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





                     THE ROLE OF THE INTERNATIONAL
                     MONETARY FUND AND THE FEDERAL
                     RESERVE IN STABILIZING EUROPE

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

                             JOINT HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON

                        DOMESTIC MONETARY POLICY

                             AND TECHNOLOGY

                                AND THE

                            SUBCOMMITTEE ON

                     INTERNATIONAL MONETARY POLICY

                               AND TRADE

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 20, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-138



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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
        Subcommittee on Domestic Monetary Policy and Technology

                MELVIN L. WATT, North Carolina, Chairman

CAROLYN B. MALONEY, New York         RON PAUL, Texas
GREGORY W. MEEKS, New York           MICHAEL N. CASTLE, Delaware
WM. LACY CLAY, Missouri              FRANK D. LUCAS, Oklahoma
BRAD SHERMAN, California             JIM GERLACH, Pennsylvania
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            BILL POSEY, Florida
KEITH ELLISON, Minnesota             LEONARD LANCE, New Jersey
JOHN ADLER, New Jersey
SUZANNE KOSMAS, Florida
        Subcommittee on International Monetary Policy and Trade

                  GREGORY W. MEEKS, New York, Chairman

LUIS V. GUTIERREZ, Illinois          GARY G. MILLER, California
MAXINE WATERS, California            EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GWEN MOORE, Wisconsin                DONALD A. MANZULLO, Illinois
ANDRE CARSON, Indiana                MICHELE BACHMANN, Minnesota
STEVE DRIEHAUS, Ohio                 ERIK PAULSEN, Minnesota
GARY PETERS, Michigan
DAN MAFFEI, New York











                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 20, 2010.................................................     1
Appendix:
    May 20, 2010.................................................    35

                               WITNESSES
                         Thursday, May 20, 2010

Morici, Peter, Professor, Robert H. Smith School of Business, 
  University of Maryland.........................................    24
Reinhart, Carmen M., Professor of Economics and Director of the 
  Center for International Economics, University of Maryland.....    21
Tarullo, Hon. Daniel K., Governor, Board of Governors of the 
  Federal Reserve System.........................................     6
Truman, Edwin M., Senior Fellow, the Peterson Institute for 
  International Economics........................................    22

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    36
    Morici, Peter................................................    37
    Reinhart, Carmen M...........................................    42
    Tarullo, Hon. Daniel K.......................................    46
    Truman, Edwin M..............................................    56

              Additional Material Submitted for the Record

Meeks, Hon. Gregory:
    Written statement of Amar Bhattacharya, G24 Secretariat......    72
    Written statement of Martin A. Weiss, Specialist in 
      International Trade and Finance, Congressional Research 
      Service....................................................    75

 
                     THE ROLE OF THE INTERNATIONAL
                     MONETARY FUND AND THE FEDERAL
                     RESERVE IN STABILIZING EUROPE

                              ----------                              


                         Thursday, May 20, 2010

             U.S. House of Representatives,
                  Subcommittee on Domestic Monetary
                         Policy and Technology, and
                      Subcommittee on International
                         Monetary Policy and Trade,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittees met, pursuant to notice, at 2 p.m., in 
room 2128, Rayburn House Office Building, Hon. Melvin L. Watt 
[chairman of the Subcommittee on Domestic Monetary Policy and 
Technology] presiding.
    Members present: Representatives Watt, Meeks, Sherman, 
Green; Paul, Royce, Manzullo, Bachmann, Paulsen, and Lance.
    Chairman Watt. This joint hearing of the Subcommittee on 
International Monetary Policy and Trade and the Subcommittee on 
Domestic Monetary Policy and Technology of the Financial 
Services Committee will come to order.
    Without objection, all members' opening statements will be 
made a part of the record, and we will recognize some members 
for opening statements
    And I will now recognize myself for an opening statement.
    Today's hearing is a part of our ongoing effort to examine 
and understand what things can cause a global economic crisis 
and threaten our economic well-being.
    Today, we will look at the sovereign debt crisis in many 
nations, particularly in Europe. We will explore the root 
causes and potential solutions to the European debt crisis with 
particular focus on the policy responses made by the Federal 
Reserve and the International Monetary Fund (IMF) to help 
stabilize European financial markets.
    In recent weeks, the European Union and the IMF agreed to a 
financial stabilization package of nearly $1 trillion, which 
will be available to all 27 Eurozone countries in the form of 
loan guarantees and direct bilateral loans if they agree to 
take strict debt reduction measures.
    As the chairman of the Domestic Monetary Policy and 
Technology Subcommittee of the Financial Services Committee, 
however, I want to focus the bulk of my attention on the 
actions of our own Federal Reserve. The Fed has agreed to 
reopen temporary currency swap facilities with foreign central 
banks, including the European Central Bank, the Bank of 
England, the Swiss National Bank, the Bank of Japan, and the 
Bank of Canada. These currency swap lines, authorized through 
January 2011, will provide foreign central banks with access to 
U.S. dollars in their local markets at fixed local rates in 
exchange for Euros or local currencies.
    We need to understand and shine the light of transparency 
on why this was necessary, whether it could extend beyond 
January of 2011, and exactly what exposure, if any, U.S. 
taxpayers could have as a result of the Fed's action.
    As I understand it, these swap facilities are designed to 
improve liquidity positions in global currency markets and 
minimize the risk that strains abroad could spread to U.S. 
markets. Some observers believe that the European debt crisis, 
if left unaddressed, could threaten the nascent U.S. economic 
recovery by shattering confidence and disrupting credit flows 
to businesses and consumers, and that it could put upward 
pressure on interest rates.
    The Fed has emphasized that these currency swaps are not a 
bailout, that they involve no direct expenditure of U.S. 
taxpayer funds to European financial institutions, and that 
under the contracts between the Fed and foreign central banks 
to swap currencies, the foreign central banks will bear any 
risk of defaults by European financial institutions.
    In addition, it appears that the Fed actually made money, 
over $5 billion, from the currency swaps of 2008 and 2009, 
because foreign central banks pay interest to the Fed when they 
draw on swap lines. We need to hear more from the Fed about the 
mechanics of these currency swap facilities and about the 
potential risk and rewards to U.S. taxpayers from many of the 
Fed's policy responses to the European debt crisis.
    As chairman of the International Monetary Policy and Trade 
Subcommittee, Chairman Meeks will be presiding over the second 
panel. While he will take the lead, I also look forward to 
questioning these witnesses about the IMF's role in stabilizing 
Europe.
    It is no accident that Chairman Meeks and I scheduled a 
joint hearing of our two subcommittees to examine the sovereign 
debt crisis in Europe because the global financial system is 
interconnected, and what happens in Europe or anywhere else in 
the world, for that matter, affects the United States and vice 
versa. Our two subcommittees will continue to monitor the 
situation in Europe and elsewhere and will conduct follow-up 
hearings as necessary.
    I will now recognize the ranking member of the Domestic 
Monetary Policy and Technology Subcommittee, Mr. Paul, for 5 
minutes.
    Dr. Paul. Thank you, Mr. Chairman.
    Mr. Chairman, I'm disappointed that yet again American 
taxpayers find themselves forced to pay billions of dollars in 
bailouts, only this time we are not bailing out profligate 
American companies but foreign governments.
    Billions of dollars of IMF funding, much of it coming from 
U.S. taxpayers, will be sent to Europe to bail out Greece and 
other European countries who might find themselves in financial 
crisis. Evidently, the lesson of the U.S. Government bailouts 
has not been learned. Bailouts do not, in fact cannot, make 
things better; they can only make things worse.
    Governments can pay for bailouts by increasing taxes, which 
takes money out of the pockets of hardworking poor and middle-
class Americans and siphons it off into the bank accounts of 
failed bankers, or governments can pay for bailouts through 
inflation, increasing the supply of money out of thin air and 
devaluing the currency, in this case, the bailout firms who 
have used this new money to reap all the benefits while the 
poor and the middle class see increased prices and the 
purchasing power of their savings reduced. Finally, governments 
can pay for bailouts through increased issuance of debt, 
increasing the tax burden of future generations in the hope of 
finding investors who will purchase bonds, which are 
increasingly unlikely ever to be paid off.
    None of these options lead to long-term stability. They 
merely attempt to patch up a fragile financial system and put 
off financial reckoning until the next crisis. Bailouts provide 
a short-term illusion of continuing prosperity, while 
underneath the same rotten fundamentals ensure that bailout 
money is merely throwing good money after bad.
    Bailing out foreign governments is just as bad. Why should 
American taxpayers be on the hook because a foreign government 
cannot cover its debts?
    What makes this situation even worse is that the bailout is 
being undertaken in a manner which is nearly impossible to 
stop. Bailout funds coming from the IMF, which receives nearly 
20 percent of its funding from the United States, require the 
approval of IMF members, including the United States, with its 
de facto veto power. Only the President can prevail upon the 
U.S. representative at the IMF to vote against this bailout. 
The people and their constitutionally elected Representatives 
in Congress are shut out.
    Compounding this is the reemergence of dollar swap lines 
from the Federal Reserve to foreign central banks, which will 
likely result in the creation of tens of hundreds of billions 
of dollars of new money. Bailouts never work. They never have 
and they never will. They only thing they do is burden the 
taxpayer and delay the inevitable collapse of the bailed-out 
entity.
    Fiscal and monetary responsibility is a tough pill to 
swallow, but it is essential for the sound functioning of the 
economy. We need to end the cycle of bailouts and ensure that 
American taxpayers will not continue to subsidize foreign 
governments.
    I yield back the balance of my time.
    Chairman Watt. I thank the gentleman for his opening 
statement. The gentleman from New York, the chairman of the 
International Monetary Policy and Trade Subcommittee, is 
recognized for 5 minutes.
    Chairman Meeks. Thank you, Mr. Chairman.
    Before I begin, let me first thank you for--as subcommittee 
chairman of the Domestic Monetary Policy and Technology 
Subcommittee-- working and putting this hearing together in a 
timely fashion. This hearing I think is happening at the most 
appropriate time, and as you correctly indicated, both of our 
subcommittees continue to monitor the situation as we move 
forward from both the domestic and international policy sides.
    And the reason why this hearing will be helpful to all of 
us is because it will help us to better understand the 
extraordinary events occurring in Europe this past month and 
the associated implication of the international monetary 
system. Specifically, we look forward to, and this hearing will 
be focusing on, actions as they pertain to the Fed and swaps, 
as indicated by Chairman Watt. But also, it will be focused on 
the actions taken by the IMF as well as the Federal Reserve to 
help Europe staunch the burgeoning sovereign debt crisis, which 
began in Greece and threatens financial markets worldwide.
    Europe represents a quarter of global GDP and is a major 
source of demand for U.S. exports. More than 20 percent of the 
total U.S. goods exports and more than 35 percent of total U.S. 
services exports go through Europe. The total value of these 
exports to the EU is more than 5 times the value of U.S. 
exports to China.
    Furthermore, European-owned firms in 2007 employed roughly 
two thirds of the 5.5 million U.S. workers on the payrolls of 
all foreign firms operating in the United States. Therefore, 
strong growth in Europe supports production and jobs in the 
United States. A prolonged and deep recession in Europe could 
or would undermine Americans' own economic recovery.
    The United States also has very strong financial linkages 
to Europe. The intensifying European debt crisis has adversely 
affected U.S. corporate bond and stock issuance. The week prior 
to the announcement of the stabilizing actions taken by the EU 
and IMF on May 9th had the lowest number of investment grade 
corporate bond sales since the week of September 15, 2008, when 
Lehman Brothers fell.
    Additionally, during that timeframe, a large number of 
initial public offerings of stock were canceled or postponed in 
the equity markets. Thus, it is not in the interest of the 
United States, or any other countries, to allow the significant 
uncertainty in the markets to continue or worsen.
    Given these important economic linkages between the United 
States and Europe, it is critical that the United States 
provide support to Europe in its efforts to quickly stabilize 
the financial markets, prevent contagion, and promptly address 
sovereign debt issues. In particular, supporting the IMF in its 
assistance to Greece and, as necessary, to other affected 
European countries, appears to be the best and most preferable 
means to effectuate United States support.
    I look forward to the testimony from today's witnesses. In 
particular, I look forward to learning about the EU's financial 
stabilization fund and the support provided by the IMF. I also 
seek to better understand how Greece and other European 
countries ended up in this situation and whether the proposed 
plans are appropriate.
    Lastly, and of particular importance to me, I hope to learn 
what impact this focus on Europe by the IMF will mean to its 
efforts in helping developing countries around the world.
    I yield back the balance of my time.
    Chairman Watt. I thank the gentleman. The gentleman from 
California, Mr. Royce, is recognized for up to 7 minutes.
    Mr. Royce. Mr. Chairman, last year, during a pretty fierce 
budget debate that we had in this committee, the Obama 
Administration quietly requested an additional $100 billion 
loan from us to the IMF, and while I and other Republicans 
raised concerns about this, opposed this measure, over our 
objections, that provision passed and our exposure to the IMF 
grew.
    I took issue with this very provision then, and I do today, 
for several reasons. First, we have near-trillion dollar 
deficits as far as the eye can see, and things continue to get 
worse. The government has lent, spent or guaranteed about $8.2 
trillion to prop up our economy in the last 2 years. While we 
were overleveraged pre-crisis, this drastic spike in taxpayer 
liabilities is a Trojan horse that has put us on a Greek-like 
course.
    Just last month, the Federal budget deficit, at $82.7 
billion, hit an all-time high for April. It was $53 billion 
higher than economists had predicted. As Chairman Bernanke has 
repeatedly said to us, this path is unsustainable.
    Second, the IMF has a poor track record when it comes to 
dealing with sovereign debt crises. Over the years, the IMF has 
developed into a dependence-inducing crutch used by weaker 
countries to avoid making the tough decisions necessary to get 
their fiscal houses in order. More than 70 nations have already 
depended on IMF aid for 20 or more years. They just keep 
rolling over and increasing the debt. Twenty-four countries 
have received IMF credit for 30 or more years. In many ways, 
the IMF has been as much part of the problem as part of the 
solution.
    Lastly, the possibility of contagion puts potential U.S. 
liabilities through the roof. Just within the IMF-EU proposal, 
U.S. exposure is roughly $54 billion. Looking at the global 
debt issues, things could get much worse. According to recent 
CDS spreads, 8 of the 10 riskiest sovereign debts in the world 
reside outside of the EU. Where will the IMF be when those 
countries move to the brink of default?
    Given these factors, the United States needs to look at 
reducing its exposure to the IMF. No loan, however large, will 
solve Europe's problems. It will simply delay and weaken the 
appetite for necessary change.
    The promise of a never-ending European welfare state is at 
the heart of the crisis. For decades, governments overcommitted 
and failed to pay for these entitlement programs, which led to 
a sea of debt. The irony that an institution of which we are 
the greatest contributor is going to rescue countries drowning 
in debt is apparent.
    Now is the time for us to address our own budgetary crisis 
and put our economy back on a path toward prosperity. The 
longer we delay, the closer we will get to being the ``United 
States of Europe.''
    I yield back the balance of my time. Thank you, Mr. 
Chairman.
    Chairman Watt. I thank the gentleman for his statement, and 
we're pleased to welcome as our first and only witness on panel 
one, Governor Daniel K. Tarullo of the Board of Governors of 
the Federal Reserve, who will be recognized for 5 minutes. We 
generally don't enforce that for Fed witnesses as rigorously as 
we do against some other folks, but there will be a lighting 
system there to prompt you: green for 4 minutes; yellow for 1 
minute, and red after the 5 minutes is over; but we'll be 
generous.
    Without objection, your entire written statement will be 
made a part of the record, and we would encourage you to 
summarize your testimony in as close to 5 minutes as you can.
    So Governor, you are recognized.

