encouraging lending to small businesses and have trained our 
own examiners to take a balanced perspective, that they not 
over-penalize loans to small businesses. We are trying to get 
as much feedback as we can. For example, we have inserted 
questions in the NFIB survey to get back more information from 
small businesses about their credit experience. And currently, 
our reserve banks around the country are holding meetings with 
small businesses, banks, and community development groups to 
try to understand better what the issues are and how we can 
improve small business lending.
    So it's a tough problem. I think there are some proposals 
from Treasury that I think are worth looking at, but we are 
certainly working with the banks on this issue.
    Ms. Velazquez. Can we talk about the $30 billion proposal 
from Treasury for a moment? Should regulators be concerned that 
the banks who participate in this program may stretch to make 
imprudent loans in an effort to reach lending levels that 
deliver higher interest rate incentives?
    Mr. Bernanke. There are various ways to structure the 
program, but all the ones that I understand basically make the 
bank have some skin in the game. That is, they share in the 
loan, and if the loan goes bad, then they'll lose at least part 
of the loss. And I think that's the reason to try to use the 
small banks in particular to make these loans, because they 
have the information and the expertise to make them. So as long 
as the banks have sufficient incentive to make good loans 
because they'll lose money if they don't, then I think that 
will reduce that risk considerably.
    Ms. Velazquez. And do you think that without any strings 
attached to the $30 billion that the banks will make small 
business loans?
    Mr. Bernanke. There should be strings attached in terms of 
being able to report that they increased their lending by a 
certain percentage.
    Mr. Watt. The gentlelady's time has expired.
    Ms. Velazquez. Thank you.
    Mr. Watt. The gentleman from California, Mr. Royce.
    Mr. Royce. Chairman Bernanke, I think most economists 
believe that creating a massive new entitlement, the health 
care entitlement bill that we passed, is going to add to our 
deficit. I do not think anyone in here believes that we are 
going to cut half a trillion dollars out of Medicare, as we say 
we are in the bill, in order to help pay for it. So, Congress 
is adding to the deficit. And on that note, in recent weeks, 
Brookshire-Hathaway and Proctor and Gamble, and Lowes, and 
Johnson and Johnson's debt traded at lower levels, lower 
yields, than Treasuries of similar maturity.
    And essentially, the market is saying it is now safer to 
loan to Warren Buffet than it is to the United States 
Government. Now, Mr. Geithner disagreed with that conclusion or 
that assessment. I would just ask you your view, because I do 
not know what else it could mean, and I would also ask if you 
have ever seen this in the bond market? What does this say 
about our fiscal outlook?
    Mr. Bernanke. It is very unusual, certainly. There are a 
number of possibilities. The one you raised, I guess, is one 
possibility, although if the U.S. Government is not paying off, 
then there's going to be a huge amount of economic dislocation 
that would affect everybody.
    I think one of the issues recently has been, and this would 
be consistent with what you are saying, that the U.S. 
Government's very large debt issuances have been very big 
auctions with lots of borrowing going on, has put some pressure 
on the normal purchasers of that debt and they have had a 
preference for diversifying into corporate debt, as you 
described. So--
    Mr. Royce. But, let me ask you about that because the 
Federal Reserve in one analysis I saw purchased a staggering 80 
percent of the $1.5 trillion of debt issued by the Federal 
Government last year. If we run a trillion and a half deficit 
here, somebody has to buy it. And I think it was the PIMCO 
analysis that said that 80 percent of that was bought by the 
Federal Government.
    I know there was some opposition from some people within 
the Fed in terms of doing that, but you have pundits quipping 
that, in essence, this is like a Ponzi scheme. So, with 
yesterday being the worst day since last July for 10-year U.S. 
Treasuries, is the Federal Reserve considering getting back 
into the business of buying U.S. Treasuries or are we laying 
off of that approach for awhile?
    Mr. Bernanke. Well, Congressman, that number is not 
correct. We purchased last year $300 billion in Treasuries, 
which was much less than 80 percent and that total number 
brought us back to $790 billion which is about where we were 
before the crisis. So, at this point, the Fed owns the smallest 
share of U.S. Government debt as it had for many, many years. 
We are not monetizing the debt and we have no immediate plans 
to do so in the future.
    Mr. Royce. Let me ask you another question. I appreciate 
your analysis on that, and I was struck when I read the 
analysis from PIMCO and I do not know how they perceived the 
amount of government intervention into the market here, but let 
me ask you one last question. The Dallas Fed president, Richard 
Fisher, said of the easy money policy during the most recent 
housing boom, rates held too low for too long during the 
previous Fed regime were an accomplice to the reckless 
behavior.
    Now, I remember The Economist, the British magazine, 
arguing at the time when we lowered the Fed funds rate to what 
effectively was below inflation, that we were going to face a 
boom, a bubble in the housing market. And they also argued that 
because Europe would have to follow suit to be competitive, it 
was going to cause a bubble there, as well.
    And year after year after year that rate was held that low. 
I would just ask you, given the Fed's track record, what 
assurances do we have that the Fed will be any more vigilant 
when the next bubble begins to form? Is it even possible to 
take away the punch bowl, as they say, just as the party is 
getting started?
    Mr. Bernanke. I do not want to rehash history, but I think 
there is a lot of conventional wisdom out there about the 
earlier episode, and we have published a paper looking at the 
evidence, and I think it is much less clear than some people 
would make it.
    But, putting that aside, we recognize that the very low 
interest rates we have today, that a number of people have been 
concerned about the possibility of creating a bubble in some 
asset class, I am not clear which one, and all I can say is 
that we agree that it is important to monitor what is happening 
in financial markets. We are doing that and although it is very 
difficult to know whether an asset is appropriately priced or 
not, we do not see at this point any major mispricing in 
important asset classes right now.
    Mr. Royce. Thank you, Chairman Bernanke.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from California has deferred until later in the process, so the 
gentleman from New York, Mr. Meeks, is recognized for 5 
minutes.
    Mr. Meeks. Thank you, Mr. Chairman. Chairman Bernanke, it 
is good to see you again. I just want to make sure that first, 
let me get an understanding with the talks in reference to 
interest rates. I know that at the last FMOC meeting, the 
President of the Federal Reserve Bank of Kansas City, Tom 
Hoenig, dissented in regards to the use of language about low 
rates for an extended period of time. He basically made the 
argument that does not give the Fed the flexibility that it 
would need in case the recovery happens at a quicker pace and 
that people are starting to build on expectations into the 
market place because of the low interest rates.
    So, do you, I am just asking you, first of all, can you 
have the flexibility that you need and then if the economy 
improves at a quicker rate, can you be flexible without 
shocking markets that are building in the expectations about 
the low interest rates?
    Mr. Bernanke. Yes, we can. Mr. Hoenig's specific concern 
was the same one I talked to Mr. Royce about, which was about 
bubbles and asset imbalances, and as I say, we are looking at 
that issue. But, I think it is very important to keep in mind 
that when we talk about an extended period, we are not saying a 
fixed period of time, we are saying a period of time which 
depends on how the economy evolves. And our statement very 
specifically says it depends on the level of resource 
utilization or unemployment, it depends on what inflation is 
doing, and it depends on inflation expectations.
    So, if those things begin to move, then obviously that is 
going to lead us to respond appropriately.
    Mr. Meeks. I'll tell you what my concerns are just in the 
housing market, for example, in that regard. What takes place, 
or what is taking place in America in a lot of communities, is 
a lot of people are underwater right now with their mortgages. 
And some are okay, they are making their payments if they have 
these adjustable rates because the interest rates are low. And 
so, they are not concerned because they are making it now, but 
if those interest rates suddenly jump up, then they are going 
to have a problem paying their mortgage, you know, that shock 
and where we go.
    Now, Bank of America has recently, I just want to ask this 
question, has said that they are going to, as opposed to just 
reducing interest rates, they are going to reduce principal by 
as much as 30 percent. So, I would like to know: (a) do you 
think that would have a significant impact on reducing 
foreclosures in the future, because I'm concerned about 
foreclosures going up in the future; and (b) what is the Fed 
doing, if anything, to encourage other banks to lower the 
principal as opposed to just reducing interest rates?
    Mr. Bernanke. Well, I think one thing we are learning is 
that when it comes to addressing foreclosures, one size does 
not fit all. There are people with different types of problems. 
There are people who have a payment which they cannot afford 
and a lot of the programs we have seen so far, like the HAMP 
program, are about getting the payment down.
    Then, you have people who are unemployed for a period of 
time. Maybe they can afford their house in a longer term, but 
for a period of time, they do not have the income and they need 
temporary help.
    Then, you have a lot of people around the country who are 
underwater, as you say, and the Federal Reserve has argued for 
several years that one strategy is to help people who are 
underwater to build up equity again so that they will have an 
incentive to stay in the home and continue to make the 
payments.
    Going forward, I think it is useful to have all these 
different strategies, because each different type applies to a 
different group of people. I don't know that much about Bank of 
America's specific approach. A lot depends on the details. But, 
I am glad to see that they are including this strategy. The 
industry was very reluctant to use principal reduction for a 
long time. And I am glad to see that they are opening up now 
the idea of using that as one tool to address foreclosures.
    The Federal Reserve, as a bank regulator, we put out 
guidance in November of 2008, and we are certainly strongly 
urging banks to be responsible in restructuring of their 
mortgages where necessary, and in particular, in participating 
in the Administration's and Congress' plans to help underwater 
borrowers.
    Mr. Meeks. Do you see or do you have the concerns that I 
have, that we could have another foreclosure crisis, though, 
given the way that the markets are and the interest rates right 
now, especially those that are still in adjustable rates, 
especially those who are underwater, because they cannot 
refinance their mortgage to get a fixed rate and thereby--
    Mr. Watt. The gentleman's time has expired, so the Chairman 
will perhaps answer that question.
    Mr. Bernanke. Later?
    Mr. Watt. Later or briefly.
    Mr. Bernanke. Okay. We control the very short-term rates. 
There are very many fewer adjustable rate mortgages out there 
now than there were a few years ago. Most people have fixed-
rate mortgages, and so they would not be affected very much by 
our policy.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Texas, Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. Good morning, 
Chairman Bernanke. Yesterday, we had a hearing, yesterday or 
the day before, with Secretary Geithner regarding the GSEs. In 
a line of questioning from my colleague from New Jersey, Mr. 
Garrett here, the Secretary first said that the debt of the 
GSEs was, ``as I said, it is not sovereign debt.'' And he also 
said, ``we are going to make sure that these institutions have 
the resources they need to meet their commitments past and 
future,'' which may be a distinction without a difference on 
whether or not the GSE debt is sovereign debt.
    Clearly, as your balance sheet has inflated, a lot of this 
is agency MBS, a lot of it is clearly GSE paper. As I 
understand your current strategy, the program to purchase the 
agency MBS is about to wind down, or has wound down. Is that 
correct?
    Mr. Bernanke. At the end of March, yes.
    Mr. Hensarling. At the end of March? So, literally in a 
matter of days. But, you still have a lot of this on your 
balance sheet. As I understand it, your strategy is to retain 
most of it, although you, to hold to maturity, although you 
hold open the option of perhaps selling it when market 
conditions improve. Do I understand the strategy of the Fed 
correctly?
    Mr. Bernanke. We would like to get back to an all-Treasury 
portfolio within a reasonable amount of time. So, we are 
currently letting GSE paper that redeems, that matures, we're 
letting it roll off. And I anticipate that at some point we 
will, in fact, have a gradual sales process so that we can 
begin to move our balance sheet back to its pre-crisis 
condition.
    Mr. Hensarling. There was an article in The American Banker 
yesterday concerning your strategy. I will read from a portion 
of it. It talks about when you announced that you would slow 
your MBS purchases, cease them by the end of the first quarter, 
that mortgage bankers winced.
    ``They fear that without the Fed to prop up such, 
securities would sink causing their yields relative to 
benchmarks like Treasury bonds to soar. Such an increase would, 
in turn, cause mortgage rates to jump, sapping demand for home 
loans in an already weak market, but it appears that the 
industry's worst fears were unfounded. Market participants 
point to several reasons for the relative stability. For one, 
their traditional MBS buyers that were pushed to the sidelines 
when the Fed came in are ready and waiting for their chance to 
get back into the market.''
    Would you agree with the assessment of that American Banker 
article?
    Mr. Bernanke. Broadly speaking, yes.
    Mr. Hensarling. Let me ask you this, Mr. Chairman, then. As 
you are aware, the Administration has not put forth a plan in 
dealing with the long-term future of the GSEs. Neither has 
Congress heretofore. I personally have introduced my own bill 
to deal with the GSEs that, over a 5-year period, would 
essentially send them back to a competitive marketplace by 
slowly ratcheting down their portfolio holdings, their 
conforming loan limits, raising their capital standards to that 
of insured depository institutions. You know, it's at last a 
plan.
    I guess my question for you, Mr. Chairman, is, I do not 
believe anybody believes that we can do without the GSEs in the 
short term, but as you have said in earlier testimony, it is 
important for us to show a sustainable fiscal path for the 
future. How important is it that the future of the GSEs be 
included in that sustainable fiscal path, and if we do not do 
it, what are the implications for you unwinding your balance 
sheet?
