[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
U.S. GOVERNMENT PRINTING OFFICE
58-048 PDF WASHINGTON : 2010
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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
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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
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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.]
A P P E N D I X
May 20, 2010
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