 STATEMENT OF THE HONORABLE DANIEL K. TARULLO, GOVERNOR, BOARD 
           OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Tarullo. Thank you, Mr. Chairman, Mr. Meeks, Mr. Paul, 
and Mr. Royce.
    Let me, in my oral remarks, make points on three topics: 
first, the nature of the European sovereign debt problems and 
the European response; second, the kinds of risks that their 
problems pose for the United States; and third, as you 
requested in your letter inviting us to testify today, the 
actions that the Federal Reserve took last week.
    First, with respect to the European sovereign debt 
problems, these have evolved over some number of years as 
aggregate debt levels have increased. Once the European 
Monetary Union was created in 1999, many investors appeared to 
assume that there was an implicit guarantee protecting the debt 
of Euro area members, probably resulting in an underpricing of 
risk associated with some sovereign issuers.
    When it became clear last fall that the Greek fiscal 
deficit was several times larger than previously thought, 
investors began to focus on the sustainability of these levels 
of debt. Spreads on Greek debt widened, and it became 
increasingly clear that Greece was losing access to market 
funding.
    Despite a fiscal consolidation plan announced by the Greek 
government and, at the beginning of the month, a $110 billion 
Euro EU-IMF program, market pressures were not contained. By 
then, concerns of investors had also arisen about the sovereign 
debt provisions of other so-called peripheral European 
countries.
    Pressures were felt in dollar funding markets, with some 
signs of dollar shortages in the interbank market bringing back 
unpleasant memories of the recent global financial crisis. In 
response to these growing problems, European leaders announced, 
on May 10th, the package of stabilization measures with which 
you are familiar.
    My second topic is the potential risk posed for the U.S. 
economy. In assessing these risks, I think it's useful to 
analyze in terms of two kinds of transmission channels, through 
financial markets and through the so-called real economy. The 
two are obviously connected, and sufficiently serious problems 
in one will exacerbate problems in the other. But as I say, 
it's a good analytic starting point for thinking about risks to 
our own economy.
    An important component of the real economy transmission 
channel is trade. If European growth slows down, U.S. exports 
will suffer, with potential effects on output and employment 
here at home. Similarly, if the Euro depreciates significantly, 
U.S. exports that compete with European products around the 
world will be adversely affected.
    If we look, though, at the likely effects of a moderate 
slowdown in European growth, the impact on U.S. growth would 
likely be discernible but relatively modest. Larger effects are 
likely to be felt only if there are significant problems in 
financial markets, which would amplify the real economy effects 
with much greater impact on wealth, lending, and production in 
the United States.
    The large U.S. institutions that do significant business in 
Europe appear to have manageable levels of exposure to the 
peripheral European sovereigns. However, if sovereign problems 
in peripheral Europe were to spill over and cause financial 
difficulties more broadly, U.S. banks would face larger losses 
on their considerably larger overall credit exposures.
    Increases in uncertainty and risk aversion could lead to 
higher funding costs, resulting in forced asset sales and 
reductions in collateral value that might lead U.S. financial 
institutions to pull back abruptly on their lending. This would 
obviously come at a particularly bad time, as we are just 
beginning to see signs that lending standards for smaller 
companies and households could soon be relaxed in our own 
economy.
    In the worst case, which I add we do not expect, broad 
uncertainty could result in a generalized unwillingness to 
extend funding. Forced asset sales could lead to further 
declines in collateral with further funding pressures, 
resulting in the freezing up of financial markets such as was 
seen following the bankruptcy of Lehman Brothers in the fall of 
2008.
    My third and final topic, what actions did the Federal 
Reserve take last week? Well, the Federal Reserve has a limited 
but important role here, one that addresses directly the 
potentially serious liquidity problems I mentioned a moment 
ago.
    Last week, as you noted, Mr. Chairman, we re-established 
dollar liquidity swap lines with the European Central Bank and 
a number of other central banks. These lines are similar to 
those which the Federal Reserve put in place during the recent 
financial crisis.
    Swaps are a well established tool of international monetary 
relations among central banks. In the current situation, the 
dollar liquidity swaps provide a backstop to counter 
significant dollar funding pressures in foreign markets. The 
swap is a temporary arrangement whereby a foreign central bank 
exchanges its currency for dollars at the prevailing exchange 
rate. There is an agreement to reverse this transaction within 
a short period of time, in no case more than 3 months.
    Under the terms of the swap agreements, all of which are 
posted on the Federal Reserve site, our dealings are only with 
the central bank, not banks, financial institutions in the 
other country to which the central bank may lend the dollars.
    Also, in accordance with the terms of the agreement, we do 
not bear the risk that the foreign currency may depreciate 
during the term of the swap, since the foreign central bank is 
committed to repay us with the same number of dollars that they 
originally took in the swap for the same number of euros or yen 
or whatever their foreign currency may be. We charge an 
interest rate well above what a normal market-level interest 
rate would be, and this indeed is intended to ensure that our 
swap facility is a backstop to forestall serious liquidity 
problems, not to be a normal source of dollar funding.
    To date, there has been fairly modest use of the swap lines 
established on May 10th. Last week, there was an 8-day, $9 
billion swap drawn by the European Central Bank. Because it was 
8 days, that will be repaid today, the 20th. There have since 
been 2 smaller swap drawings, both 84-day drawings, one of a 
little over $1 billion with the European Central Bank, and one 
a little over $200 million with the Bank of Japan. So, as of 
the end of the business day today, we'll have outstanding about 
$1.2 billion in the swap arrangements.
    Each Thursday at four o'clock, the Federal Reserve will 
post on its Web site a list of all outstanding swap 
arrangements.
    The policies announced last week in Europe, with the 
supporting role played by the swap lines, have stopped 
deterioration in dollar funding markets in Europe, but dollar 
funding markets remain strained as investors await further 
clarification of the stabilization, regulatory, and fiscal 
measures to be adopted within Europe.
    In closing, Mr. Chairman, I would say that the United 
States is in a very different position from that of the 
European countries whose debt instruments have been under such 
pressure, but their experience is another reminder, if one were 
needed, that every country with sustained budget deficits and 
rising debt, including the United States, needs to act in a 
timely manner to put in place a credible program for 
sustainable fiscal policies.
    Thank you very much, and I would be pleased to answer any 
questions you may have.
    [The prepared statement of Governor Tarullo can be found on 
page 46 of the appendix.]
    Chairman Watt. Thank you, Governor, for your very 
comprehensive statement. I will now recognize the members of 
the committee for 5 minutes of questioning each, and I will 
recognize myself initially for 5 minutes.
    In your testimony, Governor, you indicated at pages six and 
seven that the Fed's role here is ``limited though important'' 
and I wonder if you could kind of expand on that, the 
importance of it in particular. I understand the limited nature 
of it; you explained what you have outstanding and what you 
could potentially have outstanding, what about the importance 
of it?
    Mr. Tarullo. The importance, Mr. Chairman, I think is best 
understood by thinking about the experience we went through a 
couple of years ago, where dollar funding became constrained 
not because of the underlying credit situation of a particular 
financial institution but just because there is such widespread 
uncertainty in markets that those who provide funding become 
reluctant to provide funding for anything more than the 
shortest terms to almost anyone who might have exposures, in 
this case, to sovereign debt. A couple of years ago, it was to 
subprime or other kind of mortgage securities.
    From our point of view, that kind of freezing up of dollar 
funding markets is what produces these kind of amplified 
negative effects on our real economy, stopping lending at home 
because everybody begins to husband their liquidity sources at 
that moment. What I describe as our limited role is limited to 
providing expensive dollars--that's why we charge a higher rate 
on them, to make sure that they're only used to stop a really 
serious liquidity situation from developing. But, it is 
important precisely because there is assurance given that 
through the mechanisms of the European Central Bank and other 
central banks, in such circumstances, dollar funding will be 
available so that we don't have that kind of freezing up by 
institutions in search of dollars that are unavailable.
    Chairman Watt. Let me see if I can squeeze in two other 
questions quickly. First of all, we tried to address--well, in 
the regulatory reform bill there is some language that says, if 
the House bill were passed as the final bill, that this kind of 
swap arrangement would require some heavier vote in the Fed, a 
higher level. What was the vote by which--or was there a vote 
by which this was done at the Fed and did it exceed that level, 
even though it's not applicable at this current moment?
    Mr. Tarullo. Mr. Chairman, we had a meeting of the Federal 
Open Market Committee (FOMC) on Sunday, May 9th. At that 
meeting, the situation in Europe was discussed, as was the 
possible reactivation of the swap lines, and by unanimous vote, 
the FOMC granted the Chairman the authority to reactivate the 
lines.
    Chairman Watt. So I assume we didn't require anything in 
the statute more than a unanimous vote.
    [laughter]
    Chairman Watt. So that answers my question. Okay.
    You talked about the swap agreements freezing your risk of 
currencies' values going down. Obviously they--and that 
protects you against that, and then you'll get interest. But I 
assume these agreements also freeze you from the prospect of 
currencies going up for that period of time too. Is the risk--
is that interest commensurate with, say--or would you ever be 
doing this to try to see if you could make money on it anyway, 
other than the interest?
    Mr. Tarullo. We're not speculating in foreign exchange 
here, Mr. Chairman. Our purpose is, as I said, to provide a 
backup source of expensive but nonetheless available liquidity 
if needed. The interest rate that we set on the swap line is 
meant, as I said, to discourage its use as a normal source of 
dollar funding.
    We arranged to have, in essence, the same number of dollars 
and euros or dollars and yen exchanged at the end of the swap, 
and we are getting the interest on the use of those dollars 
during that period. One would anticipate, although there's no 
guarantee of this, that in a situation in which one polity is 
borrowing the currency of another that its own currency is 
probably depreciating, as we have seen some euro depreciation. 
There is, in theory though, the possibility that the currencies 
could go in the other direction.
    Chairman Watt. My time has expired, and I recognize the 
gentleman from California for 5 minutes for his questions.
    Mr. Royce. Thank you very much, Mr. Chairman.
    You mentioned the liquidity of euro debt markets. Do you 
think this is a liquidity problem rather than a solvency 
problem right now?
    Mr. Tarullo. I would say a couple of things about that, 
sir. One, the problem that we, the Federal Reserve, are 
addressing is the potential emergence of serious liquidity 
problems within the European financial system, which could in 
turn have an impact on our own financial system.
    There are obviously questions within Europe about the 
sustainability of the debt situations of some of the 
sovereigns, beginning with Greece.
    Mr. Royce. Yes, that's what I wanted to ask you. Adding 
additional liquidity into the European market, does that make 
it more likely or less likely that these excessive debt issues 
are going to be addressed?
    Mr. Tarullo. I wouldn't say, Mr. Royce, that drawing on a 
swap line makes it any more or less likely that the fiscal 
problems as such are going to be addressed. Remember, these are 
temporary lines that unwind.
    Mr. Royce. Yes.
    Mr. Tarullo. They're only meant to stop the very bad kinds 
of things from happening and so--
    Mr. Royce. But at times I wonder, if you remove the 
urgency, can you create moral hazard? And let me go down this 
line of argument with you for a minute, Daniel.
    The more leeway we give EU governments in making the 
necessary changes to reign in their excessive debt, the more 
likely other countries around the world will take our actions 
to mean that they can delay those necessary changes. That's the 
worry I have.
    In many ways I think--some people argue, some economists 
argue we saw this during the financial crisis. The Fed took 
extraordinary steps to bail out Bear Stearns, but lo and 
behold, according to some, that sent the message to Lehman 
Brothers and to other, much larger institutions, that the 
Federal Government would not let a major bank fail. And what we 
saw was that in negotiations then for additional capital or for 
merger, there was a delay, arguably, as people looked for the 
same deal that JPMorgan got with respect to the prior bailout 
at Bear Stearns.
    So it sends the message, and I wonder if we run the risk of 
repeating that hypothetical moral hazard problem that some 
economists argue was created there with this IMF-financed 
backstop. Do we delay that sense of crisis that the legislature 
has to act now, that the left government in Greece has to 
produce this solution because there is no backstop, or instead 
do we create this false sense of security?
    Mr. Tarullo. Let me try to distinguish our actions from, I 
think, the broader questions which you are raising. Our actions 
are addressed to forestalling a serious liquidity crisis in the 
short term, which has the potential for very negative effects 
in our own economy. I don't think that--
    Mr. Royce. I understand your argument there.
    Mr. Tarullo. With respect to your broader question, I think 
there is always going to be a question about the degree to 
which the availability of a stabilization package or some form 
of assistance in a particular circumstance might create a 
more--
    Mr. Royce. I'm running out of time, so I--in your opening 
statement, you mentioned the Fed's plan to reopen dollar swap 
lines with the Banks of Canada, England, and Japan, the ECB 
bank, and the Swiss National Bank, but as I said earlier, many 
of the world's riskiest sovereign debt resides outside of the 
reach of these central banks, and I worry about the extent of 
the Fed's willingness then to assist these countries because I 
wonder where this will end.
    Venezuela, Argentina, Pakistan, the Ukraine, you look at 
the probability of default according to CME--the Chicago 
Mercantile Exchange did a little study on this: 48 percent for 
Venezuela; 46 percent for Argentina, this is during the next 5 
years; Pakistan, 42; Ukraine, 35; and Iraq, 28. As we put this 