    Mr. Bernanke. Well, I think, as I said last time, if we can 
begin to map out a future for the GSEs sooner rather than 
later, even if we do not execute that immediately, it will 
remove some uncertainty from the mortgage market and it will 
also help give confidence about the future of the Federal 
budget because it will give clarity about what obligations, 
implicit or explicit, the Federal Government is taking on.
    Mr. Hensarling. Mr. Chairman, if I could, I hate to be 
rude, but I see my time is winding down. I am going to attempt 
to slip in one more question. In the next panel, we are going 
to be hearing from economist Dr. Taylor. I read part of his 
testimony and if I could quote from it:
    ``Whether one believes that these programs worked or not, 
alluding to the Federal Reserve programs, there are reasons to 
believe their consequence going forward are negative. First, 
they raise questions about Fed independence. The programs are 
not monetary policy as conventionally defined, but rather 
fiscal policy or credit allocation policy or mundustrial 
policy, a word that has not been previously in my vocabulary, 
because they try to help some firms or sectors and not others 
and are funded through money creation rather than taxes or 
borrowing.''
    Perhaps you could comment upon that in writing, on whether 
or not you agree with that assessment. Thank you.
    Mr. Watt. The gentleman's time has expired and we will 
allow subsequent written responses. The gentleman from Kansas, 
Mr. Moore, is recognized for 5 minutes.
    Mr. Moore of Kansas. Thank you, Mr. Chairman. Chairman 
Bernanke, looking at how debt and leverage have been used in 
the past decade by financial firms, non-financial businesses, 
consumers, and the government, we seem to have developed an 
unhealthy dependence on the use of credit cards, overleveraged 
balance sheets, and massive deficits to seek economic growth 
and prosperity.
    Analysis by Morgan Stanley shows total credit outstanding, 
including households, financial firms, businesses, and 
government, amounted to roughly 350 percent of GDP at the end 
of 2008. Clearly, this is unsustainable. And the McKinsey 
Global Institute noted that the leveraging can last a painful 6 
to 7 years after a financial crisis.
    Do you believe that we are too dependent on debt and 
leverage, Mr. Chairman? And if so, how should we encourage and 
restore fiscal responsibility and restraint in the use of 
credit and debt across-the-board? And most importantly, for the 
financial sector but also for government, for businesses, and 
for individuals and families?
    Mr. Bernanke. I think there are debt concerns and they 
affect different sectors differently. For the banking sector, 
for example, there was too much leverage and that is part of 
the reason why we had the financial crisis. The Federal Reserve 
and other agencies are working internationally to try to 
develop higher, more rigorous capital standards, which we will 
try to phase in slowly so as not to disrupt the recovery too 
much. But, going forward, there needs to be higher capital, and 
lower leverage in the financial system.
    More generally, we need to have a better balanced economy. 
We need more saving by consumers and we need a better fiscal 
situation, as we have discussed already several times. And 
that, in both cases, that would involve less debt by the public 
and private sectors. On the other hand, we need to make sure 
that there are sources of growth going forward. And if it is 
not going to be consumer spending, then what is it going to be?
    One area certainly is capital investment, which increases 
productivity and leads to long-term growth. And another is net 
exports. We have a current account deficit, a trade deficit, 
and we are borrowing to finance that. That is another form of 
debt. We would like to have an economy that has a better 
balance in our trade so that exports would be a source of 
demand, a source of growth for our economy.
    So, yes, debt and lack of saving is an important issue. It 
is a somewhat different issue for the financial sector, private 
sector, government, and the trade sector, but in each of those 
areas, I think we need to work to a more balanced situation.
    Mr. Moore of Kansas. Thank you. Mr. Chairman, I am 
interested in learning more about the repurchase agreements, or 
repos and reverse repos that the Fed is utilizing to safely 
unwind the emergency programs set up to deal with the crisis. 
In particular, I feel like we have not given enough attention 
to the short-term financing market that Wall Street firms and 
others have depended on for their financing. In addition to the 
repo market, I am thinking about the commercial paper and money 
markets, as well.
    When we learned about Lehman using repo 105 to conceal its 
leverage, I wonder if this short-term financing market is 
another shadow market where there is not a lot of transparency 
by its very nature. It provides an opportunity for more shady 
financial activity in the future.
    Would you explain, Mr. Chairman, how the Fed itself uses 
these repos and then share any thoughts you have on improving 
financial stability in terms of how the short-term debt and 
liquidity markets function, especially in a crisis?
    Mr. Bernanke. Well, I would like particularly to address 
the functioning of that tripartite repo market, which is a 
short-term market that allows money market mutual funds, 
pension funds, and others to park their money for short 
periods. It is a huge market, it is two and a half trillion 
dollars, or so. And the Federal Reserve has been very much 
engaged in trying to make that market stronger, more resilient.
    We were very concerned back in the crisis, one of the 
reasons we were so worried about the failures of Bear Sterns 
and Lehman Brothers was that we thought it might lead to a 
collapse of this critical market and so, in recent quarters, 
the Fed, the private sector, and others have been working 
together to try to improve how those markets function, and in 
particular, that we would have a set of protocols that we could 
have used in case a major player failed, a major firm were to 
fail.
    So, we want to make those markets stronger. That, 
indirectly, helps with the ``too-big-to-fail'' problem because 
if we feel that the system is strong enough, there is less need 
or danger in allowing a firm to fail.
    So, we are very much interested in strengthening those 
markets. The Fed is very active in the repo market now, but in 
order to help reduce reserves in the system, we are looking to 
broaden the people we trade with to include not just the 
primary dealers whom we deal with on a daily basis, but also a 
wide range of other short-term money providers like money 
market mutual funds, that we have already worked with.
    We are expanding that so that we will be able to drain 
reserves effectively as we come to the point where we need to 
tighten monetary policy.
    Mr. Moore of Kansas. Thank you, Chairman Bernanke. And Mr. 
Chairman, I yield back my time.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from New Jersey, Mr. Garrett, is recognized for 5 minutes.
    Mr. Garrett. Thanks, Mr. Chairman. Chairman Bernanke, you 
made the comment, and you said it here as well, and everybody 
agrees, that you want to try to shrink back the balance sheet 
to just the prior date, which is, everybody here agrees, a good 
thing. But, the economy was really big then, too, and since 
that time, things have changed. You have lost, sort of, the 
shadow banking system that is really not there anymore. The 
huge multiplier effect that is out there, the money supply, 
that is not there anymore, the leverage ratios that we have had 
in the past, they are not there anymore.
    So, with all that gone, which was really making the economy 
grow at a good pace, with those things gone now, and if you do 
the good thing and go back to the smaller balance sheet, would 
that not have a negative impact or see the economy shrink 
because of that, or not shrink, but not grow to the levels that 
we saw before, and would not that play into your decision-
making as far as how soon you want to shrink your balance 
sheet? And is there some sort of, I guess, metrics, that you 
are going to have to use in that sense of setting the timeline 
or establishing your balance sheet shrinkage?
    Mr. Bernanke. I think that you are right, that shrinking 
the balance sheet is akin to a monetary tightening. You sell 
mortgages on the market, you are going to tend to raise 
mortgage rates, for example, and that will tend to tighten the 
housing market and slow the economy--
    Mr. Garrett. Plus, you have all this other tightening going 
on, too.
    Mr. Bernanke. And others, as well. You are absolutely 
right. We should not even want to hold this stuff 30 years, so 
the key here I think is to, when we do come to the point we 
want to sell assets, is to do it in a gradual and predictable 
way so it has minimal impact.
    Even when we get back to the pre-crisis balance sheet, we 
will still be able to manage the short-term interest rate, the 
Federal funds rate, much as we have in the past, so if the 
economy needs stimulus, we will still be able to do that. But, 
we just would not be doing it through the--
    Mr. Garrett. So do you target the size of the balance 
sheets sort of the same way you target the funds rates now?
    Mr. Bernanke. You could think about it as a two-step 
procedure. First, we bring the funds rate down as far as it can 
go, then we cannot do that anymore, that is as far as it can 
go, and then the balance sheet is a secondary tool. When we get 
back to normal, we hope the balance sheet will be back to 
normal, and we will be going back to where we were before, 
which is just using the short-term interest rate as our basic 
tool.
    Mr. Garrett. And you will be back to where you were before 
the economy just cannot be back there because of those 
multiplier effects.
    Mr. Bernanke. I think that the economy will be able to 
recover as long as we make these adjustments in a gradual way.
    Mr. Garrett. Okay. Second question. Walk me through. I 
threw out some numbers before. If you try to pay the interest 
on reserves here, and I threw out the number, if you had a 
trillion dollars set on reserves and if the interest rates go 
up, because a lot of people expect them to, to say, 5 percent, 
to use round numbers in my head, that is $50 billion that you 
will be paying out. That is, in essence, a capital version of 
how it works, right?
    Mr. Bernanke. Yes.
    Mr. Garrett. Okay. So then, if you did that, starting 
tomorrow, let us say, how long can the Fed do that? How long 
can the Fed hold a trillion dollars here on your books, pay out 
$50 billion in interest payments, can you do that this year, 
and the next year, and the next year? How does that work?
    Mr. Bernanke. We can, for the following reason, that there 
are two sides to our balance sheet. The reverse repos, 
reserves, whatever, are financing. On the other side, agency 
MBS, which pay about 4\1/2\ percent. So, from the point of view 
of the seignorage, or the revenue we give to the Treasury, the 
money we're paying to banks from say, interest on reserves, is 
more than compensated by the income received from the mortgage-
backed securities.
    And so, in fact, for the next few years, we anticipate and 
we already have seen this, that the Fed will be sending to the 
Treasury an unusually large amount of money because the returns 
on the mortgages so much exceed the cost of funds to the Fed. 
So, because of the two sides of the balance sheet, it will not 
be costing the taxpayer any money.
    Mr. Garrett. Okay, and it is not just the cost to the 
taxpayer, but it could go on into, I do not want to use the 
word in perpetuity, but you can do it indefinitely, is what you 
are saying?
    Mr. Bernanke. Well, because half of our balance sheet is, 
we are paying right now 12 basis points and the other half we 
are paying zero because it is just cash, so we have very little 
cost of funds and so obviously we can go a long time.
    Mr. Garrett. And with just a short time left, what is the 
technical term, what are technical indicators you look to with 
regard to inflationary rates or otherwise, as far as your 
tightening policy?
    Mr. Bernanke. Well, we look obviously, at current inflation 
numbers including a variety of indicators like trim means, and 
core measures, and overall measures and so on, but we also look 
at things like the break-even rate in the inflation protected 
securities market, survey numbers, because expectations are as 
important as the level of inflation, itself. Because if people 
think inflation is going to be high, then they are going to 
demand higher wages, and prices, and that will create an 
inflation spiral. So, we look both at expectations and at 
current prices.
    Mr. Garrett. Okay. And there is the red light, so thank 
you, Mr. Chairman.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from California, Mr. Sherman, is recognized for 5 minutes.
    Mr. Sherman. Yes. To the ranking member's opening 
statement, indeed there has been an enormous and controversial 
multi-trillion dollar expansion of the Fed balance sheet and 
this has been part of an overall process called bailouts. As 
lawmakers, we would ask, well, under what law was this done? 
And the answer is, 13(3) of the Federal Reserve Act which gives 
the Federal Reserve Board unlimited authority which they have 
used to the tune of trillions of dollars, and I remember last 
year asking Chairman Bernanke whether he would accept a $12 
trillion limit. Being a man of modesty, he agreed to that, and 
then this committee adopted on voice vote a $4 trillion limit 
and no other limit was proposed, though I proposed a $4 
trillion limit, nobody else said, well, why not three or two or 
six?
    And I would like the acting ranking member to indicate 
whether he thinks it is better that we have a $4 trillion limit 
on section 13(3) or no limit at all? I yield to the gentleman. 
But I realize there are other--
    Mr. Watt. If the gentleman is yielding, and my choices are 
$4 trillion or indefinite, I prefer $4 trillion.
    Mr. Sherman. Thank you. I would hope that the senior 
leadership on the Republican side would correct some of the 
misleading press releases that have gone out from some 
Republican members attacking those who voted for a $4 trillion 
limit and implying that a $4 trillion limit was a grant of $4 
trillion of power to the ever-modest Chairman Bernanke, when in 
fact, that was indeed our choice--$4 trillion is what was in my 
amendment. The alternative is to stick with the present 
statute, which is absolutely unlimited.
    Those who propose limits should not be attacked as those 
who are calling for the removal of limits.
    With that in mind, we have a little problem in the 10 
biggest real estate markets in the country, including 
especially Los Angeles. Right now, the conforming loan limit 
and the FHA limit is $729,750. End of this year, it drops, the 
GSE limit drops in L.A., and most of these other markets to 
$417,000, a precipitous drop. This country is still dependent 
for its wealth, its consumer confidence, on home prices and is 
still dependent on the GSEs for supporting the mortgage market.
    Chairman Bernanke, do you think it would have a bad effect 
on home prices in those 10 markets and the national economy if 
we were to see a sudden, precipitous, and massive drop in the 
GSE limit?