off, the debt problem grows and the overleveraging grows. If 
the pressure comes home to bear sooner rather than later, 
perhaps it's better in the international economy to have these 
things faced before they compound as they're now compounding.
    Mr. Tarullo. I would say, Mr. Royce, as I said in my 
prepared statement, quite apart from our swaps, which are for 
the very limited purpose I indicated, there is a recognition 
that the broader stabilization package in the European Union is 
not itself a solution, and there is a need to address the 
fiscal consolidation issues within the European Union.
    Some of the urgency that you feel is being reflected in the 
way in which markets are looking at the elaboration of the 
program right now.
    Mr. Royce. Thank you, Mr. Chairman.
    Chairman Meeks. [presiding] The gentleman's time has 
expired. And I will now recognize myself for 5 minutes.
    Let me first thank you, Governor, for your testimony today, 
and for the great work that I think that you and the Federal 
Reserve are doing in these most challenging of times in which 
we now live.
    Let me ask this question first of all: I think you 
mentioned in your opening statement that the Fed has posted on 
its Web site the contracts that detail the swap arrangements 
with foreign and central banks, including the European Central 
Bank, and that is, I think, great for the transparency that 
presents itself around these agreements. My question to you is, 
I'm wondering if you might explain the process around how the 
decisions are made with which foreign central banks to sign 
agreements and what the selecting criteria are and what is 
utilized, how are you doing that?
    Mr. Tarullo. With respect, Mr. Meeks, to the swap 
arrangements which have just gone into effect, I think the 
criteria essentially arose around the question of where might 
there be these kinds of serious liquidity problems, in what set 
of financial institutions might they conceivably arise. And, as 
you'll note, what we did was to put in place swap arrangements 
with the G7 plus Switzerland, covering basically a broad part 
of the global financial system and the interconnected financial 
institutions within that system.
    With respect to some of those countries, it really is a 
matter of a backstop being available if needed. It may well not 
be needed. Some of the swap arrangements that were in place 
during the financial crisis of the last couple of years weren't 
drawn on. So to some degree, their very presence provides 
markets with the assurance that in more serious circumstances, 
the liquidity will be available.
    I would just say that in general, our criteria are 
obviously going to include the understanding of the situation, 
the potential vulnerabilities, and, of course, the kinds of 
dealings that are going on at that moment which lead to the 
need for it.
    Chairman Meeks. The currency swap facility, which was 
established in 2007 to address dollar liquidity pressures 
resulting from the global financial crises, peaked the number 
of swaps outstanding in December 2008 with a total notional 
value surpassing $580 billion. And we were told that some 
economists believe that the new swap program could peak with 
total values as much as $100 billion, large but still, I guess, 
relatively, I think, modest sums compared to the Fed's total 
balance sheet. Do you have your own estimates of peak notional 
values of total swaps outstanding for the new program? And do 
your estimates support the statement that even at the peak, the 
total value of outstanding swaps will represent only a 
relatively modest sum compared to the Federal Reserve's total 
balance sheet?
    Mr. Tarullo. Mr. Chairman, let me say a few things. First, 
as you noted, the peak drawings during the financial crisis 
were about $580 billion, all of which has been unwound, an 
indication, I think, of the capacity of these arrangements to 
function and to function smoothly and effectively.
    Second, we don't have a specific estimate as to what may be 
needed. One's hope, of course, is that the institution of the 
arrangements, their availability, means that they won't have to 
be drawn on to a considerable extent. But they might, and we 
have confidence in the arrangement that would lead to swaps 
being put in place and then being unwound.
    Third, on the general question of how much, we are always 
in a position to make our own decisions about whether to go 
through with a particular swap drawing, even within the 
confines of a particular agreement. We do retain the discretion 
to shape it as necessary. So from our point of view, this is, 
as I say, a prudent measure that is well established in central 
bank practice, has been used recently, and that we have the 
ability to control going forward.
    Chairman Meeks. My last question that I'm going to try to 
get in, it's a short question, because some of the economists 
worry that putting more U.S. money into circulation at a time 
when the Federal Reserve is looking at ways to eventually 
shrink its balance sheet would only add to inflationary 
pressures down the road. Do you agree with that statement? What 
mitigating actions is the Federal Reserve taking to prevent 
detrimental inflationary pressures from swap lines in the 
future?
    Mr. Tarullo. With respect to the swap lines, Mr. Chairman, 
they unwind within that relatively short term, so the reserves 
are not sitting on the balance sheet for a prolonged length of 
time. And of course at the present time, inflation is extremely 
subdued.
    Chairman Meeks. Thank you. The gentleman from Illinois, Mr. 
Manzullo is recognized.
    Mr. Manzullo. Thank you.
    Mr. Tarullo, when the Maastricht convergence criteria was 
struck, the annual deficit could not exceed 3 percent of GDP, 
and total national debt could not exceed 60 percent of GDP. 
Were there exceptions made to that criteria so as to enable 
countries to use the Euro?
    Mr. Tarullo. We'll go back in time, Congressman, because I 
think you're basically raising the question of what has gone 
wrong here with the EU and the requirements for state member 
participation.
    Mr. Manzullo. That's a good--that's a better question than 
mine.
    Mr. Tarullo. I think, if you recall, there were two kinds 
of problems back in the late 1990's, which many economists 
observed, about the beginning of European Monetary Union.
    I think a lot of people acknowledged the benefits that 
could be gained, but there were two kinds of questions. One was 
whether this was an optimal currency union, meaning whether it 
actually covered the kind of area with the kinds of economic 
diversity that made for a workable currency union. There are 
questions about whether there are enough fiscal stabilization 
transfer payments and the like to allow for the fact that there 
would be variance in economic performance across the euro zone.
    The second question was exactly the one that I think we are 
all addressing today, which is whether in a monetary union with 
a single currency, there would be the potential for some member 
states of that currency union to be borrowing in ways that 
resulted in the underpricing of risk because there was some 
sort of implicit guarantee in the common currency. And as you 
indicated, there were requirements.
    Mr. Manzullo. Were there exceptions made to those 
requirements?
    Mr. Tarullo. Yes. There was an exception--
    Mr. Manzullo. Did Greece meet the requirement when it came 
in, do you recall?
    Mr. Tarullo. When it came in, 2001, I believe they did.
    Mr. Manzullo. They did meet the requirement. Okay.
    Mr. Tarullo. But I think there's widespread acknowledgement 
in Europe that the mechanisms for ensuring fiscal 
sustainability and fiscal responsibility have not been 
adequate, and that's why you see the debate right now in Europe 
with proposals being offered by member states and by the 
Europe--
    Mr. Manzullo. Do you see the United States going the same 
way, with the increase that we have in our annual deficit and 
government debt?
    Mr. Tarullo. Right now, I think we need to be clear, we're 
in a very different situation, that the proportion of GDP 
accounted for by the interest payments we pay on our debt is 
substantially lower than those of the countries we're talking 
about today.
    Mr. Manzullo. What is it now?
    Mr. Tarullo. It's a couple of percent, and of course, it is 
the case that in fact the response of markets has been to go to 
U.S. Treasuries. The flight to quality has been toward United 
States Government obligations, indicating that we still are a 
safe haven for finances in periods of stress.
    Mr. Manzullo. But--
    Mr. Tarullo. Having said that, Congressman, and I think you 
were going to supplement if I didn't. There is no question, as 
Chairman Bernanke has said, and as I would repeat today, that 
for the United States going forward, a very important economic 
policy aim needs to be to put ourselves on a more fiscally 
sustainable path, which is and I think ought to be an 
imperative for us all. But it is not as if we are today in the 
same situation as Greece or some of the other countries we're 
talking about.
    Mr. Manzullo. I see many statistics that talk about the 
possibility that we could really exceed Greece's debt ratios 
because of the excessive spending that's going on in this 
country, and my concern is, who will bail out the United States 
as we push ourselves more towards the European economy or the 
European style of government?
    Mr. Tarullo. Congressman, I think that it is well within 
our capacity as a country to fix our own fiscal problems, and I 
think that Members of Congress, the Administration, and some of 
us on the Federal Reserve, have made essentially the same 
points.
    We are the world's largest and most important economy. We 
are in a position to deal with our own problems. And, as I 
said, I think it's imperative that we do so.
    Mr. Manzullo. Thank you.
    Chairman Meeks. The gentlewoman from Minnesota, Ms. 
Bachmann.
    Mrs. Bachmann. Thank you very much, Mr. Chairman, and thank 
you so much, Governor Tarullo, for coming here today to speak 
with us. I just wanted to tag on to the Congressman from 
Illinois and ask, you talked about the fiscally sustainable 
path for the United States, and I'm just curious to know, from 
the Federal Reserve's perspective, what would that fiscally 
sustainable path be? What would it look like?
    Clearly, Greece has gone out of a safe harbor zone and 
they're not on a fiscally sustainable path. What does a 
fiscally sustainable path look like in the United States?
    Mr. Tarullo. I think conventionally, the understanding of a 
fiscally sustainable path would be one in which you don't have 
your total outstanding debt continuing to rise. That is, you 
have a deficit, which when taking into account growth and the 
servicing costs associated with it, has gotten your debt 
leveled off so that you're not in a continuing period of 
increase, which then suggests to markets that you're not going 
to continue to increase your debt burden over time, and that 
has the consequent effects upon interest rates.
    So I think that, in the broadest terms, is how to 
understand fiscal sustainability over the medium to long term.
    Mrs. Bachmann. Paul Volcker had just made the statement at 
Stanford, I'm sure that you're aware of, where he said we have 
to turn this thing now, we can't wait any longer. With 
America's current fiscal situation, we can't keep the spending 
levels up; we can't keep the debt levels up; we have to do 
something and we have to turn this quickly because the time 
clock is turning.
    And I think that's something a lot of us sense, just kind 
of like an hourglass when you turn it up. We're seeing that the 
sands are coming toward their end here on America's 
opportunities to be able to turn around the fiscal situation. 
How long do you think that we have to turn this around?
    Mr. Tarullo. I wouldn't put a timeline on it. What I would 
say is that it is important sooner rather than later to begin 
developing a credible plan for achieving a fiscally sustainable 
budget. And by that, I mean it's important that we have 
presented to investors, those who buy Treasuries, those who 
invest in other arenas as well, the credible steps that will be 
taken in order to address these problems over the medium term. 
While I don't think it's appropriate for me to inject myself 
into the actual process of coming up with that, as a central 
banker, I would say that it behooves us to do something sooner 
rather than later.
    Mrs. Bachmann. The Federal Reserve is in the currency swaps 
now, and I don't know if you commented on this earlier, if you 
looked at any other additional policy steps, but what I really 
want to know is, is the Federal Reserve likely to take future 
actions regarding Greece or any other European nations that 
might get into trouble? Is the Federal Reserve looking at doing 
any future actions or is this it? Are we drawing the line?
    Mr. Tarullo. We don't have any other actions under 
consideration.
    Mrs. Bachmann. I guess what I'm concerned about is the 
moral hazard that we're creating, because if we're coming out 
and--I guess the only analogy I can look at is Fannie Mae and 
Freddie Mac. There was an implicit guarantee of the government-
sponsored entity, and everyone had the idea that if Fannie and 
Freddie ever got into trouble that the United States will bail 
them out from that. That's, as a matter of fact, what we did.
    Now we're doing that with Greece. What would lead any other 
European nation to think otherwise, that the United States 
wouldn't be there to bail them out if, God forbid, Spain's 
economy would be such that it would require a bailout, or 
Portugal or Italy or Ireland or the United Kingdom? Why would 
be bail out Greece and not any of those other European nations?
    Mr. Tarullo. The Federal Reserve swap actions are not a 
bailout for anyone, and certainly not a bailout for Greece. 
This is a matter of providing short-term liquidity, and by 
short term, we are talking no more than 3 months of swapped 
lines and frequently less, just in order to stop dollar funding 
markets from freezing.
    This is not a matter of a bailout, this is a matter of--
    Mrs. Bachmann. I think the way that my constituents back 
home view this is that if the American taxpayer is on the hook 
for up to $50 billion, they feel that is a bailout, because 
from their perspective, the money is coming out of their 
pocket; $50 billion dollars is still--in today's parlance, that 
may not seem like a lot of money, but people back home look at 
$50 billion and they see that this only may be the beginning of 
a riptide of the United States bailing out country after 
country after country essentially with borrowed money, and 
they're worried about the direction that we're going because 
they see that the United States is at a tipping point 
financially.
    And now we're in the situation where we're--whether it's 
the currency swaps or whatever it is, it's still coming out of 
their pocket.
    Mr. Tarullo. With respect to the IMF program, that's not 
something I can address, because it's not something we have any 
real authority over.
    With respect to the swaps arrangements, I think that one 
can be assured, based on long-established practice, the kinds 
of safeguards we have on market risk, the dealing only with 
central banks, that this is something that is intended to and I 
hope will keep problems from spreading more into our own 
country and not putting our own taxpayers at risk.
    Mrs. Bachmann. But is this--
    Chairman Meeks. The gentlelady's time has expired.
    Mrs. Bachmann. Thank you, Mr. Chairman. And thank you so 
much for answering the questions, Governor Tarullo. Thank you.
    Chairman Meeks. The gentleman from Texas, Mr. Green, is 
recognized for 5 minutes.
    Mr. Green. Thank you, Mr. Chairman. I thank the witness for 
appearing today, and I thank the ranking member and you for 
making this hearing possible.
    Mr. Governor, I would like to talk to you about the status 
of investments in America. We have Treasury notes, the stock 
market is an investment, the dollar is an investment. Do we 
find that foreign entities and foreign personalities are 
investing in America?
    Mr. Tarullo. Certainly, Congressman, we have a substantial 
amount of inward investment, both direct investment and 
portfolio investment, including over time a significant amount 
of investment in U.S. Treasuries, yes.
    Mr. Green. In my readings, and this is from the newspaper, 
you probably have empirical evidence, but my readings indicate 
that people are still buying America, that America is still a 
good investment, that this is a place where people are still 
bringing their assets, they want their assets in America. Is 
this an accurate assessment?
    Mr. Tarullo. It has certainly been true over time, and in 
the very short term, which is to say recent weeks, I think what 
we have seen is a substantial sense that U.S. Treasuries 
continue to represent the safest kind of investment to make 
because we have seen a significant inflow into U.S. Treasuries 
even as the European problems have evolved.
    Mr. Green. And the U.S. dollar compared to the euro, my 
understanding is that the euro is currently not as strong as it 
was a year ago and that the dollar has gained strength. Without 
knowing the exact amounts, is that a fair statement?
    Mr. Tarullo. That is absolutely true, Congressman. As you 
know, the dollar depreciated against the euro over the course 
of several years earlier in this decade, but in recent months, 
there has been a significant appreciation of the dollar vis-a-
vis the euro.
    Mr. Green. The reason I ask is because I want to give an 
accurate assessment of our country, and I don't want to paint a 
picture of the country simply falling apart, if we don't just 
cut in a Draconian way, the country is just going to fall off 
the edge, go over the precipice. I do believe that we have to 
be fiscally responsible, and I do believe that is something 
that requires our attention and that we must do it, but I don't 
want to paint a picture that is unfair as it relates to the 
strength of our country and the view that our country has, the 
way it's viewed in the world.
    America is still viewed as a great investment by other 
countries around the world. They still buy our Treasuries, they 
still invest in our dollar. It's still the place to have your 
capital if you have capital that you can place someplace; is 
that a fair statement?
    Mr. Tarullo. I think that is a fair statement. Yes, 
Congressman.
    Mr. Green. Okay. Now let's talk for a moment about the 
circumstance with Greece. It is so true, as Dr. King made known 
to us, that life is an inescapable network of mutuality tied to 
a single garment of destiny. What impacts one directly impacts 
all indirectly, but we have found in this latest crisis, 
economic crisis, that the connectivity is a lot stronger than 
many of us realized.
    AIG had connections that were important to the world's 
economic stability. A country like Greece is important to 
economic stability in the world. So, if you would--and you may 
have visited this issue prior to my coming in, and my 
apologies, I have been trying to monitor from my office and do 
a number of other things, but just briefly if you would, give 
us or me an indication as to how important the Greece scenario, 
the worst-case scenario would be to us if there is something 
that goes awry and we have to deal with the worst-case 
scenario, meaning a bankruptcy circumstance or a collapse.
    Mr. Tarullo. Congressman, I would say that the most serious 
kind of case is not one that involves Greece as such. What has 
happened over the last few months is that concerns about fiscal 
sustainability in Greece have extended to some other so-called 
peripheral European countries, which has in turn called into 
question the positions of financial institutions and others who 
may be investors in those peripheral countries. This is what 
happens when markets begin to inquire further into whether a 
position that they thought was a sustainable position might 
actually have some added exposure.
    I think from our point of view, we can't pretend that we 
can insulate ourselves, much less the Europeans, from the 
consequences of the aftermath of some of the problems that 
they're enduring right now. That is not something that is 
either appropriate or possible for us to do. What we can do and 
what we tried to do with our swap arrangements was to foreclose 
the situation in which generalized uncertainty led to a 
generalized unwillingness on the part of banks and money market 
funds and others to provide funding to all the transactions 
that go on every day--
    Mr. Green. I'm going to intercede. My time is up, and the 
chairman has been generous. Maybe you can get to it at a later 
time. I yield back, Mr. Chairman. My apologies.
    Chairman Meeks. Thank you. The gentleman from Texas, Mr. 
Paul, is recognized for 5 minutes.
    Dr. Paul. I thank the chairman. I want to follow up on the 
discussion about whether or not this is a bailout because, as 
we stated earlier, most Americans see this as a bailout.
    We obviously are committing funds. I estimate it must be 
close to $60 billion that we have committed in one way or the 
other, and if it wasn't a bailout, they wouldn't need us. What 
is the purpose?
    If they didn't need help, if they didn't need to be bailed 
out, they could just go in the market and borrow money. But 
they lost all their credit rating and nobody wants to loan 
money to Greece, so they have to be bailed out. And I think 
that is a proper term.
    But you say, no, well, we're going to get them on their 
feet again, and they're going to pay us back and we're going to 
make a profit at it. But it's the other side of this--what 
about the people who don't get bailed out and get help?
    Think about all the small companies in this country. Think 
of the people who were just about under with their mortgages, 
if they just had had help for 6 months to get back on their 
feet again. But no, they don't get the help. The big banks and 
the countries get this. And this is why the people see this as 
so unfair.
    I see it as a very unfair system as well, but one that is 
not constitutionally oriented, because if we commit monies, 
especially on these swap funds, swap arrangements, currency 
swaps--these are monies, I know it's traditional, I know it's 
accepted, but Congress doesn't appropriate this money. They 
don't authorize this money, and it's big money. It's really big 
money, so I don't see how we can avoid calling this a bailout.
    There was a time in 1979 and 1980, when our dollar was in 
trouble, and other countries came and the IMF bailed out our 
dollar and made these arrangements, but it's always because 
it's too big. If we don't bail out the big guys, if we don't 
bail out these sovereign nations, if we don't bail out these 
banks because we're really bailing out banks here; they're the 
ones who have made these loans.
    So I would like to have you further defend this idea that 
it isn't a bailout, and I would like to know, also, what kind 
of collateral we're going to get on these swap arrangements. 
They say we have collateral. Well, what kind is it going to be? 
We have collateral with all this money we gave our banks. It 
was these illiquid assets, these derivatives, these housing 
markets that nobody else wanted. We have these assets and 
they're all on the books at the Fed, but this is so unfair 
because it's done with increasing the money supply and it's a 
burden on the taxpayer.
    So, once again, see if you can convince me that this is not 
a bailout. Convince the American people. Try to talk to 
somebody who didn't get help on their mortgage or a small 
businessman who was out of business and didn't get treated as 
well as we treated these foreign nations and these foreign 
banks who have made loans to these governments.
    Mr. Tarullo. Congressman, let me say first that the Federal 
Reserve is not providing any money to Greece. We're not 
providing any liquidity. We're not providing any other 
assistance. What we have done is to say that we will in short 
tern swap arrangements provide dollars to the European Central 
Bank.
    Dr. Paul. And you get what?
    Mr. Tarullo. And we get euros at the prevailing exchange 
rate for those dollars. And then the arrangement gets unwound 
at the end of it. If it's an 8-day arrangement, as one maturing 
today--
    Dr. Paul. Why is that necessary? Why don't they just use 
the euros if it's equal, if it's an equal trade?
    Mr. Tarullo. It's necessary, Congressman, because you have 
institutions in Europe which have lent dollars, for example, 
and which are in need of funding in dollars. It may be, and 
often is, a perfectly good transaction to have entered into. 
But as conditions become very tight because there's a lot of 
uncertainty about the availability of dollars, then, as we saw 
a couple of years ago, even an institution which has been well 
run and has been careful in taking on exposures may not be able 
to get that dollar funding in the short term. But that is why 
we offer this liquidity swap only at a penalty rate.
    Dr. Paul. And where do we get the dollars to give them for 
their euros?
    Mr. Tarullo. It is created as a reserve and then unwound 
when it comes back, as they did during the financial crisis. 
But I just want to say one other thing, Congressman, which is 
that the reason we're doing this is precisely so that we 
forestall the potential for the generalized freezing up in 
credit markets, which will constrain or would constrain our own 
large institutions, which in turn would constrain their ability 
to lend to American businesses and American households.
    And I would say that at this moment, when after a period of 
watching lending standards tighten for quite some time and then 
simply not relax at all, particularly for small businesses, 
we're finally seeing some indications that those standards may 
be relaxing, that we may be able to start increasing lending to 
small businesses again. And I think this is the moment where we 
really do not want a substantial external shock to our 
financial system to undo the progress that we're making in that 
direction.
    Dr. Paul. If I may ask one quick question, what happens if 
the euro loses 50 percent of the value? Are the taxpayers, is 
the dollar at risk there? Do we lose something then?
    Mr. Tarullo. The European Central Bank is still obliged to 
pay us back the number of dollars that they drew originally. 
Market risk rests with them, not us.
    Dr. Paul. We're holding the euros.
    Chairman Meeks. The gentleman's time has expired. And 
before we close this panel, I will go to the chairman of the 
Domestic Monetary Policy Subcommittee, if he has anything.
    Chairman Watt. Mr. Chairman, I have used my 5 minutes, and 
I apologize to the Governor for having to run out. I had 
another commitment that I had to attend to, but I thank him for 
being here.
    And there's, I think, a series of votes coming that might 
intervene between--in fact, they're getting ready to start 
right now, that might intervene between this panel and the 
second panel.
    We should note that some members of the subcommittees may 
have additional questions to submit in writing. And without 
objection, the hearing record will remain open for 30 days for 
members to submit written questions to this witness and to 
place his responses in the record.
    So we thank the Governor for being here, and this part of 
the hearing is over. We'll go into recess until we can have the 
series of votes, and then we'll go to the second panel.
    Mr. Tarullo. Thank you, Mr. Chairman. And thank all of you 
for your interest.
    [recess]
    Chairman Meeks. [presiding] The hearing will come to order 
and we will resume the testimony.
    First order of business, what I would like to do is, 
without objection, enter into the record the testimony of Mr. 
Martin A. Weiss, who is a specialist in international trade and 
finance from the Congressional Research Service; and the 
testimony of Mr. Amar Bhattacharya, who is the G24 Secretariat. 
So without objection, their testimony will be made a part of 
the record.
    We have for our second panel some very knowledgeable and 
astute individuals. First, Ms. Carmen Reinhart, who is a 
professor of economics at the University of Maryland. She is 
the director of the Center for International Economics, and she 
received her Ph.D. from Columbia University. Professor Reinhart 
held positions as chief economist and vice president of the 
investment bank of Bear Stearns in the 1980's where she became 
interested in financial crises, international contagion, and 
commodity price cycles. Subsequently, she spent several years 
at the International Monetary Fund. She was a research 
associate at the National Bureau of Economic Research, a 
research fellow at the Center for Economic Policy Research, and 
a member of the Council on Foreign Relations.
    Her papers have been published in leading scholarly 
journals and her work is frequently featured in the financial 
press around the world. Her latest book, entitled, ``This Time 
is Different: Eight Centuries of Financial Folly,'' documents 
the striking similarities of the recurring booms and busts that 
have characterized financial history.
    Welcome, Ms. Reinhart.
    And we also have with us Mr. Edwin Truman, who has been the 
senior fellow at the Peterson Institute for International 
Economics since 2001, served as Assistant Secretary of the U.S. 
Treasury for International Affairs from December 1998 to 
January 2001, and returned to the U.S. Treasury as Counselor to 
the Secretary in May 2009. He directed the Division of 
International Finance of the Board of Governors of the Federal 
Reserve System from 1977 to 1998.
    Mr. Truman has been a member of numerous international 
groups working on economic and financial issues and he has 
published on international monetary economics, international 
debt problems, economic development, and European economic 
integration. He is the author and coauthor or editor of several 
books, including, ``Reform the IMF for the 21st Century: A 
Strategy for the IMF Reform'', ``Chasing Dirty Money: The Fight 
Against Money Laundering'', and ``Inflation Targeting in the 
World Economy.'' He has a B.A. from Amherst College and a Ph.D. 
from Yale, both in economics.
    And finally, we have Mr. Peter Morici, who is a professor 
at the Robert H. Smith School of Business at the University of 
Maryland. The professor is recognized as an expert on economic 
policy and international economics at the University of 
Maryland. And prior to joining the University, he served as 
Director of the Office of Economics of the U.S. International 
Trade Commission.
    He is the author of 18 books and monographs and has 
published widely in leading public policy and business 
journals, including the Harvard Business Review and Foreign 
Policy. He has lectured and offered executive programs at more 
than 100 institutions, including Columbia University, the 
Harvard Business School, and Oxford University, and his views 
are frequently featured on several networks--CNN, CBS, BBC, 
FOX, you just name them, and he's on all of them. He's on 
national broadcast networks not only here in the United States, 
but indeed in this small place that we call the Earth, he is 
everywhere.
    Thank you for being with us.
    And we will hear now from Ms. Reinhart. Your entire written 
testimony, as indicated earlier, will be submitted into the 
record, so please summarize. You will have 5 minutes to give 
testimony. You will see after 4 minutes, a yellow light will 
come on letting you know that you have 1 minute to go. We will 
be a little liberal on time if you need it, but let's try to 
stick to the time.
    Welcome, Ms. Reinhart.