    Mr. Bernanke. At this point, there is really no private 
label mortgage market around and the availability of credit for 
so-called jumbo loans and so on is very restricted, so it would 
certainly reduce availability of mortgages and increase the 
rate paid for mortgages above that new limit. Now, I think 
people should be concerned and make sure they are comfortable 
with any costs that might imply for the GSEs, given the money 
that the government is using to support the GSEs right now. 
But, I think it is certainly clear that if that happens, it 
will raise interest costs and reduce prices in those areas.
    Mr. Sherman. And I would point out for the record that the 
GSEs actually make a profit on those loans between $417,000 and 
$729,000, and I'll move on to my next question.
    It is often said that you are supposed to take away the 
punch bowl when the party gets going. This is the dullest party 
I have ever been to and I am an accountant. Thus, you do not 
need to be talking about how to make this party more dull or to 
keep it from getting going, at least in the foreseeable future.
    We do, however, need to focus on what flavor of punch. You 
have mentioned that you have lowered the interest rates. You 
have expanded your balance sheet, not so much by buying 
Treasuries, as buying private sector debt. The question is, why 
should taxpayers, assuming you should have the expanded balance 
sheet and I think that is a good assumption for the present, 
why should we expose taxpayers to the relatively small risks of 
the high quality private sector debt you have purchased? Why is 
your balance sheet not all Treasuries, rather than the various 
other investments you have made?
    Mr. Bernanke. At this point, about $100 billion out of $2.3 
trillion is related to bailouts. And given AIG's recent sales, 
we hope that would soon be down to $50 billion. We are moving 
down on that. So, this is not really about bailouts. It is 
about buying primarily mortgage-backed securities. And from our 
perspective, the Fed's perspective, these are Fannie Mae, 
Freddie Mac, and Ginnie Mae MBS, which are explicitly or 
implicitly guaranteed by the U.S. Government and so we are not 
adding any credit risk, whether we are holding it or somebody 
else, it is still a liability of the U.S. Treasury and we are 
not adding to the taxpayers' risk by buying them.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Texas, Mr. Marchant.
    Mr. Marchant. Thank you, Mr. Chairman. Mr. Bernanke, banks 
are also experiencing an historically low cost of funds, are 
they not?
    Mr. Bernanke. Yes.
    Mr. Marchant. And in this recent raise from a 1/4 of a 
point to a 1/2 point, actually, many banks are, their cost of 
deposits is much less than that. At what point will the banks 
decide that they are better off turning back to loans rather 
than placing their money, keeping their money liquid and 
placing it, perhaps, in short-term Treasuries, where they are 
making a very, not risk free, but relatively risk free yield?
    At what point does the Fed have a plan or an idea, at what 
point? Or is it an objective to wean the banks off the lower 
costs, at least from the Fed, and begin to put that liquidity, 
which is massive, back into traditional loans and then the 
economy will come up with it?
    Mr. Bernanke. We are supplying liquidity, we are not 
blocking its use in any way. Our increase in the discount 
window rate applies to a very small amount of money, basically 
the cost of funds in the markets for banks remains very, very 
low. So, we are not doing anything to prevent them from 
lending. The reason they are not lending is either they are 
concerned about their capital, or they do not believe they have 
good lending opportunities. And our view is that if we provide 
continued support to the economy with low interest rates, that 
the economy will begin to grow, will see more strength, and 
yields remain low, and that, in turn, should make increased 
opportunities for banks to make profitable loans. And when they 
see profitable loans to make, they will go ahead and make them.
    So again, we are just simply supporting a low cost of funds 
for banks, which makes, everything else being equal, it easier 
for them to raise cash to make loans. But there is a little bit 
of pushing on a string here in that unless banks feel that 
there are good opportunities out there, and right now we are 
still recovering from this very deep recession, they are going 
to be very cautious. And they are very cautious.
    But, going forward, I think I am safe to say we are already 
beginning to see some improvement in banks' outlook and their 
willingness to make loans and I suspect we will see improvement 
going forward this year.
    Mr. Marchant. The other thing that I hear from constituents 
at town hall meetings, other than health care, there are a few 
other concerns, is that a large portion of our population 
depends on their CD rates, or the amount of money that they 
have been saving all these years, for part of their income. And 
now that the income is not there, they are not spending. And 
so, another part of the economic puzzle is that if the rates 
that they can get for their money come back, they will begin to 
spend again.
    And so, at what point do you feel like the banks will not 
rely on this increased liquidity that you are providing and 
they will begin to put the loans out, raise their rates, and 
put the money back into the economy?
    Mr. Bernanke. You are right that savers are hurt by a 
situation like this in that the yields they can get are lower 
and there is no question about it. The reason we have kept 
yields low is because we are actually trying to encourage 
investment and spending that will get the economy moving again. 
And there is a trade-off there, I agree. As I said before, we 
want the banks to have access to liquidity. We have worked with 
the banks through our stress test to try to increase the 
capital they have.
    That gives them the raw materials to make loans, so to 
speak, and when they see opportunities and the economy is 
strengthening, then they should be willing to make loans. At 
that point, it will be safe for the Fed to consider raising 
rates, as the economy strengthens, and we will try to get back 
to more normal situation.
    Mr. Marchant. Thank you, Mr. Chairman.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Massachusetts, Mr. Capuano, is recognized for 5 minutes.
    Mr. Capuano. Thank you, Mr. Chairman. Chairman Bernanke, 
you have only said one thing this morning that really gets me 
concerned and I want to make sure I understand it. You said 
something about the asset-backed securities market returning to 
normal. My definition of the word normal is not a good thing in 
the ABS and I just want to make sure that your definition of 
normal is the new normal, not the old normal.
    Mr. Bernanke. Yes, it is the new normal, and I am talking 
about traditional ABS, like credit card securitizations and so 
on, I am not talking about structured credit products and all 
the things that got us in trouble.
    Mr. Capuano. That's what I hoped you meant, but I just 
needed to hear it. I did not want to get all worked up over 
nothing. I do want to talk a little bit about the gradual sales 
process that you have talked about, about the securities that 
you do hold. And I am just curious, have you started making any 
decisions as to where you are going to start--are you going to 
start with Federal agency paper, or are you going to use a 
light method, are you going to go with whatever ones have the 
biggest losses, any decisions at all?
    Mr. Bernanke. No, we are continuing to discuss it in the 
Forum C. We have not come up with a specific plan. The only 
thing we have done so far is to agree to allow both agency debt 
and agency MBS that mature to just expire and we are not 
replacing it. We are not rolling it over. So that, in itself, 
will actually reduce the portfolio over time.
    Mr. Capuano. Because, maybe I am wrong, but as I see it, 
these sales, if and when they start taking place, are really 
the first time between the whole financial crisis that this 
country might see, well, realize or recognize, a loss. Up until 
now, we may have losses on paper that we have not recognized or 
realized, but this might be the first opportunity, the first 
situation where we actually experience one. Is that a fair 
reading of the current situation?
    Mr. Bernanke. That is possible, but on the other hand, as I 
have discussed earlier, we are making an awful lot of income 
right now and that should be set against any losses that we 
might take in the future.
    Mr. Capuano. Okay, I appreciate that. I mean, obviously, as 
you go forward, we are all interested in decisions you make.
    The last item I want to talk about is actually something 
that came up when Secretary Geithner was here the other day, 
and that is Fannie and Freddie. As I read the December report 
that you have, roughly about $1.8 trillion, give or take, in 
secured assets, roughly how much of that, and I have the 
numbers here, I am not playing games. I just want to make sure 
I am reading it right.
    How much of that is Fannie and Freddie assets, roughly? Am 
I reading it right that it is around $200 billion?
    Mr. Bernanke. I even have the numbers, if you would like.
    Mr. Capuano. No, I am not trying to get you. I am trying to 
make sure I am reading it right.
    Mr. Bernanke. We have about $1.3 trillion or so in agency 
debt and securities, roughly, of which about $175 is debt and 
the rest is MBS. And I think the biggest chunk is from Fannie 
and then Freddie and then finally, Ginnie.
    Mr. Capuano. The reason I ask is obviously because, just to 
tell you where I come from. I come from the position that 
Fannie and Freddie might have been engaged in some 
inappropriate activity over the last several years, but no more 
so for the most part than private entities. And as I read these 
sheets and a lot of the stuff that you are dealing with is 
also, you know, private MBS between this and the PPIP and other 
things you are doing.
    And it just strikes me, is that a fair assessment that 
Fannie and Freddie, though may be engaged in certain unwise 
decisions for the last couple of years, was not doing in any 
more excessive manner than private agencies? The Goldmans and 
the others?
    Mr. Bernanke. They surely made mistakes and that is why 
they are losing money, but I do not think their delinquency 
rate is any higher than the private sector, and I think, I 
would just add for the record that since most of our purchases 
are of relatively new MBS, I think the standards have been 
actually much tighter in the last couple of years.
    Mr. Capuano. Good. Yes, and the reason I asked that is 
because there has been a lot of wailing and gnashing of teeth 
about how terrible Fannie and Freddie are. And I will tell you 
that historically, not within the last couple of years, 
historically, I have seen them as a positive thing for this 
country, creating the middle class by allowing people to buy 
homes, for the most part.
    And I guess, in general, because my time is running out, 
would you submit, would you suggest that we end Fannie and 
Freddie and simply go back to private mortgage or do you think 
that, again, with some of the tweaks that we might have to do 
and some of the fixes, some of them may be extreme, who knows, 
but the concept of government involvement in the mortgage 
industry is a good concept or a bad one?
    Mr. Bernanke. I wouldn't go back to the status quo ante, 
but I think that, and I gave a speech on this a couple of years 
ago, where I laid out some alternatives. I do think there are 
some scenarios where a backstop government guarantee, which is 
fully paid for, for housing, for mortgages, would be a 
reasonable strategy.
    Mr. Capuano. Great. Thank you, Mr. Chairman. Thank you, 
Chairman Bernanke.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from North Carolina, Mr. McHenry.
    Mr. McHenry. Thank you, Chairman Watt, and thank you, 
Chairman Bernanke, for being here today. I certainly appreciate 
your leadership of the Fed and trying to get our economy back 
on track. But, as we know, and as you have discussed before, 
there are two houses: monetary policy, which you and the Fed 
control; and fiscal policy, which Congress has authority over. 
And so it is certainly a challenge for you to control your dual 
mandates, being only able to control half of the quotient of 
this.
    And so with that, you know, the budget deficit. Being over 
10 percent last year, 10 percent of GDP, last year, this year, 
next year, and only subsiding just barely, the following year. 
Is this price, this high deficit, and the long-term view of 
where the deficits are going under this President's budget, is 
that priced into Fed policy and outlook?
    Mr. Bernanke. It affects Fed policy in several ways. In the 
short term, it affects overall economic activity and that 
affects our monetary policy strategy to some extent. If there 
is a loss of confidence about the ability of the government in 
the medium and longer term to achieve a sustainable fiscal 
balance, then the risk which we have seen a little bit of, I 
think, even yesterday, there was just a bit of concern, is that 
interest rates might rise because of a lack of confidence by 
creditors in the long-term fiscal stability of the government. 
And that, in turn, would tend to endanger the recovery because 
high interest rates tend to slow the economy.
    So, it would certainly be good for the Fed and for the 
country, for the economy. As I said before, it is not a 
practical goal to achieve a balanced budget this year or next 
year, but certainly there needs to be some plan for exiting 
from the current very high deficit prospects to give something 
that is more sustainable over the medium term. And that would 
be very helpful, even today, as the Fed tries to plan how we 
are going to exit our accommodative policies.
    Mr. McHenry. So, in terms of major legislation that was 
just signed into law 2 days ago, the health care policy, and 
the cost of that, was that priced into the Fed's outlook over 
the medium/long term?
    Mr. Bernanke. I know it is very controversial exactly what 
the fiscal implications of that are and I am not going to try 
to second guess the CBO or others who have priced it, but 
clearly everybody agrees that the overall fiscal outlook for 
the U.S. Government is somewhat dark over the medium term. And 
it would be very useful if there could be a bipartisan, 
concerted effort to explain, demonstrate, and decide, how the 
government is going to achieve a more sustainable fiscal 
trajectory.
    Mr. McHenry. Would you say that enacting that bill has 
negatively or positively changed the Fed's outlook on the 
economy over the medium and long term?
    Mr. Bernanke. No, I could not say. It depends on your 
assessment of the fiscal implications and, as I said, the CBO 
and others have come up with a wide variety of estimates of the 
possible fiscal implications.
    Mr. McHenry. What about the expiration at the end of this 
year of a whole variety of tax cutes put in place in 2001 and 
2003? Are the expiration of those tax cuts, priced into Fed 
policy over the short, medium, and long term for the Fed's 
outlook on the economy?
    Mr. Bernanke. To some extent. I mean, we try to make 
forecasts and our forecasts are typically 18 months ahead and 
we try to factor in our expectations of fiscal policy the best 
we can. But, of course, we recognize that there is a lot of 
uncertainty about what the implications will be for the 
economy, where the economy will be a year from now, or 18 
months from now. But, we do try to factor in all the aspects of 
fiscal policy to the extent that we can, you know, ascertain 
where we think it is going to be.