  STATEMENT OF CARMEN M. REINHART, PROFESSOR OF ECONOMICS AND 
DIRECTOR OF THE CENTER FOR INTERNATIONAL ECONOMICS, UNIVERSITY 
                          OF MARYLAND

    Ms. Reinhart. Thank you, Chairmen Meeks and Watt, and other 
members of the subcommittees for the opportunity to comment on 
the IMF's role in helping Europe deal with its economic crisis.
    I was also asked to remark on whether the external support 
for Greece and other EU member nations exacerbates moral hazard 
and on the adequacy of the proposed fiscal austerity measures.
    It's not surprising that questions have arisen about the 
legitimacy of IMF involvement in a program aimed at aborting a 
sovereign default in Greece and possibly other high-income 
countries. The last of the peacetime sovereign defaults among 
high-income countries took place during the Great Depression of 
the 1930's, well before the founding of the IMF in 1944.
    Item five of the purposes of the IMF in its articles of 
agreement reads, ``to give confidence to members by making 
general resources of the Fund temporarily available to them 
under adequate safeguards, those funds providing them with the 
opportunity to correct maladjustments in their balance of 
payments without resorting to measures destructive of national 
or international prosperity.''
    Whatever the concerns about the solvency of Greece and 
other EU nations may be, these countries also face a classic 
maladjustment in their balance of payments that arise from a 
substantial loss of international competitiveness. They are IMF 
member countries, and as such a part of the IMF's original 
mandate.
    As my recent work documents, the wealthy economies are no 
strangers to IMF programs. The United States had two IMF 
programs in the 1960's, and the U.K. holds the record with 11 
IMF programs. Portugal had a program as late as 1986. These 
programs, however, did not attempt to deal with solvency issues 
and were modest in size, as was customary in the pre-1995 
Mexican peso crisis bailout model.
    The need for Greece on fiscal austerity and other European 
economies to slash government spending is not some artificial 
imposition by the IMF or the European Union. Once investors 
decide that a country is living beyond its means, it will have 
a hard time meeting its debt obligations. Spending cuts become 
a reality of arithmetic, but fiscal austerity doesn't pay off 
quickly.
    A large and sudden contraction in government spending is 
almost sure to shrink economic activity as well. This means tax 
collections fall and unemployment and welfare benefits rise, 
undermining efforts to reduce the deficit. Even if new 
borrowing is reduced or eliminated, it takes time to whittle 
down large debt, and international investors are notoriously 
impatient.
    A restructuring of Greek sovereign debt may not be 
inevitable, but it certainly seems probable. A country such as 
Greece could seek to negotiate with its creditors to reduce its 
debt, but that path, essentially a partial default, is also no 
panacea. Argentina's economy contracted by about 15 percent 
after its default in 2001 and was shut out of international 
capital markets for a while.
    On moral hazard, as in other situations, questions now 
arise about the tradeoff between exacerbating moral hazard and 
limiting contagion. I think it is safe to conclude that the 
combination of bailouts and forbearance are well entrenched in 
the expectations that financial market participants have for 
the foreseeable future. However, on contagion, it is relevant 
to recall that Thailand has an even smaller gross domestic 
product than Greece, but in 1997, Thai financial problems 
ignited the Asian crisis.
    There are three main mechanisms for this contagion. First, 
many governments have common lenders, including international 
banks and hedge funds. If these institutions suffer large 
losses in one national market, they will pull back lending to 
the others. Second, trouble in one country acts as a wakeup 
call to investors who scour their global holdings for similar 
risks elsewhere. When they look hard enough, they will find 
something to worry about, triggering even more funding 
withdrawals. Third, Greece, casts a long shadow on the European 
continent because 15 other countries share a common currency. 
Greece debt problems called into question whether the euro will 
survive.
    The large EU-IMF package was intended to send a strong 
signal that the EU is committed to go to great lengths to avoid 
a breakdown of the euro. It is intended to provide a broad-
based coverage beyond Greece in the spirit of the TARP 
legislation in the fall of 2009.
    Like the U.S. bailout package, an important feature of the 
plan was to continue that--Greek bonds as rating agency 
downgrades had never taken place. This kind of forbearance, 
shown to toxic assets in the United States over the last 2 
years--moral hazard is an issue that cannot be understated.
    At best the EU-IMF initiative can buy some time for 
policymakers in other countries that have come under duress to 
implement difficult austerity measures and to move to 
restructure private debts. It does not change Greece's or 
anyone else's levels of outstanding debts, and their even more 
worrisome profile in the period ahead.
    [The prepared statement of Professor Reinhart can be found 
on page 42 of the appendix.]
    Chairman Meeks. Thank you.
    Mr. Truman.