    Mr. McHenry. So, certainly this adds to the high wire act 
that you are performing right now, trying to unwind with the 
fiscal policy, as well?
    Mr. Bernanke. Certainly, a part of the difficulties of 
forecasting the economy, certainly.
    Mr. McHenry. Thank you.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Massachusetts, Mr. Lynch, is recognized for 5 minutes.
    Mr. Lynch. Thank you, Mr. Chairman. I certainly appreciate 
the difficulty we are in. I know a lot of the members have 
recalled that the Federal balance sheet before the crisis was 
about $800 billion, and now it is somewhere around $2.1 
trillion. I generally agree and understand the idea of the Term 
Deposit Facility, and also the reverse repurchase agreements to 
soak up all this liquidity that is sloshing around in the 
economy in which makes the economy less responsive to your 
interest rate decisions. As you say, pushing on a string.
    Do you think that those two mechanisms will be sufficient 
to reattach or make the economy more responsive to interest 
rate controls that are traditionally used?
    Mr. Bernanke. Yes, I think so. We have really a belt and 
two pairs of suspenders at this point. We have a basic tool 
which is the interest we pay on reserves to banks, which by 
itself ought to move the whole complex of interest rates up as 
we raise that rate. There could be some slippage between that 
rate and general market rates, and those tools you mentioned 
will be able to drain reserves and tighten up that relationship 
and so that will be a second tool that assists us in managing 
interest rates. But then, if it were absolutely necessary, we 
could also sell some of our securities and that would certainly 
tighten up--
    Mr. Lynch. That is what I want to talk about. That part I 
guess I am less confident in. Do we get into trouble here in 
selling assets? And I know these are all government issues, so 
the risk part of this is already there. But for some time now, 
the whole market has been fed by--the mortgage-backed security 
market has been fed by the GSEs and I believe the Federal Home 
Loan Banks, I do not know if you have included that as well, 
but I am just concerned about selling assets into a very poor 
economy and a very poor market. And whether we might sustain 
considerable losses in those sales, and then have the 
compounding insult of having others who might buy those at 
distressed rates do very well.
    And then we end up with a similar argument we had during 
the resolution trust corporation sale of assets after the 
savings and loans bailout where some folks came in afterwards 
and capitalized greatly on the timing. When I first read your 
remarks surrounding the purchase of these assets, I thought it 
was clear that this was going to be passive ownership and 
investment and long--we are going to hold these long term. And 
that was only last March, so has there been something that has 
changed our position on this? Or can you explain that?
    Mr. Bernanke. We have had a good bit of time to discuss all 
the aspects of this exit strategy, and I think the FOMC is not 
comfortable withholding all of these securities until they 
mature, some would be 30 years and we want to move more quickly 
than that back to the pre-crisis balance sheet. But again, my 
expectation is that sales would be a slow gradual announcement 
in advance and would not create undue market impacts. You 
mentioned adding insult by selling into a weak market, of 
course in a situation where we would be selling this would be 
one where we were actually trying to tighten policy because the 
economy was back on a growth track and we were trying to avoid 
future inflation risks. So, we wouldn't be doing that in a 
really weak economy.
    Mr. Lynch. Well, you know, I appreciate that is the only 
mechanism of the three that actually shrinks the size of the 
Fed balance sheets, so I know we have to do something. I am 
just very concerned about the timing of this and what the end 
result might be, but I appreciate your comments and thank you. 
Thank you, Mr. Chairman.
    Mr. Watt. The gentleman yields back. The gentleman from New 
Jersey, Mr. Lance, is recognized for 5 minutes.
    Mr. Lance. Thank you very much, Mr. Chairman. Good morning 
to you, Chairman Bernanke. Thank you as always for being here. 
My principal concern, as I have indicated on many occasions in 
this committee, with many different witnesses, continues to be 
levels of Federal spending and the overall Federal debt now at 
$12 trillion and rising rapidly.
    As I understand it, Mr. Chairman, the ratio of national 
debt to GDP has shot up from 37 percent before the crisis to 
approximately 60 percent in Fiscal Year 2010. And the 
President's budget indicates that it may be headed towards 77 
percent of GDP by the end of the decade. As you well know 
better than almost anyone in America, except for World War II, 
the debt has never been higher as a percentage of GDP.
    Your thoughts, Mr. Chairman, on what the growth rate would 
have to be here in the United States in order to pay the 
Federal debt over the course of the next generation, perhaps 
the next 25 or 30 years?
    Mr. Bernanke. Well, the 77 percent doesn't capture the 
entire problem in that there is an awful lot of which might 
call off balance sheet, obligations, future Medicare, and 
Social Security and so on, and other obligations that are not 
fully accounted for in our debt. So, in some sense, the burden 
is greater than what you describe, and I would have to say 
looking at it from that perspective and recognizing that we are 
an aging society and those costs are going to be coming down 
the pike, I don't think there is a realistic growth rate. I 
don't know what number to tell you, but it would certainly be a 
very high number, probably not realistic, so I don't think that 
just growing out of this will be a solution.
    Mr. Lance. Nor do I. And since that is clearly not the 
solution, your thoughts on what the solution would be. 
Presumably, it is somehow to rein in levels of Federal spending 
over time and certainly to get our national expenditures as a 
percent of GDP back to a historic average as I understand it. 
Since the end of World War II, the historic average has been 
roughly 20 percent of GDP, it is now 25 percent.
    I personally am one of the co-sponsors of a constitutional 
amendment sponsored by Mr. Pence and Mr. Hensarling that would 
address this constitutionally. Your thoughts as to what level 
you would suggest long term, given the historic average being 
20 percent for the last 60 years?
    Mr. Bernanke. There are tradeoffs there that really are up 
to the elected representatives to make. The only thing I would 
say is that we need to enforce in some sense a consistent 
perspective, so those folks who believe that low tax burdens 
are very important need to also specify how they are going to 
cut spending, and those who see much benefit in spending need 
to sort of specify what their revenue source is going to be. So 
if we can force people to recognize that there are two sides to 
this, that is the way to ultimately bring down the deficits.
    Mr. Lance. What would you suggest, based upon your obvious 
extensive knowledge of the area, would be a good range as a 
percentage of GDP? And based upon your experience as a 
historian of these subjects, particularly related to the 
Depression?
    Mr. Bernanke. There is quite a range of debt to GDP and 
government spending to GDP across the developed world, and a 
lot of that depends on decisions that are being made about what 
parts of the economy will function through the government and 
which parts will be entirely private, decisions about health 
care for example. So those are very broad decisions about how 
you want to structure your economy and your society which 
again, go beyond simple fiscal issues, and I do not feel well-
placed to make those decisions for the American people or for 
the Congress.
    With that being said, obviously we are going to have to 
make some tough decisions. There is this tendency that nobody 
wants to cut and nobody wants to raise taxes. At some point, we 
are going to have to make some unattractive and tough 
decisions, and I don't envy Members of Congress who have to 
grapple with this problem, but one way or another, there needs 
to be some greater balance between revenues and expenditures.
    Mr. Lance. Thank you, Mr. Chairman. My own view is that it 
is the fundamental issue of our time, and whether or not 
America will continue to be the preeminent society in the world 
in this century is based upon whether or not we can get our 
fiscal house in order. Thank you, Mr. Chairman.
    Mr. Watt. Gentlemen, as time has expired, the gentleman 
from North Carolina, Mr. Miller, is recognized for 5 minutes.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman. I am 
also concerned about the deficit and long-term debt. At the 
beginning of the decade, your predecessor worried that we might 
spend the debt down too quickly and it might be disrupting the 
economy. That proved not to be so much of a problem in the last 
decade. And it appears that a couple of my best folks here were 
against Bush tax cuts and against the prescription drug plan 
that was more of a giveaway to the insurance industry and the 
pharmaceutical industry than it was for seniors on Medicare, 
and was not paid for.
    What is the kind of distribution of the current deficit? 
How much of it is structural, the extent to which our revenue 
and our expenditure simply do not match up and would not match 
up even if we were growing at 3 or 4 percent a year and had 
unemployment at 3 or 4 percent, so that the existing program is 
not anything new? How much is the result of the recession 
itself, the decline in revenues and the additional expenditures 
required for unemployment, for Medicaid, for childhood 
insurance, or any other kind of entitlement program that 
depends upon income? And to what extent is it because of what 
we are doing in response to the recession to try to get the 
economy going? I have heard that it is roughly 50-40-10. But 
about what is the allocation?
    Mr. Bernanke. Well, the way I would think about it is that 
again, if you look out from say 3 years from now out to 2020, 
that longer period where the forecasters are assuming something 
more normal--a more normal economy--the estimates of deficit to 
GDP are sort of 4, 5, 6 percent, that kind of range. So, since 
that would be something where the economy is close to its 
potential, then that say 5 percent would be the structural 
component.
    Mr. Miller of North Carolina. I am sorry, say that again?
    Mr. Bernanke. About 5 percent of GDP would be the 
structural component.
    Mr. Miller of North Carolina. But how much of that, of the 
deficit is that?
    Mr. Bernanke. Sorry, 5 percent of the deficit. The deficit 
is 5 percent of GDP. So today, the deficit is 10 percent of 
GDP, and what I am saying is that looking at the perspective 
deficit 5 years from now, that suggests that of that 10 percent 
today 5 percent is related to the recession and the other 5 
percent or so is related to structural issues, and that is 
looking at the next decade or so. It is probably going to get 
worse after that because of the aging of the population, 
increased medical costs, and so on. So, we are looking at even 
in the medium term, I think we need to have a goal of something 
in the order of 2 or 3 percentage points of GDP improvement in 
the structural deficit to get to something which is more 
sustainable, at least over the next decade.
    Mr. Miller of North Carolina. My view is that the most 
important thing we can do to address the deficit is to get the 
economy going to put America back to work. Do you agree with 
that?
    Mr. Bernanke. In the short term, that is absolutely 
correct. The share of revenue as the share of GDP has fallen 
from its historical 19 percent down to 15 percent, so just 
getting tax revenues back up to historical norms would take a 
good chunk out of the deficit. So that is absolutely correct, 
but that doesn't solve the very long-term issues, as you know.
    Mr. Miller of North Carolina. Sure. As to mortgages, there 
has been a good deal of discussion about the conflicts of 
interests, the various ways in which mortgages were divided 
into tranches and the tranches' interests were different, and 
especially the different interest between first and seconds. I 
understand about two thirds of all servicing mortgages is 
controlled by the four biggest banks. And those same four banks 
also hold $477 billion in second mortgages. Do you see a 
conflict of interest there, and is that something we should 
allow going forward?
    Mr. Bernanke. There is a problem there which is that under 
current rules and under current practices, the same bank might 
hold the second and the first and not be aware that those two 
go together. So, it is not uncommon for a homeowner to pay 
their second and be delinquent on their first, and so the bank 
would therefore count the second as fully current even though 
the first is delinquent. So, I think we would get, first of 
all, a better understanding of banks' financial position in 
their losses in the mortgage space if there were better 
connections between the first and the second.
    But very importantly, efforts to restructure mortgages and 
keep people out of foreclosure would be facilitated if the 
first and seconds were linked together and perhaps negotiated 
jointly rather than separately, so that there could be one 
solution to the whole problem. And the Treasury is working on 
that. There is a program called the 2MP Program where a lot of 
those large banks you referred to have signed up and the basic 
premise of this program is to try to link up the first and 
seconds, and when doing mortgage restructuring to do them 
jointly rather than separately.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Texas, Mr. Green, is recognized for 5 minutes.
    Mr. Green. Thank you, Mr. Chairman. Thank you, Mr. 
Bernanke, for appearing today. I would also like to take a 
moment if I may and thank Bank of America. If what I am reading 
in the newspaper is correct, I would like to thank them for 
producing a principal reduction program. And I am referencing 
this because we have not yet resolved the question of 
foreclosures. It is a serious question and it is one that I 
think we have to get a handle on before we can conclude that we 
are out of the woods, to borrow a phrase. My question, Mr. 
Bernanke, is this: how important is it for us to resolve the 
question of foreclosures that the, just the unusual number that 
actually have now gone into persons who are not blessed with or 
cursed with, depending on how you look at it, with adjustable 
rate mortgages. We have persons now who clearly qualify for the 
mortgages that they have, but their mortgages are now 
underwater. So how important is it for us to get a handle on 
this to avoid a double dip recession?
    Mr. Bernanke. It is certainly a risk to the economy for a 
number of reasons. One obvious reason is that in recent 
periods, as much as 30 or 40 percent of the new housing coming 
on the market is foreclosed housing, so foreclosures generate a 
supply of housing which dries down prices in the housing 
market, lowers the wealth of consumers or homeowners, increases 
the rates of delinquencies in losses in banks, and weakens the 
incentives to build new homes. So for all of those reasons, 
foreclosures besides being obviously a tragedy for homeowners 
who would like to stay in their homes, has negative effects for 
the economy and the financial system more broadly.
    And so, I certainly encourage efforts to avoid preventable 
foreclosures. Having said that, of course it is a very, very 
difficult problem, and a lot of people have been working on it, 
and unfortunately we are still looking for, I think, a 
significant number of foreclosures in 2010 and probably into 
2011 as well.
    Mr. Green. Mr. Chairman, you said you encourage, and I am 
going to ask, are you permitted to encourage other institutions 
comparable to Bank of America to do a similar thing? And I ask 
because I am not sure what the protocols are with reference to 
your office. I know that you try as best as you can to make 
sure that you don't encroach upon the province of Congress and 
others, but are you permitted to and can you encourage other 
institutions to take similar action?
    Mr. Bernanke. I think the way to proceed is to try to 
encourage banks to be in touch with troubled borrowers and to 
try to work out some solution, whether it is a principal 
reduction or some other solution; that is something that we do 
very much encourage.
    More specifically, we encourage banks to participate in the 
government programs like the HAMP and so on. As you know, the 
HAMP program has been focused on payment, on a monthly payment, 
as opposed to on principal reduction. I know they are looking 
at alternative ways of addressing foreclosures through 
principal reduction, through assisting unemployed homeowners 
and so on. And as they develop these programs, then we would 
certainly encourage banks, particularly the large servicing 
banks, to fully participate in those programs. We can't tell 
them to participate in something that doesn't quite exist yet, 
so we are hoping that Congress will develop some viable 
programs that will be attractive to the servicers to 
participate in, and we will encourage that.
    Mr. Green. Well, thank you. And I will say this, that I 
think we will do what we can and we should, but I would also 
hope that other institutions will of their own volition decide 
that they too have a role to play in this. This is why I 
compliment Bank of America, because they of their own volition 
it appears, unless there is something going on that I am not 
privy to, they have decided to engage in principal reduction.
    Reducing interest rates, I think that is a great thing to 
do, and I think that can be helpful, but principal reduction 
based upon payments made is an inducement to a person to keep 
your home and also know that you will not be underwater perhaps 
at some point in the future. Thank you for your comments, and I 
yield back, Mr. Chairman.
    Mr. Watt. Thank you. As time has expired, I would remind 
them that is the bank that is based in my congressional 
district.
    [laughter]
    Mr. Watt. Maybe there is some causal connection.
    Mr. Green. But Mr. Chairman, I know that good things happen 
whenever you show up.
    Mr. Watt. The gentleman from Missouri, Mr. Cleaver, is 
recognized for something good to happen.
    Mr. Cleaver. Thank you, Mr. Chairman. I have no questions.
    Mr. Watt. Oh, you yielded back already, or are you 
deferring? The gentleman from Illinois, Mr. Foster, is 
recognized for 5 minutes.
    Mr. Foster. I won't deal with that, Ed.
    [laughter]
    Mr. Foster. Let's see, I would like to follow up on 
Representative Waters' line of questioning having to do with 
unemployment and your offer of analytic and technical help.
    Mr. Watt. Let me apologize to Mr. Perlmutter. I thought we 
went to the other end.
    Mr. Foster. I will proceed. There is some discussion in the 
world of economists about the breaking of Okun's Law that may 
have happened in 2009. And this is very troubling to us because 
we had all of these predictions that if we went ahead past the 
stimulus and so on, all the people who run macro models said 
that the GDP would recover and that unemployment would recover.
    And if you look, roughly speaking, GDP and business 
profitability and so on, did recover as predicted by all these 
models; unemployment did not. And it is my impression, though I 
am not an expert on these models, that basically uses changes 
in GDP and then back-calculates what the change in unemployment 
should have been. And if that link broke Okun's Law, broke in 
the last year, that means that we no longer have a predictive 
policy tool in these models, and it is a very painful way for 
it to break since of course having unemployment. So, I was 
wondering your take on this. It appears in your textbook and I 
presume I can get some expert advice on how we should go 
forward from a policy point of view if our model's unemployment 
are no longer predictive.
    Mr. Bernanke. I think it is too strong to say they are no 
longer predictable. It is just that given the depth of the 
recession, the unemployment increase was even worse than you 
would have anticipated which may be a one time thing we hope, 
obviously.
    There are a number of possible explanations for it. One 
might be that in fact the GDP numbers were too optimistic. It 
could be that if you look at alternative measures of output 
like gross domestic income as opposed to product, that was a 
deeper recession, maybe that explains it. But the more 
conventional story is that as the economy dropped very sharply 
at the end of 2008, beginning of 2009, firms became very--
employers became very concerned and they cut very deeply, 
perhaps more deeply than normal. And that may be why the 
unemployment rate went up faster. And so going forward the 
question is, is there enough confidence that employers will now 
begin to rehire those people that they let go during the depth 
of the crisis?
    One issue, interestingly enough, is productivity. The firms 
cut very deeply and still managed to maintain production, and 
as a result, the productivity numbers have been extraordinary.
    Mr. Foster. And this is the IT theory, that people bought 
computer systems that allowed them, in principle, to lay off a 
bunch of workers. They weren't comfortable doing that in the 
good times and then, but did grow comfortable with the computer 
systems, and when it was time to cut they were able to keep 
shipping products--which is a plausible theory. My general 
question was, do you think that you have to put more effort 
into modeling the effect on the labor market? That is the 
approach that you have been, that is taking on the macro 
models, I am saying is it all about GDP if we get GDP right, 
the labor market is automatically dealt with correctly? That 
you need a more sophisticated modeling so that we understand--
    Mr. Bernanke. Certainly, absolutely. And we do look at the 
labor market separately and in great detail.
    Mr. Foster. Did you see this coming? The break in the 
Okun's Law?
    Mr. Bernanke. No, no we did not.
    Mr. Foster. Does the modeling reproduce the breaking in 
Okun's Law?
    Mr. Bernanke. Well, again, as I said there, we sort of have 
two explanations. One is that maybe the recession was deeper 
than we thought. The other is that the productivity gains were 
greater than we thought they would be when firms were able to 
cut their work forces and still maintain output. All that being 
said, I think that as the economy comes back and as we see job 
creation, I see no reason to think that we won't see declines 
in unemployment on the way up just as we saw increases on the 
way down.
    Mr. Foster. So you would view this as a one-time occurrence 
and we should stay back--we should return to the--
    Mr. Bernanke. It is too strong to say that we just have to 
throw out everything we know, that is certainly not the case. 
But it is an episode that we economists in general are going to 
want to understand better and look at for a long time. A 
related issue is participation rates, which have moved around a 
lot. A number of people who are looking for work and are in the 
labor force--that has been going down for a while because of an 
aging society, but we saw it rise for a period perhaps because 
people when they saw their 401(k)s, you know, being hit by the 
stock market decline, said look, we have to work harder, and 
work longer. So, there were a number of factors, a number of 
issues that were unexpected and we need to understand better, 
certainly. Thank you and I yield back.
    Mr. Watt. The gentleman from Colorado, Mr. Perlmutter.
    Mr. Perlmutter. Thank you, and just following up really on 
Mr. Foster's questions, and I'm looking at pages 20 and 21 of 
your monetary report. There are three very interesting charts 
there, and the first one is your chart 27, which shows net 
change in private payroll, and from the beginning of 2008 to 
the beginning of 2009, that's about as close to falling off a 
cliff in terms of employment as you can have.
    Now you used, when Mr. McHenry was asking you questions, 
you used going forward the situation is somewhat dark. Those 
were your words, somewhat dark. How would describe what 
happened from the beginning of 2008 to the end of 2008? Would 
you say absolutely black?
    Mr. Bernanke. I was talking about a different set of 
issues. But certainly, the recession in the latter part of 
2008/beginning of 2009, not only in the United States but 
around the world, was extraordinarily sharp. Absolutely.
    Mr. Perlmutter. And this drop in employment reflects that.
    Mr. Bernanke. Certainly.
    Mr. Perlmutter. And then, since the beginning of 2009, we 
are almost back to zero in terms of job losses.
    Mr. Bernanke. In terms of job losses.
    Mr. Perlmutter. Okay. And we have another chart. This one 
is not from your monetary report, but it is the Bureau of Labor 
Statistics, sort of the job losses that occurred in 2008 and 
the job losses as they sort of shrunk in 2009.
    But it relates to about 8 million jobs, if I am correct. So 
we still--even though things--the rate of job losses is pretty 
much stopped, we still have 8 million people who lost their 
jobs between 2008 and through 2009.
    So, you know, then you have another very interesting--and 
you were talking about productivity, your chart No. 30 in your 
report. I mean, this one basically shows America to be the most 
productive it has been per person in 60 years.
    So, I mean, there are--looking at it in that light, that is 
great news, except that we have 8 million people who are 
unemployed. So in this process of--you know, Mr. Lance, I agree 
with him. We have to deal with the debt. But we also have to 
get 8 million people, in my opinion, back to work.
    So it is, step one, get people back to work. Step two, 
grapple with this debt that exists. By getting people back to 
work, you help the revenue side of the balance sheet; dealing 
with the debt, you take care of the expense.
    Where are you in terms of the Federal Reserve in terms of 
sort of your ideas as to getting people back to work? If you 
start tightening the money supply, what do you expect to happen 
to our effort to get people back to work?
    Mr. Bernanke. Well, first, on the fiscal side, just to make 
sure you understand my position, you have to look at two 
different periods of time. In the very near term, there is a 
reason for the big deficit, and I don't think it is either 
desirable or possible to get rid of it in the next year or two.
    Down the road, when the economy is operating more normally, 
then if we can convince creditors that, in fact, we will have a 
more stable, sustainable situation, that will actually improve 
interest rates today and support the growth process today.
    From the Federal Reserve's perspective, we are recovering 
from a very deep recession, and monetary policy is just about 
as supportive and accommodative as it has ever been. Interest 
rates are close to zero, and we have more than doubled our 
balance sheet and used all these other policies to try to get 
markets working again and try to increase capital in the 
banking system.
    So we are taking very seriously the unemployment situation, 
and we take seriously that part of our mandate, for maximum 
employment.
    Mr. Perlmutter. And I would just say, in looking back at 
this unemployment chart, that the coupling of the monetary 
policy with the fiscal policy that began in early 2009 reversed 
what was freefall in this economy.
    So, personally, we have to deal with the first thing, 
employment. Then we deal with the second thing, debt. To the 
degree we can deal with them together, wonderful.
    I think the other chart that is really interesting on page 
20 is the savings chart, that people in this country who had 
not been saving now are saving at a pretty good clip. The 
Federal Government is not saving, but they are having to deal 
with a lot of folks who have needs because they have been laid 
off, they needed insurance, whatever it might be.
    But, you know, Mr. Chairman, again, we have been visiting a 
lot over the last 2 years, and I just thank you for your 
service.
    Mr. Bernanke. Thank you.
    Mr. Watt. The gentleman's time has expired and--oh, Mr. 
Adler--he is hiding down there--is recognized for 5 minutes.
    Mr. Adler. Mr. Chairman, thank you.
    Chairman Bernanke, I want to follow up on Mr. Perlmutter's 
comments. I also want to thank you in a broad sense, but 
actually in a narrow sense as well. The first time I spoke to 
you a year ago, I asked you to consider including in TALF auto 
fleet leasing.
    You weren't sure whether it was in it or was going to be in 
it. You said you would get back to me in a couple of days. And 
2 days later, you publicly announced that auto fleet leasing 
would be included in TALF.
    For my district, which has two of the four or five biggest 
auto fleet leasing services in the country, it saved hundreds 
and hundreds of jobs, great private sector companies that 
couldn't get liquidity. You did a good thing for them. So you 
used your head with a great heart, and it really did help 
people; the sort of things Mr. Perlmutter is talking about, 
employment, you saved lots of jobs. That was a great thing.
    Following up on Mr. Perlmutter's comments, I heard Mr. 
Lance and you in a dialogue regarding deficits some minutes 
ago. And I sort of share the view that we have to deal with 
deficits some time soon, not some time in the distant future.
    And I am wondering what sort of hope you can think in terms 
of, within a certain period of time, we could realistically 
start grappling with deficits because while I recognize that we 
don't have inflation now, I worry that big deficits with rising 
inflation could be very, very expensive for the American 
taxpaying public.
    Mr. Bernanke. Well, it is never too soon to start planning. 
We have--we know pretty much what is going to happen to our 
population, and we know what has been happening to costs, both 
health care costs, defense costs, and a whole variety of 
things.
    I know that the President created this commission, and both 
parties have nominated people to be part of that. I hope that 
is an effective way of putting out some options that Congress 
will consider seriously.
    But anything we can do to, at the same time that we are all 
very concerned about the current situation and looking at how 
to get the economy moving again, you know, with one eye, we 
should be also looking at the next 5 years, the next 10 years, 
and using whatever methods we can to try to develop a plan that 
we can all agree on to restore greater balance in our fiscal 
situation.
    So it is a difficult problem, but I don't think there is 
any reason why we can't start working on that more or less 
immediately.
    Mr. Adler. Thank you. I know on the Senate side, while they 
are voting on health care right now, I suspect very, very soon 
they will take up a bill or a series of bills on regulatory 
reform to try to get our financial house in order.