   STATEMENT OF EDWIN M. TRUMAN, SENIOR FELLOW, THE PETERSON 
             INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Truman. Thank you, Chairmen Meeks and Watt, and members 
of the subcommittees. I appreciate the opportunity to appear 
before you to discuss the role of the Federal Reserve and the 
International Monetary Fund in stabilizing Europe. I will 
concentrate primarily on the International Monetary Fund 
aspect.
    The Greek tragedy, which is now on center stage, was 
largely of the Greek authorities' own crafting. However, it 
also emerged as an aftershock of the global economic and 
financial crisis of 2007-2009 and has set off a European 
crisis.
    The challenge is to manage the European crisis so as to 
minimize the negative fallout on the fragile global economy and 
financial system and to reduce the severity of other 
aftershocks, which inevitably will occur over the next several 
years. How successfully the Europeans, the United States, and 
other systemically important economies deal with that challenge 
will determine the strength of our own and the global economic 
recovery now underway.
    The major policy instrument available to the United States 
to contain the European crisis and its aftermath is the 
International Monetary Fund. The United States should continue 
to provide maximum constructive support for the Fund in 
carrying out its responsibilities for the promotion of global 
growth and financial stability.
    I will summarize the rest of my testimony this afternoon 
with eight points:
    First, the program of Greek economic and financial 
stabilization and reform, approved by the IMF executive board 
on Sunday, May 10th, is ambitious and demanding. It may fail, 
but it is in the collective interest of the United States and 
the international community to give the people of Greece and 
the authorities of Greece time to implement at least the first 
phase of their program.
    Second, the European Union authorities delayed too long in 
providing a framework to support economic reform and to provide 
the necessary financial support for Greece. Consequently, the 
financial contagion has spread to other countries in the euro 
area and perhaps beyond.
    For possible future use, the EU authorities are now putting 
in place a European Stabilization Mechanism and have taken 
other steps to contain the crisis, including unconventional 
action by the European Central Bank.
    The IMF may be called upon to cooperate with the ESM using 
the Greek program as a template. A positive response by the 
United States to such a request, on appropriate terms, is fully 
consistent with the Fund's core mission. Meanwhile, the Federal 
Reserve has reactivated some of the swap arrangements that were 
deployed to contain the recent financial crisis and its impacts 
on financial markets, in my view, appropriately.
    Third, the IMF is not and should not be viewed as an 
institution that lends only to emerging market and developing 
countries. The mission of the Fund is to provide prompt and 
persuasive policy advice and to help design and finance 
economic reform programs for all its members.
    Fourth, beyond its traditional role with respect to 
macroeconomic policies, which is much needed to restore and 
maintain economic growth in Europe, a key area of IMF policy 
advice for Europe is on strengthening their banks that now face 
the high probability of another round of substantially impaired 
assets and the risk of sovereign defaults.
    Fifth, all IMF-supported programs involve a balance between 
painful policy adjustments that adversely affect economic 
growth in the short run and necessary, temporary financial 
support. The correct balance between adjustment and financing 
is a matter of intense disagreement, but both are required.
    Sixth, the contribution of IMF lending to the perpetuation 
of moral hazard is greatly exaggerated under current, and most, 
circumstances.
    Seventh, I am not greatly concerned that the IMF will be 
called upon to lend more to European countries, will run out of 
resources to lend, or will leave non-European members of the 
IMF in the financial lurch.
    And last, citizens of the United States have a great deal 
to gain from successfully containing the European crisis. 
However, if the United States and the global economy are to 
recover decisively and enter a period of sustained expansion, 
more needs to be done beyond simply containment. U.S. policies 
should be oriented towards further substantive and financial 
support for the Fund in order to provide more confidence in the 
global economic outlook and in the restoration of financial 
stability.
    Thank you very much. I look forward to your questions.
    [The prepared statement of Mr. Truman can be found on page 
56 of the appendix.]
    Chairman Meeks. Thank you.
    Mr. Morici.