    I wonder if you could comment a little bit on the sense 
that I have, and that maybe other people have, that the 
business community, the lending community, is sort of frozen 
right now, waiting to invest but not certain what the ground 
rules are going to be going forward.
    So at least I am hearing from business people in my 
district, from around the country, that they really want a new 
structure in place so that they know what the rules are going 
to be, so they can have some predictability, some certainty, 
almost, where possible before they can really move forward and 
help us recover as a private sector economy.
    Mr. Bernanke. And we hear exactly the same thing, that 
policy uncertainty, economic uncertainty, is a real drag 
because, you know, you are trying to make a decision about 
where to locate your plant or hire a bunch of parallel or 
undertake a new line of business, and you don't know what the 
economic environment, the policy environment, is going to be. 
It makes it much more difficult.
    So from the perspective of financial firms in particular, 
even though they may be concerned or oppose certain elements of 
the reform bill, I think, all else being equal, they would like 
to see--whatever happens, they would like to see it get done 
because then they would at least have--you know, have some 
certainty about what the environment is going to be, and they 
could plan better and be more willing to make investments and 
loans, I hope.
    Mr. Adler. I thank you. I yield back the balance of my 
time.
    Mr. Watt. It appears that all of the members who might 
second-guess you in the future about how you withdraw from this 
liquidity situation have not shown up. So we thank you so much 
for your testimony and, as I say, we consider you the master 
conductor, so we know that you will deal very well with the 
decisions going forward, with the brain trust you have behind 
you, of course.
    So we thank you, and we will consider this part of the 
hearing completed, and call up the second panel of witnesses so 
that we can start the second panel.
    Mr. Bernanke. Thank you.
    Mr. Watt. There may be follow-up questions in writing from 
some of the members. And of course, we will accommodate that at 
the end of the hearing.
    Has anybody seen Mr. Goodfriend? He was here earlier. So we 
will search for him just for a second, and then we will try to 
figure out--
    [pause]
    Mr. Watt. We presume he will show up shortly, so let's 
convene the second panel so as not to back ourselves into a 
time conflict with votes.
    We are pleased today to have four distinguished members--
three of whom are present--on this panel: Mr. Larry Meyer, vice 
chair of Macroeconomic Advisors; Mr. John B. Taylor, Mary and 
Robert Raymond professor of economics at Stanford University; 
Mr. Marvin Goodfriend, professor of economics, and chairman of 
the Gailliot Center for Public Policy, Tepper School of 
Business, Carnegie Mellon University--your timing is exquisite; 
and Mr. Laurence Ball, professor of economics at Johns Hopkins 
University.
    Each of you will be recognized for 5 minutes and, of 
course, the full content of your written statements will be 
made a part of the record. We would ask you to summarize your 
statements in the 5-minute window.
    The lighting system there will alert you. The green light 
will be on for 4 minutes, a yellow light will be on for 1 
minute, and then we would ask you to wrap up. We obviously 
won't cut you off in mid-sentence, but we do try to stick to 
that timeframe as closely as we can.
    So with that, Mr. Larry Meyer, vice chair of Macroeconomic 
Advisors?

   STATEMENT OF LAURENCE H. MEYER, VICE CHAIR, MACROECONOMIC 
                            ADVISORS

    Mr. Meyer. Chairman Watt, Acting Ranking Member Paul, and 
the other members of this committee who have decided to stay 
for this panel, I am particularly grateful to you--
    Mr. Watt. I suspect other members will wander in and out 
during the course of it. Make sure your microphone is on.
    Mr. Meyer. Yes, it is. Thank you for giving me this 
opportunity to discuss questions about the Fed's exits from its 
emergency liquidity facilities and from its extraordinary 
accommodative monetary policy.
    As the chairman explained to you today, but really more in 
his earlier testimony, the Fed has already closed its emergency 
liquidity facilities. They were no longer needed. These 
facilities basically closed on their own. Borrowing declined 
and virtually stopped as markets healed. Then the Fed just 
closed the door.
    The increase in the discount rate was just the last step in 
liquidity normalization. In executing aggressive easing, the 
Fed raised the level of reserves by $1 trillion, lowered the 
fund's rate to near zero, and doubled the size of its balance 
sheet to about $2 trillion.
    Exit from the Fed's extraordinarily accommodative monetary 
policy involves actively withdrawing reserves, raising the 
policy rate, and shrinking the balance sheet. Each step has one 
or more tools designed explicitly for it.
    The Fed will withdraw reserves by executing reverse repos 
and offering term deposits to depository institutions. It will 
raise the policy rate by increasing the interest rate on 
reserves. And the balance sheet will passively shrink by 
runoff, and the Fed appears to intend eventually to sell MBS.
    Sequence is about the order in which these steps will be 
taken. In his earlier testimony, the Chairman provided you with 
an outline of the likely order. The Fed in this case would 
likely withdraw reserves first, later--but not much later--
raise rates, and still later sell MBS.
    Reducing reserves first will help the next step, raising 
interest rates, reinforcing the role of interest on reserves. 
While the Fed is operating in uncharted waters so there is a 
lot of uncertainty about this exit, I believe that the tools 
are sufficient to accomplish each step, and the sequence is 
very well designed.
    The Fed can avoid unwanted inflation by exiting at the 
right time. The right time depends in part on the evolving 
outlook and forecasts, and in part on the strategy that links 
the forecast to appropriate monetary policy. I think that 
strategy is also well thought out.
    And given both our and the FOMC's expectation that the 
unemployment rate will remain quite elevated for some time, and 
that inflation will remain subdued, there is no reason to begin 
to raise the policy rate any time soon. I expect the first 
increase will not come until mid-2011.
    There is very little chance that the Fed's policies could 
lead to unwanted inflation over the next few years. Now, it is 
interesting nevertheless that some worry that inflation will be 
very high over the medium term, and some even believe we are 
headed to hyperinflation.
    There are only two ways that this can happen: a colossal 
and almost inconceivable policy error by the Fed; and your 
taking away the Fed's independence. In my judgment, the risk of 
very high inflation comes from you, not the Fed.
    Inflation and long-term inflation expectations would soar 
if you forced the Fed to monetize deficits to avoid the very 
sharp rise in interest rates that would otherwise occur at some 
point from continued unsustainable deficits. This won't happen 
if you take steps to put the deficit on a sustainable course, 
and it cannot happen if you respect the independence of the 
Fed.
    Now, the FOMC is at a zero rate only because it cannot 
lower the rate further into negative territory. If they could, 
they would. In this case, the Fed has done as much as it can 
with conventional policy. The only option at this point was to 
implement unconventional policies, and in this case credit-
easing policies.
    The Fed was by far the most aggressive central bank in 
pursuing these policies, and as a result, we will have the most 
challenging exit. Credit-easing policies involve buying longer-
term illiquid assets in markets where the flow of credit is 
impaired as a result of the financial crisis, or buying long-
term Treasuries to lower long-term rates relative to this near-
zero funds rate.
    The effectiveness of these credit-easing policies is 
controversial. I agree qualitatively with a recent New York Fed 
staff study that estimates that purchases of long-term 
Treasuries in MBS had important effects, lowering long-term 
rates, and especially mortgage rates, although I don't think 
the effects were as large as they estimate. Nevertheless, I am 
skeptical that the Fed can do much more, for example, if the 
economy slips into a double dip recession.
    Once the Fed is driven to near zero rate, the burden of 
further stabilization shifts to you. Sizable and timely fiscal 
stimulus was both needed and now viewed quite effective. The 
desirability of further stimulus, however, is understandably 
limited by concern about current and prospective deficits.
    The severe limits on monetary policy and fiscal policies in 
the case of an even weaker-than-expected economy is a further 
reason for keeping the policy rate extraordinarily low for an 
extended period. Thank you.
    [The prepared statement of Mr. Meyer can be found on page 
82 of the appendix.]
    Mr. Watt. Thank you so much.
    Next, Mr. Taylor, Mary and Robert Raymond Professor of 
Economics, Stanford University.

STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR 
               OF ECONOMICS, STANFORD UNIVERSITY

    Mr. Taylor. Thank you very much, Mr. Chairman, and Ranking 
Member Paul. I am going to address my comments to the things 
that were requested in the letter of invitation which is, 
first, an assessment briefly of the extraordinary measures the 
Fed has taken, and second, an exit strategy from those.
    I have been studying these extraordinary measures for 
several years now using empirical methods and looking at the 
data, trying to think of counterfactual hypotheses. I think it 
is most useful to divide this period of the financial crisis 
into three parts to answer the questions: the first is, if you 
like, the pre-panic period from August 2007 until the panic in 
the fall of 2008; the second is the panic period itself, which 
is the fall of 2008; and the third, I call the post-panic 
period, since then.
    It seems to me, if you look at the extraordinary actions 
taken in the pre-panic period, they did not work very well and 
were harmful in certain cases. The term ``auction facility'' 
did little to reduce tension in the interbank markets during 
this period. And as I testified in this committee 2 years ago, 
based on my research, it had very little effect--in fact, I 
think drew attention away from--the counterparty risks in the 
banking sector, which were apparent way back then.
    Most important, I think, was the extraordinary bailout 
measures, which began with Bear Stearns. They were most 
harmful, in my view. The Fed's justification for the use of 
Section 13(3) of the Federal Reserve Act in the case of Bear 
Stearns led many to believe that the Fed's balance sheet would 
again be available in case of another similar institution, such 
as Lehman Brothers, failing.
    But when the Fed was unsuccessful in getting private firms 
to help rescue Lehman over the weekend of September 13-14, 
2008, it surprisingly cut off access to its balance sheet. 
Then, the next day, it reopened its balance sheet to make loans 
to rescue the creditors of AIG. Then, it was turned off again, 
and the balance sheet was not able to make loans in the next 
event.
    It seems to me that this on again/off again bailout 
measures were an integral part of the generally unpredictable 
and confusing government response to the crisis which, in my 
view, led to the panic.
    What about action taken during the panic itself? It seems 
to me this is the most difficult period to analyze because so 
many other things were taking place, so many other government 
actions. But I believe, based on conversations with traders and 
market participants, that the actions taken in the commercial 
paper market and the actions taken with respect to the money 
market mutual funds were helpful in rebuilding confidence 
during this difficult period.
    Finally, the post-panic actions. It seems to me that, of 
course, the biggest measure taken in this period was the MBS 
program. We also had the TALF as well, which has not really 
amounted to very much.
    But my assessment of the MBS program, again based on 
empirical work looking carefully at these data, is that once 
one controls for prepayment risk and default risk, they had 
very little impacts on mortgage interest rates. I emphasize 
these estimates are uncertain.
    Now, what about exiting from these strategies? The chairman 
has listed the tools that are available. I think it is 
important to exit as soon as is practically possible. What I 
would emphasize is, in addition to the tools that he has 
listed, that there be some emphasis on a strategy for using the 
tools.
    In other words, an exit strategy is more than just simply a 
list of instruments. It is a policy describing how the 
instruments will be adjusted over time until the monetary 
framework which we are looking for is reached.
    In my testimony, the written version, I have outlined a 
possible strategy. I call it an exit rule. It is one in which 
the Federal Open Market Committee's decisions about the 
interest rate increases, which will come at some point, are 
linked to decisions to reduce the level of reserves.
    In other words, when the FOMC decides to start increasing 
the Federal funds rate target, it would also reduce reserve 
balances. It seems to me such an exit rule or exit strategy 
could be announced to the markets with whatever degree of 
precision the FOMC thinks is appropriate.
    The biggest advantage of such an exit strategy like that is 
it is predictable. It would reduce considerable uncertainty 
about the Fed's unwinding of these huge programs while 
providing, in my view, enough flexibility to adjust if the exit 
appears to be too rapid or too small.
    Thank you very much.
    [The prepared statement of Professor Taylor can be found on 
page 90 of the appendix.]
    Mr. Watt. Thank you very much, Professor Taylor.
    Next, Professor Marvin Goodfriend of the Tepper School of 
Business, Carnegie Mellon University.

  STATEMENT OF MARVIN GOODFRIEND, PROFESSOR OF ECONOMICS, AND 
   CHAIRMAN OF THE GAILLIOT CENTER FOR PUBLIC POLICY, TEPPER 
         SCHOOL OF BUSINESS, CARNEGIE MELLON UNIVERSITY

    Mr. Goodfriend. Thank you, Mr. Chairman. I am especially 
gratified to be invited to testify before the House Financial 
Services Committee today because I have spent 25 years at the 
Federal Reserve Bank of Richmond working on monetary policy, 
thinking about other aspects of the Federal Reserve's 
operations.
    The recessions and credit turmoil led the Fed into 
uncharted waters. While pushing short-term interest rates 
nearly to zero, the Fed more than doubled the size of its 
balance sheet and created roughly a trillion dollars of bank 
reserves, which it used to finance the purchase of a variety of 
non-Treasury securities to fund loans to financial institutions 
through a variety of liquidity facilities.
    In my view, the economy is likely to recover slowly, and it 
may be some time before it is appropriate for the Fed to raise 
short-term rates or shrink its balance sheet. But the point is, 
in the meantime, I think the Fed ought to position itself to 
deal flexibly and credibly with whatever comes by doing two 
things: one, taking the opportunity to improve its actual and 
perceived independence on monetary policy; and two, taking 
actions to strengthen the mechanical capability to raise 
interest rates in case it cannot first shrink its balance 
sheet.
    In my testimony, I suggest how the Fed can do these things 
by talking in terms of three distinct aspects of central 
banking: monetary policy; credit policy; and interest on 
reserves policy.
    In my classification, monetary policy involves open-market 
operations that expand or contract high-powered money, that is, 
bank reserves or currency, by buying and selling only Treasury 
securities, U.S. Treasury securities. Until the recent credit 
turmoil, the Fed satisfied virtually all of its asset 
acquisition needs in support of monetary policy by purchasing 
Treasury securities, a policy known as ``Treasuries only.''
    By adhering to Treasuries only, the Fed passes all the 
revenue from money creation back to the Treasury and leaves all 
the decisions regarding the use of that revenue to the fiscal 
authorities. Hence, and this is the first point of my 
testimony, returning to Treasuries only would strengthen the 
Fed's independence on monetary policy by narrowing the 
potential for conflict with the Treasury and Congress on fiscal 
policy.
    In my terminology, credit policy undoes Treasuries only. 
Credit policy uses the proceeds from selling Treasury 
securities to finance discount window loans and the purchase of 
non-Treasury assets by the central bank. Credit policy has no 
effect on the Federal funds rate because it doesn't change bank 
reserves.
    Credit policy works by interposing the government's 
creditworthiness between private borrowers and lenders, and 
exploiting the government's creditworthiness to lower private 
borrowing costs. All central bank credit policy initiatives 
carry some risk and involve the central bank, and ultimately 
taxpayers, in potentially costly and controversial disputes 
regarding credit allocation.
    Hence, when a central bank extends its credit policy reach 
in scale, maturity, collateral to unsupervised nondepository 
institutions, and the purchase of non-Treasury securities, that 
central bank policy infringes increasingly on the fiscal policy 
prerogatives of the fiscal authorities and properly draws 
Congress to scrutinize the Fed.
    In so doing, expansive credit initiatives undermine the 
central bank's independence. And here is the second point of my 
testimony. In order to preserve its independence on monetary 
policy and credit policy, too, the Fed should confine its 
credit initiatives to conventional last resort lending, that 
is, lending to illiquid but solvent depositories. Temporary 
lending to supervised solvent depositories on a short-term 
basis against good collateral has multiple layers of protection 
against loss, with minimal allocative effects.
    Last resort lending narrows the scope for conflict between 
the central bank and the fiscal authorities sufficiently, in my 
opinion, to be compatible with independence.
    Moving on, Chairman Bernanke, in his written testimony for 
the July 2009 report to Congress, expressed the view that the 
power of interest on reserves to put a floor under the Federal 
funds rate is perhaps the most important tool, enabling the Fed 
to raise the Federal funds rate without shrinking its balance 
sheet. I agree.
    However, the Federal funds rate slipped below interest on 
reserves in the fall of 2008 because large lenders--Fannie Mae, 
Freddie Mac, and the Federal Home Loan Banks--are legally 
ineligible to receive interest on balances that they hold at 
the Fed.
    And here is my third point. I believe that the Treasury and 
Congress should help the Fed to secure the interest on reserves 
floor by modifying regulations for the Federal funds market so 
as to exclude all but depository institutions from lending in 
that market, or by allowing all institutions eligible to lend 
to earn interest on deposits at the Fed.
    I say this because I believe the alternative options to 
raise the Federal funds rate by draining or immobilizing excess 
reserves have serious drawbacks.
    First, the Fed would likely have to drain hundreds of 
billions of dollars of reserves over a span of time to have 
much effect on the Federal funds rate at all.
    Second, the use of large-scale reverse repurchases to drain 
reserves would expose the Fed to substantial counterparty risk. 
My opinion is that the Fed should not be exposed to 
counterparty risk on private arrangements, should not be 
dependent on that sort of counterparty risk to do its job.
    And third, term deposits issued by the Fed to drain 
reserves would compete with Treasury bills, and again create 
friction with the fiscal authorities.
    And my very last point is this: More generally, the use of 
what I would call managed liabilities by our central bank would 
turn the Federal Reserve into a financial intermediary and 
potentially jeopardize its independence by facilitating the 
perpetual funding of credit policy independently of monetary 
policy. Thank you.
    [The prepared statement of Professor Goodfriend can be 
found on page 76 of the appendix.]
    Mr. Watt. Thank you so much for your testimony.
    Next, Professor Laurence Ball of the Johns Hopkins 
University.

   STATEMENT OF LAURENCE BALL, PROFESSOR OF ECONOMICS, JOHNS 
                       HOPKINS UNIVERSITY

    Mr. Ball. Chairman Watt, Ranking Member--
    Mr. Watt. Your microphone may not be on.
    Mr. Ball. Is it on now? All right. So I will get it right.
    Chairman Watt, Ranking Member Paul, I am very grateful for 
the chance to participate in this hearing.
    The eventual unwinding of the Fed's emergency policies 
raises many issues. I am going to focus on the set of issues 
that I believe are most important, which is the prospect of an 
eventual increase in the Fed's target for the Federal funds 
rate.
    This issue has two parts. One is a technical question of 
how the Fed will be able to raise the Federal funds rate when 
it decides it is the right time to do so. And the other is the 
policy question of when will be the right time for the Fed to 
raise interest rates.
    The technical question, I think, is actually quite easy, 
and Chairman Bernanke has explained it very well. The Fed has 
several tools, including interest on reserves. And to make a 
long story short, I am very confident that the Fed has the 
capability to raise interest rates whenever it decides the time 
is right.
    So let me concentrate on the harder question of when the 
time will be right. When will we know that the Fed should be 
raising interest rates again?
    The first thing I want to say about that is that a lot of 
the debate about when the Fed should raise interest rates is 
about how long it should be in time. Some people say it should 
be 6 months. Some people say it should be 2 years. I think that 
is a little bit misplaced because the right time to raise 
interest rates is defined by economic circumstances. We should 
raise rates when there is a sufficient economic recovery.
    And there is enough uncertainty about the course of the 
economy over the next few years that it is very hard to know in 
what month or year it is going to be time. We have to just wait 
and see when the circumstances are right for the interest rate 
to rise.
    So what are the right circumstances? This, I believe, has a 
fairly simple answer. Interest rates should start rising at 
some point when there is substantial progress in reducing 
unemployment.
    I think everybody in the room would agree that the current 
10 percent unemployment rate is a terrible problem for the 
United States. And I believe policy should remain very 
accommodative and do everything it can to help with reducing 
unemployment until it is clear that unemployment is falling and 
is on a path towards something much closer to what we used to 
consider normal unemployment of 5 percent or so.
    Now, probably the most important point I want to make is 
that in my view, as long as unemployment remains high, the Fed 
should not start increasing interest rates because it is 
concerned about inflation.
    A number of people, including a number of presidents at 
Federal Reserve banks, have suggested that there may be a risk 
of inflation, that maybe the Fed needs to raise interest rates 
sooner rather than later to head off the risk of inflation. And 
in my personal view, I strongly disagree with this, for two 
reasons.
    First, I think there is very little risk of inflation in 
the near future. Second, even if eventually there is a moderate 
increase of inflation, let's say to 3 percent or 4 percent, 
that is probably, on balance, a good thing, not something to be 
feared. So let me address those two points.
    Why is there little risk of inflation? If one notices that 
the Federal funds rate is zero, and the monetary base has risen 
at tremendous rates, that gives one a reason to fear inflation. 
But the reason that such accommodative monetary policy causes 
inflation is that usually it sparks an economic boom.
    Super-easy monetary policy causes the economy to overheat 
and grow too quickly, and that is what causes inflation. And 
having the economy overheat and grow too quickly is the last 
thing we have to worry about right now. So inflation is not a 
serious danger, in my opinion.
    Now, eventually the economy will recover, and eventually 
there may be some increase in inflation along the way. But 
again, if we have a moderate increase in inflation, let's say 
to 3 percent or 4 percent rather than the implicit target of 1 
to 2 percent over the last decade or so, that would probably be 
a good thing.
    The reasons are somewhat complex and discussed in my 
testimony. But briefly, somewhat higher inflation will imply 
somewhat higher nominal interest rates, which is a good thing 
because it gives the Fed more room to cut interest rates the 
next time there is a recession and we are less likely to hit 
the zero bound problem we hit in this recession.
    And then also, briefly, in my view there is no evidence 
whatsoever that 3 or 4 percent inflation causes serious damage 
to the economy. When Paul Volcker conquered inflation, that 
meant reducing inflation to 3 or 4 percent. That was considered 
perfectly acceptable at the time, and no evidence since then 
has contradicted that. Thank you.
    [The prepared statement of Professor Ball can be found on 
page 63 of the appendix.]
    Mr. Watt. I thank all of you gentlemen for your outstanding 
testimony. We will now go to member questions, and reward Mr. 
Perlmutter for skipping over him earlier by recognizing him 
first.
    Mr. Perlmutter. Thank you, Mr. Chairman, and thank you, 
gentlemen, for your testimony.
    I just want to follow up with Professor Ball. Based on your 
experience and your research and your analysis of all this, 
when do we want to start tightening up?
    And Mr. Meyer, I thought you were saying, well, we are not 
in a position of inflation or hyperinflation right now. But 
just from your background, talking to me as a policymaker, as a 
layman, what should I be looking for just in terms of when are 
we going to start tightening things up?
    You heard me on the unemployment piece. That is where I am. 
I have a lot of people I have to put back to work. So if each 
of you would respond?
    Mr. Meyer. Okay. Well, I am going to answer that in terms 
of the spirit of the ``Taylor Rule'' that John has done. I 
don't use exactly that one. But we know the Fed has two 
objectives, full employment and price stability. Okay? So the 
question is: How much does the unemployment rate have to fall, 
and where should inflation be?
    I believe the unemployment rate is going to be above 9 
percent at the end of this year, 1 percent, and likely to be 1 
percent for the next couple of years. You can't convince me 
that it is time for the Fed to begin to tighten.
    So we can talk about how low the unemployment rate should 
be. Certainly, inflation has to stabilize, from 1 percent 
probably has to begin to turn up. And the unemployment rate has 
to get down to--you know, it is hard to judge this, but in our 
case, close to 8\1/2\ percent.
    Even then, it is hard to make a really strong case for 
tightening under those circumstances because the unemployment 
rate will be higher than the Fed has ever tightened that, and 
the inflation rate will be lower than the Fed has ever 
tightened that. So I will say the middle of 2011 or later.
    Mr. Perlmutter. And Mr. Taylor? Professor?
    Mr. Taylor. I agree that it depends on what happens with 
inflation and GDP growth and employment. I do think that the 
Fed has to be ready in case we get a surprise, an unfortunate 
increase in inflation. It has to also be ready if we are more 
pleasantly surprised with a stronger recovery. And in both 
cases, some interest rate increases will be required. I think 
it depends on when they occur.
    But I would just say briefly, remember, one of the 
theories--which has been discussed a lot, one I advocate--is 
that the reasons we got into this crisis and the reasons we 
have, therefore, this high unemployment rate was the Fed held 
interest rates too low for too long for several years.
    So don't think that it is an automatic help for 
unemployment to delay the interest rate increases. It could 
very well help prevent another downturn later.
    Mr. Perlmutter. You heard it, and I would like Mr. 
Goodfriend, or Professor, to answer on this--but you heard Mr. 
Foster's question about this Okun's Law. And, I mean, 
productivity is really something that is at historic highs, 
which is wonderful.
    But people don't get back to work because you are getting 
it all done and you are making a lot of money and you are doing 
it with a lot fewer people. Does that factor into anything? Do 
you believe this Okun's Law, whatever the heck he was talking 
about, is broken?
    Mr. Goodfriend. Well, part of the productivity is cyclical. 
This happens when people's employment--you know, it goes down 
and the economy starts to recover. It is very typical. So I 
don't think that is a permanent thing.
    Mr. Perlmutter. This seems to be double pretty much 
anything in the last 60 years. And I was only going to ask one 
question, and I am sorry, Mr. Chairman. But Mr. Goodfriend?
    Mr. Watt. You have a minute and 20 seconds to go.
    Mr. Goodfriend. Yes. Where I come out on this comes from 
the lessons that I have learned studying the Volcker 
disinflation and the period of the Great Inflation before that. 
And the first thing that occurs to me to say is that the Fed, 
the government, is not in control of the public's beliefs. The 
public's beliefs are out there, and you have to stay ahead of 
those.
    I don't like to start talking about these issues in terms 
of what we think about the unemployment rate or the natural 
rate of unemployment. I was at the Fed for 25 years, and I 
learned this, if nothing else, that in environments like we 
have, the public could get very nervous and raise inflation 
expectations in long-term bond rates, if we wait too long on 
this. And if that happens, interest rates go in the wrong 
direction, we go into a double dip.