STATEMENT OF PETER MORICI, PROFESSOR, ROBERT H. SMITH SCHOOL OF 
                BUSINESS, UNIVERSITY OF MARYLAND

    Mr. Morici. Thank you for having me.
    I think, as the flash crash and events of the last week 
have demonstrated, Greece's financial circumstances have the 
potential for a dramatic impact on Europe and in turn on the 
United States, not merely through our banks but our equity 
markets as well.
    The problems in Greece really emerge from several 
interrelated problems in Europe, and they are not really of 
Greece's making alone. With economic integration, folks in 
Greece, Spain, Portugal, and elsewhere came to expect social 
benefits comparable to those in places like Denmark, Holland, 
and Germany, but they simply don't have the economies to pay 
for it.
    In the United States, social benefits are not the same in 
Mississippi as in New York, but they're not that different. We 
essentially tax Manhattan to subsidize Mississippi. In Europe, 
the Germans enjoy gold-plated benefits as they lecture the 
Greeks about Teutonic austerity and the Greeks simply are 
trying to provide benefits consistent with the expectations of 
their populations that they simply can't afford.
    What this means is essentially the Europe Currency Union, 
the common euro, requires a fiscal union where they share the 
costs of the safety net, but it also doesn't mean higher taxes 
necessarily, because probably the Europeans have taxed 
themselves to the point that is detrimental. But rather it 
means that not only must the Greeks have less, the Germans must 
have less too.
    The Europeans have taxed themselves and provided benefits 
to the point that they have virtually zero population growth in 
several countries, and their economic growth has been woefully 
slow for the last several years, actually, the last several 
decades. The bottom line is fiscal unity must be matched by--
currency unity must be matched by fiscal unity, and these 
bailouts aren't going to do much good unless we do that. And 
it's also going to require wholesale public sector reform to 
bring the social safety net in line with that necessary to 
encourage individual risk-taking and entrepreneurship.
    Right now, the way things stand is the Germans are 
confronted with the choice of either subsidizing the Greeks, 
either directly by taxing themselves and transferring money, or 
subsidizing them indirectly by having the European Central Bank 
print euros, buy Greek debt and pretend that they will someday 
be repaid.
    Make no mistake about it. These austerity programs are far 
beyond what can succeed. Greek debt is essentially in default. 
So the Europeans are basically faced with, in the north, taxing 
themselves to subsidize the south, but also in the process, 
reducing their own social benefits or enduring inflation, which 
will do the same.
    The lesson for the United States has been largely 
misunderstood, I believe. The U.S. budget doesn't make a whole 
lot of sense. The drama we had in Sacramento recently looks a 
lot like what we had in Athens last week. The problem here 
isn't so much the scope of the safety net, it's that our public 
sector is so inefficient. It really is.
    Consider healthcare, for example. We spend almost 20 
percent of GDP on healthcare. The Germans spend 12 percent. 
Arguably, their healthcare system is as good as ours. Half of 
that is paid for by the federal government or the federal and 
state governments. That should tell us something.
    Universities are comical institutions of inefficiency. 
Municipalities have become the same in recent years as they 
took advantage of the taxes they gained in the property boom to 
basically multiply bureaucrats. Ask yourself, are your 
municipal services any better or different they were 20 years 
ago? Go count noses at city hall.
    I don't mean to cast this in terms of a liberal versus 
conservative, more versus less government. But in the United 
States, we are probably facing the same financial catastrophe, 
but for the fact that we print the world's money simply because 
our public sector is not functioning properly.
    That, I believe, is part of why we're seeing the kinds of 
elections we're seeing right now. It's not a Republican or a 
Democratic issue; it's a citizen issue.
    Now in the United States, we can't fail, because we print 
the world's money. For now, the world accepts the dollar as the 
coin of the realm. However, we're not that far away from the 
day when we'll have printed so darn much of it that we will 
suffer inflation instead of outright default, and we may not be 
that far away from an alternative to the dollar emerging. And I 
would be happy to address how that could happen during the 
question period, as I am out of time.
    [The prepared statement of Professor Morici can be found on 
page 37 of the appendix.]
    Chairman Meeks. I thank all of you for your testimony, and 
now, I will recognize members for 5 minutes of questioning. I 
will yield myself the first 5 minutes for questions.
    And I will start out, I guess, with Ms. Reinhart. In 2010, 
March 2010, the prime minister of Greece vocally criticized 
unprincipled speculators for making billions of dollars every 
day by betting on a Greek default. My question is, what are 
your opinions about the role of speculators in this current 
European debt crisis and what related recommendations do you 
have for our financial regulatory efforts? What implications do 
you think that these speculator actions have for international 
finance reforms efforts and the necessity of having some 
universal coordination?
    Ms. Reinhart. Mr. Chairman, I have in the past commented 
that speculators are like vultures. They begin to circle when 
something is dying, but they don't create the problem. They 
play upon an existing problem, and the existing problem here 
was the surge in Greek debt.
    The speculator issue aside, I do think that regulatory 
reform of one kind or another will be more attuned to taking 
into account hidden debts, which also is an important lesson 
from Greece. That is, not only the debts that we see but off-
balance-sheet items that we don't see. And I think that was an 
issue, especially with the Goldman Sachs debacle.
    So I don't think that the speculator issue is a new one to 
this crisis. It crops up every time there is a crisis. But I do 
think that the issue of tackling or paying more attention to 
leverage in general and opaqueness of balance sheets, hidden 
debts are things that are very much on the agenda.
    Chairman Meeks. Let me just follow that up with, it seems 
as though there were early warnings that--and this is for 
anyone; anyone can answer this. There were early warnings about 
the past Greek sovereign debt levels. The IMF saw that, but yet 
we still have the crisis. The crisis was still created even 
though it was seen earlier.
    Now some are talking about, therefore we have to improve, 
the IMF has to improve its surveillance process. And there have 
been several ideas that have been put out there.
    I think the last G-20 launch of the mutual assessment 
process, that's one of them. And there have been other 
suggestions, which include an enhanced, multilateral approach 
involving the IMF and the enrichment of the systemic content of 
the bilateral or country-level surveillance by introducing 
thematic country reports.
    So my question to all of you would be, do you agree with 
any of those recommendations or do you have other 
recommendations? How could we improve IMF surveillance 
procedures so that we may be able to prevent a crisis before it 
happens?
    Mr. Morici. You can't improve IMF surveillance procedures 
so this won't happen. Angela Merkel is running around trashing 
naked shorts. I am not a big fan of naked shorts, if you have 
watched me on TV, but they're not what's causing this problem. 
What's causing the problem is that Greece spent too much money 
and no one has faith in this $1 trillion patch.
    The IMF has told this government repeatedly its deficits 
are too large and must be fixed. We have been surveillanced 
beyond limit, but we don't act.
    At the end of the day, the members of the IMF are sovereign 
governments, and they cannot be compelled by an international 
body to act any differently than they choose, except if they 
need cash at the moment. So the IMF's leverage at any point in 
time is strictly limited to the leverage provided by short-term 
finance. Once that goes away, they'll go back to what they're 
doing.
    How many times has the IMF made reference to China's 
undervalued currency? Does China move? No. It's a sovereign 
government. It does as it pleases. I'm sorry--I don't mean to 
point. Does this body balance the Federal budget? No. This is a 
sovereign body; the IMF is not.
    Mr. Truman. I think I agree with Peter to the extent that 
you're not going to do away with crises, but you can reduce 
their incidence and variance, and I think there is a role for 
better IMF surveillance.
    I think in the European case, maybe as in ours, there is a 
tendency, was a tendency in Europe, to say the IMF doesn't know 
what it is doing and it should stay out of our business. And 
one of the issues in this crisis was precisely that because 
Europe delayed in bringing the Fund in even though the Fund has 
a much better record at imposing policy conditionality than 
does the European Union, Europe tended not to look at IMF 
advice.
    So I think the lesson from this is that the Fund can do 
more, should do more, and should be more pointed in its 
criticisms. Certainly, Peter is right; the Fund doesn't have 
much leverage, but the bully pulpit actually provides quite a 
lot of leverage. That's what we have seen in this crisis. And I 
think there are mechanisms to improve the process.
    Chairman Meeks. My time has expired, but I'll allow--if you 
want to quickly respond, Ms. Reinhart.
    Ms. Reinhart. I would just quickly add that I share the 
view of the former speakers. I would say that we can do better 
in terms of surveillance, particularly monitoring debts, but I 
am skeptical about the ability to enforce, especially during 
the boom period when no one is willing to listen to the IMF or 
others that warn of dangers. That should apply to us now too.
    Chairman Meeks. I may have a follow-up question to that, if 
we get to a second round. My time has expired.
    I now recognize the gentleman from New Jersey, Mr. Lance, 
for 5 minutes.
    Mr. Lance. Thank you very much, Mr. Chairman.
    As I understand it in the testimony, if we distill it to 
its essence, the IMF is bailing out Greece based largely upon 
the fact that Greece provides social services to its citizens 
that it cannot afford, given the level of productivity in 
Greece. Professor, would that be a distillation with which you 
would agree?
    Mr. Morici. That is one essential element. The other 
essential element is that you're generally--providing social 
services it cannot afford. So the point that it shrinks its 
pie, look at the level of unemployment benefits and employment 
support the German government provided during the recession. 
Think of what Manhattan could provide for itself if it wasn't 
taxed, the financial sector wasn't taxed to provide to the rest 
of the country.
    My view is that it's very easy to blame the Greeks, the 
Portuguese, the Spaniards, and so forth, but it's more of a 
continental problem.
    Mr. Lance. So be it. Let us assume that it is a continental 
problem. Why should we here in this country participate in 
helping bail that situation out? Is it not at least primarily 
the responsibility of the European continent?
    Mr. Morici. Yes, however, I think you would find that the 
balance sheets of our banks would be very threatened, much as 
their balance sheets were threatened when we had our mortgage 
crisis, that if there is a sovereign debt crisis in Europe, it 
would find its way back to our major banks.
    Mr. Lance. To our major banks, not to community banks 
across America. This is--
    Mr. Morici. Community banks are already in pretty tough 
shape because the TARP wasn't used to assist them. We didn't 
have a resolution trust as we did during the savings-and-loan 
crisis. Instead, this Administration chose to prop up General 
Motors and do other things, and it was not inclined--which I 
advised in the Senate that they not do. And it was disinclined 
to set up a resolution trust type of mechanism because the 
major Wall Street banks didn't want it. They're busy having a 
good time restructuring those loans on their own and making 
cash of them, so the community banks are already in very tough 
shape.
    Mr. Lance. Thank you. Mr. Truman, do you wish to comment?
    Mr. Truman. Well, I would like to add a nuance to your 
phrase of ``bailout'' so we can understand what we are talking 
about. A bailout would be when you have a bill due, or I have a 
bill, let's put it my way and say, I have a bill to pay and you 
say, ``Ted Truman, I'll pay it for you, and you don't have to 
pay it anymore.'' In the case of an IMF loan, what we're saying 
is, we will lend you the money, you, Greece the money, to pay 
that debt. And you will pay us back, which has happened in 
every IMF program that has ever been written.
    So the financial transaction is only one of buying time for 
the debtor so that it can raise the money both to pay back the 
IMF and to pay their other debts.
    Mr. Lance. Are you confident that we will be paid back--not 
we, the IMF will be paid back from Greece in this situation?
    Mr. Truman. Yes, I am confident because ``we,'' meaning the 
American taxpayers, have been paid back every time. There are a 
few, three, countries which have debts that haven't been paid, 
and there has been a write-down of other types of debt that 
have nothing to do with this type of--
    Mr. Lance. Well, thank you. You're on the record that 
you're confident that we will be paid back, that the IMF will 
be paid back from Greece.
    Ms. Reinhart. I would like to add--
    Mr. Lance. Are you confident that we would be paid back?
    Ms. Reinhart. Yes.
    Mr. Lance. Thank you. Are you confident, Mr. Morici?
    Mr. Morici. I'm confident that the IMF will be paid back 
because it has, I think--Carmen, correct me if I'm wrong--$150 
billion in the $1 trillion at play. So they'll get paid back 
before the others do.
    The real danger, as Mr. Tarullo said, we'll get paid back 
our dollars from the ECB. We may well be in a position where 
the ECB doesn't get paid back and the euro, they'll never be--
they're going to have to print a lot of euro to pay us back. 
The real question will be whether the swaps will be worth 
anything if the euro fails.
    Mr. Lance. Thank you very much. I yield back the balance of 
my time.
    Chairman Meeks. The gentleman from North Carolina, Mr. 
Watt, is recognized for 5 minutes.
    Chairman Watt. Thank you, Mr. Chairman.
    Professor Morici, I was fascinated by both your question, 
what should it tell us, and your comment that the public sector 
is not functioning properly. I happen to agree with the second 
part of it, but I don't know what it would tell us.
    I'm accustomed to constituents writing me and telling me 
that the public sector is dysfunctional and so forth and so on. 
They're usually talking about the U.S. Postal Service, which 
has been privatized, or Fannie and Freddie, which were 
shareholder entities at least at some level. So I'm not sure 
what any of that tells us. It might tell us that Germany's 
healthcare is 12 percent and ours is 20 percent because theirs 
is socialized and ours is privatized. Ours is in the private 
sector.
    It might tell us that. I'm not arguing with you. I'm just 
telling you some of the things that might tell us. We can beat 
up on the public sector all we want, but it was, as I recalled, 
the private sector that really screwed up, that resulted in the 
financial services meltdown. Otherwise, we're blaming somebody 
that shouldn't be blamed unless you're taking the position that 
they didn't have any blame.
    Yes, the public sector is not functioning properly, but I'm 
not sure that the private sector is doing all that great 
either.
    Mr. Morici. You are responsible for what the public sector 
pays for the services it finances.
    Chairman Watt. Say that again, so I make sure I understand.
    Mr. Morici. I don't mean to put it in those terms, but--
    Chairman Watt. Go ahead.
    Mr. Morici. This government is responsible for what it pays 
for the private, for the services it provides citizens, and 
what I am saying is this government is paying too much for the 
services it provides, and it is now a large enough share of the 
economy, for example through healthcare--
    Chairman Watt. I understand that, but I don't know how that 
answers the question. And again, I actually agree with you.
    Mr. Morici. We can go down this path. You can ignore this 
problem.
    Chairman Watt. No, I don't want to go down this path 
because all that will do is be counterproductive. Let me ask 
you another question.
    Mr. Morici. I didn't--
    Chairman Watt. You mentioned the possibility of there being 
some alternative currency that would become the predominant 
currency of the world. As I recall, that currency was going to 
be the euro when the European Union decided that it would get 
together and be the dominant force that we had all thought that 
it might be. It seems to me that it is the euro that is now in 
trouble.
    What exactly would be that alternative currency that you're 
talking about? Would it be the overvalued Chinese currency? 
Would it be the euro, which is now in trouble? What alternative 
currency are you talking about?
    Mr. Morici. I think the yuan could eventually replace the 
dollar, given the way we're conducting our affairs.
    Chairman Watt. And given the fact that it's not trading 
fairly, you say out of one side we shouldn't be beating up, you 
think we shouldn't be beating up on the Chinese to make it a 
fair currency.
    Ms. Reinhart, maybe you can help us. Yes?
    Ms. Reinhart. Mr. Chairman, I would like to say that right 
now, I think talking about any other currency is really pie in 
the sky. The renminbi is not a convertible currency, no 
countries issue their debts denominated in renminbi, no 
countries peg to the renminbi. It is not traded. I think, for 
the sake of realism, we have to assume that the reserve 
currency for the foreseeable future is the dollar.
    One thing in connection with that however, I would like to 
highlight that we shouldn't get complacent. That should not--
    Chairman Watt. Oh, yes. Well, I agree with that in that 
we're becoming less and less a force in the world economy.
    Mr. Morici. Mr. Watt, if you would permit me, I think 
it's--
    Chairman Watt. Yes, sir. Go ahead. I didn't mean to cut you 
off. I won't ask another question.
    Mr. Morici. The dollar did not--I implied, I believe I said 
that we should not presume the dollar will continue to be the 
reserve currency. That's essentially what I said.
    Chairman Watt. You raised the prospect of an alternative 
currency.
    Mr. Morici. Just because of--
    Chairman Watt. I'm just trying to figure out what the 
alternative currency would be.
    Mr. Morici. Okay. You keep talking to me and you don't let 
me answer. If the chairman will give me some forbearance, we 
should not--
    Chairman Meeks. If you could, answer, and then we'll move 
on, because the gentleman's time has expired. You could answer 
the question, but as I said, he won't get a chance to answer 
because his time has expired.
    Mr. Morici. I'll try not to be unnecessarily provocative, 
Mr. Watt.
    At the current moment, at current exchange rates, China's 
economy is worth $5 trillion, ours is worth $15 trillion. It is 
my position that if China's economy was properly valued over a 
period of 3 to 5 years, it would be worth $10 trillion. Given 
how rapidly it's growing, it wouldn't be long before it was at 
least as denominated by currencies, as large as ours.
    Just because the renminbi is not convertible today does not 
mean it wouldn't be convertible 5 years from now. And the 
fundamental value of a currency is a product of what the 
economy can produce, what you can get for it, and how well the 
fiscal affairs of a country is run so that there is adequate 
confidence that too much of the currency won't be printed. 
Ergo, China will soon be as large as us if China's currency 
were fairly valued, and given the way we're printing money 
around here right now and the potential for inflation right 
now, it could be that people start to seek other currencies.
    China could make its currency convertible 5, 6, or 7 years 
from now, and people might want to start holding it instead of 
ours.
    Chairman Meeks. The gentleman from California, Mr. Sherman, 
is recognized for 5 minutes.
    Mr. Sherman. Thank you, Mr. Morici. I would think one 
possible reserve currency is U.S. Treasury inflation-protected 
securities. The idea that you have to hold a currency as 
opposed to a debt obligation of a sovereign, you--
    Mr. Morici. Well, the fact of the matter is governments 
really don't hold dollars, they hold debt securities.
    Mr. Sherman. Right, they hold bonds. When you hold a 
straight U.S. bond, you're investing in the U.S. currency. When 
you hold a Treasury inflation-protected security, you're 
holding a not fully dollar-denominated security, a security 
that is payable by the United States but in a certain 
purchasing power.
    Mr. Morici. That is true, however--
    Mr. Sherman. And that might be, if one were looking for a 
risk-free reserve currency available in today's market rather 
than the market you put forward for 5 or 10 years from now, why 
aren't more countries investing in TIPS?
    Mr. Morici. I can't answer why more countries aren't 
investing in TIPS.
    Mr. Sherman. Okay. Now commenting on--the purpose of these 
hearings is--well, first I'm going to comment on China. The 
fact is, China is doing a spectacular job of running their 
economy. They're doing so because they cheat. And we're doing a 
terrible job, in part, evidenced by the fact that we let them 
cheat. And the rich and powerful in both countries benefit from 
them cheating and us letting them cheat. So you may be right 
that they will succeed.
    But now, shifting to the focus, I think, of today's 
hearings, the bailout of Greece is not a bailout of Greece, 
it's a bailout of the banks that lent money to Greece. The 
total package for Greece and others put together by the 
Europeans is roughly $1 trillion. Am I correct in believing 
that only $39 billion of that is from the IMF, that our share 
of that $39 billion is a little less than 25 percent, probably 
more than the stated 17 percent, and that accordingly our share 
of this bailout package is roughly one percent of the total 
trillion dollars?
    Can anybody comment on that math? Mr. Truman?
    Mr. Truman. Actually, because of the way the Fund is 
financing itself today, our share is more like 10 percent, 
because the Fund is providing a little less than a third of the 
money. But half the third of the money is borrowing from 
countries other than the United States, so that we have--
    Mr. Sherman. Now you're saying the IMF is putting up a 
third of the trillion dollars?
    Mr. Truman. The IMF is putting up 27 percent of the Greek 
program. The trillion dollars is the European support 
mechanism, which is not in existence yet.
    Mr. Sherman. Right. Let me put forward the theory that the 
entire European support mechanism goes to absolute zero in 
value, it's lent entirely to countries that then immediately go 
bankrupt. How much does the United States lose?
    Mr. Truman. Well, it hasn't--it doesn't exist. I don't want 
to split hairs. The Greek program does exist.
    Mr. Sherman. Right, the trillion dollar program is not a 
program. It's an announcement, a press release.
    Mr. Truman. It's a press announcement.
    Mr. Sherman. Your colleague to your left has a good 
imagination, so I'm asking you to have a good imagination as 
well. Assuming the whole thing was not a press release, but put 
out there and actually done, and actually lost all, the whole 
trillion dollars, we would lose roughly one percent of that?
    Mr. Truman. If you want to use those numbers, which I think 
is probably exaggerated, but let's do that. So the Fund's part 
of it is \1/3\, right, and we are 20 percent of the third; 
we're, if I have my arithmetic right, \1/15\ of the total.
    Mr. Sherman. So you would expect that the IMF will be 
putting up up to $333 billion of this trillion dollar program?
    Mr. Truman. The way that it has been described by the 
Europeans in the press is that \2/3\ comes from them and \1/3\ 
comes from the IMF.
    Mr. Sherman. And we have consented to that?
    Mr. Truman. No. No one has consented to anything.
    Mr. Sherman. Okay. Shifting to another aspect of the IMF, 
due to the actions taken in 2009, which I voted against, in 
that package, Iran was given special drawing rights with a 
value of $1.6 billion. How can Iran use this and put it to use 
should they have a need for funds?
    Does anybody have a comment? What can you do with a special 
drawing right?
    Mr. Truman. Well, as a technical matter, any member of the 
Fund who receives SDRs can, if they have what's called a 
balance of payments need, transfer those SDRs to another 
country in return for currency.
    Mr. Sherman. So while we say we're trying to put sanctions 
on Iran, the biggest thing we have done economically is to 
participate in an IMF program that has provided them with 
another $1.6 billion, and in addition has made the IMF far more 
bailout-capable at a time when Iran is bailout-eligible. 
Whether the IMF would bail out Iran beyond the $1.6 billion 
remains to be seen.
    Mr. Truman. I don't think the SDR allocation makes the Fund 
more bailout-capable.
    Mr. Sherman. No, no. it's not the SDR. It's the $250 
billion that was put in makes the IMF far more bailout-capable.
    Mr. Truman. Perhaps.
    Mr. Sherman. It was a package SDR, plus additional--
    Mr. Truman. $500 billion if you want to talk about the NAB.
    Mr. Sherman. Yes. I yield back. Perhaps we could allow Ms. 
Reinhart--
    Chairman Meeks. Go ahead. I'll allow her to answer the 
question.
    Ms. Reinhart. I would just like to point out that all this 
funding is fungible, and the IMF track record has been to 
channel the money where the difficulties are and that is what 
it's doing now.
    Mr. Sherman. Greece money is a lot better than Iran, as far 
as trying to help countries with difficulty. And I yield back.
    Mr. Morici. And I would like to point out, if I might, Mr. 
Chairman, that the money you will lose if Greece fails is not--
what matters is not what you lose through the IMF, what you 
will lose going back to Wall Street yet again and bailing out 
the big banks yet again.
    Take a hard look at how much European paper is on their 
books and what that will mean relative to the tier one capital.
    Mr. Sherman. We're not bailing them out again. I yield 
back.
    Chairman Meeks. Thank you. And we have a bill that says we 
can't bail them out again.
    And let me just also just say that I want to thank all of 
the witnesses for being here. It has been my opinion that we're 
not really just trying to do anything with regards to Greece 
specifically, but it's the entire European situation, the debt 
crisis there, and hopefully so that we can prevent the problems 
coming back here to affect us here in the United States.
    I think through the last colloquy that we had with the 
Governor of the Fed, he clearly indicated that the idea is if 
we were not with--if it wasn't for the swaps on the Fed side 
and if it wasn't for the IMF participating and we just allowed 
things to happen that again the lending to small- and medium-
sized businesses, etc., and to John Q. Public could again 
freeze. And I would hope that, and part of the reason for this 
hearing is, to see what if anything that we need to do, because 
the last thing that we need to happen is direction to reverse 
itself from the positive direction of getting out of this 
financial crisis back to having what's taking place in Europe 
reverberate back to us here and cause our economy to again go 
into a tailspin.
    So with that, let me say that the Chair notes that some 
members may have additional questions for this panel, which 
they may wish to submit in writing. Without objection, the 
hearing record will remain open for 30 days for the members to 
submit written questions to these witnesses and to place their 
responses in the record.
    This hearing is now adjourned.
    [Whereupon, at 5:15 p.m., the hearing was adjourned.]








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                              May 20, 2010

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