    So in the limited time that I have to talk about this, I 
would urge everyone here to do what I have been saying in my 
testimony. Do whatever you can to create confidence in the 
public's mind about the fiscal authorities and the central bank 
being on the same page so we can anchor those beliefs. And that 
gives us a little more time to think about how to do these 
things with respect to the unemployment rate.
    Mr. Perlmutter. Thank you. Professor, anything else?
    Mr. Ball. Yes. My basic answer is that it is time to ease 
when unemployment is substantially lower. Chairman Bernanke 
talked about the Fed's dual mandate. Professor Taylor, if I 
understood, talked about there are inflation risks. There are 
unemployment risks. That sounds very reasonable and balanced.
    I think in current circumstances, we have to be somewhat 
unbalanced. The economy has a crisis in unemployment, and it is 
essential to do something about that. Relative to that, whether 
inflation is 1 percent or 2 percent or 3 percent or 4 percent 
is really a minor issue, in my opinion.
    Mr. Perlmutter. Thank you very much.
    Mr. Watt. The gentleman's time has expired.
    The gentleman from Texas, Mr. Paul, is recognized for 5 
minutes.
    Dr. Paul. I thank the chairman for yielding.
    I have a comment for Professor Ball first because you made 
the statement that it would be a good thing to get at a 4 
percent inflation rate. That type of language happens to scare 
me a whole lot because I think it is so detrimental, and in 
many ways immoral.
    Because what you are saying is the purpose of the 
government is to depreciate the currency, depreciate the value 
of the money. And who suffers the most from that? Well, the 
poor people do because their prices go up. And the older people 
who are on retirement, they suffer a lot as well. The wealthy 
people seem to be able to handle inflationary problems a lot 
better than the average person.
    And a characteristic of inflation is that you eventually 
wipe out the middle class. And, quite frankly, we do have a lot 
of inflation right now because there is an inflationary factor 
in medical care. That is the main complaint.
    Could you give me a brief answer on that, if you would 
like? Because I want to ask Mr. Taylor a question as well.
    Mr. Ball. Well, those are complicated issues. Briefly and 
very respectfully, I disagree with what you are saying. 
Research suggests that the effects of inflation are distributed 
fairly evenly across different income groups, whereas the 
effects of unemployment are very heavily concentrated on lower-
income people.
    And more generally, I think, just the costs to anybody of 3 
or 4 percent inflation, there has just been no documentation 
that they are important; whereas it is pretty obvious how 
costly unemployment it.
    Dr. Paul. Okay. Thank you.
    For Professor Taylor, you have this exit rule. If the 
economy doesn't get back to growth, as a matter of fact stays 
where it is or starts down again sharply like it might--some 
people suspect that the housing market is still in a major 
crisis--does your rule just not happen? Does it not kick in? 
You don't worry about reducing the balance sheet if the economy 
suddenly takes a downturn?
    Mr. Taylor. What I like about this proposal that I made is 
that it is very similar to the decision about increasing or not 
increasing the interest rate. So if the economy languishes, the 
interest rate will not increase, just as we discussed. If the 
economy picks up, then it will increase the interest rate.
    My proposal on reserves, it is very much like that. It is 
tied into it, so that as the Federal funds rate is increased, 
if it is, reserves will come down at a similar pace. And the 
idea is by the time the Federal funds rate reaches 2 percent, 
then reserves will be roughly at the level where the interest 
rate can be--
    Dr. Paul. So it is on automatic. I get you.
    Professor Meyer suggested that there is not much left for 
the Fed to do. You can't lower interest rates much lower. So we 
get into trouble. And the suggestion is that we just need more 
fiscal stimulation. And I think that is correct.
    Well, anyway, there is a lot of desire for more fiscal 
stimulation. We have had a lot. And even today Chairman 
Bernanke said, ``We are not in the business of monetizing 
debt.'' Of course, they just bought $300 billion worth of debt, 
and if push comes to shove, they do monetize debt.
    But wouldn't it be safe to say that if a bank can get cheap 
money--you know, 1 percent, 0 percent--and take it, because it 
is available through the Federal Reserve system, and they buy 
Treasury bills, even though that might not go on the balance 
sheet, isn't that indirectly monetizing debt?
    Mr. Taylor. I think the thing to look for in terms of 
monetizing the debt is how much the Fed--
    Dr. Paul. Actually buys?
    Mr. Taylor. --purchases. Yes. I think--and also, it is not 
an easy thing. Remember, we think about the monetization that 
occurred in the great inflation; it occurred gradually in the 
late 1960's and 1970's. There was a lot of support for that 
inflation.
    Dr. Paul. Did Professor Meyer have a comment on that?
    Mr. Meyer. Well, I have a comment on a lot of things you 
said.
    Just with respect to fiscal policy, I don't think that--I 
doubt anybody in Congress, or there certainly would be a 
majority, who would want to have a significant fiscal stimulus 
today when there is uncertainty about, one, whether the economy 
needs it, and when the budget is in such terrible shape going 
forward.
    With respect to a rule, yes. I mean, I use a rule to sort 
of follow what policy does. And, you know, the Fed is going to 
reduce reserves as it raises the funds rate. And that is what 
Chairman Bernanke sort of emphasized, when as you raise the 
interest on reserves, you could have managed reserves very 
carefully, withdraw them to keep the funds rate close to the 
interest on reserves. So that is inevitable, and that is really 
in the game plan.
    Mr. Watt. The gentleman's time has expired. I will 
recognize myself, unless somebody else comes in, as the last 
questioner.
    It seems to me that the bulk of the conversation in this 
panel and in the questions that have come up to this point have 
kind of gone beyond the 13(3) authority, and assumed that we 
are back into a situation where we can deal with monetary 
policy. We are speculating about when monetary policy ought to 
be changed, the interest rates adjusted.
    And I am more interested in the 13(3) steps that the Fed 
has taken, and the withdrawal from them. Do you get to--well, 
let me frame this a little bit further.
    One of the witnesses on the panel that was originally 
scheduled, who got snowed out, took the position that the 
United States was currently in a balance sheet recession, and 
that we ought to be very careful in withdrawing these emergency 
steps lest we get to the point that Japan ended up in.
    Now, what I am interested in is the intersection between--
not so much when you raise the interest rates; I think that is 
way out there, I believe. Is that beyond getting out of all of 
this 13(3) steps, or can we even get to the discussion about 
raising interest rates without going through the discussion 
about how you withdraw the 13(3) authority? I guess that is the 
question I want comments on.
    Mr. Meyer. Okay. So first of all, you have three things 
going there. One is the 13(3). One is rates. And the first one 
was what do you do with sort of liquidity programs. These are 
completely separate.
    The liquidity programs were put into place when there was a 
panic. Okay? The panic is over. Nobody was using those 
facilities. They closed on their own. Gone. History. Okay?
    With respect to 13(3), it is a very different animal. And 
the Federal Reserve Act says that they could only be used when 
there are unusual and exigent circumstances. Now, that is a 
very high hurdle. I believe it existed when the Fed put these 
into place. I think it clearly doesn't exist today. And the 
Fed--this is not its choice. The Fed has no choice here. It 
must close those facilities.
    Mr. Watt. So you are just assuming that all of this 
discussion is taking place post-13(3). Now, Mr. Taylor said we 
are beyond the panic. One of the questions I wrote down is, 
``Are we there yet?'' I am not sure. I am not sure we are there 
yet, but I would like your opinion on that.
    Mr. Taylor. Yes. Well, first of all, I think the use of 
13(3) actually caused some damage the way it was used. 
Remember, it was used even before the panic with respect to 
Bear Stearns. And I think that caused a lot of confusion, and I 
have written about it extensively.
    So I would like to see a return to a monetary policy, which 
13(3) is almost never used. And I think that would be a much 
better sort of standard monetary policy. I also think that it 
is very important to be more transparent about 13(3).
    Mr. Watt. But let's--maybe I need a better understanding of 
what 13(3) is. You put it into three different categories.
    Mr. Meyer. Well, the 13(3) was used for the funds to bail 
out Bear Stearns.
    Mr. Watt. So none of the other two options, the liquidity 
options or the interest rate options, should be employed at all 
until the 13(3) steps have been completely terminated? Is that 
what you are saying?
    Mr. Meyer. Well, I just would--I would just add one thing. 
Some of those emergency liquidity authorities were put in place 
using 13(3).
    Mr. Watt. All right. But then I don't have the capacity to 
distinguish those. If they were put in place under 13(3) 
authority, then I have to treat them as part of the 13(3).
    Mr. Meyer. No. They are very different.
    Mr. Watt. You know, maybe we are being semantic here. But 
the question--and that was what was confusing me because you 
all had gone on to talking about only interest rates. That is 
monetary policy. That is not 13(3) authority. Can you even get 
there, is my question, before you deal with the 13(3) 
withdrawal?
    Mr. Goodfriend. Could I just--I want to say something.
    Mr. Watt. Mr. Goodfriend?
    Mr. Goodfriend. I talked extensively about something I 
called credit policy, which is very distinct from monetary 
policy. Monetary policy was reserves, buying Treasuries only. 
Credit policy undoes Treasuries only. Credit policy is 13(3).
    Mr. Watt. But if credit policy was implemented under 
13(3)--
    Mr. Goodfriend. That's right. But the two are distinct.
    Mr. Meyer. Could I just make a point? Regular reform bills 
all make a distinction between two parts of 13(3). One is 
bailouts of individual institutions, and the other are broad-
based policies like the primary deal at credit facility that 
was just about injecting liquidity into the system, but 
injecting it through a wider base.
    These are very separate, and I understand that legislation 
will take 13(3) authority away from the Fed with respect to 
individual institutions, but leave it with respect to these 
broad-based.
    Mr. Watt. Go ahead, Professor.
    Mr. Goodfriend. I was going to say, for me, I have a 
particular take on these questions. There is the mechanical 
question of what you want to do in terms of sequencing the 
withdrawal of different 13(3) programs, and how that will 
affect the unemployment rate, and what is your view about how 
soon to do that sort of thing.
    But to me, I always think that there is a signaling effect 
of these kinds of withdrawals that has to do largely with the 
potential beliefs of the public as to what the long-term 
prospects are for inflation expectations.
    And I think it is very important to kind of get 13(3) 
behind us; if not in fact, at least create a roadmap or rule, 
like John is saying, so the public sees that the Federal 
Reserve is regaining its independence from the fiscal 
authority, and also that the fiscal authority is working well 
with the Federal Reserve, that the government works.
    I mean, we had a huge panic in the fall of 2008, I believe, 
because the public thought that the government wasn't working.
    Mr. Watt. But necessarily get 13(3) credit authority behind 
us before we go to the interest rate thing, or--
    Mr. Goodfriend. No. No, I think the discussion should be 
had so that there is a sense in the public mind of what the 
intentions are as to how to move forward to get out of 13(3).
    The point being is the public, I think, is going to be 
naturally nervous about the Federal Reserve's independence and 
commitment to stabilize the inflation rate. And that has to be 
job one. If we don't stabilize the inflation rate, the long-
term interest rate will spike up and we'll get--that, to my 
mind, is the greatest risk of a double-dip recession, a loss of 
credibility, so to speak, on inflation expectations.
    And so I believe this discussion you are having is central, 
but I think it is central for a slightly different reason, that 
to have this discussion about 13(3) openly that clarifies the 
Fed's independence vis-a-vis the fiscal authorities in Congress 
is a way of signaling to the public: The government is serious 
about doing the right thing about inflation, and that will keep 
long-term rates low.
    Mr. Watt. Okay. The only person I haven't heard from on 
this issue is Mr. Ball, and then we will close.
    Mr. Ball. Okay. Well, if I understand the question, I think 
one can view interest rate policy and the unwinding of the 
other programs as separate issues. And the reason they can be 
separated is that the Fed has the tool of interest on reserves 
to manipulate market interest rates regardless of what is 
happening to the balance sheet.
    So I think we can separate those issues. I think probably 
the Fed will and should be unwinding the various programs 
slowly because we will want to unwind them eventually, but we 
don't want to take the risk of jarring markets by dumping a lot 
of securities at one time or anything like that.
    So I think the Fed is on a proper course of gradually 
unwinding the unorthodox policies. And then there is the 
separate issue of when interest rates should be increased.
    Mr. Watt. I am not sure I am clear on it, but I probably 
won't ever be clear because this is complex territory. I am 
sure you all understand it better, and that is why we have 
these hearings, for us to try to understand it better so we can 
make better decisions.
    We are extremely appreciative of your patience and your 
presence and your testimony. Let me do a couple of housekeeping 
things here.
    I ask unanimous consent to insert in the record a statement 
from Janis Eberly entitled, ``Unwinding Emergency Federal 
Reserve Liquidity Programs, and Implications for Economic 
Recovery.''
    Your entire statements will be made a part of the record. 
The Chair notes that some members may have additional questions 
for this panel, or for Chairman Bernanke, which they may wish 
to submit in writing. Without objection, the hearing record 
will remain open for 30 days for members to submit written 
questions to these witnesses and to place their responses in 
the record.
    I think that completes all of our business, with our 
thanks, and the hearing is adjourned.
    [Whereupon, at 1:10 p.m., the hearing was adjourned.]


                            A P P E N D I X



                             March 25, 2010


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